Britain’s in recession: here’s why you don’t need to worry

published 26 April 2012

So Britain's in recession again.

The economy shrunk by 0.2% in the first quarter of 2012. If correct, it means the British economy has contracted for two quarters in a row. So technically, we're back in the dumps.

You surprised? If you were, you were in the minority, judging by the market reaction. Even the pound barely blipped at the news.

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So why are we back in recession? And what does it mean for you if anything?

Britain had the boom, now we have the bust

Britain might not actually be in recession of course. This was the first estimate of GDP. These figures are prone to revision. And no one seems to trust the Office of National Statistics anymore, though I suspect that has more to do with office politics than anything else.

But even if we're not officially in recession, we're hardly having a storming recovery either. The economy is still about 4% smaller than it was in 2008. And growth has effectively been flat since the coalition came to power.

So let's not split hairs here whatever the technical description is for Britain's economy, it's nothing to be cheerful about.

Of course, news of a recession sounds very dramatic. So it was splashed all over the headlines, and there was the usual slew of tedious hand-wringing and crowing from the punditry and politicians at large.

US commentators of a Keynesian persuasion, like the terminally smug Paul Krugman, denounced Britain's austerity experiment'.

And over here, Ed Balls, a key member of the team who drove the economy over the cliff in the first place, stood around gazing at the wreckage, tapping his foot and berating the coalition for not fixing it quickly enough.

This is nonsense, to put it gently. You want to know why Britain is in recession? We had a boom. Now we have a bust. That's the way it works. It's as simple as that.

Cast your minds back to 2008. We had world leaders panicking that the cash machines would stop functioning. The very existence of civil society was being called into question.

Yes, it was melodramatic and over the top. But we were in a serious mess. You can't then expect, less than four years on from that cliff-edge, for everything to be booming again.

Why is the US recovering faster than the UK?

But, say the critics, surely America is a sign that avoiding austerity works? No. If the US is indeed recovering now, it's because despite the best efforts of the Federal Reserve they had something closer to a proper crash.

Over here, the Bank of England slashed interest rates and immediately cut everyone's mortgage payments. But because of the structure of the US mortgage market, the Fed was unable to directly lower the cost of housing loans.

As a result, house prices collapsed and remain about a third lower than they were at the peak. Unemployment rocketed and remains extremely high. About a sixth of the population is on food stamps.

In short, it's awful. A much more painful crash than we had. But it does mean that the US banks have had to work through a lot more of their bad debt than their European and British peers. And it means that house prices have fallen to a point where they are affordable for ordinary families. They don't want to buy yet but that will change given time.

We chose the stagnation route out of the slump instead. Debts that should have been written off from mortgages to business loans - have instead been allowed to stagger on, by lowering the cost of servicing them.

Who has paid for this? Savers of course, in the form of low interest rates and high inflation. In short, resources that could have been put to far better use if asset prices had been allowed to reach a clearing' level, have instead been siphoned off to feed zombie' assets. Is it any wonder we're still in recession?

Stay positioned for stagflation

Here's the good news. There is nothing astounding about any of this. If you've been reading MoneyWeek for any length of time (or simply been keeping your eyes open), then you'd know that we're likely to be stuck with this stagflation-lite' environment for some time.

Inflation will remain ahead of interest rates for a long time to come. More quantitative easing can't be ruled out either.

It means that your priority as an investor is to protect your wealth from being eroded by inflation. That means making good use of your tax-efficient Individual Savings Account (Isa). The best cash Isas now pay just about enough to keep you ahead of inflation. Certainly, if your existing Isa pays less than 3% a year, you should find a better one.

As for investing the "invest in big blue chip, income-producing stocks" story might be getting old, but it's hard to find a better one. If you're sitting on a nice portfolio of income stocks paying decent yields, I see no reason to sell out of it.

And if you're keen to top it up, you might be interested in my colleague Stephen Bland's newsletter, The Dividend Letter. Stephen has a very simple system that he sticks to through thick and thin to build a nicely diversified portfolio of blue chip stocks with healthy yields.

As for international diversification as I've said already, I think sterling will do fine against the euro, but I wouldn't want to bet on it against the dollar. I'd get some stocks with US dollar exposure (plenty of UK blue chips fit the bill and my colleague Phil Oakley explains below why he still likes Apple). We like Japan too, because it's cheap. And of course, hold on to a bit of gold.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.