Chance of UK recession rises; house prices could fall 35 per cent

July 3, 2008 | posted by Michael Baxter in UK economy | comments (2) | Print This Post

Capital Economics, for long arch bears on house prices, recently predicted that property prices could fall by 35 per cent by the end of 2010.   It reckons 2008 will see falls of 15 per cent, and that the slide will then continue though the next two years.

It is difficult to disagree.  Right now, it seems prediction about how much house prices will fall is really guesswork. The Bank of England’s governor Mervyn King said as much recently, when he said he didn’t know how much house prices would fall.

But with inflationary pressures making it difficult for the Bank to cut interest rates, with the credit crunch making mortgages so thin on the ground, with oil at a level that makes us all blanche, it is difficult to see how price falls will come to any imminent end. 

And while those with vested interests are saying now is the time for buy-to-let investors to move back in, it is difficult to understand why someone would buy a property as an investment in current conditions, even if rent is sufficient to enable landlords to cover interest payments on mortgages.

The IMF recently said UK house prices are 30 per cent overvalued.  That is not the same thing, by the way, as saying house prices need to fall 30 per cent for their value to be right.  In fact if prices are 30 per cent overvalued they would need to fall by 23 per cent to correct this (try the maths yourself).   But markets always tend to overcorrect.  That’s how bubbles work.   Prices go too far on the way up, and fall too much on the way down.

As was pointed out in the article above, it is debatable how much falling house prices will hit consumption.  But if you are like us, or Capital Economics, you think there is a link; and, in fact, Capital Economics reckons consumption will, as a result of falling house prices, stagnate next year.

As you know, the Bank of England is worried about inflation.   It tells us current rising prices are one-offs, but few expect any imminent cuts in interest rates.  Indeed, you may recall, the Bank of International Settlements (that’s the central bank to central banks) said interest rates should go up, everywhere.  The current high price of oil and food, it said, is down to high global demand.    It is all very well the Bank of England or the Fed saying it is an external factor and there is nothing they can do about it.  But actually, that is not true.   Demand for oil is down to everyone, and don’t blame China too much; its oil consumption per capita is a fraction of the level seen in the US and UK.

So, that’s no imminent cut in interest rates, and falling house prices leading to falling consumption.  Throw into the mix news earlier this week from CIPS that its purchasing managers index has fallen to the lowest level it has ever recorded, and you can see the economic prognosis is not so good

Jonathan Loynes, Chief European Economist at Capital Economics said: “The upshot is that, after growth of around 1.7 per cent this year, we now expect the UK economy to expand by just 0.5 per cent or so in 2009 .  What’s more, while the quarterly path of growth is clearly uncertain, we think there is a strong chance at some point of a technical recession in the form of two consecutive quarters of falling output. 

“Whether or not the economy actually enters recession, the consequences of the downturn will be severe. Aside from the drop in house prices, unemployment could rise by almost 1 million by the end of 2010. Meanwhile, government borrowing is set to rise to around £60bn pa, comprehensively breaking the Chancellor’s fiscal rules, while the sterling exchange rate could fall significantly further.”

So where does hope come from?

As we have argued many times before, in such an economic downturn, the price of oil is bound to fall.     Inflation will then fall dramatically, and could turn to deflation fast.  At that time the Bank of England will be able to slash interest rates.

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Markets tumble again – wage inflation drops – is this more like the 1930s than the 1970s?

June 12, 2008 | posted by Michael Baxter in inflation | comments (4) | Print This Post

While all around the panic relates to inflation, and that we are in danger of seeing a re-run of the 1970s, more evidence emerged yesterday to suggest that the reality is quite different.

The 1970s, remember, were characterised by rising unemployment and rising prices.    The Great Depression was characterised by rising unemployment and falling prices.

The 1970s crisis was initially kicked off by a surge in the price of oil, which led to an upward spiral of wage inflation.  The era was characterised by strong union activity,  and loose monetary policy – with negative real interest rates in many economies.

