Winning the productivity race

Seven years on from the start of the Great Recession the slump looks set to go on and on.  Even David Cameron who seldom mentions the economy was stirred this week to reinforce the message that - the worst may not be over.

Certainly, in the UK we have had some growth but we still have high levels of government debt and a crippling trade deficit and our main trading partner is in real trouble.  It is now certain that the major economies in the developed world will never recover the lost demand that has opened up between actual GDP and the trend line established over the last 20 years.  This puts us in new territory, as in every other recent recession the global economy has always been able to close gap in “temporary” lost demand during the expansion phase of the economic cycle.  In real terms, people in virtually every developed country will be poorer at the end of this economic cycle than in 2007!  This is a pretty stunning revelation – we have forgotten how to grow!
 

Believing in Secular Stagnation

Across the fault lines of Adam Smith and Keynes, those who take an interest in the global economy fall into two camps - those who are general optimistic about humankind’s instinctive ability to create wealth an prosperity and those who believe we are pre-disposed to muck (no typo) things up.  You would think that those on the left are most agitated about market failures and the inefficiencies of capitalism - and many are, but social media exposes the truth that at least as many on the right are doomsayers.   Every article in the press welcoming the signs and firm evidence of recovery in the UK is met with a barrage of comments from conservatives foretelling the end of the world – house bust, savings dearth, public debt ruin, balance of payments crisis and so it goes on!

Debts Still Matter

The mind of George Osborne works in a strange and Machiavellian way.  His announcement today that austerity will continue unabated into 2016 - 17 was greeted with howls of protest from all sides, could it be that the British Chancellor knows something that we don't?  

which one is George?

Five years after the default of Lehman Brothers and three year since taking office the world is still a dangerous place even after years of pain.  What is now clear is the history of this crisis; and most developed countries have faced a number of distinct phases in this recession.

1. The credit crunch caused by a lack of liquidity in the banks 2008

2. Falling growth and a deep recession, caused by the banking failure and the subsequent free fall in asset prices in 2009

3. A false recovery 2009 – 2010 temporarily fuelled by growth in the Commodities, BRIC economies and emerging markets

4. The sovereign debt crisis triggered the very high public spending required to off-set recession (centred on the EuroZone) that rumbled on over 2011 -12

5. (Secular) Stagnation – weak growth in demand and GDP and deflationary pressure on prices in 2012-14?

As I have discussed in a recent blog there have been a number of strategies that have been deployed since 2008 with varying degrees of success.  These strategies (Abenomics, austerity, QE, etc.) have been blurred and muddled by the realpolitik of the day and no country has been able to pursue a fundamentalist approach, not even the UK under Osborne's guidance.  The main policy argument has been around the need for and the pace of debt reduction.  In a nutshell, can advance economies grow whilst carrying substantial levels of public (or private) debt?  There are good reasons for thinking that high levels of debt will be a drag on growth and these are pretty obvious:

The world's economy is off-balance

Economists around the world are dusting themselves off after a bruising few years of terrible forecasts, messed up assumptions and missed diagnosis.Whether you have been on the Rogoff / Reinhart or Krugman side of the argument there are red faces all around. The simple problem is that economies are not meant to behave in the way they are.  We have got to a point where old models (classical, Keynesian or monetarist) don’t work and excuses just don’t wash.  The problem is that after five years of negative realinterest rates the world’s economy has been unable to return to “historic trend” levels of growth – we are still bumping along the bottom.  Most economists believe that interest rates can be set to create a sustainable equilibrium in the economy where growth, employment and inflation can be held in a positive balance.  The absence of the interest rate equilibrium after years of interest rates set near or at the lower bound of zero raises the question as to what the alternatives are to negative real interest rates might be?  Larry Summers the former Secretary of the Treasury of the United States made  an important speech on this subject a couple of weeks ago.



Larry Summers - tired of waiting for the recovery

Austerity may be wunderbar

Five years on from the tsunami of the Lehman’s default and subsequent recession it’s probably a good moment to assess the relative merits of the monetary and fiscal strategies that developed countries have deployed to reboot their economies.  There have been a range of initiatives that have been tried but the “standout” response has been austerity, which can also be derived as a noun – austerian and there is even an antonym – Krugman!

