Back to the 1970s

The latest UK unemployment data was published yesterday just as the Chancellor was getting ready to deliver his 2009 budget speech. It showed the current dire state of the UK labour market. The headline unemployment rate increased to 6.7% . The even more accurate claimant count (this is explained on page 103 of the book) rose by 74,000 in March. There is no doubt, however, that the most worrying figures were those that showed that we now have 820,000 aged under 25 who are unemployed and that there was a big increase in the number of long-term unemployed. If we put these two things together the data showed that we now have 100,000 people aged from 18-24 who have been unemployed for at least a year. This is very bad news for them and for us all eventually as the impact of being unemployed for a long time is very serious. It ca have a long-lasting impact on those involved. This issue is explored on page 101 of the book ("Reading and Understanding Economics").

"Unemployment causes great suffering to those involved particularly when a severe economic downturn results in a sharp rise in those people out of work. The misery inflicted is particularly severe because the incidence of unemployment among individuals and households is very unequal. While some people will go through their entire working life without ever suffering a spell unemployed others will have to endure regular periods of economic inactivity. The longer someone is unemployed the worse it gets. They are likely to suffer a loss of self-esteem and maybe find themselves eventually cut-off from the labour market for ever".

All the evidence shows that a period of long-term unemployment is especially harmful to the young. It is essential that the Government acts swiftly to reverse this trend before those affected suffer irreversible damage. The Chancellor did announce some new initiatives to offer training or education to the young people involved. These are reminiscent of schemes like the 1970s Youth Opportunity Programme (YOP) that offered the young unemployed chances to sweep leaves or clean the streets. The problem is that the young unemployed need far more than this work experience can offer. They need the opportunity for real work that is properly paid. If this is not forthcoming we could end up with a generation that will be permanently blighted by having endured this early period of unemployment. We need the Government to show real leadership in this area and this must be done quickly.

A time of austerity in Ireland now and coming to the UK vey soon

The credit crunch has had a serious impact on public finances right across the globe. In response to their deteriorating budget position the Irish Finance Minister Brian Lenihan unveiled a series of tough measures designed to bring the Country's budget deficit back under some kind of control. The fiscal moves included sharply higher income taxes, higher rates of Capital Gains Tax and Capital Acquisitions Tax, rises in excise duties on cigarettes and size able cuts in unemployment benefit. In terms of the economy he had a gloomy forecast with output expected to contract by 8% this year. What is happening in Ireland now could soon move onto the UK in a year or so. The UK's fiscal position has also deteriorated badly in the wake of falling revenue (due to lower incomes and profits) and rising expenditure (the bailouts and higher benefits). So it is likely that just as the UK is coming out of recession in 2010 there will be the need to raise taxes and slash government spending. This could act to halt any recovery that is starting to show at that time. No wonder that the stock market remains very nervous. If investors expect 2010 to be the start of another period of rising economic activity with higher corporate profits and dividends they might well be disappointed.

Deflation gets closer...

In the opening section of Article 16 I explain the various measures of inflation used in the UK. It might be useful to illustrate the main two definitions with reference to the latest inflation data which was published today. The headlines will be dominated by the Retail Price Index (RPI) which fell to 0% in February on an annual basis compared to 0.1% in January. This is a wide measure of inflation that includes housing costs. The sharp fall in mortgage rates in the last year has driven this measure of inflation to the lowest level in nearly 50 years. However, the annual rate did not turn negative as many commentators had predicted.

The Government's preferred measure is the Consumer Prices Index (CPI) and this actually rose unexpectedly from 3% to 3.2%. As a result the Bank of England's head Mervyn King will have to write again to the Chancellor (Alistair Darling) explaining why inflation is more than one percentage point above the government's own 2% target.

Against this background the FT-SE 100 index has fallen back slightly this morning which is not that surprising as we have seen a strong rebound in the UK equity market in the last few days.

