You will recall that the Bank of England has seen its ranks split. The minutes from the last meeting of its interest rate setting MPC committee revealed two schools of thought.

On one hand are the doves who think inflation pressures are relatively under control. They point to the fact that with many one off price hikes about to fall out of the annual figures, inflation will retreat over the next few months. They then add to their positive arguments by saying wage inflation is still very muted.

But the pessimists, who count amongst their number the boss Mervyn King, also have one of the two deputies, John Gieve.

And yesterday, it was Mr Gieve’s turn to throw in his tuppence.

For the Bank’s deputy hawk, it comes down to risk. There’s risk that if rates rise too high, the economy will slow more than is necessary. But equally, if rates are not pushed up high enough, inflation could rise too much.

Right now, Mr Gieve sees the first of these two possibilities as being the biggest danger.

Yesterday he explained why he voted for a rate hike earlier this month. He said “I felt that the impact of moving to slowly on the credibility of the regime (sic) and thus the future prospects for the economy was of greater concern, given the robust rate of growth, than an unnecessary slowdown in activity.”

Continuing with his hawk theme, he added that he was “not convinced that current rates would be sufficient to bring credit growth and nominal demand back to their long-term sustainable path.”

Find out about the next instalment of “Threadneedle Street,” the tale of hawks and doves next week, when the MPC meets again.

Talking of the global economy, the IMF has been making its latest pronouncements. It’s difficult to know whether to celebrate or commiserate. Maybe it’s best to compromise. Keep the Bolly in the fridge, and crack open the Cava instead.

“Global growth is stronger than we had expected in April” said Simon Johnson, the IMF’s economic counsellor yesterday.”

Recently the IMF predicted global economic growth of 4.9 per cent this year and next, and although it is not due to make further predictions until October, it seems likely it will up the estimate.

But, alas, Mr Johnson also said, “Inflationary pressures are definitely building up.”

In a way, those comments say it all. Yes, the economy is booming, but NICE is over. We can no longer look forward to non-inflationary consistently expansionary growth, but then again we have not reached corrections, recession and paybacks either.

Here’s an idea. Set up an investment vehicle, funded to the tune of say £150,000. It could just as easily be £150 million, but let’s stick with our initial assumption, for the time being. Then assume two thirds of this backing is in the form of debt, with a third provided by shareholders. Now assume the stocks, or indeed property, into which this vehicle invests, grows in value by around 50 per cent. What a coup; what savvy investors. The investment vehicle is now worth £225,000, debts are still 100,000, meaning shareholders have seen the value of their investment soar from £50,000 to £125,000.

Now assume investors repeat that trick. They take that £125,000 and re-invest it into a new vehicle, again matched two to one by debt. Assume this vehicle also rises by 50 per cent. Lo and behold, that initial £50,000 is now worth £312,500. Such is the magic of leveraged investment; such is the stuff modern days wealth is often made of.

But pause for a moment. The analogy above was not made up to describe a property buy to let investment approach. Not yet was it produced to describe a hedge fund, or even a private equity backed venture.

No the above example was taken from a book written by John Kenneth Galbraith entitled “The Great Crash 1929.” Mr Galbraith, one of the top economists of the last century described this form of leveraged financing as madness on a heroic scale.

Now, don’t get too depressed. Don’t make for the nearest tall building and prepare to jump. We are not saying it is exactly like that now, we are merely saying there are similarities.

The last few weeks has seen the unravelling of the two Bear Stearns hedge funds caught up in the US sub-prime woe. Many fear that the fallout has only just began, and many more casualties will follow, especially since the US property market is showing no signs of moving out of reverse gear.

But the last few days has seen the emergence of new types of scare stories. This morning, the CNNMoney site headlined “Debt markets: Big threat to the buyout boom.” The article described massive corporate bond sales that are about to hit Wall St.

Kohlberg Kravis Roberts Co are currently seeking to raise $8bn through the sale of bonds to fund their purchase of processing company First Data. TPG (formerly known as Texas Pacific Group) and Goldman Sachs are planning a $7.7bn bond sale to fund their purchase of US wireless operators Alltel. In its article CNNMoney raised the spectre that some of these deals just might not get funded. Incidently, you may be interested to hear Mr Galbraith ironically titled one of the chapters in his seminal book, “In Goldman, Sachs we trust.”

But, this is not the only article to see have seen light of day over the last week that should make your hair stand on end.

Monday’s Telegraph saw the headline “Credit spree could trigger repeat of Great Depression.” The article was focusing on a warning given by the Bank for International Settlements, the world’s lender of last resort. The bank recently put out a statement saying “virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and South-East Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived.”

