13 August 2008

August 13, 2008

Steering a car by reference to what is visible in the rear view mirror is dangerous.

For forecasts to be of any value, they have to relate to the future rather than the past.  To wait until something has happened, and then say it’s going to, may fulfil a psychological need but not an an­ticipatory one.  It is the sort of behaviour pattern expected of the charlatan not the seer:  inevitable in the po­li­tician, regrettable in the central banker.


Similarly for an economy.

So why has the Bank of England adopted such practices?   Is it incompetence or insecurity?   A lack of understanding of economics trends, or a lack of confidence in their predictability?   In ei­ther event, the financial mar­kets are probably unwise to accord much significance to the Bank’s latest musings.  They are a reflection of conditions six months ago; not six months hence.


The BoE has a lot for which to answer.

The reality is that the larger part of the developed world is already in recession and that most of the rest will have fol­lowed suit by the autumn.  Currently, rates of decline of GDP are modest, but they are in­tensify­ing wor­ry­ing­ly quickly.  By year end, assuming unchanged monetary policies, it’s possible the re­ces­sion will have become one of the deepest in modern history!


Though, by comparison with the ECB, it looks prescient.

Will the UK fare worse than its competitors?   Probably not.  Economics virtuosity depends very little on the IQ of regulatory authorities.  The key factors are the competitiveness of the cor­po­rate sector, and the conscientiousness of its workers and managers.  It is true that the UK is less well placed to negotiate the current setback than it was the last one, but it is unlikely nevertheless to find itself at the bot­tom of the heap.


As so often in the past, the Europeans are charging full tilt at windmills.

That privilege is to be accorded to Europe.  Saddled with monetary austerity and exchange rate in­supportability, the region is likely to expire.  Within it, though, vari­ations will be sizeable.  Ger­many, for instance, is expected to survive with a degree of equanimity; Spain isn’t.  The dif­fer­ence is that the one is reasonably competitive, the other hopelessly uncompetitive. 


Happily, inflation is about to fall.

The good news, barely touched upon by the BoE, is that inflation rates are set to fall.  The quick­en­ing in the last eighteen months was solely due to commodity prices; in the peri­od ahead, with the latter declining, the former will slow.  But by how much?   The Bank suggests that, two years hence, retail inflation will be below 2% per annum; the realist is more likely to pre­dict that, by then, the rate will be negative!


The BoE presume the process will be pedestrian.

It’s the response of the labour market that accounts for the difference.  If pay settlements were to stay at current levels even as retail inflation began to moderate, consumer spending would pick up, and general ac­tivity revive.  The demand for commodities would stabilise, their prices flatten, and retail inflation drift only slightly lower. 


Others think it will be precipitate.

But if pay settlements were to fall away in response to lower retail inflation and higher unemploy­ment, economics activity would continue to sub­side, the demand for commodities to weaken and their prices to continue to retreat.  The re­cessionary process, like a nuclear reaction, would feed upon itself, intensi­fying as it progressed.   And negative retail inflation, lift­ing real interest rates, would become part of the problem, not the whole of the solution.


Almost nobody frets about depression.

Is the BoE worried about this scenario?   Apparently not.  The Governor, talking at his Press Con­ference, implied that economics revival would be trivially easy.  It might occur of its own accord; if it weren’t to, it’d require only a modicum of monetary accommodation.  Really?   Had he not noticed that the BoJ, presumably thinking likewise in the early nineties, proved itself unheroically incorrect?


And newspapers, irrelevantly, agonised about sterling!

The markets reacted instinctively.  They punished sterling, favouring the dollar by default.  It’s certainly true that the Fed, cut­ting interest rates hard and early, managed its economy better than others, but it’s unlikely that the crisis in the US is over.  Indeed, the latest numbers imply that, while easier money and lower taxes lifted activity, the benefit may have been temporary rather than permanent.  In the next few months, momentum could go negative again.  


Easier money must come soon.

Couple that with a huge reduction in demand from commodity producers, and the world will find itself in exaggerated excess supply.  Not until China wants to consume as much as it wants to produce will the world be able to look forward to equilibrium.  More likely a matter of decades than years!   In the meantime, interest rate cuts are the best of an unsatisfactory bunch of options.


