23 July 2008

July 23, 2008

As a Chancellor, Darling seems sadly accident-prone.

Alistair Darling said last week that the world economy was turn­ing out to be weaker than he and his officials had forecast.  He affected to be surprised by the admission and invited his audience to share the emotion.  For the most part, they declined to do so.  There would have been a bigger sur­prise, many thought, if the authorities had got something right.


He’s become the Frank Spencer of politics.

The last couple of years seemed to have been characterised by serial error-making.  Signs of im­pend­ing eco­nomics slowdown at the end of 2006, for instance, were studiously ignored─the au­thorities choos­ing restrictive policies rather than accommodative ones.  Similarly, the US real estate problem was dismissed when it emerg­ed in early 2007─the Treasury and Bank believing the UK to be immune to such issues.  Eyes were kept tight shut, moreover, in the face of the surge in pub­lic sector bor­rowing─inspiring nothing more from unimaginative officials than a new set of sleight-of-hand tax hikes.


He wanders from disaster to disaster . . .

The reality is that the outlook is grim.  That there’s going to be a recession is no longer in doubt; only its severity and duration remain uncertain.  If the authorities were thinking logically, seeing things as they are, rather than as they would wish them to be, they’d be cutting in­terest rates ag­gres­sively.  That they are not is a measure of their intellectual bank­rupt­cy.


. . . making each a little worse as he does so.

They still fret more about inflation than recession.  They argue that, relative to the pace at which consumer prices are rising, interest rates are low.  Absolutely.   But is that the relevant comparison when the CPI advance is being driven by (largely imported) commodity prices?   Shouldn’t the in­terest rate be judged relative to domestic inflation alone─to the capacity of residents to pay their bor­row­ing costs?


His economics judgment is comprehensively flawed.

The distinction is significant.  Headline inflation is 3½% per annum, and probably headed higher.  But domestic inflation (largely a function of unit labour costs) is 1½%, and possibly headed low­er.  It’s because of the latter consideration that retail spending is stalling, and house building col­lap­s­ing.  It’s because of the latter, moreover, that the electorate is vexed.


Little wonder that the electorate is tetchy.

The proposition that the SNP secured victory in the Glasgow East by-election because of its com­petence in Holyrood is fantasy.  Equally, the idea that Labour is unpopular because of Brown’s dithering is risible.  It’s the economy stupid!   Long-term incumbents al­ways get the blam­e when things go wrong; and the worse the electorate’s discomfort, the worse the ensuing drubbing at the polls.


New Labour is an ex-Party.  But what’s the end game?

The issue for Labour is what Ministers do now to minimise rejection later.  Do they juggle in­con­se­quen­tially with policies (the James Callaghan formula) in the hope of looking decisive, albeit fearing that that they’ll only make matters worse?   Do they swing sharply to the left in an attempt to shore up core sup­port (the Michael Foot option)?   Or do they attempt to readdress Middle Eng­land, seeking to cut wasteful public expenditure and thereby lower median-earner tax rates?


Honourable retirement or dishonourable profligacy?

The Prime Minister would probably prefer the third option.  If he’s to be hammered anyway, he’d like history to say of him that he did sensible economics things during his term.  He’s very con­scious of the comparisons that are going to be made between him and his predecessor.  He’d like the contrast to have some flattering aspects:  the one, electorally successful, but morally degener­ate; the other, unloved by voters, but ethi­cal­ly sound:  the one a prodigal fritterer of resources; the other a prudent accumulator of them.


Probably the latter.

Might he do so?   Not a chance.  The majority of his Cabinet, and the whole of his Parliament­ary Party, are weak straws.  They’ll be determined to use what time remains to them to load up with expense-funded goodies and negotiate sweet-heart deals with companies with which they want to work after the election.


The economy will be horrid; the stock markets maybe less so.

It looks as if it’ll be a miserable eighteen months for the economy.  Not necessarily for the se­curi­ties markets, though.  Interest rates will be cut as the recession develops, very sharply if commodi­ty prices collapse.  It’s not inconceivable that the cost of borrowing fall by 150 basis points in the remainder of 2008, and by a further 200 in the first half of 2009.  Given the narrow spread be­tween dividend and gilt yields, that implies the possibility of a strong rally for equities.  So long as corporate profits hold up (they have thus far), the risk of being out of the market might be great­er than that of being in it.   



