A British Man's Take on Debt, Saving & Investing

10 Economic Predictions for 2010

Posted on September 26, 2009 by Lee

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Before I begin, please do be aware I am not a financial or economic expert by any stretch of the imagination. Therefore please take in the content of this post with a critical degree of skepticism. From where I am sitting, this is what I forecast for our immediate futures but if you have a different view, I’d love to engage you in the comments!

Unless you have been living under a large insulated rock with no news circulation for the last 2 years, you are likely firmly aware that Britain is in a recession.

Even ignoring the sensationalist evening news soundbites and printed headlines, in reality this means job losses for ordinary people, less disposable income, an increase in personal debt and all the way along to repossession and homelessness. Whichever way you say any of those, none of them are a good thing.

It is fair to say courtesy of the work I do that I try to avoid political opinion. I am not a supporter of any political party, and I seriously consider them all to be overpaid children who look out for themselves long before any consideration is given to the best interests of the national population.

My Predictions for 2010/11

1. Politics will matter to you (and me) soon

If politics is not your thing right now, it soon will be. The three major UK political parties (Labour, Conservative, and Liberal Democrat) are deciding their monetary policies should they get into power at the next general election, and we need to carefully evaluate where these fit in with what is best for us, and what is best for our country.

UK-government-borrowing

It would appear Gordon Brown has taken his head out of the sand to his debt problem and worked out what he owes, and has agreed with the other two parties that public sector spending cuts will be an absolute necessity over the coming years. This is clearly not the best of news for public sector employees, nor of the wider economy.

After all, any additional unemployment means a real-world reduction in spending power creating the potential for redundancy spirals and an even larger, sustained increase in welfare claims for the duration.

The Institute for Fiscal Studies is predicting the biggest squeeze in spending on public services since the late 1970s when the Labour government was forced to got to the IMF for a bail-out. Both Labour and the Conservatives have said they want to more than halve the budget deficit by 2014 at the latest. Leaked Treasury documents include plans to cut spending across departments by a total of 9.3% over four years from 2010 – more than most independent experts were predicting. “Doomsday” documents uncovered recently reveal that could increase to a staggering 30%.

public_sector_spending

Even worse, according to a report (PDF) by The Office of National Statistics (ONS), this soaring Public Sector National Debt (PSND) figure does not even include our £1 trillion bailout of the banking system thus far:

“By the end of December 2008, the classification to the public sector of, first, Northern Rock and subsequently Bradford & Bingley had added around £130 billion to PSND. When the Lloyds Banking Group and RBS are included in the public sector finances, ONS has estimated that this will add an additional £1–1.5 trillion to PSND. However, this statistic needs to be treated with caution. The way in which PSND is defined means that illiquid assets held by these banks – in the form of lending to businesses; for mortgages and holdings of corporate bonds – are not taken into account. This is important because the banks’ liabilities are generally matched by their assets. What PSND shows is the extent to which the public sector’s liabilities are matched by assets which can be realised quickly.

The effect on PSND of classifying these banks to the public sector should not be interpreted as meaning that the Government (and by implication the taxpayer) has been saddled with a substantially greater debt burden. The Government has also made clear its intention to return these banks to the private sector, so in the long run the impact on PSND is unlikely to be permanent.

This may appear to be good news at first glance. You could take the view that “public sector debt is high but if we get it under control then all will be rosy”?

Not so fast. If you read inbetween the lines of that, we can deduce the possibility that:

2. Future Defaults will bring about Credit Crunch Mk.2

While the ONS report hints at better news to come, it does not immediately negate the whole issue.

The assets required for the banks to dig the government out of the hole it dug for itself in the bailouts will not be realised potentially for decades due to loan and mortgage terms. The return will trickle in month by month by month, year by year. That optimistic view assumes that businesses do not close down due to a lack of sales, whatever their sector may be.

The illiquid assets discussed by the ONS above, could very quickly go toxic in our delicate climate leading to another financial crisis. It therefore stands to reason that public sector cuts will happen in a mis-guided attempt to quicken a return back to national financial stability.

