Monday 30 April 2012

UK tax collections lower in 2011 than in 2008


Whether we tax the rich more or punish the poor, one thing is clear, HMRC collected less revenues in 2011 than it did in 2008.

The economy is smaller, of course. Nevertheless, the New Labour tax cuts - the 2 percent VAT reduction, the stamp duty holiday - also hindered collections. Moreover, these policies did little to restore growth. New Labour's enduring legacy was to dig a big fiscal hole and push the economy into it.

When the coalition arrived, these tax cuts were largely reversed. Revenues have recovered somewhat, but expenditures have continued to grow. The deficit remains dangerously bloated.

The big question is whether we can realistically return to the collections levels of 2008. Back then, the economy was buzzing as mortgage equity withdrawal and rising household indebtedness boosted up consumption. This pushed up VAT receipts and customs duties. Home sales were also higher, generating large stamp duty receipts and higher capital gains tax. The economy was growing nicely. With higher profitability, firms were paying over lots of corporate income tax.

The housing boom has gone, and despite near zero interest rates, the Bank of England has failed to revive property prices. Thus, it seems we are stuck. Tax revenues appear to be permanently lower.

This permanent revenue loss points to need for an equal adjustment on the expenditure side. Yet, we seem reluctant to embrace this new reality. There is this vague and ill formed idea that if only we could tax more heavily the ephemeral one percent of rich people, then our fiscal problems would disappear.Taxing the wealth is never easy. Our complex tax legislation offers ample opportunities for avoidance, and that isn't going to change anytime soon.

Populism will not resolve our fiscal difficulties. We have to look to fundamental expenditure reform. We need to re-prioritize, and reduce expenditures.

It will be a painful and divisive adjustment.

Ireland's ghost town



Here is a grim little home video, showcasing a half completed housing development in Ireland.

Imagine if you bought into this estate at the peak of the bubble.

(I picked this clip up from the south of dub blog).

Somebody stop Ken; he will wreck London's public transport system

The London mayoral election comes down to a choice between two clowns. The options are so awful that I can't make my mind up. Ken's cynical promise to cut bus fares might be the decider.

There is an income statement behind London's public transport system. If Ken reduces fares, then the lost revenues have to be made up elsewhere. Ken suggests that the fare reduction can be paid by using TfL's operating surplus. For those unfamiliar with this accounting concept, the operating surplus does not include any adjustment for capital depreciation. In simpler terms, Ken will pay for the fare reduction by using up the funds used to buy new buses.

That will work over the short run, but it is an extremely unattractive transport policy. Over time, the lack of capital investment will lead to a more unreliable service. Ultimately, Londoners will be paying next to nothing for a bus service that doesn't work. In a word - socialism.

Ken and his transport wrecking flunkies will argue for fare reductions in terms of poverty. Poor people need cheap transport. Well, poor people need lots of things; why not subsidize bread, Walkers crisps or Diet Coke? What about the poor people who cycle rather than use the bus, or those that walk to the shops. How do they benefit from this poorly targeted welfare scheme.

Ken's transport scam epitomizes all that is wrong with welfare in Britain. It is poorly targeted. Large numbers of middle class people, who can fully afford to pay, will benefit. Many poor people will miss out completely. It is financial vandalism. The scheme isn't properly costed out. He will use the resources needed for investment to pay for current expenditures. It is politically cynical. The fare cut will wreck the transport system long term in order to give short term political benefit for Ken.

Kim Kardashian meets the President

On Saturday night President Obama hosted the White House Correspondents' Dinner. Kim Kardashian as there; so was George Clooney, Lindsay Lohan, Reese Witherspoon, Charlize Theron, Dakota Fanning, Ivanka Trump, Kate Hudson, Claire Danes, Kevin Spacey and assorted celebrities.

Which brings me to a question; where were the journalists? Actually, I know the answer; they were at home, watching the event on TV. Like every working stiff in America, journalists are having a hard time. Whether they work in TV or in print, salaries are falling, and job security is non existent. Newspaper circulation figures are diving towards zero, and TV viewing habits are migrating to the internet.

In years past, the Correspondents dinner was an insider affair, where hacks met politicians on neutral ground. Today, no working journo could possibly afford the ticket price to this event. Their place has been taken by celebrities looking for another photo opportunity on a red carpet to promote a designer dress.

What is the impact of such an event, with its "A list" of Celebs, on Presidential approval ratings? Superficially, the mix of politics and celebrity looks powerful. However, it reminds me of that "Cool Britannia" theme that Blair worked over during his early years as PM. It looked good at the time, but as his premiership wound down, Cool Britannia was an embarrassment.

It could play out the same way for Obama. These celeb-heavy events make him look detached, flippant and elitist. Out in the heartland, it will play out badly. In electoral terms, hanging out with Kim Kardashian doesn't win votes.

Friday 27 April 2012

Barclays need to communicate better why their senior management merit multi-million pound bonuses.

Today, Barclays issued its first quarter management statement. This statement caught my eye:

Adjusted profit before tax of £2,445m, up 22%, driven by strong performances in both Retail and Business Banking and Corporate and Investment Banking with the non-Investment Bank businesses showing significant growth in adjusted profits.

This PR gold nugget came just two days after the UK Office of National Statistics published first quarter GDP data showing that the economy had fallen into the second recession in four years. Banking sector profits are up 22 percent, while the economy is tanking. How do those financial geniuses in Barclays do it?