16 July 2008

July 16, 2008

Has the bubble burst?   Are commodities collapsing?

For much of the last twelve months, while commodity prices were rising briskly, it was possible for cen­tral bankers to believe that the world economy was strong and that monetary policy ought therefore to be restrictive.  No longer.  Last week, sizeable setbacks in raw material prices, oil in particular, caus­ed the robust activity thesis to be review­ed and definitively discount­ed.  Not before time.  The reality is that recession is looming:  it’s been financial spe­culation, not fundamental demand, that’s lift­ed commo­dity markets; accordingly, with raw materials futures in now retreat, there’s nowhere for inflationists to hide. 

If so, inflation is a non-problem.

It’s calculated that, if commodity prices remain at current levels for eighteen months, retail inflation will fall sharply.  In much of the G7 world, it will dip below the central bankers’ target ranges.  If, more likely, commodity prices fall 25%, it’s going to be embarrassingly low; in many countries, significant­ly negative.

Happy days returning to stock market indices?

Unsurprisingly, the securities markets rose exuberantly.  Interest rates would be the swing factor:  the threat of hikes being replaced by the allure of cuts.  There’d still be a recession, of course, but short­er and shal­lower.  Corporate profits would still be squeezed but not devastated; dividends being maintain­ed rather than cut.  The fiscal outlook would doubtless deteriorate, but not necessarily horrifically:  discipline might be re-imposed with fairly mild cuts in public spending.  By mid-2010, conditions satisfactory again.

Sanity to central bankers’ decisions?

 The most encouraging aspect of last week was the recognition that the activities of central bankers in recent years had not stabilised economics activity, but destabilised it.  The focus on inflation had been unhelpful.  It had meant that in one period (when retail prices were barely rising), there had been excessive interest rates cuts; and, in another (when prices were temporarily quickening), ill-advised interest rate increases.  The boom had been intensified and the bust likewise.  The car’s accelerator had been appli­ed on the downhill; the brake on the uphill!

Europeans are often dangerous.

It isn’t just anglo-saxons who are making such remarks these days; it’s continentals as well.  Unsurprising perhaps.  The ECB has provided the casebook example of how not to run a central bank.  Tri­chet is a latter-day Napoleon.  Just as generations of past strategists have marvelled at the latter’s heroically ill-judged Waterloo decisions, countless trainee central bankers will in years to come stand in awe of the latter’s catastrophically error-strewn monetary judgements.

Americans brash, but sensible.

The model that the rest of the world might sensibly adopt is that of America’s Federal Reserve Board.  It’s charged with balancing the requirements of keeping inflation and recession simultaneously at bay.  It has necessarily to trade progress on the one front with retreat on the other.  Its track record, though, has been out­standingly better than that of its counterparts elsewhere in the world. 

Judgment must take precedence over prescription.

Arguably that is because the men running the ECB, the BoJ and the BoE are poor economists.  They are unable to recognise the early signs of either recession or inflation; they know little of housing finance, and less of structured products.  But it is possible that their intellectual short­comings are compounded by the rigid environment in which they have to work.  It certainly seems to be the case that the more rigid the rules, the worse the outcome.

 Democracy over bureaucracy.

All the indications are, for instance, that Trichet is prepared to go down with his ship.  The poor chap seems to think he’s doing a good job and that criticism from outsiders, whether elected national politicians or unelected federal commissioners, is mischievous.  Que faire?   Where is the Saint Helena to which to send him? 

Better the buffoon than the madman.

The Brits can deal more easily with Governor King.  But the chances are that neither Brown nor Darling will wish to do so.  Each needs to be able to point to somebody as economically inept as himself.  King is thus a rare and valued commodity.  He’s not going to be allowed to escape public opprobrium.  As unemployment accelerates and public borrowing spirals, a scapegoat will be necessary.  If he’s otherworldly and politically naïve, so much the better.

Valuations anyway will recover.

The good news is that the markets will rise.  They only fell because interest rate cuts were put on hold.  If that decision is now reversed, we go back to the status quo ante.  It’s not impossible that the indices retrace in the next three months what they’ve lost in the last six.