The 1920s/1930s depression was initially kicked off by falling asset prices, followed by banking collapse.  It was a similar story in Japan in the 1990s.

When the stock market crashed in 1929, major indices did not return to their previous high until the early 1950s.   House prices fell in the UK during the 1930s.

In a way it would actually be quite good if the present crisis was more like the earlier one.    Policy makers in the 1920s and 1930s, and Japan more recently, made a series of mistakes.   Japanese banks were slow to admit to the full extent of their losses.  It seems unlikely – fingers crossed, those same mistakes will be repeated.

But the similarities with the 1970s are obvious too.  Oil keeps rising.  Although oil is much more expensive, even after allowing for inflation, than it was the 1970s, these days our consumption of oil takes up a smaller proportion of GDP.  Oil would need to approach $200 and demand stay at current levels before our oil consumption to GDP was comparable to the 1970s.   It does, however, seem quite possible this will happen.

Evidence of mounting inflation is everywhere – and around the world.  In the UK, producer price inflation keeps hitting new all-time highs.  But inflation is also a major problem in developing economies, including China, India, Russia, Brazil and Eastern Europe.

In the UK, evidence has emerged to suggest a new wave of strikes may begin.   If inflation worsens, and union pressure leads to inflationary wage increases, then the only possible medicine will be sharp rises in the rate of interest, just at a time when slowing consumer spending, collapsing house prices and struggling industry suggest a desperate need for interest rates to be slashed.

But here is the other side of the argument, an argument that was strengthened yesterday.

Markets are down again.  The FTSE 100 fell to 5723, 700 points below its start-of-year price.    It is now 1,000 points below its seven-year high set last year, and more to the point is 1200 points below the all-time high of 6930 set on the last day of the last millennium.  So in effect we are sill in a bear period.  A bear period lasting eight and a half years – which we think is the longest bear run since the big one kicked off in 1929.

In the US, it is not quite so severe.    The Dow hit its pre-dotcom crash peak on January 14 2000 – with a score of 11722.    It passed that level in 2006, and at no stage this year has it fallen lower – although it did go within 20 points in March of this year.  Right now the Dow is over 300 points above that mark – although it has fallen 500 points this week so it is quite possible it will fall below that mark soon.

But bear in mind the 1930s, 1940s and early 1950s saw either deflation or very modest inflation.    Inflation today is much higher, and after allowing for rising prices, it seems the Dow is actually lower today – that’s in real terms, than in 2000.

More to the point, the NASDAQ is still only half of the heady heights it reached during the dotcom peak.

In other words, it is not just house prices that are falling off the edge of a cliff; US and UK major indices have suffered an appalling eight years or so.

But then yesterday also saw the unveiling of the latest UK job statistics.

It made the TV and radio news headlines  – UK unemployment rose by 38,000, hitting 5.3 per cent, from 5.2 per cent the previous month.  

It is no surprise.  Sven-Goran Eriksson and Avram Grant are not the only people to have joined the dole queue lately.    We all know that over the next few months jobs will be lost in the City, in retail and the housing sector.

Then again, by historical standards, unemployment is still low; will it stay low?

And this is when the debate gets interesting.

Because yesterday, to accompany news of the relatively small rise in unemployment, came another statistic which was more significant, but has not fallen under the full glare of the public spotlight.

Average earnings, including bonuses, rose by 3.8 per cent in the year to April 2008, down from 4.0 per cent in March. Average earnings, excluding bonuses or regular pay, rose by 3.9 per cent in the year to April, up from 3.8 per cent in March.

Remember, the retail price index rose by 4.2 per cent in the year to April.  So it appears earnings have not kept pace with inflation.

Normally, wages are only creating inflationary pressure if their rate of change, minus improvements in productivity, is above the official inflation target.      Economic productivity rose by 1.7 per cent over the year, so yes, wages are going up a little faster than they should, but only by a tiny amount.

