Practice development expert Mark Lloydbottom looks at the economic portents for 2010 and asks if you and your clients are prepared for more hard times.
In November 1949, Frank McNamara, head of the Hamilton Credit Corporation, and Alfred Bloomingdale met at Major’s Cabin Grill, a well-known New York restaurant next to the Empire State Building. Over lunch, they discussed a problem Hamilton customer: someone who had borrowed money but was now unable to repay. At the end of the meal, McNamara found himself in a similar predicament. Reaching into his pocket to settle the lunch bill in cash, he found that he had forgotten his wallet. A hurried call to his wife solved the problem, but McNamara vowed never to allow the situation to arise again. With Bloomingdale and Ralph Schneider, his attorney, McNamara pooled a sum of money to invest in a new project.
On 8 February 1950, the three met again at Major’s Cabin Grill, but this time they paid using their new business idea: the Diners Club card. No interest was charged on the card but the balance had to be paid on receipt of the statement. The credit charge card was born. Some years later the Bank of America launched a credit card which allowed debt to be rolled over and interest to be charged. In 1966, the Bank of America licensed their system to Barclays who introduced Barclaycard and ready access to unsecured debt for millions of Britons.
Less than 40 years on in 2004, the UK’s household debt exceeded £1 trillion. But in just four more years, that debt level had climbed by another 50% to £1.5 trillion – debt that had, to a large extent, given rise to increases in corporate profits and partly fuelled the increase in stock market values.
By the end of 2009 households with unsecured loans or credit amassed an average debt of more than £22,000. The government’s own debt, already substantial, has been further inflated by the £200bn that has so far gone into the quantitative easing programme.
In 1992 the average household savings rate was 11.2% of income, a rate that had reduced to about 3% before the global financial crisis. At one point in 2009 the savings rate fell to zero before recovering to just over 5% in the final months of the first decade of the 21st century.
The worldwide response to the global banking crisis has been to cut official interest rates. This move provided relief to those with mortgages but meant those with capital, especially those who depend on a return from their life’s savings, had to accept a much lower yield on their money.
The backbone of long-term saving has been a pension fund or property,
often through buy-to-let mortgages. Both have failed to live up to expectations. The collapse in the market value of shares pulled down capital values and dashed investors’ hopes of year-on-year compound growth. Meanwhile property investors have seen property values decrease, in spite of strong demand for rental property.
The nation’s finances
By the end of November 2009, the UK government had borrowed £830bn, or 59.2% of GDP; the planned budget deficit for the year is £178bn. Dealing with this debt is an immense task, yet for the short term at least, the government shows little inclination to cap or reduce public expenditure. Our spending on state benefits is now greater than the total amount of income tax paid; one in five households are on some form of housing benefit, while approaching one in six households are estimated to have no income from employment.
Are we coming out of recession?
It may well be that the recession technically ended in the final quarter of 2009 following six consecutive quarters of contraction, but the additional spending power in the economy came to a large extent from an increase in government debt and surplus household money produced by lower interest rates. Unlike the last deep recession of the 1980s, the money now entering the economy is Monopoly or phantom and will eventually have to be repaid.
Prospects - what lies ahead?
This year sees a general election. If the Conservatives regain power, they promise to introduce a “Budget for growth”. In 2010 there may well be two serious Budgets. These Budgets will have to get to grips with the economy’s fundamental problems and are likely to increase taxation, reduce public expenditure and reduce benefits; while also introducing limited spending increases in certain areas to fulfil election promises.
The result of all these measures?
While it is never easy to predict outcomes, there is a strong risk that these measures could trigger a second wave of recession as cuts in government expenditure and businesses and consumers saving and paying down debts reduces their economic spending power. Efforts to tackle the UK’s systemic debt could ripple through every business and household as well as the economy.
When will interest rates return to a more normal level? No one knows for sure. Interest rates have reduced globally, though not universally. As other countries come out of recession, interest rates may start to rise. So long as interest rates remain low people may be tempted to start incurring debt again and to up their spending; equally, while interest rates remain low, those who depend on their savings will continue to see reduced returns on their capital.
How does the ongoing uncertainty of the economic outlook – bearing in mind that what you have read is no more than a perspective on the future – affect the action you should take in 2010? In uncertain times, planning is imperative for both businesses and individuals. Only well thought through plans will see you through a year that may or may not see us on the road to recovery.
If you are able to take a breather from processing tax returns, what view do you take on the economy? If I was in practice today I would bend the ear of clients and ensure they all had their finger on the business button. Profit and cash flow forecasts are essential for all – starting with your own business. I will be more than willing to hold my hand up and say I was wrong about the economy... but somehow I don’t think that will happen.
About the author
Mark Lloydbottom has set the path for marketing and client service approaches within the UK accounting industry for the last 20 years. A respected writer and commentator, Mark Lloydbottom also formulates and writes all the PracticeWEB Publishing's PDF services.
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