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Year in review: 2012 - the year of the zombie

John Stepek
LONDON, ENGLAND - JANUARY 25: City workers walk through London's financial district after it was announced that UK economy shrank by 0.2% during the last quarter of 2010 on January 25, 2012 in London, England. The official economic figures, released by the Office for National Statistics, come a day after they calculated that Government debt had risen to an all-time record of 1 trillion GBP. (Photo by Oli Scarff/Getty Images)

There were plenty of fireworks for the Diamond Jubilee and the Olympics in 2012, but when it comes to the financial world, it was more of a damp squib.

The FTSE 100 started 2012 at a little below 5,600. Even during the now-obligatory mid-year eurozone panic, the market only fell to around 5,300. Now it looks set to end 2012 closer to its highs for the year, of around 5,900.

House prices are still sky-high in London and subdued just about everywhere else. According to the Halifax house price index, the average house price across England and Wales is around £158,000. In January, it was just under £161,000.

The UK’s cost of borrowing hasn’t changed much either. At the start of the year, it cost the UK Government just under 2% to borrow money over 10 years. It’s been as high as nearly 2.5%, and as low as below 1.5%. Now it’s around 1.8%.

Even inflation has been pretty well behaved. The year began with inflation (as measured by the official consumer price index measure) at 3.6%. It dipped as low as 2.2%, and now it’s back up to 2.7% as of October. It’s still well above target, but it’s not at headline-grabbing levels.

The dawn of the dead
In short, it’s been quiet. “Too damn quiet,” some might say.

You see, while the headline figures make it look like an uneventful year, behind the scenes things have been deteriorating. And it leaves Britain on a knife-edge, increasingly vulnerable to global events.

The 2008 financial crisis was ultimately about debt. And the trouble is, we haven’t made any real inroads into tackling that debt.

One reason economic growth is so weak – we spent much of the year in a technical recession, and we still can’t be sure of just how much growth was down to the artificial boost of the Olympics – is because the banks remain so fragile.

And that’s why 2012 was the year that the idea of the economic ‘zombie’ really hit the mainstream.

A ‘zombie’ is a company or household that is only surviving by the grace and forbearance of its lenders. If interest rates were at normal levels, it couldn’t possibly get by – the company couldn’t pay its bills or the homeowners couldn’t pay their mortgage.

These zombies only stagger on in their state of undeath because banks can’t afford to write the debts off and shut the business down, or repossess the home, because their own balance sheets are too fragile to take the hit. The Bank of England reckons the UK’s biggest banks may still be short of up to £60 billion to cope with write-offs, fines and new regulations.

As for the nation itself – well, so much for austerity. The Government is borrowing more than it was at this time last year. We remain heavily indebted as a nation and it looks as though the chancellor may well miss his targets for reducing our deficit (our annual overspend).

Our overall national debt pile will continue to climb for years to come.

We’re still addicted to artificial stimulants
The situation hasn’t improved at all this year. We’re no closer to having anything approaching a ‘normal’ economy. Interest rates remain at 0.5%, their lowest level in the history of the Bank of England.

In fact, if anything, we are even more dependent on cheap money than we were in 2011. At this time last year, the Bank had printed £275 billion of money via quantitative easing to buy British government bonds (gilts). 12 months later, that total has gone up to £375 billion.

In other words, monetary policy got a lot looser this year and yet all we’ve got to show for it is a flat-to-falling housing market, a meagre rise in the stock market, and a flat-lining economy.

Worse still, the independence of the Bank has been increasingly undermined.

Just before his Autumn Statement, the chancellor made the decision to take more than £35 billion in interest payments that the Bank had received on the gilts it bought as part of the quantitative easing programme, to help make the public finances look a little less ugly than they actually are.

Why is that a problem? Without getting too technical about it, quantitative easing is meant to be a tool that forces the banks to lend more money. It’s not meant to be used to help fund government spending, as otherwise it becomes obvious that the process just involves one part of the Government (the Bank of England) writing a very large cheque for another part of the government (the Treasury) to spend.

That’s called “monetising the deficit”, which is a fancy term for “doing a Zimbabwe”.

This matters, because confidence matters. The pound has been reasonably stable this year. Borrowing costs for the UK remain low. But that’s largely because markets have had little choice. The UK economy looks awful. But so do most other places.

One key risk for 2013 is that this may change. The US has its problems, but having experienced a true property crash and a genuinely nasty recession, many of its own ‘zombies’ have been laid to rest. The housing market there now looks as though it is bottoming out.

Meanwhile, in Europe, things are as messy as ever. But if the sheer level of panic reduces, then Britain will no longer look as inviting as a safe haven.

It’s ironic. But if investors decide that other economies are looking more attractive, at a time when Britain is stagnating and shambling along, then they might start looking at us with a more critical eye.

Even if the Bank of England prints more money to buy more Government debt, investors could abandon the pound, driving up inflation, and eventually forcing interest rates higher.

And that would kill our zombie economy stone dead.

John Stepek is the editor of MoneyWeek