Unions do not the have the muscle they once did. A repeat of the winter of discontent seems unlikely.  There has been plenty of anecdotal evidence to suggest some workers at least are accepting pay cuts.

This is a trend to watch.    So far it would seem that despite the escalating rises in oil and food, the dreaded secondary effect on wages is just not happening.

This is good news, but it could turn to bad news.  Central banks need to watch this very carefully.  Remember, there is typically an 18-month time lag between a change in the rate of interest and its full impact.

The combination of rising unemployment, falling asset prices – both property and equities, and modest wage rises which could easily turn into wage falls, means there is a real threat of deflation.

The challenge facing central banks is to anticipate deflation 18 months in advance, so that they can relax lending in time. 

Right now, central banks seem to have an almost unprecedented balancing act.  The economy could go either way – inflation or deflation.  One wrong move – and it could be disastrous.

Senior management at commercial banks may be overpaid, but right now, central bankers deserve every penny of their remuneration.
markets 08

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The great shift – have we diagnosed the wrong economic disease?

June 9, 2008 | posted by Michael Baxter in UK economy, credit crunch | comments (0) | Print This Post

The last few days have seen a new development – a development that is so far barely showing up on the media’s radar screen – but could yet prove to be both the most important and, if ignored, the most dangerous development yet in the economic crisis of 2008.

In the story of 20th century recessions, there were two big ones.  There were the late 1920s and 1930s (1930s in the US) and the 1970s.     They were both awful, although for most economies the earlier crisis was the worst, but they were also very different.

The 1970s crisis was sparked off by the escalating price of oil – this pushed up prices and led to inflation, while unemployment rose at the same time.    The twin curses of rising inflation and unemployment were referred to as stagflation.

The earlier downturn was kicked off initially via a crash in asset prices, followed by various banking crises and the nasty period of depression – which saw falling prices, or deflation.

In the mid 1990s, what has become known as the lost decade of Japanese growth, was quite similar to the 1930s depression.  Asset prices fell, losses at banks mounted, followed by banking collapse.   Japan experienced deflation – and the central bank of the Rising Sun suffered the shock of discovering that once prices are falling, conventional monetary policy becomes largely ineffective.   You can’t set negative interest rates – otherwise consumers stick their cash under their mattress, and once deflation falls to a level so that even zero interest rates are ineffective, then the central bank is truly stuck.

This begs the question, which of these two crises from the past is the current crisis most alike?  It is an important question, because the economic medicine required is quite different.  In fact, if the wrong medicine is diagnosed, things could actually be made much worse.

When he came up with his famous theory of general employment, Keynes was working during the midst of depression-torn Britain.    His recommendations were adopted by the Roosevelt government in the US in what became known as the ‘new deal.’    Keynes’ cure to a depression involves measures designed to get demand up.  So that’s cuts in interest rates, government spending designed to create employment, and tax cuts aimed especially at low-income earners.    Why the low-income earners especially?  Well this was not necessarily a moral argument, rather the idea was based on economic theory.  Low wage owners tend to save less, so if they have more disposable income they are more likely to spend any new money.  

Keynes’ theory was all about getting people to spend – because when that happens demand rises, new jobs are created, even more people spend, and a fortuitous upward spiral is created.

The medicine Keynes developed was designed for a depression; for a period of falling inflation and employment, leading to low demand.  Depressions can occur when a downward spiral of pessimism sets in. In times of trouble people tend to save, this leads to less money being spent, demand falls, unemployment rises,  and people save even more.  Keynes’ ideas were designed to break this downward spiral.

The crisis of the 1970s was the opposite.  In fact, many would argue that the root cause of the 1970s period of stagflation was the Keynesian economic policy of previous governments.  Subsidies had made business inefficient, job creation schemes had meant labour was employed in areas that weren’t productive, and decades of policy designed to get demand up, had created inflationary pressures.

