Austerity's Catch-22

Remember this piece by Joseph Heller that sets out the problem for a scared fighter pilot trying to get grounded in WW2? 

………There was only one catch and that was Catch-22, which specified that a concern for one's safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn't, but if he were sane he had to fly them. If he flew them he was crazy and didn't have to; but if he didn't want to he was sane and had to.  Yossarian was moved very deeply by the absolute simplicity of this clause of Catch-22 and let out a respectful whistle.....

Keep your feet on the ground

Perhaps Joseph Heller has had a hand in designing the current recession:

Recovery in advanced countries where high levels of debt have coexisted with negative real interest rates for many years must require increased public spending, tax cuts, QE or other measures that may well, in the medium term, cause interest rates and rise choke off growth.  So, like Yossarian in Catch-22 one can only let out a respectful whistle at the perfect symmetry of our predicament.  To escape this vicious circle of low growth, no growth, etc - there have been two standout tactics and both are a kind of madness, they are:

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.

All work and no pay

The next generation are taking over, after 25 years of being the sole bread winner in the family two of my three daughters are about to step into the world of work – well let’s hope so!  Being equipped with a degree is no longer a passport to wealth and prosperity it may not even be enough to secure a job.  One of these daughters has taken the option to take a year out from University to gain experience working for a number of business as an intern during a "year in industry", which is sandwiched between her 2nd and 3rd years.  She secured three internships, where she is working for no money to gain experience; some might say this has been a pretty poor introduction to the world of work.  The reality is that she has the opportunity to work for three outstanding companies and has already been offered a permanent position!  This “year in industry” seems an eminently sensible idea, she gets to see different businesses and roles close up and they get the chance to check her out.

Get on yer bike!

My daughter’s situation is a microcosm of the whole job market, which has been a buyer’s market since 2007.  Those of us who work in the private sector have had to survive wholesale downsizing, salary freezes, smaller or no bonuses and a broader squeeze on company benefits (pensions, etc).  This reduction in take home pay has reduced demand and slowed growth; but this flexibility has allowed the UK economy to maintain relatively high levels of employment.  Now the economy is growing again the somewhat vexed question is - how long will it take for this increased economic activity to feed through into higher take home pay and rising living standards?  I say vexed because living standards have fallen by as much at 5% over the last 5 years and in real terms by much more.

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

Other Men’s Flowers

There are plenty of people who live their life at work as is it were some intellectual exercise, choosing to take decisions that are for the great good but have a terrible impact on their own careers.  Field Marshal the Lord Wavell was one, he chose to pick a fight with an obdurate and all-powerful Churchill and was summarily dispatched to pull together his famous anthology of poetry “Other Men’sFlowers” rather than take any further part in the Second World War.  Britain lost her most talented commander but gained a literary gem. 

If you don't have it, do buy it

One might expect this kind of selfless attitude from a Wykehamist but it’s wholly unexpected, and unwelcome, from an Etonian and a politician to boot!

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

The Great British Bail-in

There is an old boy in our local community who has, over the last 15 years, restored a scruffy over-grown wood into a beautiful heathland with heathers, gorse and wonderful roan trees.  This labour of love has been completed with some support from the village but without the time, leadership and effort of one man we wouldn’t be able to enjoy the great amenity he has created.  He has done this because he can afford time but he has given this time so lovingly.





Not out of the woods

 As with this wood so with the national economy;  in 2008 the British economy and our way of life was hanging in the balance.  The financial bust created a structural deficit that amounted to 6% of the national economy (caused by the banking collapse) and on top of that we had the recession the rest of the developed world suffered adding some 4% to the downturn.  There is no precedent for a the UK economy taking a 10% hit to its national income in two years.  Following the bust we have been through a very painful process of rebalancing the economy so we can start again.  The rebuilding process has been achieved by a section of society is the same stoic and silent approach that the man in wood has brought to his restoration.

Who's Been Eating My Porridge

Even the Bank of England has now confirmed that the green shoots of recovery are growing strongly and that we have reached escape velocity.  Even inflation is falling towards the Government’s target range of 2%.   Some might describe this as the perfect Goldilocks scenario for our economy– not too hot not to cold! However there is one angry bear that might ruin the breakfast – poor productivity and falling living standards.

The Return of the Robber Barons

In the US there has been a huge row brewing on the “take” that the top 1% earners have as a proportion of all wages, currently they earn 20%.  This is the highest share since 1928; the roaring twenties with The Great Gatsby and all that.  Conversely in the UK there is a remorseless focus on the poor share that low paid workers receive, the so called crisis in living standards;  and this weekend Ed Miliband offered a cack-handed subsidy solution to this important issue.

