Posts Tagged ‘Finance’

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Permanent! Do recessions and economic depressions cause permanent damage to the economy, or do we see a catch-up period in the years that follow? In some ways it is like asking whether going on holiday damages your total level of productivity. Do you work extra hard in the days before going away and then when you return, so that within a few weeks, as far as backlog of work is concerned, it is as if you never went away? Do holidays cause permanent damage to output?

The answer to that question is quite important because it may determine whether the UK will boom later this decade. One thing we can say is this. The Great Depression in the US during the 1930s was very nasty, but within a decade or so of it ending, US GDP was much greater than it would have been had growth followed the pre-depression trajectory.

Recessions caused by financial crises tend to be different. They tend to be more severe and it can take longer for recovery to occur. Various economists have had a go at calculating the permanent loss of GDP that occurs after a recession caused by a financial crisis. Estimates vary, but, according to Capital Economics, they are all – or nearly all – within the 2 to 10 per cent mark. That is to say once the dust has settled and things have returned to normal, total GDP is between 2 and 10 per cent less than what it would have been had the financial crisis never occurred.

Of course the causal link may be the other way round. It may be that GDP in the years leading up to a financial crisis is illusionary. It is not so much that such a crisis causes permanent loss; rather it is that total output was not real, not really real, and largely constructed from the economic equivalent of smoke and mirrors.
Right now

UK GDP is around 15 per cent short of what it would have been had things carried on, or as most forecasters had predicted before 2008. By the end of next year, the gap between actuality and what one might loosely call potential is likely to be around 16.5 per cent.

So let’s say that permanent damage caused to the economy lies somewhere halfway between the 2 and 10 per cent figures, and is 6 per cent. That means the UK will eventually claw back no less than 10.5 per cent of GDP lost during the downturn. Let’s say this happens between 2015 and 2020 – not an unreasonable assumption – and that underlying growth is 2.5 per cent. During this half a decade annual growth should average around 4 per cent a year. And funnily enough, this is precisely what Capital Economics expects to happen.

In the build-up to the financial crisis Capital Economics was definitely one of the more bearish of commentators, and made its name for forecasting something of a crash in UK house prices. Indeed, when it comes to forecasts of UK house prices it remains distinctly bearish. Yet, earlier this week it forecast what one can only really call a boom for the UK economy within two or three years.

It suggests the loss to the UK’s permanent output was limited by two key factors. Firstly, spending on R&D as a proportion of GDP has actually been higher since the recession began. Theoretically potential output continued to grow, even if actual output didn’t. It also suggested that because unemployment did not rise to the kind of levels seen in the past, there was less permanent damage. The rationale behind this is that people who have been unemployed for an extended period of time often lose hope, and become less productive in the future.

© Investment & Business News 2013

Uk Population

Here’s a chart for the UK population as of now with a line for the official projections 10 years hence.

As a tool for prediction this chart can be quite powerful; pictures speak a lot louder than words.  The way to use the chart is to imagine the blue and red lines being pulled across the page as we all move inexorably towards God’s waiting room on the right.

We’ll be pulled past 2 marks on the way. The left block shows where young people (16 – 24) might find themselves becoming employed and paying taxes – remember that 20% don’t though so the ‘new workers’ line is copied and shifted lower.

The next mark, for the retiring age for men, shows an ever increasing rate of retirees, after a very steep previous 10 years there will be another 7 million arriving during our 10 year look into the future. You might notice an almost mirror image of the lowered ‘new workers’ line but the unemployed are living off the state too, so there is another 1 million to be added to the line on the right if we want to balance workers vs. state supported.

Unfortunately, because the leading edge of retirees points up and the leading edge of new workers points down, things just get worse. While this demonstrates the ex-growth nature of the economy it is reassuring to compare the huge block of substantially employed people and the much smaller wedge shaped block of the already retired.

So it looks a lot less gloomy right now but as our 10 year view unfolds it builds to uncomfortable levels all the way up to and past the baby boomer’s peak in 15 years.

Note how the red projection line slumps after the retirement age. I’d like to think that this is not an early death syndrome but rather an indication that retired people like to head off to countries with blue skies and sunshine. As we have seen, the retiree level is really lower than the new workers level and that’s a significant first; it just gets progressively worse after this as the retirees line builds even steeper and the workers line pulls across a dip. Incidentally there are dips because WW1 and WW2 were one breeding cycle apart (27 years) and the resulting post war pulses have yet to die down.

If you are about 50 now you are at the population peak age. Births subsequently declined for 13 consecutive years, and that was another first, signalling the end of centuries of perpetual population growth. Because accounting practices, pension arrangements, government finance, and much more, all worked because growth conveniently forgave all sorts of silly thinking, there were, and still are, bound to be some serious consequences.  The way the world works has changed forever.

