17 September 2008

September 17, 2008

Finally, belatedly, the authorities are scared.  Well, they might be.

Tumbling equity prices, failing banks and stalling economics activity!   1929 or 2008?   The paral­lels are unnerving, and they’re to be found not just in the official statistics, but in the authorities’ policy res­ponses as well.  Look at the in­ani­ties coming from central bankers and regulators and politicians:  seven­­ty years ago, recommendations ranged from the mindless to the counter­productive; and it’s no different today.


Inevitably, though, the politicos are looking for a scapegoat.

Why, for instance, has short selling been banned?   Was it the fundamental cause of plunging va­lu­a­tions, or merely the mechanism by which prescient investors shed over­valued stock?   The latter, of course.  Would the authorities have preferred that traders create a false market by not selling what they thought to be expensive?   How would that have squared with the precept of the “client’s” in­ter­ests being pre-eminent?


The City trader serves the purpose.

Blaming the City Slicker (a creature it is easy to dislike) was a diversionary tactic.  It aimed to ex­cul­pate the genuine ma­lefactor—the Bureaucratic Nincompoop.  Amazingly, the ploy worked:  the gul­lible media (News­night’s Paxman in the van) bayed for blood. 


The fault in reality lies in the banking executive.

In the case of Hbos, the share price collapsed because of balance sheet pressures.  The bank’s loan book, un­der­mined by falling house prices and rising unemployment, was deteriorating rapidly.  Non-perform­ing mort­gages were about to soar.  And, because it couldn’t refinance itself in the whole­sale mar­ket, bankruptcy loomed.  In­vestors who were clever enough to analyse the situation rush­ed to sell the stock.  Whether they used the long or the short mechanism to do so was irrelevant:  block­ing the one would merely divert action to the other.


His misjudgement was the sine qua non.

It’s not City traders who should be blamed, but Banking executives.  It was the latter, not the former, who developed inappropriate business models (as in so many cases, the fault lying probably in the “long tail” of the probability distributions).  And it was these models that, when stressed, failed and brought the banks to within a whisker of insolvency.  It’s the executives therefore who should be pil­loried; they being the prin­cipal authors of the country’s housing misery.


Regulators are a waste of space.

But what of the regulators?   What were they doing when the banks were being chronically ir­res­pon­si­ble?   Re­viewing the mathematics?   Tinkering with the assumptions?   No, they were conducting foot­lingly ir­relevant in­ves­tigations into banks’ administrative procedures and personnel policies; re­quir­ing that they “knew their customers” and had the paperwork in place to justify it!  


They should be severely downsized.

It’s time for the FSA to answer for its shortcomings; for the rest of us to acknowledge that, though ex­­tra­ordinarily expensive, the regulatory structure is comprehensively unfit for purpose.  The sad fact is that the agencies in­hibit business that’s honest but not that which is dishonest.  The FSA hadn’t a clue that anything was amiss in Northern Rock (insisting on the fundamental soundness of the or­ganisation long after everybody in the markets knew the game was up) and it was similarly wide of the mark in its analysis of Hbos. 


 Central banks likewise.  Learn to forecast or get out of the kitchen.

The BoE is no less culpable.  Its recent economics forecasts have been a disgrace:  not an antici­pa­tion of reality, but a lagged response to it.  Far from stabilising conditions, its actions have de­stabi­lis­ed them.  Not to have recognised the dangers of depression (until the last few days) amounts al­most to criminal negligence; not to have ranked the avoidance of slump higher than the contain­ment of in­flation, hints at a fractured normative apparatus!  


Slash rates!

What should the Bank do now?   First, review forecasting techniques; any change necessarily con­stituting an im­provement.  Secondly, cut interest rates by several hundred basis points; hoping there­by to re­vive demand, warming consumer appetites before the onset of glacial depression. 


Inflation is a non issue.

Such a policy would doubtless weaken sterling in the short term.  Excellent.  All the better for net exports.  But what about inflation?   No problem.  Commodity prices are in freefall.  Retail inflation is going to moderate sharply in the next twelve months.  If it does so a little less sharply, all to the good.


Stock markets set to rally.

How might the security markets react?   Favourably.  Government bonds would lead the way, but they’d be followed within weeks by corporate fixed interest and equities.  Investors would want to know how corporate profits (banks aside) responded to the early stages of recession.  If they were seen to hold up quite well (wages taking most of the strain), valuations would embark up­on a sus­tain­ed recovery.