3. Government Public-Sector Cuts Will Backfire

Much as the way out of a recession is for individuals to spend (preferably their own money and not someone elses), so is true for government. Keynesian economics argues that government attempts to balance their budget during The Great Depression actually made the effects and duration worse than if they had done nothing, as they encouraged a nation of savers rather than spenders. Once that spiral was entered, it was extremely difficult to break.

4. The Thrift Paradox will hit the UK

Peter Hahn from the Cass Business School recently commented

“People aged under 40 have lived through an ever-expanding world of credit during their adult lives.”

It is therefore a reasonable forecast that the most natural reaction to a sudden, prolonged decrease in available credit for those so accustomed to easy access will be – for those who do not immediately financially implode – to become  chronic long-term savers.

Back in mid-2007, borrowing money seemed so secure, easy, and cheap. The Northern Rock Together deal – a 95% mortgage topped up with a loan of up to 30% – became the image of the easy credit generation. Times were good, and money was spent freely.

A recent Bank of England report warns in view of the painful decrease, that “households may respond by increasing their precautionary saving.” Looking at previous recessions for some historical context, the 1990s saw savings increased sharply, and remaining so for some time.

Reining in spending would have an effect on the growth of the economy as a whole and, in turn, individuals own income and their ability to save. “Any attempt to reduce consumption is likely to push down on output and hence household incomes. That could actually make it harder for households to increase their saving – an effect know as the paradox of thrift.”

5. The UK will enter its own Great Depression

All political parties are discussing the need for public sector culling that will increase the unemployment level substantially. All three have acknowledged the intention of increasing taxes to try and raise revenue, and lowering or stopping benefit payments thus reducing the income of those still employed further. Read that last sentence again, I’ll be coming back to it in a moment.

unemployment_rate

If that trend continues, we could be looking at 15-20% unemployment come May-July 2010, and that could be easily achievable if somewhere between 10-30% of the public sector workforce is cut as proposed or leaked.

6. Reduced public sector workforce will create a debt spiral

Welfare state payouts will increase, less money will be spent in the wider economy causing private sector job losses, causing less money to be spent in the wider economy, increasing welfare state payouts, ad infinitum.

The end result would be to bankrupt the country in short order as the majority end up subsisting on state handouts rather than contributing to our GDP. If state handouts cease at this point, our country will jump back about 200 years.

7. Increased taxation will reduce the desire to spend or earn

What taxes are raised and in what order will decide which of these scenarios occurs first, but raising any taxes is generally a bad idea during a recession; If less people spend or earn then less money circulates within the economy. If it becomes personally uneconomical to earn a high salary, the remaining workforce will be affected by a general malaise in climbing the corporate ladders as doing so results in no net benefit.

The rate of VAT (Value Added Tax or Sales Tax for US readers) is set to return to 17.5% in January 2010 when the temporary 15% measure expires, just in time to cause a reduction in excitement during the January sales. A key time for flagging High Street businesses to drum up trade and try and create confidence and a positive balance sheet come the end of the financial year. It has been suggested that within the period between then and 2014 we could quite likely see VAT rising to 20% or even 25%, reducing the desire to spend even further. It isn’t the first time such concerns have surfaced, except there is considered a more pressing need this time.

Income tax could be set to soar, costing a typical family to come home with £53 less per week than they do now, making taxation affect ordinary families from both ends of their finances; not only do the things they buy cost more, they have less take-home pay to buy them with.

8. The Welfare State will be severely curtailed or abolished

It is by far one of the largest expenditures of our government today, accounting for over a fifth of gross annual spending and rising rapidly in our current climate, increasing government debt still further. In reality whichever party takes power will need to reduce the spend on social welfare in an attempt to cut back its obligations.

social_spending

9. High inflation will occur

I expect the Conservatives in particular – but any party in reality – will be happy to have the real rate of inflation at 10% to reduce the real value of our national debt, hold public sector pay flat and wait for the second term before raising interest rates to slow it.

