Six Economic Predictions for 2014
The views represented in this article are solely those of the author and may not be construed as in any way representative of the views or policies of Oxford Royale Summer Schools.
Forecasting is a mug’s game. That’s certainly true if you’re… a professional forecaster.
Britain’s Office of Budget Responsibility, the non-partisan body established to forecast economic growth numbers for the Treasury, has no better a record than its in-house predecessors – it called the recovery too early, having to revise down its 2012 growth estimate from 2.5% to 0.7% in 2011, it then called it too late, having to raise its 2014 prediction to 2.4 % from 1.8% at the end of 2013. As has been the case with official bodies everywhere for the duration of the crisis, the OBR has tended to forecast with both eyes on the rear-view mirror, making official predictions less a case of staring into the future than attempting to extrapolate the past.
While this error makes a great deal of official forecasting redundant, so too does the obsession with reversions to the mean. Danny Blanchflower’s role as the malcontent-in-chief of the British monetary policy scene occasionally produces some genuinely alarming insights. The notion that the OBR will always model a reversion to mean, irrespective of the evidence it is presented with in the immediate term, is alarming from an accuracy perspective and helps explain some of the irrational exuberance of supposedly impartial forecasters in the depth of this financial crisis. The government compels all financial services firms who are advertising to do so with the notice that “past performance is no guide to future returns”, and it would be a boon to accuracy were its own statisticians to remember this.
All of the above notwithstanding, it is easy to be wise after the event. Predicting the course of the modern economy is difficult because it involves a mental conflict between what should happen and what does happen. I firmly believe that this is the greatest difficulty facing investors at present. There is a sense amongst many, myself included, that something along the lines of the following is true – gold up, gilts down, inflation up, house prices down. These may be logical positions, but this is not a logical market – following any of these through would make one a disastrous investor. Instead, we are, to an extent, trapped in semi-permanent quantitative easing, where the government is determined that the riskier the asset, the greater its outperformance.
Most of the predictions below are directly tied to government intervention in supposedly free-market economies. At some point most investors assume a resumption of the mean – free floating capital markets without the government deliberately driving asset prices skywards. Like the assumptions of resuming normalcy by the economists at the OBR, I fear we may be sadly mistaken here – governments in the modern era do not relinquish powers they have assumed for themselves, particularly when they have gone to the trouble of summoning into being vast bureaucracies to administer them. There might be nothing new under the sun, but in modern terms, when the corruption of the market runs this hard and this deep throughout the West, we are in what seems to be uncharted territory.
With all that in mind, here are my economic predictions for 2014…
1. UK GDP growth to hit 4% p.a.
2. UK house prices to rise by 15% in London, 7.5% elsewhere
The early years of the financial crisis were marked by a degree of desperation and panic, but also by a kind of exuberance and excitement which has become lost somewhat as it enters the second half of its first decade. President Obama’s adviser Rahm Emanuel has been eviscerated in the Right-wing press for saying that “you never let a serious crisis go to waste”, but he captured the mood of the age. The sense that the vanishing certainties of the old order presented the opportunity to put something more robust, equitable and durable in its place was near universal. Instead, the determination of central banks to support the foundations of the existing economic structures across the West meant that we are stuck facing the same models and the same problems. This is particularly the case in Britain, which will begin 2014 with a model of economic growth which is reliant on government spending (which has not been reduced as a result of austerity, although if anything it may now be allocated less efficiently), and house price inflation. The coming year is set to be a good year for both.
First, government spending. This is projected to come in at £719bn in 2014, having begun the life of this parliament at £672bn. Since the austerity government took up the reins of power in the UK, the national debt has grown and the deficit, which was supposed to have vanished by 2015, will now last until 2018. In the meantime, very few of the structural problems which the UK economy faces have been resolved. The British have the worst trade deficit in the industrial world, and the inflation in the price of household essentials has far outstripped the headline national rate (see Tullett Prebon note here).
In the long term, this is a troublesome prescription. In the short term, it bodes well for a recovery based on debt-fuelled consumption by both state and citizen. Nowhere is this more true than in housing. The Government’s Help to Buy scheme, which incepts on January 1st, ought more accurately to be titled Help to Buy a More Expensive Flat. Making housing more affordable for the poor means addressing the supply component of supply and demand. This cannot happen for political reasons – Tory voters do not like building on green-field land, while existing homeowners do not want to see the value of their assets fall. Instead, the government has decided to guarantee the tranche of mortgages between 5% and 25% for prospective home buyers in a bid to see the return of 95% mortgages.
