We are poorer than we think....

I will start this post by jumping back in time. In June of 2008 I wrote a post called 'The Cigarette Lighter Problem' and a sharp commentator argued that we (in the UK) were not poorer than we thought. I responded to the comment as follows:

You correctly identify that exchange rates are out of line with PPP. In this case I could change £1 and buy several lighters if I took that money into a Chinese shop.

This has been one of the consistent arguments of this blog. Exchange rates are going to have to shift.

You suggest that is that there is not much difference in the value created by our cheap labour and that of China, so we will not be poorer in the future. However, it is evident from your own argument that our purchasing power is being significantly subsidised by China (and I would add - many others).

The imbalance in the exchange rates means that we have not been paying the full value for the goods that we purchase. We have had our purchasing subsidised by China.

If we take away that subsidy (exchange rate corrects), then our purchasing power will diminish significantly. This, by any reasonable definition, means that we will be poorer. At its most simple, the lighter we bought for 59p will go up in price.

Right from the commencement of the blog, I have made similar arguments, and proposed that the UK will see a fall in the general standard of living as illusory forms of wealth disappear, in particular illusory wealth founded in debt accumulation. Over the last year, the illusion of wealth has finally started to fade in the most visible way - through inflation outstripping earnings:


For the regular readers of this blog, this inflation rate will only surprise in that it is not much higher. However, expectations of further rises in inflation are coupling with severe declines in consumer confidence. If you would like to see the reason for the fall in confidence, it is apparent in the following chart:



Interestingly, the rate of personal insolvency and house repossession has ameliorated, but it seems to be reasonable to question whether this might continue.



The reason for why we can expect these trends to reverse are explained in the Wall Street Journal:

U.K. households' disposable income fell for the second consecutive quarter in the first three months of 2011, forcing consumers to eat into their savings to maintain their lifestyles, official data showed Tuesday.

The weakness of consumer spending is one of the major headwinds facing the U.K. economy and reduces the likelihood the Bank of England will raise its key interest rate in the near term.

In its final reading of the economy's first-quarter performance, the Office for National Statistics said gross domestic product grew an unrevised 0.5% between January and March after shrinking 0.5% in the fourth quarter. However, the ONS lowered estimated GDP growth on an annual basis to 1.6% from 1.8% due to a revisions in previous quarters of 2010.

The ONS said household real disposable income fell by 0.8% in the first quarter after a fall of 0.9% in the fourth quarter of last year. The drop in real disposable income is a result of households being squeezed between inflation of 4.5%—more than twice the Bank of England's 2% target—and stagnant wage growth.

The household savings ratio fell to 4.6% in the first quarter from 5.1% in the fourth quarter. The drop in savings came despite an increase in wages—which grew by 0.9% in the first quarter compared with a 0.5% increase in the previous quarter—indicating that consumers are having to dip into their savings to maintain their lifestyles due to high inflation.

It seems that the answer to the reduction in real income is to pull out the credit cards and supplement income with debt. From the Bank of England (here), they chart the growth in consumer borrowing, and it is notable that whilst growth rates for credit card debt declined for a while, there is a new upwards trend. Of particular interest is that other forms of unsecured lending seem to be increasing even more dramatically, and also secured lending is on the increase. Some of this might be explained by higher university fees, but I do not have the statistics to hand to see the impact of this factor. As a note, for those who look at the figures at the BOE, note that this is changes in growth of borrowing. Needless to say, the savings rate is also in decline.

Overall, what we are seeing is a real decline in the ability of people to live to the standard of living to which they are used, and the response is to use borrowing as crutch for their standard of living. What should be happening is the opposite. With ongoing uncertainty, consumers should be rebuilding their balance sheets, and preparing and adapting to tougher times. The problem is that this is all taking place in an environment of astoundingly low interest rates and an ongoing massive government fiscal deficit. This from Liam Halligan in the Telegraph:

Yes, I know the entire political debate has shifted and the Conservatives seem to have won reasonably wide support for their “austerity” programme. This doesn’t surprise me. Some of us argued for years that if the Tories abandoned their misguided pledge to “match Gordon Brown’s spending plans” and actually admitted that UK borrowing was far too high under Labour, and Government expenditure out of control, then they would win popular support.

What does surprise me, though, is that despite the broad support the Tories have received since taking office, and despite endless rhetoric about “living within our means”, UK fiscal policy is actually becoming more profligate. Far from insulating ourselves from systemic dangers, we are making the UK even weaker.

During April and May, the first two months of this fiscal year, the Government borrowed £27.4bn according to figures released last week, up from £25.9bn during the same months in 2010. That’s right, we’re borrowing more – despite all the Treasury’s tough talk.

These borrowing rises happened despite higher tax receipts in April and May – up around 8pc on last year. But spending was also higher, not only on benefits and social services, but debt interest too. Interest payments, in fact, were up a staggering 18pc on last year, even though gilt yields have been kept artificially low by so-called “quantitative easing” – that is, creating money from thin air in order to buy your own government bonds, an activity the UK has practised to a greater extent than any other major economy on earth.

In addition to the 2011 borrowing increase, a further borrowing rise was also sneaked through last week, when the 2010 total borrowing figure was revised upwards from £139.4bn to £143.2bn.

Add to this that the UK is still in trouble with the current account balance (which is just not as bad as before), and we have a picture of an economy that is sliding to further ruin. The government and Bank of England are both trying to lift the economy out of the doldrums, but the only result is an ongoing slide in real standard of living. Has it not occurred to either the government or the BoE that they seem to be, at best, holding the country on the brink, but doing so at such an astounding cost? Surely, this must lead to some change in thinking? The situation is not improving, and there are still external shocks still to be fully felt. For example, the Euro-Greek crisis still has yet to really bite.

I do not often post now, so I must by necessity be broad in my approach. As such, I will end the post with a single point. We have now watched governments managing to keep plates spinning, and prevent an all out collapse of the economy. They have expended all their ammunition, and do not have anything left in their dubious armoury. I did not believe that they could possibly keep the plates spinning this long, but they have done so. However, as much as they try to magic the ongoing crisis away, it just keeps coming back. And the longer they delay, the more they tinker and seek to direct the economy, the greater the accumulation of problems. The one thing that nobody wants to do is to acknowledge that the world has changed.

The world that was taken for granted by countries like the UK started to evaporate a decade ago. The world is now one of hyper-competition, and it is a competition for a finite supply of resource. The economic fight is over the distribution of the finite resources. There is only one solution in such a situation, and that is to reform and make your economy lean and efficient. That is the one thing that is barely addressed....and no amount of expenditure of magic bullets will fix this.