Economics News

February 25, 2011

May you, my Cam and Isis, preach it long!
The right divine of King to govern wrong.

Alexander Pope, Dunciad—Is the top man at the Bank of England another Stuart? Will public opinion displace the former, as it did the latter?

If in doubt, look at the data.
The economics outlook is not good. Activity is decelerating progressively. Six months ago, only 55% of statistical releases were indicating a moderating trend. Today, more than 65% are.

They’re bad and getting worse.
How bad will things get? Possibly very bad. It looks as if the downturn will be aggravated by a restrictive monetary policy, not alleviated by an accommodative one. Inflation is quickening; and the Bank of England is preparing to raise interest rates, therefore.

The B-of-E, moreover, . . .
Opinion in the MPC has hardened a good deal in the last three months. The hawks have gained ground; the doves lost it. And the authority of the Governor, his recent Press Conferences having been a shambles, is in question.

. . . looks set to hike rates.
The shape of the yield curve implies that interest rates will be raised from ½% to 1¼% during the course of 2011, and will possibly continue to go up in 2012. If so, GDP is going to take a knock. It’ll start to dip in the closing months of this year, and’ll fall at an annual rate of 1½%, say, for a while thereafter.

Is official optimism to be taken seriously?
Bizarrely, Government Ministers are still talking about recovery. They seem to be expecting an expansion in the private sector that’ll compensate for the enforced contraction in the public one. A sensible enough objective, but one that would have required taxation to be cut and interest rates to be kept low.

Sadly, no!
That the authorities got the inputs wrong is almost certain to result in their getting the outputs wrong as well: private debility will reinforce public austerity, not offset it. In the US, things have been different. It’ll be reflected in the months to come in the opinion polls. In the States, Obama’s ratings will improve; in Britain, Cameron’s will decline.

In Japan, things aren’t much better.
It’s not just here that things are going awry. Japan’s recent numbers have also disappointed. Its fourth quarter’s GDP estimate was a shock; likewise, its early 2011 trade returns.

Customers aren’t buying.
In January, the country recorded a deficit! In part, that was the result of soaring raw material prices; in part, and more worryingly, the consequence of softening export volumes! It looked as if the rest of the world might be losing its appetite for Japanese products; belts having been tightened and credit cards spurned.

China most obviously.
Significantly, China’s imports were dropping particularly quickly. Over the last six months or so, the country has been reversing its previously expansive credit policies. Unsurprisingly, domestic demand has taken a knock. Other countries pursuing similar policies will fare similarly.

Will India buck the trend? Very unlikely.
India’s Government claims that growth will stay brisk this year and next, but that’s more wishful thinking than dispassionate analysis. If inflation is to be reined back, the trade accounts returned to balance, interest rates will have to stay high for some time. GDP will decelerate sharply. In the second half of 2011, growth may be below 5% per annum; in the first half of 2012, barely positive.

Nor will Germany.
What about Europe? Germany, like India, is officially optimistic. It’s just raised its forecast for 2012. But it recognises that everything depends on exports. If its customers choose not to buy, Germany too will falter.

The EMU will weigh it down.
And how are its customers, primarily its neighbours in the EZ, doing? Not at all well. Some have collapsed under the strains imposed by the single currency, others are just breathing rather heavily. Whether Monetary Union survives is the big question. Whether the members of the group fare well in the next couple of years is not. That Commissioners and ECB officials claim otherwise says more about their arrogance than their intellect.

Equities to fall only modestly, though.
The outlook for economies is not much in doubt. But that for equities is. The latter won’t do well, but they might not collapse. Near term, they’ll be supported by an undemanding valuation (PEs low and dividend yields high) set in the context of improving corporate profits.

Potentially to rise again next year.
Later on, the fundamentals might change. If Governments (either the current lot or, more likely, their successors) can bring themselves to encourage economics efficiency rather than political correctness, if they can cut taxation and regulation, the potential for appreciation would be substantial.

