The Confidence Fairy

George Osborne has presented himself as the “Iron Chancellor” willing and able to make the tough decisions required to see-through the Tories “long term economic plan”.  With an Election 80 days away it’s time to assess his track record in this regard as he is now promising (with some glee) another 3 years of austerity, as he tries to achieve a budget surplus in by 2018. Osborne believes the winning narrative goes like this: Labour wrecked the economy, we inherited unsustainable debts, we then embarked on un-popular but necessary polices to restore confidence in the UK economy and bring down the deficit, these policies took time to work but supported by monetary policy (QE) the plan is now paying dividends.  One would have to be a dumb fish to swallow this story hook line and sinker.

Taking the bait

A Free Lunch for Europe

In three short years Angela Merkel has gone from being the Superwoman to the Boggiewoman of Europe.  Having faced down the Euro crisis of 2011-12 she became the heroine of the hour – being fated around the world and the re-elected at home in 2014.  Her unwavering commitment to securing the Euro based on secure fiscal framework has made her the Mistress of Austerity.  It was she who enforced the bail-out process and the “Fiscal Pact” that accompanied the money.

Here's looking at you PIIGS

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

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!
 

What a hedgehog knows

When, in 1948, Mikhail Naimy  wrote “The more elaborate his labyrinths, the further from the Sun his face” he was already living in a world that was being over-run by complexity.  Most of the greatest insights in art and science since the end of the Second World War have been conceived in a dense soup of analysis.  There will no more be simple insights that change the world – mastering the complexity is everything.  The keen amateur who is able to think freely and creatively is no longer taken seriously;  the potting shed had been replaced by the data centre such is the explosion of data and variables required to understand the problems we face. We are living in the age of the Fox (who knows many small things).
This up-tick in complexity is obvious in the world of macro-economics as the simple relationships between money, prices, capacity and rates of interest no longer seem to work.  Also old certainties about productivity and wealth have been debunked – this is an uncomfortable world for the Hedgehog – (who only knows one big thing).  Obvious problems create resolutions that can be faced with bravery, although tactics may vary we can unite behind a shared vision or oppose it full on.   If the problem is too complex to articulate then there will be no solution only a vacuum.

Where are the hedgehogs

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.

The IMF gives more poor advice

The IMF have made some interesting pronouncements over the last few years – having missed the credit crunch and the “great recession” that followed they at first endorsed the UKs plan A and then decried it just as it was starting to work – so we shouldn’t hold up too much hope that the Fund will have anything sensible to say on the matter of European recovery.  No one was too interested when they published their World Economic Outlook, which is normally like a school report – “the UK could try harder”, “France needs to apply herself and complete home work on time” – you get the picture.  But this time round it was a bit more specific and surprisingly so; normally the IMF is reasonably hawkish, looking to solve problems through monetary policy (what would expect, it’s a bank) but in this report the IMF suggest substantially increased public spending on infrastructure investment, and across much of the world.   It asserts that when unemployment is high and interest rates are low, the benefits will be greater if investment is paid for by increased borrowing, rather than cutting other spending or raising taxes. Most interestingly, the IMF declares that good infrastructure investment will reduce rather than increase government debt burdens as public infrastructure investments pay for themselves.  Confusingly the whole 44 page synopsis of the WEO highlights a number of risks to the world economy – political risk in Russia, property bubbles, shortages of natural gas, etc;  but report hardly mentions the debts run up by governments and leverage in the banking system - convenient eh!

Christine Lagarde Head of the IMF points the way forward

Cutting Taxes and Axing Osborne

In 2010 the Tories had plan A, deficit reduction, and by and large the British public bought the idea, which was simple, “We have to cut the deficit because sky-high public debt will kill growth and investment and lead to long term depression”.  Some of this proved to be wrong but enough of the narrative still works.  In all polls that ask the question “who do you trust to manage the economy?” the Tories are in a comfortably lead. We Brits have a long memory and the Brown / Balls bubble will not be forgotten and more recently Ball’s idiotic call for a plan B made him the laughing stock of Westminster.

