What does it mean when a nation becomes so uncertain about the future of its economy that it suddenly stops buying clothes? We are about to find out.
According to UBS analyst Adam Cochrane and his team, who did a survey of 2,000 consumers’ spending intentions, there has been a sudden and significant drop in our desire to buy apparel compared to six months ago.
Although the UK has seen robust growth recently, Cochrane calls this a “false dawn.” To state the obvious, the only thing that changed in the economy between then and now is the certainty that the UK will leave the European Union:
The drop was driven by a decline in consumers’ assessments of their personal finances, UBS’s survey says:
Older British people — those who, infamously, favoured Brexit by a large margin — led the way:
Of course, all of this is just based on consumers’ feelings. Has any of it showed up in the real world yet?
According to Samuel Tombs, chief UK economist at Pantheon Macroeconomics, it has. Q4 2016 GDP growth was 0.7% quarter-on-quarter (or 1.9% year-over-year). That’s healthy growth. But it is not sustainable, Tombs believes, because it was based on consumers spending down their savings, as opposed to enjoying their income gains. UK consumers’ savings rate today is only 3.3% of their total disposable income. That’s lower than the rate during the 2008 crisis:
Why might Brits suddenly drain their savings so that they can’t even think about buying new clothes?
This next chart offers one clue. Wage growth is going nowhere:
Wages have been going nowhere for a long time, though. What really changed is the inflation situation. Small wage gains are valuable in an economy where there is no inflation — and there has not been significant inflation in Britain for years. But with Brexit devaluing the pound, suddenly inflation is over 2% and future expectations of inflation are even worse:
Now this is all starting to make sense: Consumers know that Brexit is causing inflation, so they are spending the money they have now — while it retains its value — before inflation makes them poorer. Clothes in the future are likely to be more expensive, so why buy them?
We noted earlier that consumers were holding less money and taking out less debt since Brexit, and the more recent figures from February show that trend continues. This is money held:
And here is the debt picture:
Suddenly, the UK looks like a country that has reached the end of its savings, spent the last of its money, and doesn’t want to take on more debt.
Now let’s expand this scenario beyond clothes.
Would you, as a foreign investor, want to put money into a country that is so anxious about its economic future that it prefers to huddle in old rags rather than buy new socks? (I’m exaggerating for effect.)
In fact, foreign money has poured into Britain in the last few months in large part because the falling pound has made everything suddenly cheaper. This has created a sudden feel-good effect.
But Pantheon’s Tombs believes the surge in UK exports — which improved Q4 trade deficit and reduced the UK’s dependence on foreign finance — won’t be sustained. Here is what that net international investment looks like in a chart against GDP. Note that the peak we are at now is far higher than the zenith of the 2008 property credit bubble:
Domestic assets bought by foreigners are, by definition, equivalent liabilities for Brits domestically (i.e. if a Chinese person pays £1 million for a factory, they recognise the factory as an asset and we owe them a factory, as a liability.) That stock of foreign assets inside the UK is now at 560% of GDP, Tombs believes:
“The stock of overseas investors’ assets in Britain amounts to a huge 560% of annual GDP; sterling would be hit if only a small share of investors take fright. The headline GDP number, therefore, is not a signal that the economy is in fine fettle. GDP growth will slow sharply as households stop slashing their saving rate, while the U.K.’s dependence on foreign finance leaves sterling vulnerable to another crash, further hitting consumers’ real incomes.”
We’re surfing on a wave of foreign money, in other words. If the wave washes out, then the currency devaluation and price inflation we have seen so far will be a mere appetiser before the main course, Tombs argues:
UBS’s Cochrane is so concerned about the fragility of consumer confidence that he called the recent positive numbers from the broader economy a “false dawn.” In a note to clients he said:
Expectations to spend have deteriorated significantly.
Consumer confidence has held up well so far but we think with real wages set to decline the discretionary spend will follow.
We think the better than expected Q4 2016 is a false dawn and earnings forecasts will remain under downward pressure for 2017. However, we think the tough macro conditions will continue into 2018 which limits the upside optionality on earnings upgrades and multiple expansion.
Business Insider has heard this argument before. Famously, economists expected the economy to collapse immediately after the EU Referendum in June of 2016 — and it did not. Since then, the Leave camp has taken that as proof that the UK can sail on without help from Europe.
Perhaps it can.
Otherwise, pray for warm weather. So that we won’t need new clothes.
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This column does not necessarily reflect the opinion of Business Insider.
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