But only if Governments behave!!!
Moreover, once activity has started to retreat, once inflation is back under control, commodity prices sliding, Central Banks will cut interest rates again. It’s not impossible therefore that, after a dreary 2011, the indices enjoy a brighter 2012.

Economics Views

February 24, 2011

Spoils of war aren’t divided fairly;
nor fruits of fragile economics recovery.

The one caused ill-feeling between Agamemnon and Achilles in an earlier period; the other may be doing so between Governments and People now.

Marx would have been unsurprised by recent developments.
Economics growth in Germany in the last twelve months or so has been quite strong, but the benefits seem not to have been shared equitably amongst the population. The boss has been rewarded; the worker hasn’t. That’s the message that emerges from two of last week’s polls: the first, the IFO’s reading of investor sentiment; the second, the result of Hamburg’s State elections. While business confidence has soared, incumbent politicians’ approval ratings have crashed!

He’d have seen the “greed” of the businessman . . .
Germany isn’t alone in this respect. Everywhere in the world, the message is similar. Economics “recovery” has been disappointing: growth anaemic but inflation brisk; benefits restricted to the few, not dispersed amongst the many.

. . . as a nail in the coffin of capitalism.
In the States, Democrats thought they had only to reactivate the economy to get returned to office. They thought that a faster growth rate would please everybody. Not so. Bankers and businessmen grabbed all the loot. There was nothing left for anybody else. Last November’s electoral landslide was the consequence.

He was wrong: such trends don’t persist.
In Ireland, where the pain has been greater and the sense of outrage stronger, the reaction against the incumbents is going to be more extreme: Fianna Fáil may get as little as 14% of the vote! In Greece and Spain, the disenchantment is comparable; in the rest of Europe, only slightly less severe.

Public opinion eventually influences businessmen.
Arguably, the disturbances in North Africa reflect the same disillusionment. Governments there, no less than elsewhere, are felt to be out of touch. Too much concerned with their own interests; too little with those of the general public.

But the process is sometimes lengthy.
Even in China, political opposition may be on the march again. Amongst workers, real wages seem to have continued to rise, but disappointingly slowly. The authorities in Beijing are perceived to be on the side of the rich and powerful, against the poor and powerless. The interests of the one are protected; those of the other undermined.

And nearly always messy.
In Britain, the popularity of the Coalition has fallen sharply. Understandably so. It’s seemed not to notice the deteriorating economics situation. It’s focused on other issues: the “big society” on the one hand, the “alternative voting” system on the other. Both are the stuff of political vanity. Both are thought by the public to be a waste of time and money.

Few Governments survive the transition.
Will any incumbent Government be saved from the wrath of its voters? Probably not. But the best hope for them is a long and robust economics recovery. That’s what they’re all pinning their hopes on. Are those hopes justified? No way!

Economics downturn turfs them out.
The business cycle marches to a tune set by a disinterested drummer. The last trough occurred in December 2008; the next peak is due in autumn 2011. Growth is already slowing. It’ll continue to do so. And it’ll go negative if, as seems increasingly likely, Central Banks raise interest rates into the slowdown!!!

Stock prices look set to falter, but not necessarily crash.
Asset valuations are also vulnerable. But equities are cautiously valued at the moment. And it’s possible that profits will prove resilient in a downturn (wages taking the bigger hit). In that event, the indices might fall only modestly.

Economics Views

February 17, 2011

Some truth is spoken,
that more may be concealed.

Mr Justice Darling, Scintillae Juris—is the Bank acknowledging some errors of judgment to prevent censure for others?

The Bank misanalysed the economy prior to the financial crisis.
During the previous couple of years, the Governor of the Bank of England had routinely forecast favourable developments for the UK economy. Last week, he had finally to acknowledge he’d been wrong. Growth was likely to be unsatisfactorily slow for some time; inflation unacceptably fast.

And it’s misanalysed it subsequently as well.
The hope had been that an expansive credit environment and a restrictive fiscal one would sustain activity but inhibit prices. It might have done so had the authorities not turned a blind eye to the public sector’s excessive pay deals. Civil Servants and Doctors, Teachers and Tube Drivers, all helped themselves unstintingly to the public purse. And those who should have been supervising proceedings (the politicians, on the one hand; the BOE’s forecasters, on the other) looked on indulgently.

