June 25, 2007 | posted by Michael Baxter in IABN | comments (0) |

Nicholas Sarkozy has been hailed as France’s answer to Margaret Thatcher. He is described as an admirer of the British economic system, a man who wants to reform France’s stifling labour regulations, and yet the French equivalent of Mrs T seems to be bent on implementing policies Harold Wilson would have been proud of.

If France is set to join Germany on the road to recovery, then she has got to do a lot better.

Last week saw just the latest in a long line of examples. Maybe the problem was that Tony Blair had run out of felt tip pens. He had so many red lines scribbled on his papers, that when the French proposed a change that was about as blatant a foul as the one its best football player performed in his last ever game of the last match of the last World Cup, it was as if Mr Blair didn’t seem to have enough ink to quickly colour in a red card to show his French counterpart.

And so the French managed to get the words “free and undistorted competition” dropped from the preamble of the new proposed EU treaty. Does it matter? The British seem to think that the removal of the words will make little difference, and EU Competition Commissioner Neelie Kroes said “The (European) Commission will continue to enforce Europe’s competition rules firmly and fairly: to bust cartels and monopolies, to vet mergers, to control state subsidies.”

But, whatever the legal implication of the French move, one thing is clear. By French standards, Nicholas Sarkozy may be thought of as a free marketeer, but he is about as likely to adopt Thatcherite policies as his countrymen are likely to embrace English food.

Last week, Mr Sarkozy showed his hand when he said “Competition as ideology, as a dogma, what has it provided for Europe? Fewer and fewer people who vote in European elections and fewer and fewer who believed in Europe…I believe in competition, I believe in the market, but I believe in competition as a way, not an end in itself. ” Even more tellingly he said “The word ‘protection’ is no longer taboo.”

Last month Mr Sarkozy accused the European Central Bank (ECB) of “fighting inflation that doesn’t exist,” and said it had been increasing the rate of interest when it wasn’t necessary. He implied the ECB should put on a kinder face, to be less pre-occupied with inflation, and willing to lower interest rates, thus boosting employment, even if that meant slightly higher inflation. In other words he was recommending the economic polices of the 1970s. Back then we believed there was a trade off between inflation and unemployment, a relationship known as the Philips Curve. Economic thinking of the ’80s rejected the Philips Curve, suggesting that trade off between inflation and unemployment only existed in the short-term.

But, the truth is, Mr Sarkozy’s move to scrap the “free and undistorted competition” bit from the constitution’s preamble should come as no surprise.

Four years ago he was the French minister who was behind the French government’s decision to bail out its engineering giant Alstom.

One of Sarkozy’s first acts as president was to meet up with unions at Airbus. He was keen to discuss ideas for an alternative to job losses at the firm. He was not necessarily wrong to do this, but it wasn’t very Anglo Saxon. You can’t imagine Mrs T, or even Tony Blair for that matter, making it their first task to get unions on side.

For years, while the UK has allowed its big companies to be sold abroad, the French have apparently built a latter day business Maginot line, in an attempt to keep French business, French.

But, like the original Maginot line, it doesn’t always work. The merger of Mittal Steel and Arcelor went ahead, despite French resistance.

But maybe the real danger to France lies in the possibility business will find a way around the back of this new line. Perhaps the ones to find this route will be private equity.

The French economy has one big thing going for it. Among all the big economies of the EU it has less of a long-term demographic time bomb. Its birth rate is higher than in most other large EU countries. It may never face a time when its working population is smaller than its retired populace.

Quite ironic, when you think about it. It insists on protecting its indigenous business, and arguably the result is an economy that has lost its way.

But in another respect, its attitude to another form of protection appears less enthusiastic, and its population is set to carry on growing, and as a result, its longer term economic prognosis is set fair.

June 22, 2007 | posted by Michael Baxter in IABN | comments (0) |

It will come as little surprise to learn that interest-only mortgages are becoming more popular, while repayment mortgages are declining.

According to a report published by Paragon Mortgages yesterday, the proportion of mortgage broker business made up of interest-only mortgages has risen from 11 per cent to 26 per cent over the last four years.

Paragon says repayment mortgages appear to have declined in popularity. Their market share has fallen from over 70 per cent in 2003, to 58 per cent now.

