UK Bubble, UK Economy

Don't say another word about the coalition's expenditure cuts until you see this chart

2012-01-28T16:06:00.002Z

The UK government borrowed £120 billion last year. It borrowed around £150 billion in each of the two previous years. The government's debt stock reached £1 trillion in January.

Before anyone says another emotive word about cruel expenditure cuts and the need to protect the welfare state, can we at least agree that this rate of borrowing is unsustainable? Is there anyone out there who thinks that UK economy is large enough to absorb this debt accumulation?

Since we all agree that the government deficit must be reduced rapidly, let us now work out the best way to do that. Do we need to raise taxes? What expenditures need to be cut? What social services should be protected and which ones can we reform?

Germany wants the EU to take over Greece.

2012-01-28T15:35:00.001Z

There are moments when it becomes obvious that the Europe has gone insane. Today was one such occasion. The Financial Times reported that the German government wants to appoint an external budget Commissioner for Greece. This unelected official would have the power to veto budget decisions taken by the Greek government and Parliament. This bureaucrat would approve all major public expenditures. To further extend effective EU control over the Greek government, Greece would also have to adopt a law that required external debt service had first claim on tax revenues.

Meanwhile, in Athens, no one knew about the German plan to end Greek independence. A senior Greek finance ministry official said he was unaware of the proposal. Imagine that, one country proposes the terminating the independence of another country, and can't even be bothered to tell them.

There are so many reasons why this mad idea cannot work, it is difficult to know where to start. Let's just focus on one potential problem. While Greece may be a chaotic place, it remains a country based on the rule of law. It has a constitution. That document defines the powers and responsibilities of its parliament, the Cabinet and its president. It has no provision for an outsider to come in and take over the government in return for an EU loan. This proposal is simply illegal.

This proposal smacks of desperation, weak thinking, and a detachment from reality. It is, quite simply, an insane idea.

The State of the Union

2012-01-27T02:53:00.002Z

The end of western civilization

2012-01-27T02:36:00.004Z

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

2012-01-25T04:47:00.003Z

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

2012-01-25T04:10:00.000Z

So what did I miss?

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

2011-12-17T05:54:00.014Z

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.

The superficial reason for the crisis is well understood and can be summed up in a single word - debt. Yet the crisis begs a deeper question; why did seemingly rationale people allow their governments to accumulate unsustainable debt stocks?

The temptation is to point the scrawny finger of blame towards politicians, who were enticed to take up credits from bankers. It is an explanation that neatly targets two disreputable and discredited groups. Yet, on closer reflection, this explanation seems insufficient.

During the1960s, European governments maintained balanced budgets. Their banking sectors were conservative and managed risk prudently. European economy was growing rapidly and living standards were converging to those in North America. Europe, back then, was a well-run place.

Something happened along the way. The harmony of the the 1950s and 1960s was disrupted. A rough date for the turning point seems to be 1970. Thereafter, governments began to run fiscal deficits, accumulate debt, and use interest rates to engineer asset price bubbles.

This shift was demand driven; it was what the voters wanted. Europeans demanded two inconsistent things. First, they wanted governments to provide a generous social safety net, but they didn't want to pay high taxes to finance it. Second, they wanted to be rich, but they didn't want to work for it.

Politicians found a temporary fix for both problems - debt. Governments bridged the gap between expenditures and revenues by borrowing. Governments liberalised financial markets, allowing private households to accumulate large debt burdens to finance consumption. Financial market liberalisation unleashed huge asset price inflation that gave people the illusion that there were becoming more wealthy.

Nevertheless, the question remains why European attitudes to debt changed so dramatically in the 1970s. My best guess is that the answer lies in demographics. In the early 1970s, fertility rates across Europe collapsed. Many Europeans decided that they wouldn't have children. Those that did decide to have children, had far fewer than their parents.

Childless people have a very different attitude to the future compared to parents. People with children worry about the future in a deeply personal way. They worry about the world that their children will inherit.Leaving an inheritance of debt and financial disorder, for most parents, is anathema.

Childless people also worry about the future but in a more abstract way. Public sector debt, particular kind that matures in the distant future, is a problem for someone else, or to be more precise, the children of someone else. Childless people have no biological investment in the future.

This biological disconnect with the future has created a profound paradox in Europe today. Ask anyone individually how they feel about the future, and you will invariably receive a passionate answer, highlighting the need to protect the environment, to invest in education, and build a better future through investment in public services.

Actions are often a better guide to how people really feel about the future. Over the last 30 years, Europeans have behaved as if the world would end in 2020. Both collectively and individually,Europeans have built up unsustainable debt levels. People have not saved sufficiently to finance their pensions. Education standards across the continent have disintegrated. Europeans protest loudly about the environment, but continue consuming ever-increasing amounts of energy. They are mawkish and excessively sentimental about children, yet seem unwilling to bear the financial sacrifices of raising a new generation. They want high levels of public expenditure, but will evade taxes as soon as an opportunity presents itself.

In retrospect, the most surprising aspect of the crash was that everyone was surprised when it happened. Looking back ,it seems almost surreal that people believed that governments and households could build up such large debt stocks without consequences. It was stupid to think that asset prices could consistently outstrip the economic growth.Next year is when accounts are settled. The disconnect between rhetoric and reality will disappear. Europe is about to meet the future that it prepared for itself over the last forty years.

Nick Clegg - Hero

2011-12-16T20:41:00.003Z

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

2011-12-16T05:18:00.005Z

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

2011-12-16T04:49:00.006Z

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

2011-12-15T05:16:00.000Z

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)

2011-12-15T05:07:00.003Z

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

2011-12-15T03:42:00.000Z

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?

2011-12-15T03:34:00.002Z

The Euro-crisis in quotes

2011-12-14T04:28:00.014Z

This is what I learnt from today's research on the Eurozone crisis:

The new EU fiscal compact is little more than a blank piece of paper.

Britain's failure to agree to this compact was the greatest foreign policy disaster in our history.

Allowing the ECB to buy government bonds won't help.

Cameron's veto did the Eurozone a favour by obscuring the fact that the fiscal compact is only a blank piece of paper.

An obscure Belgian wanted to eat David Cameron if he didn't agree to the compact.

The sordid details are found below......

Petr Necas, the prime minister of the Czech Republic
“Right now, (the EU summit agreement) is not much more than a blank sheet of paper and even the name of the future treaty might still change. I think that it would be politically short-sighted to come out with strong statements that we should sign that piece of paper.”

Will Hutton, the Observer
"As an act of self-defeating, crass stupidity, (Cameron's veto) has rarely been equalled in British foreign policy."

Fredrik Reinfeldt, the prime minister of Sweden
"My position is that it's important to know exactly what consequences this will have before we sign an agreement. Some people think we should say no, some people think we should say yes."

Anthony Peters, strategist at SwissInvest
"Am I alone in being concerned that everyone seems to be clamouring for the ECB to resort to bond purchases as the "magic bullet" when every other "magic bullet" has so far failed to offer reprieve? Let's face it; QE has not saved Japan, QE has not saved the UK and QE has not saved the US either. All that QE really seems to have done is to postpone Judgement Day."

Larry Elliott, Guardian Economics Editor
"It did what European summits always do: outlined a plan with the details to be inked in later, in this case at the next summit in three months' time. David Cameron's use of the veto rather obscured the fact that nothing has really been resolved."

Guy Verhofstadt, obscure Belgian and leader of the European Parliament's liberal group.
"David Cameron will come to the conclusion that he has made the blunder of a lifetime. There is one golden rule in politics: you only walk away if you are sure that the others will. When you are invited to a table, it is either as a guest or you are part of a menu.""

A lose-lose position? I don't think so.

2011-12-13T05:26:00.003Z

The FT had some harsh words for David Cameron.

"Mr Cameron’s coalition is now in a lose-lose position. If the eurozone fails in the effort to rescue the single currency, Britain will be caught in the ensuing economic tsunami. If the euro is eventually saved by the creation of a fiscal union, Britain will find itself marginalised in European Union decision-making in areas pivotal to its own prosperity."

Is that really an accurate description of Britain's current predicament?

True, if the Euro fails, Britain will be caught in the "economic tsunami." But that observation is rather superficial. In or out of a fiscal union, there is nothing that Britain can do to save the Euro. Economically, Britain isn't big enough to alter the fate of the single currency. It could perhaps contribute some cash to bail out Southern Europe. That generosity would weaken our finances to bankroll the fiscal irresponsibility of others. Moreover, it would be a big ask, especially as other Eurozone countries - notably Germany - aren't ready to offer any substantive fiscal transfers.

Nevertheless, we aren't helpless victims waiting to be drowned as waves crash onshore. We have an independent currency. This puts us in a far better position to mitigate the consequences of a Eurozone collapse. To maintain our monetary independence, we had to isolate ourselves from the rest of Europe. We had to stay out of the single currency. Sometimes, isolation is preferable to collegiality.

Then we come to this old canard about influence. What is the true value of influence within the EU? Over the last fifteen years, our partners have conjured up a profoundly unstable single currency, which now threatens to destroy every economy from the North Atlantic to the Black Sea. European economies are over-indebted and over-regulated. Economic growth is anaemic; European banks are on the verge of collapse, and everyone thinks they should retire at 50. Did any British government ever persuade our continental partners to stop screwing things up?

By staying out of the European Fiscal Union, we maintain the right to influence our own fiscal policies. We could, for example, cut corporate income tax, and make our economy the most attractive in Europe for foreign investment. We could also decide to go on a borrowing binge and pile up a public debt stock that would embarrass Italy and Greece. Whatever we decide, the choice is ours.

Hands up anyone who thinks the Eurozone might still be in trouble

2011-12-13T04:26:00.001Z

The repugnant culture of impunity

2011-12-13T04:12:00.002Z

Why are bankers rich, and the rest of us poor?

Before the financial crisis, the generally accepted answer was that bankers are cleverer and more talented than everyone else. They were risk-takers, achievers, and wealth creators. Bankers were paid more because success needed to be rewarded and failure had to be punished. Therefore, it seemed reasonable that the CEO of High Street bank should take home uncountable millions, while the rest of us should make do on 1500 quid a month.

Then came the crisis. One after another, banks and building societies collapsed. To prevent the complete annihilation of the financial system, the government and the Bank of England had to step in with guarantees, capital injections and emergency liquidity schemes. Who ponied up the cash? It was of course the taxpayer. Take for example RBS; the British government injected £45 billion into RBS. Today that investment is worth only £20 billion.

With billions of pounds on the line, a few taxpayers wondered how that extraordinary talent pool running RBS generated such a massive financial loss. They were so clever wise and wonderful, why did RBS go down in flames?

Yesterday, the Financial Services Agency published a report on the failure of the Royal Bank of Scotland. There are three striking things about report.

First, the report castigates the banks management. It describes a litany of poor management decisions, excessive risk-taking, and utter incompetence. In short, RBS management didn't know what they were doing. They were not up to the job of running a large financial institution. They simply didn't understand the risks inherent in banking.

Second, the magnitude of the risks that RBS took before the crisis was simply breathtaking. A year or so before RBS failed, the management decided to buy out ABN Amro. They financed this operation by a massive borrowing binge, exhausting bank capital, and rendering the institution vulnerable to the slightest perturbation in market conditions. The FSA report states that at the end of 2007 RBS had a Tier 1 capital adequacy ratio of just two percent.

In other words, the bank had no buffers to absorb any losses. The RBS management had used the bank to place a massive bet. Whichever way it turned out, they would win. Despite the fact that RBS failed, they walked away with their takeover bonuses intact, and left the losses to the rest of us.

The RBS management also exhausted the ban's liquidity. To illustrate this point, RBS did an interesting calculation. Recently, there has been some regulatory changes designed to strengthen commercial bank liquidity. In future, banks will need to maintain something called liquidity coverage ratio - the LCR. The FSA report wondered what the RBS would need to do to meet this requirement:

RBS would,therefore, have had to increase by between £125bn and £166bn its stock of high-quality unencumbered liquid assets or, alternatively, reduce its reliance on short-term wholesale funding in order to comply with the LCR standard.

Ordinary people, understandably, get a little perplexed when numbers like £166 billion are thrown around. Is that a big number or a very big number? Well, it's about 11 to 12 percent of GDP, or approximately the size of the UK fiscal deficit. How could the financial services agency allow such an important bank to become so illiquid and so under-capitalised?

This brings us onto the third and most depressing observation about this report; the scandalous lack of accountability. The chairman of the FSA - Adair Turner provided a cute quote which addresses the tricky question why no one will be held accountable for this disaster":

“People want to know why RBS failed and why no-one has been punished. This Report aims to answer those questions. It describes the errors of judgement and execution made by RBS executive management which, in combination, resulted in RBS being one of the banks which failed amid the global crisis. These were decisions for whose commercial consequences the RBS executive and Board were ultimately responsible. It describes, however, why the FSA’s Enforcement Division concluded that there was not sufficient evidence to bring enforcement action which has a reasonable chance of success in Tribunal or court proceedings."

So there you have it, there wasn't sufficient evidence and there wasn't a reasonable chance of success in holding anyone accountable for the collapse of RBS.

Adair, why don't you give it a go. Why don't you take the risk and haul in the RBS board and management into a court and see if you can put together a reasonable case against them. These people walked away with millions and left the rest of us with a massive £25 billion debt.

The RBS debacle provides scant evidence of talent and the concomitant need for it to be rewarded. Instead, RBS exposed the rotten heart of the UK financial system and its repugnant culture of impunity. Why are bankers rich? Because they can rob the rest of us and get away with it.

Labour wants Britain to be part of the EU Fiscal union

2011-12-12T04:57:00.012Z

"Where we've got most of the European Union countries signing up to an agreement where Britain will not be present in the room, despite there being very significant decisions being taken within the room.

Britain this morning is more isolated than at any point in the 35 years of British membership of Europe. It is not in Britain's national interest for decisions to be taken without us even at the table.

I don't glory in Britain's isolation this morning and I regret just how badly David Cameron's negotiating strategy has let Britain down. Strip away all the rhetoric and look at the reality: Britain today is more isolated than at any point in the 35 years since we joined the European community.

"We ended up going into a summit without allies, without alliances and ultimately we ended up with an outcome that showed we lacked influence."

Douglas Alexander, the shadow foreign secretary,

It would appear that Labour would have signed us up to the EU's fiscal compact. Mr. Alexander wanted us to be in "the room" when the fiscal policy of deadbeat countries like Greece and Italy are decided.

It is true. Britain will not be in the room when those discussion takes place. We will not be able to influence the timing and pace of the necessary but draconian expenditure cuts that will be necessary to stabilise those countries. Why would we want such a thing? What would we gain?

However, no one from the continent will be in the cabinet room in 10 Downing street when our elected government decides taxation and expenditure policy here in the UK. That, Mr. Alexander, is called national self-determination. It is a precious thing. It should not be traded for a treasonous promise of influence in other people's affairs.

It is sad that Mr. Alexander doesn't understand when it is sometimes in the national interest to leave one room in order to keep others out of your room.

The eurozone is like a sackful of kittens

2011-12-12T04:57:00.006Z

The Eurozone is like a batch of newly born kittens. Evil Mr. Bond Market can't cope with them and has decided to put them into a sack and throw them into the canal.