Falling oil prices (revisited)

In parallel with the World's stock markets oil prices continue to slide with UK's Brent crude falling to just over $40/barrel. This is very much a reflection of the strong expectation that the global economy will remain depressed for many months ahead. Any hopes of a speedy recovery have been firmly rebuffed by a series of gloomy economic and corporate stories unveiled this week. The message is now clear that demand for oil will remain weak for the foreseeable future. In response OPEC is desperately trying to reduce the supply of crude oil. Indeed the oil producers' cartel has already acted to reduce production by millions of barrels a day in a vain attempt to underpin prices. However, it is becoming clear that the action taken so far will not be enough to halt the slide. We can expect OPEC to act soon to make further reductions in production levels at their next meeting which takes place on the 15 March.

Obama's new economic stimulus package

The new Obama administration has unveiled an extra package of some $2trillion with the aim of saving the US banking system from total collapse. The Treasury Secretary (Timothy Geithner) set out the dire position in very plain language:

"The US was in the midst of its worst economic crisis in generations with a challenge more complex than any our financial system has faced".

Such a pessimistic view has inevitably spooked the financial markets with the Dow Jones falling sharply as a result. Indeed the index fell 200 points during the 30 minutes of the speech! This can be hardly the response he was hoping to see.

The need for such a comprehensive package of measures was re-enforced by the latest US employment figures which were released last Friday. They showed that almost 600,000 jobs had been lost in January 2009. This resulted in the unemployment rate hitting 7.6% which is the highest in 17 years. (if you want to see the significance of this data see Article 17, page 118 of my book).

The Obama package includes:

1) Plans to buy from the US banks billions of dollars worth of their so caled "toxic" assets. These are the mortgage backed securities and other high risk derivatives.

2) Extra resources will be used to try to keep homeowners in their properties.

3) The US Treasury will use $1trillion to guarantee loans from high street financial institutions to help finance cars, mortgages and various other projects.

The reaction to the Obama package has been mixed. Some feel that the latest bail out plans are too little too late. Indeed it has been estimated that even with this extra effort we could see up to 1000 US banks fail over the next 3-5 years. These are indeed worrying times!

Quantitative easing explained

In these worrying economic times the official authorities (made up of governments and the central banks) have done much to try to stimulate their anaemic economies. We have seen the governments act with several fiscal stimulus packages with a combination of higher official spending and lower taxes. At the same time the central banks have cut short-term interest rates to record lows. In the latest case the European Central Bank cut their main rate to just 2% last week. Sadly despite these measures the world economy looks to be on the verge of a deeply worrying meltdown. As a result the authorities are now considering yet more desperate measures. One of these is called quantitative easing. So what does this mean?

To put it simply the central bank injects extra money into the economy as a means of expanding the money supply. This is normally done through the process of the central bank acting to buy various types of government securities in the international bond market. The intention of this activity is to drive down the rate of longer-term interest rates to match the reductions already made in short-term rates. You should remember that the interest rate on the bond (or yield as it is normally called) goes down as the price increases in response to the extra government-induced demand for these securities. This would also tend to cause other long-term interest rates to fall including some mortgage rates and most importantly the corporate lending rates. In addition the banks will end up with extra cash resources to lend to either individuals or companies as they swap their bonds for cash which they receive from the central banks.

The downside of this policy is the risk that it can be seen to be increasing inflationary pressures especialy when the economic activity eventually picks up again. At the moment this looks like a risk that the authorities will be prepared to take.

If you go to see my latest blog for "Reading and Understanding the Financial Times" I will tell you more about this policy tool.

The fall and fall of UK House Prices

According to the latest survey by the Nationwide Building Society UK house prices fell by nearly 16% in 2008. As a result the average price has now hit a little over £153,000. This time last year most economists had expected some fall in house prices in the coming year. However, it should be said that the actual reduction has been far more dramatic than anticipated. The main reason for this development has been the change in the availability of mortgages. Gone are the days when banks and building societies lent money with almost no regard to the ability of the households to repay their debts. We have gone back to the pattern of the 1970s when lenders have to beg financial institutions for new mortgage funds. With the lack of available funds the demand for houses has collapsed. These tighter lending conditions look set to remain in place for much of 2009. In addition with more and more people being made redundant on a daily basis it is hard to see any confidence returning to the UK housing market in the foreseeable future.

You can access information on this house price data if you follow this link...

http://www.nationwide.co.uk/hpi/