Not without massive help from the British state. Barclays are able to borrow from the Bank of England at near zero rates. It then lends this free money to the private sector at much higher interest rates. The differences between its funding rate and lending rate - its spread - is huge. With this kind of state support, any imbecile could make £2.5 billion in profits.

Barclays are not inclined to show any gratitude for this extraordinary generousity. Lacking the merest shred of decency and discretion, it decided to pay massive bonuses to their senior management.

As soon as the bank announced another round of megabuck bonuses a media firestorm broke out. Despite the massive negative publicity and near universal condemnation of the remuneration polices, Barclays were undeterred. Marcus Agius, the chairman of Barclays, explained the issue in the following manner:

"Evidently, we have not done a good enough job in articulating our case: on some matters we should have communicated earlier and more clearly. For this I apologise and I assure you that in the future we will be engaging differently and more purposefully with shareholders in order to ensure that we obtain a broader level of support on remuneration policy and practice."

I have always thought that the PR departments of UK banks lived in a netherworld where the understanding of the real world was, at best, vague and hazy. However, this statement suggests that Mr. Argius lives on a demented fifth dimension. He thinks with a slicker communications strategy that Barclays can obtain a "broader level of support on remuneration policy"

There are some misguided souls who think that the reprehensible misbehavior of Barclays is an indictment of capitalism. I share your anger but not your diagnosis. What we are witnessing here is not capitalism but corporate welfare; a cynical inversion of the socialist ideal, where the state protects and nurtures rich bankers rather than the poor and vulnerable.

I doubt that Mr. Argius or Mr. Diamond really care how this bonus scam looks to the rest of us. The money is in their accounts and not ours. That is all that matters.

Nevertheless, an ominious nightfall is now shrouding this country. The economy is wrecked, and the guilty men remain in control. They think they can conjure up forgetfulness and confusion with a better communications strategy. But you can't spin away five years of economic stagnation. Press releases can not paper over our desperate predicament. It was Banks like Barclays that laid waste to this great country. We all know it, and we will not forget.

Thursday 26 April 2012

Keynesian policies always fail.

The twentieth century produced many pernicious ideas. Keynesian economics may not be the worst, but its capacity to misled governments remains potent. Despite numerous historical examples of abject failure, advanced economies gave Keynes another go in response to the current global crisis.

The results have been dismal. During the current crisis, several countries have blown up their fiscal deficits in the hope that growth would return. All have been cruelly disappointed. Growth has stagnated. In Europe, the consequences of this policy experiment have most damaging. Stimulus efforts carried the single currency to the brink of disintegration. In Ireland, Portugal and Greece, large deficits have brought utter ruin. Spain, the Netherlands and Italy are all teetering on the brink of the abyss.

If it were true that running up a deficit could spur sustainable growth then Greece - with its 16 percent of GDP deficit in 2009 - should have been growing at a stratospheric rate. This point also holds the for UK. Since 2008, the UK has recorded deficits of between 8 and 11 percent; historically unprecedented deficits, and yet the economy has recorded two recessions in four years.

Simply put; higher fiscal deficits are not associated with higher growth rates. This empirical regularity should have been sufficient to deter politicians from engaging in fiscal stimulus. Sadly, it did nothing to deter policy makers from doing something stupid in order to be seen by electorates as doing something.

The boiler-plate justification for a Keynesian policy response is that the economy is suffering from a lack of aggregate demand. This lack of demand requires government intervention in the form of tax cuts, public expenditure increases and rising deficits. The evidence for this lack of demand usually takes three forms; high unemployment rates, a large output gap and falling household consumption.

In the case of the UK, this lack of demand hypothesis is highly questionable. Lets start with unemployment. It is true that the unemployment rate is high, especially so in the case of young people. Yet, we also know that inward migration continues unabated. Many hard working migrants are coming to the UK, finding work, and settling here.

This sits very uncomfortably with the idea that there is a lack of demand for workers. What is true, however, is that many young people prefer to claim benefits rather than take low paid employment. We can argue the merits of this decision, but lets leave that debate for later. The main point is that a high level of measured unemployment does not mean that the economy is suffering from a lack of demand.

Does a large "output gap" - the difference between actual and potential output - imply an lack of aggregate demand? Potential output is never directly observed; it has to be estimated. The easiest way is to look at past growth rates and extrapolate where we would be if the recession hadn't happened. This simple method suggests that currently output is about 15 percent lower than where it should be. In other words, the UK output gap is huge, and therefore there is substantial "lack of demand".

However, if past growth rates were generated by unsustainable activities like huge asset bubbles and massive credit growth, then the post crisis growth slowdown might reflect a fundamental structural change in the economy. Estimating the potential output using past growth will massively over estimate the size the output gap.

There is one very compelling piece of evidence suggesting that the current output gap is actually quite small - inflation. If the gap were large and there were lots of unemployed resources, then there would be downward pressure on prices. Do we see that today? Nope. What we see in the UK right now is the fastest inflation rate in any large advanced economy.

So what about household consumption? What is the story there? It is true that household consumption has been very weak of late. Does that imply a lack of demand?

In a narrow accounting sense it does. Less household consumption means lower aggregate demand. However, accounting relationships tell us nothing about household behaviour. Looking at the way that fiscal policy is behaving right now, with its huge deficits, rising debt and unjustifiable expenditure to GDP ratios, a rational household might think that this unsustainable mix of Keynesian polices can only lead to one place; higher taxes, slow growth and ultimately a massive crisis.

What would a rational household do? It would understand that it will be poorer in the future, and that it would be prudent to cut back expenditures and save more. In other words, the expansionary fiscal polices create uncertainty and risk that lead households to reduce consumption and aggregate demand. Fiscal deficits and higher public expenditures are not the solution, they are the cause of the problem.

