UK Recession Watch- Britain's Great Depression?


by Nadeem Walayat
Global Research, February 17, 2009
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The purpose of this analysis is to map out to the trend of the UK recession for 2009 and 2010 in terms of depth, the bottom and the potential recovery. The most recently released GDP data shows that the UK economy actually did fall off of the edge of a cliff during the fourth quarter of 2008 by contracting by a shocking 1.5% GDP. This compares against the governments recent forecast for 2% GDP contraction for the whole of 2009 which paints a picture of gross under estimation of the actual extent of the degree of economic contraction that is taking place at this time, and hence the adoption of the easy going terminology of "Quantative Easing" to hide the truth of money printing on a scale that could bankrupt Britain, the evidence of which has been played out in the currency markets with sterling's fall to a 23 year low against the dollar, a fall of over 30% in barely 6 months.

The fourth quarter GDP crash of 1.5% is far higher than expected and explains why the government panicked as evident by the deep interest rate cuts from 5% to 1% in just 4 months. The rate cuts are in addition to the £1 trillion banking sector bailout liabilities. The rate of contraction at 1.5% per quarter implies an annualised collapse in the UK economy of 6% which would amount to loss of national income of £72 billion, against which the government has so far committed £40 billion in the form of tax cuts, industry support and stimulus packages. However the deviation of the trend for 2.5% growth per annum puts the gap at an additional £30 billion per annum.

The £1 trillion committed towards halting the banking sectors collapse on face value seems like a huge amount that should kick start lending, however this should be set against contraction of an estimated 30% of the UK credit market or £1.2 trillion as distressed foreign banks pulled the plug on UK operations, on top of which we have had housing market deflation of £250 billion, and stock portfolios erasing a further £400 billion, which sets the £1 trillion of injections and liabilities against deflation of an estimated £1.85 trillion.

The recession looks set to run throughout 2009, with the consensus view forming pf the opinion that the recession will be the worst since the Great Depression of the 1930's during which time the UK economy contracted by 10%, the question now being raised is whether Britain is heading for its own Great Depression on a scale worse than that of the 1930's ?

Britain's Great Depression of the 1930's

Britain's GDP during the 1930's Great Depression fell by 10%, which on face value compares favourably against that of the United States that saw GDP contract by 30%. However unlike the United States, Britain did NOT boom during the 1920's on the contrary the 1920's was a period of stagnation that started out with the Depression of 1918 to 1921 that saw GDP fall by 25%. Therefore Britain's Great Depression in fact started in 1918 and did not end until 1937 and therefore lasted nearly 20 years. However in today's economy, Britain is coming off of a 10 year+ boom, therefore even a 10% contraction would not be on the scale of what Britain experienced during its Great Depression. However the argument could be made that having enjoyed a boom, Britain subsequent bust will unwind much of the gains made during the past 10 years as the United States experienced during the 1930's, therefore this suggests economic contraction on a greater scale than that of the 1930's, especially if protectionism takes hold which was the nail in Britain's economic coffin during the 1930's.

British GDP Has Already Collapsed by 30%

British GDP (AMBI) at the end of 2008 is estimated at £1.275 trillion, against £1.267 trillion at the end of 2007. However sterling has collapsed against major global currencies by 30% or more, which translates into a real terms collapse in the countries GDP of 30%, i.e. 2007 GDP of $2.7 trillion has now fallen to $1.8 trillion a collapse in GDP of over 30%. The Government, Bank of England and FSA are failing in their primary duty which is to preserve the purchasing power of the currency.

The Labour government has destroyed the purchasing power of the British Pound by 30% so as to save on 1% or 2% on the actual officially published GDP data during 2009. That's a price of 30% for a net benefit of at most 1.5% which will still not prevent a deep recession from occurring. Quantative Easing is madness personified which for several months had been supported by the mainstream press which my November article illustrated -Bankrupt Britain Trending Towards Hyper-Inflation? , which sacrifices long-term growth for possible short-term benefit

Therefore whatever is the conclusion of this analysis in terms of sterling GDP contraction during 2009, what readers need to remember is that the real purchasing power of Britain's currency loss of 30% means that the countries GDP has already been sacrificed in lieu of hoodwinking the electorate into believing that things are not as bad as they actually are.