John Heron, managing director of Paragon Mortgages, explained: “Repayment mortgages remain the mortgage of choice for owner occupiers. The interest-only sector has grown both with house prices and buy-to-let. Interest-only mortgages are ideal for buy-to-let investors who benefit by maintaining gearing and at the end of the term, have the choice to either re-finance or sell the investment property to pay back the loan.”

It does seem to us that this move away from repayment mortgages is very dangerous. Geared investment, is by its very nature risky. But in the buy-to-let market gearing has reached a level of terrifying proportions. That’s fine as long as prices are going up, and yield from property covers interest on mortgages.

But if things change - and we have argued many times here that they may well change - then all those highly geared investments will look about as foolish as the highly geared investments that permeated financial circles before the 1929 crash.

June 22, 2007 | posted by Michael Baxter in IABN | comments (0) |

Just for once, it appears economics has failed to live up to its mantle as the gloomy science. Yesterday the CBI revealed a rare combination. Strength is returning to manufacturers, and price pressure from the sector is falling too.

Every month, the CBI asks its members from the manufacturing fraternity a series of questions. For example: are orders up or down on last year, do you expect the prices you charge over the next three months to go up or down?

Of late, there has been good news and bad. The good news is that the CBI index, which tracks whether orders are up or down, has been showing improvements. In fact, back in March the difference between manufacturers who said orders were up on last year, and those who said they were down, hit plus 8, and that was the highest score in 12 years.

But while orders were rising, so too were the prices manufacturers were charging. In fact, the CBI price expectation index hit a score of 21 in March, which was also a 12-year high.

With manufacturers expecting to up their prices, one would expect to see a rise in consumer inflation down the line.

But others argued that maybe what we were seeing was just temporary. For two years prior to the price index rising, manufacturers had been paying out more and more for products they were buying in, but they were not passing these costs on. But lately, manufacturers’ input price inflation has been falling.

Maybe all we have been seeing is a delayed reaction. Manufacturers have been playing catch up, passing on all those extra input costs they were paying for in 2005 and early 2006. But once they have caught up, or so goes the argument, maybe manufacturers will lower the rate at which they increase prices.

It’s an important point, because the final outcome could determine the future level of inflation, and rate of interest.

Yesterday the CBI had good news, twice over.

Firstly, the index for tracking order books against last year hit plus 8 again in June. That’s the highest level since March, and the joint highest level in 12 years.

Secondly, the price expectation index fell to 16. That’s the lowest level this year.

But, of course, two swallows don’t make a summer. A score of 16 for the price expectation index is still quite high. Next month will give a better indication of whether we are seeing a new and positive trend, or whether June’s good news was a one off.

June 22, 2007 | posted by Michael Baxter in IABN | comments (0) |

And while the Standard was busy telling us how little tax the super rich pay, the FT broke a story revealing how the gap between the very rich and the average is getting wider.

According to the pink-un, which has been busy analysing data from the Office of National Statistics, the gap between the top 0.1 per cent of the UK population and Mr and Mrs Average is now at the highest level since the 1930s.

The FT report said that, as recently as 2003-2004, 19,000 individuals in the UK were earning in excess of £500,000 a year. But, says the paper, “HM Revenues and Customs estimates show that this has shot up to 30,000 this financial year.”

Understand, there is no talk that these people are avoiding tax. Their earnings are boosting the exchequer’s revenue. Given this, you may say: does it matter?

Does it matter if the richer are getting richer relative to the poor, if the poor, or even the average, are getting richer in absolute terms?

One danger, of course, is that resentment will grow. But there is another problem.

The uneven distribution of wealth, we suspect, is one factor that is pushing up house prices. Maybe, in time, it will push up prices of luxury goods too. If the poor, or average, find they are not able to afford property or luxury goods like they used to, it could be argued that the growth in the number of members of the rich club is making others worse off.

But, setting aside these arguments about luxury goods and property inflation, it is possible to have a scenario when GDP per capita is growing, but the average person is getting poorer.

Maybe, in some forms of economics analysis, we need to start putting more emphasis on median, rather than the mean average.

You will recall, the median takes a series of numbers, puts them in order, and the mid point is the median. The mean just takes all the numbers, adds them up, and divides by the sample size.

