A Closer Look at the Markets

December 22, 2010

CNBC Television

17 December 2010

Roger Nightingale, economist,  joined CNBC on Friday to take a closer look at the markets.

Economics Views

December 22, 2010

When your horse shows signs of incapacity,
turn him out to graze.

Horace—not just horses, but politicians also; especially those suffering from aegri somnia!

Wedded bliss is rare.
Marriages that are contracted in haste tend to be regretted at leisure. That may apply as much to the political variety as the conjugal one. Britain’s Coalition between Tories and LibDems illustrates the point.

It requires conceit to be suppressed.
At the outset, there was a good deal of optimism; each party feigning compromise and goodwill. It didn’t last. As 2010 drew to a close, barely six months after the deal was signed, each distrusted the other.

Some people find that impossibly hard.
Will they stay together for a while longer or separate immediately? Probably, the former. A rupture now, leading to an election in a few weeks time, would destroy the LibDems. Their popular support is half what it used to be; they’d be lucky to keep more than a handful of seats in Westminster.

Most LibDems, for instance.
Accordingly, while the Business Secretary, a man of inestimable naïveté, may talk about deployment of the “nuclear option,” the threat will not impress colleagues, nor worry partners. The LibDems are as optionless now as their predecessors were in the thirties. They have to live with the marriage they contracted; they have to hope that the economy improves and that the electorate forgets.

Vince Cable was a brief candle.
For the Business Secretary himself, there will be no comeback, no redemption. He’s finished as a politician: ostensibly, still in the Cabinet, he’s effectively out of it. Nobody’ll ever trust him again.

He lacked intelligence and discrimination.
What caused him to say the things he did? Why so indiscreet in front of strangers? Because, it is suggested, he’s a man of extraordinarily bad judgment. His analysis of the banking problem was poor, and the remedy he recommended for it worse; his assessment of the university tuition problem banal, and the solution he proposed for it puerile.

And had no understanding of finance.
But it was his lack of focus on public sector excesses that will weigh most heavily against him. On the day on which news of his indiscretions broke, November’s record borrowings were announced. Did he, the Business Secretary, fret about the deterioration? No. He continued to press for higher levels of social spending. He was another Nero; a man who fiddled discordantly while fiscal Britain burned.

Let’s hope David Cameron is better endowed.
The Prime Minister must get a grip. If happy-clappy spenders aren’t soon disciplined, the country’s inflation rate and credit standing will be threatened. The previous administration missed the chance to time the cuts to coincide with the economy’s upturn (mid-2009 to mid-2011). So the current one has had to delay them until its downturn (2012 and 2013). Politics will become very difficult in that period. It’ll not be a time for bleeding-hearts.

Equities have been performing well.
Hitherto, London’s equity markets have held up well: inclusive of reinvested dividends, the indices have risen recently to all-time records. Easy money and strong profits have been the driving forces. An expectation that the recovery would “broaden and deepen” in the next couple of years added to the optimism.

They’ll continue to do so for a while.
The reality may be less favourable. Economies will slow from the second half of 2011and credit, albeit inappropriately, may be tightened. There’s no near-term threat to the indices, but it’d be surprising if the advances were to continue much beyond late summer.

Economics News

December 22, 2010

Complete abstinence is easier
than perfect moderation.

Saint Augustine—and, in things like credit availability, much more dangerous!

The periodicity of a pendulum is regular.
Economics activity progresses cyclically: relative to a fairly stable underlying trend, GDP tends to advance and retreat according to a regularly recurring chronology. Central Banks acknowledge the cycle, and try to dampen it. They know that inflation is likely to rise in the second half of an upswing, and unemployment in the comparable part of a downturn.

So is that of an economy.
To avoid both Scylla and Charybdis, Central Banks have to steer a middle course. Monetary policy has to be counter-cyclical. Credit must be curbed when activity is high and quickening; enhanced when it’s low and slowing.

Central Banks usually operate an offsetting credit policy.
But, sometimes, arguably far too often, the authorities get things the wrong way round. They tighten when it’s appropriate to be loosening; and loosen when it’s appropriate to be tightening. Instead of dampening the cycle, they exacerbate it. Instead of reducing the risks of unemployment or inflation, they increase them.

