'The Worst Economic Downturn In 60 Years'

by Gary North
by Gary North

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So said the Chancellor of the Exchequer, the senior economic official in Great Britain. The story ran on August 30.

Britain is facing "arguably the worst" economic downturn in 60 years which will be "more profound and long-lasting" than people had expected, Alistair Darling, the chancellor, tells the Guardian today.

In the government's gravest assessment of the economy, which follows a warning from a Bank of England policymaker that 2 million people could be out of work by Christmas, Darling admits he had no idea how serious the credit crunch would become.

It was later reported by another source that the interview had taken place two weeks earlier.

This means that the economy by mid-August had convinced the Chancellor to give the interview.

I recall no negative economic statement this forthright by any incumbent senior politician in my lifetime. This simply is not done.

The response to this article was a fall in the British pound on Monday, September 1. The decline continued all week.

The bad economic news arrived at his office rather late. The British public has been well aware of this for months. On June 30, the London Times ran this headline: "Families' cash fears worst for 26 years."

The monthly poll of consumer sentiment found that householders' confidence about future economic prospects had sunk to its lowest level since 1982. Confidence in existing economic conditions dropped during June to levels not seen since late 1992, at the end of the last recession.

A new survey from Lloyds TSB also shows that people are more worried about losing their job than at any point in the past three years, as employers feel the effects of the downturn and may have to lay off staff.

The GfK NOP poll – based on people's views on their own finances as well as wider economic conditions – found that the overall confidence index sank by five points this month to a reading of minus 34, on a par with the lowest level since the poll began in 1974. The record low of minus 35 was reached in March 1990, immediately before the start of the last recession.

Willingness to make "big ticket" purchases has also fallen to a record low. Figures published last week showed that families suffered the steepest decline in disposable incomes for nearly a decade during the first three months of the year.

House-price falls are accelerating as potential buyers retreat from the market in expectation of cheaper property values in future. The number of homes changing hands last month fell to its lowest in 30 years, according to the property website Hometrack. The average house price dropped by another 1 per cent in June, twice as fast as in May.

Recent figures indicate that home prices in July were down 10% over July, 2007, the month before the international credit crunch began.

The biggest drag on the British economy is the housing market where mortgage approvals are down by more than 70 percent compared to just one year ago. Given the difficult market, Prime Minister Gordon Brown's government is eliminating the home-buyer tax – known as the stamp duty – on residential home purchases of less than $312,000. That rate would affect just less than half of all homes on the market in Britain.

We are in an international economic slowdown. The Organization for Economic Cooperation, a mainstream international organization, has been unusually frank. It has predicted economic contraction for Great Britain for the next two quarters. It has said that Germany, Italy, and France will barely grow.

"We are facing difficult times, you know we are in a situation where you have the combination of the credit crunch together with high oil and food prices and we have not seen that coming together. It is unique, which the IMF itself has said we have not seen this since the 1930s in fact," said Darling.

Here is what is remarkable about Darling's statements. As recently as April, he shrugged off all such talk. The Times reported this on April 10.

Alistair Darling moved to calm fears about a house price crash yesterday and stood by his predictions for economic growth despite a gloomy forecast from the International Monetary Fund.

The Chancellor told the Radio 4 programme Today that there were still "grounds for optimism" in the face of an "unprecedented shock to the economy". He said that there would "obviously" be a slowdown but stuck to his Budget projection that the economy would grow by between 1.75 and 2.25 per cent this year and between 2.25 and 2.75 per cent in 2009. . . .

Mr Darling said that Britain had a "strong economy that had proved remarkably resilient" in the slowdown. He said that the IMF had downgraded Britain by less than other big economies. He also insisted that Britain was better placed than other countries to cope with the downturn.

The downturn has proven to be relentless. The figures reveal that Great Britain is moving rapidly into a recession. Finally, Darling decided to come clean. He admitted publicly what the British public has known for months.

I would like to say something like this: "When a senior politician finally admits that there is an economic crisis, the crisis is large." But there are no precedents for such an announcement.

AN INTERNATIONAL CRISIS

The economic slowdown that has engulfed the United States is not limited to the United States. The expansion of fiat money under Alan Greenspan, beginning in the summer of 2000, and continuing until his retirement at the end of January, 2006, was sufficient to expand the international economy.

Greenspan's policies created a massive international real estate bubble. He did this with the cooperation of other central banks. These central banks purchased the IOUs of Fannie Mae and Freddie Mac on the assumption that the United States government stood behind this debt. No such legal guarantee was ever made for either organization. But central bankers believed that the United States government would intervene in the case of a breakdown of these private organizations. As yet, this has not happened, but it is clear that it is going to happen if the two organizations go bankrupt.