David Miliband's brother

The tales of low income poverty and indecent wealth tie together neatly in the recent spat at the Grangemouth oil refinery in Scotland.  The refinery is owned by one of Britain’s wealthier individuals,   Jim Ratcliffe, the somewhat reclusive 61-year-old chemical engineer turned offshore billionaire and owner of Ineos.  The dispute at Grangemouth was initially about victimisation of a Union leader but it turned into a battle of wills between Ratcliffe and the Union Unite over pay and conditions at the plant in return for job security and investment.  Ratcliffe played “hardball” by threatening to close the plant and eventually a deal was done on his terms.  The left has painted Ratcliffe as a sinister bogeyman and the media have added to the fun by christening him “Doctor No” in deference to his lifestyle on his €100 million super-yacht Hampshire ll.   The yacht is 258 feet long with a helicopter cum sports deck, a crew of 23 and seven suites, the perfect lair for the “Bond villain”.

Ratcliffe's yacht - Hampshire ll 

On yer bike

The result of the 2015 election in the UK will probably depend on two things; the effect of economic recovery on living standards and the success David Cameron has in renegotiating our terms of membership within the European Union.  In short, if the recovery delivers improvements in living standards the coalition will probably be re-elected and if the European negotiation is successful the Tories might expect to form a majority government.  I have argued for a long while that Labour’s crisis in living standards is erroneous; as the marginal nature of disposable income means that we will see a substantial recovery in take home pay over the next 18 months.  The European issue is more vexed.  Mr Cameron has two options on Europe, a Harold Wilson like renegotiation (nothing changes at all) or a Margaret Thatcher like renegotiation, which achieved some changes but within the broadly unchanged  framework.

Here come the Bulgarian's

Starman Waiting in the Sky

Britain’s star man central banker, Mark Carney, has hardly blown our minds, getting off to a pretty slow start.

Apologies to David Bowie

Since he arrived in July the economy has continued to recover and all the attention has been on Ben Bernanke at the Fed - and the talk of tapering QE in the US.  In his first few months he has taken the first tentative steps – issuing some forward guidance, taking on the funding for lending scheme and the Help to Buy scheme.  But today for the first time Mr Carney stepped out from the shaddows.  The occasion was a 125th birthday party for the Financial Times, so Mr Carney was able to talk to a well-informed audience rather than having to sound bite for the benefit of the BBC’s simple minded economics experts.  The back drop to his speech is that the UK is the best performing economy in the G7 with annual growth of about 2% and rising, relatively low unemployment and no prospect of a deflationary bust - that is still a possibility in Europe, Japan or even in the US.

Unglobalization - the decline in world trade

The declining growth in world trade has got economists baffled.  Some economists think this is important whilst others are not so fazed.  On the face of it we should care because the volume of trade has broadly mirrored the growth in GDP (wealth) across world so any decline may signal a slowdown in GDP growth.   The chart below shows the long run growth in world trade and the impact of the 2008 recession.  The steep decline and bounce back between 2008 and 2010 is not surprising but the lack of sustained recovery since 2010 is a worry, particularly in the developed world.

The Selfish Giant and other fictions

Clio Barnard's film The Selfish Giant has already been described as "hauntingly perfect" and "jaggedly moving" as it premieres at the Cannes film festival, the director herself is being feted as a new and important presence in British cinema.  I have to declare some skin in this game as the original story (The Selfish Giant) by Oscar Wilde was my mother’s  favorite children’s book, and if you have children and you haven’t read the story you should pop out and buy it now!  The story goes something like this -
When the Giant returns from long trip away from home and discovers the local children playing in his beautiful garden, he chases the children away and builds a high wall around his plot to keep them out. The garden laments the loss of the children’s laughter and when spring comes, the plants and trees blossom everywhere except for the giant’s garden, which remains covered in winter snow.  From here the story then develops beautifully and sadly  -  you had better buy the book.

One of Ritva Voutila's original illustrations

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

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

We're Mad As Hell

Many of us will be experts in the dark arts of sequestration, whereby we create an ultimatum that will have future consequences.  At a personal level it might be “Give up smoking or I will leave you” or it might have a geopolitical significance “declare war on Serbia and we will declare war on you”.  Some of the most dangerous events in history have been triggered by intransigence enshrined in law.  The problem with sequestration is that is hardens attitudes and creates false deadlines and makes sensible negotiation all but impossible.

It may be that comparing one of the causes of the First World War with the current debt crisis in the US is somewhat melodramatic; but the important point is that a possible default by the US government has been conjured from a law that was meant to protect the US economy. 

Tea Party Slogan - reads badly in English!

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!