Didn’t anybody notice what was happening to public sector pay?
It was no great surprise that Brown and Darling chose not to notice. They needed the support of the public sector in the forthcoming election. But what could possibly explain the insouciance of their successors—Cameron and Osborne? Didn’t they see? Or didn’t they think it important? In either event, their competence has to be questioned!

So now it’ll be the private sector that’s squeezed again!
So what lies ahead? Apparently, there’s still a reluctance to demand higher levels of efficiency from public employees. No appetite to lift the retirement age, nor to scale back pay, nor even to tackle absenteeism. Instead, the Governor will raise interest rates. He prefers to squeeze the private sector rather than the public one!

The conjunction of negatives is frightening.
Growth will be hit in consequence. The cyclical downturn will coincide with higher interest rates and, eventually, with lower public spending. Each of the negatives will reinforce the others. The chances are there’ll be a recession; possibly a severe one.

There’ll be a recession . . .
There’s another anxiety: food prices. Harvests in many parts of the world have been poor this year; in some countries, very poor. Supply will be inadequate. There’ll be shortages in consequence. And if some countries are determined enough to satisfy their needs, the shortages for others will be intensified.

. . . exacerbated by food prices . . .
How much prices will rise is difficult to estimate. But a (further) hike of 10% is not unlikely; one of 20% not impossible. The effect on the rest of the economy will be significant. What’s spent on “essentials” can’t be spent on “non-essentials.” In the second half of 2011 and the first half of 2012, GDP may sink by an extra 1%!

. . . and unmitigated by financial services.
And the financial services sector, the country’s saviour in the early part of the century, will be in no position to continue to work the miracle. The regulation of the City is to be handled in future by the EU!!! There’s a risk in consequence that valuable parts of it (not commercial bankers, of course, but fund managers, brokers, actuaries etc.) will move elsewhere!

Will valuations hold up? Possibly.
Under normal circumstances, a recession set in the context of a credit squeeze would provoke a notable bear market! This time round, though, the setback may be only moderate. Valuations are low, profits are currently growing quite strongly, and may continue to hold up in the face of a sagging economy. Why? Because domestic pay levels, initially in the private sector only, but later in the public one as well, will take a disproportionate share of the pain.

A Look at the European Market

February 14, 2011

CNBC Television

11 February 2011

A Look at the European Market

For a look at this week’s European market action.

I prefer rogues to fools

February 14, 2011

I prefer rogues to fools,
because they sometimes take a rest.

Alexandre Dumas fils—Blair and Brown were tireless; Cameron and Clegg likewise!

Kenneth Clarke’s perceptiveness hasn’t always been acute, but it looked sharp last week when he claimed the outlook for Britain’s economy was frightful. He was right. Activity was slowing, inflation quickening and the trade gap widening. The country had become sclerotic: its people complacent and its companies inefficient.

He warned that things would get worse before they got better. The business cycle was due to peak in a few months. Between now and then, GDP would probably grow—but at progressively slower rates. Afterwards, there was a distinct possibility it’d decline.

If the Bank of England had to raise interest rates significantly, the recession might be severe. Was there a risk of the Old Lady’s doing so? There certainly was. An unacceptably high inflation rate might be the trigger, but a run on sterling (and gilts) was the greater threat. If it looked as if the UK were headed the way of Greece or Ireland, there wasn’t much doubt that credit would be squeezed.

Why had things got so bad? Why was the economy that had been so good in the nineties so bad now? Kenneth Clarke offered no explanation. If he’d been pressed, though, he’d probably have recognised the contributions of two main factors.

The huge transfer of resources from the private sector to the public one was the first. It was the former that produced the wealth; the latter that consumed it. Unsurprisingly, the economy’s characteristics reflected the reallocation.

The Bank of England’s decision to bail out Scotland’s delinquent banks was the second. It was a guiding principle of Schumpeter’s economics that, if the good were to be encouraged to succeed, the bad had to be allowed to fail. Preventing failures inhibited successes. Governor King and Deputy Tucker should have known better.

