March 28, 2008 | posted by Michael Baxter in UK economy | comments (0) |

It was around this time last year that Alan Greenspan said he put the chances of a US recession at about one in three.       Not many agreed with him at the time, they felt he was being far too pessimistic.

Now a similar projection is being made about the UK.   According to a report produced by the chief European economist at Lehman Brothers, there is slightly over a one in three chance the UK will fall into recession.

The Lehman man said, “The chances that the UK economy will follow a path similar to that of the US now seem sufficiently high to warrant considerable investor interest in the possibility of much more aggressive action from the Bank of England, akin to that taken by the Federal Reserve.”

Mr Hume said, “The probability of a technical recession of two quarters of negative growth at some point over the next two years has now risen to about 35 per cent. We put the probability of an outright recession of negative year-on-year growth at 20 per cent.”

And from us, here is a warning.    Expect more and more reports of this nature over the next few months.    

Mr Hume seems to think that the catalyst of a UK recession would be falls in UK house prices – and you know what we think about that. 

February 14, 2008 | posted by Michael Baxter in UK economy | comments (2) |

Fascinating fact number one: cash was the best performing asset last year.Fascinating comparison number one;  the way economic growth has been leveraged on low inflation.

Question to make you feel a little queasy: “Whether high levels of leverage can persist in a more-volatile and inflation-prone economic environment?”

Conclusion to make you want rush for the sickbowl, but perhaps pop open the champagne all at the same time: “The credit crisis of 2007–08 is not just another permutation of the leveraged boom and bust cycles that have been so familiar over the past two decades. Rather, the current credit crunch represents the death throes of a rather inefficient economic arrangement that was only sustainable under disinflationary conditions.

“Resource scarcity,” begins the Barclays Capital Equity Gilt Study 2008,  “is the single most important social, political and economic factor of our era and will remain so for the foreseeable future.” It goes on to warn that we are depleting the stock of natural resources at an accelerating rate and says, ”The rise in per capita consumption of natural resources has been vastly accelerated by rising prosperity in the developing economies. The scale of the potential increase in aggregate demand is large enough to warrant doubts that it can be satisfied.”

Turning aside from the Barclays report for a moment – it does seem to be human nature to dismiss warnings that our consumption of natural resources is unsustainable, because these warnings have not come true before – but this is dangerous. You must bear in mind that the experiences of the last hundred years or so are actually not statistically significant. The industrial age – which is now gathering new momentum with the development of India and China, has, in the scheme of things, occurred in a blink of a eye.

We all know bubbles don’t tend to look like bubbles until they burst. They often surge in the last throes before they end – but the forces that lie behind our exploitation of natural resource, are deeper and slower to react. If we are sitting in the midst of a raw material bubble, then the trajectory of this bubble will necessarily be much more drawn out than any we have witnessed before – the experiences to date are totally consistent with this.

Meanwhile, back with Barclays Capital, it said, “In many, if not most, instances, the more accessible stocks of resources have already been exploited. Increasingly, future demand will only be met by utilising the less productive and more marginal stocks. Given the pace of economic growth in the developing world, the supply/demand balance in most resources becomes critical within a one to two decade timetable. For some resource sectors, the prospect of complete exhaustion within this timeframe is a realistic scenario if hypothesised deposits and technological advances disappoint. Resource scarcity is likely to wreak significant changes to the global economy, ending the long trend of decreasing volatility in growth and inflation.”

“The net result of intensifying natural resource scarcities is an increase in structural upward pressures on inflation and a worsening trade-off between inflation and growth. ”

And then comes the damning conclusion “To prevent the inception of an inflationary spiral in the future, monetary policy-makers will have to become somewhat tougher than has been the case over the past two decades. In particular, central banks will be more constrained in dealing with the aftermath of speculative bubbles and phases of excess leverage. Macroeconomic volatility is therefore likely to rise as policy-makers find their ability to smooth the cycle constrained by inflation. In time, this development will break the familiar cycle of the past two decades, under which the seeds of each new speculative bubble germinate in the ashes of the previous bubble. Leverage levels, notably in the household sectors of developed economies, will most likely start a long drift lower. In this context, the credit crisis of 2007–08 is not just another permutation of the leveraged boom and bust cycles that have been so familiar over the past two decades. Rather, the current credit crunch represents the death throes of a rather inefficient economic arrangement that was only sustainable under disinflationary conditions.”

Barclays went on to talk about what it calls “the four demons of illusion.”

Back in the mid 1990s, Roger Bootle, head man at Capital Economics wrote a book called the Death of Inflation. In it, he said that technological change, and the surge in supply created by globalisation, would lead to an era of low inflation.

He was right. But, low inflation may have led to low interest rates and allowed the UK to enjoy its longest-ever run of economic growth – but it has also led to apparently unsustainable high asset prices.