But, occasionally, a reinforcing one!
How come? It’s partly because they mis-analyse the cycle, but mainly because they’re thrown off course by unforeseen “events.” In the recent past, for instance, there was a hiccup (a banking crisis) in the second half of 2008. Had it not happened at that time, the authorities would probably have started to tighten credit in advance of the anticipated cyclical recovery.

There’s a risk of that happening now.
Instead, they persuaded themselves to stay in a loosening mode. They judged it more important to stabilise the banks than the cycle. They argued that equilibrium in the latter was impossible unless it occurred also in the former.

It was caused by their response to the banking crisis.
But they’d underestimated the extent of the problem. Though the transfer of resources from non-banks to banks had been mind-bogglingly huge, it failed to restore equilibrium. Indeed, it made things worse: banks weren’t saved, but many non-banks were destroyed.

A mistake to try to redeem the irredeemable.
In the years following the crisis, the extent of the authorities’ miscalculation gradually became apparent. Overall liquidity had been persistently excessive, but the condition of banks’ balance sheets deteriorated. Their lending to the wealth-creating parts of the economy was hopelessly inadequate; but their payment of bonuses to themselves, unconscionable.

It didn’t stabilise economies . . .
The non-bank economy, meanwhile, was unbalanced. In sectors in which activity was progressing moderately satisfactorily, there was a risk of inflation. In those in which inflation was satisfactory, there was a risk of recession.

. . . but destabilised them.
It began to dawn on a fretful world that the course being steered by the Central Bankers would not avoid both monsters; it might instead encounter both. Unemployment might rise concurrently with inflation. It had happened already in parts of the EZ; it might become commonplace in 2011.

And politics may make matters worse.
And politics was beginning to be unhelpful. Elected legislators didn’t usually say much about credit policy, but these were unusual times. In the US, for instance, the Republican Party was doing very strange things. Sarah Palin got all the publicity, but Ron Paul wielded the bigger stick. He wanted the fiscal deficit slashed and credit curtailed. If he got his way, the policy might be implemented just as the economy hit the skids at the end of 2011!

In the States and Germany . . .
Chancellor Merkel likewise. She’d now realised that the single currency was doomed. Monetary union required political union. It’d work in Europe only if Germany were prepared to pick up the tab for the debts for all the other countries. It wasn’t.

. . . there’s an appetite for austerity.
Ms Merkel was the paymaster. And her man at the Bundesbank, Axel Weber, was about to become the effective boss of the ECB. He’d say money must be tightened. It probably would be, and might coincide with a similar trend in the States. If so, and if China acted similarly (to contain inflation), the world could find credit scarce and expensive in the latter part of next year—at precisely the time that the cyclical downswing was getting under way.

Depression can’t be ruled out.
That’s what happened in the States in the early thirties. It’s what happened also in Japan in the early nineties. Could it happen on a global basis next year? If it did, economies would suffer severely, and asset valuations significantly.

No immediate risk, but time to begin to think defensively.
Which would suffer most? A lot would depend on how protectionist the world had become by then, but, as a general rule, it’d be sensible to lower the weightings attached to the high betas (economies as well as stock markets). Investment skill would lie in avoiding losses rather than making gains.

Economics Views

December 22, 2010

In times like these, it helps to recall that
there’ve always been times like these.

Paul Harvey—what changes are perceptions of the extent of the unusualness!

Inflation in the UK is above par.
November’s inflation number was a little higher than expected. At 3⅓%, the increase in the CPI in Britain in the preceding twelve months wasn’t absolutely awful, just relatively disappointing. Other countries experiencing comparably fast activity and similarly soft currency had reported much lower figures.

Probably the result of public sector excess.
What was the problem here? Not the private sector, but the public one! The former had behaved responsibly, the latter irresponsibly. The one had kept pay rises restrained and productivity advances brisk. The other had been allowed to run amok. In the decade prior to the financial crisis, the public sector had experienced no financial discipline; and in the years thereafter, none either.

It can’t go on.
Predictably, Gordon Brown’s administration had turned a blind eye to the excesses prior to the poll. Less predictably, David Cameron’s had winked at them afterwards. It’s unlikely that the indulgence will last much longer, though.