There is only one answer to the UK's current mess. The government needs to balance the books; and the sooner the better. This is not to say that the adjustment will not be painful. Make no mistake, there will be short run output losses. However, the sooner the fiscal policy is on a sustainable trajectory, the quicker growth will return.

Keynesian economics is a pernicious idea. Whenever it has been tried, the most it has achieved is a temporary upward blip in the growth rate. Ultimately, it leads to slow growth, higher debt levels, lower investment, and higher inflation. It prolonged the great depression during the 1930s. It failed to jump start growth in Japan despite almost 20 years of pump priming demand. It royally screwed this country in 1970s and it is doing it again today.

Wednesday 25 April 2012

The UK is back in recession; it is time to change course


That is one grim-looking chart. The UK is back in recession. It is almost five years after the collapse of Northern Rock - the event that heralded the crisis - and the UK output is nowhere near its pre-crisis peak. We are half way through a lost decade of growth.

After five years of abject failure, it is time to reappraise policies and change course. The first priority must be the normalization of monetary policy. The Bank of England must raise rates to a the point where they are higher than the inflation rate. That would imply that rates should be at least four percent.  This would, more than anything else, reflect a commitment to exit the crisis and return to some degree of normalcy. It would have a profound effect on expectations.  In contrast, we gain nothing by keeping rates close to zero.

Then, we need to turn to public expenditure. The government needs to be downsized. We must restore confidence in public finances. The coalition have made a start in this direction, but their plans are too timid and the consolidation isn't fast enough. Moreover, we should forget about raising taxes, which will only serve to discourage growth and investment.

The kind of expenditure reductions needed to balance the government accounts are huge.  Therefore, we will need to fundamentally rethink the role of the state.  All options should be on the table; privatizing the NHS, school vouchers, introducing motorway tolls, ending rail subsidies, abolishing housing benefits, and cutting off fiscal support to Scotland.

Third, we need serious welfare reform. We need to provide proper incentives for work. It is madness to have a one in four of our young people unemployed while at the same time importing hundreds of thousands of hard working migrants to do jobs our young people won't do.

Finally, we have to clean up the banks. They need to honestly admit to losses, stop paying unmerited six digit salaries and recapitalize their balance sheets through retaining profits rather than distributing dividends and bonuses.

Without a change in policies, UK output will continue to flat-line.  Do we want another five years of near zero growth?

Tuesday 24 April 2012

A big devaluation, but no export-led growth


The sterling effective exchange rate is one reason why the UK has recorded the highest inflation rate of any advanced economy.

With the onset of the crisis, the Bank of England allowed sterling to depreciate dramatically in 2008-9.

The depreciation was supposed to spur export led growth, and eventually dig the UK economy out of its current hole.

It hasn't happened. Instead, import prices rose, living standards fell, while the economy has flat-lined for almost five straight years.

The one chart that encapsulates recent British economic history


It is a chart that never ceases to amaze me.

Who pays income tax?


I received this chart from Jim. It shows, as he suggested in an earlier comment, that the top 1 percent of wage earners pay 27 percent of all income tax receipts. The bottom 50 percent of earners pay just over 10 percent of total income tax receipts.

Income tax only accounts for just over a third of total tax receipts, so the overall tax burden on the lower 50 percent is higher. Taxes such as excise duties and VAT tend to be highly regressive.

Thanks Jim for the chart. It is much appreciated. If anyone else finds something interesting, please send it to me here.  I am always looking for interesting content for my posts.

Sunday 22 April 2012

A two percent inflation rate by the end of the year? All things are possible...


The Bank of England produced this intriguing chart in their most recent inflation report.

The chart illustrates their current assessment of the likelihood that the Bank will meet its two percent inflation target (the dark purple line).

Since the current rate is well above the target, it is a near certainty that it will miss the target in the near term. Hence, the probability is close to 100 percent.

Looking forward, the bank think inflation will fall sharply, such that by the end of the year the Bank thinks that there is 50 percent chance that the target will be met.

The chart also shows the Bank's assessment from November last year. Notice that the bank was more confident of a sharp decline of inflation back at the end of last year than it is now. The light purple line, representing the November expectation, is below the dark purple line, representing the current expectation.

The most recent inflation number rose "unexpectedly". It was yet another "unsurprising" inflation surprise. This is consistent with the grim reality that the Bank has misjudged the post-crisis potency of inflation.

Will the Bank make the 2 percent target by the end of the year? All things are possible, but when our central bank has produced almost a third of a trillion quids worth of new money, you got to wonder about a 50-50 chance.

Friday 20 April 2012

In Britain, only the little people pay taxes

The New York hotelier Leona Helmsley once famously said that "only the little people pay tax". For speaking this great truth, Leona was audited by the US revenue service. They found out that she claimed deductions on furniture that she purchased for her home. She ended up in jail for tax evasion.

I was reminded of Leona when I read a comment on one of my recent posts. The reader claimed that one percent of the rich paid around 27 percent of UK tax revenues. So who is right? The reader who left the comment or Leona?

Personally, I am with Leona. To understand why, we need a quick dip into the structure of UK tax revenues. In fiscal year 2011, HM Revenues and Customs received £419 billion. Did a small group of high earners contribute over a quarter of this amount?

