London’s blue-chip FTSE 100 index closed at a nine-month high on Friday, finally recouping all the ground lost since the UK went into lockdown in March. The City is not alone. In New York, shares are at levels never seen before. As someone once said: they think it’s all over.
And in a sense it is. Current share prices do not reflect the current state of the major global economies, which, outside of China and a few other Asian countries, is grim. Rather, they are looking ahead and trying to predict what life will be like in six months or a year’s time.
By then, the expectation is that mass vaccination programmes will have beaten back the threat of Covid-19, physical-distancing rules will have been lifted and life will be returning to the way it was pre-crisis.
Even if there is some doubt about the pace of immunisation, it seems reasonable to assume that 2021 is going to be a better year for the economy than 2020, and perhaps a lot better. Indeed, Torsten Bell, the chief executive of the Resolution Foundation thinktank, went so far as to hold the possibility of a repeat of the “roaring 20s” as households spend the money they have saved this year.
From a historical perspective, Bell is wide of the mark because the roaring 20s were a US not a UK phenomenon. There was a frenetic post-first world war boom but it lasted little more than a year and ended with a major contraction of the economy in 1921 – the biggest one-year fall in output of the industrial age until 2020. After that, it was a bit of a slog because the makeup of the UK economy was heavily weighted towards industries that were in structural decline, such as cotton and shipbuilding. The reason there was a relatively modest fall in UK output in the Great Depression was that the poor performance in the 1920s meant it had less far to fall.
In another sense, though, Bell is right on the money. The UK’s savings ratio shot up to 29% during the second quarter of 2020, in large part because people had nothing to spend their wages on. This trend was, according to the Institute for Fiscal Studies, most marked among better-off workers. Those on the lowest earnings – most likely to have lost their jobs or to have been furloughed on 80% of their previous pay – dipped into their savings.
After a brief interlude in the summer, restrictions on hospitality venues and shop were tightened once more in the autumn. That means there is plenty of pent-up demand ready to be unleashed once consumers feel confident enough to spend and are allowed to do so. This is exactly what happened after the first world war when the end of rationing prompted a colossal – if short-lived – spending spree.
The pent-up demand story is already evident in the housing market, where the Bank of England reported last week that mortgage approvals rose to their highest level in 13 years in October. There was really no need for Rishi Sunak’s temporary cut in stamp duty.
So what stands in the way of the “roaring 2020s” becoming a reality? One possibility is that it could all come to grief because of inflation, as it did in 1921. If prices were to start rising rapidly, the Bank of England would come under pressure to raise interest rates and that would kill the boom stone dead.
Currently, this doesn’t look all that likely. There would be a serious inflation threat if harm caused to the economy by the pandemic meant supply could not keep up with demand. So far, though, there has been no serious long-term damage to the supply side of the economy, while rising unemployment and the squeeze on living standards for those in vulnerable sectors means there is plenty of spare capacity to be used up before inflation becomes a problem. That said, ultra-low interest rates and the expansion of the Bank of England’s quantitative-easing programme mean there is already plenty of asset-price inflation.
Policy error is the other big potential threat. Sunak has to make a judgment reasonably soon about how much support he is going to continue to give to the economy – and for how long. At present, the furlough runs until the end of March, as does the £20-a-week top-up to universal credit.
Consumer confidence is weak. The same Bank of England release detailing the 13-year high for mortgage approvals also showed people paying back their credit card debts. Last week’s collapse of Arcadia and Debenhams will have heightened fears – especially among low-income workers – of unemployment.
Back in the 1920s, monetary and fiscal policy were rigidly orthodox. The Bank of England wanted Britain back on the gold standard and the Treasury wanted to balance the budget. Times change. An increase in interest rates from Threadneedle Street is years away and Sunak is on course to borrow more this year to support the economy than any chancellor in peacetime history. He would be both brave – and foolish – to assume it is job done.
Ultimately, there is a limit to what the Bank and the Treasury can do because – as was the case in the interwar period – Britain’s problems are as much to do with the structure of the economy as they are to do with demand. By the late 1930s, industrial production in the UK was growing fast, not simply because the pound had come off the gold standard but because of a shift from heavy industry to light engineering and the production of cars and other consumer goods. Failure to learn that lesson will mean that any post-pandemic boom will once again be a flash in the pan.