On debt, services and value

6 min read

Ring the church bells, strike up the band, order the fireworks….UK GDP is looking cool and sentiment is improving across the country. With growth now closer to 3% than to 2%, Britain is not the sick man of Europe but the new Arnold Schwarzenegger. Or is it?

First up, it should not be forgotten that this country suffered a harder landing than most of its peers in the downturn and that it therefore is setting out on its recovery from a much lower base. Sceptics will be quick to point out that quarterly output peaked in Q1 2008 at £393 bln and that, six years on, we have still not regained that figure. That might be the case but as I have frequently argued that GDP is the worst possible measure of economic health, other than the available alternatives maybe, and I would treat the results with just a small pinch of salt.

GDP is fine and dandy but as we Brits learnt in the immediate aftermath of pre-2007 boom time under the leadership of the invisible Scotsman, borrowing £1bn and spending it on public services might create £1bn of increased GDP but it does not generate any value added. He created the concept of “investing” in the public services, especially in health and education. Other than when creating infrastructure, I struggle to see this as investment; it’s expenditure. I was once drawn on this and had it explained to me that spending on health is investment for nursing a worker back to health and putting him back into productive work was, ipso facto, an investment in the economy.

Bit by bit those who are now getting back into work will join and the groundswell should do much good. However, it will also knock the trade balance into a cocked hat which will in turn depress the currency and drive imported inflation.

Thus, I suppose, if enjoying a restful and distracting week-end helps workers become more productive come Monday, then buying a season ticket for Derby County or Oldham Athletic, let alone Chelsea or ManU for relaxation purposes and hence to an improvement in mental health must be tax deductible as an investment in future output capacity rather than simply being deemed to be a huge (and some might argue wasteful) discretionary expense. As ever, I digress.

In a service based economy with a disproportionately large public service sector, GDP can become a become a bit of a distraction and cover up for a shortage in value-added output. More to the point, when GDP is being funded by an endless increase in debt, it becomes a tad self-defeating. Sure, the US is in recovery and annual GDP has grown since the bottom of the recession in Q2 2009 when it was US$14.35trn to US$15.85trn for the last reading for Q3 2013 but it should be borne in mind that during the same period total public sector debt has increased from US$11.545trn to US$16.738trn. So, how many dollars need to be borrowed to create how many dollars of GDP growth?

Is what we are seeing really what we are getting or is all this GDP stuff a bit like a Hollywood film set?

It’s the demand…

Instinctively, I believe the situation in the UK to be better than some of the commentators are prepared to give it credit for. Pre-crisis, an enormous amount of the UK’s GDP came out of the City and with it the spending power to drive growth across the platform. That froth has now gone and although there is much moaning and wailing that the recovery is based more on the book-value of residential housing than on anything else – and that it is this phenomenon which has been driving increased household consumption – I’m happy to see growth which is evidently not quite so heavily based on the dubiously good fortunes of the few.

Yes, growth is consumption led but you show me investment led growth and I’ll show you falsified figures. Business invests to meet demand, not to create it – unless of course you’re Apple and even they, as we saw in the after-market last night, can’t please all of the people for all of the time. Record quarterly sales and record quarterly profits just don’t seem to cut it anymore if you’re the company which has become iconic by making and selling things people didn’t know they needed.

I live well away from London where the much heralded wealth effect of soaring real estate prices is unknown but even there one is beginning to feel that things are improving, albeit in tiny increments. Perhaps the biggest shift in sentiment is that those who were able to hold on to their job through the down-turn are now less fearful of losing it. That is where I sense the main shift in sentiment is coming from. Bit by bit those who are now getting back into work will join and the groundswell should do much good. However, it will also knock the trade balance into a cocked hat which will in turn depress the currency and drive imported inflation. A horrid equation and one which will already be taxing the Bank of England.

Buy or sell Sterling? There’s a trade which should offer enough volatility this year to keep the minds busy.