The UK, however, was the prettiest kitten of all, and Mr. Bond Market has decided to keep that one. The UK is very sad about the other kittens; really, she is....

but she would prefer to be purring cutely by Mr. Bond Market's feet, than sinking to the bottom of the canal with her brothers and sisters.

The EU agreement would have meant savage expenditure cuts in Britain

2011-12-12T04:32:00.003Z

The British are a self-obsessed lot. Since the EU summit, press coverage has been almost entirely devoted to our veto over a new treaty. Selfishly, We wanted to keep our right to determine British fiscal policy. We didn't want to trade it to gain a 27th share in deciding the fiscal stance of countries like Slovenia. Some call that isolation, others might call it sanity.But what about our dearly beloved European partners? Shouldn't we spare a thought for them?

Their proposed inter-governmental agreement locks them into a very restricted budgetary framework.If the spirit of the agreement is implemented, then European countries will be running balanced budgets for at least 20 years. Since every EU country is running a large deficit right now, this must mean deep expenditure cuts and higher taxes. Moreover, Countries that fail to comply with the new fiscal compact should expect painful sanctions. It will be two decades of gruel and hard tack for the continent.

There is a delicious irony for the Left in Britain. They complain that Cameron has isolated Britain, that he was outmanoeuvred by the French, and that he has done irreparable damage to UK interests. At home, they protest that the coalition's fiscal adjustment strategy rests on cruel savage cuts in social protection, along with growth-destroying tax increases.

The left is unwilling to give Cameron any credit for keeping the UK out of an agreement that would have envisaged a more rapid fiscal adjustment. Would it not be better to be out of a fiscal union that would signal the end of the British system of social protection? After all, what is more important? Protecting the vulnerable in Britain or saving the Euro?

The future of Britain is bleak - at least that is what I read today

2011-12-11T00:05:00.011Z

Judging by the headlines from the Guardian and the Independent, isolation seems to be the word of the moment. I woke up to alarming reports that Britain is now cut adrift from Europe, destined to walk this cursed earth alone and friendless. While the 26 other members of the Union happily huddle around the warm fire of fiscal union, Britain freezes on the icy tundra.

We are about to discover the dismal depths of international loneliness. As Russell Crowe might say "Europe is the light; and Britain is the darkness". When we vetoed a new EU treaty, we were cast out, driven from the community of respectable countries. We are ostracised; boycotted and shunned. By a diktat from Germany and France, Britain will henceforth be unwelcome; expelled from the European family. We are excommunicated and damned. Throughout the continent of Europe, Britain is the unmentionable name;"I know not of that place", the chorus will shout.

Our crime was a grievous one. We callously pursued our own selfish national interest rather than focus on the noble fraternal aspirations of Germany and France. Pride and arrogance blinded us to the necessity of submitting our budgetary policies to the European Commission for approval. The nation was gripped in a collective madness. We had this insane idea that we could determine our expenditure and taxation policies. Leftists and Europhiles here in London have promised us grim retribution for our defiance.

We will quickly learn the error of our ways. To be outside the Euro-federalist circle can mean only one thing - grinding and relentless poverty; just ask Norway, Switzerland, Canada, Australia or New Zealand. In the fullness of time, we will knock on the door and ask for admission into the new European structures. Like a shivering child, who ignored the wise admonition of a loving parent, we will ask for forgiveness.

So, Mr. Cameron enjoy your moment of popularity, the Lib-Dems, Guardian journalists, and other unsavory characters want you back on a plane to Brussels to undo the calamitous veto that you so brazenly waved about this week.Thankfully, the European Commission is a patient overload. So long as we are prepared to bend our knees and swear obedience, we can again return to sit by the fireside of European federalism.

Hero

2011-12-10T04:41:00.002Z

David Cameron - Patriot and Freedom Fighter

The EU summit; some quick observations

2011-12-09T14:16:00.004Z

Here are my quick observations on the outcomes of the EU summit. The UK's decision to opt out has soaked up all the attention. The Guardian calls it "isolation", as if it were a bad thing to stop running with the rest of the lemmings as they merrily head towards the cliff edge.

Did the summit provide enough to save the Euro? My sense is that the crisis will continue. The measures were not enough to stem to loss of confidence in Eurozone public debt markets.

• EU leaders described the deal as based on a new "fiscal compact" and "on significantly stronger co-ordination of economic policies in areas of common interest".

This is the kind of sentence that generates a hundred questions. Here are a few for starters; what exactly will be a "fiscal compact"? What happens if countries disagree over the compact? Who will adjudicate disagreements? Who will monitor the compact? What happens if a country fails to meet its obligations under the compact?

Although the questions mount, we can be sure that all answers lead to Brussels and a further consolidation of decision making in the hands of the EU Commission. How does a transfer of budget decisions from Rome to Brussels help pay down Italy's debt stock? It will work if Brussels prevents the Italian government from spending and forces it to raise taxes.

• Eurozone states' budgets should be balanced or in surplus; this principle will be deemed respected if, as a rule, the annual structural deficit does not exceed 0.5% of gross domestic product.

European governments are a long way from balanced budgets. At best, this is a medium term objective. Presumably, if bond markets believe the commitment, then bond yields might fall.

The structural deficit target is open to abuse. These deficits need to be estimated, and countries could play around with the numbers. Moreover, the 0.5 percent deficit target looks a little loose. It is probably not sufficient to bring debt levels down over the medium term.

It would have been far better if the Eurozone had chosen an overall balance target; it would have been more transparent and more effective at bringing debt levels down.

Bond-holders will see through this measure and heavily discount its significance.

• Such a rule will also be introduced in eurozone member states' own national legal systems.

Germany has such a rule in its legal framework, and it has been there since the late 1960s. However, it has so many loopholes that the German government can run any deficit it likes. The resolution to the Eurozone crisis does not reside in the law; governments simply need to stop accumulating debt. That means less spending and more taxes.

Eurozone countries must report national debt issuance plans in advance.

What happens when a country wants to issue too much debt; can the other countries stop them? If so, how?

• As soon as a eurozone member state is in breach of the 3% deficit ceiling, there will be automatic consequences, including possible sanctions, unless a qualified majority of eurozone states is opposed.

The original Euro agreement had a similar clause, but Eurozone countries chose to ignore it. There were sanctions, an adjudication process and regular assessments. Germany was the first country to ignore the rules in 2003. France followed, then Portugal....and so it went on.....

• The European Stability Mechanism (ESM), the eurozone's permanent bailout fund, is aimed to enter into force in July 2012; the existing European Financial Stability Facility (EFSF) will remain active until mid-2013. The overall ceiling of the EFSF/ESM of €500bn (£426bn) will be reviewed in March 2012.

A simple question; does the ESM/EFSF really have €500 billion and if so, who ponied up the cash? Also, why does the ceiling need to be reviewed in March. Answer; because it is probably not big enough to catch Italy if it falls out of the bond market. In other words, the crisis is likely to continue.

• Voting rules in the ESM will be changed to allow decisions by a qualified majority of 85% in emergencies, although that remains subject to confirmation by the Finnish parliament.

A classic result from an EU summit; a convoluted voting mechanism for an obscure European institution with a big budget.

Meanwhile, back in the Italian bond market.....

Teachers pretend to teach and kids pretend to pass exams.

2011-12-09T04:00:00.002Z

If I were a foreigner, I would find it hilarious that a school examiners offered seminars to teachers where they could learn exam questions. Unfortunately, I was born in Britain and happen to think that a corruption free education system is a central requirement of a successful economy.

How did things get so bad? For at least 20 years, we have poured ever increasing amounts of cash into the state education system. Despite this massive expenditure, deteriorating education standards are evident everywhere except in the exam results. Now we have a hint why exam scores increased as children left school barely literate and numerate; teachers were spoon feeding exam answers.

This scandal will follow a predictable course. Over the next few days, there will be a clamour for action. Politicians will demand action to "restore faith in Britain's exam system". A small number of examiners will be fired, and perhaps, the scandal might claim the license of an exam board. Within a few weeks, the scandal will subside, and educational standards will continue to slide. Next year, there will be another crop of stellar exam results and everyone will know that our children will leave school as functional idiots.

Britain's education system is a disgrace; teachers pretend to teach and kids pretend to pass exams. What makes the system so appalling is that everyone knows this and allows it to continue.

The end of independent Ireland

2011-12-09T03:10:00.003Z

While the outcome of this week's EU summit is uncertain, one thing is sure; neither Mr Sarkozy or Mrs Merkel will turn round to ask the Irish prime minister - Enda Kenny for his opinion. The only time the leaders of France and Germany will speak to him directly will be when they ask him to sign the final agreement. Ireland isn't even a bit part actor in this drama, it is in the audience like the rest of us.

When it is Enda Kenny's turn to hold the pen, he will sign away the last vestiges of Irish independence. Henceforth, Ireland will be a province of a highly centralised and undemocratic European state. The Irish parliament will have powers broadly similar to that of a municipal council. Monetary and fiscal policy will now be determined in Brussels and in Frankfurt. In legal matters, the final Court of Appeal will be in Strasbourg. Ireland will have no ability to determine policies in a wide range of issues such as agriculture, fisheries, industry, and foreign affairs.

As a Brit looking across the Irish sea I can't help wonder what the fuss in Ireland was all about. According to the Irish national myth, it struggled for 800 years to break the yoke of English oppression. During the height of the First World War, a small gang of nationalists rose up and the subsequent violence destroyed the heart out of Dublin. After much bloodshed, Britain and Ireland signed an agreement that granted dominion status to Ireland in 1921. Over the next 20 years, Irish governments repeatedly reneged on that agreement, and unilaterally declared a republic in 1949. For its part, Britain took these treaty violations with remarkable grace.

In the late 60s, inter communal violence again broke out in Northern Ireland. Britain expended huge amounts of money trying to keep the peace. Hundreds of young British men died there. Thousands of Irish men and women perished in a pointless ethnic struggle that lasted decades. Despite all that misery and pain, in political terms, the Good Friday agreement returned Ulster to where it started; a province with its own parliament within the United Kingdom.

The troubles in Ireland ended in the mid 1990s, just as the the Irish housing bubble on both sides of the border was starting to explode. (Better house prices than bombs, I suppose). By the time, the bubble finally burst Irish nationalism was a spent force. The Irish state was bankrupt, the economy was ruined and migration, the age-old curse of Ireland, had returned. The utter demoralisation of the Irish people meant that Mr Kenny's could take a trip to continent to sign away Irish independence and no one in Ireland cares. Debt and recession had transformed Ireland into a small largely irrelevant colony in the fringes of the Europe.

Perhaps, British tactics in Ireland were a little too militaristic. Instead of sending an army, the Brits should have sent over a boatload of mortgage brokers and bankers. If in the early 20th century the Brits are generated a housing bubble and subsequent banking crisis, Ireland would have never left the United Kingdom.

EU pressures agencies who respond with threat of mass eurozone downgrade

2011-12-08T03:37:00.004Z

Sinister officials from the European Securities and Markets Authority (ESMA) have been "visiting offices" of credit ratings agencies, such as Standard & Poor's, Moody's and Fitch. Allegedly, officials are looking for "wrong-doing" and threaten to impose heavy penalties if they find anything.

An ESMA mouthpiece promised that the agency "will publish a report on the outcome of our first on-site inspections of ratings agencies. Our inspectors are examining how the rating agencies conduct their business and arrive at ratings. If we were to find wrongdoing, ESMA has the power to fine agencies, suspend their ratings and we could even withdraw their licence."

A simple question; why are these visits taking place now? Why didn't it occur to the ESMA to book these visits four years ago when Eurozone debt received high credit ratings from the agency?

Imagine for a moment, if heavily indebted Europe withdrew the license of one of the agencies, say S&P. The obvious implication is that the agency would be forced to stop operating within the EU. Presumably, the S&P could no longer supply any ratings for European bonds. Therefore, the 'AAA" countries would automatically lose their prestigious rating. That would be quite a result; the Eurozone would no longer have to worry about ratings downgrades.

Still, I suspect that the transition to a ratings-free bond market might create a few little difficulties. Since European banks are required to keep a proportion of their assets in high quality AAA paper, the sudden disappearance of a credit rating agency would be a little problematic. How could the banks differentiate between that high yielding equity tranche of subprime Las Vegas housing debt from a German government bond? At least subprime debt has a rating.

Am I missing something, but I suspect the threat to withdraw credit rating licenses isn't that credible. These friendly visits haven't discouraged the ratings agencies from threatening mass Eurozone downgrade. Today S&P announced that "we will concurrently review the 'AAA' long-term rating on the EU with the ratings on the eurozone member states."

Lets get something straight; the Eurozone is not facing a catastrophic crisis because credit agencies have downgraded its debt. The crisis stems from the massive accumulation of debt. Ratings downgrades are a symptom not a cause of this crisis. It is an obvious point, but it seems lost on the EU.

The EU summit - admit it, you can't wait to see what happens

2011-12-08T03:19:00.000Z

What will be the outcome of this week's Eurozone summit? Will it be enough to save the Euro?

Will Sarkozy and Merkel will find sufficient backing for their crisis plan? Will we have a fiscal union by Monday morning? Will it apply to all 27 EU states? Or will the Eurozone go it alone? Or will there be seventeen currencies where there is now just one?

Can Europe do anything to prevent a recession next year?

So many questions, so few answers.....

One thing is for sure, this won't be the last crisis summit for Europe. I expect to see at least one a month for the next two years.

UK house prices down 16 percent from their peak

2011-12-08T02:50:00.000Z

For the last two years, UK house prices have bounced around. One month, they are up; the next they are down. November was a down month, but who knows, January could record an increase.

Overall, house prices are down 16 percent from their summer 2007 peak. Call me Cassandra if you want, but I don't think house prices will recover this side of 2020.

This is the age of austerity

2011-12-07T04:31:00.004Z

I was really irritated by a recent blog post from Paul Krugman. He was writing about UK historical debt levels.....

And you really have to marvel, given that historical record, at the deficit panic now so widespread.
That uptick at the end — you’ll see it if you squint — is what’s driving the Cameron government’s insistence on slashing spending in a liquidity trap. It’s also interesting to note — contrary to what you often hear — that at the time Keynes was writing, and calling for fiscal stimulus, Britain was substantially deeper in debt than Britain or the United States are now.

UK debt levels were higher both after the first and second world wars. Wartime government relied heavily on the patriotism of investors, in particular households, to buy war bonds. That patriotism was not rewarded in the post war period when the value of those bonds were destroyed by decades of rapid inflation. It was a lesson that has lingered in the minds of investors for decades afterwards.

Moreover, the UK financial system before the election of the Meryl-Streep lookalike was largely closed and heavily regulated. It wasn't easy for investors to buy more attractive higher yielding bonds abroad. Capital controls prevented investors placing money overseas. High street banks operated a cartel, controlling interest rates, and keeping them low. British investors were trapped by regulation and post-war government liked it that way.