The surging rise in oil, caused by the Arab oil embargo, was just the catalyst – goes the argument.     Inflation only set in because the foundations for inflation were already in place.   Margaret Thatcher and Ronald Reagan pursued policies which in many respects were the opposite of Keynesianism.  Chancellor Geoffrey Howe upped the rate of interest in the midst of recession, for example.

Alan Greenspan was worried about deflation – that is why he cut US interest rates to 1 per cent.     Maybe he was wrong, certainly many believe today’s credit crunch is down to him, creating an unsustainable credit boom.

Ben Bernanke probably knows more about the 1930s depression than anyone else alive.    As an academic he made his name on his studies into that period.  

But, which one is it today?    If it is 1970s type inflation, then now is not the time for cuts in interest rates.  As painful as it may be, we may need even need higher interest rates. 

But if it is 1930s, then the current inflation surge is just a one-off, governments and central banks should instead revisit the policy recommendations of Keynes.

Evidence has emerged over the last few days that the current crisis may be closer to the 1930s – and to find out why, read the next article.

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Is deflation the enemy within?

June 9, 2008 | posted by Michael Baxter in Taxation, credit crunch | comments (2) | Print This Post

Beating inflation has been likened to squeezing toothpaste back into its tube.    The trouble is, because you can’t have negative interest rates, beating deflation is even harder – perhaps it is akin to squeezing toothpaste back into the tube, while at the same time you are standing on one leg, drinking a glass of milk and singing the national anthem backwards.

Policymakers must not let inflation get a hold again, but then again, neither must they let deflation get a toehold.

In classical economic theory, unemployment is not supposed to exist in the longer-term, or, as economists call it, equilibrium. If there is unemployment, then wages will keep falling so that demand for labour rises until unemployment reduces to zero. There are two problems with this theory.  Unemployment means low national income, which means low spending, which can lead to even higher unemployment.  If everyone was to take a cut in pay, the net effect on the economy will be lower consumer demand, and perhaps rising unemployment.

A classical economist will say, it just needs time.   Economic depressions sort themselves out, in the end.    They say, in the longer term there will be no unemployment.  By contrast, Keynes once said: “The long-term is a misleading guide to current affairs; in the long-term we are all dead.”

The second problem with this theory is based on the belief that equilibrium can never exist.    This is a theory that is currently being promoted by George Soros, but actually, the anti-equilibrium argument goes back decades.   It involves scientific concepts such as the second law of thermodynamics and entropy, but fascinating though this debate is, it is not relevant to today’s discussion.

It does seem to be true to say that the general thinking today would say this: 1930s-type depression requires tax cuts, lower interest rates and lots of money being pumped into the system by central banks.    A 1970s type stagflation requires painful tightening in monetary and fiscal policies – so that’s less government spending, more tax and higher interest rates.

Today, oil and food are shooting up in price – this suggests inflation. 

Today, asset prices, and house prices in particular, are crashing – not just in the UK, but in the US too, and in Spain.  This brings back memories of 1930s-type depressions.

The key to all this, though, surely rests with wage inflation. 

If wages rise in tandem with oil and food, then expect a rerun of the 1970s – inflation will soar.  

If unemployment rises, and wages fall, then expect the period of high raw material costs to end, expect demand for oil to plummet, and expect its price to fall, followed by falling prices elsewhere.    In short, expect deflation.

Now, browse the business pages of today’s newspapers and you won’t fail to notice that job losses are back on the agenda.  The Times headlined: “Major threat to building jobs as Persimmon closes new sites.”  The Guardian talked about 1,800 job losses at Norwich Union, and elsewhere headlined: “housebuilders begin to shore up unfinished properties and cut jobs.”   

Last week, a report from the Centre of Economics and Business Research (CEBR) predicted total job losses in the UK business services sector over the next two years of 40,000, the first reduction in the sector since 2001.   CEBR reckons people working for estate agents will be especially badly hit, with around 5 per cent losing their jobs.  

