December 29, 2006 | posted by Michael Baxter in IABN | comments (0) |

There’s something oddly perverse about economic
policy. When prices are cheap, thanks to cheap imports from China, consumers are
happy. The Bank of England lowers the rate of interest, in turn making us feel even
better off.

When times are getting tougher, and the price of oil makes us feel the cost of
running our cars, the Bank of England ups the rate of interest, making us worse off still.

But maybe the changes in the rate of interest, designed to stop inflation, are in
fact making it worse - in the long run that is. Economics can be like that. Policy
designed to avoid something happening, can make it happen.

It all depends on what you think causes inflation. If you believe the Monetarists
got it right, and it’s down to the money supply, then we have a problem, and the
policy of the last few years is making it a lot worse.

Economists used to talk about a phenomenon known as the Philips Curve. This
was the idea that there was a trade off between unemployment and inflation; a little
bit of inflation was a good thing, because it enabled full employment. The trouble is
this: when markets, and the labour market in particular, start to expect inflation, the
Philips Curve stops working. And for it to work, inflation has to be greater than
expected. It appears that, in the long run, the trade off is not between unemployment
and inflation, rather it’s between accelerating inflation and unemployment.

But of late, and particularly in the UK, we have had the best of both worlds. The
beast known as inflation has stayed curled up in its cave, while workers went off to
work like they had never done before.

Maybe the underlying reason for this lies with demographics. The high
unemployment of the ’70s and ’80s coincided with the period when the baby boomers
were leaving school. With those days behind us, simple demographics are keeping
unemployment down.

The usual characteristics of an economy with a static or falling working population are
often full employment, low inflation, but low growth. This time, however, we are having fast growth.

The Bank of England, seeing low inflation has kept the rate of
interest low, making us feel good and an creating an unprecedented, consumer boom.

But this has led to worrying growth in the Money Supply, and the
spiralling asset prices of recent years.

So what happens when the era of cheap imports comes to an end. Maybe, just
as the high price of oil was a one off, so too has been the falling high street prices?
And maybe inflation has not been laid up in its cage at all, rather it’s been building its
strength.

The shortage of labour has brought with it immigration, longer working hours, and
people working past normal retirement ages.

And, as Peter Spencer from the Ernst and Young ITEM Club says, the UK is
experiencing an output gap, which means that the UK is producing at below its
capacity, and is capable of growing at faster pace than it is. The rate of interest,
Professor Spencer has previously said, has been a 1/2 percent lower than it would
have been thanks to this extra labour pool the UK has been able to call upon.

But, in the medium term, problems set in. And this output gap could lead to the
UK growing too fast. In order to stop inflation, the rate of interest would need to rise,
and rates of 5.75 percent may be required. Professor Spencer told Investment and
Business News: “My natural interest rate figure of 5.75% assumes that the benefit
from immigration broadly continues as a trend and is not just a blip. If so, the medium
term implication is that rates must rise, even though the short run (blip) effect may be
to lower them.”

But the ITEMS Club’s top economist says his interest rate projection takes no
account of consumer debt.

So it seems to us that in the medium term the UK walks a tightrope. The rising
level of the work force will promote much better growth, and give government
finances a big boost. But, the Bank of England must up the rate of interest to stop the
UK from overheating. Given the high level of consumer debt and house prices, there
are dangers in that and the rate of interest required to temper inflation could spark a
consumer spending crisis.

The rise in immigration could lead to a rise in the natural level of unemployment,
meaning the Philips Curve would become an issue again, with the government
having to make a direct choice between unemployment and inflation.

Then again, you pay your money and take your choice. Do you want low growth,
low inflation and low unemployment, or do you want faster growth? In economics,
good news and bad news can be bed fellows. In the long run, the UK faces a
pension time bomb. The scenario described above could be a mixed blessing in the
medium term, but in the long term, it could be the solution to the needs of our future
pensioners, and that, dear reader, is you and me

Article written by Michael Baxter

December 29, 2006 | posted by Michael Baxter in IABN | comments (0) |

There has been lots of bad news coming out of the US of late. And top of the bad news pile is the US housing market. Recent analysis on Moodys.com has predicted that 20 metro areas, out of 379 across the US, could see property prices crash, or at least fall by more than 10 percent. Furthermore, the report estimates that around 100 areas face the significant probability of experiencing declines within a year.