Living it up - throwing a light on living standards

Since 2009 the UK has been in a liquidity trap, where depressed consumer spending has contributed to an overall shortage in demand.  This demand shortfall played its part in creating the “flatlining” economy that Ed Balls was so fond of.

We won't remember them!

The main reason for this lack of demand has been the squeeze on private sector pay and living standards, this squeeze has been vicious and this is because disposable income is “marginal”.  A wage earner on average income of £37,000 only has about £15,000 of disposable income a year after paying for taxes, housing costs, utilities and transport.  Since 2008 pay increases have been less than 2% a year and prices have increased at 3.5%.  Five years of real earnings decline at 1.5% annually means a reduction of £2,600 or a whopping 17% of disposable income. This squeeze was combined with a rise in the saving rate, as Britons have lowered their debt-to-income ratios.  

Living in the past

The last few days of summer traditionally bring us some warm weather before the autumn gales roll in off the Atlantic Ocean, and this year is no exception.  The orchards are dripping with fruit and the late flowering Asters and Dahlias provide a splash of colour before we drift into a world of grey and cold. To soak-up this fleeting moment fruitfulness before the mists roll in one could hardly pick a better spot than Brighton; nestling at the foot of the South Down a short distance from the Garden of England (the weald of Kent) the town is perfectly placed for an early autumn break.

Brighton Pier

Sadly for those planning to enjoy the last warm weather of the year they will have to share the town with the Labour Party gathering for their annual party conference.  For a modern new look Party Brighton is a strange place to pick, reminiscent of old fashioned 70s conferences where Trades Union bosses owned the agenda with a block vote and a Sterling crisis was the most likely ex-curricular distraction.  On second thoughts maybe the conference organisers have got the location spot on; Ed Miliband’s Labour party is starting to resemble the Harold Wilson era more and more.  Wilson was adept at the politics if not government, endlessly shifting his position to remain in power, his governments achieved little and left the UK in a parlous state.  Ed Miliband has a similar style – all grease paint but no show.  So it should be of no surprise that, as deftly as a well-trained circus act, the Labour Party have switched horses from a strategy that demanded a “plan B” for economic recovery to new mount that demands action to improve living standards.

Handbrake Politics

Although we are only 65% of the way through the duration of this government’s ‘fixed term’ it’s probably a good time assess the achievements of the coalition; as the next 18 months will be more about electioneering than government.  This audit is obviously vital for the LibDems and Nick Clegg as they had to prove two things over the last 3 years, firstly that they are fit for government and secondly that coalition is better than one party government. Nick Clegg’s speech at the recent LibDem party conference offered us the radical message, that the last three years of coalition is not just be an historical aberration but a permanent fixture.  His talk of "bringing down the two party system" and ending what he calls the "clapped-out politics of red and blue" is a bold pitch for a party with such a low standing in the opinion polls - about 10% share!

The Right Type of Recovery

The doomsayers in the British media, having been unable to call the timing of the recovery in the UK, are venting their frustration on the type of recovery we are ‘enjoying’.  A short while ago these same experts were screaming that we were on the edge of a triple dip recession and they blamed risk adverse banks and frightened consumers, who were both rebuilding their reserves and savings.  In six short months we have metamorphosed from ‘triple dippers’ to the ‘northern tiger’– growing at a rate not seen since the 1990s.  In a typically display of British pessimism we have been unable to take this good news at face value and the icons of our ‘thoughtful media’ the BBC, the FT and The Telegraph all tell us that we are in having the ‘wrong type of recovery'!  These doomsters say that at some point, the bond markets will bite us in the backside and that, house prices will fall, the cost of borrowing will rise and we will be back in recession. The overall indebtedness of our economy is the thing that worries these media luminaries and the numbers are quite frightening - currently we owe 300% of our GDP.

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!

Ding Ding Round Three of the Cameron Miliband Rivalry

All great rivalries are dependent on time to reach maturity, conflict in repetition is addictive, the history adds to the fame and to the pain.  So the show down between Obama’s and Assad has none of the piquancy that the second gulf war delivered – the animosity between the Bush family and Sadam Hussein was palpable because of the history.  In the same way, who can remember the first match between Federer and Nadal - a lame affair fought out in the Miami Masters in 2004, not a harbinger for the excruciating excitement their later battles would provide.   And what about the Ashes, even when the quality of the cricket is poor the weight of history turns every match into a nerve shredding struggle.  Sadly these intense rivalries seldom materialise in the world of politics and this is particularly true in the UK.

A Northern Tiger the UK economy roars back!