Meanwhile, analysts at JPMorgan Chase reckon 40,000 jobs will go in the City.

Actually, though, if you really want an idea of where we are going, look West.    Data from the US Labor Department revealed that US unemployment rose at its fastest rate in two years during May.  US unemployment is now 5.5 per cent, from 5 per cent.

So employment is falling a time of surging price of  oil.  Hence talk of 1970s-type stagflation.

But there is one big difference today.    In the UK, at least, unions do not have the power they used to have.     In the 1970s, pay cuts, even pay rises below inflation, were not considered acceptable.

But consider these words spoken by the GMB Union.    Martin Smith, from the GMB union told the BBC that his members were being asked to consider pay cuts of between 30 and 40 per cent.  “We’re also hearing on the grapevine from a number of our employers up and down the country that they’re also feeling the squeeze, and they want to start talking about pay cuts and other ways of saving money,” he said.

All of a sudden the question is being asked – will you accept a cut in pay in order to safeguard your job?  According to the BBC: “The Federation of Small Businesses says lower wages and longer hours may be the only way to prevent redundancies.”

Lower wages may prevent redundancies now, but the result could be a 1930s-type downwards spiral.  Pay cuts are the opposite of what Keynes would recommend.

At the end of 2006, we told of a report saying that in the US, corporate profits make up the higher percentage of GDP than at any time since 1929.    This suggests that businesses can afford to cut prices, by eating into profits.

The GMB warning is just that: a warning.     It may or may not prove to be a sign of things to come.

But, as you know, we are predicting that oil will, perhaps after rising this year, perhaps even after hitting $200, fall back eventually.   This could spell deflation.

It may be, just maybe, that inflation is not set to make a comeback at all.  That stagflation still sits in its grave, with a stake in its heart, and garlic infused in its coffin.      It may be that deflation is the real threat.

Policymakers need to watch this new pattern like a hawk.  But if pay cuts prove to be endemic, then they will need to immediately drop their hawk-like warning, and move into dove mode and slash rates. Fast.

At the same time, the government will have to drop its beloved fiscal rules – and borrow and spend – tax cuts in particular will be essential.

The time to act may not be now – but it may be soon.   

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The banks who say Recession

May 13, 2008 | posted by Michael Baxter in US economy, credit crunch | comments (0) | Print This Post

Yesterday bank chiefs used the “R” word.

This is what Stephen Green, chairman of HSBC, said: “The outlook for the rest of the year remains unusually difficult to foresee in the current environment. Many parts of the world continue to enjoy strong economic growth … however, it seems increasingly likely that the US will enter a recession in 2008, the length of which is uncertain.”

As for the long-awaited recovery in the US housing market, this is what HSBC CEO Michael Geoghegan said: “We don’t think this is a 2008 event, it’s a 2009 event.”

Meanwhile, while at a conference in New York, JPMorgan Chase & Co’s chief executive, James Dimon, said that although he felt the credit crisis was around three-quarters of the way through,  a US economic recovery is still some time off.

“Even if the capital markets crisis resolves, it does not mean that this country will not go into a bad recession,” he said.

“The recession just started. We don’t know if it’s going to be mild or severe…We’re thinking there’s a third of a chance that it’s going to be pretty bad… closer to the 1982 recession than the very mild recessions we had in 2001 and 1990.”

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To be in recession, or not to be in recession

February 4, 2008 | posted by Michael Baxter in US economy | comments (0) | Print This Post

Last week, the National Institute of Economic and Social Research (NIESR) surprised many when it predicted only a modest slowdown in the US this year. It reckons the US will grow by 2.2 percent in 2008; that’s below trend, but hardly the stuff recessions are made of.

NIESR has a good track record too. It was a lone voice saying recession would be avoided in 1998 during the era of the East Asia, Russia and LTCM crises, for example.

