What to do with a problem like Germany? Cut interest-rates further….

Over the past year there has been something of a sea change for the economy of Germany. After a period of what in these times was strong economic growth the engine of the Euro area has stuttered and coughed. If we look at it in annual terms economic growth went from the 2.2% of 2016 and 2017 to 1.4% last year and the latter was the story of two halves as the second half saw the economic contract in the third quarter and flat line in the fourth. This fits with our subject of yesterday Deutsche Bank which has seen its share price fall by 36% over the past year as both it and its home economy have struggled. Oh and that new bad bank plan rallied the share price for a day and a bit as it is back to 6.03 Euros. So it looks like another new plan is singing along with Queen.

Another one bites the dust
Another one bites the dust
And another one gone, and another one gone
Another one bites the dust.

What Next?

The opening quarter of this year offered some relief as Germany saw the economy grow by 0.4%. However yesterday in its June report the Bundesbank pointed out that it was not convinced that this represented a genuine turn for the better. 

Special effects that contributed to a noticeable rise in gross domestic product in the first quarter are either expiring or being reversed.

Google Translate is a little clunky here but we see that it feels that the construction industry will not have boosted the economy.

So is the construction industry on a quarterly average with certain Rebound effects. Due to weather conditions, construction activity had widened considerably in the winter months.

Also it feels that the ongoing problems with sales of diesel engined cars which we see pretty much everywhere we look will impact again after flattering things as 2019 opened.

Furthermore, due to delivery difficulties as a result of the introduction of the new emissions test procedure WLTP (Worldwide Harmonized Light Vehicles Test Procedure) last fall. Deferred car purchases have been made up for the most part.

It notes that the industrial production sector had a rough April.

Industrial production decreased in the April 2019 strongly. In seasonally adjusted account it fell below the previous month’s level by 2½%. As a result, industrial production also fell sharply compared to the mean of the winter months (- 2%).

Do the business surveys back this up?

If we start with construction then here is the latest from Markit.

After a solid performance in early-spring, the German
construction sector continued to lose momentum during May, recording its weakest rise in total activity for four months……It’s been a largely positive start to the year for the sector, but a first fall in new orders in nine months points to some downside risks to the short-term outlook.

So broadly yes and maybe further slowing is ahead. 

However as we look wider Markit is more optimistic than the Bundesbank.

The Composite Output Index continued to point to a modest
pace of growth across Germany’s private sector. At 52.6, the latest reading was up from 52.2 in April and the highest in three months, but still below the long-run series average of 53.4 (since 1998).

That is interesting as central banks love to peruse PMI numbers. Mind you perhaps they had advance warning of this released this morning from the ZEW Institute.

The German ZEW headline numbers for June showed that the economic sentiment index arrived at -21.1 versus -5.9 expectations and -2.1 last. While the sub-index current conditions figure jumped to 7.8 versus 6.0 expected and 8.2 booked previously, bettering market expectations. ( FXSTREET )

There is a little irony in the present being better than expected but it is rather swamped by the collapse in expectations. The ZEW is an arcane index that is hard to get a handle on so we should not overstate its significance but the change is eye-catching.

A policy response

I was going to point out that this was going to be an influence on the policy of the European Central Bank or ECB. This comes in two forms as firstly Germany is such a bell weather for the Euro area and according to recently updated ECB capital key is 26.4% of it. Also of course there is the thought that overall ECB policy is basically set for Germany. Thus I was expecting some news or what have become called “sauces” from the ECB summer camp at Sintra which opened last night. This morning we have already learned that President Draghi packed more than his shorts, sun cream and sunglasses.

In this environment, what matters is that monetary policy remains committed to its objective and does not resign itself to too-low inflation.

Here he is setting out his stall and the emphasis is his. There is a clear hint in the way that he is pointing at “too-low inflation” as in the coded language of central bankers it leads to this.

Looking forward, the risk outlook remains tilted to the downside, and indicators for the coming quarters point to lingering softness.

So now not only do we have too-low inflation we have a weak economy too. So if we were a pot on the stove we are now gently simmering. Then Mario turns up the gas.

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.

First though we have to wait as he continues with the dead duck that is Forward Guidance.

We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation.

After all if it worked we would not be here would we? But then we get to boiling point.

This applies to all instruments of our monetary policy stance.

Further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools.

And the APP still has considerable headroom.

For newer readers the APP is the Asset Purchase Programme or how it has operated what has become called Quantitative Easing or QE. This is significant because if there is a country which lacks headroom it is our subject of today Germany. This is because it has been running a fiscal surplus and reducing its national debt which combined with the existing ECB purchases means there are not so many to buy these days. Not Italy though as there are plenty of its bonds around.

Finally we get a reinforcement of the theoretical framework with this.

What matters for our policy calibration is our medium-term policy aim: an inflation rate below, but close to, 2%. That aim is symmetric, which means that, if we are to deliver that value of inflation in the medium term, inflation has to be above that level at some time in the future.


We may have seen the central banking equivalent of what is called a “one-two” in boxing. Yesterday the German Bundesbank talks of an economic contraction and today Mario Draghi is hinting that more easing  is on its way.  What this may mean is that whilst the Bundesbank is unlikely to be leading the charge for easier policy it will not stand in its way. Also if Mario Draghi is going to do this there is not a lot of time left as he departs in October, does he plan to go with a bang?

