The vicious cycle

The Bank Of England has revealed that they are less optimistic about the economic outlook than many people.

Mervyn King, governor of the Bank of England, cut his growth forecast and declared that there is as much chance that the economy will still be shrinking this time next year, as there is of it growing.

This will be bad news for the Labour Party who were hoping for a sign of recovery before they are forced to go to the polls next year although, with the way things are going, even a remarkable turnaround in the economy seems unlikely to save them.

Mr King said: "The economy will eventually heal but the process may be slow. This is not like the typical business cycle in the post-war period... Even if there is some recovery in output over the next six to nine months, we don't know how sustainable that will prove to be."

As you will know, this more or less reflects my own view - but obviously phrased in more diplomatic terms than I would do. There may be a minor bounce in the general downward trend, but I still believe that we are set for a long and protracted depression.

The reason I think this is that the fundamental flaws in the economy have not been addressed.

The first issue is the trade deficit. Any growth in GDP has to be balanced by what is going out of our economy through trade - and for the last 15 years or more that deficit has been growing and now far outstrips any increase in GDP. As I've pointed out before, if your GDP grows by 1.5%, but your trade deficit is 4% of GDP that is a net shrinkage in your economy.

It really is a simple issue. Annual growth in GDP equates to your annual pay rise while the trade deficit equates to inflation. If your income increases by 2%, but inflation rises by 5% you are 3% worse off.

Then there is the question of debt. The credit crunch is a symptom of that - not the cause. The apparent failure in regulation of banks is basically due to the fact that our economy is based on the accumulation of debt to feed economic growth. To regulate that would have meant curtailing growth and that was why the governments didn't just fail to act - they couldn't act.

And because that debt is used to buy goods which are largely sourced from overseas that adds to the trade deficit - it's a vicious cycle. The more you need to grow the economy the more we have to borrow to buy. The more we buy the bigger our trade deficit gets. The bigger our trade deficit gets the more we need to grow our economy and so we borrow ... and so on.

Only when we address these two fundamental weaknesses in our economy will we start to see a real sustainable upturn in our economy. The only way I can see us doing that is by making more of what we buy - and the only way I can see us doing that is through protectionism.

If anyone has a better idea then let's hear it.