Economic policies were largely dictated by the heavy indebtedness of the government, who had to limit interest rates in order to keep debt servicing costs down. During the post war period, the UK government ran balanced budgets up to the the early 1970s. Despite this heavy hand of financial repression and tight fiscal policies, the UK economy was regularly subjected to exchange rate crises. Remember the Suez crisis? Or the 1967 sterling devaluation. No, I don't either, but my undergraduate text books told me of sudden reversals of economic policies and decades of sub-standard economic growth.

However, history only takes us so far. The plan fact is that modern bond holders have become very nervous about governments that have debt to GDP ratios higher than 100 percent. Investors don't care that the UK government ran a large war time deficits and conned widows out of their savings in order to fund the fight against Hitler. Investors today care about whether they will be paid the full value of their investments.

Recent experiences in Europe tell us that when a country runs up a debt level of more than 100 percent, investors are unlikely to keep lending. There are no options for a bond financed stimulus. Governments can run up deficits by relying on central banks to print money to make up the difference, but that quickly leads to inflation. The Bank of England is doing this at the moment. It is printing money to finance the UK fiscal deficit. This is why the UK has the highest rate of inflation of any advanced economy. This is also why UK living standards are falling rapidly.

As this week's events in Europe prove, no one seriously thinks that another round of fiscal stimulus is a viable economic strategy. Keynes is a defunct economist, and Keynesianism is, intellectually speaking, a spent force. Mr. Krugman needs to catch up with the moment. This is the age of fiscal austerity.

The five reasons why S&P put the Eurozone on a downgrade watch

2011-12-06T04:34:00.000Z

Standard and Poors have warned the European leaders that it might downgrade eurozone sovereign debt. The credit rating agency listed five solid reasons for their decision.

Tightening credit conditions across the eurozone;
Markedly higher risk premiums on a growing number of eurozone sovereigns, including some that are currently rated 'AAA';
Continuing disagreements among European policy makers on how to tackle the debt crisis;
High levels of government and household indebtedness across a large area of the eurozone;
The rising risk of economic recession in the eurozone as a whole in 2012.

The EC recently published proposals to restrict the activities of credit rating agencies. Presumably, it is to prevent them from speaking the truth, like S&P did today, about the appalling debt crisis that now threatens to consume Europe.

If you don't like the message, gag the messenger.

Stupidity is always punished

2011-12-06T04:22:00.002Z

Historians will have a hard time explaining western attitudes to China during the early 21st century.

Industrial espionage is rampant. infringements of intellectual property rights are so widespread that they barely merit a comment. When sometime actually tries to seek redress in a Chinese court, they are guaranteed to fail, as Sir James Dyson recently discovered.

From today's Telegraph.....

Sir James Dyson says he has spent £3.5m fighting Chinese companies who stole his designs last year and even hired private detectives to spy on illegal Asian workshops where his bladeless fans are taken apart and copied.

The British inventor accused Chinese authorities of turning a blind eye to native companies which violate intellectual property rights by imitating successful designs. Sir James said he had spent £3.5m pursuing often futile legal cases in Chinese court.

Chinese firms steal British designs, and produce the goods cheaper than here. The Chinese ship the goods over to Britain, and wipe out British manufacturing. The design costs are shouldered by us, the profits are earned in China.

As my much beloved Grandmother often said "stupidity is always punished".

The Republic of Retirees

2011-12-05T05:09:00.005Z

The penny has dropped, as the English might say, in Germany. The German newspaper Die Welt produced a shocking graphic, illustrating the projected population decline in each federal state by 2060. Germany is getting old very fast. Germans aren't producing enough children to replace the current population. Inevitably, this can only mean one thing. There will be far fewer Germans in 50 years.

Of course, immigration can arrest this trend. However, the demographic crash in Germany is so brutal and sudden that the inward flows required to stabilize the German population would be more accurately described as re-population rather than a benign migration.

Germans often have a strange optimism in adversity. According to Die Welt, ageing brings with it opportunities. Demographic change will create at least a million new jobs in the health care sectors; doctors, nurses, especially the geriatric care ones. Yes, I can see that logic. The implication for the German car industry, I would hazard to suggest, is less certain.

Die Welt's optimism has a technlogical dimension. The ageing population will also "accelerate the use of robots to replace human labour." Apparently, Germany is well placed to take advantage of this transformation, given its high tech export orientated industrial sector. The German vision for Europe is one where German designed and built cyber-nurses look after ageing populations across the grey continent. There is nothing like talking up technology to avoid consideration of a deep seated social issue.

However, I have a different question; if the German population is about to start shrinking, it follows that the German economy will also start to slow and possibly decline. So, how will Germany support the Mediterranean basket cases?

If anyone has an answer to that question, please let me know.....don't tell me it will be cyber-nurses....

This week is going to be a bad one for France

2011-12-05T04:30:00.005Z

Nicolas Sarkozy and Angela Merkel are going to meet on Monday to put together yet another "save the Euro" plan. The problems remain the same; Eurozone economies are uncompetitive, growing old and insolvent.

Sarkozy would like Germany to use its tax receipts to prop up the failed states in Southern Europe. Merkel, understandably, is a little reluctant to hand over German resources in order to fund the Mediterranean money pit. She thinks, again quite reasonably, that Germany should get something in return. She demands that the Eurozone forms a "Fiscal Union". She thinks that effective German control over continental fiscal policy seems a fair swap for Italy and the other waster countries receiving German tax receipts.

During the meeting, Merkel will probably remind Sarkozy of a new ZDF poll that shows that the percentage of German votors who approve of the Chancellor's handling of the crisis has risen sharply over the last month - from 45 to 63 percent.

The sad truth for Mr. Sarkozy is that his position is rather vulnerable. Mrs Merkel, in contrast, has the money and rock solid political support back home. The political concessions will be only going one way this week; from west to east across the Rhine.

UK banks reduce their customer funding gaps

2011-12-05T00:24:00.002Z

UK Banks may have learnt something from the crisis. Banks have tried hard to reduce their dependence on the wholesale funding market. It was Northern Rock's excessive use of the wholesale funding market and comparatively weak depositor base that pushed it over the edge during the summer of 2007.

The customer funding gap is the difference between customer lending and customer deposits. In this context, "customer" has a wide meaning, referring to all non-bank borrowers and depositors.

This gap as fallen by over £600 billion since the onset of the crisis. It has also fallen as a percentage of customer loans. According to the Bank of England, the bulk of this decline is due to reduced overseas lending and in lending to non-bank financial companies.

The good news is that this development has made our banks a little more resilient to any renewed funding pressures. And when we look across the channel, one has to be very fearful of what problems the Eurozone might dump on Britain.

If the euro crashes, the UK will not escape a whipping

2011-12-03T03:02:00.006Z

Balance sheet of UK banks as at 2011 H1

All this chatter about the immanent collapse of the Euro is extremely disturbing. The UK would not would escape the consequences; all would be punished.

Our banking system is very exposed to Europe. Almost 17 percent of UK commercial bank assets are credits for European customers. UK bank capital buffers (marked as equity on the liabilities side of the above chart) only amounts to a little over 5 percent of total assets. The UK banking system would be bankrupted if a third of those European credits were not repaid.

Under normal circumstances, assuming a loan loss rate of 33 percent would be absurd. But these are not normal times. If the Euro crashes, the payment system of 17 of our closest trading partners would collapse.

There are few historical precedents to guide us. I can only think of two; the collapse of the Austro-Hungarian empire after the first world war and the end of the Soviet Union. In both cases, the economic consequences were appalling.

Lets hope that the Eurozone can cobble together a rescue plan.

UK banks are deleveraging, but is it enough?

2011-12-02T04:42:00.001Z

What have UK banks been doing since 2008, when the Lehmann failure nearly brought down the global financial system?

The chart above looks at the long term trend in UK banking system's average leverage ratio. This ratio compares the value of bank assets to available capital. It is a simple calculation; there is none of this dubious risk weighting of assets that turns vulnerable banks into risk-free institutions.

Charts are funny things, and can often be misleading. The leverage ratio has fallen sharply over the last three or so years. This improvement looks impressive only because the ratio was so unbelievably high just prior to the crisis. At that time, banks, on average, had just one pound of capital for every 48 quid of assets.

Take a closer look at that chart and you will notice two disturbing things. First, the ratio has started to creep up. Second, the ratio still remains high by historical standards. In other words, UK banks still look a little vulnerable.

Time more capital, and that means no more dividend payments and certainly no more bonus payments to undeserving bankers.

Mortgage rates set to rise

2011-12-02T04:24:00.000Z

"To maintain profit margins, banks may try to pass on the increase in borrowing costs in their lending rates."

"[Experience from the last financial crisis] suggests it may be during 2012 that any significant increase in banks' lending rates occurs."

Mervyn King, December 1, 2011

So, 2012 will be another great year for the UK housing market.

I am sorry renter girl

2011-12-01T03:46:00.002Z

In a recent post, I received a stinging comment from a fellow blogger rentergirl. I have received nastier comments, but this one really hurt. This was because I have always really liked her blog, and still do. In the past we have communicated via email.

Rentergirl's complaint was that I had made some snide comments in a photo of an OWS demonstrator (see here). I am going to come in with my hands up; she is right, I was wrong. I was rather nasty about the young man in the photo.

However, I also should be clear that I don't support the "Occupy" movement. It is a visceral reaction that stems from a profound fear of the mob. Their objectives and critique of capitalism might have some merit, but the idea of occupations and street demonstrations provoke deep seated anxieties. It is the fear of violence and confrontation that sets me off. In the same vein, I was deeply disturbed by the recent riots in London. I found the whole thing extremely distressing.

I really dislike the illegality of it all; I know the area around St. Pauls well, and I resent the fact that it is now occupied. I was particularly upset when the Cathedral was closed. It opened up all kinds of fears about religious freedom; a subject that matters very much to me. I just want the occupiers to go away. This is where the animosity towards the demonstrators is coming from, Rentergirl.

I still believe that there are other less confrontational routes that can be utilized to generate change.

Estimating the cost of the recession

2011-12-01T03:14:00.001Z

How costly has the crisis been for the UK economy? One straightforward way of assessing that question is to look at the difference between where the economy would have been if the crisis hadn't happened and where it is today.

The Office of Budget(OBR) responsibility undertook this exercise as part of their work monitoring UK fiscal performance. The blue line represents actual output per person for the UK economy. In slightly simpler language, this is what UK workers, on average, produce in terms of goods and services.The red dotted line in the chart above represents the trend output per person. This is what we would have produced, given the part growth rates, assuming the recession had not happened. The difference between the two lines represents the cost due to the recession.

The answer according to the OBR appears to be about six percent. In other words, we would have been on average six percent better off if the crisis hadn't happened.

This is a large number. However, the UK economy remains mired in difficulty. The prospects for sustainable recovery seem bleak. Over time, the cost of this crisis can only increase.

Its official, the most recent recession was the longest in almost 100 years

2011-11-28T15:18:00.002Z

Martin Weale, external member of the Monetary Policy Committee, Bank of England recently gave a speech, where he compared the recent recession with previous ones. It was a shocking assessment.

"We are experiencing the slowest economic recovery since the First World War.There have been six recessions since 1920.... In Charts 1 and 2 I show the time profiles of these (recessions).

The 1932 trough, like the trough in the current recession, was about 7 percent below peak with the recession in 1979 being milder. But we can also see that, for the three completed cycles, the time needed for output to recover to its pre-recession level was no more than four years and one month.

We might now ask how long it is likely to be before output regains its level of early 2008. The central estimate of economic growth associated with the MPC’s latest forecast, published in the Inflation Report, shows this happening in the third quarter of 2013."

To summarize; the 2008 recession was deepest since the end of the second world war, and the recovery has been the weakest in almost 100 years. The UK economy will not return to its pre-recession output level until the second half of 2013.

Here is a curious question; what is the key difference between this recession and previous ones? Quantitative Easing - the Bank of England's attempt to systematically support commercial bank balance sheets by printing money, creating negative real interest rates and robbing savers.

Rather than speeding up economic recovery, Quantitiative Easing has delayed it.

Guess which country has the highest inflation rate of any major industrialised economy?

2011-11-28T00:21:00.000Z

It is the UK, of course. Quantitative easing does exactly what economic theory would predict. If the Bank of England prints more money, the inflation rate increases.

Deja vu, all over again

2011-11-27T21:44:00.000Z

The credit crunch is back.

The Financial Times reports that European Banks have sold only two thirds of the bonds required to cover the debt that matures this year. This has left a funding gap of $241 billion. That is a big nasty number.

This funding crisis is just another manifestation of the sovereign debt crisis. As the probability of a sovereign default has increased, investors have shied away from European banks holding government bonds.

Another terrible day for Europe

2011-11-26T02:30:00.001Z

Can Europe survive another day like yesterday? The financial pages and the news wires carried an unrelenting series of bad news stories.

Portugal, from the BBC....

Portugal has had its debt rating cut by Fitch to so-called "junk" status, and warned it could be cut again.

Fitch made the downgrade because of its "large fiscal imbalances, high indebtedness across all sectors and adverse macroeconomic outlook".

Belgium, from Bloomberg...

Belgium’s credit rating was cut one step to AA by Standard & Poor’s, which said bank guarantees, lack of policy consensus and slowing growth will make it difficult to reduce the euro region’s fifth-highest debt load.

The rating was lowered from AA+, with a negative outlook, London-based S&P said yesterday in a statement. The action by S&P is the first downgrade for Belgium in almost 13 years and puts its credit ranking on a par with the S&P local-currency ratings of the Czech Republic, Kuwait and Chile.

Hungary....

The foreign- and local-currency bond ratings were cut one step to Ba1 from Baa3, the company said in a statement yesterday. Moody’s assigned a negative outlook. The country is rated the lowest investment grade at Standard & Poor’s and Fitch Ratings.

Hungary’s foreign-currency debt maturing next year will soar to 1.37 trillion forint ($5.8 billion), a 48 percent increase from this year. That will rise to 1.48 trillion forint in 2013 and peak at 1.65 trillion forint in 2014 as Hungary repays the 20 billion-euro ($26.5 billion) bailout. Hungary had $51.3 billion in foreign-exchange reserves at the end of September, according to Bloomberg data.

Italy, from the Telegraph...

Italy had to pay record rates in a €10bn bond sale, despite reports that the European Central Bank was buying Italian debt in the secondary market to try to support the auction.

The auction will be a blow to Mario Monti, the new Italian prime minister, who is battling to persuade markets that he can reduce the €1.9 trillion debt burden.

Italy sold six-month debt for a yield of 6.504pc - nearly double the 3.5pc yield demanded by investors at an auction at the end of October.

The auction will be a blow to Mario Monti, the new Italian prime minister, who is battling to persuade markets that he can reduce the €1.9 trillion debt burden of the eurozone's third largest economy.

Greece, from Reuters....

Greece's budget deficit will not fall below a key euro zone ceiling in 2014 as planned, if the debt-laden country fails to decide additional austerity measures in June, a set of updated forecasts revealed on Friday.

Assuming no more measures are taken, the budget gap will narrow to just 4.2 percent of gross domestic product in 2015 instead of the 1.1 percent assumed under a previous set of forecasts made in June, the finance ministry data showed.

Such a nice boy.....

2011-11-26T02:18:00.004Z

What got him so mad....?

More leverage equals bigger housing bubbles.

