The solo becomes a duet

The world economy is a bit like my early love life – long periods or inactivity and boredom interspersed with rare flashes of excitement.  Growing up in rural England with no Facebook, mobile phone, nor any natural ability to chat up girls made things pretty dull!  The same is true of the world economy - one minute we are in a world of dull stagnation and deflation and the next we are in mortal danger, thanks to Greece.

The excitement of a good riot

Forgive and Forget

The Greek crisis is about the only story being covered by the financial press.  It’s the perfect seasonal pantomime not unlike Cinderella – a damsel in distress (Greece and its distressed debts) the drama of a tight deadline (Greece could run out of cash in March), comedy villains (the Trokia of the ECB, the European Commission and the IMF), a grumpy old maid (Angela Merkel) a handsome prince (Alexis Tsipras, the Greek prime minister, and his henchman Yanis Varoufakis, the finance minister).  The only questions are; where is the Fairy Godmother who might save the damsel in distress and will there be a happy ending?

George and Yanis - could this be the start of a special relationship?

Who is rigging the market now?

In the run up to the credit crunch the market manipulations perpetrated by the world’s largest investment banks are now well known to us.  The banks rigged many of the important markets required for the global economy – proprietary trading held sway, credit and other derivative products were miss-sold, reference interest rates (Libor and others) were fixed and so it goes on.  Fortunately for us governments around the globe and their central bankers have been on a mission to sort out these market abuses.  The Wolves of Wall Street have been tamed by the Gnomes from Zurich, the ECB and the Fed – all very reassuring.  That is until one looks closely at the market manipulation now being pushed through by Central Banks culminating in the completely unexpected decision of the Swiss National Bank (SNB) to remove the 1.20 floor on the Swiss franc against the Euro.

Anything the banks can do .....

As Gavyn Davies tells us this was “one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971. The decision has been heavily criticised, both for its tactical handling of the foreign exchange market, and for the collapse of the centrepiece of its monetary strategy, without (apparently) any overriding cause. The credibility of a central bank that has traditionally been hugely respected by the markets has clearly been dented.”

Demand for the old normal

For the last six years the developed world has been suffering from a chronic shortage of demand: demand for goods, demand and services, demand for investment.  The need to deleverage personal, corporate and government debt has meant that there has been massive excess capacity and a huge shortfall in aggregate demand.  This lack of demand has been driving up unemployment and driving down prices.  All this has been complicated by the fact that we in the West are at the zero bound of interest rates this nasty cocktail has been characterised as secular stagnation.  Over the last six years wages in all normal income groups have flat-lined and living standards will now be lower at the end of this economic cycle than they were in 2008 – this is extraordinary, almost unheard of in the developed world.  Or is it?  Thomas Piketty, the French Rock Star Economist (is that an oxymoron as the French have no rock stars?) would have us all believe that we are now returning to a more normal state of affairs, where vast pools of wealth lie idle in the hands of a financial elite and the rest of us jog along at a steady but uninspiring rate.

A French Rock Star??

Crude benefits of falling oil prices

The ending of QE in the US and the fall in the price of oil from over $115 a barrel to under $60 a barrel were the defining economic events of 2014, but their consequences will not be felt until next year.  The ending of QE in the autumn brought to an end the huge expansion of the US Federal Reserve’s balance sheet, since 2008 the Fed has pumped some $2.3tn of “new money” into the world economy which has had a wondrous effect on asset prices in all sorts of weird and wonderful places.  London property prices have boomed, stocks in emerging markets reached new heights and bond prices sky rocketed as yields collapsed – also commodity prices boomed and oil was not left out of the party.  Between 2009 and 2011 oil prices rose from $40 to $125 a barrel, driven by ever increasing demand from emerging markets and $1.9tn of US and UK QE.  Following the boom in commodity prices between 2011 and 2013 prices stabilised at a high level before falling off a cliff in 2014.

The Crude Story

Time up for QE

No one really understands it and because of this opinions are all the more divided and intransigent. Despite this incoherence the market has understood enough to know that it drives asset prices and confidence in future prices.  It is QE – quantitative easing.

Ben Bernanke - the Godfather of QE

QE is where Central Banks print themselves some money to buy bonds and other instruments from the banks, the idea is that this puts cash / liquidity into the economy increasing the money supply and making credit more freely available.  Under “normal” conditions of growth (+2-3% annually)and inflation (around 2% annually) equilibrium this would drive up aggregate demand (growth)  and inflation as the banks push this extra liquidity out into the market in the form of loans.

Where no hawks dare to fly

The doves at the Fed led by the chief "cooer" Janet Yellen have found a new reason to keep interest rates at an historical low.