10 September 2008

September 10, 2008

Anxiety about failure afflicts nearly everybody.

It’s difficult for most people to sustain self-confidence when performance is poor.  Sports­men, novel­ists and lovers have a particularly acute problem in this regard.  Economists and poli­ti­ci­ans seem not to:  their self-belief remains undimmed by failure.  Either they can’t analyse the evidence; or they sup­pose we can’t.


 Except, apparently, those most prone to it.

The European Commission demonstrated the point last week.  Though its economics track record in recent years has been entirely unblemished by insightful analysis, there’s been an on-going willing­ness to make bold pro­nounce­ments.  Its current views?   That, amongst EU mem­bers, the UK is the one most vulnerable to recession. 


 JC Trichet is a psychological phenomenon.

Really?   Why so?   It didn’t spell out its logic.  Perhaps, it felt Britain’s housing finance sys­tem was problematical; making it more vulnerable than others in the Union.  Per­haps, bizarrely, it believed that non-membership of the euro would prove to be a burden!


JG Brown likewise.

Prime Minister Brown has a similarly elevated perception of his analytical abilities, and produced last week a similarly unconvincing programme for the alleviation of fuel poverty.  The energy com­pa­nies, he indicated, were to be asked to provide the wherewithal to subsidise the installation of extra in­su­la­tion in people’s homes.  The scheme, though, would be complicated, and expensive to run.  Most wor­ry­ing­ly, resources would continue to be drawn from the productive private sector and dis­si­pated in the unproductive public one! 


His energy plans are modest, perhaps counterproductive.

Worse, those most in need of help, those at the lower end of the income scale, might be unable to af­ford to pay their share of the insulation cost.  In recession, warmth today will carry a higher priority than warmth tomorrow.  Prospective insulation will appear to be an indulgence; existing utility bills won’t.  The risk is, therefore, that the programme will do little for the deserving poor, subsidising in­stead the (arguably) less deserving middle class. 


Fortuitously, oil prices are tumbling.

Moreover, the scheme may be rendered irrelevant by falling energy costs.  Within weeks, it looks as if the spot price of oil will be below that a year earlier.  By winter, it might be 25% lower.  But how quickly would such a bene­fit, if one were to occur, be passed on to consumers?   The PM, had he car­ed more about people than image, would have raised this point with the utilities.


General inflation will fall also.

There is another implication stemming from falling commodity prices:  lower retail inflation.  Al­ready, monthly data are showing useful reductions.  By year end, annual num­bers will be close to target; by spring, they’ll be well below it.



But what about wage settlements?

Thereafter, the big issue will be the response of wages.  Will they continue to rise at current rates, causing real spending power to soar and inflation to level off?   Or will they moderate in line with prices, pre­ser­ving the squeeze on the consumer and the downwards trend in inflation?   The consensus presumes the for­m­er; the cognoscenti worry about the latter.



Central bankers are pessimistic.

Central bankers, believing themselves to be cautious, assessing inflation a greater risk than re­ces­sion, take the former line.  The ECB, for instance, argues that there is no need to reflate the economy; it will happen of its own accord.   A recovery is expected to begin in the current quarter and will in­ten­sify in the next.  Time enough to cut interest rates, they say, when inflation is below target.



Excellent.  They’re counter-indicators! 

Thankfully, the Fed is more open-minded.  The consumer’s summer spending spree, financed by tax cuts, is now over.  Activity is stalling and liquidity inadequate.  The US monetary system has stum­bled; proving itself incapable of meeting the requirements of its house buyers.  A government guaran­tee was necessary to secure its survival. 



Interest rates will fall.

The conclusion to which Bernanke will come is that interest rates are too high.  As the data weak­en again, and as inflation falls away, cheaper credit will be forthcoming.  Last cycle, the Fed funds rate came down to 1%; this time it’ll probably go lower.



Bonds will rise straight away.

And the securities markets?   Bonds, especially government bonds, will rise strongly and persistently.  Once investors believe the economics softness to be durable, once the extent of the reduction in in­flation is appreciated, there’ll be a surge of buying.  Two years hence, yields at the longer end of the market might be half their current levels.



Equities with a delay.

Equities will not like recession.  But, for those companies (the overwhelming majority) that can sur­vive it and largely maintain profitability, the rewards will be substantial.  Current valuations presume the worst of both worlds:  recession and inflation.  Reality will be a pleasant surprise.



