Recessions come in many shapes and sizes, but they all have one thing in common - a reduction in the total value of economic activity. Because economic activity is a result of the interaction of supply and demand, one might think a change in either supply or demand can change the total value of business done. In fact it is the total value of demand which determines how much activity there will be. If supply increases but demand stays the same either prices fall per unit of sales or some goods remain unsold. If supply reduces but demand stays the same, prices rise. In either event the total value of sales remains the same. It is the value of demand or, if you prefer, the amount people choose to spend, which determines the total value of sales.
When credit is so cheap that people do not think twice about spending on the never-never there can be a huge boost in the total value of sales. Manufacturers of sumptuous beds, big televisions, fancy double-doored fridge-freezers and many more modern nicenesses increase production because there is a queue of people wanting to upgrade their stuff now and pay over the next few years. The difficulty comes in sustaining the expansion. Every business which increases the value of its sales by £10,000 in one year has to receive that extra again £10,000 the next year just to stand still. Yet we have seen steady growth in total sales for more than a decade, much of it funded by credit.
Now the borrowed chickens are coming home to roost. Not only can the expansion not be maintained but a sustained reduction in economic activity has been confirmed. It has been headline news all day: it's a recession, official. Until today it was an inevitability. Everyone knew it was happening, so what has changed?
That is where my random thought comes in. I have no idea whether it is right or wrong. My thought is that "official" confirmation of that which we all knew anyway will cause behaviour to change. Instead of having a desire to retrench people will feel a compulsion to do so. Switching to the supermarket's own brand baked beans instead of Heinz or Cross & Blackwell will become a switch to the supermarket's economy line of baked beans. The weekly treat of an evening in the pub will become fortnightly. New clothes, new beds, a larger telly and all the rest of it will be approached with far more caution than would have been the case just two or three days ago.
I might be wrong, but I feel announcing the recession as an apocalyptic event will have the effect of slowing spending far faster than would otherwise have happened. We will never know whether this will prove to be beneficial or detrimental in the longer term because what actually happens will be fact and what might have happened will only be hypothesis. Undoubtedly a sharp decrease in spending will lead to redundancies in retail and manufacturing businesses which, by a domino effect, will further reduce spending power. Some businesses will fold completely, many would have folded anyway through withdrawal of credit facilities and more will be dragged down by the combination of tight credit and falling sales.
For several weeks we have been told about the problem banks face. They lent too much against too little security and have to re-balance their books. The supply of credit to finance consumer spending on unnecessary luxuries has been reduced. But that is only one side of the equation. If people who might have been tempted to borrow money are no longer tempted because they are retrenching, the lack of supply of credit is no more the cause of reducing spending than lack of demand for credit.
If I am right in thinking that the way the recession has been announced will have a profound influence on spending patterns, we can expect quite a sharp downturn in consumer demand. This should result in the credit bubble deflating quite quickly. There will be many business casualties along the way but it should help keep the recession short. What we will then need to worry about is whether the country's economy can expand through something other than a credit bubble. That is a whole new kettle of ballgame.
When credit is so cheap that people do not think twice about spending on the never-never there can be a huge boost in the total value of sales. Manufacturers of sumptuous beds, big televisions, fancy double-doored fridge-freezers and many more modern nicenesses increase production because there is a queue of people wanting to upgrade their stuff now and pay over the next few years. The difficulty comes in sustaining the expansion. Every business which increases the value of its sales by £10,000 in one year has to receive that extra again £10,000 the next year just to stand still. Yet we have seen steady growth in total sales for more than a decade, much of it funded by credit.
Now the borrowed chickens are coming home to roost. Not only can the expansion not be maintained but a sustained reduction in economic activity has been confirmed. It has been headline news all day: it's a recession, official. Until today it was an inevitability. Everyone knew it was happening, so what has changed?
That is where my random thought comes in. I have no idea whether it is right or wrong. My thought is that "official" confirmation of that which we all knew anyway will cause behaviour to change. Instead of having a desire to retrench people will feel a compulsion to do so. Switching to the supermarket's own brand baked beans instead of Heinz or Cross & Blackwell will become a switch to the supermarket's economy line of baked beans. The weekly treat of an evening in the pub will become fortnightly. New clothes, new beds, a larger telly and all the rest of it will be approached with far more caution than would have been the case just two or three days ago.
I might be wrong, but I feel announcing the recession as an apocalyptic event will have the effect of slowing spending far faster than would otherwise have happened. We will never know whether this will prove to be beneficial or detrimental in the longer term because what actually happens will be fact and what might have happened will only be hypothesis. Undoubtedly a sharp decrease in spending will lead to redundancies in retail and manufacturing businesses which, by a domino effect, will further reduce spending power. Some businesses will fold completely, many would have folded anyway through withdrawal of credit facilities and more will be dragged down by the combination of tight credit and falling sales.
For several weeks we have been told about the problem banks face. They lent too much against too little security and have to re-balance their books. The supply of credit to finance consumer spending on unnecessary luxuries has been reduced. But that is only one side of the equation. If people who might have been tempted to borrow money are no longer tempted because they are retrenching, the lack of supply of credit is no more the cause of reducing spending than lack of demand for credit.
If I am right in thinking that the way the recession has been announced will have a profound influence on spending patterns, we can expect quite a sharp downturn in consumer demand. This should result in the credit bubble deflating quite quickly. There will be many business casualties along the way but it should help keep the recession short. What we will then need to worry about is whether the country's economy can expand through something other than a credit bubble. That is a whole new kettle of ballgame.
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There will be many business casualties along the way but it should help keep the recession short. What we will then need to worry about is whether the country's economy can expand through something other than a credit bubble.
Exactly, let's get it over with, especially the house price crash and we can all start again. Don't forget that 85% of all credit went into the property price bubble, only 15% went into the proverbial holidays and flat screen TVs.
I have a plan for keeping house prices low and stable, diverting credit into the productive economy and reducing taxes on income and production, it's called Land Value Tax, but the myth that home ownership is the automatic and rightful path to riches is too deeply engrained, I am afraid.
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