With the expansion of fiat money and the reduction of interest rates around the world, the world has indulged in fantasy. Investors have bought houses on the assumption that there would be enormous on-paper profits, year after year, for holding residential real estate. Tens of millions of families have moved into houses that they can just barely afford to pay for. They assumed that this investment decision would enable them to live in much nicer housing and also provide capital gains. In other words, they believed in the tooth fairy. They believed they could live in their gingerbread houses and get rich with them, too. It was going to be a win-win deal. It has now become a lose-lose deal. Investors have lost fortunes, and they are going to lose far more money. The solvency of Freddie Mac and Fannie Mae has been called into question on the Web and on the stock market. Their share prices have collapsed. So have the share prices of the banks that financed the building boom.

We are now seeing the entire Western world facing a recession. China and Asia have not yet hit the brick wall, but their stock markets are down by over 50% over the last year. This indicates that the days of wine and roses are over for Asia, too.

China's central bank has inflated the currency consistently by close to 20% per annum for years. This is now catching up with the nation. Prices are rising; bottlenecks are appearing; and businesses are going bankrupt that had relied on cheap labor. The Austrian theory of the trade cycle still is alive and well in Asia. When Asian central banks begin to cut back on the expansion of their currencies, the recession will hit them the way that it has hit the West.

The fact that the Chancellor of the Exchequer would go public with his assessment of the economy indicates that the incumbent politicians have been covering up the real situation all year. Darling went public because no other incumbent politician was willing to do so. The British public is well aware of the situation. Voters in Great Britain have been voting Labour politicians out of office. Labour has been the incumbent party, and Labour will now pay politically. The same situation is facing the Republican Party in the United States. There is no escape from reality of this economic crisis. Incumbent politicians are saying as little as possible, but the reality of the economy cannot be hidden indefinitely.

THE MAINSTREAM FINANCIAL MEDIA

The mainstream financial media in 2008 finally caught up with what obscure financial newsletters such as mine warned about in 2005, and which began to appear in 2006. The financial markets have learned the reality of fiat money's effects, as explained by the Austrian theory of the trade cycle, beginning in August of 2007. It has taken over a year for the inescapable reality of the Austrian theory the trade cycle to become apparent to the mainstream media. Now, it has actually caught the attention of a senior government official. I do not expect this candor to spread to other incumbent politicians.

I especially don't think this will happen in the United States between now and the general election in November. The Democrats will do their best to blame the Bush Administration for the crisis. The Bush Administration deserves plenty of blame, but the real culprit has been Alan Greenspan. He always had bipartisan support, and no one even today is willing to call a spade a spade in the mainstream media. It was Federal Reserve policy more than it was Bush's deficits that led to the present crisis. Bush's deficits have exacerbated the situation, but the public really does not care about government deficits or any other deficits. When politicians come up with tax cuts for the middle class, most voters approve. Democrat politicians vote for the tax cuts, if the tax cuts are for the middle class. The deficits continue.

So far, the Federal government has contented itself with pontificating about the need for public action. It has done almost nothing. This is good. Whatever it does is going to cost taxpayers dearly. But it is likely that as the Fannie Mae and Freddie Mac crisis accelerates, and housing continues downward over the next year, the government is going to intervene in the housing market. It is going to nationalize Fannie Mae and Freddie Mac. It is going to do so in the name of the voters, but in fact it will do so because the central bank of China holds at least $350 billion in Fannie Mae and Freddie Mac debt. This will be a bailout of the biggest banks in the world: central banks.

Anyone who says that the worst is behind us has got to show that he never said it before, and that the evidence clearly indicates that the new engine of economic growth has begun to accelerate. There is no identifiable engine of growth today. There is no large segment of the American economy, the British economy, the European economy, or the Asian economy that indicates that there has been a turnaround, and that the engines are sufficiently large to pull the stagnating national trains.

At this point, investors had better pay close attention to the logic and evidence of every argument, if there is an argument, presented by somebody who says that the worst is behind us. He has to show that the consumer has become optimistic again. He also has to show that the consumer can continue to spend as much as he has spent over the last six years, despite the fact that his home's equity is declining and may actually be negative. He has to show that the consumer can tap into low-interest loans that will enable him to expand his consumption without increasing his monthly economic payments on debt, which is the crucial limiting factor on whether or not the consumer will go into further debt. The old statement, follow the money, applies equally well when there is no new money to follow.

CONCLUSION

The international economy will continue downward for the rest of 2008. The housing markets in Western Europe and North America will continue downward for at least two years, and possibly as long as five years. The end of the illusion regarding living in your own ever-expanding ATM is here.

We now await the re-inflation of the money supply by Western central banks. Even then, I don't think it will be enough to reignite the housing markets. The bloom is off the rose. Only the thorns remain.

September 6, 2008

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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