No one else will say it, so I will!  The UK is in the grip of a full economic recovery, this recovery does not look fragile, nor unbalanced, nor debt driven and it’s probably unstoppable.  So how has it been possible for the sick man of Europe, as we were described barely six months ago, transform himself into the “northern tiger” that we have become.  After years of miserable economic data, there was unanimity that the UK was permanently stuck in a liquidity trap where the shortfall in demand was looking like a problem without solution.  Having thrown monetary policy (£375bn of QE), fiscal policy and a much weaker currency at the problem,  the economy was still flat-lining and all the talk was of a triple dip, much to the amusement of the Labour opposition.

Not Your Bucks hands off the Vodafone windfall

I have been a trenchant opponent of multi-national corporations who see no need to pay UK corporation tax mainly because this behaviour is anti-competitive.  Amazon and Starbucks and other businesses have been free to grow their unprofitable companies to the detriment of our own domestic businesses.  I strongly believe that multi-national corporations must operate on a level playing field or be ‘red carded’.
This week we have a slightly different tax avoidance story that has got everyone excited.  Vodafone are about to realise a £84bn windfall on the sale of their 45% stake in Verizon Wireless, their US partner.  Not a bad return on the £20bn invested in 1999.  Our cash strapped government and specifically the House of Commons public accounts committee can’t wait to get their hands on some of the loot and ministers are already dreaming up ways of spending these unplanned revenues.  However, before they all get too excited there is a suspicion that the company is going to manipulating the rules to avoid capital gains tax.

Beating the Bully Boy Assad

In the macho world of global politics appeasement is the dirtiest of all words.  Failure to stand-up to the bully, whether in the play-ground or at the United Nations is, for most Westerners, a cardinal sin.  The moral maze is simple to navigate when the bully turns his attention to neighbouring states, we should be free to step in to protect the interest and sovereignty of a defending nation – so with Kuwait in the first Gulf War – but when the violence is contained within the Bully’s own borders the maze becomes exponentially more complex.  Accordingly, politicians who turn their military might on their own people are amongst the most reviled of men, but calibrating the correct response is problematic in the extreme.

Mondeo Man Trap can win Cameron the next election

The tide has turned on the British economy; after the tsunami of the credit crunch we have been beached on the mudflats of no/low growth of for four years.  There have been moments when it seemed the after-shocks would create move waves, the Euro crisis being the most obvious risk.  There have even been moments when recovery seemed to be ebbing our way only to evaporate into the stinking sands of a flat-lining growth.  In December last year I blogged that we were at the beginning of the end and amazingly I think I called the low water mark correctly and 8 months on the sparkling waters of recovery our flooding in bringing relief to many parts of our economy. 

Low water - but the tide is coming in!

This change in the tide is very welcome but growth is still weak and localised.  Most of the benefits are being felt in London and its hinterland and only in pockets outside the south east of England.  More worrying our neighbours in Europe are still up to their knees in thick mud and going nowhere fast.  With a new governor at the Bank of England and only 20 months of the coalition government to run people in high places can't afford another false start, they need a full spring tide to come flooding in to all parts if our economy. 

Zero to Hero the UK's flexible economy

News this week that there may be as many as 1 million workers on ‘Zero Hours’ contracts in the UK has come as a bit of a shock to the liberal elite.  A Zero Hours contract is where the employee signs up to an employment contract, which has no guaranteed pay or hours of work, these contracts are used by retailers and hotel industry, which need a ready supply of unskilled workers without the risk of taking on more fixed costs. 

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. 

Carney's Conundrum declining productivity

Understanding the mystery of our terrible productivity performance since 2007 in the UK is at the heart of Mark Carney’s concerns (this is a topic of great interest  to Mr Carney).   His analysis of this productivity fall is important to get right as it will determine whether the Bank of England decides to pursue a looser monetary policy or not.  Many economists believe that, after a brief period of decline at the start of a recession, productivity should pick up pretty quickly as a slimmed down labour force is raises production per head.  Before examining why our productivity has declined so much we should look at some numbers.

Less is More More or Less

Three years ago many were expecting the worst from austerity, how could we possible keep the lights on whilst slashing public expenditure - crime would soar, schools would fail and there would be rioting on the streets.  But how different things look now, a new light now shines on the old problems and there is a shake up to the accepted liberal order.

On the PIIGS back - time to dump the Euro

It’s a life time since the Great Depression but the events on the twenties and thirties maintain a strong hold on our economic and political psyche.  During the intervening years the gold standard has figured prominently as the boogieman that deprived countries of the policy options required to combat the deepening slump. Firm evidence for the overly restrictive nature of the standard is provided by the economic rebound enjoyed by most countries choosing to exit the system, Britain being foremost in this regard.  What’s puzzling us today is why countries stayed wedded to the gold standard for so long.  The relative merits of the gold standard depended on the valuation on joining;  France joined as an under-valued currency whereas Britain re-joined in 1925 as an over-valued currency, this meant that when recession struck Britain was at a significant disadvantage to France and other competitive economies.  Without room to manoeuvre (easing monetary policy and lowering interest rates)  Britain ended up in economic and political turmoil, with an unemployment rate of  25% and the collapse of the Labour government who did not return to power until 1945.