3 September 2008

September 3, 2008

Is Darling demonstrating bad luck or bad judgment?

If Alistair Darling hadn’t been economically blind, he’d have seen the recession coming; if not fi­nan­cially ill-informed, he’d have anticipated the mort­gage disaster; if not fiscally in­ade­quate, the 10p in­come tax fias­co.  The fact that he foresaw none of these problems speaks volumes about his judgment.  The man is in the wrong job:  a redeployment is urgently required.


Probably the latter.

Why then did the markets fall so severely when he outlined his thoughts about the coun­try’s pros­pects?   Did investors presume he knew something they didn’t?   What, for instance?   Gi­ven his serial mis­analysis of conditions in the past, his pessimism now might more reasonably have been in­ter­pre­t­ed as justification for optimism!


He’s out of his depth!

He hadn’t even got the historical angle right.  He hadn’t meant that the outlook was the worst for sixty years, but for seventy!   He hadn’t meant to compare the current situation with that in the for­ties, but in the thirties.  The problem today is not inadequate supply, but deficient demand.  It’s not the grey stagnation of the post-war phase we have to worry about; but the vivid poverty of the pre-war one!   Is the Chancellor’s knowledge of the past as bad as that of the present?  


The lunatics have to be kept in the asylum.

So what is the genuine outlook?   Bad, but not necessarily catastrophic.  The world economy is two thirds of the way through a fairly severe cyclical downturn.  Exacerbating the problem is the per­verse behaviour of central bankers.  They are rais­ing interest rates rather than re­ducing them; in­ten­si­fying the economics decline rather than mitigating it. 


Not invited to run it.

Their excuse is that they would otherwise be accommodating inflationary pressure and condoning financial delinquency.  Why do they think the latter so bad?   Because, like the Colonel Blimps they so much resemble, they’re obsessed with the mistakes they made in the last war!   Determined not to repeat them, they shut their eyes to other, often much more serious, errors.  Now, for instance, by avoid­ing inflation, they risk provoking depression!


In a slump, which countries will suffer most?

In that event, would Britain be one of the worst hit countries?   Highly unlikely!   In periods of ex­cess supply, exacerbated by central banking austerity, it is usually the “best” economies that suffer most.  In the thirties, where was the pain harshest?   In the States, Germany and Argentina.  All three were exceedingly competitive; all three would, in conditions of normal domestic demand and reasonably free access to foreign markets, have grown strongly.  But, because sales col­laps­ed, and because the initial weakness was intensified by senseless monetary authorities restricting credit and sense­less politicians restricting international trade, these were the countries which found them­selves with the largest overhang of excess production. 


China is highly vulnerable . . .

America’s political system survived the ensuing slump, but only just.  Germany’s and Argentina’s didn’t.  Mounting unemployment and devastating social dislocation were the result.  It took the one a generation to recover its poise; the other seems not yet to have done so.


. . . because it’s so efficient!

Is there a parallel with the current situation?   Of course.  In the worst case scenario, one in which central bankers and politicians are as mis-guided now as they were then, it will be China that suf­fers most.  What would happen to its surging output if sales were restricted?   Fac­to­ries would have to be closed and workers laid off.  The government in Beijing would respond by en­cou­raging com­­pe­titiveness:  pay cuts on the one hand, currency devaluation on the other.  But that might only pro­voke protectionism in the rest of the world.  Bottom line:  certainty of di­sas­ter economically, pos­si­bility of it politically.


Also, but less dangerously, Commodity producers and Europeans.

In a severe downturn, commodity producers would also suffer more than most.  Theirs are “high beta” economies:  they outperform on the way up, but underperform on the way down.  Ad­di­ti­on­al­ly, the EZ would be vulnerable.  Its currency is hugely overvalued and, in the adjustment that must inevitably come, the potential for political fracture would be high.  The exposure is not reckoned to be as great as was Ger­many’s or Argentina’s in the thirties, but there are pa­ral­lels nevertheless.


Britain’s pain will be only mediocre.

Britain, by comparison, although only by comparison, would fare satisfactorily:  its currency more sensibly priced, and its central bankers less obsessively bigoted.  Additionally, it looks as if it’ll soon have a new Prime Minister and Chancellor.  If that were to enable it to free itself from its Middle Eastern entanglements and, better still, its European ones, the case for optimism would be almost persuasive.  Negligible interest rates, economics and political stability, rising security prices.





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