If we were to start examining GDP per median capita, and judge economic success by this measure, then maybe we would find we are not doing quite as well as we thought.

June 22, 2007 | posted by Michael Baxter in IABN | comments (0) |

Do you remember all that furore over flat taxation a couple of years back? Flat taxation, just in case you need reminding, is this idea that we all pay one flat rate of tax - the same percentage rate for everyone, regardless of income. It has many advantages: it’s simple, it encourages the work ethic, but it has one big drawback - it’s not fair.

Progressive taxation, that’s to say when the ratio between tax and income rises the more you earn, is deeply enshrined into British thinking.

And yet, according to a report in yesterday’s Evening Standard, only 65 people who filed a tax return in 2004/2005 declared a taxable income of £10 million or more. But, according to the Sunday Times rich list, the UK boasts 350 people on £10 million or more a year. The inference is clear - the more you earn, the more you can afford to be clever with your accounting, and the cleverer you can be at legal tax avoidance.

The Standard report was really focusing on individuals who claim non-domicile tax status, in which they don’t pay tax on overseas earnings, and people who live less than 90 days a year in the UK.

But, of late, another tax break has been enjoying centre stage. Taper relief on capital gains tax means that tax can be reduced to just 10 per cent of capital gains enjoyed from some types of assets, providing the assets are held for two years or more. The trouble is that many in the private equity business are remunerated in the form of capital gains, rather than income, so they’re benefiting from taper relief.

Many, including MPs on the Treasury Select Committee currently looking at private equity, are scratching their heads right now. They can’t quite see how the ladies and gentleman working in private equity can justify paying just 10 per cent tax.

At a time when unions take every opportunity they can manage to have a swipe at private equity, any hint that these people the unions love to hate are paying less than their fair dues in tax, is bound to raise hackles.

The trouble is several fold. For one thing, the rationale behind taper relief was devised with good intentions. It was designed to encourage an entrepreneurial spirit. Entrepreneurs, who are prepared to take risks, are the life-blood of future economic success.

It’s just that private equity and its older but less well off twin - venture capital, really come in two guises. When it boosts business, perhaps enables new business to get off the ground or turns around firms that were struggling, it is good for the UK. And it needs to be encouraged.

But, when it’s just a form of asset stripping, it’s not so good.

But how you differentiate between the two? It’s nigh on impossible.

There is another problem. While many argue for the abolition of capital gains tax, so that higher earners pay 40 per cent tax regardless of how their money was earned, capital gains tax in other countries is much lower.

In the US, capital gains tax on assets held over the longer term is 15 per cent - although it’s quite a complex system - and by 2011 the tax rate is scheduled to be 20 per cent in most cases.

The danger is that if the UK were to abolish taper relief we would lose our competitive edge. We may feel it’s wrong for the super rich to pay less tax, but if our rivals accept this system, we may have to go against our principles.

But, here is some news to surprise you.

In the US, private equity is also coming under ever closer scrutiny. And now there’s just a whiff that US senators are looking to change the way their equivalent of taper relief is applied stateside.

However, taper relief is not the only way the chancellor can play with taxation to encourage risk taking.

Risk takers who forego salary in order to promote their business should be rewarded. If their earnings are modest in one year, then in other years when they earn more, perhaps their tax bill should be reduced. This could be achieved by upping personal allowances on capital gains or even allowing income tax personal allowances to be carried forward.

That way risk takers will be able to mitigate against risk, by enjoying tax breaks on modest gains.

But any system that enables the super rich to pay less tax, any system that takes from the poor and gives to the rich, would not only have Robin Hood turning in his grave - it’s wrong, plain and simple.

June 22, 2007 | posted by Michael Baxter in IABN | comments (0) |

Earlier this year, a BBC journalist, during the course of her report, made a throw away comment. She said: “House prices always go up.” It was not meant to be controversial, it appeared she merely thought she was stating a fact. She could just have easily have said: “Two plus two equals four.”

It’s this implicit faith that so many have in the underlying strength of house prices, that is perhaps the main factor causing prices to go up. Inflation in any guise is like that. Expectation of price rises can cause the prices to go up.

