A Chilling Forecast For The Economy Of The U.K.

An article in the Telegraph this evening suggests that the economy of Great Britain could shrink by between five and ten percent next year. That is a grave number.

The article cites the usual complaint about banks not lending money to the private sector. Probably a somewhat valid criticism, though I continue to maintain that forcing banks to lend into this environment will only perpetuate the asset quality problems that they are trying to overcome. But, I think significantly, the article also points to a mindset that is creeping into private enterprise. Specifically, it is a mindset of deflationary expectations that causes new investment and expansion to be indefinitely deferred.

“It is easy to see that things could be even worse,” he said. “Despite the public declarations by the Government that the banks ought to be lending more, it is clear that the primary concern of many of our largest banks is to shore up their balance sheets and, for those on the end of government bail-outs, to pay back their Treasury paymasters.

“With few incentives for banks to behave otherwise, credit availability to businesses may become even worse during 2009. At the same time, businesses are already starting to become entrenched in a deflationary mindset where investment budgets are curtailed not only because budgets are tight, but also because prices are falling.”

With companies facing major pressure on their balance sheets, they look likely to slash their investment budgets, in so doing cutting staff numbers and wage bills next year. If this combines with a sudden sharp increase in the rate at which consumers save rather than spend, the result could be that a major chunk of UK economic output is lost, he said.

If indeed the psychology of deflation or even a sense of wait and see becomes the dominant driver of business and the consumer then all of the levers of the financial authorities are going to be pulled for naught. Whether in the U.K. or the U.S. the ultimate arbiter of this crisis is going to be the psychology of the private sector.

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