Let's start with the one tax where we can identify the underlying income distribution - income. This tax accounts for £153 billion of total revenues. That is only a third of all taxes. The super rich aren't paying huge amounts of income tax. After all, the wealthy aren't on an hourly wage. Moreover, only a tiny minority of income tax payers earn over £500,000 a year. That might be a comfortable salary, but it doesn't put the recipient in the same league as Warren Buffet.

There is a second wage based tax - national insurance contributions or NIC, from which the Treasury picks up another $96 billion. However, NIC has an earnings cap. So, the super wealthy aren't paying significant amounts of PAYE or NIC.

What about the underlying income distribution of people paying all the other taxes? Can we say how much these taxpayers earn? I don’t think so.

Corporation tax is another big tax revenue earner. This tax, by definition, is not paid by individuals. It is paid by firms. The "one percent pays 27 percent" can't apply here.

VAT is another big one. This tax is levied on consumption and it comprises of 20 percent of total revenues. The "one percent" is definitely not consuming 27 of GDP; the underlying tax base for VAT. So, I reckon the claim fails here too.

Then we have the naughty taxes, or as I prefer to call them, morality taxes; duties on tobacco, wine betting, fuel, air passenger duty and so on. These taxes raise about £50 billion. Again, it isn't the one percent who are consuming a quarter of the countries' beer and tabs. It is ordinary individuals.

So, how much tax does the one percent actually pay. In terms of a precise number, I suspect no one really knows. If anyone tells you that they do know, ask them where their number comes from. If it is from a survey, then laugh loudly. When it comes to disclosing income and tax payments, people routinely lie in surveys.

Notwithstanding this difficulty, it is hard to see how the one percent could be paying a significant amount. The tax system relies very heavily on consumption taxes - VAT, duties, excises. Ordinary people - not the rich, who are paying those taxes. As for income based taxes - income tax and NIC - very little revenue is generated from the highest earners. There is a very simple reason for this; the rich don't become rich because they receive wages. They become rich through the acquisition of assets and asset-appreciation. That kind of wealth creation is out of the reach of the UK tax system.

If the rich aren't paying then who is putting up the bulk of the cash to keep Her Majesty's Government running? It is the middle-classes that pay the bulk of income tax and national insurance contributions. It is people earning between £50,000 and £150,000 a year and buys lots of stuff to generate VAT.

Leona has sadly long since passed away.To digress slightly, I don't think she was the monster she was painted out to be, but that story is for another post. Nevertheless, her words are immortal; they live on. The principle holds true in the UK. We don’t know precisely how much the rich pay in taxes, but we know they don’t pay much. The responsibility for paying taxes is left to the little people.

Thursday 19 April 2012

March Inflation - another entirely predictable surprise

According to the UK press everyone was surprised by the March inflation number.

It was a bad one. CPI annual inflation – the Government’s target measure – was 3.5 per cent, up from 3.4 per cent in February. Meanwhile, the more accurate retail price index increased by 3.6 per cent compared to the same month last year.

Why would anyone be surprised by rising prices. The Bank of England has printed a third of a trillion in cash. At the same time, GDP is declining. Think about that for a moment, more cash and no extra output.

That must mean more money chasing fewer goods. Only one thing can happen in a situation like that. Prices go up, which is exactly what happened.

The surprising thing is that people are surprised.

A quick primer on the US Healthcare issue



Coverage of this issue in the UK media is abysmal. This video provides some interesting insights into the healthcare debate across the Atlantic

Tuesday 17 April 2012

Don't pick on the rich; why ordinary people should pay more tax

The rich should pay more tax. I bet you haven't met many people who would disagree with that statement. Even our so-called Conservative Chancellor has recently complained about the lack of revenues coming from the nation's wealthiest individuals.

The problem is how to get the rich to pay up.

There are four great truths about the wealthy. They explain why the principle of taxing the rich will never form the basis of our tax system.

First, rich people own stuff, like companies and land, and over time these assets becomes more valuable. They don't receive wages. Taxing capital appreciation is very hard. Revenues can only be realized when the rich sell their assets, which the don't do very often.

Second, rich people often borrow large amounts of money to buy valuable assets that generates more wealth. Moreover, they use the assets they already own as collateral. Very few people became wealthy without first becoming heavily leveraged. In contrast, poor people have no assets, can't borrow and therefore remain poor.

Leverage also helps reduce tax burdens. The rich, through the companies they own, can use interest payments reduce their taxable income. Leverage also dramatically complicates tax arrangements and this confusion always favours the rich. A clever well-paid accountant, with their interest deductions and write-offs, will always outmaneuvers a poorly paid tax inspector.

Third, globally they are footloose. They may choose to live in London today; New York tomorrow, and Mumbai the day after that. If the tax rate in one country is too high, they move to another country with a lower rate.

Fourth, wealth buys political power. With pliable politicians, the rich influence the tax system, creating complicated loopholes, and as we already know, a confused and badly drafted tax system facilitates tax avoidance.

Taken together, this means that the rich are never likely to be the primary source of taxation. Over time, our tax system has come to reflect the inherent difficulty of getting the rich to pay more. Just look at tax revenues. Value-added tax and income tax are the two main pillars of our tax system. The burden of both taxes fall heavily on ordinary individuals. These two pillars are supported by resource taxes, for example those levied on North Sea oil, and penalty taxes, such as those levied on smoking, drinking and gambling. Wealth taxes contribute only a negligible amount to overall revenues.

Bereft of any easy pickings from the wealthy, the UK tax system essentially takes money from the middle-class through income tax, and from everyone through consumption taxes like VAT. Taxes are mostly a middle class affair.

