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Gordon Brown Spending His Way out of Economic Contraction into Stagflation

Economics / Recession 2008 - 2010 Oct 27, 2008 - 05:42 PM GMT

By: Nadeem_Walayat

Economics Best Financial Markets Analysis ArticleFriday's announcement of surprisingly high 0.5% GDP contraction well above the forecasts of 0.2% and the Market Oracle forecast of 0.3%, confirmed that the UK economy is heading for a deep recession which looks set to beat the 1990's recession that saw a 2.5% contraction in GDP from peak to trough.


The consequences of economic contraction were seen earlier in the month with the surge in unemployment of 10% as the below graph illustrates. However dynamics of today's labour market suggests at this point in time that unemployment is forecast to rise to just above 2.5 million by April 2010 (the deadline for announcing the next election).

Today Gordon Brown defended his borrowing binge to prevent an economic bust by spending his way out of recession and thus abandoning the golden rule of keeping public debt to below 40% of GDP, with the expectations that Chancellor Alistair Darling announcing more concrete borrowing figures later this week.

The extra debt burden of £500 billion would cost the tax payer approx £25 billion a year in extra interest which effectively nearly doubles the countries official government debt of £590 billion which tends to exclude in what can be termed as creative accounting other public sector debt, such as un-funded public sector pension liabilities of more than £800 billion with other hidden debt totaling £100 billion would put real UK public debt at some £2 trillion or some 160% of annual GDP which is far above the governments official limit of 40% of GDP. However economic contraction will shrink UK GDP and hence the gap between spending and income will be again be filled by more debt. Therefore we could see public debt rise to as much as 100% of GDP and if the hidden debt is included, a rise to 200% of GDP.

The consequences of all this increased debt based spending will be higher inflation and higher taxes and hence the perfect storm of consumer price inflation coupled with asset price deflation as the stock and housing market slump continues, therefore a pushing the UK economy into a prolonged period of stagflation.

I have pointed as long as go as March 2008, with literally monthly reminders that that the Labour governments anticipated policy of spending its way out of recession would herald the perfect storm of asset price deflation coupled with consumer price inflation due to a collapse in sterling and therefore push the economy into a prolonged period of stagflation which is what is now coming to pass as the below sterling graph illustrates (Friday 24th Oct).

UK Interest Rates

As long ago as April 2008, I began speculating that the Government would force the bank of England to abandon the inflation target no matter how high inflation rose. This expectation has grown over intervening period which reached a crescendo level in early October that despite the highest inflation rate in over 16 years of 5.2% CPI, the Government would order the Bank to cut rates by 0.5% at Thursday's scheduled MPC meeting, as events transpired Gordon Brown announced the interest rate cut at wednesday PMQ's at the House of Commons, exactly 24 hours before the anticipated rate cut event.

The next scheduled rate cut is for 0.5% in November with the forecast for interest rates to be cut to 3.25% by Sept 2009, as per the UK Interest rate forecast as of early October 2008, as an update to the expired September 2007 interest rate forecast for UK interest rates to fall to 5% by September 2008.

However those expecting rate cuts on par with the US i.e. to below 2% are forgetting one fundamental fact and that is that the British Pound is NOT the reserve currency of the world, but the US Dollar is and therefore extra money printing by the government to save the economy carries a huge cost in terms of future economic performance and inflation as investors start to view the british economy as a big version of Iceland as I pointed out some 2 weeks ago, This will become more evident as the government seeks to spend ever larger amounts of ,money the consequences of which will be the British Pound will crash lower far further than anyone expects today.

Over the coming days and weeks, I will seek to address reader demands for updates and generate forecasts for the UK economy over the coming years into a 2010 general election. Subscribe to our always free newsletter to get the scheduled analysis in your inbox on the day of publication.

Scheduled newsletters cover the following forecasts and topics -

  • UK Inflation forecast 2009, Why the Bank of England always gets it wrong on inflation.
  • UK GDP forecast 2009 to 2010, How deep will the recession be.
  • UK Housing Market forecast 2008 to 2010, an extensive update to the existing forecast of a 15% fall over 2 years and 25% for London as of August 07.
  • Crude Oil Forecast Update - Existing Fall from $146 to $80 over 3 to 6 months (July 07)
  • The Real Secrets of Successful Trading, the culmination of 20+ years of trading experience, an update to Beating the 1987 Crash.

On a positive note, the deleveraging of the asset markets is presenting excellent long-term mega-trend opportunities as the recent article highlights - Stocks Bear Market Long-term Investing Strategy

By Nadeem Walayat
http://www.marketoracle.co.uk

Copyright © 2005-08 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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