In addition to our recent post on the impact of the UK fiscal stimulus (see post), two further thoughts come to mind:
1. Our original post assumed constant purchasing parity of the Pounds borrowed. Of course, this will only be correct in a world of zero price changes. If the Bank of England achieves it's target inflation rate of 2% per annum, then the purchasing parity equivalent of £350 billion at 2017 prices would be £297.76 billion in 2009 prices. To put it another way around one seventh of the debt will be lost to inflation. None of the press comment has taken this into account.
Of course, our assumption may prove to be quite heroic. There is a good case to suggest that the inflation out-turn for the next 8 years will be below 2% (a period of deflation ahead), which worsens the case for borrowers. There is also a good argument in favour of inflation averaging above 2% (the resumption of globalisation), which improves the case for borrowers. For those of a scenario bent, this may be an interesting critical uncertainty for the near future.
2. We are now starting to see some estimates of the reserve capitalisation that the UK banks will be required to hold in the future. In a thoughtful piece in The Economist (see article), Alan Greenspan estimates that the bank equity to assets ratio will have to rise from about 10% to about 14% in the New Normal. If this capitalisation is held in the form of gilts, then an additional £80 billion to £200 billion will need to be bought by the banks in order for them to achieve their new capital adequacy requirements.
Of course, this is all banking speak. What is important in the real economy is what this might mean in commercial terms. If Alan Greenspan is right, the bank multiplier (the number of times a bank can lend and relend its deposits) will fall from 1:9 to 1:7. For every £1 deposited, instead of £9 beng lent, £7 will be lent. In effect, this will represent a 22.2% reduction in available credit for every deposit made. It seems that the Age of Scarcity will start with a shortage of credit!
This is something that businesses might like to start factoring into their strategic plans right away. If external credit is tight (remember, our view is through to 2017), then retained earnings will have a much greater significance. Growth in the New Normal is likely to be organic rather than through acquisitions. If so, then one can question the use of share buy-backs as a financial device, and speculate upon the revision of dividend policies by major corporations.
© The European Futures Observatory 2008