But the Justice Secretary couldn’t claim that all the economy’s problems were inherited. Nor that they were the result of poor advice from public servants. The Coalition had condoned many of the errors of its predecessors by choosing not to censure the Treasury or the FSA. Worse, it’d increased the powers of the Bank of England!

Additionally, it chose to deploy English taxpayers’ funds to support Irish banks! It had been bad enough wasting money on domestic miscreants. Doing so for the overseas variety was incomprehensible.

There was worse to follow. The regulation of the financial services sector (Britain’s USP) was passed, despite the Coalition’s promises to the contrary, to officials in the EU! Operational rules were no longer to be set by the FSA in London, but by the Commission in Brussels. Out of the frying pan; into the fire!

The sins of the country’s commercial bankers had been visited on its fund managers and brokers, corporate financiers and lawyers, actuaries and accountants. The Commission had always wanted to undermine the City. It believed (self-servingly) that mishaps in the past (those relating to the single currency, for instance) were the result of anglo-saxon speculation. It’d been angling for years for the authority to tackle the issue. Now, thanks to Cameron and Osborne, Clegg and Cable, it could set to work!

Economics News

February 11, 2011

It’s easier to fight another man’s principles
than live up to your own.

Alfred Adler—that presumes you have some, and the indications are that most politicians don’t!

Who is to legislate for the UK?
The House of Commons is minded one way; the European Court of Justice another. At issue is not the particular but the principle. What’s decided is of minor importance in comparison with who decides it. Are the country’s laws to be written by a group of Brits elected by their countrymen, or a bunch of foreigners unelected by anybody?

European lawyers or British parliamentarians?
How will the Prime Minister react? He’s inclined, he says, to favour the will of Parliament, but his track record on these matters isn’t good. He had to eat his words on the promise of a referendum on the constitution and also on the promise not to use British taxpayers’ funds to support the euro. On each occasion, he claimed he regretted his shortcomings, and assured the country there’d be no further breaches. Hmph.

Cameron can’t avoid the issue for ever.
He has more to worry about than a few broken promises. The economy isn’t performing well and voters are blaming him rather than his predecessors. Inflation is fast and quickening; the trade gap broad and widening. Meanwhile, though the spending cuts haven’t yet begun to bite, half the population deems them to be too severe!

His problem is that the economy is stalling and his popularity slipping.
The Government knows it’s in trouble, but doesn’t know what to do to get out of it. Instead it’s opting for a set of unconnected public relations stunts. Its attitude to good universities on the one hand, to reprobate bankers on the other (the first slighting, the second fawning), demonstrates its lack of strategy.

He’s given up on logic.
It’s deliberately ignored the obvious deficiency in the educational system. The failure of the state schools isn’t to be remedied, but camouflaged by forcing their ill-prepared alumni into the top universities. It’s a policy that Pol Pot might have employed!

And resorted to gimmicks.
Meanwhile, the rogue elements in the financial system are to go almost wholly unpunished. The commercial bankers will be allowed to continue to cream off for their own bonuses much of the money that the taxpayer supplied for the reactivation of the economy. Worse, the regulators who failed to anticipate the crisis will keep their jobs and their platinum-plated pensions.

The world economy is not quickening; it’s slowing.
Elsewhere in the world, economies are growing patchily. China is still strong and so are most commodity producers. Japan and Germany are faring quite well. America too. Most of the rest are disappointing. Many may find themselves in trouble as the business cycle turns down later this year.

America scores relatively well, but not absolutely.
The US is still the world’s economics lynchpin. Its numbers are satisfactory: growth moderate, inflation low and unemployment falling. But they’re hardly spectacular. Indeed, given the extent of the monetary stimulus, the performance is slightly disappointing.

Germany also.
It’s much the same story for Germany. Superlative by comparison with the rest of the EU, but only by comparison. It’s not Germany that’s doing well, but the rest of the region that’s doing badly.