The distributional aspects of government expenditure and more complicated. Some expenditures are directed towards the poor, such as unemployment benefit. Other public expenditures, such as health and education, are enjoyed by the poor; the comparatively well-off; and everyone in between.

This leads us to the irresolvable tension embedded in our system of public finances. The wealthy have largely exited the system, both in terms of being beneficiaries of public expenditures and in terms of paying taxes. The middle classes receive extensive benefits from system and pay heavily for it, in terms of income and consumption tax. They would like to see their tax burden is reduced, but they don't want to endure any expenditure cuts. The poor pay only a marginal amount of taxation, largely through VAT, but they receive significant benefits from public expenditures. They want to see more public expenditure and are indifferent to the tax burden.

This means that there is always a coalition to keep public expenditure high, in some cases, to increase it. The number of voters who want to reduce taxation is always in a minority.

So public expenditure just keeps on rising, and taxation fails to keep pace. How does the government make up the difference? It borrows. It passes the burden of paying for current public expenditure on to future generations. They are utterly disenfranchised since they don't vote and in many cases have not yet been born.

It is a dishonest system, and this is where the rich become very useful. It allows everyone to conjure up a solution that superficially seems plausible. The rich have more money; therefore they should pay more taxes. If it were that easy, it would have happened already.

The harsh truth about UK public finances is that the people who benefit from it also have to pay for it. That means us. If we want less tax then we must have lower expenditure. If we want to stop burdening future generations with large debts, then revenues must equal expenditures.

So forget about the rich. They live in a different world. They don't get much out of our current system of public expenditures. They have no intention of paying more. They have ample means to avoid tax.

The rest of us must pay. That is how it has always been, and it will never change.

Monday 16 April 2012

Sterling devaluation; it made things worse in Europe and did nothing to help the UK economy


The Economist recently produced a chart linking the interest rates on ten year government bonds with the net external borrowing a country had previously undertaken. (This external borrowing was captured by the net international investment position. Countries both borrow and lend so obviously the net position is the key thing).

The result is pretty stark; countries that borrowed the most abroad - Ireland, Portugal and Greece - have all found themselves shut out of international capital markets. By this metric, Spain also looks vulnerable. The UK, in contrast, looks safer. So does Italy, the US and Germany.

If only the world were that simple and that we could explain the recent crises in Europe purely in terms of too much external borrowing. All the countries currently paying high yields are also members of the eurozone. These countries, by definition, do not have an independent monetary policy. The high yields could be picking up their lack of policy options in the face of huge economic shocks.

The UK also borrowed heavily before the crisis. Once the crisis exploded, it made full use of its monetary independence. Sterling devalued sharply. This significantly reduced our net international investment position. We took investor's money when the value of sterling was high; we will pay them back at a lower exchange rate.

In economic terms, a devaluation works in much the same way as a default. Creditors not debtors take the hit. Before we start crying a river of tears for for our mistreated foreign investors,buying foreign assets entails foreign exchange risk. Those foreign investors knew this when they took a gamble on the UK economy and invested here.

Nevertheless, all over the world, foreign investors took a major hit when sterling dropped 25 percent. Some of those losses are sitting on European bank balance sheets. These losses would have translated into write-offs and generally inhibited the recovery of the European banking system.

This is not to say that the sterling devaluation is the primary cause of Europe's current stagnation and torpor. Europe has a multitude of problems, and the current value of sterling is pretty low on the list. Nevertheless, the Bank of England's post-crisis devaluation made a bad situation worse. The sterling devaluation did no favours for our friends on the continent. It made their exports more expensive and reduced the value of their investments.

The Europeans can take some comfort from the fact that the devaluation did nothing to help the UK economy. Exports haven't really benefited from the lower value of sterling. Import prices rose sharply; the UK suffered the highest inflation rate of any advanced economy. The recovery after the recession was slower than any other recorded downturn. In real terms, the economy is still about 4 percent smaller than it was in 2007. In summary, the devaluation was a complete failure, like so much of the post-crisis policy response.

Still, the UK appears to be on the right side of the Economist's little chart. HMG has not yet been shut out of financial markets like the eurozone periphery. Our yields are low and our net investment position is unremarkable by international standards.

Before we breath a collective sigh of relief, there is iron law in economics; as soon as stable relationship between two variables, it falls apart.

Is the UK safe? Just wait and see.....

Sunday 15 April 2012

Dumb question

The ECB and the Bank of England are giving out loans to banks at near zero interest rates.

Why can't I have a loan like that? Why can't you? I could use it to pay down credit card debt, or invest in high interest risk free Italian and Greek bonds. I have collateral to offer. I have a TV, and a car. I can't imagine that these assets are any less risky than those taken by the ECB or the BoE to support loans to ailing European banks.

Why should banks receive such preferential treatment from Europe's central banks?

Of course.....I know the answer.....

Saturday 14 April 2012

European youth unemployment rates


In relative terms, there aren't that many young people in Europe. It is, after all, rapidly becoming a global old people's home.

Nevertheless, the continent's youth are finding it hard to find work. In Spain and Greece, half of all under-25s are unemployed. In Britain it is one in four. Everywhere except Germany, the youth unemployment rate is in double digits.

Just one more datapoint tracking the decline of this once great continent.....

The age of debt


Debt accumulation - all the eurozone countries are at it.

How long can Europe continue to build up their public indebtedness? Not for much longer.

Friday 13 April 2012

When does the great Spanish bailout begin?

Over the last five months, the European Central Bank has undertaken one of the greatest financial sector bailouts in human history. Through its obscurely named LTRO facility, it has lent out over a trillion Euros to beleaguered European Banks at extremely low interests. In turn these banks have used part of those funds to buy government bonds.