The typical US citizen is far more indebted than the overstretched Brits, and it is felt that a US housing market slowdown poses a much greater threat to Uncle Sam’s economy than a similar slow down in the UK.

And yet, markets celebrated the last couple of months of 2006 by spending, with the Dow hitting new highs with almost tedious regularity.

There seem to be two reasons for the good performance. Firstly there is oil. The latter half of 2006 saw sharp falls, at one point dropping to $20 lower than the level hit in July.

Then there is, perhaps, a deeper reason. Company valuations relative to forward profit projections are at a ratio of just 15, compared to typical ‘PEs’ of 25 back in 2000.

The falling price of oil is causing celebration for two reasons. Firstly, cheaper oil means we are better off - of course it does. Secondly, cheaper oil should means lower inflation, meaning lower interest rates, meaning the housing market could be off the hook. But here, we could be seeing the biggest economic fallacy of the last few years. Maybe, the link between oil and inflation, not to mention the link between cheap imported goods and low inflation, is a false link - at least in the long run - and economic policy has been flawed.

And to find out why, read below

Article first written by Michael Baxter on 4 October 2006

December 29, 2006 | posted by Michael Baxter in IABN | comments (0) |

“Flattery is a false coin that is only
current thanks to our vanity” said the 17th Century French writer, Fran#231;ois
de La Rochefoucauld. 2006 saw markets in the US hit
all time highs, while hopes that inflation is back under control have led to
renewed optimism, both in the US and across the pond.
But, is inflation really dead, or have we been living off a false currency,
and spending coins that are not real?

Here are two articles that look at the conflict between markets and inflation, and we ask, are the paramters that
have given the UK the golden era of low unemployment and low inflation
changing? But in the long run is this inevitable, because we
have been living off a false hope and that actually the change is essential,
and to our ultimate benefit?

December 28, 2006 | posted by Michael Baxter in IABN | comments (0) |

2006 was a traumatic period for the dollar. In fact back in November, the dollar passed a milestone, falling to $1.30 to the euro, while as of this morning sterling was sitting at $1.96. With the US economy expected to slow while the eurozone at last starts to take up the slack left by Uncle Sam, throw in the economy behind The Great Wall and it’s no surprise the dollar has suffered. Capital Economics is predicting $1.4 to the euro soon, while the Sunday Times recently headlined on the front page of the business section “Pound set to hit $2.”

You can understand why the dollar is so precarious. Uncle’s Sam’s massive current account deficit, propagated by spending US consumers, was inevitably going to have an impact, and 2006 has been full of predictions of gloom for the currency. Warren Buffett, for example, said he planned to sell many of his US assets in favour of assets from overseas in anticipation of a falling dollar. But the question some have asked is this: If the greenback is dropping on the back of a poor balance of payments, why isn’t the pound falling too?

The answer is actually quite obvious, but lying within the whys and wherefores there is a mystery.

The UK may have a poor record in its balance of payments in recent years, but it is nowhere near as bad as the US, with the UK current account deficit in the region of two percent of GDP, compared to five or even six percent of GDP in the US. The mystery relates to why the UK deficit is not a good deal worse, because if you examine the facts, you would have thought the UK would have an even higher current account shortfall.

In recent years, the UK’s current account has benefited from a positive flow of investment income. We get more money in from investments than we fork out. This has helped to greatly reduce the overall deficit. Yet, and this is the puzzle, the value of investments abroad is actually lower than the value of investments held in the UK by overseas individuals and institutions. In short, we are making more money from less.

There is only one possible explanation for this strange phenomenon. It’s thought that foreigners are typically investing in UK bonds and other low risk forms of investments, perhaps encouraged by the UK’s relatively high rate of interest. With that low risk, yield is inevitably low too.