2011-11-26T00:41:00.000Z

Everyone knows it to be true; if the household sector increases its borrowing, then the housing market will explode. The curious thing about this chart is some of the really leveraged countries we never hear about - like the Netherlands and Denmark.

What happened there, I wonder? Will they suddenly jump out of the wardrobe and say "Boo"?

If Caesar were alive, you'd be chained to an oar

2011-11-25T16:43:00.006Z

Public sector unions will be on strike on Wednesday. The cause of the dispute is pensions. The unions think that if they forego a day's pay, they will secure a post retirement income that will be multiples of what the rest of us will receive.

The strike reminds me of a latin proverb that would neatly resolve the matter:

"Caesar si viveret, ad remum dareris"

Roughly translated; "If Caesar were alive, you'd be chained to an oar."

Austerity will be a severe instructor

2011-11-25T16:28:00.004Z

Another bad day....

Yields on government bonds are rising across the Eurozone. With each basis point increase, Europe's access to the bond market is slowly drying up. The policy options are closing up. Soon, the choice for Europe's over-indebted countries will be binary; austerity or default.

Before you ask, dismantling the Euro is not an option. The pain that may emerge from default or reducing the fiscal deficit will be seem mild compared to the chaos and collapse that will follow the demise of the single currency. The Euro may have been a disastrous project, but that discussion ceased to be meaningful over a decade ago. If the Euro falls, the economies of Europe will be wiped out. There might yet be a day for dismantling the single currency but it resides in the distant future.

The preferred option has to be austerity. It will provide governments will some limited ability to determine the timing and distribution of pain. A default will unleash another round of banking failures and sharp reductions in output. The consequences will be pernicious and arbitrary.

Austerity will also teach Europe a long overdue lesson; excessive government borrowing stores up trouble for the future. Sooner or later, there will be a reckoning. After thirty years of excess, that moment has come.

A day when everything was clear and people said what they meant.

2011-11-24T05:37:00.006Z

Yesterday was a day of remarkable clarity and transparency.

The day began with the publication of a European Commission paper on the creation of a unified European bond. The EC's press release was blunt about the purpose and implications of the initiative.

Such common issuance of bonds by the euro-area Member States would imply a significant deepening of Economic and Monetary Union.

It would create new means through which governments finance their debt, by offering safe and liquid investment opportunities for savers and financial institutions and by setting up a euro-area wide integrated bond market that matches its US Dollar counterpart in terms of size and liquidity.

The fiscal framework underlying EMU would similarly undergo a substantial change, as Stability Bonds would need to be accompanied by closer and stricter fiscal surveillance to ensure budgetary discipline.

....(A)greement on common issuance could have an immediate impact on market expectations and thereby lower average and marginal funding costs for those Member States currently facing funding pressures.

The Commission believes that a single debt issuance agency will resolve the European sovereign debt crisis, but it will only do so, if fiscal policy decision-making becomes more centralized. While this may be a contentious claim, it does accurately reflect the thinking of the Euro-federalists.

The next big event yesterday was the German bond auction. It went very badly. The German government was unable to sell about 35 percent of the €6 billion of the 10-year bonds it offered to the market. If Germany, with its well run economy, can not sell its debt, then what does that say about the prospects for a European stability bond?

The market had a straightforward answer for that question. A centralized European bond issuance would mean that German tax payers would have to underwrite Italian, Spanish and Greek fiscal deficits. While Germany might be a successful economy, it isn't so large that it could easily shoulder the burden of southern European fiscal extravagance.

Bond markets have concluded - correctly - that a European stability bond would undermine German fiscal sustainability; hence, the sudden reluctance to buy German debt. Centralizing debt redistributes the burden around Europe, but it does no reduce the overall level of Eurozone debt. Therefore, the appetite for German bonds suddenly fell.

Will the European Commission get the opportunity to issue their stability bonds and centralize European fiscal policy?

When Mrs Merkel addressed the German parliament yesterday, she was also very clear. The answer was a very firm no.

Will stability bonds, issued by the European Commission, save Europe?

2011-11-24T05:14:00.002Z

Computer says no....

Forget about it; the ECB isn't going to bailout the Eurozone

2011-11-18T02:28:00.005Z

Yesterday was rough for the eurozone. Government bond yields rose sharply. Countries that thought they were immune from the crisis - France, Austria and the Netherlands - are now seeing their borrowing costs rise. No one is now safe from the contagion.

There is "almost unanimous agreement" that only the ECB can save the eurozone. The rescue plan is disarmingly simple. The central bank should bail out eurozone governments directly through direct purchases of bonds.

There is only two difficulties with the plan. First, that "almost unanimous agreement" does not extend to Germany or the ECB itself. Second, the ECB is legally prevented from providing credit to member state governments, the EC or any other EU institution. So, an ECB-centered bailout isn't happening, and there is no other credible bailout plan on the table. So where does the Eurozone go from here?

Broadly speaking, there are two answers to this question. The first tries to re-establish the ECB bailout plan by designing an elaborate financially engineered scam whereby the ECB provides credit indirectly to illiquid governments. Almost weekly, these plans emerge. They stir up excitement in financial markets and policy circles. Then an official from the German finance ministry or the ECB describe the plan as either unworkable or illegal and the excitement dies down.

The second answer is austerity. Illiquid governments like Italy and Spain have to balance their books. They have to rein in expenditures and raise more taxes. If austerity results in a recession that reduces tax revenues, and increases the fiscal deficit, then another round of cuts and tax hikes are required. Governments just have to keep cutting and taxing until they can convince bond markets that their fiscal position is sustainable. Greece, Ireland, and Portugal have all gone down that road. So far, none of these countries have been able to successfully return to the bond market.

Many Eurozone policy makers balk at the idea of supervising brutal cuts in living standards. However, the bond market has no time for squeamish polititicans. The choice is cut the fiscal deficit or face being shut out of capital markets. Slowly, European politicians are getting the message.

But what of Germany and the ECB? Wouldn't things be so much easier if they quietly acquiesed and allowed the ECB to fund eurozone fiscal deficits? Once the central bank begins printing money to keep those Southern European wastrels afloat, when will it stop? Will it be any easier to adjust after two years of funding Italian public sector wages than it is today? Once the ECB starts bailing out Southern Europe, the incentive to cut deficits will vanish. Germany knows that a bailout will only prolong the crisis. The ECB knows it too.

Four more years

2011-11-17T03:42:00.000Z

The Bank of England are forecasting a sharp downturn in economic growth next year.

After four years of negative interest rates, double digit fiscal deficits, quantitative easing, a 25 percent exchange rate depreciation, and massive bank bailouts, the UK economy is heading for another recession.

The Bank of England's response to the crisis isn't the solution, it is the problem.

The disturbances this summer may be only a foretaste of what is to come from a generation this government seems to have abandoned

2011-11-17T03:22:00.003Z

Diane Abbot produced a long whinge about youth unemployment in the Huffington Post.

"It seems as if a whole generation of young people is going to pay the price of this government's economic policies.

A whole generation may be doomed to a lifetime on the fringes of the job market."

The labour market for young people is very fluid. Many young adults are transitioning from education to employment. Others have specific career goals that demand lengthy application processes. Perhaps, the best guide to the youth labour market is the number of people aged 18-24 who have been unemployed for more than six months.

So what does the data tell us? Long term youth unemployment did increase sharply. Unfortunately for Diane, the greater part of that increase occurred before the last election when Labour were in office. The last available data is for August 2011, when 108,000 young adults were unemployed for longer than a year. In June 2010, that number was 96,000, while in 2008, it was only 38,000.

Throwing around partisan numbers has only limited usefulness. What we need is practical policies to increase growth and lower unemployment. Diane thinks that the solution lies with the public sector. If only the government were bigger, then youth of Hackney would find a job:

"(T)he cuts in the public sector are slashing jobs which the private sector cannot replace. Neo-liberal economic theory says that if you slash the public sector the private sector will grow.

In reality cuts in the public sector also affect private sector jobs in areas like building and construction, that depend on public sector contracts for schools etc."

The answer is simple; more public expenditure creates more private sector jobs. Instead, that stupid Mr. Osborne is "doggedly pursuing policies designed to appease bankers and the bond markets".

Diane ends her post with the ominous threat of violence.

(Mr. Osborne) has to be prepared to rethink his policies. Otherwise the disturbances this summer may be only a foretaste of what is to come from a generation this government seems to have abandoned."

If the coalition doesn't reverse their cruel cuts, then the kids will go out onto the street and trash the local high street. Forget about elections and democracy, government policies should be designed to placate thieves and rioters.

Perhaps, I am being a little unfair, but it is perhaps useful to contextualize Diane's argument with a few additional observations:

Public expenditure rose sharply during the last 18 months of the previous Labour government. It now accounts for about half of GDP. At the same time, long term youth unemployment more than doubled.
The Coalition came to office about a year ago, and long term unemployment is broadly unchanged. However, Diana blames the coalition for youth unemployment, despite the data suggesting that Labour was responsible for the increase.
She wants higher public expenditure, even though the correlation seems to suggest higher public expenditure is associated with higher youth unemployment.
She claims that we are likely to see more street violence from disaffected youth if the coalition continue to balance the government's accounts.

Hopefully, Mr. Milliband and his colleagues can do better than this....

How to make simple things really, really complicated

2011-11-17T02:22:00.000Z

By Alma Acevedo

A modern philosophy professor zigzags during the eighty minutes lecture between derisively questioning the term “truth” and passionately recycling the usual departmental politics.

A doctor of ethics categorically concludes that ethics cannot be taught and that, consequently, no judgments (ethical or otherwise) will be allowed during the course. Ethics, he contends, “is not a matter of content, but bringing students to reflection by means of problematization.”

Their colleague from the humanities mockingly queries the very concept of “human nature” while rhetorically wondering why so much thought has been invested in attempts to define it.

In spite of variations, these college professors share a common preoccupation: to “problematize” is the essence of education. They are discipline agnostics; some, outright nonbelievers. They dogmatically attack discipline believers and hopeful seekers for, yes, their dogmatism. All student comments are equally celebrated, while the discipline’s very substance and worth are just as equally doubted.

Since boundless openness is the only acceptable value, non-judgment is imposed. Pinches of cynicism and fashion consciousness -- and occasionally of indolence -- are often part of the mix. Whether heirs of Descartes, Hume, Kant, Darwin, Marx, Nietzsche, Freud, Foucault or any number of modern and postmodern thinkers, an intellectual and ethical limbo supports their podiums.

To “problematize” is a popular postmodernist, critical theory and critical thinking ringtone. Simply stated, it means knowledge cannot be taken for granted but must be openly approached as a “problem”. More than merely identifying and stating a question or issue, the verb connotes the sceptic’s challenge to received, reasonable or commonsense notions.

The exercise may soon morph into subjectivism, relativism, and even nihilism. The ethics professor, for example, shuns all talk of ethical principles, virtues and conclusions, for these reek of naiveté, intolerance, tradition, or the authority (imposition) of some (usually oppressive) power structure. His students will spend the term “problematizing”, endlessly shuffling possible interpretations of “good” and “evil” by means of value clarification and thought experiments such as trolley problems, survival lotteries, and lifeboat games. The shock, intrigue and even amusement factors will weigh more than the soundness of the arguments.

Armed with “buts”, while lacking good reasons, students will construct and deconstruct, define and redefine “the problem” until they secretly confirm what they had suspected all along: that it is impossible or arbitrary to reach ethical conclusions, because they are always debatable and ultimately meaningless. Woe to them who dare to reasonably argue otherwise! Their position will likely be labeled as simplistic, intolerant, fundamentalist or merely old-fashioned. Since there is no such thing as a “right” or “better” answer, individual preferences or feelings, voiced by the most persevering or forceful debater, are the final words.

Whether advertently or not, the ethics professor has imposed non-judgment. Even common moral intuitions, such as “stealing is ethically wrong”, have been subjected to the dogmatic straightjacket of the open-ended problem. An inevitable question—if there is no truth, how can there be philosophy?—is, though, never entertained.

To reasonably assess a discipline is different from according it scornful and sweeping dismissal -- an attitude particularly discordant when undertaken by those voluntarily in charge of its teaching. To critically claim that there are limits to what may be known is different from claiming that nothing may be known about anything whatsoever. In its extreme expression, openness becomes indifference; inquisitiveness, endless doubt. An open window, just like an open mind, lets in the fresh air but also the flies and the dirt. A well-fitting screen is necessary out of prudence and common sense. Besides, if all knowledge is to be questioned, how is one to tell whether the window is open, and who could be trusted with that task? What is a window, for that matter? In this cognitive vacuum, openness, too, is problematic: an open mind is as justified as a closed one, and as unintelligible. Defining and “privileging” openness presupposes some criterion. Reasonably supporting and deliberately choosing openness involves -- horror! -- a judgment.

The word “professor”, the dictionary tells us, comes from the Latin profiteri: to declare publicly or profess. Thus, a professor is a “person who professes to be an expert in some art or science.” The profession thus presupposes some expertise in a course of learning and, consequently, the possibility of the attending discipline. Without an object, the affirmation of expertise rings hollow. The verb “to profess”, though, has an additional meaning: to make a pretense of or pretend. “To pretend” is to make believe, to feign. Is this the meaning of some professing at the podium?

Many will claim that the podium has always been used by not a few college professors as the arena for favorite quirks or particular quarrels. Quite likely. Yet, historical maladies are no less troubling; probably more so. Young adults hardly need their moral and intellectual doubts to be legitimized, particularly when this springs from sources they deem knowledgeable and credible.

New York Times columnist David Brooks, for instance, recently wrote about the study led by Notre Dame sociologist Christian Smith among America’s young adults (Smith et al., Lost in Transition, OUP: 2011). Facing a moral problem, most respondents (ages 18-23) could neither determine the right decision nor discriminate amoral from non-moral situations. Individual feelings and preferences took the place of basic ethical reasoning. (For a vivid portrayal of such flawed ethical thinking, and ignorance of elementary historical facts, see Ray Comfort’s documentary film 180). Brooks added that “many of these shortcomings will sort themselves out” as these young people enter social institutions that “inculcate certain habits”.

But, what sort of habits will these be? Moreover, do we wish our college graduates to be more like clay to be moulded or like artists ready with the character and competencies to do their own moulding? Isn’t subjectivism and the dismissal of intellectual and moral criteria modeled and advocated from the podium? Furthermore, the eternally recurring “problem” and “relentless doubt” lectures hardly make for inspiring fare and may represent significant opportunity costs. It is hard to imagine the excitement of an Archimedes in students if there is neither a discipline to discover nor a truth to follow.

Indiscriminately blaming higher education is, of course, simplistic and unwarranted. Many variables account for the state of affairs recorded by Smith and his colleagues (and frequently witnessed by those who regularly interact with youngsters). It has been traced, for example, to secularism (syndicated columnist Dennis Prager), and to parents who, for the sake of tolerance, “are failing to ensure that our children understand how to frame moral issues and make judgments about right conduct and about what is good in life” (Economist).