It has led to a boom funded by debt – and to an extent, creditors have not really considered the cost of repaying the debt – rather they have merely factored-in interest rate payments.

If the Barclays report is right, and we are about to enter an age in which inflation rises, and interest rates tend to be much higher – and by the way Alan Greenspan has made similar predictions, then all of a sudden all that debt will seem like a terrible curse.

Recently, some analysts have dismissed some forecasts of doom as being little more than Cassandra-like ranting. They forget that, according to Homer, Cassandra’s prophecies were always true, it’s just that no one believed them.

As one of our readers once said to us, it’s as if the world’s markets are slowly suddenly realising, the emperor that is a boom based on debt has no clothes.

Does this mean things are all simply awful? Not at all, there are good reasons for believing we can move to a scenario in which we are less-reliant on the earths scarce and highly valuable natural resources. But the first stage in grappling with a problem is in recognising the problem exists – and that is what we are witnessing at the moment.

February 14, 2008 | posted by Michael Baxter in UK economy | comments (1) |

If you are a regular reader of this newsletter you know the dilemma. But, yesterday, the Bank of England spelt it out in full.

You may recall, earlier this year the Daily Express called for urgent rate cuts. It has been a common theme – why can’t the British central bank take a leaf out of the Fed’s book, ask some, and slash rates – get the economy rolling along? The solution to the current economic difficulties does, after all, seem obvious. And so obvious is this solution that many have predicted sharp falls in the official cost of borrowing this year – some think rates will drop to just 4 per cent by the year’s end – from the current level of 5.25 per cent.

Well, yesterday, the Bank of England’s good doctor, Mervyn King explained why this may not be so simple.

Yesterday, the Bank’s latest quarterly inflation report was published, and here is the bit that matters.

Markets seem to be predicting a fall in interest rates to 4.5 per cent by the beginning of next year – and yet yesterday’s report showed that if that happens, it expects inflation to average 2.3 per cent over the next two years – that’s above its official target of 2 per cent.

Well, that’s alright, you may say – inflation will only be a fraction over target – go for it. Well that is the wrong thing to do; if you deliberately target a rate above the level you are supposed to, you stand the risk of making things far worse.

After all, the Bank of England doesn’t know for sure what inflation will be, it deals in guesses. It admits this and even presents its projections in the form of fan charts – showing the probability it is wrong.

Besides, if it were to deliberately target an inflation rate above its official target – it would send out the wrong message – that it is relaxed about inflation.

The reports also raises the spectre that in the short-term, inflation could rise more than a full percentage point above target – eliciting another letter from its governor to the chancellor – a danger we warned of last month.

But there is good news. Based on the assumption rates stay where they are, the Bank of England thinks inflation will fall below target – just. So, in fact, the report seems to imply at least one more quarter of a per cent drop, maybe two.

But, sometimes you have to stand back, take a helicopter view, and that’s what Mervyn did yesterday.

Looking at house prices, he said, “There’s no reason to expect house prices to be markedly above where they are now.”

But, looking at all this doom and gloom doing the rounds, he said, “Don’t be taken in by too many of the analysts, who are perhaps coloured somewhat by the environment within which they have to work in the financial sector. Getting outside is a pretty good antidote to that.”

And in those comments he seemed to reflect a growing feeling that the banks have become so pre-occupied with their problems that they have just assumed we are suffering just as much – it is possible the banks are just plain wrong.

February 7, 2008 | posted by Michael Baxter in UK economy | comments (1) |

It’s that time of the month again today. By the time you read this you will probably know whether rates have stayed on hold or been cut. There is even an outside chance the Bank of England will cut rates by more than a quarter of a per cent – although it seems unlikely.

The arguments for and against the change have been rehearsed here many times – but maybe they are really distracting us from the real issue.

Maybe instead we should be looking at a far more significant debate which is beginning to take on a new traction, and say that actually the key to seeing the US and UK through the credit crunch lies not in playing with interest rates – but rather with tax breaks for the poor.

And in eliciting support for this view we can call up one incredibly credible witness. ( I am incredulously intrigued - Ed)

Keynes, the greatest economist of the 20th century, said there are times when monetary policy just doesn’t work.

If consumers are already in debt, if asset prices are too high, then the last thing you need are measures to encourage more borrowing. Many argue that by doing this, you are merely sweeping today’s dusty problems under the bed, creating the risk they will return in the future.

Keynes would argue, though, that there are times when encouraging borrowing to get an economy moving, is about as effective as “pushing on a string.” It was one of the great man’s most-famous quotes, and it seems as relevant today as when he said it.

Keynes instead said the answer was to give a boost to the poor – tax breaks, and job creation.

Keynes himself was a man who seemed to propose policies that these days are considered to be socialist, but with his condescending way, and public school manner, never really endeared himself to the people he wrote so brilliantly in favour of supporting.