Everyone seemed happy. The banks have cash, which they can use to buy higher yielding assets. The governments can continue to run large fiscal deficits, relying on the banks to provide the necessary funding. Actually, it looks a lot like a victim-less crime.

The problem is that the scam isn't actually working. Interest rates on Spanish bonds are now around 6 percent; close to the point where Ireland, Portugal and Greece got their big bailout packages. Italian interest rates are also on the rise. Even some of the northern European countries are starting to wobble. Is it so hard to imagine a moment where France joins Italy and Spain in the great 21st century bond market shut out? Actually, it looks very likely if the French elect a Socialist as President.

The European crisis is in transition. It started by testing the weakest and smallest countries in the EU. In the early days, European institutions confidentially handled the bailout when it was just Greece with their hands out looking for cash. When Ireland and Portugal sank, it exhausted all the available EU bailout money. The crisis is now looking to devour larger dishes. There is no bailout money left in the EU coffers for the big basket cases like Spain and Italy.

The Spanish Prime Minister confessed to the limited options for an EC-led bailout. He summed up the situation starkly "To talk about a bail-out for Spain at the moment makes no sense. Spain is not going to be rescued; it's not possible to rescue Spain, there's no intention to, it's not necessary and therefore it's not going to be rescued."

If Spain can no longer borrow from the market at reasonable rates, then there is only one institution that can prevent a meltdown - the ECB. When the shut out begins, Europe's central bank will have a terrible choice to make. Either it lets Spain slide into the abyss or it begins another bailout operation.

Assuming Spain is rescued then Italy will not be far behind. In order to successfully provide enough resources to fund the combined fiscal deficits of five major EU countries, the ECB will have to produce astronomical amounts of liquidity. When this happens, the ECB will have lost control of monetary policy. Its credit creation policies have become subservient to the fiscal decisions of hard pressed Southern European politicians.

Some optimistic souls think that this will all work out without any inflation. European economies are mired in recession and that there will be no pressure on prices. Oil prices seem to think otherwise. Furthermore, inflation is beginning to pick up in Europe. It is low at the moment, and superficially in seems containable.

Once the inflationary spiral kicks off, all kinds of crazy things start to happen. I know, it is hard to see it today, but monetary policy operates with a long delay. Just wait; but 2014, when inflation and recession are raging across this dying and moribund continent we will be lamenting the terrible decisions taken to save Italy and Spain during the summer of 2012.

Thursday 12 April 2012

What would HMG have down without the BoE?


The UK government has issued over a trillion quids worth of debt. That is about £17,000 for every man, woman and child in Britain.

Would the government managed to issue that extraordinary figure without the Bank of England (the green component in the chart above)? I don't think so.

UK recovery weaker than in the US


The UK economy hit the bottom of the recession two and a half years ago, i.e 10 quarters ago. During the first four quarters, the economy recaptured about 3 percentage points of lost GDP. Thereafter, the recovery stalled.

Reasons? The crisis in Europe has dragged the UK economy down

What is that phrase the Euro-centralizers use? Ah yes, "ever closer union". We have tied ourselves to a corpse.

Debt race


I found this shocking chart on Al Fin's blog.

This chart encapsulates why western civilization is in a terminal crisis.

Wednesday 11 April 2012

Vibrant Europe? Dying Europe

Today, I received in my inbox a press release announcing the creation of a new European movement, titled titled the Vibrant Europe Forum.

The press release started with this inspiring paragraph:

Thirty high profile representatives call for action to turn an increasingly weary Europe into a ‘vibrant’ Europe by means of a declaration signed in Maastricht’s Castle Vaeshartelt. The commitment was unique in that key individuals from all walks of life, generations and countries far beyond the confines of Europe came together around their commitments to have European citizens’ voices heard. CEOs of multinationals, world leading academics, activists and politicians from various parties, including the Social Democrats, Greens, Liberals and Christian Democrats, agreed to pressure their constituencies on behalf of their societies and act as change agents with a view to make a lasting difference at the European elections of 2014.

Herein lies the paradox of Europe. Thirty self defined Euro-elites set themselves up as spokespeople for 350 million Europeans. They come together to have, as they grandly put it, "to have European citizens voices heard".

Press release tells us that this group comprises of just four occupations; CEOs, academics, activists and politicians. There were no tinkers, tailors soldiers and sailors ready to speak up for a vibrant Europe. Other workaday occupations were also missing; there were no doctors, nurses; carpenters, bricklayers, or shopkeepers. The bankers and other assorted criminals were not present when this self appointed group signed its declaration of principles.

This group of thirty representatives may be highly unrepresentative but that doesn't stop them from their self appointed task of making a "lasting difference", becoming"change agents", allegedly acting on "behalf of their societies".

This is the story of Modern Europe. A small group of Euro federalists believe that they know what is best for the rest of us. After 40 years of bureaucratic manoeuvring and deception they have created a quasi-European state. They have also brought a continent to the brink of disaster. Their regulations has crippled our economies, their financial bubbles have destroyed our savings, and their treaties have robbed us of our sovereignty. Their single currency has laid waste economies of southern Europe, unemployment is rising everywhere, while economic growth is virtually non-existent.

Vibrant Europe? Dying Europe would have been a more appropriate title for their elitist forum.

Tuesday 10 April 2012

When will the bond price bubble burst?