Again, the Smith study’s interviewees are neither necessarily representative of all young adults, nor students of discipline agnostics and nonbelievers. Even if they were, causally attributing their responses to these teachings would be untenable. Moreover, there are many academics, whether discipline believers or aspirants, who value their disciplines and fair-mindedly assess their shortcomings, insights, and contributions. They approach the podium as the place from which to share with students, to the best of their ability, their intellectual and moral resources.

The way to the podium may well be paved with good intentions. Undoubtedly, many discipline agnostics and nonbelievers are hardworking academics and honest, affable persons, who are unaware of the possible harm and opportunity costs their behavior entails. They, too, may rightly conceive educational ends and means as ultimately at the service of human dignity and the pursuit of the common good.

Yet, scepticism, says the French philosopher Jacques Maritain, “is one of the most alarming symptoms of the crisis of our civilization” (Man and the State, 1951). It is a disturbing sign of what ails some college and university podiums.

Alma Acevedo, PhD, teaches courses in applied ethics and conducts research in this field. First published on mercatornet.com

Should the Bank of England hand out free money to everyone?

2011-11-16T03:23:00.009Z

The UK economy is barely growing. To stimulate demand, should the Bank of England mail out a voucher worth fifty quid to every citizen of this fair land and tell them to go out and spend it on beer, fags and cheap Chinese electronics? It sounds like a mad idea, but is it any stranger than the Bank of England printing money to buy up goverment debt?

In a recent speech to the Council of Mortgage lenders - Charlie Bean, Deputy Governor for Monetary Policy, Bank of England - seriously discussed the voucher distribution idea:

"Several commentators have suggested that the effectiveness of quantitative easing could be enhanced by spending the newly created money on something other than government debt.

For instance, one idea that has been floated involves sending households a voucher, which could then be spent in the shops and redeemed for cash by the retailer. This may sound like a good idea, as it seems to get the money quickly into action in stimulating demand. Now, such a policy in effect combines an increase in borrowing to finance a temporary increase in income tax allowances with some conventional quantitative easing in which gilts are exchanged for claims on the Bank of England

But economic theory, as well as considerable evidence, suggests that such a temporary increase in disposable income would be likely to be very largely saved. Only households that wish to borrow, but presently cannot, would be likely to increase their spending materially. And making the voucher time-limited would do little to help, as households could always use the voucher instead of the cash they would have spent.

In sum, this hardly seems the most effective way to add additional stimulus."

Charlie thinks that if we received some free money, we wouldn't spend it; we would save it. On this point, he is right. However, Charlie is actually making a deep and fundamental point about fiscal policy and its ability to influence output. If it is true that we would save that spare note gifted from the BoE, it is also true that any temporary tax reduction would also be saved. In fact, any attempt to to use fiscal policy to stimulate the economy by temporarily boosting disposable income is a wasted effort.

Charlie's observation about fiscal policy has further implications. For the last four years, the UK government has issued huge amounts of debt. Since government debt has to be paid off in the future, we all know that taxes will also have to increase in the future. This means that our future disposable income will fall, and since we know we will be poorer, we are spend less now. So, running up large fiscal deficits actually depresses consumption. The conclusion is the same - fiscal stimulus doesn't work.

Mr. Bean doesn't believe in fiscal stimulus but what about quantitative easing? Printing new money doesn't create more output, it only increases the claims on a fixed amount of output. The inevitable consequence of more money will be more inflation, which is exactly what happened after the previous round of quantitative easing. Inflation went up, the economy barely grew, and unemployment remained constant.

Being a central banker Mr. Bean understands the inflationary implications of quantitative easing. Nevertheless, he still thinks borrowers will respond to quantitative easing and spend more. This is because inflation erodes the real value of debt. Inflation makes borrowers permanently better off. However, for those on fixed incomes, and savers with bank deposits, inflation makes them permanently poorer. So, quantitative easing is about robbing savers to placate debtors. This is hardly a strategy for sustained economic growth.

There is only one way that the UK can recover from this crisis. Tighten monetary policy to restore positive real interest rates. Balance the budget and pay off government debt. Reduce the size of the government and generate space for permanent reductions in taxes for working families. Reform the benefits system to create incentives for work rather than unemployment. Break up monopolies, and downsize and privatize state owned banks.

This is the only way forward for the UK economy. The question is how long will it take policy makers like Mr. Bean to realize it?

No lender of last resort for the Eurozone

2011-11-16T02:33:00.000Z

Jens Weidmann, Bundesbank president, recently gave an interview to the Financial Times. Here is what he said about the role of the European Central Bank and whether it should start to fund the deficits of eurozone member states like Italy, Greece and Spain.

His answer was remarkably direct and honest, leaving little room for the argument that the ECB should come to the rescue of bankrupt Eurozone countries.

Financial Times: Can you explain why the ECB cannot be lender of last resort (for Eurozone governments)?

Jens Weidmann: The eurosystem is a lender of last resort – for solvent but illiquid banks. It must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty [prohibiting monetary financing – or central bank funding of governments]. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions.

I think the prohibition of monetary financing is very important in ensuring the credibility and independence of the central bank, which allow us to deliver on our primary objective of price stability. This is a very fundamental issue. If we now overstep that mandate, we call into question our own independence.

European debt heat map

2011-11-16T02:23:00.002Z

Notice the high debt ratios in France, Germany and Belgium - three key players in the Eurozone core.

From the Economist

Worst case scenarios

2011-11-15T04:07:00.016Z

The German chancellor - Angela Merkel - described the European debt crisis as "maybe Europe's most difficult hours since world war two". Merkel doesn't seem the kind of politician that over-cooks her messages. If this is indeed a moment of extreme crisis, then it is time to examine worst-case scenarios.

The European single currency is close to collapse. Already French and German civil servants are putting together a strategy whereby some of the Eurozone members re-introduce national currencies. When chaos is raging, technocratic solutions are beguiling. They provide a reassuring sense of order and calm.

If only the world could be crafted like the outlines of PowerPoint presentations and strategy papers. Unfortunately, once the Eurozone begin to disintegrate, those carefully drafted plans will be quickly consigned to the circular filing cabinets below minister's desks. There will be no orderly departures from the single currency. The eurozone collapse will be ugly and brutal.

It will start with Greece, who will set off a chain reaction of Eurozone departures. Like falling dominos, one Eurozone country after another will be forced to reintroduce their national currency. There will be a race to the bottom as each exiting country devalues to steal jobs from their neighbours. The likeliest outcome will be 17 European currencies where there is currently only one.

Eurozone disintegration will be immediately followed by a massive surge in inflation. Countries like Greece can reasonably expect the value of the new currencies to drop by half, as exchange rates realign with underlying fundamentals. If Europe is lucky, it will avoid hyperinflation. If not, we can expect the value all European financial assets to be wiped out within months. Imagine a continent of ageing hippies without savings, and you will be about 10 percent of the way towards understanding what the post-EMU Europe will look like.

Inevitably, output will collapse, the financial system will disintegrate, and unemployment will go through the proverbial roof. The great depression will look like a gentle blip compared to the implosion of the Europe.

These are just the short run consequences of Eurozone disintegration.It is anyone's guess as to the political consequences of the total destruction of the European economy. Nevertheless, the very idea of the European Union will suffer catastrophic shock. Member countries will naturally begin a long and vicious period of mutual recrimination. Germany will blame Southern Europe; France will blame Germany, while many in Britain will say "I told you so". Efforts to create an "ever closer union" will be abandoned, probably forever. In the short run, the infrastructure of union is likely to remain, but few will take it seriously. The European Union would become a wretched institutional mess hanging over Europe.

Many will welcome the demise of the European Union. Certainly, European integration has been running at a pace far faster than the vast majority of ordinary Europeans were willing to accept. Animosity towards the EU had been growing across Europe long before the current crisis. European integration had become a cynical exercise where politicians routinely ignored the wishes of their electorates.

However, the European enterprise was created to conceal the deep and unpleasant truth. There was a time when Europe dominated the world, but for at least 50 years or possibly longer, Europe has been in decline. This retreat has taken many forms; political, demographic, military, economic, and cultural.

The creation of a quasi-European state sustained the pretense that Europe still mattered. European politicians in rapidly diminishing states like France, Italy and the UK could argue that Europe still mattered. Rather like the Greek public debt numbers, the claim was based on false accounting. Adding together 27 decrepit and ossified countries does not create a dynamic superstate. Once the Eurozone goes, that conceit will be finally exposed.

"It is not a solution to divide, the solution is to integrate. We have to create a stronger European Union"

2011-11-13T23:07:00.005Z

That is what Jose Manuel Barroso - the EU Commission President - thinks.

The crisis of the moment is Italy, which needs to find money to cover its deficit. It also needs to convince bondholders to keep buying its debt.

Italian bondholders want to know one thing; will they get back all the money they lent to Italy on time? The Italian state is broke. Economic growth is negligible, while the outstanding debt stock is massive. There are good reasons to think they might not.

Therefore, Mr. Barroso's statement is loaded with financial implications. He's saying "if we have more European integration, then Italy gets more money".

So, if there is more integration, as Mr. Barroso suggests, then who is going to pony up with the cash to cover Italy's debts?

Germany is reluctant, France is almost as broke as Italy, and the UK government would fall if it began to support the bankrupt Italian state. Other European economies to too small to matter.

Integration doesn't pay off debt; only money can do that. So, Mr. Barroso's causality between integration and problem resolution seems a little faulty.

I don't think we have heard the last of him

2011-11-13T02:30:00.000Z

Berlusconi may have resigned but he remains head of one of Italy's largest party.

He still owns all the main TV stations.

Italy's crushing debt stock is still there.

So is the corruption.

Italy is still in the eurozone.

Just watch what happens next in Italy, political infighting, chaos and ultimately collapse.

In other words, it is a re-run of the Greek debacle.

Getting the priorities right

2011-11-13T02:24:00.002Z

I love the concluding sentence from this article from the Telegraph. UK passport controls were relaxed because the French authorities were complaining about congestion.

Bureaucratic necessity wins out every time.

All but the most cursory checks were abandoned on passengers on British-registered coaches as they arrived at Dover, Britain's biggest port.

Instead of passports being scanned electronically, border guards checked that the picture matched the holder. It means they were not cross-checked to a computer database to establish if the holder was a wanted terrorist, criminal or immigration offender.

The policy was in place for four years after being introduced when Labour was in power, but never disclosed to Parliament.

It was implemented because the French complained about congestion in Calais caused by backlogs at passport control.

The crazy US housing downturn

2011-11-11T04:06:00.000Z

It is only when we look at long term data on housing starts that we begin to understand the magnitude of the crash that has befallen the US housing market. Currently, new home housing starts are at the their lowest level in fifty years.

Furthermore, the downturn has been far more prolonged than any previous downturn.

The current economic crisis is unique in so many ways.

UK population projections; there will be more of us, and we will be much older

2011-11-11T03:39:00.001Z

The ONS has produced an alarming population projection. With a decade or so, the UK will be home to at least 70 million people.

Over the last couple of decades, around half of the growth in the population has come from migration. Suppose, for a moment, that the UK economy continues to stagnate, while emerging market and low income countries continue to grow rapidly. What would happen if migration flows were to dry up?

Currently, there is a clamour to reduce migration. Our much beloved Home Secretary - Teresa May - finds herself in trouble on this very issue. Notwithstanding the passport chaos from this summer, it is getting harder for people to move to the UK.

The indigenous UK population tends to be much older than the new arrivals. If migrants fail to arrive, then the ratio of workers to pensioners could well be much lower than the ones suggested in this short video.

But be careful for what you wish for. If the migrants stop coming, who will do the work and pay taxes to maintain those generous state pensions?

Eurozone breakup draws closer

2011-11-10T03:11:00.003Z

Who would have thought that the future of the Euro depended on a lecherous old geriatric?

Yesterday, Berlusconi resigned. Today, Italian borrowing costs soared. 10-year bond yields are now well above the 7 percent - a level at which the Italian fiscal position is unsustainable. Thus, the lesson of today was about the bankruptcy of the Italian political system. As bad as he was, Sleazy Silvio was still a better option than any other Italian politician. He was the best Italy had to offer.

While the rest of us are learning about the appalling limitations of Italian politics, that old bore - Jose Manuel Barroso - issued yet another "stern warning" about the impeding dangers of a collapsing single currency. He has been issuing press releases on this theme for at least four years. He calls for concerted action to protect the Euro, organizes a high level meeting amoun Eurozone leaders, and yet the situation just keeps getting worse.

Barroso's fear that the Eurozone will implode is now rapidly turning into a reality. According to Reuters, French and German officials are already working on an exit plan for insolvent Eurozone members.French President Nicolas Sarkozy implied that a breakup was the best course for Europe when he advocated a two-speed Europe. Northern euro zone countries would "accelerate and deepen integration", while the Southern laggards would be ejected.

Meanwhile, over in Frankfort, the ECB are desperately buying up Italian bonds. It is a forlorn attempt to stabilize financial markets and keep Italian rates down. However, it is a failing strategy. Italian bond rates keep rising; Europe slides ever closer to the abyss.

As the abyss beckons, one horrifying reality is beginning to emerge - there is nothing anyone can do to save Italy. After four years of bailouts, the world has finally produced a financial crisis that can not be resolved by a handout to financial institutions. This isn't a case of "too big to fail". There isn't enough money in the world to save Italy.

After Italy, who is next? Already, that fearful disease - financial contagion - has fingered another potential victim. French interest rates have begun to rise.

Mr. Berlusconi - as seen by the Economist magazine

2011-11-10T02:47:00.001Z

So farewell then Mr Berlusconi

2011-11-09T03:11:00.002Z

Mr Berlusconi seemed - in equal measure - both a repulsive and comical figure. Over the last two years, his personal life has become increasingly bizarre and shameless. Italy deserves better. It is a relief to hear that he is finally resigning. It should have happened sooner, but better now than next week, or some other long overdue moment in the future.

Nevertheless, there is a danger that one reads too much into his departure. When reporting on Italy, the mainstream media have often blended Mr Berlusconi's outrageous personal lifestyle, and his contempt for the Italian public with Italy is rapidly deteriorating economic situation. Likewise, financial markets welcomed the news of the Italian prime minister's impending resignation. The implication seems to be that Berlusconi's exit both lowers public sector default risk and increases the profitability of Italian publicly traded firms - a proposition that seems rather implausible when explicitly articulated.

The Italian economy continues to be in a parlous state and Mr Berlusconi's departure changes nothing. The public sector debt stock sits at about 120 percent of GDP. The economy has barely grown in a decade. Italy is rapidly ageing population. It has a sclerotic and overregulated private sector. Its judicial system is barely functioning. These problems did not suddenly emerge when Mr Berlusconi became Prime Minister. They will not disappear when he finally leaves office.

It takes decades of government mismanagement to build up a deficit of 120 percent of GDP. This number is a ratio comprising of nominal debt and nominal GDP. Notwithstanding the mathematics behind ratios, as a rough approximation, it would take about 24 years for a fiscal deficit of five percent per year to build up a debt stock of this magnitude.

When Berlusconi first became prime minister, the Italian debt stock was already over 100 percent of GDP. His great achievement was to stabilise the debt at roughly the level he inherited when entering office. He didn't improve things much, but neither did he make matters worse.