The UK, on the other hand, typically invests in equities and other more risky assets. And since it’s been an outstanding couple of years for equity investment, the economy has enjoyed much higher returns on its more modest investment. It’s as if Great Britain plc, or so the Bank of England has said, is like a bank or venture capitalist borrowing to invest in projects that earn a higher rate of return than the cost of funding.

But as any financial advisor would tell you, greater risk may mean that from time to time, you will enjoy a better reward, but sometimes the risk backfires. The same danger exists for the UK.

For 2007, the problem is this: 22 percent of the UK’s total overseas assets are invested
in the US. If the US economy slows next year, the way most expect, then the UK is likely to see a big fall in investment income, or so says Paul Dales from Capital Economics. He said that Capital Economics estimates that a US slowdown “could reduce the UK’s annual investment income surplus by anywhere up to 1.5% of GDP.” he added “This, in turn, could leave the sterling exchange rate looking fundamentally over-valued at current levels.”

Of course there’s another implied prediction in the Capital Economics theory: that as the US economy slows, then US equities will not perform as well as they have been. In other words, it is predicting, by inference, that US equities will have a bad year next year.

For further information

Dollar loses ground against euroBBC

Dollar Posts Longest Decline in Seven Months on Rate-Cut BetsBloomberg

December 22, 2006 | posted by Michael Baxter in IABN | comments (0) |

Six weeks ago, the Bank of England surprised no-one when it upped the rate of interest. Now, the question on economists’, borrowers’ and lenders’ lips (so that’s just about everyone) should be; what next?

Was the hike to 5 percent a temporary rise? One that is likely to be followed by sharp falls in 2007, or are we moving into an era when the rate of interest’s natural level is set to be higher? In recent weeks we have noticed a sharp change. Whereas, not so long ago, many believed rates would fall back next year, with Capital Economics, for example, predicting a return to 3.5 percent in 2007, now the thinking seems to be that inflation has to be nipped in the bud. And that central banks must raise rates, perhaps more than once, and keep them there until inflation is well and truly slain - and that, goes the argument, could take several years.

back in November, two quite different, and normally quite dovish, groups threw their pennies worth into the equation. The Royal Institute of Chartered Surveyors, a group that normally sees its members’ interests best served by having rates low, and the doves of the economic world - Capital Economics, seem to fly the nest, and become swooping hawks, urging the central banks to take a tough line.

RICS thinks we need to move fast, or otherwise things will get more serious. Its chief economist Milan Khatri said: “The recovery of the economy this year has exceeded all expectations, the stock market is at its highest level for over 5 years and there has yet to be any noticeable negative impact from the August interest rate rise on the economy or the housing market…The experience of late 2003 and 2004 shows that it takes several rounds of interest rate rises to take the heat out of the housing market when the economy is performing well”.

And Capital Economics applied economic theory to the problem as it warned: “Higher rates and weaker growth may bring little or no immediate reduction in inflation. Central banks need to be prepared to sit it out. Interest rates may need to be kept high for an extended period.”

Capital Economic’s esteemed top man, Roger Bootle, has been thinking about the Philips Curve. This is the idea, commonly accepted as truth before the stagflation of 1970s, that there was a trade off between inflation and unemployment. That to keep unemployment down, we need to tolerate a little inflation.

The theory was apparently blown apart, during that nasty period of economic history, the ’70s, when the world got both. Inflation went up and up, while unemployment rose too. That was known as stagflation.

Some explained the dismal performance of that era by saying it was because of factors beyond our control - such as the rising price of oil, that inflation rose, and that prices went up regardless of what the job market was doing. While from the world of academia, Edmund Phelps, who recently won a Nobel prize for his work, said that actually the relationship was not between inflation and unemployment at all, rather it was between inflation expectations and unemployment.

But the ’90s changed all that thinking. We had low inflation and low unemployment. It was a golden era, when the world’s top economies could have their cake and eat it at the same time.

Mr Bootle reckons he knows why. Globalisation, he says, made the Philips Curve flat. Thanks to trade, the world could grow, demand could soar, the jobs market could thrive, and yet inflation could stay in check.

But that’s all very well, argues Mr Bootle. But if we can have low unemployment without inflation setting in, equally we can have rising inflation, and rising unemployment. The two factors seem independent of each other.

