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.

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