The Full Monty on Osborne's economic policy

In the five years that have elapsed since the global financial crisis  erupted in the summer of 2008 living standards in the UK have dropped sharply (in 2008 a single person earning £13,000 would have reached the minimum they needed to get by. if their wage had risen in line with average increases, they would now be earning £14,000 – which is roughly three thousand short of the £16,850 salary needed to cover the same basic standard of living today).  During this period we have had two governments who have been  attempting to nurse our broken economy back to health.  In  the first two years of the crisis we had the 'fag end' of a long running Labour government, who had little stomach for the fight.  The only Labour minister who came out of this period with any credit was Alistair Darling the who, despite constant interference from Gordon Brown (self styled saviour of the world), did an excellent job of first aid on a patient that was dead on its feet.  His sensible approach to encouraging consumption through sales tax reductions and the motor car recycling scheme combined with a massive blood transfusion of QE made sure that Britain survived the trauma of an imploding financial services industry and the cataclysmic effect this had on credit markets and the tax take.  The rest of the Labour government were in shock as they watched 13 years of neo-socialism unwind before their eyes. 

Hard Times - the need for structural change

Having already had a go at The Duchess of Cambridge Hilary Mantel recently struck a blow against another great British institution, Charles Dickens, her timing was impeccable as we in Britain still relies on Dickens for our economic guidance:

Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery

Mounting debt has been the cause of so much fun and subsequent misery is the West and particularly in the UK.  However, we have now had two months of uninterrupted good news on the economy, or rather we have had no really bad for two months.  The green shoots that I pointed at in December are now in plain view for all to see, but like a newly sown lawn there are still dangers ahead.  The chief threat is the overall level of debt and the threat of inflation and higher interest rates.  With negative real interest rates it’s possible to feel economically secure but if they were to rise to  5% how many governments, businesses and private individuals  would survive, this form of stress testing is deeply unfashionable as we all contemplate ‘free money’ for the nest 2-3 years.

So what are the numbers?  In the UK net debt is about 300% of GDP or about £7.5tn this is split quite equally in three areas - government debt, corporate debts (companies) and personal debt.  Added to this we have an enormous banking sector that is still in a very fragile state with poor liquidity and bloated balance sheets.  The important question is how much of this debt is distressed, or likely to default?  With notional interest rates of 0.5% and real interest rates at -2.5% many insolvent businesses and individuals can hang on in there but if real interest rates were to rise to 5% there would be real fall out.  It is the risk of this fall out that has encouraged George Osborne and the Bank of England to water down austerity and use monetary stimulus (QE) to keep the money supply up and interest rates down.  There is no doubt that the initial stages of the crisis were well handled by Alistair Darling and the emergency measures to bolster demand (cuts in VAT) and the massive injections of QE saved our banking sector and keep our weakened economy alive.  Since 2010 Osborne has pursued a very limited agenda of ‘austerity light’ balanced by more QE and the result is that we have survived but the big issues remain unresolved.  Overall debt is still way too high, structural changes to improve our competiveness have been focused on the one area where we don’t need growth, the already over priced housing market.  The good news is that over the last three years corporate and private debts have fallen from 232% of GDP to 208%.  We should expect this improvement in the private sector liquidity to continue at this gentle rate as most forecasters believe we have at least 2-3 years of low interest rates and low inflation.  The issue is that we will need 5-6 years of benign inflationary conditions to get back to a sensible ratio of debt to wealth (GDP).  On the debit side the Government has increased its own debt burden so much that this has more than compensated for the de-leveraging by families and private firms. General government debt has reached 90pc of GDP, up from 43.5pc when the crisis erupted in mid-2007.  And it seems that we are 3 or 4 years away from any significant reductions (where economic growth outstrips growth in government spending).

The up-shot of all of this is that we only have a few years to put in place the structural changes that the economy requires for us to be competitive before rising inflation and defaults kill off the recovery and pushes us back into depression.  The structural changes we need to consider would include:

1.     Deal with pension time bomb – increase  the retirement age and increase contributions
2.     Balance our economy with an industrial policy drives growth in the north of England and supports industries (other than finance) where we have shown that we can compete globally
3.     Simplifying tax to increase participation (reduce the black economy and tax avoidance)
4.     Improve the skills base of our young people and drive down unemployment for this group
5.     Improve our infra-structures – road, airports and rail networks
6.     Deregulate property industry to break the link between rents and values, which makes landlords happy to keep properties empty rather than occupied at lower rents.

Reinhart and Rogoff - Battered but not beaten

Like boxer who has taken a pounding Reinhart and Rogoff, the Harvard economics duo, have donned the dark glasses and have been responding to their critics.  They strongly contest that their research was slipshod and that their Excel skills are childlike, but the accusations that they doctored the figures to suit their point of view just won’t go away.