Devolution with dilution solving the Lothian question

Right the way across the globe old political structures are being torn down, the Arab spring has turned to Muslim winter, austerity in Europe drives people against their politicians and more generally the catholic South of Europe is in conflict with the Lutheran North.  In the BRIC economies rapid growth has not assuaged the thirst for change.  It must be something in the water that’s affecting us all, or is it just money or the shortage of it?  Interestingly it’s the middle classes and in particular the young middle classes who are after a change and they have forgotten their manners;  the post baby boomer generation thought they had it all in the Credit Boom and now they are feeling the pinch and look likely to be in recovery mode for years to come. In Blighty we have been somewhat protected although we having to acclimatise to coalition government and the rise of independence fever.  We may not be rioting on the streets in protest to austerity but we are close to a more fundamental breakdown.

The politics of Austerity – north south divide

There are two threats to recovery in the Eurozone, one is rising interest rates an inevitable consequence of Europe being two years behind the US in the recovery cycle and the second is politics.  It could prove to be a long hot summer in the PIIGS economies and in the dusty hallways of the European Central bank (ECB).  The good people of Italy, Spain, Ireland, Greece and specifically Portugal are being asked to endure years (potentially a decade) of austerity.  This Lutheran penance is being applied on these warm blooded catholic nations by the iron will and ice cold determination of German and Dutch bankers supported by the EU and the IMF.  The cheer leader for this chilling approach is Jeroen Dijsselbloem, Dutch finance minister and president of the Eurogroup, the Eurozone’s finance ministers.  His determination that these indebted economies on the fringe of the Eurozone should bail themselves out at breakneck speed is at the heart of the politics.

Money can't buy me love - but it'll get me new hip

In the last month there has be a sea change in British politics, which threatens to overturn the consensus that has held sway since 1945.  All the major political parties have finally recognised that there needs to be a more sustainable relationship between the size of our economy and the scale of our welfare state. We are all children of Beveridge and his report (published in 1942),  which set the roadmap for defeating the ‘the five greats’ - squalor, ignorance, want, idleness and disease.  It’s clear that much of his mission is now accomplished and its time to redefine these ‘greats’ (mine would be Debt, Greed, Intolerance, Ignorance and Security) but the vision can wait, all the focus is now devoted to the funding model for our state provided services.

Winning Ugly - with Clegg

Barack Obama has confirmed that Nick Clegg is better looking than David Cameron and for the British voter both look pretty ugly at the moment!  With less than two years to run before the next general election it’s time for David Cameron to assess two things: Firstly will it be a good election to win; secondly if it is worth wining is majority government advisable?

Bernanke Vernacular

Ben Bernanke the Chairman of the Federal Reserve Bank has been on quite a journey since 2007, having saved the world after the Lehman's default he has nursed the US economy back to health quicker than anyone would have dared to hope.  The soon to be retiring Chairman of the Fed  warned us this week that over the next year he would start tapering off the amount of money the Fed pours into quantitative easing, which is currently running at $85bn a month.  This effectively signals the end of ‘near zero’ interest rates in the US and around the world. 

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!

Obama's mad plan to arm the opposition in Syria

It’s been a busy week in the world of Middle Eastern politics, or more accurately it’s been a busy week in the world of Shia politics.  The Islamic world is not homogeneous, with a number of factions dating back to first days of the religion.  Today the intense rivalry between Islam's two big sects, the Sunni and the Shia, shapes the politics of the Islamic world. Recently a potent mix of religion and politics has sharpened the divide between Iran’s Shia government and the Gulf States, most of which have Sunni governments.  Things run pretty deep between the two sects as many Sunnis do not consider Shia to be proper Muslims. So what divides Sunni and Shia?  On the death, in 632, of Islam’s founder, the Prophet Muhammad; Arabs who followed him were split over who was the rightful heir to the prophet.  Abu Bakr, a friend of the Prophet and father of his wife Aisha had the majority backing and this sect became known as the Sunnis and today they make up 80% of Muslims. Others thought Muhammad’s family the rightful successors.  They claimed the Prophet had anointed Ali, his cousin and son-in-law—they became known as the Shia.   As time went on the religious beliefs of the two groups started to diverge.
Today the world’s 1.6 billion Muslims all agree that Allah is the only God and Muhammad his messenger. The Sunnis rely heavily on the practice of the Prophet and his teachings, the Shia see their Ayatollahs as reflections of God on earth. This has led Sunnis to accuse Shia of heresy, while Shia point to Sunni dogmatism.  Being the minority party the Shia have been careful not to be drawn into large scale conflict with the Sunni’s, although the Iran Iraq war in the 80s was an exception to this pragmatism. The "Shia Crescent" runs from Iran, through Syria to Hizbullah in Lebanon and is at the centre of much of the trouble in the region today.