In the UK, it seems that this faith in the strength of property prices was tempered by decades of inflation. In the early ’50s we suffered two years of inflation in excess of 7 per cent. In the 1960s inflation was on average just over 3 per cent, but in the ’70s inflation frequently moved into double digits, peaking at 24.2 per cent in 1975. In the 1980s inflation averaged around 8 per cent.

For mortgage owners the experience of four decades formed the view that when you buy a property, the wise thing to do is take out as large a mortgage as you can possibly afford, because, thanks to wage inflation, in real terms your mortgage gets cheaper every year.

It was this experience, formed over four decades, that has created the British love affair with the housing market.

But today, average house prices to income are at record levels. According to the Council Of Mortgage Lenders, the average mortgage taken out by a first time buyer is now 3.33 median income of first time buyers. This compares with a ratio of just 2.31 in the last quarter of 1989.

But it is affordable, or so say the market’s supporters. They talk about how, thanks to low interest rates, the percentage of income taken up by the mortgage is lower today that it was. In that last quarter of 1989, for example, first time buyers were typically forking out 25.7 per cent of their income on interest payments. In April of this year, the ratio was just 18.7 per cent.

Combine the apparent greater affordability of mortgages with demographic factors causing demand for housing to grow faster than supply, and it is argued that the housing market is secure.

But there are many dangers in this argument. For one thing, figures that suggest mortgage payments as a percentage of income are lower than in the past are potentially misleading. For another thing, the mortgage is especially vulnerable to a fundamental change in interest rates. But the most serious danger is this: many see their property as their pension. This is an incredibly dangerous situation, and could provoke a nasty fallout in the years to come.

A whistle stop tour of why the argument that figures suggesting mortgages are cheaper today is misleading goes something like this. First, this argument ignores the effect of today’s lower inflation. It seems likely that the cost of a 25 year mortgage, taken out today and assuming inflation stays at the current rate, will probably be more expensive, as a proportion of income earned over the next 25 years, than ever seen before.

In other words, discount future payments against future earnings, and the cost of today’s mortgage as a percentage of income is probably at an all time high.

These days, we often forget about repaying mortgages. We tend to focus on interest only. In fact, the Council of Mortgage Lenders’ figures comparing the cost of a mortgage today with income with the past only takes into account interest. But, remember, even if the rate of interest was zero, the loan would still have to be re-paid.

According to the Office of National Statistics, in April 2006 the median wage in the UK was £447 a week. That works out at £23,244. And yet, the average property price today is £181,000, or so says the Nationwide. That’s almost eight times income. Assuming this average earner pays 38 per cent income and NI tax (which is about right according to current tax rates), then this average person would have to pay 100 per cent of net earnings for 12 years to pay off the debt.

Council Of Mortgage Lenders’ figures also ignore MIRAS. Back in the late ’80s and early ’90s, there were significant tax breaks to paying a mortgage. Take that into account, and all of a sudden the cost of paying a mortgage today, compared to the late ’80s and early ’90s, is not so favourable.

So that’s why mortgage are more expensive as a ratio of income than we have been led to think they are.

Then there’s the danger that mortgages are set to rise anyway. Oil is pushing $70 a barrel again, corn is rocketing in price, and manufacturers and retailers are upping prices at the fastest rate for some time. (According to the CBI high street prices are rising at the fastest rate since 1998.) And then throw into the mix the recent rises in the money supply, and there are reasons aplenty to fear more hikes in the rate of interest.

Many mortgage holders have not yet felt the cost of recent rates rises as they are on fixed mortgages. But the terms of these mortgages will be ending soon, and, with that, their costs will shoot up.

Another factor that could push up inflation, and with it the rate of interest, is the Chinese policy relating to its currency. If China does what the US wants, and allows the yaun to appreciate, this could lead to much higher prices in the west. Remember it’s been cheap imports from China that have helped keep inflation down. A rise in the Chinese currency would up the costs of these imports.

Then there is evidence that the real rate of interest relative to inflation is rising. The gradual unwinding of the carry trade, in which people borrow from countries such as Japan, where rates are low and lend to countries where rates are much higher, is seemingly impacting on the supply of credit. The credit boom has also been aided by the willingness of certain countries, such as China and oil exporters, to lend money to the US and UK.