Finally, to complete the picture of woe, private equity’s IPOs have proven something of a damp squib. The Blackstone IPO saw shares soar on the first two days, but at close of play yesterday the share price was back down to the IPO price. Shares in the private equity group Fortress Investment Group, which was IPOed earlier this year, are also down.

Are we saying it’s going to be like 1929 all over again? No. With the global economy growing so rapidly, with the massive influx of capacity from China and India and, hopefully, with the massive influx of consumers from these two economies to follow down the line, there are plenty of reasons to assume the global economy will continue to boom.

But, always be aware of the downside. The last few years have seen a nasty disease catch hold. Leveraged investment, be it in property or equity, is dangerous.

Curiously though, private equity is perhaps less vulnerable. Private equity might raise its funding from a easy and over-optimistic supply of cash, but it fundamentally relies on the businesses it buys doing well. Managers of these private equity owned businesses might be well paid, but they are only well paid if the firm they head hits sales and profit targets.

Private equity could just create a level of efficiency that has never been seen before. But, expect tears along the way, and don’t be surprised if the tears burst their banks and we see corporate flooding to match that recently seen in South Yorkshire.

If there is one respect in which economists seem united in praising Gordon Brown, it’s in his decision to make the Bank of England independent. At last, the rate of interest was set to fight inflation, not to deal with short-term political concerns.

But, supposing rates continue their march north? Many economists expect rates to hit 6 per cent, and some are now predicting they will go even higher. Just as he prepares to change jobs, Mr Brown must be sweating a bit.
But, the trouble is that the Bank of England seems split. Some, including Mervyn King, the bank’s governor, worry about the rising money supply, and signs that manufacturers and now even retailers are upping prices.
Others take a more relaxed approach, and point to the fact that the CPI index is set to fall over the next few months, and how wage inflation has stayed muted.
We saw the result of these two views earlier this month when four members of the bank’s monetary policy committee voted to increase the rate of interest, while five voted to keep it on hold.
It was the second time Mervyn King was outvoted, the previous occasion being August 2005 when the bank’s committee went against him and voted to lower rates - a move that, with the benefit of hindsight, appears to have been wrong.
Some say that Mevyn deliberately voted against the majority, in order to reduce expectations of inflation and perhaps to encourage the recent fall in long-term rates.
The argument goes like this. If the market rate of interest moves upwards, and we see a bigger gap between long-term rates and the official bank rate, then the Bank of England may not need to increase rates. So simply by creating the impression that rates may go up, it might not be necessary to increase them.
But not all subscribe to this rather subtle view of rate setting. Others think that what we saw earlier this month was quite simply a divergence in opinions. In which case, they argue, maybe Mr King’s position as governor could be vulnerable. He is due for re-appointment in 12 months’ time. And right now, there is just a whiff of conjecture, that if Mr King continues to lead the bank towards an upward rate of interest, while some members continue to disagree, his re-appointment might not be quite so certain as it would have been.

The latest report from the Association of Realtors was out yesterday. In May the median price of an existing home fell to $233,700 - that’s down 2.1 per cent from a year earlier, but up 1.8 per cent from the previous month.
But signs are that things are set to get worse. Just 5.99 million homes were sold in May, which is the slowest pace of existing home sales since June 2003. The Association of Realtors reckons there’s now 8-9 months supply of homes on the market - and you would need to rewind records back to 1992 to find the last time the supply was so high.
Lawrence Yun, the Realtors’ senior economist, said: “The market is underperforming when you consider positive fundamentals such as the strength in job creation, economic growth, favourable mortgage interest rates and flat home prices. It appears some buyers are simply waiting for more signs of stability before they get serious about getting into the market.”
Mind you, it is worth seeing the US market in the context of the UK market. The median price of a home in the US may be $233,700, but according to the Nationwide the mean average price of a home in the UK is £181,584. Given that we saw the sterling dollar exchange rate return to $2 a to the pound yesterday, that equates to $363,000. Or, to put it another way, in sterling the median price of a US home is just £116,000. So you can see why many think the UK faces a much bigger danger of a crash in house prices than Uncle Sam. For feedback and comment contact

If the UK lags behind its main economic competitors in terms of productivity, then maybe we need to look towards our education system as providing the long-term solution.

In addition to publishing a report on the UK’s productivity gap, the Centre for Economic Performance at the London School of Economics has also just published a report which asks the question: “Has Labour delivered on the policy proprieties of ‘education, education and education’?

