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.

January 23, 2008 | posted by Michael Baxter in UK economy | comments (0) |

If you ever studied economics at A-level you would have been told that the answer to a deficit in the balance of trade, was increasing the rate of interest. Such a move, goes the theory, will lead to less demand, and therefore less imports. Strange then, because in the real world, the relationship seems to work the other way round. A cut in interest rates leads to less money flowing into the economy, so the currency falls, and exports improve, and imports reduce.

So how can theory and practice be so different?

The answer really lies in the difference between short and long run. In the short run a cut in interest can lead to a cheaper currency, helping the balance of trade; in the long run, well there the picture gets murky.

Yesterday, in what, by the way, was one of the best speeches we are aware of from a central banker on the issues plaguing the global economy, Mervyn King put his finger on key issues. He talked about two gales, both blowing in different directions. The gale from the US – the credit crunch, and the gale from the east – higher commodity prices.

“A lower average level of the exchange rate can, by supporting overall economic activity, help protect us from the worst effects of the wind blowing across the Atlantic” said Mr King, “but, by pushing up import prices, it will exacerbate the impact of the other wind now buffeting the UK economy, which comes from the east – the inflationary effect of higher energy and food prices.”

And that says it all. Lower interest rates are good because they help push the pound down, thus lifting exports and help grapple with the underlying lack of balance in the economy. But lower interest rates encourage more borrowing, thus exacerbating the underlying problem of too much spending and not enough saving.

A lower pound helps exporters, but it leads to inflationary pressure too.

Yesterday, Mr King made the headlines when he joked, “It is possible that inflation could rise to the level at which I would need to write an open letter of explanation, possibly more than one, to the Chancellor.”

He added, “Although there is little we can do now to avoid some rise in inflation this year, the task of the Monetary Policy Committee is to ensure that it is short-lived. If inflation expectations were to pick up in the wake of a rise in inflation this year, then only a more-prolonged slowdown would allow inflation to return to target. But if the rise in inflation does not affect longer-term expectations, then inflation could start to fall back towards the end of the year.”

The fundamental problem, though, as Mr King rightly pointed out, “The low level of national saving is apparent from the current account deficit – our new net borrowing from overseas – which in the third quarter of last year was, relative to GDP, the biggest in the past fifty years and the largest in the G7. It is possible to run a current account deficit for a considerable period. Australia, for example, has done so in every year since 1974. But our own position is becoming more difficult. For some years we have been able to finance current account deficits by borrowing, often through banks, at unusually-low interest rates on world capital markets. Such borrowing is now becoming more expensive. Unless we spend less and save more, our current account position will deteriorate.”

To read the full speech click here

January 21, 2008 | posted by Michael Baxter in UK economy | comments (1) |

Now all eyes turn to abroad. The British consumer is out of puff, the government can no longer afford to boost the economy with spending, but at least there are our foreign partners.

Well, we can’t rely on the US of course, Uncle Sam is sneezing like no one’s business, but this time around, it seems as if the UK can avoid catching a cold, maybe just a mild headache for a year or so, fixed by the economic paracetamol of reducing interest rates, and the flow of investment from abroad. At least that’s what the ITEM Club appears to be saying with its latest economic forecast.

The ITEM Club, from Ernst Young, which by the way is highly revered, reckons economic growth will slow to 1.8 per cent this year, down from 3.1 per cent last year, and then pick up slightly in 2009, with growth of 2.4 per cent, before it fires along on all cylinders in 2010.

Here’s the good news: the ITEM Club says, “Despite the credit crunch, a rebalancing of the economy – as personal savings increase and consumer spending and house price growth slow – will in the longer term be good for the UK.”

It says that, “With the weakness in the High Street likely to hold down inflation, there is room for interest rates to be cut to prevent the abrupt reversal in the credit markets leading to a reversal in the economy.”

It also says the UK markets for credit are being frozen of supply, rather than demand. Presumably, then, as credit is restored, it expects us go out spending again.

“Fortunately,” says the ITEM Club, “It looks as though Sovereign Wealth Funds (SWFs) are coming to the rescue by providing the banks with more capital. However, this is no panacea. So far, the US banks have raised about $25 billion from the SWFs, which is only about a quarter of the total losses so far announced. Moreover, these funds are expensive. They push up the banks’ cost of capital and thus the interest rate margins they will expect on new business. In any case, in the UK the biggest problem seems to lie elsewhere – with mortgage banks and building societies that are now finding it difficult to borrow from other banks. It is not yet clear how this situation will resolve itself.”

The ITEM Club also says business remains in good shape and is in a position to pick up the baton from the consumer. Manufacturing – or what is left of it after 10 years of living with an overvalued currency – is set to benefit from a lower exchange rate and the expansion of overseas markets. ITEM forecasts manufacturing output to grow by 1.4 per cent in 2008 and 2.5 per cent in 2009, after flirting with recession for years.

But here is the catch. With the prospect of slower growth this year, and hence slower tax revenues, ITEM forecasts a grim outlook for the public finances. The current deficit over the first eight months of the financial year came in at £23.1 billion – £8.6 billion worse than last year. Net borrowing was £36.2 billion, £10.2 billion worse.