So much for all the doubts relating to house prices over the next few years.

But there is another fear. Another bigger danger lurks.

What a happens when the baby boomers retire, and there are more people retired than working? There is a danger then that inflation could soar.

It is irrelevant how much money we have saved; if demand for goods and services is greater than our capacity to produce, inflation will set in.

If baby boomers see their property, and maybe their buy-to-let portfolios as their pension, then when they retire, a big danger awaits us all. There is no production in property. Just because house prices have gone up in price, the UK is not wealthier. At least, not in our ability to produce GDP.

The danger is that overreliance on property could create a new wave of inflation, and much higher interest rates.

The key to providing income for the retired baby boomers, is either through making our capital sweat harder, meaning more investment in business, or through investing abroad into economies where capacity will be less constrained.

But instead, high property prices are encouraging us to spend when we should be saving; when we should be investing our capital abroad. Instead, foreigners are investing in us.

The UK and US both suffer from massive balance of payments deficits. These are being fed by consumer spending, which is fed by high asset prices. Unless the deficits turn to surplus when our baby boomers retire, the result will be higher inflation and a crash in asset values.

This doomsday scenario can be avoided by a correction in asset prices, sooner, rather than later.

So, what do you think? Agree or disagree? Tell me what you think on the editor’s blog at Find.co.uk

June 21, 2007 | posted by Michael Baxter in IABN | comments (0) |

History is full of regrets. But in the league table of lost chances, some shine out. Perhaps the Manchester United of errors, would be the agents who turned down the Beatles (perhaps Liverpool would be a better analogy). But, back in 2003, another error leapt to the top of the premier table of ‘if onlys’

In 2003, Yahoo was offered that rapidly expanding, but unproven, company called Google for $3 billion. Today, that same company has a market capitalisation of $158 billion.

Still, who knows? Maybe if Google had been bought and been absorbed within Yahoo, the company would not have taken off so fast, so perhaps this was not such a cast iron error after all.

Even so, Yahoo is still smarting over that one. So imagine the temptation when it is offered the chance to get its sticky little fingers on MySpace.

You will probably recall that MySpace is currently owned by News Corp, with Rupert Murdoch picking it up for $580 million. Mr Murdoch was once known as a dotcom cynic, but he read this one right. Just a few months after the purchase, MySpace agreed an advertising deal with Google worth $900 million.

But now Mr Murdoch has offered the MySpace bit of his empire to Yahoo.

Here’s the catch. He wants 25 per cent of Yahoo (the company is valued at $76 billion) in return.

If Yahoo were to agree - and it seems unlikely it will as the company has done very well of late out of buying smaller firms - it would smack a tad of desperation.

This morning, Yahoo announced the purchase of a sports web site Rivals.com. It has not discussed the amount being paid, but clearly this is small fry.

Yahoo may be content to pick up small little companies here and there, but it seems that in the big league, it is increasingly looking like a player out of sorts.

Earlier this week the company announced the resignation of chief executive Terry Semel, who will be replaced by Jerry Yang, one of the original co-founders of Yahoo.

Now Mr Yang knows the Yahoo business inside out, but he does not have a track record as a savvy deal-making chief exec. He was just a dotcom whiz kid, who was ahead of the game when he and his chum David Filo founded Yahoo in 1994.

Rumour has it that Microsoft is considering making an offer for Yahoo, and it’s difficult not to conclude from the News Corp proposition, that Mr Murdoch too would like to own the number two search engine company.

Maybe Mr Yang, who was there at the beginning, will be at the helm again at the very end.

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June 21, 2007 | posted by Michael Baxter in IABN | comments (0) |

Here’s a surprise! We aren’t saving enough. And this “despite pensions being front page news for much of the past year,” said an incredulous Ian Naismith, head of pensions market development at Scottish Widows.

Mr Naismith said: “When you strip out those people that are relying on final-salary schemes, three-quarters of the UK population is still not on track for a comfortable retirement.”

According to the latest Scottish Widows UK Pensions Report, only 49 per cent of us are saving “adequately”. That’s up from 46 per cent the previous year, but 24 per cent of us aren’t saving at all. (Figures relate to individuals who are 30 plus and earning more than £10,000 per year.)