There are substantial savings to be made in pensions.
If the fiscal deficit is to be cut by enough to comfort the financial markets, there will have to be a severe squeeze on public sector budgets. In the near term, that’ll mean cuts in employment levels and reductions in real pay. Later on, pensions entitlements will have also to be regularised.

They’re long overdue.
Why the disparity between the two parts of the economy has been allowed to persist for so long is reprehensible. The cost of public sector pensions is at least 40% of salaries; it’s barely 15% of the private sector number. Governments recognise the unfairness, but have usually lacked the courage to tackle it—understandable in an administration that’s on the way out, but very discouraging in one that’s newly elected.

But difficult to engineer in coalition.
Coalitions are difficult to operate, of course. It’s difficult to balance the aspirations of contending elements. The leaders may be relaxed, the grassroots are often at each others’ throats.

LibDems, unsurprisingly, are proving unreliable.
In Britain, the surprise is not that Tories and LibDems are irritated with each other, but that it was university tuition fees that caused the problem. What will happen when matters of genuine principle are at stake? The wars in the Middle East, for instance? The disaster that is Europe? It doesn’t bode well.

Obama, though not in coalition, is also having problems.
In the United States, the politics are also looking troubled. The economy is satisfactory—growth in line with potential, inflation low, and deficits moderating—but the administration is haemorrhaging support. Conservatives fret about public spending and quantitative easing. Progressives balk at the slow progress in dealing with the wars.

Likewise, much of the rest of the old world.
It’s somewhat similar throughout the old industrial world. Few Governments would survive a near-term election. Voters’ expectations haven’t yet been lowered sufficiently. For the moment, perhaps for another five years, incumbency will be a big disadvantage.

Markets may rise further, but clouds are gathering.
Stock markets, on the other hand, are temporarily well placed. Liquidity remains plentiful, corporate profits strong, and inflation moderating. It’s the medium term that investors have to worry about. It looks as if monetary conservatism may eventually become the norm. The Republicans in the States may impose their will on the Fed, the Bundesbank on the ECB, and China’s monetary hawks on the Central Bank in Beijing. If so, economies will falter and asset valuations retreat.

Economics News

December 12, 2010

A university education helps you despise the
wealth that it stops you getting.

Russell Green—there’s causality between educational standards and economics growth: it goes from the latter to the former!

During horrific Middle Eastern wars, university students were quiescent.
The undergraduate and the banker share many characteristics: unconscionable selfishness and financial naïveté, for instance. But both, rather ironically, have very high opinions of themselves. They suppose the contributions they make to the community to be high, but the costs they impose on it low!

They marched only when their handouts were threatened
Last week’s events highlighted the parallel. Neither Parliamentarians debating tuition fees inside the Chamber, nor students terrorising the streets outside (the one puerile, the other neanderthal) seemed to have a firm grasp of the issues. It had been much the same when the Bank of England attempted to save RBS and HBOS in 2008: the Governor and his Deputy acting boldly, but not very responsibly.

Blame the Bank of England!
They recommended that the bad banks be saved, not closed; that taxpayers’ funds be sequestrated to this end. It set a precedent. If the taxpayer could be forced to bail out a delinquent bank, why not an underperforming university as well? And if the greedy banker was to be rewarded for his incompetence, why not the covetous undergraduate for his folly? King and Tucker have a lot for which to answer!!

Of course, the student must bear a large part of the cost of his education.
The reality is simple. Education is expensive; university education very expensive. But who’s to pay the bills? There are only two alternatives: the general taxpayer or the student himself. Both may benefit from higher levels of educational attainment, but the lion’s share accrues to the latter. It has to be he, therefore, who pays the bulk of the cost (delayed, of course, to suit his cash flow profile).

If he can’t see that, he oughtn’t to be at university.
How could people come to any other conclusion? Only bankers might be avaricious enough, LibDems dim enough, to propose anything else. Did the thousands of students who marched up Whitehall not understand? Or did they just pretend not to? Were they fools or knaves? It’d be a damning indictment of their intellect if the former; a damning indictment of their morality if the latter!