Shia Muslim distribution 

While Syria has dominated the world news there has been an interesting development in Iran.  Hassan Rohani, Iran’s sole moderate candidate has won the presidential race.  It seems that the electorate in Iran is tired of the grinding of poverty that has characterised the rule of the departing premier Mahmoud Ahmadi-Nejad.   Mr Rohani is backed by two former presidents Akbar Hashemi Rafsanjani, a centrist, and Mohammad Khatami, and these reformist, both called on their supporters to vote for Mr Rohani and help the country distance itself from radicalism.  Mr Rohani has promised to establish a government that will save the country’s economy and help resolve its fractured relationship with the western world to ease international sanctions.  There are obvious concerns as many voters have bitter memories of the last elections in 2009 when they believe their votes were stolen by Mahmoud Ahmadi-Nejad, although the transition seems to be going smoothly.  Mr Rohani is not a true reformer but he has used the campaign to raise many concerns of the modernisers.
Meanwhile with unenviable timing President Barack Obama’s has decided to send unspecified “direct military support” to Syria’s Sunni rebels ramping up the stakes with Shia globally (The Assad Regime is Shia), just at the moment when moderates need encouragement in Iran.  The evidence that has been used to give cover for this active participation (use of poison gas) seems pretty thin and is strangely reminiscent of the ‘weapons of mass destruction’ ruse used in Iraq.  Despite the opportunities to further the moderates cause in Iran it seems that Obama wants to keep up the Presidential tradition of starting an unwinnable war, that has been in place since the time of Bill Clinton.
Sunni-Shia tensions became centre stage after the US-led invasion of Iraq in 2003 that catapulted the Shia majority in Iraq to power.   Iraq became a sectarian bloodbath, with Christian communities caught between Sunni and Shia bloodletting.  Syria is now in the same place and the last thing we need is for the USA to be taking sides.  Neutrality is particularly important as the sectarianism is the consequence not the cause of this conflict, which started as a civic uprising against the Assad family (part of the Arab Spring).  Obama is getting into very deep water as he will be directly attacking Hezbollah, Iran’s Lebanese proxy, as well as the Shia Islamist government of Nouri al-Maliki in Iraq.
What no one in the Pentagon can tell us is the impact this direct attack on the Shia world will have on neighboring states such as Turkey where the Sunni ruling party of Recep Tayyip Erdogan already have major issues with the minority Shia population that make up a fifth of the country’s population. Mr Obama is belatedly entering a very complex geo-religious drama and he would be well advised to leave well alone.

Bad Banks Good Business

Finally Stephen Hester, the CEO of RBS, has fallen on his sword.  The fact that he seems relaxed about this act of self destruction tells us quite a bit about the relationship between him and his owners (the HM’s Government).   It’s probable that Hester is a good banker, good enough to have turned around RBS and secured a return on investment for the tax payer.  Having inherited a bank with a balance sheet larger than the UK's economy and with over 250,000 employees he has been chipping away at the bad bits and selling non-core business to create something that resembles a stable universal bank.  The problem he has had is that he has been working work a government and the Bank of England who have absolutely no vision or plan for our Financial Services industry.
At the outset RBS should have been split into a nationalised Bad Bank, with all the most distressed loans and risky businesses under one roof and a Good Bank made up of the safer business.  Instead of this we have a part nationalised quite bad bank that is unable to perform its part in our financial infra-structure.  As a result lending is down and we are still months away from returning RBS to the private sector, this is distorting the market for financial services and holding back the recovery.