6 August 2008

August 6, 2008

Economies are weak:  the developed emaciated; the undeveloped sickening.

Last week’s economics data, uniformly disappointing once again, will have disturbed the world’s central bankers.  Things have not been going as they expected:  the system’s predisposition to re­cession has been much higher than that to inflation.  The decision to raise interest rates was there­fore wrong.  Will there be popular cen­­sure, even ju­di­cial re­tribution?   They ought to be. 


It’s largely the fault of central banks.

The indictment is straightforward:  by focusing on the minor problem and ignoring the major one, central banks have not reduced economics instability, but have increased it.  Just about every­where in the de­vel­oped world, conditions have deteriorated─re­tail sales weakening, production retreating and senti­ment col­lapsing.  The risk now is that recession gives way to depression.


Only the Fed comes out of the last twelve months undisgraced.

Significantly, though, economics trends have not been uniformly disastrous.  They’ve been a good less bad in the States than elsewhere.  Is that because Bernanke, more perceptive than his counter­parts, cut interest rates fairly aggressively and encouraged a weaker dollar?   Possibly so.  Con­di­tions have been worst in the EU where Trichet, palpably out of his depth, has been lifting in­terest rates and encouraging a higher euro!


There’ll be no near-term recovery.

That a sharp downturn in the industrial world has already started is no longer denied.  The concern is now how long it will last, how severe it will be.  The optimists argue that the principal source of weak­ness, the housing sector, is already turning round.  By year-end, they say, recovery will have begun.  Con­currently, retreating commodity prices will lift real wages and, presently, con­sump­tion as well.


In the next twelve months, rising unemployment will be the problem.

Sadly, the reality is that the economy may get worse for several quarters before it gets better.  It is true that the weak­ness thus far has been inspired by tight credit and inadequate spending power.  But there may be worse to come.  Activity hasn’t yet felt the consequences of a labour market set­back.  Can the evil day be delayed much longer?


Consumption (and house prices) may plummet.

Will employers be able to continue to maintain their workforces in the face of moderating sales?   Of course not.  At some stage, possibly in the current quarter, more like­ly in the next one, there’ll be a sizeable correction.  Employment will fall by a full percentage point and drift back fairly steep­ly for several months there­after.  Consumer spending power will be slashed and sentiment devastated.  Recovery will be de­layed a full year.


Inflation, however, will evaporate.

It’s true that raw material prices will be falling, but that’s unlikely to boost GDP for months.  The initial ef­fects will be negative:  higher real interest rates and diminished exports to com­modity pro­ducers.  And it’s quite possible that, during 2009, lower retail inflation will be used by em­ploy­ers as a justification for lower pay settlements.  Not until 2010 will the scene be set for a cy­c­lical recovery.  And not unless interest rates are taken down to negligible levels will it be a robust one. 


In politics, it’ll be:  out with the old; in with the new.

The political scene is relatively easy to forecast.  Incumbents will be blamed for the down­turn, and they’ll have no defence against the charge.  Because they took credit for the good times that were not of their making, they’ll have to take responsibility for the bad times that are equally not their fault.  They’ll be dismissed from office.  Oppositions, deserving and otherwise, will be swept to power.


And equity indices may rise . . .

The stock market scene is less easy to forecast, but the likelihood is that the indices will perform reasonably strongly.  What everybody now knows is that the world econo­my needs lower interest rates rather than higher ones.  The policy rever­sal may take a few months to implement, but it’s going to occur, and it’s going to be comprehensive.  Official rates will come down to zero in Japan and Europe, to 1% in the US, 2% in the UK. 


. . . as profits prove resilient and bond yields don’t.

Profits, meanwhile, may hold up fairly well.  Although the volume of sales will be soft, mar­gins will be protected by moderating pay settlements and falling costs of materials.  Set in the con­text of historically low bond yields and chronically unattractive property markets (residential as well as commercial), money will gravitate towards equities.  A strong recovery is possible in the re­main­der of 2009; new all time highs are likely in 2010.


The pensions sector deserves a boost.

Good news for pensions.  The official calculation of surpluses and deficits should be ignored.  It’s the cash flow projections that determine a fund’s viability.  They look quite good now; they’ll look much better in eighteen months.


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