Not a hawk in sight

The latest buzz words are “Pent up wage deflation” and they provide an elaborate excuse for ultra loose monetary policy. The essence of the idea is that in the Great Recession of 2009-2011 the market rate for jobs fell appreciably but that because wages are "sticky" and actual wages remained flat. This stickiness of wages is a function organised labour (Trade unions), employee nervous to move jobs and employers who are reluctant to loose key staff.

Janet Yellen - barking up the wrong tree

Over the last 40 years (well up until 2008) the role of central bankers was pretty clear – keep inflation under control - and it’s no surprise that during the great inflationary period 1970-2000 monetarist held sway.  Interest rates were raised, money supply was squeezed, unemployment rocketed (and then fell) and it was possible to pronounce the demise of Keynesian economics with complete certainty.  The fun went out of economics - the “Great Moderation” proved that once and for all we were the masters of our own economic destiny.  Then the credit crunch struck and the financial crisis kicked off which in turn led to the “Great Recession”, from which the developed world is still trying to escape.

Central Bankers - from heroes to zeros

The Bank for International Settlements (BIS), the only institution to call the financial crisis in 2007, has weighed back into the macro economic debate in the last few days in its annual report.  The report sets out a significant criticism on the current crop of central bankers, in essence the BIS lays the blames Yellen and Co for the falling: growth, demand and employment.  The expansion of national balance sheets and negative real interest rates are now the problem not the solution. The Keynesian approach that all central bankers have followed is now coming under close scrutiny as the global economy struggles to gain economic momentum. The process of piling the "cart" with more and more debt means Central Bankers are running a huge risk as the road ahead may not be as smooth as the would like!

Let's hope there are no pot holes ahead

Selling England by the Pound

The English are having a bad year, we are on the brink of losing our last meaningful colony and these storm blasted islands have endured the worst weather on record and we are only in April! Despite all this we are still standing and there remain three things that the English can be proud of:

• Getting drunk and then fighting for their lives 
• Being polite and stand-offish
• Having a weak currency

A Spaniard - what you find when you Google an image of a drunk English Gentleman!

The starkly contrasting social habits of the English are well documented but the relatively value of our currency has been brushed under the (garishly patterned) carpet  by the long line of Keynesian and neo-Keynesian economist who believe that  we will eventually take our place on the global top table of exporters if we continuously devalue our currency.

A sticky mess for economists

I have spent a fair amount of my leisure time racing on sailing boats, where one becomes paranoid about wasting the wind, the tide or ones position on the water.  This is in stark contrast to the rest of my life where waste is everywhere; I waste time in mindless meetings and commuting, I waste money on an over indulged family and some would argue that I am wasting my life away writing this blog!  But all that is going to change; waste is out and utilisation is in – or so says the Governor of The Bank of England (BoE).

Having spent the last five years providing as much slack as possible to keep the banking system on its feet and the economy off its deathbed, there is now a new mood and doctrine.  When Mark Carney arrived in the UK in July last year he promised us Forward Guidance on interest rates – he would hold rates at 0.5% until we achieved full employment.  So like a seasoned skipper he turned the yacht downwind and let all her sails out.  The economy (helped by a friendly gust of overseas investment) has picked up speed, employment rates have shot up and people are wondering when we will need to tighten things up.  If we don’t tighten things up and the economic tail-winds pick-up we could get into a real mess.

He should have tightened up a bit earlier

Emerging market emergency?

The mere thought of the US Federal Reserve tapering their asset purchase programme (QE) in May last year put the world into a spin.  As sellers sold out their positions, currencies were devalued and Central Banks had to step in with higher interest rates.  Nine months on and the Fed has begun to taper by $10 billion a month and the impact on emerging markets is ratcheting-up.  This time last year the Fed started buying $85bn of asset purchases a month they and least we forget they are still pouring $65 billion a month into the world economy?  On the face of it this is a small reduction, $20bn a month after $2tn or more of asset purchases in four years, but it is having a material effect in emerging markets and may well come home to haunt us in the West .

The QE 1 - just a good excuse to remember this grand ship

The morning after the night before

Like a terrible hangover that takes an age to clear the developed world has been limping along, since the aftermath of the financial crisis.  There is lack of vigour, a kind of listlessness that Larry Summers has characterised as “secular stagnation”.   Economies, unable to return to the optimistic per-party state they enjoyed from 1995 to 2007, are now settling for survival rather than growth – the pounding headache makes future endeavours unthinkable – we are definitely in the bunker. There are four connected things going on here: dehydration, nausea, a sense of injustice and finally despair – sounds familiar? Secular stagnation is not inevitable we can find a cure. But as Larry tells us “ without a clear diagnosis of our problem and a commitment to structural increases in demand, we will be condemned to oscillating between inadequate growth and unsustainable finance”. And he goes on to say that " A strategy that relies on interest rates significantly below growth rates for long periods of time virtually guarantees the emergence of substantial bubbles and dangerous build-ups in leverage"  - which is exactly where we are low growth, poor levels of employment, low levels of investment - but the very high risk of bubbles and other financial risks.