So farewell Mr Berlusconi, you inherited a mess when you first became prime minister, and you leave a mess for your successor.

Italy remains on the edge of a meltdown.

The one percent meets the ninety-nine percent

2011-11-09T02:38:00.002Z

Lets make up some new money - it will make us happy

2011-11-07T12:37:00.001Z

Jim Lacey - professor of strategic studies at the US Marine Corps War College - was recently walking through the Occupy Wall Street camp in New York. He noticed an interesting development in monetary theory.

As luck would have it, though, many of them will not have to worry about money for much longer, as several OWS occupiers had the answer to everyone’s financial problems. This innovative group, all sporting $4-bill badges, claimed to have reimagined money. Intrigued, I asked how such a reimagination worked. In short, it seems that people are to create money as they need it for their own happiness and the happiness of others.

This I liked, as I have a wonderful imagination and a deep need to use my money so as to increase my own happiness. I promptly imagined a page of my notebook into $10,000 and gave it to one of the $4 lapel-badge ladies.

She looked at the sheet of paper and smiled at me. So far, so good. I then asked for her laptop and told her she could keep the $8,000 change I was due so as to further increase her own happiness. She quickly turned away, taking her laptop with her and leaving me short $10,000 of reimagined money.

I assume the system has some kinks that the revolution will figure out as it goes.

Before we all snicker at the naivety of the $4 demonstrators, isn't this the same idea that the Bank of England is pursuing? Aren't they printing money to try to make us happy?

UK Public Expenditure - Where Does The Money Go?

2011-11-06T19:35:00.000Z

During the last fiscal year, the UK government spent £691 billion. Where did the money go? Most of it went on social benefits, health and education. Interest payments took up a sizable chunk, despite the Bank of England's attempts to keep rates low. Public investment was also a hefty number.

If Her Majesty's Government is going to make a sizable reduction in public expenditure, there is little point looking for savings among the other items. We could abolish the foreign office (FCO), stop offering AID to poor countries and leave the EC, and the savings would quite limited. However, we might get somewhere if we abolished Scotland, Wales and Northern Ireland.

Violent OWS Protesters Prevent Woman in Wheelchair From Leaving Event

2011-11-05T14:44:00.001Z

A referendum on austerity

2011-11-01T10:09:00.000Z

The Greeks will be allowed to vote on their austerity package. A curious idea; will they vote for lower social spending, public sector wage cuts and reduced pensions? Or will they go with a fantasy that Greece is richer than it really is?

How would Britain vote if such a referendum were held here?

Tasteful

2011-11-01T10:06:00.001Z

Foreclosure Firm Threw Homeless-Themed Party

EU looks to China for a bailout.

2011-10-28T17:37:00.000+01:00

The head of the European bailout fund - the EFSF - is on his way to China. He is looking for cash from the Communists.

What does this say about the eurozone? At a minimum, it looks desperate.

Do you think eurozone leaders will be raising any human rights issues when they next visit Beijing?

What is the price for silence?

No more Germany

2011-10-25T08:38:00.002+01:00

While the BBC has focused on the projection that the world's population will reach seven billion by next week, I was struck by another alarming forecast; if current German fertility rates continue for the next two hundred years, its population will shrink by 98 percent. The projection comes from David Goldman's recent book "Why civilizations die".

How seriously should we take such a forecast? Would the fertility rate back in 1811 tell us anything about rates today? Goldman's forecast does tell us the logical consequences of current fertility rates. If they remain unchanged, a very big if, then Germany disappears in 200 hundred years. That is always a useful thing to know.

Germany's current fertility rate is below the level necessary to sustain its current population level. Moreover, it is hard to see how it could be reversed. The consequences of lower fertility will be severe. Germany is ageing rapidly, and has a welfare system that will either collapse or change radically.

Can anyone explain why Germany won't exist in 200 years? Or, to put the same question into different words, are there any reasons to think that German fertility rates will increase to at least 2.1 children per woman on a sustainable basis?

The UK Inflation-Unemployment Trade-Off

2011-10-22T00:32:00.007+01:00

One more tentative step towards better data visualisations. This is a motion chart of the famous UK phillips curve - the relationship between inflation and unemployment.

Before you press the start button on this little application, click on the little bubble within the chart. If all goes to plan, then you should see the chart trace out the inflation and unemployment rates since 1991.

What does this application tell us?

First, in the early 1990s, the trade off was very bad; lots of unemployment and inflation.

Second, the Conservatives managed to reduce unemployment without actually increasing inflation. This was a major achievement.

Third, Labour managed to keep both unemployment and inflation down, at least until the crisis.

Finally, inflation has shot up since the crisis began. Unemployment is up too, but it hasn't reached the levels experienced during the 1990s recession.

(Finally, two things; first this is a flash based application. It won't work on an Ipad. Second, I have had some technical problems with this thing. It may not work on any machine apart from my own. If so, I am sorry, but I have reached the limits of my abilities with this kind of thing. Let me know if there are any problems, it would be useful to get some feedback)

Pay back time in Greece

2011-10-21T02:34:00.002+01:00

Today, the Greek parliament narrowly passed yet another austerity package. Like the previous packages, it contains another round of public sector downsizing; wage cuts, benefits reductions, cuts in civil service numbers. Overall, the package was nasty; top full of dreadful and desperate measures designed to stem Greece's slide into the abyss.

The streets of Athens witnessed another day of mayhem. In their incandescent rage, Greeks feel the need to take to the street. I am not quite sure about the purpose of these demonstrations. Tramping around the centre of the capital isn't going to generate any additional revenue for the Greek state. Nor will it contribute directly to economic growth.

It all begs the question would it not have been better to constrain public expenditure during the years of economic growth, rather than let things slowly drift along. Year after year, the Greek public sector spent more than it received. Government debt rose, in terms of GDP. There were opportunities to fix the Greek economy, but it was easier politically to let things slide.

Whether Greece defaults or not, the country will have to pay for those decades of fiscal irresponsibility with declining living standards and deteriorating public services. The next time you hear someone advocate higher public expenditures, remind them of Greece.

It is payback time in Greece and it is a terrible thing to watch. I wouldn't want to see anything like that here. So lets agree to take the fiscal medicine now, get government finances in order, and avoid the kind of crisis that has destroyed Greece.

Time is running out

2011-10-19T04:14:00.006+01:00

If, four years ago, Mervyn King had posted his recent speech to the Institute of Directors on a blog, he would have placed himself firmly on the outer fringes of the bubble doomsayers. At that time, there were a small number of bloggers who predicted the imminent collapse of the UK and US economies. For the most part, their dire predictions were not taken seriously. I know, I was there, and I have a large archive of blog posts to prove it.

The governor said some extraordinary things to the Institute. With remarkable candidness, he suggested that is is now time to accept that the "underlying problem is one of solvency not liquidity - solvency of banks and solvency of countries". Moreover, he acknowledged that the "underlying problems of excessive debt have not gone away."

Where did all this debt come from? According to King, the deep structural cause of the crisis lies in global imbalances. These imbalances have existed on two levels. Globally, Asian economies, in particular but not exclusively China, have kept their exchange rates low, exported cheap goods, earned huge quantities of dollars. This cash was recycled back to the US to buy government debt. This has allowed the US government to run up huge deficits. It also permitted US public to maintain consumption levels that could not be sustained by current US production.

On a European level, Germany has played the role of China, while southern Europe ran up huge external and fiscal deficits. The German private sector accumulated large cash balances that were sent southwards to keep Club Med spending. Other countries were in on the scam too, for example, the Netherlands, Finland and Sweden.

King is not wrong when he points to these global imbalances as the font of all our troubles. However, every sentient economist on the planet has known about these imbalances since at least 2005. The plain fact is that China likes the current arrangement. Germany, on the other hand, has begun to see the limits of running up huge surpluses and exporting capital to southern Europe. Still, surplus countries like China and Germany will continue to ride these global imbalances to the limit. There will be no "global consensus" to rebalance the World economy.

Herein lies the central problem for the Bank of England. It can do nothing reduce these imbalances. So, King has decided that the Bank of England should mimic the Chinese model. The Bank has already engaged in two massive rounds of monetary creation, and it is about to start another. The irony seems lost on King. He points to global imbalances yet uses UK monetary policy to depreciate sterling in an attempt to get into the game.

Sterling has lost perhaps a quarter of its purchasing power since the beginning of the crisis. Unfortunately, the devaluation has not resulted in a recovery. Exports picked up slightly, but the uptick barely registered in the GDP numbers. Inflation, on the other hand, has surged with remarkable violence. The headline rate is now running at 5.2 percent.

Why didn't quantitative easing work for us, when it worked like miracle-grow in China? It is not difficult to generate double digit growth when you have half a billion under-employed peasants toiling in the field and then take them into the cities to work in Ipad factories. The only spare labour capacity in the UK is the feral under-class that live in our major cities and thrive on a complex system of social benefits. Quantitative easing was never going to work in the UK. We didn't have enough workers; although we have plenty of shirkers.

Half way through his speech, King told the Institute of Directors that "Time is running out" for the global economy. This is almost certainly true. Furthermore, it is a truly frightening statement. However, if the only answer to his alarmist and deeply depressing assessment of our economic predicament is printing money, then we are truly screwed. It won't save the UK economy and does nothing to reduce global imbalances.

Only economic growth can resolve Europe's crisis

2011-10-18T04:00:00.007+01:00

It wasn't a good weekend for Europe. Politicians gathered, hoping to "decisively resolve" the crisis facing the continent. The big idea was to create a super sized bailout fund. Bond investors were going to be shocked at the amount of resources to back-stop EU economies and rediscover that old desire to buy Italian and Spanish bonds with yields similar to those offered on German bonds.

The press releases were ready to go, but the big breakthrough didn't arrive. No one could find a magic wand and conjure up €2 trillion from €440 billion.

Rather than spend their time concocting incredible schemes of financial engineering, EU politicians would have found it more profitable to seriously ponder Europe's most pressing difficulty - a lack of growth.

For at least three decades Europe has grown more slowly than its competitors in North America and Asia. Occasionally, a brave soul would come forward and articulate the causes of this lack of growth. European economies are over regulated, which has built up daunting barriers to innovation and investment. Welfare systems are overly generous and spawned a pernicious web of disincentives, permitting early retirement, discouraging work and encouraging idleness.

This catastrophic collection of misguided policies is what Frenchified politicians call the European social model. It is built upon extremely high levels of public expenditure. To pay for this extravagance, Europeans have faced some of the highest tax rates in the world. Despite oppressive tax regimes, many European governments have failed to balance their books. Expenditures were invariably higher the revenues, leaving large fiscal deficits.

To meet the shortfall of taxes relative to expenditure, governments have gone to the bond market and issued debt. Debt levels have been crawling upwards since the early 1970s. Periodically, governments have gone through a familiar cycle of trying to reduce indebtedness, only to retreat as the social costs of adjustment created loud protests and the formless menace of electoral ruin.

It is not just the public sector that has fallen into the trap of borrowing to pay for current expenditure. That celebrated lack growth also translated into stagnant living standards. Rather than acknowledge this reality, many European households borrowed to preserve high consumption levels. As a consequence, household sector debt in many countries has risen spectacularly.

Banks have been the great facilitator in this colossal increase in borrowing. Banks bought those dodgy European bonds, and extended a massive wave of credit to households. Capital buffers were reduced, dubious enterprises were financed, and the end result was a proliferation of weak and over-extended banks.

After three decades of studiously piling up debt, Europe now has to face the consequences. Five countries in the euro zone - Italy, Spain, Greece, Ireland, and Portugal - are finding impossible to fund their fiscal deficits. At least one government, Greece, will default on its public debt. Naturally, bondholders are reluctant to support borrowers who are unlikely to repay their debts. A debt default would shatter Europe's vulnerable financial system. Bank balance sheets are already weak, while bank capital buffers are inadequate.

As the continent confronts a two-pronged crisis, European politicians remain wedded to a dangerous idea. They believe that the Continent's problems could be resolved by a temporary infusion of cash. At the moment, Europe has available about €440 billion in its bailout fund - the EFSF. Unfortunately, this fund is too small to simultaneously deal with Europe's fiscal crisis and recapitalize its ailing banking system.

Some European politicians would like the European Central bank to step up and fund European fiscal deficits. However, the treaty the established the ECB explicitly forbids the bank from providing liquidity to governments. So the search continues for an untapped source of cash that will permit governments to continue spending more than they generate in revenues.

It is the inability to grow that lies at the heart of this crisis. Ironically, the high levels of debt and weakened banking system would not matter much if economies were growing rapidly. With strong growth, tax revenues would increase, and debt to GDP ratios would fall rapidly. Bank balance sheets could recover, borrowers could repay their debts, and banks could accumulate capital buffers.

European politicians are a cowardly bunch. They have been unwilling to confront the causes of stagnant growth. They have taken the seemingly easier route and look for cash to in a futile effort to maintain high government expenditure, excessive regulation, and bloated welfare systems.

Nevertheless, this crisis is telling politicians that the old way of doing things has reached a terminal point. The European social model can no longer continue. Unfortunately, a breakthrough will only come when European politicians forget about short-term "decisive plans" and seriously begin to deregulate their economies and downsize welfare systems.

It is growth and not cash that will ultimately provide a solution to Europe’s problems.

The coming demographic crisis - a new interactive data application

2011-10-16T05:33:00.008+01:00

ukhousebubble.blogspot.com

The decline in the number of workers per retiree affects all advanced countries. No one escapes the demographic time bomb.

I had a few difficulties putting this data app together. Sizing the thing to make it fit on the blog page has proved to be quite a challenge. This is mostly because I often don't know what I am doing with these graphics packages.

It is a learning process I suppose.

All property is theft

2011-10-15T19:12:00.000+01:00

From the Occupy Wall Street demonstration.

What is yours is mine, but what is mine is my own.

Ten bizarre things that happened yesterday

2011-10-14T03:26:00.003+01:00

Is it just me? News stories have a strange surreal quality.Here are just a few of the weird and wonderful things that happened yesterday:

Standard and Poors downgraded Spain.
Fitch downgraded UBS.
The Portuguese government won’t pay the 13th and 14th month salary payment for civil services who earn €1,000 a month. Two Christmas bonuses a year; it can only happen in Europe.
Slovakia voted in favour of the European bailout fund – the EFSF. The Slovakian parliament voted against it earlier this week. Barroso thanked Slovakia.
German banks told the EU that they didn’t want to increase their capital buffers. If things go pear-shaped, these same German banks won’t be slow to ask for a bailout.
Hedge Fund managers aren't supposed to do jail time. However, Raj Rajaratnam, has broken that glass ceiling. He is off to Club Fed for insider trading. He received 11 years for retribution and correction. Ironically, he will be sent to the same prison as Bernie Madoff. Mercifully, there are no insider traders in the City of London.
The US economy records another huge external deficit.
At last, some good news; in the last three months, JP Morgan fired 1,000 investment bankers while their bonus pool is down by $700 million.
There is a 48 hour train strike in Greece, which should boost growth and help pay down that mountain of debt.
Berlusconi is still Prime Minister of Italy, but that could change tomorrow after the confidence vote. Italy even managed to sell some five year bonds. The real question is who is mad enough to buy them. The ECB?