Peter Spencer, Chief Economic Adviser to the Ernst Young ITEM Club, said, “Now that the economy is slowing sharply, the public finances will deteriorate equally rapidly…The Treasury failed to take advantage of years of good growth to put our public finances on a sounder basis, so our ability to respond by easing fiscal policy has been compromised. The Government should have begun to sort out the national finances three or four years ago. Brown’s famous self-imposed ‘golden rule’ was meant to stop us getting into this kind of bind but I’m afraid it will now make matters worse.”

Mr Spencer summed up, “This is the time for new resolutions and this year is going to be a year of adjustment. We are facing serious problems as a nation of borrowers, particularly the Chancellor. However, it is important to put these into perspective. The economy is fundamentally sound, the problems in the inter-bank market seem to be resolving themselves, employment is high and inflation under control despite the inflationary threats from world commodity and currency markets.”

All in all then, a kind of “not bad” report. But, the ITEM Club is basing its assumptions on the belief that house prices will not crash this year. On one hand it says, “We are facing serious problems as a nation of borrowers,” but on the other hand says demand for credit is still strong, and that lower interest rates, presumably by leading to more borrowing, will create the recovery.

Mr Spencer says, “We have been living beyond our means, lured by the offers of cheap no-questions-asked credit, and tempted by the high prices that the family silver will fetch in international markets. In the future, most families have no option but to tighten their belts. They can no longer afford to dip into housing equity to keep up the growth in spending.” And yet the ITEM Club reckons we will see only a mild slowdown.

With the world’s biggest importer in such dire straits, we are not sure how the economy can experience such a soft landing, unless, that is, lower interest rates mean we carry on borrowing too much, making us even more vulnerable to the next economic crisis. Remember this, the latest data revealed that actually average earnings before bonuses are lagging behind the changes in the Retail Price Index – the average worker is getting worse off.

January 18, 2008 | posted by Michael Baxter in UK economy | comments (0) |

It’s a funny kind of downturn. If the economy is dropping like a northern rock, and we face the very real prospect of recession, then explain the latest data on jobs, published this week by the Office for National Statistics.

The number of people in employment for the three months to November 2007 was 29.36 million. This is the highest figure since comparable records began in 1971 and is up 175,000 over the quarter and 263,000 over the year. The period enjoyed the largest quarterly increase in the number of people in employment since 1997.

Okay, we know what you are thinking, employment is up, but that’s because the size of the workforce is growing, and unemployment is probably up too.

Well, drop your cynicism. Apparently, the unemployment rate is at its lowest level since 1975.

Mind you, the rise in employment was much greater than the fall in unemployment, for while employment rose 175,000, unemployment fell by 13,000. The unemployment level is now 5.3 per cent.

Normally, of course, when employment rises at a faster rate than the fall in unemployment, economists put it down to immigration. This time around though, the figures show that more than half of the people who returned to work were over 50. These are individuals who were mostly counted as economically inactive, and so did not show up in the unemployment data.

So, that means the labour market is booming, and since employment and unemployment both now stand at their most desirable levels in 30 years, you can’t even say immigrants are putting a strain on the economy. How can they when the unemployment level is so impressive? As for talk of a recession, and a crash in property prices – surely that must be overdone.

But, if you are a regular reader of this newsletter, you will know we are about to reveal the catch, and here it is.

Sure, unemployment might be down and employment up, but it appears these rosy figures come at a price. Maybe the reason why the outlook has improved so, is that we are charging less for our time. For the real rate at which we are being remunerated is falling. As for our remuneration per unit of output, well that’s way down.

Apparently, average earnings before bonuses were up 3.7 per cent in the 12-month period to December, while the retail price index (RPI) jumped by 4 per cent. Even if you include bonuses, then average wages went up by 4 per cent, only matching the RPI index.

You might argue, ah yes, but the Bank of England no longer targets the RPI rate, instead it targets the consumer price index, which rose by 2.1 per cent in December. But that is a fatuous argument; the RPI index is a much more realistic account of the inflation rate we all experience, because it includes mortgage payments and council tax.

Don’t forget, by the way, that with all the woe currently coming forth from the City, bonus rates are surely set to fall, meaning we will be even worse off relative to inflation in the months to follow.

But then the picture gets even more murky, because during the 12 months to December, when average earnings with bonuses, and the RPI, both rose by 4 per cent; productivity, that’s output per worker, jumped by 2.6 per cent.

Now, you would normally expect productivity plus RPI index to equate to average earnings inflation. That this is not happening, means someone else is benefiting from the improvements in productivity.

Until recently, this explained the ever-growing level of uneven distribution of income, with the return to capital, which is owned by shareholders, growing faster than the return to labour.

So that’s a little odd. If the return to capital is doing so well, how is it that the economy is apparently on the rocks? (No Northern Rock pun intended.)

It seems that maybe the real problem is that, while the economy has been growing, our spending has grown even faster. This has led to the debt crisis.

The good news: average earnings minus productivity are at such a low level, that inflationary pressures from the labour market seem minimal, which in turn will give encouragement to the Bank of England, when it considers reducing interest rates.

But does this mean the UK will as a result avoid a recession, or that the property market will avoid a major crisis. The answer is No. In the US, unemployment is even lower, and yet the economy is in a horrible mess.

Don’t forget, the big argument made by bulls is that rises in earnings will eventually make all our debt affordable. But if earnings are not even keeping up with inflation, this argument must be about as solid as those rocks you find in the north (pun intended).