This week marked the tenth anniversary of the beginning of the financial crisis. On August 9th, 2007 the French bank BNP Paribas decided to halt withdrawals from three hedge funds holding subprime mortgage debt because it realised that it had no idea what they were really worth. Within a few weeks credit started to dry up and on 14th September Northern Rock sought and received a liquidity support measure from the Bank of England. But the overall impact was muted to start with. The FTSE 100 hit a seven year high in October and recession did not follow until 12 months later after the crash of Lehman Brothers.
Looking back the UK’s economic performance since the crisis has been pretty dire. Since the third quarter of 2007 GDP has grown by 10.9%, little more than 1% p.a. Compared with previous decades we can estimate that we have lost potential growth of a further 10%-20%. In the previous decade, 1997-2007 UK output increased by 33.5%. In the decade before that it increased by 26.2% despite the 1992 recession. In the years 1977-87, despite the global crisis of 1982, it grew by 29%.
Over this past decade other economies like Australia and Canada, boosted by minerals output, have grown by 28% and 17% respectively. The US has performed a little better than the UK at 14.8% but the UK has certainly outstripped the Eurozone which has managed growth of just 5.4%.
However, as I have often argued before, we should really look at GDP per capita and here the rate of growth over these ten years is a pitiful 3.2%. The national debt has trebled from £534 billion to £1.6 trillion. But personal debt levels also continue to rise. Just in the past year according to the Bank of England, the value of outstanding car loans, credit card balances and personal loans has risen by a staggering 10%. Household incomes have risen on average by just 1.5% over the same period. As inflation is rising a little more than that the media report that people are being squeezed. But that does not explain the huge increase in borrowing.
The media as so often does not really understand the economic trends. They say that incomes on average have risen by just 1.5% but more people are in work and more of the jobs are low paid. It does not mean that everyone’s income has only risen by 1.5% but the average income has. Since 2007 the number of self-employed workers has risen by nearly a million. The rate of unemployment is the lowest since 1975.
A particularly acute problem is the rate of productivity. It is by raising productivity that a nation becomes richer. However, the rate of growth in UK productivity is negligible. Not all jobs are productive. Those who produce output include brick layers but not teachers; accountants but not politicians; farmhands but not doctors in general practice. As Robert Kennedy famously said GDP does not measure all the things we value in society. But it does pay the bills.
Globalisation has also had its price. We are familiar with the idea that we have exported manufacturing jobs to China and Donald Trump got himself elected saying he would reverse the process. But the fact is that if a job can be performed more cheaply somewhere else in the world, whether it’s in manufacturing or services, than there is powerful economic reason to move the job to that cheaper source. That force has kept downward pressure on jobs in the richer western economies so there has been little real wage growth in decades.
So the conclusion is that much of the growth we are generating is built on credit, not productivity. With interest rates at such a low rate this appears affordable but in reality these low interest rates are themselves distorting the economy and must rise eventually. When they do many borrowers will find themselves in serious difficulties.
And therefore so will the lenders. The Bank of England claims to be taking steps to crack down on careless lending but it can’t really be working. Most people don’t buy a car these days. They enter in to a finance arrangement where the car itself is the collateral for the loan. Since this is a vastly depreciating asset, and since there are more and more of these arrangements, presently estimated at around £40 billion, the prognosis for second hand car prices is not rosy.
It is ten years since the last banking crisis and they tend to occur roughly every eight to ten years so arguably one is overdue. In 1966 a credit crunch in the US sent the S&P 500 down by more than 20%; in 1974 there was a global bear market with contributing factors ranging from the end of the Bretton Woods currency regime to the OPEC oil crisis; in 1982 there was a Latin American sovereign debt crisis; in 1990 the Japanese bubble blew up; in 1997/8 there was a financial crisis across much of Asia; and of course there was the 2007/8 banking crisis. We can add in the tech bubble of 2000 which was also pumped up by central bank cash and loose monetary policy.
We already know that there are banks in serious trouble in the Eurozone. In Spain, Banco Popular had to be rescued in June, partly because of a run on the bank. In Italy the government intervened to resolve a crisis at Veneto Banca and Banca Popolare di Vicenza at a cost of around €17 billion. It is estimated that there is a further €130 billion of bad debts in the Italian banking system. There will be lots more across the rest of the Eurozone.
So what is the EU planning to do about it? A recent paper proposed freezing the accounts of depositors at any bank when it runs into trouble, so that a run can be stopped before it gathers momentum. The ban would be imposed by the EU, and people would only be allowed to take out the cash they needed to get by day-to-day. You can see what they are trying to do. Rather than the state having to bail out banks with vast sums they would stop this at source. But what are the likely consequences? At the first sign of trouble depositors will rush to get their money out before the EU bureaucrats can take action. Even worse, any bank with a questionable reputation will lose its deposits as depositors move the money to safer more reliable banks; German banks, say rather than Italian or Spanish.
The imbalances created by the currency union have to be recycled through the financial system creating vast flows across borders. Without proper regulation sooner or later that will blow up.
But this is not just about the Eurozone and its unsustainable design. Global cash movements are vast. The pool of global liquidity is estimated to be $115 trillion, roughly 50% bigger than GDP. Growing global liquidity - and credit expansion in particular - results in vulnerabilities building up within the financial system, in the form of overinflated asset prices, risky borrowing and lending, and maturity or funding mismatches (which is what brought Northern Rock down.)
Many think this is a crisis of capitalism. I disagree. If it were capitalism we would allow banks to fail. Capitalism should allow capital to be allocated where is it most needed and best managed. In capitalism if you run out of cash you go to the wall. In banking if you run out of cash you go to the Central Bank who print you some more or you go to the government who borrow from the future to bail you out. That does not encourage good behaviour. It means that banks carry on misbehaving knowing they will be bailed out if they fail.