Drill down into the figures and an even more worrying trend emerges. Almost half of all those who are saving adequately work for the public sector, and yet this prudent lot only make up a third of the workforce.

Here’s a question for you mathematicians. In that case, what percentage of non public sector workers are saving adequately? Don’t worry, we will save you the time, so you can put your calculator away. It’s around 38 per cent.

Apparently, workers are now saving an average of 7.9 per cent of their gross income, whereas Scottish Widows reckons the saving rate should be nearer 12 per cent of earnings. Then again, last year the actual savings rate was only 5.8 per cent, so we are getting better.

But there is a glaring hole in the figures. Many people see their property, and their property buy-to-let portfolio as their pension. Setting aside whether or not this is a sensible strategy, because the Scottish Widows report does not refer to this, the data is not showing us the complete picture.

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June 21, 2007 | posted by Michael Baxter in IABN | comments (0) |

Five members of the Bank of England Monetary Policy Committee are trying to hold back the tide. Yesterday the minutes of the latest meeting of the UK’s interest rate setting committee were published. Five voted to keep rates on hold, four for a rise.

But the committee’s only King - Mervyn, who also happens to be its chairman, was one of the four who voted for a rise.

Mervyn King was outvoted in a similar way once before. Back in August 2005, he voted against lowering the rate of interest, but he lost, and rates were dropped to 4.5 per cent.

Given what happened next, given the rising tide of inflation, which has now been above target for 13 months, and the four rates hikes we have seen over the last ten months, it would appear that in 2005 Mr King was right, and the doves wrong. Maybe, if the bank had not lowered rates back then, the current interest rate climate would be a lot kinder.

And so it would appear, the bank has repeated that same mistake. Its last inflation report said rates would need to rise again before inflation falls to target. The money supply is growing rapidly and the high level of house prices are creating a willingness to spend more and save less.

It seems the inflation tide will make at least one other rate hike inevitable. And yet the five dove voters seem to think they can ignore the tide.

It was like that back in the first few years of the last millennium. The King’s advisors said their Lord was so powerful that he could command the very tide to stop. To prove his underlings wrong, he sat on the beach, and…well you know the rest.

Poor old Canute, his name has become synonymous with foolish men who try to stop the inevitable, when, in fact, his motivation was the opposite.

Let’s hope Mervyn King’s name is not tarred with a similar brush.

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June 21, 2007 | posted by Michael Baxter in IABN | comments (0) |

If this is a slowdown, then roll on the pick up. Press and analysts have hailed the long awaited high street slow down, with both Tesco and Sainsbury releasing ‘disappointing’ sales figures in the last few days.

Sainsbury could ‘only’ manage a 5.1 per cent rise in like for like sales in the three months to 16 June. This was against market expectations of 5.5 per cent increase. Meanwhile, Tesco did even ‘worse’, with like for like sales growth of 4.7 per cent in the 13 weeks to May 26.

The results are being hailed as indicative of a retail sector that is at last reacting to the four interest rate rises of the last ten months. Sainsbury’s chief executive Justin King said: “It is very clear that households’ budgets are being squeezed.” Earlier in the week, Tesco’s finance director Andrew Higginson, talked about customers being “a bit more cautious”, and told Bloomberg that he expects a “tougher year”.

For his part, Justin King talked about how, when times are harder, he would expect customers to look that little bit more carefully for good quality food at the right price. He said that Sainsbury, which is after all a long way behind Tesco and Asda in diversification, will not suffer too badly from a slow down because food will always be popular.

Incidentally, Mr King also talked about food inflation continuing to rise. He said: “The weather has been incredibly difficult for the farming community in recent months.”

Tesco focused on its overseas sales. Its boss Terry Leahy said: “International is delivering particularly strong growth; pushing on well with both new store development and the integration of the stores we acquired last year.”

And yet, all things considered, these results weren’t so bad.

In the case of Sainsbsury, the year on year comparison was with a particularly buoyant period last year, which included the world cup. And while Tesco saw its worse performance in a year, when you consider the remarkable growth the retailer has enjoyed, it was inevitable things would slow a touch.

If the Bank of England wants to find reassurance from these figures that its rate hikes are working, then frankly it would have to examine them through rose tinted spectacles.

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