And the banker, coincidentally, shouldn’t be in a bank!
It’d be a different matter if people were being forced to go to university. They’re not. If they no longer find the deal attractive, let them not go. How do they respond to this line of reasoning? Angrily. They want it both ways: they want an option which lets them keep the profits if the trade goes as intended, but to pass on the losses to others if it doesn’t! Does that sound familiar? It certainly does!!!

Nor the LibDem in a Coalition.
And what of the Coalition? Can it survive? Not for long. The LibDems, like the Liberals in the thirties, are disintegrating. The party does not have much of a future. It may not exist after the next election. It’s possible instead that it’ll divide into three parts: one being absorbed by the Tories, a second by the Socialists and a third by the Greens.

Economics activity is moderating.
The world economy, meanwhile, is drifting into slower growth. China looks as if it’ll be the swing factor. Last week, the authorities indicated that they’re going to tighten liquidity fairly sharply. They’d prefer to slow things down a little straight away, rather than a lot later on. Of course they would! But there’s a risk that the setback is immediate and severe.

In America, tax rates’ll be cut.
In the US, the Republicans look as if they’ll be able to get the tax reductions they want. Will that boost consumption and investment? Probably not. But it’ll have one big advantage: it’ll force them to keep public spending under wraps.

In the EZ, attention’ll focus on the fiscal deficit.
In Europe, attention is still focused on the single currency and on what the authorities there think sets it at risk: the fiscal deficit. In Greece and Ireland and elsewhere, therefore, public spending is being slashed and taxation lifted. The outlook for some of the economies is consequently poor: their GDPs may fall at more than 5% per annum for several years.

High beta is a double edged sword.
Will the emergers and the commodity producers hold up in these circumstances? Probably not. They’ll share in the pain. They’re high beta economies. They’ll fall faster than the average for a while.

Valuations to continue to rise.
Markets, though, will hold up—in the short term at least. They were temporarily depressed by the euro’s troubles, but bounced back as soon as the immediate crisis passed. Valuations of both bonds and equities are expected to continue to rise. Easy money, low inflation and resilient profits will do the business.

Economics Views

December 9, 2010

The capacity to observe accurately
is called cynicism by those who’ve not got it.

George Bernard Shaw—we need more cynics and fewer bankers!

Is economics activity quickening or slowing?
The mood amongst most economics commentators is upbeat, but it’s not clear that their optimism is justified by the data. World growth seems to have peaked in mid-summer and to have slowed since then. In the months ahead, the trend is likely to continue—possibly steepen.

The data says the latter, commentators the former.
Underlining the potential for disappointment, last week’s numbers were a little dull. Germany’s exports had faltered in October, and so had Japan’s machine orders. Britain’s retail sales in the autumn were anaemic, likewise the US’s job creation.

What’s unambiguously worsening is the condition of the banks.
But there was even worse news from the banks. Far from improving, their balance sheets were deteriorating again. The rescue packages, launched two years ago, had failed. Lenders that were delinquent then were delinquent still. To survive, they needed continual infusions of taxpayer funds.

The bail-outs were a mistake.
Good money was being thrown after bad. The process was sacrificing what was economically viable in a futile attempt to save what wasn’t. EuroZone countries had led the way, but others, including a number in the emerging world, were likely to have to follow.

Will Britain’s Parliamentary Commission agree?
Coincidentally, it was against this backdrop that the UK’s Independent Commission on Banking began its inquiry. It’d been asked to investigate the charge that consolidation amongst lenders after the 2008 crisis had diminished competition and restricted consumer choice. Last week, a number of the banks’ CEOs were summoned to answer the charge. They attempted, not very seriously, to refute it.

Or will they, like the B-of-E, in 2008 . . .
Competition amongst banks, they claimed, was fierce; choice extensive; and bankers blameless. It was, they contended, market forces that set interest rates! economics uncertainties that limited the provision of credit to small companies and first-time house buyers!! a surfeit of competence, not a of lack of competition, that generated executives’ bonuses!!!

. . . be taken in by smooth-talking bankers?
Self-serving rot, of course. But how will the hitherto spineless authorities respond? Will they admit that it’d been wrong to save the Scottish rascals two years ago, and wrong to save the Irish rogues two weeks ago? Will they therefore commit themselves to not bailing out whoever next comes begging?

