The State of the Union

The end of western civilization

Perhaps I'm naive, but I was expecting a slightly more robust response from the British public when government debt crossed the trillion dollar mark.

I will concede that the muted response could be because big numbers are hard to understand. Maybe if we heard that UK public sector debt amounts to £17,000 worth of debt for every man woman and child in the country. 17,000 quid is something that most of us can appreciate. Do I have that kind of cash to pay off my share of the British debt stock? Do you?

The amount of public indebtedness is alarming, but there's something that worries me more. Over the last four years, UK government borrowed over £400 billion. In other words, public debt is growing at the rate of about £100 billion a year. Again, let's put that number into something more manageable. The British government is borrowing about £2,000 a year per person. Moreover, there are few signs that this rate of debt accumulation is likely to slow any time soon. Sure, the coalition talks a good game. But the scoreline says something quite different. During the last 12 months, the government added £120 billion to the public debt stock. Britain is drowning in debt.

There are some some dismal types who think this debt addiction, which is a European wide phenomenon, signifies the prelude to the collapse of Western civilisation. European economies have no dynamism, no entrepreneurial spirit, and this is why they cannot grow. Europe now emits the mild odour of a graveyard. European governments have to borrow extraordinary amounts of money to keep their decrepit and outdated welfare systems ticking over.

Maybe, that conclusion is a little apocalyptic. Nevertheless, Europe cannot continue on this trajectory. One where another Europe were paid in full for its lax attitude to debt accumulation. As we now see in southern Europe, comes a day when governments can borrow no more. When that happens, the adjustment process is immediate and brutal.

There is no reason to despair

I go away for a few weeks. Freed from the internet, I lose track of events. What has happened to our fair kingdom in my absence?

Nothing good, it seems. The kingdom is on the verge of breaking up. Scotland wants its independence. It wants to free itself from the oppressive, brutal but democratically elected tyrants in London. Instead, it would rather sleep under the warm blanket of Euro-domination. I will freely admit it. I just don't understand why Scotland would want to trade London for Brussels.

Back in London, opinion polls hint that Boris might lose. I should be happy but I am not. There is something worse than Boris and that is Ken. Why can't they both lose? Because it would mean a Lib-dem victory. Who should Londoners vote for when all the options are so dreadful? I have no advice to offer on this question.

Economic news remains unrelentingly bad. The UK just added a digit to its debt stock. Her Majesty's government now owes over a trillion quid. As far as I can tell, Londoners seem rather nonplussed by that shocking aggregate. It is as if public debt was an abstraction. We know it is there, but we don't really need to worry about it, do we?

I was also surprised to read that British warships are in the Gulf ready to keep the sea lanes open should the Iranians be daft enough to try to close them. Again, my reaction was surprise. I thought we had abolished the Navy in the last round of defence cuts. Military matters usually bore me, but even I know that we need ships to bomb the Iranians. Do we have some kind of secret yet extremely cheap weapon that we can fire from London?

However, the headline of the day has to be a quote from that old fool from the Bank of England - Mervyn King. There is no reason to despair he counselled. All crises come to an end. So the country is about to break up; the capital can't decide which idiot to have as a mayor, public sector debt is rising out of control, and our government is threatening to go to war for the third time in a decade.

Despair? I am well beyond despair. I need to get back on the Costa Concordia.

I'm Back

So what did I miss?

Looking forward to the New Year? Thought not....

Enjoy the holidays. It is the calm before the storm. The New Year will herald the end of Europe as we know it. Next year will be the most traumatic for the continent since the end of the war.

Europe has accumulated an astounding list of problems. It is almost certainly in a recession, and it has not yet   recovered from the last one. Credit downgrades threaten the entire continent. Fitch has warned Italy, France, Ireland, Belgium, Slovenia and Cyprus of a "near-term" downgrade. Moody's has just downgraded Belgium.

The European financial system is on the verge of disintegration. The single currency is close to collapse. European banks are desperately scrambling for cash. The inter-bank market has stopped working. Banks are reducing their exposure to sovereign debt, making it harder, if not impossible for governments to finance their huge fiscal deficits.   In January alone, Eurozone governments need to find €80 billion just a rollover their existing debt and keep the lights on.

Living standards are declining everywhere. Unemployment is rising, and inflation is creeping upwards. European politicians seemed overwhelmed and unable to develop any credible responses to the mounting crisis.  There are ominous signs of unrest across the continent.  Europe feels as if it is ready to explode.

Nick Clegg - Hero

With a single phone call, Deputy Prime Minister routed the French. He castigated the French Prime Minister Francois Fillon, telling him that his remarks about the UK's credit rating were "unacceptable" and that steps should be taken “to calm the rhetoric”.

Following the telephone conversation, Le Monde reported the following "communique" from the Hôtel Matignon:

"Prime Minister Francois Fillon on Friday called the Deputy Prime Minister of Britain, Nick Clegg, to clear up misunderstandings after his statements describing economic developments in Britain as “alarming". The Prime Minister ”would not want to adversely affect the credit rating of the UK," said his spokesperson on Friday."

Mr. Fillon had earlier said "nos amis britanniques étaient encore plus endettés que nous et avaient un déficit plus élevé". Loosely translated, Britain is as screwed as France.