And Japan.
Likewise Japan. The country is competitive and its export deliveries are strong. But only just strong enough to compensate for its still weak domestic appetites.

Only the PRC is motoring, but probably not for long.
Will China continue to grow rapidly? Of course not. The cycle is soon to turn and, additionally, the monetary stimulus has been reversed. Instead of moderating the retrenchment, it’s likely it’ll intensify it.

Another severe recession?
The last couple of cycles have brought surprisingly sharp downturns. It’s not impossible the next one will be severe as well. That’s hardly a favourable outlook for employees, nor for incumbent politicians of course.

Asset prices to hold up?
Ironically, the securities market might hold its nerve (and its valuation) quite well. Shortly after economies lose traction, liquidity will be eased again. So long as inflation is headed south (likely to be so because commodity prices and wage settlements will respond fairly quickly), interest rates will be cut (in China, the priority might be stability in property valuations rather than food prices). If so, the dip in the indices would be modest.

London may slip relatively.
London looks set to lag. Its USP, the high value-added parts of the financial sector, are to be emasculated, visited with the sins of its low value-added counterpart (the commercial banks), and regulated as a punishment by vengeful Eurocrats. It may be a few years before equilibrium is re-established!

Economics Views

February 11, 2011

Merit envies success, and success presumes merit.

Jean Rostand, De la vanité — but, in politics, failure seems sometimes to presume merit!

How is it possible for politicians to think so highly of themselves?
Blair and Brown were classic micro-managers. In every area of the country’s affairs, they meddled incessantly. They thought they knew better than professional managers, and wished therefore to be in a position to amend the latter’s “inappropriate” decisions. To this end, they suffocated the country with rules and regulations. Everything had to be operated within an environment of (usually ill-considered and invariably ill-drafted) targets and guidelines.

New Labour believed it knew all the answers.
The result, unsurprisingly, was failure. Professional managers mightn’t have been perfect, but they were significantly better than their political masters. Under New Labour, performance deteriorated. The Departments of Education and Health, for instance, despite having huge sums of money thrown at them, continued to be blots on society. Transport and Justice shockingly worse: manifestly unfit for purpose.

New Coalition a fortiori.
It’d been hoped that the Coalition would behave differently. Sadly, it hasn’t. Cameron and Clegg are replicating all the worst features of Blair and Brown. In some cases, they seem intent on out-doing the nonsenses of their predecessors.

The plans for universities are worrying.
Their treatment of universities is a case in point. Currently, the good ones (there aren’t many) take a disproportionately large number of pupils from fee-paying schools and a correspondingly small one from state schools. That’s unsatisfactory, say the Coalition’s Yahoos. Something ought to be done. Everybody agrees. But what?

It’s nearly always a mistake to subvert logic to politics.
Time perhaps for the Houyhnhnms to analyse the problem. Willetts is ideally qualified to do so, but he’s allowing his ambition to overwhelm his intellect. The issue isn’t complicated: if top universities have been favouring independent schools unfairly (arguably, to preserve society in their own fossilised image), there’d be a case for quotas; if the problem is one instead of state schools being incompetent (of their failing to educate pupils to pre-university standards), quotas would be irrelevant.

The problem, still to be unattended, is the state school.
Which is it? The latter, of course. And the remedy should be applied to the malaise: to state schools. Cameron and Clegg are attacking good universities (one of the few aspects of education that’s working satisfactorily) to divert attention from bad schools (the worst of the many that aren’t). The “guidelines” will fail, of course. In a year to two, they’ll be dropped. And the carbuncle of bad state schools will go unlanced!

And, in finance, it’s the marauding commercial banks,
The Coalition’s treatment of commercial banks has been similarly infantile. Cameron and Osborne, Clegg and Cable are playing politics rather than economics. The deal that’s been “agreed” on bonuses and lending is a farce.

The authorities, singly and collectively, ought to be asham¬ed of themselves.
That the Regulators weren’t censured for their failure is the equivalent of the Local Education Authorities not being called to book for theirs. That bankers have been allowed to pay themselves the money allocated to them by taxpayers for the reactivation of the economy is the equivalent of teachers taking a salary but refusing to educate their pupils. New Labour started the rot. New Coalition has continued it.

