UK Economy A Flood Of Questions?

I have been watching with wonder as the economic news flowing from the UK has been spun to give the impression of robust growth. How do you explain the pick up in growth to a mature country that has been struggling under debt? In general the UK economy is not particularly competitive, over-weighted in the service sector and global finance it is vulnerable to problems that surface throughout the world. As usual we must look deeper into the facts to get a clear picture of what is really happening. It now appears much of the recent strength comes from the fact that thousands of Britons are receiving compensation for Payment Protection Insurance (PPI).  Most Americans reading about the pickup in Britain's economy never even heard of the PPI. The total paid out so far, £13.3bn or about 22 billion American dollars has been a huge economic boost. More about this later in the article.

Damage from flooding brings the wrong kind of growth

In recent weeks we have seen extraordinary amounts of rainfall in England and Wales which has caused flooding in many areas. But even this has not put a damper on the economy, the British Pound, or enthusiasm. When the water levels finally subside we'll have a chance to fully assess the damage to the economy and who the winners and losers from the flooding are.

At last count, 5,800 properties had been flooded, this is a pretty small number considering the scope of the recent flooding , but it's still a nightmare for those affected. Insurers have been estimating average repair works of around £35,000 per household or the equivalent 58,000 American dollars on just houses. So add on other damages and the costs mount up very fast. On top of that, many thousands of households have had to be evacuated, even if the homes have not in the end been damaged. With the help of local authorities and the Environment Agency we have seen the people of the UK battling to protect their properties from rising flood-waters. All of these people have taken big losses in terms of time and effort, many have had to take time off from work or been unable to get to work.

Many farmers have been struggling with flooded fields and ruined crops. Transport problems have also made it difficult to get supplies such as bedding and feed to livestock farmers. This might turn out to be a benefit in the future for unaffected farmers if spoiled produce means higher prices, but still it is a double edged sword for the economy as it spills over and harms consumers.  Mark Carney, the Bank of England governor predicts that the flooding will reduce economic activity during the quarter but thinks it will catch up to forecast in coming months. Often following weather events we see a pick up in repair work and people buying things like carpets and furniture to replace damaged items. Even in areas where flooding has been less of a problem, the heavy and persistent rain has highlighted problems with things like roofs that need repair.

But let us return to the issue of the recent economic strength. Because of  "mis-selling"  Payment Protection Insurance banks in the UK were forced to compensate customers who bought the insurance policies, but often did not need them. Research suggests that only 12% of those receiving the cash have saved any of it. Much of this consumer windfall has been spent as the cash was dished out on holidays and cars, according to a survey. As previously noted the "booming" car sales in the UK have been put down to money from these PPI payments. Experts have said the PPI is the equivalent of a 1% kick to UK GDP, making it a more effective than any recent government incentive to spend.

To many the strength of Britain's recovery has been confirmed by vehicle sales that surged in the last twelve months by almost 11% to 2.26 million vehicles. By all appearances consumers have been feeling more confident, credit is more readily available (around three quarters of private purchases are on credit) and PPI compensation payments have provided the few grand needed for the deposit. What has surprised some people is the evidence that consumers are spending the cash, rather than using it to reduce debts. That at least would be a reasonable conclusion to draw from the recovery of sales of expensive items. Still we must note that UK retail sales fell in January by 1.5% last month.

With a population of around 65 million people this means the average person in the UK received a huge one time check. This payout so far would be the equivalent of sending every man, woman, and child in America a check for 330 dollars and ask them to spend, spend, spend! Reason for recent UK growth explained. This brings us to the elephant in the room. What happens when the PPI payments stop flowing? In many ways this has been a big money-creation exercise for the benefit of consumers. In just over a year and a half  banks have paid out most of the £16bn they were ordered to pay out. This represents an economic boost and a bigger direct fiscal stimulus than anything the government has attempted since the crisis of 2008, it even involves more money than the temporary VAT cut of 2009.

I contend PPI payments are the reason why the recovery in Britain appears so robust during the last three months of 2013. It is difficult to judge whether PPI compensation has been more effective in encouraging the recovery than quantitative easing, or Funding for Lending or the two phases of Help to Buy.  But those initiatives are qualitatively very different from the PPI stimulus - they all in effect pump mind-boggling quantities of cheap loans into the economy, money that eventually has to be paid back. The PPI payments are free, no-strings attached cash. PPI compensation is as close as we've seen to what the economists call "helicopter money" or the distribution of bundles of money to everyone, or in this case millions of households.

The PPI cash has depleted capital resources at the banks and may be a suppressant of their appetites to lend. It looks like the payments have arrived at a time when consumers have tired of cutting back and have decided to treat themselves to something special. Remember this money flowed directly to those with a history of taking loans, this makes it very targeted. With the PPI payments about to end the question is whether the economic momentum it has generated has created escape velocity or just a temporary boost, I think the later. As for the flooding, In my opinion destruction of a countries resources and property is never a good thing and this time we may see the water wash away a lot of optimism.


 Footnote; For more articles that may relate to this post see the posts below, comments are welcome and encouraged,
                   http://brucewilds.blogspot.com/2012/10/a-helicopter-drop-for-england.html
                   http://brucewilds.blogspot.com/2013/01/currencies-games-in-danger-zone.html