In fact, continues the argument, what determines inflation is expectations, and our experience in the recent past. A one off shock leading to price rises, could reverberate around the economic system, leading to higher inflation expectations. Mr Bootle put it this way: “The result is that across a range of unemployment rates, the current inflation rate is determined, not by the current state of the economy, but rather by the inflation rate inherited from the past, plus the influence of current shocks and the change in inflation expectations. Those expectations will be heavily influenced by recent inflation experience, including the reaction to shocks.”

Mr Bootle is a clever man, and no doubt his argument contains a lot of truth in it. Nevertheless, we think he has underestimated the importance of technology and the Internet. Technology has made labour more productive and the Internet has broken the inflation habit. Retailers can no longer rely on our grudging acceptance of price rises, the net gives us too much information to allow for that.

The laws of economics are used to explain what’s happening around us. And every now and again, an older, formally discredited law, such as the Philips Curve gets dragged out of the economic cupboard. But surely, another law is just as important: Moore’s Law. The remarkable change in technology promoted extraordinary gains in communication and has facilitated globalisation, and has also enabled the emergence of the Internet, which exerts a constraint on inflation.

Until Moore’s law is allowed for within economic theory, any model that seeks to explain what is going on, is flawed.

December 21, 2006 | posted by Michael Baxter in IABN | comments (0) |

With the Chancellor shifting his borrowing target goal posts almost as often as Jose Mourinho is referred to the Football Association, one persistent economic enigma has been, and is, whether Gordon Brown will meet his fiscal rules or not. According to calculations from Centre of Business and Economics research, with the economy likely to slow next year, Mr Brown is likely to hand over to his successor an economy on course to breach both his fiscal rules.
CEBR expect that the ratio of net debt to gross domestic product will exceed 40 per cent in 2008-09 due to slower economic growth #151; breaching the second fiscal rule #151; while the Chancellor or his successor are also likely to break the first fiscal rule, the golden rule, by posting public sector deficits on current account in each year up to 2010. These are key findings from the CEBR’s winter release of its Quarterly Business Forecast.
One of the Chancellor’s problems is that the likes of Premiership footballers, city high-fliers and pop stars working partly in the UK are increasingly able to operate outside the UK tax net. High taxes in the UK and the easy availability of tax havens abroad mean that it is increasingly difficult to get high income earners to be based in the UK for tax purposes, so an increasing part of GDP is escaping the tax net. In addition, middle income earners are becoming increasingly averse to high rates of such taxes as VAT, income tax and stamp duty.

Another problem is that like the Bank of England (and no independent forecaster) the Treasury expects faster growth in 2007 than in 2006. This is a long shot. CEBR’s forecast is for economic growth to slow from 2.6 per cent in 2006 to 2.3 per cent 2007 and 2.0 per cent in 2008. Weaker growth in the United States, higher interest rates and low real earnings growth will cause a slowdown in consumer spending and business investment in the United Kingdom. The world slowdown will also reduce UK export growth in 2007, according to cebr, causing a deteriorating net trade position. All in all, this will also impact on fiscal revenues, with public sector net borrowing remaining high rather than falling by £4.5 billion as the Chancellor hopes. With public expenditure likely to remain high, public sector net debt and current borrowing are forecast to roughly remain at current levels in the next two financial years. As a result the ratio of net debt to gross domestic product is predicted to rise above the 40 per cent ceiling set by Gordon Brown in 2008-09 and the current budget will average a deficit this cycle.
On the monetary front consumer price inflation is set to retreat marginally below the Bank of England’s targets in the second quarter, according to CEBR’s forecasts. This will give some room for interest rates to end 2007 at 4.75 per cent. However this does not rule out a further rate rise in the first quarter of 2007, particularly if wage inflation rises in the January pay settlement round.
At the beginning of this year CEBR forecasted 2006 economic growth to average 2.6 per cent, suggesting that the Chancellor was, for once, too pessimistic about growth. That forecast now looks pretty well spot on. Yet despite the economic upswing, public finances have failed to improve, and with the expectation of slower economic growth in 2007, the outlook for public borrowing is not positive #151; even after ignoring the Chancellor’s projected investment spending spree.
On our CEBR, unless taxes rises are even more pronounced or expenditure growth sharply cut, the Chancellor will break his first fiscal rule this cycle and his second fiscal rule in 2008-09. All this is likely to mean larger tax collection efforts by Whitehall on the one hand, and less effort required by Monte Carlo and the Isle of Man on the other.