Asset prices may slip a little as the scales fall from investors’ eyes.
The world economy is approaching its cyclical peak. In the retrenchment that’s going to follow, it’d be helpful to have lower interest rates. Instead, because of rising inflation, many countries’ll find they have to raise them. Stock price indices will falter. Not yet perhaps, but shortly.

Economics News

February 9, 2011

It’s sad the only people who know how to run the country are driving cabs and cutting hair.

George Burns—many a true word spoken in jest; would cabbies and barbers be any worse than Britain’s incumbents?

Why do some motor cars have fewer accidents than others?
In periods of economics weakness, it’s normal for Central Banks to cut interest rates and quicken the growth of money supply. But the policy only makes sense so long as the extra liquidity boosts activity rather than prices. In the US in last couple of years, that’s been the case; in the UK in the same period, it hasn’t.

It’s partly a matter of driver skill; partly of vehicle responsiveness.
The difference comes down to the response of the labour market. In America, it’s been flexible and the increase in wages consequently modest. In Britain, the first has been inflexible and the second immodest. Unsurprisingly, the Fed’s credibility is currently running high, but the Bank of England’s low.

The BOE has finally acknowledged that it has problems.
A couple of weeks ago, very belatedly, Governor King drew attention to the problem. He noted that pay rises in the UK, those in the public sector in particular, had absorbed a disproportionately large share of the monetary largesse. Prices were quickening, but activity wasn’t.

Most importantly, public sector pay.
It’s a condition that Brown and Darling should have addressed in the final years of their term of office. It’s one that Cameron and Osborne, Clegg and Cable, should have attacked with urgency as soon as they took over. Sadly, they didn’t. It’s something that officials in the Bank and the Treasury should have spotted and brought to the attention of their political masters. Sadly, they didn’t.

It should have been restrained two years ago.
The reality is that those employed in the public sector, whether Local Authorities or Quangos, Civil Service or Central Bank, are grossly over-compensated (especially on the pensions front) and unconscionably under-worked (especially in regard to the retirement age). The anomaly is obvious to everybody except those blinded by being part of the system.

The near term outlook is not good.
Will the iniquity finally be tackled? Possibly. But, if so, it’ll be a year or two before benefits accrue. In the short term, there’ll be strikes and higher unit costs.

Especially in the context of restrictive credit policies elsewhere in the world.
Another problem that may shortly exercise the authorities is the cyclical condition of the world economy. Activity (relative to trend) is due to turn down in the closing months of 2011. Will Britain be able to avoid a recession? The odds are not favourable. And they’re not improved by the increasingly restrictive monetary stance that’s being adopted by countries like China and India, Australia and Brazil.

Britain another Greece?
That’ll slow the pace of world activity in any event. But it might do something much worse. It might expose sterling and gilts to critical scrutiny. If the international investment community should start to see the UK in 2011 in the same light as Greece and Ireland in 2010, the availability of credit would be reduced and its cost increased. In that event, recession would be certain.

And the City regulated by Brussels!!!
There’s another factor that threatens the British economy. It concerns the outlook for financial services. The regulation of the sector is being passed, despite Cameron’s promise to the contrary, to officials in the EU! Operational rules will no longer be set by an incompetent sub-section of the FSA in London, but by a vindictive sub-section of the Commission in Brussels. Out of the frying pan; into the fire!

Cameron has a lot for which to answer.
The outlook is frightful: sins of commercial bankers being visited on fund managers and brokers, corporate financiers and lawyers, actuaries and accountants. Compliance officials will attempt to destroy what they can’t understand. Europe’s political elite believes (self-servingly) that the single currency was set at risk in 2010, not by domestic inconsistencies, but by marauding anglo-saxon speculators. The Commission intends, now that HMG has given it the power to do so, to eliminate the perceived threat once and for all.

