Solving Secular Stagnation

There is now a sense of gloom that pervades the corridors of power in the developed world, six years on from the Lehman Brothers' default and the ensuing “great recession” we are still in the economic dead-zone.  In particular Europe is marred by low growth, high unemployment, falling prices and the worry is that this is the “new normal”.  Most economist are satisfied that the problem is poor aggregate demand, caused by falling investment in both the private and public sectors combined with diminishing disposable income - wages have been flat for years.  This malaise has been characterised as “Secular Stagnation” (SS), a term made famous by Larry Summers a former Head of the US Treasury department.

Larry Summers - feeling the torpor of Secular Stagnation

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

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.

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

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

Ignoring the Wealth of Nations

When Adam Smith published his economic treatise in 1776 he gave the world a number of defining ideas for wealth creation and preservation.  The first was that regulations on commerce are a menace and counter-productive. Smith’s amazing insight was that a nation’s wealth is really the stream of goods and services that it creates not the gold it accumulates.  Another important idea was that a country’s future income depends upon this capital accumulation (wealth) and that the more that is invested in better productive processes, the more wealth will be created in the future. As an adjunct to this idea people must be confident that their capital will be secure. The countries that prosper are those that grow their capital, manage it well, and protect it. The final theme is of course the “pin factory” and that productive capacity rests on specialisation (the division of labour) and the accumulation of capital that this makes possible.

My thanks to the Adam Smith Institute

The Rate Debate Gets Interesting

Five years ago today Lehman Brothers the Wall Street Investment Bank went bust and for a few days the world held its breath to see what other banking titans might fall.  In the nick of time a new breed of super-hero was to step into the breach and save the day; central bankers arrived at the scene of the crash their pockets bulging with credit and cash for bail-outs and thank God they did.

Since the emergence of this new class of super-hero we have all be enthralled to the charms of negative real interest rates, quantitative easing and other creative policies for easing the money supply.  A new arrival on planet earth might be forgiven for thinking that messrs Carney, Bernanke and Kuroda actually are the people who rule the world and in fact they probably do!

I'm forever blowing bubbles

The soccer fans of West Ham United have sung the song ‘I’m forever blowing bubbles’ since God was a boy (or least since the mid 1920s) and whatever relevance it may have to inspiring sportsman has been lost in the mists of time.  The chorus of this American ballad goes;

I'm forever blowing bubbles,

Pretty bubbles in the air,

They fly so high,

Nearly reach the sky,

Then like my dreams,

They fade and die.

Fortune's always hiding,

I've looked everywhere,

I'm forever blowing bubbles,

Pretty bubbles in the air.

As with sports so with finance, the economic cycle is an endless treadmill of  precarious bubbles that ‘fade and die’.  The simple truth is that markets (people) are lazy, we are programmed to take the easy option, that’s evolution for you.  And this rubs off in the world of finance, we almost always lurch from one soft option to the next; in the last 15 years we have had the dotcom boom, the alchemy of algorithmic trading, the credit bubble and the addictive pleasures of QE.   In the good old days we had central bankers who would from time to time burst the bubble and insist that we get back to the serious business of controlling inflation and nurturing sustainable growth.  With deflationary pressure all around the Fed have been busy blowing bubbles not bursting them, but this is about to change.  

 In the last week the markets for both bonds and equities have been in full scale retreat, frightened by the smoke signals coming out of the Fed, which is pouring $85bn of new money into the US economy every month.  QE has had the effect of lowering interest rates and presumably nurturing some growth and new jobs.  All this has been achieved without stoking the fires of inflation but this can’t go on forever; in the short run negative real interest rates have a positive impact in the longer run (just ask the Japanese) worthless money kills ambition and productivity. It is therefore somewhat worrying that our Central bankers are now so cautious on the need to wind back QE and return to real money.  Probably more worrying is the fact that these self-same central bankers now believe that they should have a remit for ensuring high levels of employment and positive rates of growth rather than just managing the money supply and inflation.  News that the Fed will use QE until employment rates rise to 92.5% and to be in a world where employment should be the sole arbiter of interest rates and money supply is a madness of schizophrenic proportions.  Have we have forgotten all the important lessons of the of the 80s and 90s when we had raging inflation, high interest rates and low employment?  The world’s central bankers need to get back to their day jobs of managing inflation, otherwise more pretty bubbles will fade and die!

Lost Productivity Killing the West

The developed world’s economy is still staggering shakily after the credit bubble burst in 2008, all the indicators are flat-lining or falling; GDP growth is poor, liquidity is tight, employment is falling and real interest rates are negative, but above all productivity is the problem.  Productivity is a calculation that takes constant price GDP per hour worked and per worker or all GDP divided by the average number of people in work in the year and divided again by the average number of hours worked.  The charts express this as an index based at 100 in 2007.

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. 

The case for a Bad Bank

The Government's asset purchase scheme has 'spent' £375bn buying up gilts (UK Government Bonds) from our distressed banking sector, what they call Quantitative Easing (QE). The scheme was meant to be self financing but this week The Bank of England stressed that although likely deliver a £17bn profit, its possible that losses made on the sale of the gilts would rise to £75bn, producing a net loss of £8bn to the public finances in 2020.  As well as pointing out some long term risks they also confirmed that more QE is unlikely to beneficial, what a surprise!

QE - keeping the lights on!

In a parallel universe within the Bank the Deputy Governor, a Mr Bailey, confirmed that despite this massive commitment to asset purchasing our 'too big to fail' banks may still need a further injection of Capital, he said “I agree there is a need to strengthen the capital position,” he told MPs.  .  He hinted that the extra Capital might be necessary before Lloyds and RBS are returned to the private sector.  Some 'experts' suggest the figure could be as high as £50bn

The Bank of England and the Labour Government missed a big opportunity to resolve our banking crisis back in 2009 when they decided to prop up the banks rather than buy up the distressed assets to create a Nationalised 'Bad Bank'.  The coalition Government have also kept their heads firmly in the sand on this since 2010.  The result is that after four years on and with £375 billion spent on QE we still have a broken banking sector. 

If the Government had broaden the asset types for the QE programme we could now be in a situation where Lloyds, RBS and Barclays could be providing the credit and lending services that our economy so desperately needs.  Meanwhile the Bank of England could be managing the run-off of asset sales from 'Bad Bank'.  It's now emerging that this 'Bad Bank' construct maybe needed to bail-out the UK's over-blown and poorly regulated Private Equity business. When it rains ......!

Yet another Bank of England study (my they have been busy) has confirmed that many UK businesses have been left “fragile and susceptible to default” by private equity’s leveraged buy out (LBO) model.  In the first decade of this century Private Equity sector used leveraged finance to 'buy' many of our best UK companies, actually what they did was to borrow a load of money and then pass these debts on to the balance sheet of the acquired business.  Companies like Boots, Manchester United, Saga, Debenhams and all suffered the same fate.  These businesses are now loaded with the debt estimated at £160bn. See the chart on the left.

When people think of Zombie business we image small run down family companies hardly able to meet the pay-role, the reality is much more serious.  We now have some of our best business over loaded with debts that they will take years to pay off.  This is killing productivity and we are losing the opportunities to expand exports and employment at home because of the greed in our financial service industry.  This may is some way explain the UK's terrible productivity performance sine 2008.

But setting up a 'Bad Bank' the government could free both our banks and our leading businesses from the effect of the credit boom and bust setting the economy on a course of recovery.  The next question will be how do we get our money back from the Private Equity millionaires who have done their bit to wreck our economy.

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