The Morning after the night before

Economists playing with fire

I have a sixteen year old daughter who is working hard on her final secondary school exams (UK ‘A’ levels) the results of which will determine the type of degree and which university she will attend – these are important times!  Being a more focused individual than her father she is already weighing her options and it’s straight fight between Economics and History.  Over the Christmas holiday we had a number of discussions around the relative merits of these options; initially I supported the view that Economics would be a more relevant and “useful” degree but now I am not so sure.
Having missed the vital signs of the credit crunch and the ensuing recession in 2008/09 economists around the world are red faced again and having to play catch up on the startling and unexpected rebound that the US and UK economies kicked off in 2013.  Not a single note-worthy economist was able to forecast up-tick in GDP growth or the stellar year stock markets enjoyed in 2013!   Famously, Olivier Blanchard (the International Monetary Fund's chief economist)  warned George Osborne that his austerity programme was "playing with fire" just as the UK emerged into recovery!

Economists playing with fire  

So if they can't tell us what is going to happen what are economists for?  It's a legitimate question to ask - if economist can’t forecast what is going to happen do they have any practical use? Being increasingly unsure of the future, they spend their days trying to piece together the past and polishing their excuses.  But why should economists worry about the past - as James Buchan told us “Economists, like royal children, are not punished for their errors”.

Life "Sans Gaz"

The great and the good of the economics world have been debating the possibility of growth without bubbles.  Larry Summers and other commentators have proposed that the dynamic growth enjoyed by the West between 1994 and 2008 was due to a stream of bubbles (dotcom, the euro, the credit boom and commodities) that kept growth rates artificially high.  Without a stream of future bubbles the developed world may not be able to grow at a rate that improves living standards.  Fortunately human being are well adapted to bubble recognition  (it occurs when the capital gain an investor expects over time is much greater than the potential change in interest rates in that same time period) and once one person has spotted a bubble we all dive in!
Stripping out these instances of temporary and unsustainable exuberance we are left will a pretty anemic performance in global GDP growth.  The inability to grow without market bubbles providing the fuel to the global engine has been coined secular stagnation – low growth, high debts, falling prices and high unemployment.

Here's to the next bubble

Before we all throw in the towel,  it's possible that the champagne that has been on ice for five years is about to pop its cork in a shower of new bubbles – the housing market is building up a head of steam in a number of key markets – parts of the US, the UK, Germany and parts of Scandinavia. In other markets there is still a considerable over hang in supply (Spain, Ireland, Greece and parts of the US) and the pain that investors and lenders have been through ought be burned into their collective consciousness.

Where have all the bubbles gone

The UK economy may be in the midst of a stellar year in which growth has returned, most unexpectedly, but there are special circumstances that have benefited us.  Elsewhere in the developed world, we face a persistent economic stagnation. Across the developed world employment rates are low, wages and disposable income are depressed; real interest are still negative; government debt is staggeringly high and rising; companies and individuals prefer to hoard cash than invest and to cap it all it looks like deflation is now stalking the planet. 

Despite extraordinary efforts by the world’s central bankers in the aftermath of the Lehman’s default, which has included the massive increase of liquidity (QE) and negative real interest rates, five years on the outlook is pretty poor.  Larry Summers re-coined the term secular stagnation to characterise the economic landscape and went on to float the idea that the west has grown on the back of asset bubbles for the last 20 years (Property, DotCom, Emerging markets, Sub-prime, etc) and that any return to pre-2008 levels of growth will demand some new bubble to help us along.  Larry Summers suggests the level of real interest rates required to generate full employment might be, say, -2 or -3 per cent.  More practically bankers in both the Fed and the ECB are now contemplating negative interest rates on short term money they hold over-night as a way of stimulating demand.  

Where have all the bubbles gone

Janet Yellen - she's a pussycat

In the UK there has been a major row about the politics of the leader of the opposition’s father and the fact that he was a communist.  Clearly the background of important politicians and officials is in the public interest, whether they like it or not.  In the US, Obama has nominated Janet Yellen to be Chairman of the Federal Reserve and whilst she is not a communist for some Republicans that fact that she is a self-confessed Keynesian is even worse than being a Marxist!  And as Gavyn Davies says “A 67-year old leopard is unlikely to change its spots”.

Janet Yellen - she's a pussycat