Walking with the Dinosaurs

I spent last week at a finance conference in Asia, and what a revelation it was!  The contrast between the vibrant growth and optimism of Singapore and the depressed state of old world bankers was tangible.  It was like watching a Brontosaurus eat its last lunch.  In the distance I could hear the rumbling of another dinosaur.  Paul Krugman!

There is no doubt that Paul Krugman punches above his weight, a Nobel Laureate, Professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics blogger in chief at the NYT.  As he says in a recent blog post, he has had a good run over the last two weeks.  The unraveling of Reinhart’s and Rogoff’s research on the 90% tipping point for debt to GDP ratio was greeted with great glee by Keynesian economists. 

To QE or not to QE that is the question

I have just moved jobs and this has prompted me to think about the challenges that Mark Carney the in-coming Governor of the Bank of England (BoE), will face.  He arrives with stellar credentials and a reputation as one of the world most expert central bankers.  He became the central banker for his own country Canada in 2008 and has taken credit for Canada’s OK performance since the financial meltdown following Lehman’s failure in the summer of 2008. He has used a mixture of monetary measures to help the Canadian economy recover, quantitative easing, and monetary tightening have both been deployed more readily than in other economies. 

Mark Carney - Magician or Muppet?

His arrival in Threadneedle Street  is vitally important for the British chancellor, George Osborne, who has run out of ideas for getting our economy growing again

Mr carney must be wishing that he had been appointed a little earlier as the BoE as the current governor has already blown £375bn on quantitative easing – but the firepower may be drying up.  The main issues he faces are:

1.      Springing the liquidity trap in private consumption and getting the banks lending again
2.      Managing inflation that has be stubbornly high unlike in japan and other advanced    economies where deflation is a major concern
3.      Re-structuring the banks and dealing with the debt over hand in the private equity business
4.      Implementing a new regulatory regime for the banks without killing off this vital sector

     Getting the economy to grow after 5 years of flat lining, with other major economies using QE and monetary policy to improve competitiveness (currency devaluation) we need action that supports the real economy.  

For some time the markets have been convinced that more monetary activism is on the way and this has had the pound plunging, along with yields on UK government bonds. Abenomics  being unleashed by Haruhiko Kuroda, the new Bank of Japan governor, have only stirred expectations of exceptionally aggressive easing with Mr Carney in charge.

Last week Mr Carney acknowledged on that the UK was one of the economies which the International Monetary Fund has said is in “crisis”. Like any in-coming manager he will want to paint the current situation as black as possible; so having talked the UK economy down what room for manoeuvre will Mark Carney have?

He created excitement in December when he mooted the idea that central banks could set targets for the overall size of the economy, or nominal gross domestic product, rather than inflation. But in the budgets Mr Osborne opted for relatively minor changes to the Bank of England’s remit as he kept the 2 per cent inflation target but clarified that policy makers could prioritise growth, provided inflation remained under control.  Economists called the new remit a “damp squib” after all the hype.

So what might change?

     One area of policy that will clearly change under Mr Carney is what is known in central bank speak as “forward guidance”. The idea is that private consumers make spending decision their view on forward interest rates,  if they believe interest rates will remain at ultra-low levels for an extended period they may be less inclined to save. Under Mr Carney’s stewardship, the Bank of Canada became the first central bank in the Group of Seven leading industrialised nations to promise to keep interest rates low a long way into the future. The US Federal Reserve has since gone further, committing to keep interest rates low until unemployment falls below 6.5 per cent. With the UK’s poor record on inflation such a commitment might be more difficult

     He may well consider more quantitative easing, but after our £375bn binge he maybe less include or able to continue the asset purchase scheme.  He could however be a little more radical than the current regime at the BoE and contemplate more structural measures.  He could look at more proactive restructuring of RBS and Lloyds Banking group and some of the private equity funds.  The UK economy is suffering from a large number of zombie companies weighed down by debt but hanging on due to ultra low interest rates.  Rather than raise interest rates, which would damage the housing market and consumers Mr Carney could insist the banks take more proactive steps to restructure debts that will never be paid off.  This might cause some short term unemployment pain but a clear out of Zombie companies would clear the way for more vibrant private sector growth.  Any return to large scale QE and continued negative real interest rates would be a firm signal that both the government and the Bank of England think that bank creditors (savers) should continue pick up the tab for the wild over spending between 2000-2009.    