Maybe banks are so pre-occupied with their own problems that they make the mistake of transposing their difficulties on to everyone else. They are blind, perhaps, to what is happening in the real world.

That may be true – but here is an individual whose credentials for predicting economic growth are every bit as impressive as NIESR’s, and he is saying the opposite.

Jim Rogers, legendary investor, co-founder with George Soros of the Quantum Fund, and famous for predicting the commodity rally in the late 90s, is altogether less sanguine.

“Conceivably we could have just had recession, hard times, sliding dollar, inflation, etc., but I’m afraid it’s going to be much worse,” he told Fortune magazine. “Bernanke is printing huge amounts of money,” added the guru. “He’s out of control and the Fed is out of control. We are probably going to have one of the worst recessions we’ve had since the Second World War. It’s not a good scene.”

Well at least Rogers and NIESR have something in common. They are both critical of recent moves by the Fed in slashing interest rates. Last week, NIESR said “It is possible that the Federal Reserve acted precipitately to technical fall-out from losses at Société Générale in France, which seems to have sparked much of the panic trading. The Banque de France informed the Federal Reserve of the matter in advance of their meeting scheduled for the following week. It is possible that if the Federal Reserve had waited for all the information they needed, they might not have acted, and indeed they may have damaged their credibility by their precipitate action.”

Meanwhile, Capital Economics seems to getting a little more bearish. Latest data revealed a fall in non-farm payrolls for the first time in four years in January. It’s been the strong labour market that has led some to predict only a soft landing for the US. So when data starts telling a worrying story on the US jobs markets, you know it’s time to fret.

Right now, the US rate of interest is, in real terms, negative. Even so, Capital Economics is worried about the US housing market. The Case-Shiller 10-city house price index fell by a record 8.4 per cent over the 12 months to last November. But “more worrying,” it says, “is the acceleration in the decline. The 20-city index fell at an annualised rate of 16.2 per cent between August and November.”

It says, “With the excess inventory of unsold homes at an almost unprecedented level, prices are likely to fall a lot further. This could constrain consumption growth for a number of years, although it may not cause an outright decline in spending in any one or more quarters. The further house prices fall, the more risk there is of a complete consumer capitulation. On the other hand, the monetary and fiscal stimulus now in place will have a potentially powerful offsetting effect on consumers in the second half of this year.”

And there you see the dilemma. NIESR doesn’t understand why the Fed has slashed rates and the US government has announced such big tax breaks. Jim Rogers too is criticising the Fed, but for quite different reasons, but Capital Economics is saying the only hope for the US lies with the measures announced by the Fed and George W.

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Recession, soft landing or something else?

January 24, 2008 | posted by Michael Baxter in UK economy, US economy | comments (0) | Print This Post

Markets don’t do things by half. Things are either wonderful or dreadful. And the last few days have seen both moods permeate Wall Street – with the massive falls of last week followed up by big rises yesterday.

So are we in for recession, or a mere slow-down in growth, or are things set to get a lot worse?

Today we take a good look. To see these articles in on one complete run, click here

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R is for recession, or is it for relax as fears are overdone

January 14, 2008 | posted by Michael Baxter in UK economy | comments (0) | Print This Post

The ‘R’ word is back. If one were to produce a graph plotting usage of the word “recession” in the media, then right now the graph would be going though the top of the screen. But here is another word for you to try: “relax.” Two reports have been produced recently which appear to show all the fears doing the rounds are overdone.

First there was a report from Barclays Capital looking at these 1.2 million, or so, people who are due to be coming off fixed rate mortgages this year. Now we have said many times that David Smith, economics editor for The Sunday Times, seems to be anxious to win the award of most-optimistic economics journalist of the year. And yesterday he was true to form. In an article headed “A sense of balance on consumer gloom,” he said, “One factor that has been over-hyped is the mortgage ‘re-set’, as people come off existing fixed rate mortgages onto higher ones. According to analysis by Barclays Capital, this is a red herring. The maximum pain from re-sets this year will be £2.1 billion, and the likelihood is of something significantly lower.”