He may be about to do what Wilson and Foot and Brown couldn’t.
For the first time in half a century, there’s a real risk that Britain’s financial community will seek to set up shop elsewhere in the world. If that happens, it’ll be a slow process, but one with a lasting impact on the economy. In the past, the City has quickened Britain’s GDP growth by about 1% per annum. In the future, it might slow it by almost as much!

Stock indices won’t fly in such circumstances, but nor will they tank.
It’s a fairly gloomy analysis, but one that’s not wholly unsatisfactory for investors. Valuations are low and, with profits strong, getting lower. Moreover, there’ll be a recovery, perhaps only partial, in the medium term. Even the City of London might perk up: in its history, it’s survived bigger threats than those posed by loathsome Eurocrats. While the indices might find the going tough for a while, therefore, the year could provide some attractive buying opportunities.

Is Mervyn King a latter-day Odysseus?

February 9, 2011

Is Mervyn King a latter-day Odysseus?
Is he having to negotiate the tricky passage between Scylla and Charybdis?

The Bank of England’s economics analysis has been less than sparkling in recent years. It’s not just that it failed to predict a number of major developments in the period, but that it seemed not even to notice them until long after they’d occurred. The faltering response to cyclical downturns beginning in 2001 and 2006 illustrates the point; likewise that to the quickening pace of inflation in 2010.

Will the Old Lady recover her poise in 2011 and 2012? Will her forecasts become accurate and her credit policy appropriate? The auguries aren’t good. She suggests that inflation will slow of its own accord, but that real activity will hold up reasonably well! An improbable combination; and one that’s already unravelling. At the end of 2010, prices were reported to be accelerating, but activity sagging.

The reality is that a new cyclical downturn is due to start in the coming autumn. It’s unlikely the Bank’s monetary stance will be accommodative enough to offset the chronology; it’s especially unlikely to be able to do so when key parts of the rest of the world are beginning to tighten. China and India, for instance, are opting for austerity; so are Australia and Brazil; and so, perhaps accidentally, is the EZ.

That’ll slow the pace of world activity in any event. But it might do something much worse. It might expose sterling and gilts to painful scrutiny. If the investment community were to start to see the UK in 2011 in the same light as Greece and Ireland in 2010, the Bank would be unable to prevent a dearth of credit in the UK; and unable to prevent domestic activity being significantly weakened, therefore.

There’s another factor that threatens the British economy. It concerns the outlook for financial services. The regulation of the sector is being passed, despite Cameron’s promise to the contrary, to officials in the EU! Operational rules will no longer be set by an incompetent sub-section of the FSA in London, but by a vindictive sub-section of the Commission in Brussels.

The outlook is frightful: sins of commercial bankers being visited on fund managers and brokers, corporate financiers and lawyers, actuaries and accountants. Compliance officials will attempt to destroy what they can’t understand. Europe’s political elite believes (perhaps self-servingly) that the single currency was set at risk in 2010, not by domestic inconsistencies, but by marauding anglo-saxon hedge funds. The Commission intends, now that HMG has given it the power to do so, to eliminate the threat once and for all.

For the first time in half a century, there’s a real risk that Britain’s financial community will seek to set up shop elsewhere in the world. If that happens, it’ll be a slow process, but one that has a lasting impact on the economy. Over the last few decades, the City has quickened GDP growth by about 1% per annum. In future, it might slow it by almost as much!

What, meanwhile, is to be made of the Bank’s prognosis for inflation? Does it really believe that containment without recession is possible? Of course not. It’s just that it’s too embarrassing to have to admit it. The Governor has chosen discretion over honesty; to stay in his job rather than resign. He’s hoping, like Macawber, that something will turn up.

Unsurprisingly, but of course belatedly, he’s realised that much of the problem is attributable to public sector pay. Those employed in the Civil Service and Local Authorities, in the innumerable Quangos and in the Bank itself, are grossly over-compensated (especially on the pensions front) and unconscionably under-worked (especially in regard to the retirement age). Sadly, Brown and Darling chose not to tackle the issue at the end of their administration; Cameron and Osborne not to give it a high priority in the early months of theirs. If, finally, a squeeze is to start to be imposed, the near-term result will be a rash of strikes. Lower pay settlements will not kick in until 2012!