So well done, Mr. Clegg for delivering victory over that capricious enemy from across the English Channel. I sense national renaissance and economic recovery will quickly follow.

Despite being carried away with patriotic fervour following Mr. Clegg's victory, I still have one nagging thought, who was right on the substance?

Corporate borrowing continues to contract

Quantitative easing was always sold as a strategy for supporting the UK economy. Bond purchases by the Bank of England would lower interest rates, and encourage credit growth and ultimately investment.

Quantitative easing has been an utter failure. Corporate sector bank lending slowed sharply with the onset of the crisis. Since 2009, private sector credit growth has been negative, which is equivalent to saying that firms have been paying their loans back.  Furthermore, recent data provides no support whatever for the view that the corporate sector will again begin to borrow.

In a recent financial stability report, the Bank of England addressed this issue with some rather cute language.

"In the United Kingdom, bank lending to companies remained weak in 2011 Q3. In the case of larger companies, this contraction seemed to reflect weak demand for credit rather than credit constraints."

The Bank of England didn't address the question why firms were not keen to take out new loans. Well, I can provide an explanation. Rather than stabilise the economy, quantitative easing creates enormous uncertainty about the future. Firms understand the relationship between monetary growth and inflation. They see negative real interest rates, and expect massive macroeconomic instability in the future. This discourages them from investing, which in turn depresses growth.

Quantitative easing is not about promoting economic growth, it is about providing cheap credit to the government to fund its deficit. It is about providing subsidised liquidity to the banking sector. It is about penalising savers in order to subsidise borrowers.

The issue is not whether quantitative easing works. The last two years of economic data has decisively resolved that question. The real issues are how much longer the Bank of England will continue with this insane policy and how much long-term damage quantitative easing will do to the UK economy.

Shoot my neighbour, don't shoot me

Christian Noyer, the governor of the Bank of France was misrepresented in the press yesterday. Several UK newspapers gave the impression that he thought that the UK deserved to lose its triple A rating.

What he actually said was that French economic fundamentals were sufficiently strong to avoid a downgrade. Moreover, if France were downgraded, then a British downgrade should also follow. To support his argument, he pointed out that compared to France the UK has a higher deficit, a roughly comparable debt stock, higher inflation and lower growth.

Mr. Noyer's comments are accurate. UK macroeconomic numbers are slightly worse than those in France. In fact, economies across Europe are performing abysmally. It doesn't much matter whether a country is inside or outside the euro, economic growth is slowing rapidly and a continent-wide recession looks very likely for the first half of next year.

What makes France more vulnerable to a downgrade is not primarily its weak macroeconomic performance. Rather, it is because it belongs to a monetary union that includes several countries that cannot finance their fiscal deficits. To counter this lack of financing, France is moving closer to a fiscal union. The expectation is that France would have to use its own fiscal resources to bail out its neighbours. This will place a massive burden on the already weakened French economy.

In contrast, UK is not encumbered by the financial problems of its weak and feeble neighbours. Notwithstanding the impending European recession, it is better to be outside the euro right now. Unfortunately, there are no orderly exit strategies from the single currency. Once inside the euro, countries are trapped. Any attempt to leave would bring the whole Eurozone system down.

Thus, it seems, that Eurozone was one of those things that countries joined in haste, and now can repent at their leisure.

How to sell a garden shed for a million pounds

A man wants to sell his decrepid old shed at the bottom of his garden.  He calls in an estate agent and tells him that he wants to list it for a million quid.  The estate agent realizes that this is a mad request and refuses to list the shed.

A week later, the man calls into the estate agent and tells him "I managed to sell my shed to my neighbour for my asking price of one million pounds".

"How did you manage that?" asks the extremely surprised estate agent.

"He gave me two gardening magazines worth half a million quid each".

The BoE misses their inflation target (again)

The latest UK inflation number came out a few days ago. Unfortunately, I was too carried away with Cameron's historic stand against EU encroachment to pay any attention. The number fell slightly but a single snow drop doesn't mean that we will shortly be able to ski down Oxford Street.

UK inflation is the highest amongst the advanced economies. Since early 2005, inflation has been above target for all but three short periods amounting to 12 months out of a possible 77 months. More bluntly, over the last six years, the Bank of England monetary policy committee has met its mandated target in just 15 percent of the time. 

In normal circumstances, inflation occurs when an economy is operating above capacity. However, the UK has been operating massively below trend since 2008.  Why have prices increased while output has stagnated and unemployment increased?

The  thing that resolves this conundrum is quantitative easing.  The Bank of England has been printing money, which has driven up prices.  QE has also generated negative interest rates, which creates enormous uncertainty that in turn discourages investment.  Why would a firm build capacity today when there prospects of more inflation induced macroeconomic instability is on the horizon? 

QE isn't working.  We know this because the data tells us so.  It is time to try something different.

It is not a level playing field

China has decided to impose punitive duties on US car imports. The Chinese commerce ministry has decreed that US car manufacturers are guilty of trade dumping. The duty hike will range from betwen 2 and 21 percent depending on the size of the imported car engine.

Perhaps it is time for the US to retaliate. I wonder who would win that contest?

When?