One thing is for sure, we are spending more money on this area than before. In 1987/88, 4.9 per cent of our GDP was spent on education and training, but by 2005/06 it was 5.6 per cent, which is close to the OECD average. Between 1997 and 2007 the number of full time teachers increased by 9 per cent, and class sizes have fallen, with 88 per cent of classes today having less than 30 pupils, compared with 72 per cent in 1997.

Even so, there is still as stark contract with private schools, where teachers have half the number of pupils in a class.

The big question though, is whether this extra spending on education has impacted on results.

The LSE report says that attainment at school has improved in recent years. But there are concerns about the extent to which this reflects ‘teaching to the test’ and why, despite impressive improvements in primary school attainment in the late 1990s, this has subsequently stalled. There is, however, some evidence that the National Literacy and Numeracy Strategies have successfully increased standards, especially for boys.

It does seem that many of the ideas for improving education have had a debatable impact.

Of course, two of the government’s watch words for improving education have been choice and competition. The snag here is that for many, choice really is limited. As the Centre for Economic Performance said: “State schools discriminate on the basis of residence.” The report also cited evidence that competition has had little impact. It said findings suggest that simply offering parents a wider choice of schools and forcing schools to compete does not seem to be a remedy for poor standards in education; such a policy might also exacerbate inequalities.

To us though, it seems the issue is this. It takes time for changes to have impact. Too many changes, and the impact many never be felt. Maybe what education needs is consistency.

We said above, that the UK’s productivity per hour is 20 per cent lower than in France, and 18 per cent lower than in the US. In other words, if our productivity was comparable to the level in the US, the UK would be 18 per cent better off per capita.

Improved education may only be a part of the solution to our low productivity, but it’s a big part. Given the huge improvements in productivity that could be achieved, it could be argued that spending 5.6 per cent of our GDP on education is still far too low. After all, if we were to double our expenditure, and we then halved the productivity gap with the US we would be quids in.

The snag is the relationship between spending on education and GDP growth only exists in the long term. Governments are rarely, if ever, in office long enough to see the results of that spending on education filter through to the economy.

But, even so, unless we are to rely more and more on immigration, the UK needs better education. It always will. What we spend will never be enough, but it seems to us, we could justify spending a lot more than we do, even if this does cause a budget deficit for the next decade and a half, or longer.

But perhaps we need to see an end to change for change’s sake. The struggle to eke out ever-greater efficiencies, could be costing us more money, though never letting education settle down.

Sometimes economics can overcomplicate things. We can talk about the importance of this, and the significance of that, but if you really want to determine how well an economy is performing, perhaps there is no better measure than to look at how productive we are.

And the UK economy, despite drawing praise from the likes of the IMF and OECD on innumerable occasions over the last few years, despite enjoying the longest run of economic growth ever, still suffers from one potentially crippling problem.
To put it bluntly we are not very productive. In fact, for every hour worked Germany produces 13 per cent more than us, the US produces 18 per cent more, and France a staggering 20 per cent more.
According to the Centre for Economic Performance at the London School of Economics, if we could match France’s productivity we could either work one less day a week without being any worse off, or alternatively, we could enjoy 20 per cent higher earnings.
It’s not a new problem either. The UK’s failure to produce as much per hour as our competitors has long been a millstone around our economic necks.
Back in the 1970s and even before that, it was not difficult to explain. We could blame unions, poor management, and over-rigid structure to the economy, but in the post Thatcher age, it’s not so easy to look for reasons.
And give both the current, and previous, government some credit; apparently our productivity per hour relative to our main economic competitors has been improving since the early 1990s.

One of the reasons why productivity in France is so high, is because labour laws are so tough there, that employers need a better reason to recruit than in the UK. If you like, French employers require a higher marginal productivity of labour in order to justify recruitment. Unemployment is therefore much higher, but productivity amongst those who are working is much greater.
But it would be stretching credibility to suggest this factor alone explains why French productivity is greater than in the UK, and it certainly does not explain the 18 per cent differential with the US.
What then is the explanation? LSE’s Centre for Economic Performance has several explanations.
Explanation number one is the relative low level of RD spending in the UK. Not only does our RD spending lag behind that of our rivals, it has been getting worse. In 2004, the UK spent just 1.1 per cent of GDP on business RD activities, compared with an average of 1.7 per cent for France, Germany and the United States, and a UK level of 1.81 per cent in 1981.

The UK also seems to lack skilled workers. According to the Leitch report, the UK’s skills base remains mediocre by international standards. Seven million adults lack functional numeracy, while five million lack functional literacy. Recent OECD figures suggest that the proportion of low-skilled people in the UK is three times higher than in the United States, and almost double the proportions in Germany and Japan. This is reflected in a significantly lower proportion of intermediate skills.

