We love bubbles – but UK has yet to recover from the last two

 
Allister Heath

ONE last push – that is all that is needed for the UK stock market to finally bury the ghost of the dot.com bubble and bust. Remarkably, the FTSE 100 has still not got back to the level it reached on the last trading day of the previous millennium, a time of euphoria and irrational exuberance, which goes to show just how long the effects of a bubble can take to wear off.

It has been 14 years and counting; 2014 will almost certainly be the year that the stock market hits an all-time high – an event which could happen any day now or which might conceivably take months, such is the unpredictability of it all – and that the economy returns to the level of output it reached just prior to the financial crisis of 2007-09.

The FTSE 100, which closed at 6,836.73 last night, is now under 100 points from its previous record close; it peaked briefly at 6,950.60 on 30 December 1999, before closing at 6,930.20 on that day, a level it has never returned to since. In real terms, after adjusting for inflation, the index remains far lower than it was; against that, however, need to be set dividends, which over time drive returns and mean that investors have done much better than the index statistic would suggest. Investors often claim to be in it for the long run; but in this case we are talking about the really, really long term.

Over 50 or 100 year periods, the only thing that matters is the supply-side: how much companies invest, technological innovation, the extent of the division of labour and knowledge, trade, the efficiency of financial markets, the size of the labour force, the quality of human and other sorts of capital, and how the tax and regulatory system incentivises work, savings, investment and productivity growth.

In the shorter-term, however, a period that spans at least 20 years, shocks to demand also matter hugely: bubbles caused by loose monetary policy (such as that of the 1980s, of the late 1990s and of the 2000s) can inflict massive disruption when they burst, and recessions caused by excessively tight money (a nightmare that many Eurozone economies still face today) can also impose immense, long-lasting damage. That doesn’t mean that we shouldn’t care about the long-run, of course: policies that help an economy grow in the very short-term but that inflict havoc and impose large costs in the future (such as vast debts) should be avoided like the plague.

All of this should be born in mind when the IMF releases its latest economic growth forecasts later today. These are widely expected to predict an expansion of 2.4 per cent this year, up from 1.9 per cent; the IMF had only revised its forecasts three months ago, prior to which it still thought the UK would expand by just 1.5 per cent. Britain is set to do much better than Germany, Italy, Spain and of course France. As ever, the IMF is behind the curve: the private sector has already priced in these sorts of levels of growth or even better.

Much of our recovery is cyclical in nature: the banking system is working better, wages have fallen, many dud projects have been liquidated and the economy is moving on. As to structural reforms, the good and the bad are cancelling each other out, and the UK isn’t becoming economically freer, according to the latest Heritage Foundation index of economic freedom. The UK is rated 74.9, the 14th freest; our score is the same as last year’s, with modest improvements in government spending, labour rules, inflation, and trade offset by deteriorations in freedom elsewhere.

The real problem is that some of our recovery is being caused by a good old artificial stoking of demand: interest rates are still at crisis levels and vast amounts of subsidised credit are being injected into the housing and consumer sectors. We are at risk, once again, of enjoying too much of a good thing. When will we learn?

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

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