I plead the fifth amendment

2011-10-14T02:45:00.000+01:00

Just in case anyone is wondering what the fifth amendment of the US constitution actually says, here it is....

"No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation."

What do we want? Free education!

2011-10-14T00:46:00.000+01:00

A young activist lays out the case for free college tuition.

Well, he convinced me.

Where do I send the cheque?

Yet another comprehensive plan to fix Europe

2011-10-13T03:56:00.006+01:00

Today, the European Commission announced a comprehensive plan to decisively deal with the euro zone sovereign debt crisis.

Haven't we been here before? Over the last three years, the Commission bravely spoke on several occasions of ambitious rescue plans only to discover that those plans were not sufficient to stabilize the European financial system or resolve the growing public sector funding issues in southern Europe.

This latest plan comes in five parts.

Decisive action on Greece so that "all doubt is removed" about the country's economic sustainability.
Increasing the size of the EFSF to €440 billion and accelerating the launch of its permanent successor, the European Stability Mechanism.
Co-ordinated action on strengthening Europe's banks. Banks should set aside more assets to cover losses through private funding or national governments if necessary. If this is still not adequate, they can tap into the EFSF, but if they do they will not be allowed to pay dividends of bonuses
Speeding up policies to enhance growth and stability, such as free trade agreements
Building greater integration for economic governance across the euro zone.

Let us start from the bottom of this list and work our way to the top.

Building greater economic integration will do nothing to eliminate the crisis. The problem is about funding and not European governance structures. Unless someone somewhere is willing to put more money into southern European governments then the crisis will continue. Integration or disintegration - it is a question that isn't being asked right now.

Likewise, free trade agreements will not help. In the long run, more free-trade might boost growth, but the best, the effect will be marginal. Again, it won't put any money on the table for Greece or Italy.

The next three measures illustrate the limited options available at this late stage of the crisis. European banks are under capitalized. Somewhat surprisingly, banks and continue to pay dividends and large bonuses despite the fact that they were short of capital. This speaks volumes about modern Europe and the shortsighted nature of those who run its financial system.

Be that as it may, the penny is finally dropped, and policymakers now realize that a devastating European banking crisis could be on the horizon. To avoid this crisis, the European Commission would like national governments to recapitalize banks. This will increase indebtedness of European governments, making them more vulnerable to funding crises. The plan will replace one problem with another. This illustrates the great lesson of the early 21st century - financial engineering can move risk around, but it cannot eliminate it.

The Commission also suggests that the European bailout fund - the EFSF - could be used to recapitalize banks. The problem here is that money cannot be spent twice. If the bailout fund is used to sort out the banks, it can't be used to bail out governments.

The European Commission is aware of this rather obvious constraint. They would like to increase the size of the bailout fund from its current underfunded level of €440 billion. Since all European governments are out of money, the only institution that can bring new cash to the table is the European Central Bank. There are, however, powerful legal restrictions on the ECB that prevents it from bailing out governments.

Realizing this conundrum, European Commission has played around with some vocabulary. The bailout fund will be renamed and in future it will be known as the European Stability Mechanism. Whatever it might be called, bailout fund remains at €440 billion. This more or less guarantees that the crisis will linger on.

Finally, there is the promise of decisive action on Greece. This can only mean one thing- a default. The only remaining issue is the size of the haircut that great creditors will have to accept.

Overall, it isn't much of a plan. In the coming weeks and months, the European Commission will be announcing further comprehensive plans to stabilize Europe.

So what is the answer to Europe's economic crisis? Alice Cook's plan to save Europe can be encapsulated in one word - honesty.

European Policy makers need to be brutally honest with their electorates. Welfare systems are unsustainable and without reform, it is inevitable that they will collapse. European workers are overpaid and uncompetitive. Public sectors are too large and need to be reduced in order to make room for the wealth creating private sector. Financial systems have become too bloated and need to be downsized. Europe is ageing rapidly.

Europe should have produced more children but didn't. It put aside the family as an institution and focused on personal consumption and debt accumulation. It was a big mistake, but there isn't much that Europe can do now after four decades of neglect. However, this unfortunate choice has a consequence; those public pensions, that we thought we would receive when we retired, were illusory. Europeans need to understand the appalling consequences of poor demographic decision-making.

Europeans also need to hear that printing money doesn't create wealth and increasing government debt cannot get Europe out of a debt crisis.

Above all, Europeans need to hear that they are about to get much poorer. They may demonstrate in the city square if they want, but it won't change anything. However, with honesty comes genuine change and reform.

So Mr. Fox, you have a friend.....

2011-10-13T03:12:00.003+01:00

I know I should be more diligent and read up on the latest political crisis. Unfortunately, I can't get much beyond the headlines of the Liam Fox saga.

Based on my limited and negligent reading, I gather that Mr Fox has a friend that has subsequently proved to be an embarrassment. I've also picked up that there is a security dimension to the scandal since Mr Fox is the U.K.'s Defence Minister. This is hard to believe, since successive Labour and Conservative governments had downsized UK military capacity to the point where it no longer offers any protection against any threat beyond a suicide bomber. I can't see why the fact that the Defence Minister has a male friend would make the UK more vulnerable that it has already become.

Part of my reluctance to delve deeper into this story is that there are so many more important issues floating around at the moment. There is, for example, the impending collapse of the Italian government. This could set in motion a sequence of events that could finally lead to the collapse of the euro, and unleash the greatest European economic downturn since the Black Death. The US is threatening sanctions against Iran for a despicable plot to assassinate the Saudi ambassador. A major European bank has just failed. Unemployment has risen sharply in the United Kingdom. The Federal Reserve is again thinking of printing cash in the vain hope that the US economy will begin to recover.

Perhaps there is something we're not being told. Maybe in a few days we might learn why this otherwise unforgivably dull story has dominated the newspapers.

Goldman's sweet deal with HRMC

2011-10-12T02:58:00.003+01:00

There are days when I am filled with despair about Britain. I just read this article in Telegraph about the reprehensible behaviour of Goldman Sachs, and the despicable response of Her Majesty's tax collectors.

It appears that the Bank "seconded" its staff to an offshore subsidiary - Goldman Sachs Services Ltd. According to the Telegraph, this scheme allowed those big banking bonuses to be indirectly invested into elaborate share option schemes. However, in 2009, a British judge called time on this caper, describing it "a way of keeping information about the GS accounts and payroll out of the public domain and confidential".

When the scheme was declared illegal, Goldman owed the UK taxpayer interest on its outstanding obligations. Did it play the good corporate citizen and pay? What do bears do in the forest? What do greedy bankers do in the city of London?

This is how the Telegraph descries that happened next:

But Goldman Sachs refused to pay its £30.8m bill. By 2010, according to a public judgment, the unpaid bill with accumulated interest had mounted to £40m.

According to a leaked Government document revealing the minutes of a meeting on December 8 2010 chaired by HMRC general counsel Anthony Inglese, Goldman's tactics were obstructive.

The document also claims that the permanent secretary Dave Hartnett had "shaken hands" on a secret settlement with Goldman Sachs.

When you are paying out tax as a wage earner, don't you wish you could "shake hands" on a secret settlement?

Rather than negotiating with these deviants, the HMRC should have promptly returned them to court where a sturdy English judge should have rebuked them, and handed out further punishment to provide both retribution and compensation.

Of course, that didn't happen. A slimey compromise seemed the better option for the HMRC.

Slovaks vote down the bail out fund, but don't worry, they will get a second chance to vote again.

2011-10-12T02:35:00.001+01:00

The Slovakian Parliament has just voted down an extension of the European bailout fund - the EFSF. Obviously, this was the wrong answer as far as Brussels is concerned and shortly, the Slovakians will be given an opportunity to vote again in order to arrive at the right "European" answer.

Richard Sulik - one of the Slovak party leaders - offered some interesting insights in to Europe and its single currency in an interview with Der Speigel.

In case you haven't already seen it, here is a translation of that interview.

From Spiegel:

Only two countries, Malta and Slovakia, have yet to ratify the expansion of the euro bailout fund. Its fate may be in the hands of a minor Slovak party headed by Richard Sulik. In an interview, the politician explains why he hopes the fund will fail and what he sees as the only way to save the euro.

SPIEGEL ONLINE: Mr. Sulik, do you want to go down in European Union history as the man who destroyed the euro?

Richard Sulik : No. Where did you get that idea?

SPIEGEL ONLINE: Slovakia has yet to approve the expansion of the euro backstop fund, the European Financial Stability Facility (EFSF), because your Freedom and Solidarity (SaS) party is blocking the reform. If a majority of Slovak parliamentarians don't support the EFSF expansion, it could ultimately mean the end of the common currency.

Sulik: The opposite is actually the case. The greatest threat to the euro is the bailout fund itself.

SPIEGEL ONLINE: How so?

Sulik: It's an attempt to use fresh debt to solve the debt crisis. That will never work. But, for me, the main issue is protecting the money of Slovak taxpayers. We're supposed to contribute the largest share of the bailout fund measured in terms of economic strength. That's unacceptable.

SPIEGEL ONLINE: That sounds almost nationalist. But, at the same time, you've had what might be considered an ideal European career. When you were 12, you came to Germany and attended school and university here. After the Cold War ended, you returned home to help build up your homeland. Do you care nothing about European solidarity?

Sulik: If we now choose to follow our own path, the solidarity of the others will also crumble. And that would be for the best. Once that happens, we would finally stop with all this debt nonsense. Continuously taking on more debts hurts the euro. Every country has to help itself. That's very easy; one just has to make it happen.

SPIEGEL ONLINE: Slovakia's parliament is scheduled to vote on the bailout fund expansion on Oct. 11. How do you predict the vote will turn out?

Sulik: It's still open. The ruling coalition is composed of four parties. My party will vote "no"; the other three coalition parties intend to say "yes." What the opposition says is decisive.

SPIEGEL ONLINE: The Social Democrats have offered your coalition partners to support the reform in return for new elections. Do you think the coalition is in danger of collapse?

Sulik: I don't see any reason why it would.

SPIEGEL ONLINE: What will you do should the EFSF reform pass despite your opposition?

Sulik: For Slovakia, it would be best not to join the bailout fund. Our membership in the euro zone, after all, was not conditional on us becoming members of strange associations like the EFSF, which damage the currency.

SPIEGEL ONLINE: If the euro only causes problems, why doesn't Slovakia's government just pull the country out of the euro zone?

Sulik: I don't see the euro as the problem. It's a good project. Everyone involved can benefit from it -- but only if they stick to the ground rules. And that's exactly what we're demanding.

SPIEGEL ONLINE: Which ground rules should we be following?

Sulik: We have to observe three points: First, we have to strictly adhere to the existing rules, such as not being liable for others' debts, just as it's spelled out in Article 125 of the Lisbon Treaty. Second, we have to let Greece go bankrupt and have the banks involved in the debt-restructuring. The creditors will have to relinquish 50 to perhaps 70 percent of their claims. So far, the agreements on that have been a joke. Third, we have to be adamant about cost-cutting and manage budgets in a responsible way.

SPIEGEL ONLINE: Many experts fear that a conflagration would break out across Europe should Greece go bankrupt and that the crisis will spill over into other countries, including Portugal, Spain and Italy.

Sulik: Politicians can't allow themselves to be pressured by the financial markets. Just because equity prices fall and the euro loses value against the dollar is no reason for giving in to panic.

SPIEGEL ONLINE: But do you really believe that politicians can calm the financial markets by stubbornly sticking to their principles?

Sulik: Let's just ignore the markets. It's ridiculous how politicians orient themselves based on whether stock prices rise or fall a few percentage points.

SPIEGEL ONLINE: You're not afraid that a Greek insolvency could mark the beginning of the crisis instead of the end?

Sulik: No. There's not going to be a domino effect along the lines of "first Greece, then Portugal and finally Italy." Just because one country goes broke doesn't mean the other ones automatically will.

SPIEGEL ONLINE: Nevertheless, banks could run into significant problems should they be forced to write down billions in sovereign bond holdings.

Sulik: So what? They took on too much risk. That one might go broke as a consequence of bad decisions is just part of the market economy. Of course, states have to protect the savings of their populations. But that's much cheaper than bailing banks out. And that, in turn, is much cheaper than bailing entire states out.

SPIEGEL ONLINE: Does one of your reasons for not wanting to help Greece have to do with the fact that Slovakia itself is one of the poorest countries in the EU?

Sulík: A few years back, we survived an economic crisis. With great effort and tough reforms, we put it behind us. Today, Slovakia has the lowest average salaries in the euro zone. How am I supposed to explain to people that they are going to have to pay a higher value-added tax (VAT) so that Greeks can get pensions three times as high as the ones in Slovakia?

SPIEGEL ONLINE: What can the Greeks learn from the reforms carried out in Slovakia?

Sulik: They have to make cuts in the state apparatus. The Slovaks could also give them a few good ideas about the tax system. We have a flat tax when it comes to income taxes. Our tax system is simple and clear.

SPIEGEL ONLINE: One last time: Do you honestly believe the euro has any future at all?

Sulík: I believe the euro has a future. But only if the rules are followed.

Interview conducted by Maria Marquart

UK regional house prices; what happened?

2011-10-11T03:12:00.005+01:00

ukhousebubble.blogspot.com

There was a time when I could string out ten posts from the regional house price data set. "Today, we are going to look at the East Midland. Just look at that bubble. What were they thinking when house prices rose 50 percent in two years".

Now, I can put all the prices in one post. However, the story remains the same; massive price appreciation, followed by bust and generalized ruin.

Under Offer (part one and two)

2011-10-10T23:53:00.003+01:00

Urban civilisation versus the desert dwellers

2011-10-10T22:38:00.001+01:00

This article from the Chief Rabbi - Jonathan Sachs - summed up neatly Britain today. This paragraph seemed particularly apt:

"(E)very urban civilisation becomes vulnerable when it grows decadent from within. People live in towns and get used to luxuries. The rich grow indolent, the poor resentful. ...People no longer think in terms of the common good. They are no longer willing to make sacrifices for one another. Essentially they lose the will to defend themselves. They then become easy prey for the desert dwellers, the people used to fighting to stay alive."

Just to put the quote in context, Sachs was suggesting that the writing of the 14th-century Islamic thinker Ibn Khaldun might have insights to the modern condition, hence, the reference to desert dwellers.

In Britain today, the "common good" means anonymous and personally distant welfare provision. There does appear to be a marked reluctance to provide any defence, both literally and metaphorically. Indolence and resentfulness - that pretty much describes the prevailing atmosphere right now.

What is driving UK inflation upwards?

2011-10-09T02:55:00.006+01:00

ukhousebubble.blogspot.com

This was a tricky little number to put together. Interactive charts are complicated. At the same time, they are far more effective at illustrating key trends compared to static charts.

This chart, covering inflationary developments over the last decade, tells quite a story. It is a tale told in seven chapters.

First, the Bank of England has failed to meet its two percent inflation target since 2006. There have been the odd occasions when it went below, but in general, inflation has been well north of the target.

Second, before 2006 the BoE were lucky. Prices for goods, such as electronics, were actually falling. This is the "Asia" effect, as China and other emerging economies industrialised and flooded the UK and other western economies with cheap goods.