Then, there’s management. The LSE report cites research from Bloom and Van Reenen that found that UK firms are significantly worse managed than French, German and US firms. After taking into account differences in industry and firm size, they link this to the preponderance of family firms - an ownership structure that is encouraged by the UK’s inheritance tax system.

And here’s a finding to make you sit up. Research from Bloom, Sadun and Van Reenen found that US multinationals operating in the UK have much higher productivity than other multinationals in the UK. They explain this differential by suggesting US managed companies make better use of IT.

Then there’s regulation in the retail sector. Every time Tesco or one of the other larger retailers opens a new store, we read about the effect on local stores, about corner shops going out of business, about suppliers being squeezed. But the LSE report said: “Productivity growth in UK retail between 1995 and 2004 was considerably slower than in the United States. Some attribute the US surge …to the introduction of large retail formats (‘big boxes’), which are more efficient than small stores.” According to this interpretation, lower retail productivity growth in the UK could be linked to increasingly severe planning restrictions against large stores.

So much for the reasons, what can be done about it?

It seems that in at least one area there is good news, but we just have to be patient. The UK now has a series of tax incentives for RD. There is apparently plenty of evidence to suggest this will have a positive impact on RD in the long-run, but that it can take a long time, and it is simply too early for the RD tax credit to have made much impact yet.

As for our problem for low skilled workers, clearly the answer lies with education. See article below.

As for poor management, maybe private equity will have a big impact here. In all the criticism we continuously hear about private equity, about how it asset strips and how it borrows against a company’s own assets in order to fund buying that company, it is worth remembering private equity’s overriding concern is to make the businesses it owns more efficient. This is an objective that is compatible with solving the UK’s chronic productivity problems.

Finally, it does seem the UK is often hamstrung by over-regulation, especially in planning.

Retailers often struggle to get permission to build new, bigger stores. Renewable energy development, especially the construction of wind farms, is often held back by local pressure groups trying to block planning permission. We see the same problem in the housing market of course, where construction lags behind demand, causing house prices to soar and all the problems associated with that.

The solutions are manifold, but we would like to leave you with two thoughts.

While the UK lags behind our competitors in terms of productivity, in the city it’s the opposite, with productivity leading the world.

Maybe, a part of the UK’s problem lies in the property market. The enthusiasm with which we embrace property investment, which is, after all, an asset that contributes very little to GDP, contrasts with our lack of enthusiasm for investing in areas that do promote production. Maybe the ultimate solution lies with shifting the UK’s focus on house prices.

When something is a success, it is tempting to ask was it skill or luck?The UK economy is still enjoying its longest run of uninterrupted economic growth ever recorded- and since records go back to the time the UK was an agrarian economy, which depended on the harvest, it’s a reasonable bet to say it’s the best run of economic growth ever (let’s face it, no one can prove us wrong).

But, was it down to clever old Tony and Gordon, or was it down to factors beyond their control? More to the point, was it down to globalisation?

Jeremy Tigue, manager of the legendary Foreign Colonial Investment Trust, has been asking that very question, but specifically to the markets.

Tigue said the “decision at the outset of his Government to give the Bank of England independence to set interest rates was an enlightened one that has given the economy more flexibility and instilled more confidence in investors. Likewise, the development of AIM with attractive tax perks and, ironically given the current controversy over the earnings of private equity professionals, the introduction of accelerated tapering relief on private companies also provided a fillip to investment markets.”

But for Tigue, the real hero was Margaret Thatcher. He says “the changes brought in by Thatcher’s government shaped the UK investment market to make it the success it is today.”

“Perhaps the most significant of these was privatisation which started with British Telecom in 1984 and extended to many other companies including British Airways, BAA and British Gas to name a few. This move was completely unexpected but served to force companies to become more efficient. It was also accompanied by a massive marketing drive to encourage the UK public to invest in stocks and shares, with innovative techniques used to draw-in the uninitiated, such as partly-paid shares, which enabled investors to pay for their shares in instalments but still benefit from 100% of the upside. Many people for whom share buying had been an alien concept, suddenly piled into these companies and within a matter of a few months the number of UK shareholders tripled, driving up the stock markets. Investment trust savings schemes were able to take advantage of this new environment and ride the new wave of demand,” said Tigue.

Tigue also points to the convergence of the roles of stock brokers, who bought shares from jobbers, and jobbers themselves, who physically traded shares on the trading floor. Commonly referred to as the Big Bang, this brought down the high commission rates which were previously commanded by the two roles and boosted liquidity in markets with more share trading taking place.