     Mr Carney could also build on the Funding for Lending Scheme (FFLS), unveiled by the Treasury and the Bank of England last summer, has had some success in easing borrowing constraints on would-be homeowners. But, while conditions in the mortgage market have improved, lending to small and medium sized businesses remains constrained.  Revamping Funding for Lending is an easy win for Mr Carney, who indicated this year that he was willing to use the scheme to boost credit creation.  The problem with FFLS is that it is essentially a mechanism for civil servants to pick winners - a role they are very badly suited to.

If I was in his shoes I would consider a contrary approach, which would mean raising interest rates.  The medicine of ultra-low interest rates in the advanced world has proved a failure in Japan over 10 -15 years and has not worked in the US, UK or Europe in the last 5 years.  Where aging populations comprise a substantial part of the total private consumption and where companies turn cash into share buy backs low interest rates are a killer blow.  We need to move to a world where there are real positive interest rates on 2-3% rather than the current negative real interest rates.  This would also have the benefit of dealing with Zombie companies and force the banks to restructure quickly.  There would definitely be more pain in the short term but we surely benefit in the medium term with a more dynamic and health real economy.

Trusting your political career to economic theory is a dangerous game

In 2010, two Harvard economists, Carmen Reinhart and Kenneth Rogoff,  published an academic paper entitled  “Growth in a Time of Debt”  which used research on around 20 of economies over the last 250 years to show that annual GDP growth ranges between about 3 per cent and 4 per cent when the ratio of public debt to GDP is below 90 per cent. But average growth collapses to -0.1 per cent when the ratio rises above a 90 per cent threshold.  Much political capital has been expended by Osborne and other on the dangers of exceeding the 90% debt / GDP ratio.  Why 90% should be such a perfect tipping point should seem strange to anyone with an ounce of common sense, but more important men than me have pinned their careers to this ‘fact’.

Consumer spending - the key to recovery

The coalition government have been pilloried for the lack of an industrial policy and for the terrible performance in productivity and exports , but the truth is that these are pretty irrelevant.  When looking for pertinent commentary that illuminates rather than obfuscates the current economic situation in the UK and globally look no further than The Economist.  While the Chancellor, George Osborne, prattles on about ‘the march of the makers’ and turning the UK into a magnet for corporate in-ward investment, The Economist is happy to point out the elephant in the room. 

Measure for measure

The Daily Telegraph is agonising over the huge question that all major (well run) economies are facing - namely why is employment growing when growth is so poor.

http://www.telegraph.co.uk/finance/comment/jeremy-warner/9863483/No-one-really-understands-whats-going-on-in-our-economy.html

The real problem here is about the measures - when the global economy is expanding, it's probably a good idea to keep an eye on inflation as an indicator of monetary growth.  When debt is the problem (government, private and banking) we need other objectives. Should we not be measuring the reduction in the levels of these debts?  And these measures should be absolute not as a % of GDP (which measures growth).   It seems to me that growth is an erroneous expectation, whilst we are downsizing the size of:  our state, the banks and private debts.   In fact  GDP flat-lining could rationalised as good news.  The ineptitude of this Government is to have set goals to shrink the economy but still expect to be judged on GDP growth!

The other major major problem with keeping a focus on these growth orientated measures is that we end up penalising the very people we should be supporting  - SAVERS!  

The united policy of both UK governments since the credit crunch (Gordon Brown's and David Cameron's) have been to pay for the years of largess by stealing the hard earned savers of the middle classes.  Policies of increases taxation on savers and QE, which keeps interest rates low are both death to savers.  This approach can be blamed on the fact that they focus on the wrong measures - if they were able to see that growth is unlikely when you need to reduce debt they would be rewarding savings.  The natural consequence of this is that they would be squeezing the life out of zombie companies and over borrowed individuals who are killing our economy, which would give new life to those who can create the green shoots of recovery 

Kicking the habit of QE

The great and the good have been trying to resolve the riddle of rising employment with no GDP growth. This implied weakness in productivity is certainly a troubling and new phenomenon.  There are a myriad possibilities that might be contributing factors, I have picked four: high government spending, low productivity, poor tax receipts and poor private sector performance.  The common threads that harness these 'four horses of the apocalypse'  are quantitative easing (QE) and the associated low interest rates and high inflation.