December 20, 2006 | posted by Michael Baxter in IABN | comments (0) |

This is the last issue of Investment and Business News this year. And we thought we would end the year with a look back at how things changed in 2007 with the economy.

In January, it was all very different. The UK was moving forward in a low gear, and was projected to grow at around 2.1 percent. Interest rate watchers were talking about the inevitability of rates falling from the then level of 4.5 percent, and many feared a slowing China would lead to an end to the years of rapid global economic growth.

In the third issue of the year, talk was that the Eurozone was set to outperform the UK, while the highly respected ITEM Club, from Ernst and Young, predicted an inflation rate of around 2 percent in 2006, and UK growth of 2.3 percent.

By March there was talk that inflation was edging up- but only by a tad. Bank Of England Monetary Policy member, Kate Barker, said: “The most likely outcome is for a slightly slower pace of UK growth in 2006 than the MPC’s February central projection. This all adds up to a finely-balanced judgment for interest rates.’
Then in April, as spring arrived, we wrote ” Many have been predicting a fall in the UK rate of interest at some point this year, although with every month, the predictions for this fall seem to go back a month”.
They proved prophetic words, for just a few weeks later, from his elevated position, the hawk looked down upon the poor unsuspecting doves, and prepared to swoop, ruffling a lot more than just feathers. The Bank of England governor, Mervyn King, said there was a 50-50 chance inflation would hit 3 percent this year, and said: “We are ready to take whatever action” is necessary to fight inflation.
From that point onwards it seemed to change. Inflation crept upwards, hitting 2.7 percent in November, the highest level ever recorded for the CPI index, while the Retail Price Index soared to 3.9 percent. Given that unions often base their wage demands on RPI data, and January is the month when many of the deals are agreed- many fear the recent rise in the RPI index, passing an eight year high, could spell something of a spiral in the months ahead.

As for the rate of interest, the doves were left clambering for shelter in their cote, as, instead of falling as most expected in January, it rose, not once, but twice, finishing the year at 5 percent. Many believe the New Year will see another rise, and perhaps a further hike will follow beyond that too.

But, good news#33; It wasn’t only inflation and growth that scored higher than expected. In fact, despite the predictions seen earlier in the year, the UK was enjoying a 2.7 percent growth rate by November, and rather than seeing our cousins across the channel leave us behind, as many expected, the UK pipped the Eurozone, which grew by 2.6 percent.

As for the US, it saw annualised growth drop o 2.2 percent in the third quarter.

So what about 2007? The crystal balls says - well you will have to wait until the New Year, when we will read the tea leaves and exercise all our powers of prescience to make our prediction.
Our first issue of 2007 will be winging its way to you on January 2. Then we will take another look back at 2006, recalling the winners and losers of the year; tell you what the experts are predicting for the markets; and look back at what was a surprising year for house prices.

Investment and Business News is a succinct, erudite and informative roundup of today’s top news stories on business and the economy, with analysis thrown in. It’s free, and to subscribe: visit this link

December 19, 2006 | posted by Michael Baxter in IABN | comments (0) |

Here we go again - it’s that time of the month, when the Royal Institute of Chartered Surveyors (RICS) publishes the results of its latest survey, when it asks members whether house prices are up or down.

It takes the difference between the percentage number of those who said house prices were up, and the percent of those who said they were down, and, after its team of analysts have made some swift shuffling with their abacus beads, announces the RICS index.

It’s a good barometer index - and seemed to signpost the 2004 and 2005 downturn, going negative several months before the likes of the Nationwide and Halifax reported falls in prices.