But right now, the debate is re-playing itself in the US.

As you know, George Dubya’s big idea – well it probably wasn’t his idea – was this massive $146bn tax break to US citizens. Under the plan, 117 million US individuals will receive a rebate of around $600, while married couples will be getting around $1,200.

It is a bold move. If the Brown government took a similar action, then our PM would be accused of blatant electioneering with the tax system. But, the measures taken are what Keynes would have recommended.

But, some people in the US felt the Bush plan didn’t go far enough, and yesterday a Democrat idea for handing out $157bn, but geared more to the poorer families (and in particular pensioners and disabled veterans) was discussed and finally narrowly rejected in the US House of Representatives.

Meanwhile, in the UK there is a growing debate on what the government should do. It is clear that government finances are strapped. A growing number of economists believe Gordon Brown will break his golden rule this cycle. If the Office for National Statistics decided to include government guarantees to Northern Rock in national debt, then the accounts will look even worse.

Yet it seems we are heading for a position when the economy needs tax cuts – especially tax cuts aimed at the poor – who traditionally have lower savings ratios – to get the economy moving.

Don’t be surprised if, ultimately, the golden rule is changed. This is increasingly looking like a meaningless measure – but cut through it all and the real problem facing the UK is that government borrowing was too high in the years of plenty. There is real danger we are about to pay the price for that.

February 5, 2008 | posted by Michael Baxter in UK economy | comments (3) |

The Centre for Policy Studies is not a fan of the Labour Government. If you browse its web site, you will find a plethora of articles with headlines such as “Tories’ economic legacy has been squandered” and “The EU’s costs are outweighing the benefits.” It seems that many of the articles on the site seem to reflect the views held by members sitting on a certain wing of the Tory Party.

There is nothing wrong with that, we live in a democracy and many would argue these are legitimate views, but in the interests of balance, it often seems to damage the credibility of an argument when it is presented with too much of a political stance.

Even so, it is difficult to argue with the latest report from the Centre. Entitled “Why do we feel so broke?” and penned by Charlie Elphicke, who by the way was selected last year to represent the Conservative Party in Dover.  It makes damming reading.

The average household’s disposable income after deducting housing costs is lower today than it was in 2002.

The report showed that for an average family, gross income rose by 19 per cent over the five years between 2002 and 2007. But then, when you take off tax, and add on child tax credit, earnings after tax rose by around 18 per cent.

But then, if you take into account council tax, mortgage interest payments, water, gas and electricity and household repair costs, then the level of disposable income after these items actually fell 5 per cent.

Now this analysis isn’t perfect. After all, mortgage repayments, utility bills, and council tax have seen above-average inflation increases. By focusing on household costs, Mr Elphicke was in effect focusing on data that would by default throw up a particularly bad result. After all, it ignores areas where inflation has actually been negative.

If, instead, we compare the data with official inflation figures, the result isn’t quite so bad. The RPI index (that’s the older measure used for calculating inflation, which includes mortgage repayments and council tax) increased by 17 per cent over that period. So disposable income just about kept ahead of inflation.

Even so, the report tells a story which often seems to get forgotten.

Latest data from the Office for National Statistics revealed that average earnings with bonuses rose by 4 per cent in the 12-month period to December. This was exactly the same as the increase in the Retail Price Index over that period.

There’s lies, damned lies and statistics. These days, when targeting inflation, the Bank of England is supposed to keep the Consumer Price Index within 1 percentage point of 2 per cent. But people fall into the trap of comparing our earnings with this index – and it’s a misleading guide. The RPI index, on the other hand, is a far more accurate gauge of how inflation is affecting us.

So, just bear all this in mind next time an economist, or a property market bull, paints a rosy picture, saying as earnings start to rise interest payments will become more affordable.

But there is something else that neither the report from the Centre for Policy Studies, or indeed the official RPI data, take into account.

Sure, mortgage interest payments have shot up, but what about the cost of repaying the initial sum borrowed.

We all know that between 2002 and 2007 house prices rose much, much faster than inflation. And with that increase, the size of mortgages rose dramatically too. And yet, the area of biggest cost increases is the one area which just about all reports systematically ignore.

Now, you might say, the cost of repaying a mortgage doesn’t matter. Well, you could to an extent have got away with that argument in the 1970s, when runaway inflation made the size of a mortgage relative to earnings reduce very rapidly. But in today’s era of low inflation, surely the repayment of the initial amount borrowed is more important than ever.

An economist answering to the name of Minsky, once talked about three stages in the development of a credit bubble. Stage 1, borrowing is affordable. Stage 2, borrowers can’t afford to repay the loan, but they can afford to pay interest. Stage 3, they can’t even afford interest, and may borrow from elsewhere to repay existing loans.