British Pound Crash Failing to Boost Manufacturing

Manufacturing was supposed to the save the economy from the economic bust in the light of sterling's 30% devaluation, however given the collapse in global trade and demand which has put paid to that false assumption, as I pointed out over 6 months ago, sterling's fall will not benefit Britain as the manufacturing base of the country has shrunk to such as small sector of the economy that it cannot hope to offset the Financial sector's depression which once contributed more than £40 billion in profits a year to Britain's bottom line, and now is consuming tax payers fund to the tunes of several hundreds of billions into an ever expanding black hole.

To make matters worse the crash in the oil price has hit UK North Sea oil foreign exchange earnings and therefore contributes to sterling's downtrend with an exchange rate drop of 30%+ that offsets a large part of the benefits of the fall in crude oil prices. In fact we may reach a point in the near future of rising petrol prices despite continuously depressed crude oil prices, which the analysis of 8th December ( Crude Oil Forecast 2009- Time to Buy?) concluded would remain depressed for the duration of economic contraction i.e. probably the whole of 2009.

UK Interest Rates

The February rate cut to 1% fulfills the forecast target for 2009 (4th Dec 08 - UK Interest Rates Forecast to Crash to 1% ). ,The next stop would be a similar Zero Interest Rate Policy (ZIRP) as that adopted by the United States that have cut their interest rate to 0.25%.

Whilst the base interest rate stands at 1%, the 3 month libor rate is at 2.14% and the real economic interest rate is at 3.54%, which clearly indicate evidence that the banks are still refusing to the lend and in-effect hoarding government bailout cash injections much of which is being used to reward bonuses to culpable staff.

Financial Armageddon.... Postponed?

2 minutes and 20 seconds into this C-Span video clip, Rep. Paul Kanjorski of Pennsylvania explains how the Federal Reserve told Congress members about a "tremendous draw-down of money market accounts in the United States, to the tune of $550 billion dollars." According to Kanjorski, this electronic transfer occurred over the period of an hour and threatened a further $5 trillion to be drawn out triggering a total collapse of the Worlds Financial System, which then prompted Hank Paulson's emergency $700 billion TARP bailout action.

Video Served by Youtube

Following Septembers close call with financial armageddon the governments of the world have been busy recapitalising bankrupt banks with tax payers monies, however the $500 trillion derivatives monster continues to deleverage and thereby implying that the risks of financial armageddon have only marginally improved on September 2008. There still exists the high potential risk of financial and economic collapse that would be accompanied by extreme currency market volatility.

Bankrupt Banks - HBOS Blows Up in LLoyds TSB's Face

The shot-gun wedding between HBOS and LLoyds TSB last September in the amidst of the financial markets panic following Lehman's bankruptcy to prevent another Northern Rock nationalisation is increasingly blowing up in Lloyds TSB's face as yet again the reassuring words that bankers say one week turn out to be completely untrue. The Lloyds Chairman was congratulating himself barely 3 weeks ago of how the takeover would result in cost savings of £1.5 billion per year. With today's announcement of a £10 billion loss by HBOS for 2008 shatters the Chairman's illusion and Lloyds TSB's balance sheet, as ever it will not be the bankers that pay the price but the tax payer. Already the UK Tax payer has pumped in capital injections of £18 billion into the LLoyds TSB HBOS group.

The Lloyds TSB share price crashed by nearly 50% on the news to close at just 61p valuing the bank at just £10 billion, which is set against UK Tax payer capital injections of £18 billion which therefore values tax payers £18 billion investment at just £4 billion, or a £480 loss suffered by every UK tax payer. As I have warned several times over the past 6 months, the government propaganda of actually making a profit on these capital injections into bankrupt banks is an illusion which is now being borne out.

Given the size of the HBOS and Lloyds TSB loan book, then that £10 billion loss is just the tip of the ice berg as 2009 will turn out to be a worse year than 2008 in economic terms as £10 billion of share holder equity cannot hope to defend against a loan book well in excess of £1 trillion, where even a further 1% loss due to bad debts would equate to more than total shareholder equity, and given the crash in UK house prices of 20% to date with a further 18% expected as per the UK housing market forecast, I cannot imagine how the bank can hope to survive in its present form.

