Worried about the day of reckoning? Calm down – it has passed already

By Anatole Kaletsky (THE TIMES, 27/07/06):

HOT WEATHER is usually associated, at least in Britain, with levity and fun — scantily clad sunbathers in Hyde Park, outdoor concerts, open-air pubs, garden parties, Wimbledon, Pimm’s and so on. This summer, however, the national mood is anything but hedonistic. The soaring temperatures, instead of providing the usual excuse for silly-season clichés, seem to be turning our thoughts to the apocalyptic.

Take the headlines yesterday on this very page: “We’re all heading for the fiery furnace” (about cheap flights and global warming); “At the third stroke, get the hell out” (about the infernal year ahead for the Prime Minister); “When terror becomes error” (about the genuine hell engulfing the Middle East). The sense of guilt and foreboding about the future of the world is understandable. After all, diabolical is a perfect word to describe the self-righteous Israeli killers, as well as the avowed terrorists in Lebanon. And apocalyptic may well be a plausible adjective for the palpable evidence that climate change has passed the point of no return.

There is, however, an intellectual fallacy that usually surfaces when the mood in Britain turns penitential, and which I have started to observe among politicians, businessmen and financiers. This is the quasi-religious idea that Britain, in particular, will soon face a terrible “day of reckoning” for the affluence, overindulgence and idleness of the past decade; that after the ten fat years that we have enjoyed from the mid-1990s onwards, the country must suffer a run of lean years, with all the political, economic and social consequences that this will inevitably entail.

The idea that Britain is on the brink of economic crisis is more prevalent than ever this summer because of four narrower causes of economic anxiety overlaid on the great global issues I mentioned above. These are the possibility of much higher taxes after the Blair-Brown transition; the continuing inability of Britain to balance its international payments; the prospect that rising interest rates will puncture a “bubble” of house prices and mortgage borrowing; and, finally, the threat of “stagflation” in the US economy.

How worried should you be that any or all of these threats will ruin you financially by the time you return from holiday, long before you are fried by global warming or blown up as a “collateral casualty” in the Middle East conflict? How worried should Gordon Brown be that the golden economic legacy he inherited as Chancellor from the Tories will have turned to lead by the time he reaches the top?

Most people in the City would answer that the economic prospects for Britain are indeed darker than at any time since Labour came to power. I beg to differ. In my view a serious decline in the British economy is a worry that you (and Mr Brown) can forget about, even as you fret about all the real dangers threatening the country and the world in the years ahead.

Why am I so optimistic? There are two broad reasons. First, the long-term structural underpinnings of the British economic miracle that began in the mid-1990s are still mostly in place. And while everyone recognises some of these structural advantages — the deregulation and privatisation of the Thatcher period and the monetary policy framework created by Mr Brown — the most important one is still not fully appreciated by the business community, the media and the financial markets. This underappreciated strength is Britain’s comparative advantage in finance and business services. London’s unique position as the hub of the international financial system, conducting more foreign exchange trading and other international transactions than New York, Tokyo and Frankfurt combined, has meant that Britain has been a greater beneficiary from globalisation than any other leading economy. As long as world trade keeps growing and financial services continue to be liberalised across the globe, the people of Britain will continue to enjoy increases in their relative living standards and capital gains on their houses. This rising standard of living may seem to be unearned through harder work, but it is in fact firmly underpinned by the changing structure of the global economy. This shift in the global terms of trade in our favour largely answers the worries about rising debt levels, house prices and trade imbalances that have been so prevalent in Britain throughout the past 15 years.

The second reason for becoming more optimistic about Britain’s prospects just as the world seems to be turning glummer is more short term. While British fortunes have usually followed America’s in past economic cycles, this time Britain appears to be leading, rather than following, the US cycle. This means that, whereas America is now on the brink of a serious slowdown, a big correction in house prices and a possible upsurge of inflation, Britain has probably experienced the worst of these problems already.

The clearest example of this cyclical divergence between America and Britain can be seen in the housing market, which is pulling out of its two-year slowdown in Britain just as the US market declines. And the earlier downturn in the British cycle has kept inflation subdued, while it has steadily risen in the US. As a result, there is much less reason to worry about sharply increasing interest rates in Britain than in the US.

From the mid-1990s until about two years ago, I had consistently occupied a position of extreme optimism on the British economic spectrum. Then in the middle of 2004, I switched to a much more cautious stance. I felt that the combination of an overheated housing market and the pressure on government finances from half- hearted public service reforms would make a deterioration in the economy almost inevitable. But in the past two years we have seen a significant slowdown — and hard as it is to credit, the dreaded “day of reckoning” for the British economy may be over already, before it even began.