Despite the Tory’s hard talk on deficit reduction the reality is that progress has been hampered by the coalition’s bargaining (with the illiberal Lib Dems), which ring fenced welfare, the NHS and pensions from the ravages of austerity.  Nearly all the cuts imposed in this Parliament have been born by spending departments that receive less 40% of the entire public sector budget.  There have been some interesting results – less spending on police has reduce crime, less spending on “enterprise” has helped growth take off, lower spending on Europe has made Europe even less popular and a huge increase in international aid has seen our stock in the world fall dramatically!

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

La Belle Époque - revisited

As we remember 1914 and the horrific shock that World War inflicted on Europe and the terrible waste of life the two World Wars inflicted it might also be sensible to recognise the economic shockwaves that these events triggered.  The two World Wars and the depression that was sandwiched between them, changed everything economically.  The old colonial powers lost their possessions and incomes from abroad; inflation was unleashed on the world as never before – destroying the inherited capital of the über- rich, labour organised and the world was changed. 1914 destroyed the La Belle Époque and changed almost everything!

By the '50s the old rich where on skid row!

Let Them Eat Cake

The key to good economics is timing, Adam Smith was banging on about pins when pins where the last word in precision technology, Keynes was lucky to be at the height of his powers when the world needed him most and Milton Friedman took his bow when everyone had gotten bored of trying to make Keynes ‘General Theory' work.  Enter stage right Thomas Piketty, who is also lucky to be making his pronouncements on inequality as a new gilded age dawns bright.  Incidentally, one of the last gilded ages led to Equality, Fraternity and Liberty by way of the Guillotine so M. Piketty, a Frenchman, should be careful what he wishes for.

Exécution de Marie Antoinette 16 octobre 1793

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.

European Hunger Games

For anyone who was growing up in the 1970s there is a short list of things that one has to be concerned about:  The music of The Bay City Rollers, the instant pudding - “angel delight”, playing rugby against the Welsh and inflation.

The Great Barry John laying waste to England

Although the oil price shocks affected all industrialised economies inflation had a particularly severe impact on the UK, we quickly became known as the sick man of Europe.  Our smoke stack industries were failing against new competitors and trades unions made it impossible for us to improve productivity; this labour intransigence forced unemployment to horrific levels.  But worst of all, Inflation was in double digits eating up savings, wealth and security and against all the laws of Keynesian economics we had high inflation, high unemployment and high interest rates – stagflation!  Like a creeping terminal disease it infected all parts of our economy and did untold social damage; many of today’s most potent social problems steam directly from this time – rising divorce rates, poor parenting, plunging standards in education, rising crime rates and so it goes on.

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

Judgement Day for Economists

The economic discussion on how to solve the evolving recession and global stagnation has become increasingly political with Krugman and Summers on the left and Rogoff and Co on the right.  Too much energy is now being spent on self-defence,  protecting one's reputation takes precedence over new thinking.

The depression in the 1930s gave us Keynes and stagflation in the 70's gave us Friedman and I am pretty sure there will be a new luminary to rise from the ashes of the current mess we are in. Frankly, neither of the "old schools" looks likely to predict the "first best solution" correctly.

Keynesians really struggle to find an elegant solution to the ending current cash hoarding and low private sector investment when their demand side policies would further raise public debt.  Why would a company or an individual risk investing in new ventures in a country where sovereign debt is increasingly out of control and where there is a risk of default or very high interest rates in the future(particularly when most investors are not followers of Keynes)?  The risk of slowly reducing asset value is always preferable the risk of a total loss investment.   Followers of Keynes offer no insights into how this conundrum is resolved.

In the same way monetarist struggle to solve the problem of very low private sector investment when real interest rates have been and are likely to be negative for years to come.  They argue for more public sector austerity, that would reduce demand and further endanger recovery.  They also can’t resolve the problem that supply side solutions would further erode labour share (the % of national income earned by employees), which is one of the main reason for falling demand and productivity.

Rogoff on the left and Krugman on the right - just for a change

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