“By doing away with the old culture, the markets became much more efficient. It also marked the start of a new yuppy culture which saw younger people advancing up the promotions ladder more quickly as the older generation took early retirement. Another significant change which took place but is not oft-talked about was the abolition of currency exchange controls, which freed up a large proportion of the international market for UK investors. Yet perversely, those who remained in the UK have actually been better off, as the UK stock market took off making it one of the best performers in the world between 1979 and the present day,” added Tigue.
“The Thatcher years laid the key foundations for the Blair years, opening up the UK and reducing the influence of Government in matters best left to markets. Mr. Brown, in turn, inherits a rich legacy with London regarded as the world’s premier global financial centre and a source of enormous wealth creation. As he mulls the populist demands to clamp down on the wealth inequalities that inevitably have followed this, he should not forgot the risks that could accompany hasty interventionism.”

Yesterday, the Observer reported an analysis showing that the yield enjoyed by new buy-to-let investors on an average property is now lower than the return on putting money in the bank. Then, this morning, the Independent reported on findings from the Liberal Democrats that the average Brit now spends more of his or her income on servicing debt than at any other time during the last ten years.

First here’s the news for buy-to-let investors. Apparently, the HSBC has found the rental yield on an average property is lower than the return on cash usually enjoyed in ISA savings products. What is more, the analysis was produced before the May hike in the rate of interest. What with another rise in rates expected soon, it would appear the differential between yield on cash, and yield on property, is set to get even bigger.

HSBC also pointed out that the yield to buy-to-let investors also has to cover the cost of property maintenance.

The property industry insists the market is due for a slow-down, maybe a mild correction, but talk of a crash remains taboo.

And yet, if most would-be first-time buyers are finding it all but impossible to jump into the property market, if buy-to-let investors are finding it more profitable to put their money in the bank, one has to ask where new blood is to come from?

You know that when you buy and sell a property you are also reliant not only on the person buying your home, but the person buying their home. The shorter the chain behind you the better. It’s much easier to sell to a new entrant into the market.

It’s therefore difficult then to see where future growth is going to come from, unless we rely solely on wealthy immigrants.

And that brings us to debt. Vince Cable, the Liberal Democrats’ shadow Chancellor, has calculated that the typical household now has to spend 9 per cent of its income on interest payments for debt, compared to just 7.5 per cent in 1997.

Interest costs have risen from 7.5 per cent of household income in 1997 to 9 per cent today.
But a more worrying stat is this. Apparently, the average family now has debt equating to 164 per cent of their income. That’s the highest ratio in the developed world and the highest ratio ever seen in the UK.
We have argued before, that of late the UK seems to have caught a nasty disease; it’s called ‘forget about the size of debt and just worry about the interest.’ Many in the UK, including economists, seem to have lost sight of the fact that debt has to be repaid, eventually.

Talking of protecting domestic businesses, can you imagine the furore if the London Stock Exchange (LSE) was in fact the French Stock Exchange, and it was the corporate symbol of all that is successful about the French economy?

The French government was unhappy enough about the merger between Euronext and the New York Stock Exchange. It lost the battle, but Euronext is a hotchpotch of exchanges scattered across Europe. The LSE on the other hand is the trading platform that sits at the core of the City. It is crucial to the success of the UK’s most important asset - the city of London.

And yet for much of last year the LSE found itself having to shake off the advances from a queue of suitors. One of those would-be purchasers, the NASDAQ, still owns a ring, sitting on the LSE’s fourth finger. For NASDAQ owns 30 per cent of the LSE. Its stake provides a constant reminder of how close the LSE is to becoming an offshoot of the US Stock Exchange. But, throughout it all, the British government has kept quiet.

Its boss, Clara Furse, has fought her way to keeping the LSE independent. But many felt she was living on borrowed time, that sooner or later she would lose the fight.

But now the LSE has gone a step closer to securing its independent future. It has made an offer for Borsa Italiana, which has been accepted.

The Milan-based stock exchange has itself been on the receiving end of advances. Last November it seemed as if it was about to be swallowed up by Deutsche Borse, but the merger was called off at the last minute.

In all, the LSE will be forking out euro;1.6 billion for Borsa Italiana, and once the two are combined the company will boast a board of 12, with seven members from the LSE and the rest from the Italian side.

The LSE needs 50 per cent of its shareholders to approve the deal, so NASDAQ would have to team up with other shareholders to stop the merger.

But once complete, NASDAQ will find it self with a smaller shareholding in the company, less influence, and maybe the London/Milan combo will create a power that is too big for NASDAQ and other hopefuls to mount a credible offer in the near future.