Third, prices for non-traded services have consistently exceeded the BoE's target. The UK was secretly inflating for a decade at around 4 percent a year.

Fourth, wage settlements broadly kept pace with services inflation before 2006.

Fifth, things started to go wrong in 2006. Cheap Chinese goods no longer kept the inflation rate down. The BoE were forced to raise interest rates, and popped the asset bubble that kept the UK economy growing at 3 percent a year. The financial crisis wasn't far behind. By the summer of 2007, UK banks started wobbling.

Sixth, once the financial crisis hit town in 2008, wage settlements declined sharply and fell below the headline inflation rate. Living standards began to fall.

Seventh, quantitative easing led to a devaluation of sterling, and the prices of those cheap Asian goods began to rise rather rapidly. Recently, the CPI inflation rate for goods is increasing at roughly the same pace as domestically produced services. Overall, inflation is now rising at around five percent a year.

Anyway, if you like the data application, please circulate it to friends and family. It was meant to be seen by as many people as possible.

When time permits, I will put together more......

UK house price to earnings ratio (again)

2011-10-08T04:37:00.000+01:00

If there are any problems using this data application, please let me know.

This is what I think about the Occupy Wall street movement.

2011-10-07T04:06:00.002+01:00

One of my regular readers - Steve - recently asked me what I think about the "Occupy Wall Street" movement.

Well, Steve, they scare me. I fear chaos and disorder. A riotous mob is a recurring nightmare for me, that goes back to childhood. They are a disorderly rabble, and if they prosper they will offer only social unrest. As a Londoner, I found the recent riots extremely disturbing. It was a tense time, where some of my deepest anxieties came to surface.

I believe the demands of the "Occupy Wall Street" are impossiblist nonsense. In any practical sense, they offer nothing useful.

However, I also believe that the roots of this movement is in the irresponsible and inflationary policies of western governments. When the likes of Greenspan and King unleashed their asset bubbles, they set of an inevitable chain reaction that would lead to a crash, and an economic slump that would increase discontent and eventually destabilise politics in advanced economies. The "Occupy Wall Street" movement is really only symptom of an illness that has afflicted the advanced economies for the last two decades.

Quantitative easing is just the latest manifestation of this short sighted and destructive approach to economic policy. What Western economies need is order; balanced budgets, positive interest rates, and genuine welfare reform that restores incentives for work and investment.

What is that old line about the definition of madness?

2011-10-07T03:46:00.002+01:00

Quantitative easing is back. The Bank of England is on its third attempt to reflate the economy by printing cash.

We are now four years into the crisis and policy makers have made little if any progress towards stabilising the economy. Growth is non-existent, inflation is running at 5 percent, unemployment is high, and the housing market continues to slide. Inevitably, the FTSE is in the toilet.

Fiscal policy is the only area where there has been any progress. Even here, the results have been somewhat paltry, although the hope is that things will look better next year.

Printing money doesn't generate income and wealth. Only production can do that. This requires entrepreneurs finding suitable labour and acquiring capital in order to make things.

The bank will justify their renewed cash creation in terms of kick-starting bank lending. True, firms need credit. However, previous quantitative easing efforts failed to restore credit lines to small and medium enterprises.

Why? Because firms need something much more important than loans in order to survive, and ultimately prosper. Firms need macroecoomic stability. They need to believe in the future.

Quantitative easing means future chaos; it means inflation, negative real interest rates, and the possibility of more crisis. Entrepreneurs understand that QE is a panic reaction; a cheap attempt at creating the illusion of prosperity. It can not be a basis for returning the UK to stable growth.

The previous two attemps at quantitative easing only served to prolong the crisis. The third attempt will also fail. There is that tired old line that the definition of insanity is to keep trying the same failed policies, expecting things to change this time. Yet despite its overuse, it accurately explains the behaviour of the Bank of England.

Seven reasons why European banks continue to struggle

2011-10-05T03:35:00.009+01:00

The European financial system is again in trouble.

Dexia, the Franco-Belgian bank, has just received a government guarantee. European Union finance ministers are again cobbling together late night rescue plans in an effort to prevent the financial crisis from worsening.

So what is going wrong with Europe's banks? In no particular order, there are seven reasons why European banks continue to struggle:

1. Banks are under capitalized

Bank capital acts as a buffer that can absorb losses. However, bank capital comes with one major drawback; it is expensive. For decades, European banks reduced their costly capital buffers in order to maximize profits.

When the crash happened, many banks ran dangerously low on capital. Since then, European banks have tried to strengthen their capital base. Unfortunately, new risks to bank portfolios have emerged, especially from sovereign debt markets. Despite efforts to increase buffers, European banks remain under capitalized.

2. Weaker banks are holding back the pack

Some European banks are especially short of capital. Banks are intimately connected through the interbank market. A failing in one bank threatens all banks. Therefore the weak banks are causing problems for the strong ones.

3. Investor fear

In an atmosphere of endless stress-enhancing uncertainty, investors are unwilling to invest in banks. At best, this makes capital raising efforts expensive. At worst, for some banks it has become almost impossible to raise new funds. Furthermore, investor demand for bank debt is weak. This has made it difficult for some banks to roll over maturing debt.

4. Asset quality

Far too many European banks provided massive amounts of credit to high risk markets such as real estate. Many European property markets have fallen in a deep slump. Borrowers - that is to say property speculators - are finding it difficult to service debt. Therefore, the asset quality of many banks is, to say the least, dubious.

5. Funding pressures

European banks remain highly dependent on wholesale funding rather than deposits. Moreover, many banks are faced with growing maturity problems. They've been unable to extend maturities and the liabilities side of their balance sheets are becoming increasingly short-term. This growing dependence on short term financing is proving to be quite destabilising.

6. Government debt

European banks are holding unhealthy amounts of southern European debt. Within the Euro area, the probability of sovereign debt default has grown. With each sovereign debt downgrade, European banks have become more vulnerable. The big fear remains an actual default, which would severely test European bank balance sheets.

7. The bankers

With one or two exceptions, European banks are run by the same jokers that drove the European financial system into crisis. The vast majority of these senior bankers made their careers through excessive risk-taking and over leveraging. Unsurprisingly, they are unable to comprehend the fundamental changes wrought by the crisis. They lack the skills needed to downsize balance sheets.

So, four years after the crisis started, and Europe has made little if any progress towards stabilising balance sheets and digging its way back to profitability.

Time for another bank bailout. However, are European taxpayers ready to see obscene amounts of money being pumped into banks, with the usual post-bailout bonus pay outs to failed bankers?

Never below two

2011-10-04T04:31:00.002+01:00

Over the last ten years, UK services inflation has never been below two percent. As often as not, it has been above four percent.

The story of UK inflation is straightforward. Cheap manufactured goods from Asia kept the inflation rate low, which the service sector, which can not easily be substituted by foreign competitors just kept raising their prices.

If you want proof, just take a look at tube prices in London.

Why a single European Financial Supervisor would be a bad idea.

2011-10-02T17:06:00.017+01:00

There are few problems facing Europe where a solution cannot be found in Brussels. Exchange rate management, tax policy, the environment, trade, foreign relations, and defence - the European Commission has the answer to every challenge. Furthermore, the answer is always the same; member states should delegate more decision-making authority to the Commission.

Right now, the Commission feels confident that it can wrest control of financial supervision from the member states. Earlier this year, it established three European Systemic Risk Boards, covering banks, markets and insurances and pensions respectively. This followed from proposals made in September 2009, which advocated the creation of three European Supervisory Authorities – a European Banking Authority, a European Securities and Markets Authority, and a European Insurance and Occupational Pensions Authority. When it sees an opportunity, the European Commission moves fast.

Superficially, the case for centralization is strong. Europe has gone through a dramatic financial crisis. Supervision has failed on a massive scale, with dreadful economic consequences. Moreover, European financial institutions are breaking out of their national constraints and diversifying into new markets across the Union. A solitary Europe wide financial supervisory framework seems obvious.

How would such an institution, or collection of institutions, work? First, consider the most practical question; where would the new European financial supervisory agency be located? This would be an easy question at the national level. The supervisor would live among the banks. It would be located in the financial centre.

Europe doesn't work that way. Everybody takes turns. Right now, France has the joint capital of Europe-Strasbourg. Belgium has the Commission and Parliament. Germany has the ECB. Spain and Portugal already have a large number of minor European institutions. London would appear to be the obvious choice, but the UK has unwisely chosen to maintain national sovereignty of exchange rate policy. There will be the inevitable food fight among member states, rather like for the honour of hosting the olympics. Most likely, it will be sited somewhere in Eastern Europe, probably Warsaw or Budapest. After all, it is now their turn. There might also be a compromise solution breaking up the institution so that it could be sited in two or three worthy locations.

Once this institution, or loose confederation of institutions, becomes operational, it would be confronted by 27 national banking systems, each working under its own legal system. Harmonization is a word that trips off easily from the tongue; it is much harder to implement it as a practical policy. European civil servants can quickly write up a directive of new banking standards. That is the easy part.

A "one size fits all" European financial sector supervisory framwork would create insurmountable problems. How would one reconcile the supervisory needs of internationalist investment banks located in city of London with the sleepy banking system in Italy? Where can one find common ground between the state directed banks of France with the highly communal credit unions of Cyprus?

European-level supervision would also create a massive distance - both literal and metaphorical - between the regulator and the regulated. Information and market knowledege are the core of effective supervision. It is not an "arms-length" business. When identifying the risk of a banking blow-out, one onsite inspection of a bank by a knowledgeable supervisor, looking at loan quality, can worth a million off-site inspection reports received by a desk based supervisor living in another country.

The answer, of course, would be to create a network of regional supervisory bodies, one for each country. This would be reinventing what Europe already has, only this time it will be controlled by Europe rather than national parliaments.

This still leaves the intractable question of how to supervise banks that traverse multiple jurisdictions. It is a difficult question, but it is not one that a centralized regulator in Europe can answer any better than a national regulator. For example, HSBC, as its name suggests-the Hong Kong and Shanghai Banking Corporation-has operations around the world. It is hard to see how an EU-wide regulator based in Eastern Europe can confront the complexities of HSBC any better than the FSA does right now in London.

Handing financial sector supervision over to Brussels is a bad idea. It is bad politics because it will strengthen an institution-the European commission- that most Europeans would prefer to see weakened. More than that, it would offer no tangible improvements on the current European supervisory structure. Rather than reduce the likelihood of a new crisis, it would make one more likely.

However, that kind of objection has not stopped the Commission in the past. The proto-supervisory institutions are already named, their extravagent budgets are prepared, now it is time for the member-states to hand over the files and let Brussels take over.

The credit crunch continues

2011-10-02T05:23:00.006+01:00

Click on the image for a larger version

Deep impact

2011-10-01T21:11:00.005+01:00

There is an apocryphal story that in the summer of 2006, the US Federal Reserve became worried about the property bubble that was raging in many US cities.

So the Fed dusted off its macroeconomic models and conducted a simulation to see how the US economy would respond to a 20 percent fall in house prices. The model predicted that the US economy could easily absorb that kind of correction and that there would be no major impact on output or employment.

June 2006 was about the time that the housing market peaked in America. Throughout the summer it started to weaken slightly with prices beginning to fall 2007. The immediate impact on employment was, as the model projected, minimal. Employment continued to grow throughout 2007 reaching a peak in January 2008.

Thereafter, it was as if the US labour market had been hit by a meteor. Within two years, almost 8 million jobs disappeared. The post-housing bubble recession eliminated 1 private sector job in 14.

So what is the moral of the story?

Well, there are perhaps too many to enumerate. The obvious ones are the poor predictive power of economic models, the complacency of economists, and their inability to understand the interactions between financial markets and the real sector. Poor bank supervision, perverse incentives in financial institutions, and self-destructive financial engineering would be another three to add to the list. Bonuses, speculation, greed, corporate stupidity, declining moral values, the masculine inadequacies of Bill Clinton, the arrogance of Alan Greenspan and the war-like tendencies of the Bush family - I could go on......

However, the really big lesson is that asset bubbles hide the underlying weaknesses of economies. For at least a decade, the US was losing a battle over competitiveness with Asia. Manufacturing jobs were moving eastwards, and America was de-industrializing. The story is equally true for the UK and much of Europe.

Rapidly growing housing prices, cheap credit, and growing household indebtedness obscured this dangerous tendency. Once the crash happened, US economy and its labour market underwent a brutal awakening to the new global economic realities.

The European Commission makes a play to further centralize power in Brussels

2011-09-30T04:25:00.003+01:00

European Commission President - Jose Manuel Barroso - outlined his dastardly plan for dominating the free people of Europe.

He gave a frightening speech to the European Parliament this week where he outlined a power grab by the European Commission. While the Eurozone crisis inflicts misery on Southern Europe, the Federalists in Brussels see it as an opportunity to diminish the authority of member states and centralize power and control within the European Commission.

Do you think I exaggerate? Do you think my language is too alarmist? Judge for yourself. Here is what the man said:

No more domestic fiscal policy:

"We need to complete our monetary union with an economic union. It was an illusion to think that we could have a common currency and a single market with national approaches to economic and budgetary policy."

The European Commission (or a related institution) will start to issue bonds:

"Once the euro area is fully equipped with the instruments necessary to ensure both integration and discipline, the issuance of joint debt will be seen as a natural and advantageous step for all."

"The Commission will present options for (such) "Stability Bonds" in the coming weeks. Some of these options can be implemented within the current (EU) Treaty, whereas fully fledged 'euro bonds' would require Treaty change."

The Commission will surpress credit rating agencies and take over responsibility for bank resolution.

"The Commission will deliver .... proposals by the end of this year, namely rules on credit rating agencies, bank resolution, on personal responsibility of financial operatives."

The Commission will regulate derivatives and pay for bankers.

"Wehave already tabled 29 pieces of legislation. You have already adopted several of them, including the creation of independent supervising authorities, which are already working. Now it is important to approve our proposals for new rules on:derivatives; naked short selling and credit default swaps; fair remuneration for bankers."

The Commission wants a financial transactions tax:

"Today, the Commission adopted a proposal for the Financial Transaction Tax."

The Commission will determine tax policy (This is a cleverly worded request couched in terms of negotiating treaties with third parties. However, how can the Commission negotiate while tax policy within the Union varies across countries? It can't unless it takes the lead in harmonising tax policy.)

"We cannot afford to turn a blind eye to tax evaders. So it is time to adopt our proposals on savings tax within the European Union. And I call on the Member States to finally give the Commission the mandate we have asked for to negotiate tax agreements for the whole European Union with third countries."

The European Commission takes over responsibility for foreign policy. (A suble play on words; what exactly is the euro area? I don't think he meant the eurozone.):

"It is also time to have unified external representation of the euro area."

Taken together, Barroso proposals amount to a complete takeover of EU fiscal policy and financial markets.

Can he be stopped? Barroso had a warning for those who oppose the centralizing meglomania of the European Commission:

"The pace of our joint endeavor cannot be dictated by the slowest. A member state has the right not to move. But not the right to block the moves of others. Our willingness to envisage Treaty change will reinforce the credibility of our decisions now."