In the long-run, this is staggeringly irresponsible. Encouraging high loan-to-value lending to borrowers who are, by definition, sub-prime, is a curious way of building stability into the system. Moreover, having a low deposit suggests either a constitutional irresponsibility on behalf of the borrower who would rather spend their income on trinkets, or, much more likely, a very low disposable income. If the latter is the case, then the borrower of a 95% mortgage is not likely to have much of a ceiling where interest rate rises are concerned. Locking a significant portion of young borrowers into potentially ruinous mortgages is an odd thing to make a central pillar of your response to the challenge of financial stability, yet it is what this government has done. The long-term effect will be to denude the Bank of England of its one weapon in the battle against inflation – rate rises.
In the shorter term, though, the effect will be to push up prices, a lot. At a conservative estimate, I believe that UK house prices will go up 7.5% next year, and double that in London, as the national mood swings towards ‘now or never’ and supply remains constricted.
This will have a huge impact on GDP. The effect of house prices on GDP numbers is not fully appreciated and deserves a greater examination at some point in the future. In the meantime, suffice it to say that a rising tide in the housing market disproportionately lifts the good ship Government. The UK is due sterling growth next year as a result of this. As was the case in 2014, this will be growth which exists as an illusion on a statistician’s screen, a portent of trouble to come rather than a reward for the hard work already performed. I think growth will boom next year, but that this is not to be taken as a healthy sign. I call it at 4%.
3. S&P 500 past 2,000
4. Gold to fall to $800
The omnipotent central bank is one of the great mainstays of our time – nobody quite believes it, but by dint of collective effort and wilful suspension of disbelief, market participants have convinced themselves that everybody else believes that it is true, even if they are wise enough to see that the emperor is naked. This is a curious situation – markets are buoyed not so much by the confidence of speculators as by their cunning. They look to buy not because of the market fundamentals but because they see that everyone else is buying irrationally and, clear-eyed, seek to profit from their speculation.
This has already been a good year for the stock markets. Despite the risk of tapering (reducing, not removing, asset purchases), the prospects for next year are also excellent. As far as is foreseeable, quantitative easing is now a permanent programme aimed at supporting asset prices by driving the price of low-risk assets down to such an extent that investors prefer higher-risk assets which may already be over-valued. No matter what happens in the real economy next year, the forces at work supporting the markets will continue to rage. I take the S&P 500 to be up at least 10% next year at over the 2,000 mark.
This is not true for all assets, though. I have written already in this series that I believe gold to be the natural investment for a period of extended uncertainty, such as this one. It is also a poor investment to be making when the market narrative has moved against it so much in the West. Tied to the myth of central bank omnipotence is the idea that sound money no longer matters. The rationale for buying gold is that scarcity is an essential property of money, and that the lack of scarcity means that fiat money is unlikely to maintain a value close to its current peak. This is a belief justified by history. On the other hand, the entire economic edifice of the West is now built around an altar to loose money. You can fight the Fed all you want, but your reward for doing so in the year ahead will be a feeling of self-righteous satisfaction rather than one of rising prosperity. I see gold going down to $800, despite continued buying from China as it plays the long game.
5. Eurozone inflation to rise to 2%
6. Exit talk to be German, rather than periphery, focussed
On the topic of market narratives, the Eurozone ones seems to be being discussed more quietly than has been the case for some time. Again, very few of the root causes of the crisis – particularly the internal imbalances resulting from fixed exchange rates between member states – appear to be resolved. Both Ireland and Spain have performed heroics in largely satisfying the demands of their rescuers, although the benefits have been far more obvious in the former than the latter.
I doubt that the single currency will get through another year without a crisis. That said, the poverty of imagination of the leaders of its constituent nations is such that it is extremely unlikely that any of the peripherals will seek to leave. A greater existential threat will be the growth in Eurozone inflation which is likely on the back of the rate cut at the end of 2013. At present, inflation of 0.7% allows for both monetary expansionism and Teutonic face-saving. However, with the worst of austerity now passed in the periphery, and lending strong in the northern core, it is likely that inflation will rise in the year ahead towards the 2% mark.
This would not be earth-shattering elsewhere. In Germany, it is likely, however, to prompt an existential crisis. The nation is still shaped, at a policy experience, by the events of the first half of the last century. Not only is inflation seen as morally undesirable, but the validity of the entire European project is placed in doubt when it acts as a means of debasing the value of money in order to facilitate the profligate spending habits of foreign governments. The German involvement in Europe is part-war guilt, part-paternalism, part-imperium. These forces are too great for the country to leave, but expect dissenting voices to dominate the Eurozone debate in its most important member in the year ahead.
The year to come will be an exciting one for an investor, and a worrying one for the many for whom the excitement of investors should not be a priority in monetary policy design. One thing’s certain, though. We won’t be reverting to the mean any time soon.