Firstly, let's look at low interest rates. The Bank of England has held rates at 0.5% for the last four years, given inflation has been running at over 3% for most of this period we have had real negative rates of interest averaging -2.5%+.  Trying to grow the economy when savers (people and businesses) are losing 2.5% of their income and value every year, is going to be tough.  These negative rates have been helpful in some respects - propping up failing businesses and over extended families.  But there has been a huge down side in penalising pensioners, other savers and well run businesses.  This benefits equation is clearly out of balance with low interest rates helping distressed non-contributors while disadvantaging those who, ordinarily, would be the engine for growth.  These secure businesses and private individuals who are most likely to invest and spend must be the main components for GDP growth.

The negative interest rate has had another significant effect on the business world.  Well run and productive businesses looking to invest have had the distraction of having to make increasingly large pension provisions as investment return dwindle to nothing.   Another bi-product of negative interest rates has been an overvalued Pound, which has damaged our exports and sucked in cheap foreign goods.  The cumulative effect of negative interest rates  have had the unintended consequence of creating a vast number if Zombie companies - I have been banging on about this for a while. Zombie companies can't afford to make the redundancies required and are in a permanent loss making position, only able to pay the interest on outstanding loans.  I have estimate that these Zombie companies in the UK amount to over 3 million employees. These unproductive businesses and employees are soaking up financial and human capital resources that other better run businesses need. 

So while negative interest rates seem like a good idea, keeping mortgage payments low they also have put a massive break on the economic growth.

The other consequence of QE has been stubbornly high inflation, which has been running at 2-4% over the last three years.  The cumulative effect of negative interest rates and high inflation has been the killer blow that has forced savers to hoard cash and business to shelve investment plans.  The Government has been unlucky that the Pound has been perceived as a safe haven, sheltered from the storms buffeting the Euro and the Dollar. 

These mistakes in economic management were started by Gordon Brown in the aftermath of the credit crunch, desperate to keep the economy afloat with an election looming 'Gordo' was not planning ahead.  The Coalition have, under the guidance of The Bank of England, continued the process of QE, which exchanges future government debt for short term monetary relief.  In retrospect a more traditional approach to maintaining low inflation (with all the pain and insolvency that would have caused) would have made the 'dip' steeper but may have accelerated the recovering.  The path we have chosen looks likely to offer a stagnant economy for the foreseeable future, unless the government change tack.

To rectify the problem the focus needs to be on lowering inflation, rewarding savers (not the over borrowed),  whilst maintaining the value of our currency (which is starting to come under pressure).  Oddly these are complimentary medicines and we need to start now!

Zombie 2

Here is a link to a quite interesting discussion between the senior staffers at the Economist on why UK GDP is so flat with rising employment levels.  They offer 3 or 4 alternative reasons but perhaps the most compelling is this idea of Zombie companies holding us back.
These are companies are typically loss making but surviving because of the low interest rates on their loans.  The Bansk are unwilling to close them down because of the 'right offs' this would entail that will harm there balance sheets, when they need to bolster their capital reserves.

The Economist believes more credit easing by the Government might be the solution; allowing the cash strapped banks to 'let go' of fold these unproductive loans so new more dynamic companies can come through.  Feels like any solution will take a while.

http://www.economist.com/multimedia?bclid=1213687645001&bctid=2117131437001

See my last blog on this - We're all Zombies now http://getwd50.blogspot.com/2013/01/were-all-zombies-now.html

Calling the end of the recession

Who should we rely on to call the end of the recession, no me for sure but Gavyn Davies (Ex GS partner).  The graphs he uses in his blog show that the downward revisions in forecast and the expected outcomes for 2013 mean we could be at the tipping point for returning to growth.

As he says - http://blogs.ft.com/gavyndavies/2012/12/09/forecasts-suggest-a-turning-point-in-the-global-economy/

In order to achieve the calendar year averages shown in the graphs, the annualised growth rate in global GDP would need to bottom at about 2.4 per cent in the current quarter, and then gradually rise to 3.5 per cent by 2013 Q4. In other words, the global economy would now be at a critical turning point.

What this means in English is that we are nearing the end of the global recession and we should not be overly neg about the up-swing - its happened before!

If GDP = C + I + G + (X-M)

The Government and media commentators are obsessed with our GDP growth.  When the Government’s spending is in balance GDP may be a relevant measure but when we are running a huge deficit and need to cut government expenditure it’s not so helpful.  We should obviously be interested in growth associated with (Consumption goods & services (C) + Investments (I)  (Exports (X)  Imports (M)) but when 50% of the economy is Government Spending (G) we should not expect to grow GDP whilst hacking back G