Then, all of a sudden credit dries up – backlash against the untenable borrowing occurs – this is called the Minsky moment.

For some time now, much of the lending on houses was only repayable if the houses went up in value – it seems Minsky’s moment might be upon us.

February 5, 2008 | posted by Michael Baxter in UK economy | comments (0) |

The latest report from the Chartered Institute of Purchasing and Supply (CIPS) is the stuff central bankers’ nightmares are made of.

It seems whichever way a central banker views the report, he or she is sure to come out in a cold sweat.

The Purchasing Managers Index, published by CIPS, fell to 50.1 in January, that’s the lowest level since August 2005. The good news, anything above 50 signifies expansion, so CIPS are not saying we are in a manufacturing recession yet, just very close. But, the New Orders Index, which provides an indication of how the sector is moving, fell to 49.7.

CIPS said, “The rate of contraction was only slight but companies reported lacklustre demand, particularly in key foreign markets.“ So that’s a worry, consumers are off the boil, we all know that, and with the pound falling, we need exporters to take up the slack, and start exporting. Yet the CIPS New Export Orders Index fell to 47.6, reflecting, as CIPS put it, “the effect of the softer economic conditions in a number of key markets, most noticeably in the US.”

Now, in the UK, the manufacturing sector has this tendency to play with recession, like a child with his favourite toy.

But, right now, we need our manufacturers more than ever, and we need them to get exporting.

Okay, so none of that is good. But why should central bankers, whose remit is merely to worry about inflation, be fretting?

Well, the answer to that lies with the prices our manufacturers are being charged, and the prices they are then charging their customers.

The CIPS prices paid index shot up to 69.3, the highest level since July 2006.

But, more to the point, the prices charged index leapt to 57.9, the highest level ever recorded.

So that’s an industry heading for recession, while prices are soaring. There is a word to describe that, and that word is stagflation.

Have you seen that film Cloverfield yet? In a cynical, age, when we think we have seen just about all the frights Hollywood can conjure, it is a truly scary monster flick, perhaps having a similar impact on audiences to that the original King Kong had when it was released.

But, for Mervyn King and chums, the latest CIPS data, must be even-more frightening.

January 29, 2008 | posted by Michael Baxter in UK economy | comments (0) |

If you take a hard gander at the latest report from the Office for National Statistics, looking at family spending over the last 50 years, there are no real surprises. But it makes a fascinating read, all the same – and maybe there are lessons to be learned.

First fascinating thing, which should come as no surprise, is the amount we spend on food and non-alcoholic drinks. Back in 1957, 33 per cent of the average household’s weekly budget was taken by spending in this area. But by 2006, spending had reduced to 15 per cent of the budget.

Then there’s tobacco. Half a century ago, your average household forked out 6 per cent of its readies on a smoke. Today, it’s just 1 per cent. The amount we spend on footwear and clothing halved too, falling from 10 per cent to 5 per cent.

But alas, while economic progress gave with one hand, it took with the other, because our spending on housing (including mortgage interest payments and rent) is now the single-largest item, accounting for 19 per cent of spending. In 1957, housing accounted for just 9 per cent.

So here is the first lesson. It appears that in the UK, while the amount of money we save on food, clothing and tobacco, rises, we have spent much of the saving on our houses. Presumably, soaring house prices have eaten up much of our economic gain, perhaps in turn reducing the extent to which we are truly better off.

Then there is fuel. The amount we have spent on fuel, light and power has halved over the period. No wonder the soaring price of oil hasn’t led to an economic disaster as it once would have done. That’s the second lesson we learn from the data.

But the third is a more-general point. Economic theory tells us that as our incomes rises, we save more. It was partly for that reason that Keynes said a partial solution to solving an economic depression was to boost the incomes of poorer families – via creating jobs and unemployment benefit. Those same sentiments have been repeated recently, with George W’s recent tax announcement being hailed as a Keynesian move, because it especially benefits poorer Americans.

That man Joseph Stiglitz, the economist described here yesterday as the possible successor to Keynes, talked about tax cuts benefiting the poor as being the partial solution to the current economic crisis.

But, actually, what the latest data from the Office for National Statistics seems to tell us is that increases in income only lead to increases in saving in the short-run.

In time, we always find new ways to spend our increased wealth. The ONS stats, for example, only started measuring leisure services from 1987, so small was this area before then, and yet by 2006 this took up 15 per cent of our spending, making it the joint second-largest area of our spending, second only to housing costs, and tying with food and non-alcoholic drink for second spot.

The ONS says average gross household income in 2006 was £642 a week. Of this amount £62 was spent on transport, £58.50 on recreation and leisure, £37.90 on restaurants and hotels, and £11.70 on communication.

We are better off, sure, but our debts keep soaring, and we always seem to want more. It seems the more we earn, the more we yearn.