HBOS Bankrupting Lloyds TSB

Lets get one thing straight, LLoyds TSB / HBOS is to big to be allowed to fail, therefore in this crisis there are two measures of bankruptcy without loss of banking operations and they are a. Nationalisation , where in effect the shareholders lose all off their holdings and in effect the bank is bankrupt as far as they are concerned, and b. Capital injections that dilute existing shareholder equity and increase tax payer exposure, in this regard the governments current holding at 43% of the group is pretty close to the magic 50.1% majority shareholding level that to all intents and purposes means nationalisation by the backdoor, and given the £10 billion loss it is only matter of time before further capital is injected into Lloyds TSB / HBOS, therefore it is highly probable that the bank will be effectively become bankrupt as far as shareholders are concerned sooner rather than later as has occurred already with the Royal Bank of Scotland where the governments holding now stands at 78% which is just a stones throw away from full nationalisation and as Northern Rock shareholders have found out, nationalisation results in the 100% destruction of shareholder equity as I warned of before Lehman's went bust (09 Sep 2008 - BANKRUPT Banks Wiped Out by Tulip Backed Securities)

Lloyds TSB / HBOS Depositors

Many customers holding accounts across the two banks are worried that they are now unnecessarily exposed in terms of the FSCS £50k guarantee per financial institution. In this respect I have some good news in that the guarantee is per licence, and as HBOS retains a separate licence to Lloyds TSB which means that savings are guaranteed at £50k per person per bank i.e. a £100k guarantee across both banks.

LLoyds TSB / HBOS Service

The 30 million or so customers of the giant UK retail bank will experience a deterioration in the quality of service as costs are cut and the number of staff that services the client base is significantly reduced this means less branches and less counter staff and therefore longer branch queues and greater difficulty in resolving account issues. Also the merger of the two has yet to be processed in terms of combining operations that was purported to save £1.5 billion per year, therefore expectations are for much disruption in client account operations especially where queries requiring manual intervention to be resolved.

Nationalisation - The Only Solution

The banks are bankrupt ! The only things keeping them alive is tax payer moneys in the form of capital injections and loans that are now nudging above £1 trillion. The only real solution as I highlighted last November ( Bankrupt Britain Trending Towards Hyper-Inflation?) is for the systematic nationalisation of all of the retail banks, where each bank is MADE INSOLVENT, then the profitable assets nationalised and quickly restructured with new competent management and re-privatised with clear limits on its business plan so as to avoid trading in any Securitized debt and a ban on any money market borrowings which are the prime reason the banks are now exposed to bankruptcy. Other controls should be placed on pay limits across the group so as to prevent the culture of bonuses that has destroyed the banks. Also retail banks should always be limited to operating within the means of their depositor base, which is how 99.9% of the public assumed was the way they operated.

IMF Revises UK GDP Forecast Again.

The IMF has revised its GDP forecast for the UK economy for 2009 from -1.5% (November 2009) to -2.8%, and the forecast for 2010 is now +0.2%. The forecast still seems overly optimistic in the light of UK fourth quarter GDP contraction of -1.5%. The IMF has a good track record of being WRONG, overly optimistic forecasts that are continuously revised lower.

The Institute of Fiscal Studies Talking Sense

Finally reports from mainstream institutions are starting to emerge that reflect the crash in the UK economy that will hit the economy hard for many years after the recession ends. The IFS in a recent press release states :

Treasury figures suggest that the credit crunch will cost the Exchequer an ongoing 3.5% of national income (or a little over £50 billion a year in today’s terms) in lost tax revenue and additional social security spending. This excludes any long-term impact from the Government’s interventions in the financial sector, although even a large one-off loss adding to public sector debt should increase the ongoing cost in extra borrowing relatively modestly compared to the impact already reflected in current Treasury forecasts.

In the PBR the Treasury signaled spending cuts and tax increases starting in 2010–11 and raising 2.6% of national income (£38 billion a year) by 2015– 16. If the public finances evolve as the Treasury hopes, this tightening would have to remain in place until the early 2030s before debt returns below the ceiling of 40% of national income Gordon Brown set as one of his two fiscal rules in 1997. So there is no prospect of a Government being able to readopt these rules any time soon. We hope they will be reformed in any event.