Back in those crazy hazy days of the housing bubble, the quickest way to becoming a social leper was to suggest that property prices were overvalued. People didn't like to hear that their three-bedroom terraced homes might not continue to effortlessly and indefinitely generate wealth. In many cases, homeowners could becrangengry by an innocent comment like "house price inflation can't rise at 20 percent a year while incomes are growing at only three percent"

I was always staggered by the number of casual conversations one would hear in public about house prices. When I was in restaurants, my favourite and perhaps intrusive pastime was to earwig into conversations to see when people started to blather on about how much wealth was now embedded in their property. It was almost guaranteed that it if two middle-aged couples were together it would only be a matter of 15 minute into the starter before the great British conversation would begin.

Those were glorious days for homeowners. Walking along the High Street estate agent was a very comforting activity. The windows would be full of adverts blaring out six-figure numbers telling you that your net worth had just increased by 10 percent since Christmas.

It wasn't so much that people could not conceive that prices would crash. Many older homeowners remembered the early 1990s. Rather, the evidence kept contradicting any competing claim that prices were overvalued. London property prices looked overvalued in 2003, but then the increased sharply in 2004. The market looked overvalued in 2004; but along came 2005 proving that the top of the market had not yet been reached. With each passing year of double-digit inflation, it was harder to win an argument suggesting that home prices were richly priced. Arguments in defence of rising prices became circular; property will continue to appreciate because everyone expects it. Because everyone acts on that expectation, prices increase, confirming the initial expectation.

It wasn't just circular expectations that kept the fire burning. Fear played its part. People were afraid of missing out or being left behind. Moreover, it wasn't a groundless fear. Far too many couples found their dreams of homeowner ship shattered by the extraordinary pre-2007 house price inflation.

Then along came Northern Rock.....the rest you know.....

These days, it is hard to find anyone who didn't see the crash coming. Over the last four years, I've yet to find a single person who would admit to being genuinely surprised by the post-NRK collapse in UK property values.

There is a rough and imperfect parallel between the Blair-Brown housing bubble and today's UK government bond prices. Objectively, everyone senses that something is not quite right. The government is running up huge deficits, and the Bank of England is printing money to fill the gap. Yet today's bond rates do not reflect the strange and almost certainly unsustainable current policy regime.

Since bond prices are low today, despite massive deficits, then why can't they continue to be low indefinitely? If bond rates remain low indefinitely then what is the problem with large deficits? This is the logic that prevails within the Bank of England. There is no problem because everything is fine today. If it is fine today, then it must be fine tomorrow

But this is the problem with economic crises. We are lulled into a false sense of security. Asset valuations may go awry, but so long as there are no upfront economic costs, people see happy to go along for the ride. Then there is the correction and before you can say "I need a bailout", everyone is blaming someone else for the ensuing disaster.

UK government bonds seem mispriced. The question is when will the bubble burst? This year? Next year? Or in five years time? Whenever it happens, I can assure you that afterwards everyone will tell you that they saw the crash coming.

Monday 9 April 2012

Debt Management Office CEO voices concerns about quantitative easing

The CEO of the UK's debt management office - Robert Stheeman - is very concerned about the Bank of England's quantitative easing.

In some respects, the story surprised me. On reflection, I couldn't think of any other public official voicing who had suggested that there was something amiss about the £325 billion worth of funny money created by the country's central bank. I thought that QE was shrouded in a conspiracy of silence and that only highly marginalised bloggers like myself could liberally question the policy.

Mr. Stheeman willingness to speak out suggests that concerns about UK macroeconomic management is now starting to have a resonance within policy circles. The UK is now in its fifth year of stagnation and there is no end in sight to either the BoE's money creation scam, nor the government's reckless spendfest.

Mr. Stheeman's is worried that quantitative easing distorrts the country's debt markets. The Bank of England now owns almost a third of the UK's government debt stock. Superficially, that might seem like one arm of the public sector borrowing to another. It might also lull others into thinking that if the debt is held by the Bank of England, then in some vague way, it doesn't really matter, since it is not held by the private sector. Not true. The increasing domination by the Bank of England for government debt market is extremely perilous.

To see why, think for a moment what would happen if the government was running up those huge deficits and the BoE wasn't around to help. The Debt management office would have to issue huge amounts of debt to the private sector, who would have to be persuaded to hold it. The only way that they could be persuaded would be if interest rates increased. This will increase the government's debt servicing costs and if the borrowing continued the government reach a point in which debt sustainability would come into question. Or to put it more bluntly, bond holdres would begin to doubt that the government could repay its debts.

This brings us to the real purpose behind quantitative easing. Instead of relying on the private sector to finance the government's huge deficits, the central bank issues newly created money to cover the shortfall. It does this by buying bonds from banks, who then go and buy the newly issued bonds from the debt management office. Moreover, this newly-created money also keeps interest rates down.

This may seem like a wonderful risk-free solution to the country's fiscal deficits; the government runs up big deficits and interest rates remain low. It is true that over the short run quantitative easing will allow reckless fiscal policies and keep interest rates down. The counterpart to the BoE's bond buying activities is cash. If the central bank prints money but eventually there will be inflation. In the case of the UK this has, to some extent, already happened. We have the highest inflation rate of any major advanced economy.

Inflation is a thing that bondholders fear above all other risks. It destroys the real value of their investments. The UK debt management office know that if bondholders start to believe that inflation is going to rise, then they will start to dump UK debt.

The problem for the debt management agency is that this could happen any time. All it would take would be for a comparatively small number of bondholders to become frightened and start to sell their bonds. Interest rates would quickly rise, sending a signal to other bondholders that the game is up in the UK. Before you can say, "UK government is solvent and there's no reason to panic", the bond market implodes and bondholders are running towards the fire exit.