And the Bank’s reaction? Will liquidity be kept plentiful to forestall the recession that wasn’t forecast? Or reduced to moderate the inflation that wasn’t forecast either? It’ll be a difficult choice: Scylla on the one side, Charybdis on the other.

It’s a fairly gloomy analysis, but one that’s not wholly unsatisfactory for investors. Valuations are low and, with profits strong, getting lower. Moreover, there’ll be a recovery, perhaps only partial, in the medium term. Even the City of London might perk up: in its history, it’s survived bigger threats than that posed loathsome Eurocrats. While the indices might find the going tough for a while, therefore, the year could provide some attractive buying opportunities.

Economics Views

February 3, 2011

The world is composed of two kinds of people:
those who do the work and those who take the credit.

Indira Gandhi—it’s a division between governed and governors, regulated and regulators, non-bankers and bankers!

It’s not much use closing the stable door after the horse has bolted.
No bank, said a Treasury Select Committee earlier this week, should be deemed too large (or too politically significant) to fail. Of course not. Only those who reject Schumpeterian economics, who dismiss the virtues of competitive selection, would think otherwise. Sadly, the world was infested with such people when the global financial crisis struck a couple of years ago. Nowhere more so than Britain.

It’s more important to censure those who left it open.
The Bank of England, the Treasury, the Government and the Press were virtually unanimous in declaring that resources should be transferred from non-banks to banks. In their opinion, such a therapy would save the economy as a whole. That the competent and blameless would be penalised, the feckless and culpable rewarded, was a small price to pay for deliverance. Hmph! It was an analysis that might have come from the pen of Franz Kafka at his satirical best!

The Treasury Select Committee did the one but not the other.
What a disaster! The banks took the money and, no great surprise to anybody with a triple-digit IQ, paid it to themselves. The non-banking community was left impoverished and emasculated. The economy as a whole didn’t recover; it languished.

Those who failed us are, for the most part, still wallowing in public sector luxury.
The Select Committee’s report recognised the error of judgment, but was reluctant to allocate blame. It didn’t censure the second-hand car salesmen who ran the commercial banks. Nor, shamefully, those who were appointed to regulate the financial system; nor, even more shamefully, those who organised (without Parliamentary support, let alone electoral consent) the bailouts.

Was Ed Balls prepared to acknowledge his errors of judgment?
What did the Shadow Chancellor think of the episode? He too was anxious to draw a veil over the identity of those responsible for the period’s maladministration. Speaking on television earlier this week, he chose to blame nobody—least of all the politicians who were in power at the time. He condemned only the Coalition for implementing spending cuts now. They’d derail the recovery, he said. Van extension of the procedure that had caused the original problem: homeopathy in economics! More strictures for the private sector; more indulgence for the public one.

Not he! It was the Coalition that was misanalysing the situation.
Did he not realise that spending cuts now were the direct consequence of spending excesses in an earlier period? If Whitehall and the Local Authorities had been disciplined when he was in office, there’d be no need now to make cuts. If, in particular, the failing Scottish banks had been allowed to fail, the economy might now be well on its way to genuine recovery.

Amongst developed countries, only Germany, Japan and the US look good.
The key to economics virtuosity was efficiency and competitiveness, not bureaucratic profligacy. Germany and Japan had progressed the hard way, through productivity and pay restraint. These countries were currently achieving reasonable growth in the context of financial stability. The US had opted for a different combination—devaluation and pay restraint—but it too was faring well. Most of the rest of the developed world had yet to bite the bullet.

Australian and Brazil do temporarily.
Commodity producers were vulnerable. So long as metal and food and energy prices stayed high, they’d look good. But they’d be beached whales, exposed and impotent, when prices fell.

Stock prices will drift. The summer may be critical.
And security valuations? They’d likely find the going tough. Although corporate profits would stay strong during 2011, and although inflation would eventually plunge, liquidity would become much less plentiful. It’d be surprising, therefore, if the indices rose significantly; it was more likely they’d fall modestly.

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