Unfortunately, the Green Budget does not expect tax revenues to grow as strongly as the Treasury hopes over the next few years. In the absence of any additional spending cuts or tax increases, we forecast that the Treasury would have to borrow 1.5% of national income more in 2015–16 than it predicted at PBR time – even if the economy performs no worse than expected in the PBR. This would take public sector net debt above 60% of national income, from where it would decline only very gradually over subsequent decades.

The key point is that the IFS states that the Uk will run a 1.5% budget deficit until 2016, and UK debt is not expected to return to below the ceiling of 40% of GDP until 2030 from a rate above 60%. This therefore supports my scenario that after the recession the UK will be heading for many, many years of stagflation.

Confederation of British Industry Forecasts 3.3% 2009 Contraction

The CBI - The UK's leading business group predicts the recession, which began in the third quarter of 2008, will last throughout 2009. The economy is expected to contract by 3.3 per cent and unemployment will reach close to 2.9 million by the end of the year. After six quarters of negative growth, the economy is expected to stabilise early next year with the recovery building throughout 2010.

The CBI predicts the economy will contract by a cumulative 4.5 per cent over the six quarters of negative growth. GDP growth for 2009 has been revised down from -1.7 per cent in November to -3.3 percent. In 2010, GDP growth is expected to be 0.0 per cent.

The impact of the recession and the fiscal stimulus will take a toll on the public finances with net borrowing for 2009/10 expected to reach £149 billion and £168 billion in 2010/11, which represent 10.6 per cent and 11.8 percent of GDP respectively.

The CBI is clearly following hot on the heels of the IMF in doubling its rate of contraction for the UK economy from Novembers -1.7% to now -3.3%. The key point here is the CBI now recognises that government borrowing is set to soar for the tax years 2009-10 and 2010-11 totaling £317 billion, up £100 billion and now virtually identical to my forecast of November 2008 of £314 billion, did the CBI read my forecast ?

UK Money Supply

One of the key driving forces of the 1930's Great Depression was the collapse in the money supply of the United States that fell by 25% and was tracked lower by GDP. However that lessons appears to be have learned given the amount of Quantative easing taking as both the US and UK governments embrace the money printing presses in an attempt to stop deflation from taking hold and thus igniting another Great Depression. Yes, rampant growth in the money supply is inflationary, however the money supply adjusted for the velocity of money paints a truer picture a the below graph illustrates

UK Money supply M4 (blue) has risen sharply from the 10% targeted low of mid 2008 to the current level of 16.6%, on face value this is highly inflationary and has been taken by many economists and market commentators to suggest much higher forward inflation. However the money supply adjusted for the velocity of money which takes into account the state of the economy as a consequence of the credit freeze tells a completely different story. The UK economy is now in extreme real monetary deflation of approaching -15%. The leading indicator of the implied money supply, is suggesting recent deep interest rate cuts will lift future money supply growth out of extreme deflation, however it will still be far from supporting the levels north of 15% which accurately forecast forward inflation during 2008.

Therefore the primary objective of the UK government is to prevent a deflationary downward spiral from taking hold at ANY COST. The Bank of England has been instructed to ignore inflation, and focus wholly on preventing DEFLATION. The price for this will be higher future inflation IF they succeed in preventing the deflationary downward spiral that if they fail WILL result in a another GREAT DEPRESSION. For more on the impact of economic deflation, download the world's foremost expert on and proponent of the deflationary scenario, Robert Prechter's FREE 60-page Deflation Survival eBook

UK Inflation

The Bank of England's quarterly inflation report forecast UK inflation of just 0.5% in 2 years time, with the UK economy now forecast to have fallen by GDP 4% by the middle of this year. It was not so many months ago that the Bank of England was forecasting growth of 2% for 2009.

Bank Governor Mervyn King implied by his accompanying statement that he does not have a clue what he is doing, as the UK economy under his and Gordon Browns collective stewardship continues to fall off the edge of a cliff, the Bank of England Governor stated :

“The United Kingdom economy is in deep recession. The length and depth of the recession will depend to a significant extent on developments in the rest of the world, where a severe economic downturn has taken hold.â€