9 July 2008

July 9, 2008

Recession most horrid!

The story last week was not one of unremitting economics gloom─but it came close.  Data from Europe were universally frightful, those Asia and America only patchily less so.  A global recession seems now to be assured.  The only uncertainty is how severe it’ll be.

It’s possible, almost, to sympathise with politicians.

Politicians, understandably, are worried.  They know they’ll have to contend with angry electorates.  Few leaders will survive.  President Sarkozy spoke for many of them, therefore, when he criticised the Central Banks─the ECB in particular.   

Even French ones.

He said, in effect, that a focus on the containment of inflation was desirable only so long as inflation were society’s principal threat.  That was no longer the case.  Today, recession loomed.  Depression could not be ruled out.  Central Banks ought to change their strategy accordingly. 

And even though it was they who created the problem!

Quite right.  But it was the dozy politicians, the French leading the way, who established the man­date for the ECB.  It was they who made the catastrophic mistake of setting an uncompromising inflation target.  It was they who made it impossible for elected politicians to sack an ECB Chairman, even though he might be clinically insane.    

Recommendation:  limit the French do what they’re good at.

There’s a message here.  Don’t let Europeans, notably the French, write constitutions.  Though the latter have had more practice than any other people, they can’t get the hang of it.  They’re too pre­scriptive.  Instead of relying on the common sense of the authorities at the time of crisis, they try to envisage every eventuality at the outset, and dictate the appropriate response to it.  Predictably, they fail. 

Let them cook; don’t let them write constitutions.

What are they to do now about Trichet?   Do they have to wait until the EZ economy is traumatised, un­til the people take direct action, until barricades are thrown up in the streets of Madrid and Lisbon and Dublin?   Isn’t it possible to commit the poor chap to an institution before the onset of disaster? 

EMU is a disaster.  There’s no remedy.

There must be feverished discussions going on at this very moment.  The problem is urgent.  Parts of Europe are already in precipitous decline.  Six months hence, if policies haven’t changed in the meantime, unemploy­ment rates will be rising at ½% per month, and still accelerating!   At that stage, a number of politicians, even those who have thitherto been cringingly pusillanimous, will be prepared to cut their losses.  They’ll deliver an ultimatum:  either Trichet goes or they withdraw from the euro. 

It’s unlikely the euro will survive.

Catch 22.  In either event, there’ll be a huge loss of face.  The status of the European Union will plumb new lows.  To sack the demented Trichet (unconstitutionally) will be humiliating; to supervise the dismemberment of the EuroZone worse still.  Each of the options will provoke guffaws of ill-concealed mirth in the corridors of power of the rest of the world! 

By comparison, but only by comparison, Britain looks good.

Britain won’t come out of the debacle smelling of roses either.  It’ll be conceded that the Governor of the BoE is a less bad judge of economics circumstances than the Chairman of the ECB, but that will be to damn with faint praise.  The reality is that Mervyn King, squinting through his spectacles, failed to see the approach of the housing meltdown, and failed immediately afterwards to see the onset of the recession.  Even now, as activity plunges, he thinks the quickening pace of price rises to be the main threat:  last week, he left interest rates unchanged! 

King’s reputation is shattered; Brown’s likewise.

The one thing the UK has going for it is that it is not locked into the madness of EMU.  It is a decision for which the Scotsman occupying No 10 is to be heartily congratulated.  If only he’d extend­ed the logic he used then to refuse to sign up to the Lisbon Treaty, posterity might have said of him that he was a man of great judgment.  As it is, he’ll not be much more than a footnote in history; less Emily Brontë’s brooding Heathcliff, more the Reverend William Audry’s boastful Express Engine; less the romantic gypsy breaking women’s hearts, more the indecisive powerhouse fail­ing to live up to potential. 

Valuations, housing and equities, tell the story.

And the stock markets?   They are vulnerable so long as the lunatics are in charge of the asylum.  The conjunction of recession and tight money is very bearish.  It won’t last for long.  But even a few weeks will seem an eternity.  Not until interest rates are cut boldly and urgently will the prospects look brighter.  Best, therefore, though equities are probably cheap, to defer purchases for a while. 


2 July 2008

July 2, 2008

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