In theory, the impact of the global credit crunch of 2008 is supposed to be dissipating. The global economy is growing and the banks are back making money. Political and business leaders are speaking about a return to normality.
Yet conditions are still very far from "normal".
Bank of England interest rates are nominally 0.5%. Yet the historic average interest rate since the Bank of England was founded in 1694 is 5%. Monetary authorities around the world are not only setting negative real interest rates, but also seeking to fill the economic hole left by the credit collapse with new money: the so-called "quantative easing". These are very extreme monetary positions.
Although the US policy makers remain concerned about deflation in the Dollar, the UK faces different problems: British inflation is quite high. The general inflation number remains consistently higher than in global competitors, and more to the point, the UK housing market has continued to boom. Whereas in the US we have seen house price falls of as much as 40%; in the UK, nominal prices have continued to rise. Despite the slowing of the economy, and the prospect of significant action to cut the unsustainably high deficit, house prices have continued to rise. Some point to unexpectedly strong GDP growth numbers, but the fact remains that the sustainability of UK growth is a huge question while interest rates remain so low, and the deficit remains high. Growth rests upon these two highly unstable foundations, and now both the government and the Bank of England must address their problems and try to return the British economy to more normal conditions. Yet the conditions that obtained before the credit crunch set in were not normal either: the longest boom in history was funded by the largest credit expansion in history, followed by the bankruptcy of the banking system, which required the largest bank rescue in history.
The UK has used the global credit expansion to fund house prices, and not investment: hence Britain has both a weak physical infrastructure and inadequate investment in business. It is not surprising that the country has created a structurally high rate of inflation. The question is now what happens to house prices when the government cuts expenditure and interest rates go up?
This is not an academic discussion: the BAnk of England is already moving towards a more hawkish stance, while the Osborne budget suggested that the cuts in government expenditure would be of the order of an across the board cut of 20%, and in certain areas, much higher. Indeed the Russian drought and Canadian floods that are conspiring to increase the price of wheat, may mean that the inflationary ogre will be at the door much sooner than previously forecast.
So, the gloomy profits warnings from the likes of Next may indeed be quite justified. The British economy still has a very long way to go before we can speak of sustainable conditions for growth. Gordon Brown, who foolishly decreed an "end to boom and bust" without understanding that his own policies were themselves distorting the business cycle, has left a poisonous legacy.
The gloom of autumn will soon be upon us, although confidence in the coalition will probably protect Sterling somewhat- though it will be the inevitable hike in rates that will protect it more.
The price will be higher unemployment and -finally- an inevitable correction in the housing market.