Failures have to fail, if successes are to succeed.
Probably not. A precedent has been set. However inept the bank and however clueless the CEO, the bill for misbehaviour is to be passed to the taxpayer. Bad news for the economy, of course. It tells bankers that standards needn’t be raised: failure is condoned not censured. For banks, the role model has become the RMT; for their CEO’s, Bob Crow.

Scarce resources have to be used wisely.
The Bank of England, author of the bail-outs, is substantially to blame for the mess. But the new Government is not blameless. It had two years to think things through. It had the opportunity, on taking office, to reverse the misjudgments of its predecessors.

Better to cut corporation tax than to mollycoddle banks.
It didn’t. It chose instead to compound them, wasting another £7bns, via Dublin. That money would have been better spent reducing corporation tax. If it had been, companies might not be transferring their HQs out of London!

Stock prices nevertheless to continue to rise.
None of this will do much to dent the rally in securities prices. For a few more months, money will be easy, inflation low and profits resilient. The indices may rise by another 15%.

Economics News

December 8, 2010

The French Revolution made the rich poor,
but not the poor rich.
Fisher Ames—European Monetary Union has done something rather similar.

Economics growth is moderating . . .
It’s significant that economics forecasters in most parts of the world have been raising their estimates of growth in 2010 and lowering them for 2011 and 2012. The changes are an acknowledgement of the cyclical condition of activity. They recognise that growth rates are likely to have peaked in mid-summer and are set to fall away progressively in the next two or three years. What is not clear is whether there’ll be a recession; and, if so, how severe it’ll be.

. . . even the forecasters are saying so.
In the UK, the Office for Budget Responsibility lifted growth expectations for the current year quite substantially, but reduced those for the next couple relatively little. In Germany, the Bundesbank did much the same. In China, however, the proportions were reversed: estimates for the future being cut back by rather more than those for the present had been raised.

The next recovery is a long way off.
What’s being rejected just about everywhere is the facile proposition of an accelerating recovery: one that would “deepen and broaden” during the early years of the decade. It’s finally being admitted that, if conditions are to return to “normal,” they’ll not do so until well into the next upturn. Spring 2014 may be the earliest date for a full blown recovery. Between now and then, anxiety levels are likely to remain high.

US labour markets are a key indicator.
Reminding everybody of the fragility of current conditions, the US labour market report for November was a little disappointing. Jobs had been created, but insufficiently quickly to keep up with the work-force. Accordingly, the unemployment rate (a lagging indicator) crept up. That risked depressing the levels of consumption in the months ahead.

And Bernanke is worried about lies ahead.
Fed Chairman Bernanke recognised the problem. The economy, he noted, was not yet operating in a “self-sustaining” mode. Left alone, it’d decelerate. His programme of bond purchases was expected to help, but wouldn’t necessarily be sufficient.

Trichet also. But he daren’t say it.
ECB President Trichet probably also recognised the problem, but had to pretend otherwise. That was because the EZ found itself in a highly polarised condition—economically and politically. In some countries, GDP was growing briskly; in others, collapsing. In some, the national authorities wanted money policy to be loosened; in others, tightened. The ECB itself was in an impossible position. It could say nothing, nor do anything, without causing offence to part of its constituency!

How are the weak to be saved?
It was the outlook for the weaker members of the EZ that was most worrying. Data showed that their economies had been contracting when growth in the rest of the world was fastest. So how would they fare in a global slowdown? Might there be a danger of systemic failure, of political revolution?

Will the strong come to their aid?
Or would Europe’s successful countries be prepared to bail out its unsuccessful ones? More importantly perhaps, did the former have the resources to do so? The questions hadn’t been posed properly. But initial indications were negative. Voters in Germany and England were sceptical. And the costs huge: high enough, even if the political will existed, to render the task impossible.

Will the people be asked?
Chancellor Merkel in Germany seemed to be aware of the views of her constituents and was shifting her stance on the EZ a little. Prime Minister Cameron in Britain was not. His actions since taking office had been disappointing. He had upped the Budget for the Brussels bureaucrats, and contributed generously to the fund to help Irish banks. Would he ever say “No” to anything for which Europeans asked? Probably not.

In Britain, the commitment to spending cuts is fading.
His policies played into the hands of those who opposed public spending cuts, of course. What, it was being asked, were the priorities of the Coalition? How could it be so mean to the poor at home but so generous to the rich overseas?