The index then went positive again in November last year, pre-empting the 2006 recovery. Ever since, the RICS index has climbed until it hit 47.7 in October, the highest level we have recorded since May 2004. Now the score for November is out- the index is down - but only by 0.3 percent to 47.4.
RICS spokesman, Jeremy Leaf, said: “Strong employment conditions and a robust economy continue to shield the market from any dip. A further interest-rate rise in the New Year may have a mid-term effect. We expect house prices to rise by 7 percent following a 9 percent jump in 2006.”

December 19, 2006 | posted by Michael Baxter in IABN | comments (0) |

Talking of comings and goings, it appears the poor old web designer and their like have seen his or her stock rise and fall with the markets. Back in the late ’90s, web expertise seemed to be the IT skill to have, but within a few short beats of the cruel economic heart beat, your Internet expert went from being the cat’s whiskers to the dog’s dinner.

But according to the Association of Technology Staffing Companies (ATSC), the web designer can come out and purr again. Yesterday, it published the results of a study showing web technicians have seen a 27 percent rise in their pay over the last year.

Who are these people we refer to? Well, ATSC has them as IT professionals skilled in key web technologies (Java, Enterprise JavaBeans, Microsoft .Net and BEA Weblogic Server). If that’s you, here is the quote you will want to read, cut out, and before sticking it on your wall, thrust in front of your employer.

Ann Swain, Chief Executive of ATSC said: “Web developers are back among the IT elite. The increase in online multimedia applications, such as podcasts, and the growth of advertising on next generation websites, is generating strong demand for their skills.”

“We are now facing a skills crisis similar to the late 90s. Back then it seemed every train carriage had at least one 20 year-old reading a Java manual, but the excitement is more muted now, and graduates are not flocking to learn web technologies in the numbers they once did.”

December 19, 2006 | posted by Michael Baxter in IABN | comments (0) |

So which way do you run? Do you go with the herd? Or do you go the other way? Going against markets can be a brave act, but in the long run, if you get the timing right, it can also be very profitable.

Take the recent rises and falls of the markets. The savvy investors bailed out in the late’90s, because the market tide in favour of investing was too strong. And then three or so years on, when all around there was miserable selling, the same investor jumped back in. It’s easier said than done, of course, but then again back in 2003, you didn’t need to be a genius, or expert in market movements, to work out that a good buying opportunity was emerging

Pity the big insurers- the likes of Standard Life, for example. No doubt run by extremely smart fund managers, who could see the writing on the wall, and sniff a buying opportunity within a mile. Their problem was that they weren’t allowed to buy when, no doubt, they wanted to.

The FSA’s rules on solvency meant that when equities fell earlier this decade, insurers were forced to swap equities for cash - giving rise to a selling frenzy, which perhaps prolonged the length of the bear market. Yet, if these big investors had been allowed to stay put, no doubt, they would be counting a lot more bucks right now- and perhaps, by avoiding the losses FSA rules enforced upon them, they would be flush with money today - and markets would be even higher. Maybe the FSA is a potential explanation for why the FTSE 100 has failed to pass its all time high, when the Dow did this with such aplomb recently.

But while all around the herd and regulator said sell, BT stayed where it was.

It faced a potentially crippling pension deficit - but did it cower with the rest- and run for cash? It did not. On the face of it, this fortitude for equity investment didn’t help much, but scratch beneath the surface, and it was a very smart decision.

In fact the pension deficit has risen at BT; it’s now standing at a superficially alarming £3.4 billion. That compares with a deficit of £2.1 billion in 2002. But here’s the good news. There have been changes in the way the deficit has been calculated, making more cautious assumptions on returns, and allowing greater longevity for workers. Back in 2002, BT had expected the members of its pension scheme to last until they were 83.8, now it reckons its average retiree won’t draw his last breath until he is 85.4.

Apparently, BT reckons that if it had calculated the pension deficit under the previous methodology, it would be in credit now.

Some analysts reckon that if BT had changed tactics and went from equities to bonds, like so many others- then the company itself may have been drawing its last breath today, - and the crown guarantee, which means the government protects BT’s pensioners, would have had to come into force.

Moving forward, BT plans to pump £280 million into the scheme each year, making three payments in 2007, and now reckons it will have the deficit licked in no time at all.