We need to protect our greatest economic asset - The City of London

It’s this total lack of planning and direction that marks out the coalition’s approach to our economy.  Cameron and Osborne had the advantage of watching labour screw up things between 2007 – 2010 and they should have had a very clear picture of how to turn things around.  Instead, like all weak administrations, they relied on a commission on banking (Vicker’s inquiry) to do their dirty work for them, this wasted two years and didn’t move the debate forward.  The central questions of the UK’s banking sector are quite simple and we just needed to make up our minds and get on with it.
Should Retail Banks be allowed to play the in the capital markets and be investment banks?  The answer to this is obvious. No!  There must be a reasonable number of retail banks in the UK who can support the market for deposits, transfers and loans.  They should access the capital market through Broker Dealers who do not have retail clients and they should be limited in the activities and products they can provide to corporate clients (businesses).
The second question is – should the capital adequacy rules be the same for Retail Banks and Investment Banks?  And the answer to this one is also obvious. No!  Retail banks don’t need the leverage or risk profile that investment banks might want, they should be extremely well capitalised with a high percentage of liquid assets (cash), this might be a ratio of 30%+ rather than the 17%+ target that the Basel 3 regulations envisage.  Investment banks need more rope and leverage and this inherent risk will be obvious to their sophisticated clients.
The third question relates to Private Equity businesses and their relationship to the banks.  It is a national disgrace that we have so few small and medium sized businesses that become global players and the way we fund business expansion is directly responsible for this.  Should we allow the short termism associated with Private Equity ownership to mar our industrial and services landscape in the way that it does today?  The leverage buy-out and the associated loss of productivity is killing off large swathes of our commercial infrastructure; companies as varied as Boots and Manchester United FC are unable to compete globally because greedy management and Venture capitalist have saddle the business in debt for the single purpose of personal wealth creation.   The tax laws need to be changed to ensure commercial logic rather than personal greed drive our private sector, it is a scandal the Boots has paid no corporation tax in the last 5 years despite making profits in excess of £5bn.
The fourth problem is the whole business of wealth management and the management of long-term savings. The great explosion of hedge funds and their incestuous relationship with the Prime Brokers (our largest investment banks) is another can of worms. There needs to be clear separation between the various types of asset managers and all of these must be separate from the dealer broker investment banks.  As consumers we should have a more distinct choice to reflect our varying risk appetites
We need to remember that the Financial services industry is our best and most productive sector.  We are the world’s leaders in finance innovation and London’s geographical position between the Far East and New York, combined with our language makes us the natural home for the finance capital of the world.  It is a scandal that the government has no plan or vision for the regulation, development of this core business, and this is symptomatic of their idle approach to structural change and recovery

My Word! My Bonds!

The early signs of recovery were visible in December but after a few months of bumping along the bottom we now have some more consistent evidence that the economy is moving forwards, rather than sideways.  Our service sector (63% of the economy) is leading the way and even construction (7%) and manufacturing (11%) are making a contribution.  The problem of indebtedness still overhangs us like a thunder cloud threatening to rain on our parade.  The overall level of debt is frightening in itself (over 300% of GDP if we include all government and private debt)  but it’s the possibility of rising inflation and interest rates that really terrifies commentators.  At a 0.5% base rate we can certainly manage the problem at base rates of 5% things will be very different.  The one certainty is that rates will rise in the medium term – and this one-way bet is now reflected in an increasingly jittery bond market. 

Weaning ourselves off negative real interest rates is going to be painful but the earlier we start the more manageable the pain will be.  If we remain in the cloud-cuckoo land of negative real interest rates we will be at the whim of the markets but if we can be brave and set our own agenda we might well become a safe haven for a global bond market in distress.  At some point bond prices will start to fall and yields and interest rates will rise, the tipping point is not far off and fickle markets could turn this natural evolution into a full blown bear market for bonds, with an unprecedented sell off which would drive up interest rates dramatically.  Britain has one small advantage in that we are emerging from recession about a year in front of the Eurozone our main export market and we are better placed to deal with some increase in interest rates that our main competition. By implementing a small increase in interest rates now we could secure low interest rates of the longer term as the bond market doubt about the level of sovereign debt mount.

There are obvious risks to this approach, would marginally higher interest rates slow economic activity and therefore drive up government expenditure on benefits?  Also the treat to Sterling and the impact of reduced imports but this would be countered by the deflationary impact on imports.  These are serious concern but the pale into insignificance when weighed against the more cataclysmic option of being at the mercy of a dying bond market

The arrival of Mark Carney at the Bank of England gives us an excuse the look afresh at our options and I hope he will be brave and take a contrarian view of the world and our place in it. 

Constructing a time for change

We have all become experts on the economics of recession, even my daughter can wax lyrical on about the benefits of quantitative easing and the need for fiscal measures to reduce government debt, but the big new thing is ‘structural change’.  The Greeks have been told to embrace it as have the French but what does this mean and how might it apply in the UK?

If any economy were to exist without government interference and regulation it might in theory be 100% efficient, but there would be unacceptable abuses of wealth and power that would lead to social and political instability that would create its own inefficiencies. So over the years governments and other organisations have layered legal frameworks over the way we all make, spend and invest money, this generally helps to regulate markets but over time creates unwanted complexity that distort markets and drives down efficiency.  Taxation is a great example of this, when the first legislated income tax were levied on the British in the 1799 no one could have envisaged the tangle of tax legislation that we have today, the current income tax rules stretch to 17,000 pages of legislation!  Every so often it becomes necessary to clear out unwanted or unnecessary legislation – this is one form of structural change.  The second type of structural change is the execution of an industrial policy or plan.  Nick Ridley famously said that the job of the Industry minister was to shut down the ministry, how wrong he was, reducing red tape and easing over regulation is important work but there needs to be a plan for our economy.