Meanwhile, the Halifax, which by the way also down-played the significance of this impending mortgage re-set throughout most of last year, has just published more data, which no doubt is supposed to reassure us. The Halifax says, “The value of the UK’s private housing stock rose by 9 per cent (nearly £320bn) in 2007 to a record £4.0 trillion (£4,000 billion). The value of the housing stock has more than tripled over the past decade, rising by 208 per cent from £1.3 trillion in 1997. By comparison, the headline retail price index (RPI) has risen by 31 per cent over the past ten years.” And then, finally putting the knife into the pessimists who have been saying we have too much debt, added, “The value of the private housing stock (£4.0 trillion) was 3.4 times the value of outstanding mortgage debt of £1.2 trillion at the end of 2007. Ten years ago, private sector housing assets were 3.0 times higher than mortgage debt. Housing assets have increased by more than mortgage debt levels in each year since 1995.”

What puzzles us a tad abut this Halifax data is this. Presumably, if house prices were to double again, to a level that surely even the most optimistic bull would say is unsustainable, the Halifax logic would suggest the UK is in even better health. In other words, the Halifax report seems to be saying the more the property bubble is inflated, the less likely it is we will suffer a debt problem. Now to our way of thinking, that smacks of upside down logic.

As for the report on mortgage ‘re-sets’, surely the point about all these 1.2 million people coming off fixed rate mortgages is that some will find it a struggle. Some, especially those with poor credit records, will find it impossible to secure a viable mortgage deal. It’s these people at the margin who will be the key. If 90 per cent of individuals with fixed rate mortgage deals coming to an end have no problem at all making ends meet, this is an irrelevance if 10 per cent find they have to sell their homes and downsize. The sale of homes by these 10 per cent would lead to a big jump in the supply of homes for sale, and prices would fall, making the Halifax’s rosy data on our wealth look decidedly, well how can we put it politely, say, non-rosy in a dried-up desert sort of way.

Mind you, there has been some good news creeping into the economic data of late. Since the steps taken by central banks to pump liquidity into the system at the end of last year, the interbank rate has been falling, and the difference been the interbank rate and official rates set by central banks is now barely above average. So hurrah for that. But don’t forget, interbank rates are also supposed to reflect expectations for future changes in bank rate, and since just about everyone is expecting the Fed and Bank of England to lower interest rates this year, maybe the latest news from the interbank market is not quite so good after all.

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Uncle Sam hits panic button

January 9, 2008 | posted by Michael Baxter in US economy | comments (0) | Print This Post

Shh, shh, this Christmas it was oh so quiet. But then, with the first working week of the year, we saw the start of another big riot.

That great Icelandic economist, Bjork, couldn’t have said it better. There was movement up and down, but by the last day of last year the Dow was just 20 points up on the score seen 10 days earlier. Then the markets blew a fuse, and then, bang, the bottom dropped out of the markets faster than a presidential campaign. It seems that so far this year, speculators have fallen out of love with the Dow, which has plummeted 675 points since the end of the last day of 2007.

DowJones

At the moment, it appears bad news on the US housing market is a bit like French trains. It comes in thick and fast and on time. The analogy doesn’t end there either, because French trains are subsidised by the state; in the US, the housing market boom was subsidised by questionable short-term policies, and rock bottom interest rates.

The latest index from the National Association of Realtors revealed that sales agreements for pending sales fell 2.6 per cent in November, much worse than expected. The Association also cut its estimate for the fall in prices during the last quarter to 5.3 per cent on last year, down on its previous estimate. To complete the unhappy picture it has now put back its estimate for a recovery in the market to 2009.