While the current rate of inflation is at an all-time low, the rate is picking up, and sharply. Where will the end of that graph be in 12 months time? Quantitative Easing (printing money) was never going to have been a bright idea.

inflation99-09

An increase in inflation is both good and bad, depending on your viewpoint. Yes it will help reduce the relative cost of servicing existing debt, for the rest of us it is fraught with a tranche of problems:

Reduction in spending power. Inflation will cause the value of the pound to drop in relative terms. Everything you buy will be more expensive, from food to utilities to petrol to consumer goods. Imagine what you pay out now but taking a 30% pay cut from your job. It has the same effect, just from a different angle.

Reduction in disposable cash. Because of the increased costs of everyday living, discretionary spending will drop as the population attempts to conserve what it has to keep buying the necessities. The end result is again, less money circulating in the economy, job losses, pay freezes and unemployment.

Savings worth less. The actual figures in your savings account may not change, but the value of those savings will decrease over time. Inflation has a very real effect on money squirreled away by virtue of the spending power reduction. To keep inflation high, interest rates will be kept low, meaning your savings suffer from both ends. Not only are they worth less, but they will grow at a much slower rate as well.

When rates are finally raised to bring inflation down – it having done its job – many years of damage will have been done to any you have left.

10. House prices will fall considerably

Despite the ongoing belief that house prices will not fall much further, anyone who takes the time to dig up the data will see we have already seen the very peak of the bubble we are in.

house-price-bubbleWhat this means in real terms (ignoring the pressures of other inflation), house prices may drop as far back as those seen in 2000. In other words what cost £184,131 in the peak of 2007 may sink back to about £80,000.

This may sound positive, but given the predicted level of inflation increase, the threat of increased taxes, a potentially devalued pound, and lower wages, house pricing may remain as unattainable then as they are now for first time buyers, if not more so.

Despite all this, my advice surprisingly remains the same.

Even if inflation does chip away at the real value of your debts, having any debt hanging over you during a prolonged recession will feel like the Grim Reaper has you on his list. If the worst does happen and you lose your job, knowing you have outstanding debt will make it all the more stressful. Do yourself an emotional favour now and work your way out of it, even if doing so later may work out slightly cheaper.

What is the answer? I wish I had one, but I do not, and the problem is, neither do those in power. Any potential fix has a raft of problems, and I think in general we are in for a very painful new decade. The only real fix without major problems would be explosive growth, and that isn’t going to happen any time soon that I can foresee.

All we can do is try and secure our own financial positions as best we can now, so that the next 3-5 years are more an annoyance than a life-changing period of economic negativity.

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Further Reading:

People aged under 40 have lived through an ever-expanding world of credit during their adult lives.
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Category Debt, Economics, News & Statistics, Risk
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  1. 26 09 09 16:54

    The Katana: Must Read Articles of The Week | Financial Samurai

4 Comments to “10 Economic Predictions for 2010”

  1. Wow Lee, nice post and excellent predictions! Are you sure you aren’t the script writer for the next Terminator movie?! :) Cause it was nice knowing you if so!

    Great job doing the weekly round up. I’ve got to highlight this post on FS.

    For the record, I think you guys will be all right. Everything is coming back and 2010 will be a great yr for u!

    Cheers.

  2. Just added this post on the the first edition of The Katana Weekly Round Up! Nice.

  3. Angela says:

    Hi Lee

    What an absolutely spot on report.
    What really upsets me on top of all you say, knowing it to be true, is that the bailout money in the US and here is being used to play the stockmarket and have the working public believe that it will grow better in equities than it will in savings at 3.5%.
    This is an illusion folks, wake up.
    3.5% is better than a big fat minus 100%
    The brokers and bankers will suck you in to this market rally in the belief that things are getting better.
    They are playing with money they just printed, you are playing with your savings, and believe me, they will pull the rug and leave you holding the empty bag.
    It’s what banks are good at.

    • Lee says:

      Hi Angela – welcome :)

      What you say is entirely on the money. The stock market continues to this day to be – apparently – completely detached from the ‘real world’. The Dow closed again yesterday above 10k. The FTSE seems to be on another rally. This is logically insane, and cannot sustain itself in the long term.

      I’m more worried now about our country’s stability than I was when I wrote this post!

      Lee



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