A tortuous route to recovery

In the UK, the last purge of regulation was in Margaret Thatcher’s time when whole industries we privatised, state owned housing was sold off and the City was deregulated.  We are need of a similar dose of medicine today, but where to start.  The coalition government has started to tackle Welfare and need to have a look at Health and Pension spending, and there seems a growing consensus in all political parties that nothing should be ‘off-limits’; even Ed Balls thinks we need a cap on Pension spending.  With so much to do the government should focus on only the most inefficient markets. 
Housing and construction is and obvious example of a market that has become grossly inefficient, where we still have inflated house prices and a lack of liquidity in the market.  The housing and property markets are hamstrung in two important ways.  Firstly accounting rules require that any property owned as an investment is valued regularly and these valuations are based on the recent letting prices, this means that landlords are incentivised to keep properties empty rather than rented out at lower prices. If one links this market distortion to the bureaucracy around ‘change of use’, (changing the use of a building from commercial office space to residential) we have a structural problem that means that many buildings are left empty and rents are inflated, which also drives up the overall cost of housing in the UK.  Deregulated the property industry to allow a free market in property value and ease the change of use criteria we could increase the rented market and bring house prices down generally.  This is an alternative to the lunacy of Tim Boles (the housing minister) and George Osborne who are intent on driving up house prices by making cheap credit available to new house buyers – many of who will be landlords and investors.  Rather than perpetuate the structural inefficiencies in this market we should deregulate to increase supply and competition; resolving these issues in our £5.2tn housing market would have untold benefits for the economy, including:

• Improved mobility of labour and a less pronounced north south divide
• Increase consumer spending as a % of national income
• Lower indebtedness (lower mortgages)
• Increased pension contributions

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.

Abenomics on the ragged edge

Economist around the world watch Japan with baited breath, there is much at stake for the both sides of the argument, The Keynesian wing have their fingers tightly crossed hoping that Abenomics will finally  be the solution to kick starting the world third largest economy, that has been moribund for years. Others on the monetarist wing believe that it will end in tears, and it looks like the markets are voting in favour of the monetarist.

Abenomics is in fact a sort of con-trick, the Bank of Japan (BoJ) is trying to break a deflationary cycle but massive doses of Quantitative Easing (QE) alongside a huge increase in government spending on capital projects.  It is hoped that these two levers will prize economic growth out of an economy that has been going sideways for 20 years.   What everyone knows, is that the moment inflation resurfaces and growth returns, the BoJ will return to a more prudent approach.  This highly transparent strategy has now turned into a game of cat and mouse between the BoJ and the markets.  This week bond yields rose (higher interest rates expected), stock prices fell and the yen rose a little against the dollar last week.  Paul Krugman argues that higher bond yields, a weaker stock market and a stronger exchange rate are all in response to a tighter monetary policy than the one now promised (a broken promise).  The markets don’t believe the Haruhiko Kuroda the new governor at the BoJ is going to be as mad as he says he will be!  The big questions are:

1. Will the markets believe that the policy to risk all for 2% inflation is real or just a short term con-trick 

2. Will interest rates remain lower enough to see this policy through
3. Will the fourth arrow of increase sales taxes to fund the capital spend programme actually be delivered

It’s difficult to believe that the BoJ will be utterly reckless for much longer, everyone knows that Mr Kuroda is trying a form of blind man’s bluff.  The markets will take a medium term view so this promise ‘to be reckless for a little while’ doesn’t cut much ice.  

A further difficulty is that the whole plan depends on low interest rates, to force down the value of the Yen (supporting export growth) and to drive up consumer spending in Japan.  But low interest rates are going to be dependent on the level and expectation of government debt, which already unsustainably high.  If interest rates rise then the need slash capital spending would create a very swift about turn in policy and this is what the markets believe will happen – this could become one-way bet.  

In addition to the interest rate time bomb another problem is that Abenomics has weaken the Japanese banking sector, which is now sitting on Y821tn ($8tn) of government bonds (the result of government debt and QE) and the bottom is falling out of this market.  This is making it very difficult for the Banks to lend money to new and growing businesses.   

The net result of all of this is that Shinzo Abe is on a tightrope above a shark infested river.  He needs to tread a fine line between a credible reflationary policy and need for low interest rates to manage the crippling public debt.  He might just totter across the ravine and receive a hero’s welcome but my money is on him ending up in the torrent with the short sellers enjoying a tasty lunch.