Belated news, but hardly out of date: the FT on Monday had a remarkably pessimistic commentary on its op-ed page by Wolfgang Münchau, saying, in essence, that the credit crunch will be even nastier in the UK than in the US, because our economy is still more run on smoke and mirrors than theirs.
In the next few years, I expect the UK economic miracle to be exposed for what it was: an overlong joyride on the back of an overlong asset price bubble. The UK economy is about to undergo a downturn at least as large as that of the US – maybe even worse, because of an even more inflated housing market and because the financial sector constitutes a larger share of gross domestic product.
According to my calculations, UK residential property prices are about 30 per cent above their trend in real terms. If the trend has not changed in the past few years, that would suggest that inflation-adjusted prices could fall by up to 40 per cent from peak to trough.
A house price crash would take time to unfold. Assuming a constant inflation rate of 2 per cent a year, nominal house prices would have to go down by about an unprecedented 25 per cent if the decline stretched over six years. Remember: the first stages of a housing downturn consist of denial followed by anger. A fall in actual prices is a relatively late-stage phenomenon of a housing crash.
The UK financial sector is in no less trouble. The credit crisis has a lot further to run, as it moves from one subsector to another. As I have argued previously, credit default swaps pose very serious risks to financial stability and the City of London has been the centre of the European CDS market.
This, remember, is the view of an associate editor of the Financial Times, hardly a ranting anti-capitalist rag. In fact Münchau goes on to say that one of the worst consequences will be that working in the financial sector will no longer be cool — so the people who see their house prices slide by forty per cent can console themselves that there is some banker even worse off than they are, since his job is no longer fashionable.