Cameron doesn’t know what to think . . .
The Government was even losing the initiative on the issue of University fees. Neither Cameron nor Clegg seemed to be able to explain the virtues of the system they’d proposed. It was the student who, though unashamedly wanting to rip off the taxpayer, was getting the sympathetic hearing.

. . . and Clegg doesn’t know how to.
But for the slightly better tone of the economy recently, the incumbents’ poll ratings would have been very depressed. A year hence, they might be! If, by then, the world has slipped into embarrassingly slow growth, the Coalition will be deeply unpopular. And there’ll no longer be any prospect of radical reform. If it’s not been done in the first twelve months of the Parliament, it’ll not be done at all!

Market valuations to rise nevertheless.
Though the economics and politics are likely to be difficult in this period, the securities markets may be strong. Credit policies will become less expansive in a number of regions, but are unlikely to be restrictive anywhere. Couple that with slowing inflation and better corporate profits, and valuations will rise.

Economics Views : 1 Dec

December 3, 2010

What makes people think what they think
is a mystery.

Psychologists claim to understand the causality. But, demonstrably, they don’t.

Stock markets grind data very slowly.
Investor psychology is sometimes enlightened and sometimes perverse. But it’s always difficult to manage. Those who try to do so rarely succeed; usually, they make matters worse.

But exceedingly finely.
The banking crisis demonstrates the phenomenon. Two years ago, it was thought to be a largely Anglo-Saxon problem. Bureaucrats at the Commission in Brussels and Central Bankers at the ECB in Frankfurt oozed Schadenfreude.

And the longer they take, the more robust the conclusion they reach.
The reality was otherwise. Irresponsible banking hadn’t been confined to the US and the UK. It’d been rife in much of Europe as well. But, while countries in the one group were quick to acknowledge their misbehaviour, those in the other had tried to hide it.

The European banking crisis is a case in point.
Only slowly did the truth emerge and only slowly therefore did investor sentiment deteriorate. But, once started, the process proved irreversible. Investors distrusted official statements. If a Minister or Central Banker declared his banking system to be safe, he didn’t calm the market’s anxieties, but inflame them!

Investors were initially dismissive.
The issue became one, not just of local banks, but of the future of the single currency. Investors wanted to know how a country choosing to leave the EMS would treat its euro-denominated debt. Would it be honoured or repudiated? The question was posed, but not answered.

But are now obsessive.
Understandably nervous, investors avoided the debt of suspect countries. That caused their bond yields to rise, and the higher they went the greater became the risk of systemic default. Banks and Governments might have been able to survive “normal” interest rate premiums, but not these “abnormal” ones. Disaster was assured.

Yield differentials make it clear they expect disaster.
Today, only Germany and its close acolytes (the Netherlands and Austria) are trusted. Only they are able to raise money in the bond markets. If the EMS is to survive, therefore, if the EU itself is to have a future, it’ll be necessary, at least temporarily, for the strong to guarantee the borrowings of the weak.

If the EuroZone is to survive, . . .
Will the former be prepared to do so? Not unless they also take charge of the latter’s financial affairs: the control of their budgets and the regulation of their banks. Goodbye, in that event, to democracy.

. . . Germany’ll have to provide blanket guarantees.
Does the Commission or the ECB have anything insightful to say about these matters? Of course not. Neither knows how to deal with the markets. Both nevertheless spout nonsense. Trichet claims that the single currency is fundamentally “sound;” Barroso, that it’s been a great “success.” Hmph.

The UK could have escaped; but it hasn’t.
Britain, sadly, isn’t free from the sickness. She’s wasted one fortune trying to save her own failed banks, and now she’s busy wasting a second trying to save Europe’s. There might have been a change of Government, but there’s been no change of policies.

Amongst the old brigade, the US and Japan are best placed.
The good news is that the non-European developed economies have been performing fairly well. In the middle quarters of 2010, the US, the UK and Japan produced a conjunction of growth, inflation and external deficit that verged on the satisfactory. It’ll probably not last. Activity will slow during 2011. But, for those operating sensibly, it’s possible to hope that the retrenchment will be modest.

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