The workings of pension schemes are of particular interest. With perpetual growth there was always a bigger pool of funds to pay out the liabilities so nobody needed to be particularly efficient. That is no longer the case and you can be sure there will be a raft of pension scheme failures.

With such a huge pension liability arriving over the next 15 years the pension funds have to prepare by switching out of equities and into bonds and then progressively the bonds are then sold as net payouts increase. Logically we might expect weak equities and strong bonds eventually followed by weak bonds.  When the bond sell-off stage arrives one wonders how the Government finances will work – who will they sell bonds to then?

An ex growth world has some implications for equities. Shareholders have got used to accepting lower yields in exchange for corporate growth. As soon as the growth stops then a proper yield will be required. As an example a company yielding 2% and going ex-growth might have to yield 4% to remain attractive. So that means the share price would have to halve!  How likely is this scenario?

Well take a supermarket for example. As a footfall company, whose profits are directly linked to the traffic through the door, the impact of an ex-growth population will be severe. Actually the population is not quite ex-growth, it is just slowing down, but even so companies in this category are subject to massive falls as soon as their growth is seen to end. Just to be safe, sell all your growth stocks?

You can see why there was a property boom over recent decades as the only way the available housing stock grew was via owners dying or new houses being built. Looking back it seems so obvious that fewer old people (from a previously smaller population) supplying demand from a much bigger block of house seekers would result in big price rises.

The chart is giving a strong indication of a repeat performance. Note how there is a bulge moving into the first time buyers age groups and then compare that to the lower height of the chart where old people might shuffle off. Demand will clearly outstrip supply for a while and looking forward 10 years this is increased by immigration as can be seen by the way the bulge actually grows as it moves across. The low end of the housing market looks like a good bet and you can expect a rally in the house builders too.

All this is good for the economy with an added twist. The baby boomers already have a house and yet they are about to inherit their parents houses which can easily be sold on at today’s fairly substantial prices; an added boost to the economy for several years to come.

This last point reinforces the idea that retiring couples with windfall cash will head for the sun. That’s bullish for overseas holiday homes so get in while they are depressed.

Any negatives? Well the way the dotted red line sits above the blue line has implications for NHS services over the next 10 years. It doesn’t look much but in percentage terms there is a significant increase with a detrimental age bias to account for too. An already stretched service has a crisis looming.

The big bulge in the new adults group will all be driving cars for the first time; good for the motor industry but bad for traffic jams.

Conclusions:  No great dramas for the next 10 years but this is the lull before the storm. After 15 years the peak of the baby boomers will be at retirement age and from then on it is hard to see how the books stack up unless the, already brimming, country is filled with more foreigners.

The houses to buyers ratio is likely to top out, leading to a sustained bear market in house prices. The stock market will slump horribly as it goes absolutely ex-growth and the pension funds go into net draw down.  The Government will find it hard to fund the state pension burden and increased demands on public services. Borrowing to bridge the gap will be hard as traditional lenders, in the net draw-down scenario, have no need to buy bonds. Interest rates may well climb as a result and then the National debt financing costs spiral up. Pay more, borrow more, pay higher; sounds familiar.

A UK Government default before 2028?  Not so hard to imagine is it?

Data – The Office for National Statistics

Opinion – Patrick O’Connormist

According to data from the ONS, the number of people aged 65 or over in employment has risen from 890,000 in the first quarter of 2012 to just under a million in Q1 of this year.

According to a survey from NS&I, just under a third of Britain’s adults (31 per cent) do not know how they will finance their needs in later life, including such eventualities as long-term illness, nursing home or care fees and care of others, including partners, parents and siblings.

On the subject of retiring over 65, Nigel Green – who is the chief executive of the large IFA the deVere Group – said: “Naturally, it’s hugely positive if the over 65s who are working past the traditional retirement age are doing so because they choose to, but it’s totally different if they’re being forced to carry on working as they can’t afford to retire.” He said: “I suspect the majority are working because they have to.” He continued: “The ONS findings show once again that as a nation we’re simply not saving enough. There needs to be a radical shift in the savings culture.”

The NS&I research shows that “over a quarter of Britons (27 per cent) who have yet to consider financial planning in later life admit they do not want to think about such events. 23 per cent say they simply have not had time to think about their later life financial needs, and just under a fifth (19 per cent) prefer to take a short-term view of their finances and use the money they have for the present.

A further 12 per cent don’t consider that this situation will affect them in the near future and believe they will have plenty of time to consider such planning going forward, while 7 per cent of Britons do not consider later life financial planning as important.”

So what does that tell us?

Clearly we have to save more and we will, as the baby boomers wake up to their pension crisis in the making.

But if a large chunk of the UK populace starts to save more won’t that lead to recession? This is what happened in Japan 20 years ago, and we all know what happened next.

© Investment & Business News 2013