On a net basis, it appears that the private sector is unwilling to hold higher levels of government debt. Another round of QE might prove to be very destabilising in terms of bond-holder expectations. An announcement from the BoE that the economy needs yet another surge of money creation might be the detonator that blows up the UK government bond market.

Saturday 7 April 2012

It is time to end the era of policy extremism

Britain is now in its fifth year of economic stagnation. Since the Northern Rock failure, and the beginning of the financial crisis, there has been the occasional quarter of positive growth, but the uptick have been invariably followed by disappointing quarters of flat or even negative growth. UK GDP is still about 4 percent lower than it was at the end of 2007.

This recession is unique. Over the last century, the UK has suffered periodic downturns, typically about once a decade. But there was always the robust upswing, usually within two years of the initial crash. But something is different this time. The economy seems stuck and unable to recover.

We are by no means alone in experiencing this strange era of stagnation. Growth has disappeared throughout Europe. Across the Atlantic, the US economy is doing little better. This week's US employment numbers were extremely disappointing. For the last two decades, Japan has been trapped in the dead pool of near zero growth.

Nevertheless, one shouldn't think that stagnation is a global event. Asia, Latin America, and even Africa are all enjoying robust growth. The global crisis is really a problem for advanced economies. The rest of the world, more or less, is doing just fine.

There is a second perhaps more important distinction between emerging and advanced economies. The emerging economies are playing a very straight game in terms of macroeconomic policy management. In Europe and North America, governments and central banks are pursuing what is become euphemistically described as an unorthodox policy measures. Central banks have pushed policy rates close to zero. They are also pumping out huge quantities of cash, primarily into the balance sheets of stricken banks. Ministries of finance are borrowing huge amounts of money to finance historically unprecedented gaps between tax revenues and expenditures.

The justification for these extremist policies is that they prevented an apocalyptic meltdown. Central bankers and finance ministers tell us that without negative interest rates and double-digit deficits economies in advanced countries would have collapsed. A desperate time needed desperate measures.

With each passing quarter, this hypothetical apocalypse grows larger. An obvious lesson might be that quantitative easing,and rapidly accelerating debts might not be the right strategy for sustained economic growth.

That is a very uncomfortable conclusion. There are far too many politicians and central bankers who are now deeply compromised by these policies. To reverse the strategy and return to more sensible monetary and fiscal policies would be to admit that the policy extremism the last four years was a dreadful and unforgivable mistake. Therefore, there are strong incentives to exaggerate the magnitude of the 2007-8 crisis.

Nevertheless, the question remains how do we get out of this policy quagmire. Everyone understands that at some point interest rates will have to rise and that deficits will have to fall. However, everyone understood this back in 2008 and when interest rates were slashed and deficits ramped up. Everybody also thought that by 2012 everything will be back to normal. Yet here we are. Growth is still basically zero, and the macroeconomic policy framework is a total mess.

Where will we be in another four years? Will the BoE still be operating their quantitative easing scam, along with negative real interest rates? Will the government continue to run up massive deficits? Personally, I don't think so. Things have to change. If nothing else, debt levels cannot continue to grow much beyond their current level. This is what southern Europe discovered over the last two years. Sooner or later, bondholders say no and walk away. Eventually, creating money to fund deficits leads to uncontrollable inflation.

There are limits to policy extremism.

Thursday 5 April 2012

UK house prices increase by 2.2 percent in March


What do you think? How much attention should we give to the latest Halifax housing inflation index?

The increase in March was impressive - 2.2 percent compared to the previous months. Then again, prices fell by 0.4 percent in February. As the chart above illustrates, there have been many false dawns for the UK property market.

Nevertheless, our dear old central bank is doing its best to pump up the market. Policy rates are still at 0.5 percent.

With interest rates at an all time low, it has never been a better time to buy! Or is it a better time to sell? Maybe you should hold, things could get better in a year. Or perhaps things will be worse. Alternatively, renting could be the way to go.

Take the advice you want to hear, and I hope it works out.

Tuesday 3 April 2012

I thought it was a joke

I woke up on Sunday, ready for the usual April 1st stories in the newspapers. I checked out the Telegraph and thought I spotted an early one...

Internet activity 'to be monitored' under new laws

Ministers are preparing a major expansion of the Government's powers to monitor the email exchanges and website visits of every person in the UK, it was reported today

Under legislation expected in next month's Queen's Speech, internet companies will be instructed to install hardware enabling GCHQ – the Government's electronic "listening" agency – to examine "on demand" any phone call made, text message and email sent, and website accessed in "real time".


Monday morning arrives and the story is still there. This piece wasn't the conjured up by the fertile imagination of a bored journalist. The government want the unrestrained power to monitor everything we write and say online.

The justification is, of course, terrorism. This is how an anonymous government spokesperson explained it:

"It is vital that police and security services are able to obtain communications data in certain circumstances to investigate serious crime and terrorism and to protect the public. We need to take action to maintain the continued availability of communications data as technology changes."

At this stage in the post, I am tempted to go through a long discussion about why this proposal is a grave threat to our ancient liberties. However, I wonder whether it is worth the effort. Do we really need to explain why the government should not have unrestricted access to our phone calls and email? Either we, as a people, value our freedoms and shout out a collective deafening NO. Or we roll over and meekly accept the consequences of this offensive initiative.

There are days when I wake up and fear for the future of this country. Today was one of those days.

Does this sound like your hometown?