Roger Martin-Fagg delivered a revealing workshop at Ashridge management school on the current state of the economy and where we go from here.
His principal theme is that money supply into the economy has dried up, which in mature economies is the primary driver of GDP. Whilst growth turned fractionally positive in the last quarter of 2009, that included the effect of £200bn of new money supply in the form of Quantitative Easing this fiscal, and the massive benefit to the economy generated by the car scrappage scheme, due to end this month. How dramatically would have GDP fallen were it not for all the money pumped into the economy via Government measures? Martin-Fagg believes it would have been apocalyptic without these unprecedented steps.
Here's the catch. In order for money supply to grow back to the 7-11% annual trend growth needed to produce 3%+ annual GDP, the banks need to start lending again. However, they can't, whatever the exhortations of Government, as long as the value of assets on their balance sheets are overstated. UK banks in particular continue to deleverage their balance sheets, and will discretely write down (or write off) parts of their asset base for a while longer in order to build up their Core Tier 1 Capital base and sweep the rest of the bad news under the carpet. Lending therefore will be severely constricted from its traditional source whilst the banks' capital base is insufficient. That can only get worse as global rules tighten, as they will when Basle III requires them to decrease leverage ratios further.
Meanwhile the consumer expects taxes to rise over the next few years whoever forms the next Government, so are paying debt down as fast as they can. Unused debt provisions extended to individuals in the expansionist prior decade are also being withdrawn by banks.
Quantitative Easing aside, Government has been consistently increasing investment in the economy since early 2008. On the other hand business investment has fallen to around -12% in the last two quarters, and exports have not sustained their growth, so the only thing preventing the economy from shrinking is Government spending. Guess what's going to happen after the May election? Pressure on Government to reduce public sector net borrowings will intensify, leaving very little stimulus left to prop the economy up.
The net result, Martin-Fagg argues, is a further recession in 6 months' time accompanied by further quantitative easing.
He is not alone. A report from the McKinsey Global Institute shares his behavioural-led approach, and realistically highlights at least 2-3 more years of deleveraging.
Here is The Economist's summary of what it means:
Assigning the odds of further deleveraging is not the same as gauging its likely economic impact. To do that, the study looks to history. It finds 32 examples of sustained deleveraging (at least three consecutive years in which ratios of total debt to GDP fell by at least 10%) in the aftermath of a financial crisis. In some cases the debt burden was reduced by default. In others it was inflated away. But in about half the cases—which the report regards as the most appropriate points of comparison—the deleveraging came through a prolonged period of belt-tightening, where credit grew more slowly than output. The message from these episodes is sobering. Typically deleveraging began about two years after the beginning of the financial crisis and lasted for six to seven years. In almost every case output shrank for the first two or three years of the process.
The Solid red circles on the above chart represent household debt ratios at over 300% of GDP. This compares with 286% after the Second World War. In other words, at a record high comparable with or worse than the worst prior scenarios.
All this means that the economic characteristics over the next few years point to slowdown, asset price stagnation (including property prices), therefore low levels of corporate borrowing and consumer lending, along with higher taxes.
In business terms, Martin Fagg's predictions are as follows:
- There will be a wave of innovation across all sectors — creative destruction — as new ways of creating value drive out old, less effective and less efficient business models.
- There will be a marked change in social values and preferences from consuming to being; from transactions to relationships. Trust will be a key differentiator. This will be particularly noticeable in the under 35 age group. Businesses will be required to demonstrate their green credentials and apply more sustainable business models to attract customers — particularly in this age band.
- There will be a significant increase in business failures and start-ups.
- The banks will be bypassed by informal networks of business people linking entrepreneurs with funding.
Taken in context of the long tail theory, this may yet be the best ever time to be specialised and entrepreneurial.