But while the latest bad news on US house prices came into the station, the New York Times added to the feeling of disquiet when it suggested that US mortgage lending giant Countrywide had been falsifying documents relating to the bankruptcy of a homeowner in Pennsylvania. Countrywide denied there was any truth in the report, but while the air was still thick with denial the rumour mill ground out talk that Countrywide is planning to file for bankruptcy. It denies these rumours too, but these days a whiff of a rumour like that is enough to send markets into freefall.

Yet maybe we should not be too worried. Bloomberg surveyed 62 economists and found that the average expectation is for 1.5 per cent annualised growth in the first six months of this year. That is at the same level seen in the last quarter of 2007.

Bizarrely, although these economists are not expecting recession (the odds have been put at 40 per cent), they say it will feel like it. Bloomberg quoted Mickey Levy, chief economist at Bank of America Corp. in New York as saying “It’s soft economic activity that feels like a recession.”

Maybe the problem is this. Thanks to technological change, US productivity is rising, so if productivity is rising then GDP needs to rise just as fast, otherwise demand will not meet supply, and rises in unemployment will result.

The US is also beginning to import a little less and export a little more. So that’s good for GDP and good for correcting the underlying problems with the US, but it won’t feel like good news for consumers.

If, however, the US does manage to avoid recession, then it really will be a remarkable performance. After all, not so long ago they were saying that if the housing market stops growing, recession would occur, and yet subsequent events showed that house prices hadn’t merely stopped growing, rather they were falling.

Maybe the remarkable changes in technology really are making a huge difference, maybe it is “a new paradigm now.” The only snag with that argument is that history tells us that when people start saying, “Ah, it’s different this time,” then it’s time to get worried.

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Is the US already in recession?

January 8, 2008 | posted by Michael Baxter in US economy | comments (0) | Print This Post

Recession is a technical term: and refers to a period in which economic growth is negative for two successive quarters. There is a snag with that definition. How do you know you are in the middle of a recession, when actually it can only be truly measured in hindsight?

For that reason, the Fed has been notoriously bad at saying when the US was in recession: often getting the call completely wrong, famously denying the US was in recession earlier this decade, when eventually it turned out it was.

And now a growing chorus of voices are saying the Fed has got it wrong again. Now David Rosenberg, chief North American economist at Merrill Lynch has joined the list of pessimists.

Talking to the Telegraph, Mr Rosenberg pointed to what he called the four key barometers, that’s employment, real personal income, industrial production, and real sales activity in retail and manufacturing, and said, “According to our analysis, this [recession] isn’t even a forecast any more but is a present day reality.”

Last year, Joseph Stiglitz, former chief economist at the World Bank, and winner of the Nobel Memorial Prize in Economics, and a man who is drawing increasing eulogy as one of the top economists in the world (he has even been compared to Keynes) told Bloomberg “I’m very pessimistic…It’s not just the housing sector. Over the last five to six years our economy has been bolstered by the real estate sector…Americans have been taking money out of their houses to finance a consumption binge.” He said, “That game is over…Alan Greenspan really made a mess of all this…He pushed out too much liquidity at the wrong time. He supported the tax cut in 2001, which is the beginning of these problems. He encouraged people to take out variable rate mortgages. That helped create the subprime crisis.”

Messers Stiglitz and Greenspan, it appears, are becoming economic rivals. The former World Bank man, for example, lambasted the IMF and Fed for the way they handled the East Asia and Russian debt crisis in the late ’90s , saying their policy mistakes confined economies in the region to unnecessary hardship, while Greenspan says the IMF action helped stave off recession in the West.

But then, Stiglitz is not alone in his criticism of Greenspan. Recently, Patrick Artus, one of France’s most influential economists, said Greenspan was a “very bad” Fed chairman. In an interview with Bloomberg he said, “Greenspan was an arsonist and a fireman combined. He derived all his glory from his reaction to the savings-and-loans crisis, to the collapse of Long-Term Capital Management LP, and to Sept. 11, 2001. But LTCM and the savings-and-loans crisis were his doing. He absolutely failed to see where the malfunctions in the US economy were.”

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