Having run out of ideas the government’s last throw of the dice was to poach Mark Carney from The Bank of Canada, a galacticos amongst central bankers, to spring us from the liquidity trap. Carney’s main reason for jumping ship was that the UK economy was “where the challenges are greatest”. If this was his first attempt at forward guidance it must be the most effective communication every uttered by a central banker; because by the time of his arrival the economy was out of intensive care and just two months on we are in the initial stages of a minor economic miracle!
|Are we the Northern Tiger? The UK's economy roars back|
Identifying the causes of the welcome up-tick is quite problematic, let’s start with the government’s policies. In a recent post I graded the government’s handling of the economy against four criteria: Fiscal policy, Monetary policy, Deficit reduction and Structural reform. I found that I could not score them above poor and anything apart from fiscal policy – where they have made some efforts to improve of the UK’s competitiveness. So I think we can safely discount government policy as being the main cause of the rapid turnaround.
So without much help from the Treasury (the QE tap was turned off in 2011 and there has been no tax give away) how have we sprung the liquidity trap? There have been some injections of cash into the economy from various banking compensation schemes that have made a material difference and belatedly the Funding for Lending scheme is freeing up credit conditions, which has certainly helped the recovery in our construction sector (about 10% of the economy). But these factors cannot explain the startling turn around.
More confusingly we are now in the grip of a minor export boom. Why have export orders been rising whilst our main trading partners are in the grip of their own recession? There has even been a positive move in our balance of payments, which is astounding as we might have expected imports to rise faster than exports as domestic consumer confidence returns. It’s likely that this boom in exports is due to a number of factors but the most likely it is that large global companies that scaled back production in the UK in the early stages of recovery, are choosing to crank this up in Britain. They have selected Britain for a number of reasons: our domestic market is in good shape, the pound is still good value and we are not in the Euro zone, which is still a big risk.
The export boom and the causes of it are the key to understanding why Britain has enjoyed such a quick turn around. Our improvement has mirrored the growing crisis in emerging markets. Following the credit crunch and the resulting deflation in asset values in the developed world, huge sums of money were washed up on the far flung shores of the BRICS and other emerging economies. Following this initial flight poor returns (low interest rates) in the West have encouraged more money to flow into increasingly surprising destinations. But what goes round comes round and now the music has stopped and long term interest rates are rising much of that money is now flowing back. The dramatic rises in the London property market are firm evidence of these capital flows. Fortunately for the UK we are at the front of the queue for these capital in-flows as we are not in the Euro zone and we have a better priced currency than the US. The other reason for picking the UK is our flexible labour market and the scope for us to improve productivity in the coming years. In fact the the key to sustaining the recovery will be this latency in our productivity. If, as investors are betting, there is considerable scope to improve productivity in the UK we should be able to enjoy a long period of growth and low inflation. It is this bet on our ability to repeat the productivity improvements we made between '95-,07 that is bringing the liquidity and growth to all sectors of our economy.