This has already impacted German financial markets as they look at the newswires and price German bonds even higher. After all if you expect a large buyer why not make them pay for it? So it is now being paid even more to borrow as the benchmark ten-year yield reaches another threshold at -0.3%. Or if you prefer the futures contract has hit all time highs in the 172s.

Of course if the easing worked we would not be here so there is an element of going through the motions about this. Also let’s face it only central bankers and their cheerleaders think low inflation is a bad idea. Sadly the media so rarely challenge them on how they will make people better off via them being poorer.



What to do with a problem like Deutsche Bank?

By definition a credit crunch involves what Taylor Swift would call “trouble,trouble,trouble” for the banking sector in general and some banks in particular. A feature of the 2007/08 one is that we find that what we might call the bad smell emanating from the banking sector has never really cleared. This is especially true in Europe as Wolf Street pointed out on Friday.

European bank shares – which have been getting crushed and re-crushed for 12 years – are getting re-crushed again. On Friday, the Stoxx 600 Banks index, which covers major European banks, including our hero Deutsche Bank, dropped to an intraday low of 130.5 and closed at 131.2, thereby revisiting the dismal depth of December 24, 2018 (130.8).


European banks did not soar on the first trading day after Christmas, unlike other stocks. Instead they fell further and hit their multi-year low on December 27 (129). The index is down 21.5% from a year ago and 33% from January 2018:

From the point of view of a Martian observing events this would provoke some head scratching, after all there have been reports of recovery for years. He or she would soon note that there is something else going on as the Financial Times points out.

Almost $12tn in bonds trading with sub-zero yield

This poses a problem for banks who essentially live off there being positive interest-rates, as otherwise there is the alternative of cash which suddenly looks rather attractive with its yield of 0%. Anyway our Martian is bright enough to know that it isn’t really necessary to worry too much about the maths as long ago those on Mars learnt that one of the best guides to human behaviour was to head in the opposite direction when we release official denials.

Deutsche Bank

Germany’s premier bank has found itself in the cross hairs of this issue and its travails have become quite a long-running saga. One way of looking at this comes from when we looked at it back on the 29th of August last year.

Back at the peak the share price was more like 94 Euros according to my monthly chart. From a shareholder point of view there has also been the pain of various rights issues to bolster the financial position. These tell their own story as the sale of 359.8 million shares raised 8.5 billion Euros  in 2014 whereas three years later the sale of 687.5 million was required to raise 8 billion Euros. The price was in the former 22.5 Euros and in the latter 11.65 Euros.

As you can see one of the most successful trades of the last decade is selling Deutsche Bank shares, especially if you do so in the face of the periodic rallies. So well done to anyone who has. The main danger is that you get called an “evil (usually foreign) speculator by the establishment. Putting it another way this has been the mother of bear markets, Another perspective is pointed out by the fact that Deutsche Bank had a dividend of 4.5 Euros pre credit crunch whereas this month the share price fall below 6 Euros.

Merger Mania

Regular readers will be aware of the phase where the apparent plan was to merge with Commerzbank. The catch was that really the only benefit from this would be to muddy the accounts for a year or two. Whereas on the other side of the coin a bank to big to fail (TBTF) would hardly be improved by making it even bigger! In spite of that there were several goes at this but eventually the plan folded like a deck chair.

A New Hope?

Last night the Financial Times published this story.

Deutsche Bank is preparing a deep overhaul of its trading operations including the creation of a so-called bad bank to hold tens of billions of euros of assets as chief executive Christian Sewing shifts Germany’s biggest lender away from investment banking.The plan would see the bad bank house or sell assets valued by the German lender in its accounts at up to €50bn after adjusting for risk.

I can see three initial issues with this.

1 Bad banks are so 2010 and it is now 2019

2.In itself a Bad bank does not solve anything as it is just an accounting exercise. What is needed is a behavioural change. Otherwise the shareholder liability does not change one iota.

3. If those “assets” could be sold as ” valued by the German lender in its accounts” then this would have happened many years ago!

Or as Earth,Wind and Fire put it.

Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away

There is something which leaps of the page at me so here it is.

While the derivatives destined for the non-core unit still provide some cash flow, all the profit on the deals — and therefore the associated bonuses for those who arranged them — were booked up-front.

What could go wrong? Well Enron style accountancy results in another Enron. Or in the UK there was the case of Atlantic Computers some years back which booked profits up front and kicked liabilities forwards in time. So the lesson of not taking profits up front had been learnt but there is a catch. as Enron and Atlantic Computers collapsed but this does not happen to TBTF banks. So those managers who took the bonuses up front have done something which I would make subject to the law of fraud. For them it was something of a perfect crime as years later they have got away with it and we are being told the assets are fine.

Or maybe they are not quite so fine.

In the years since the instruments were first arranged, they have become a major drag on the bank’s capital because of their more stringent treatment under new regulations introduced after the financial crisis, said the people briefed on the plan.

There is an obvious contradiction here as if you sell these assets to someone they too will get “more stringent treatment under new regulations ” and thus will reduce the price, but I guess they are hoping we will not spot that.

Seldom does something in the financial press make me laugh out loud but this did.

The German bank believes it can divest the assets without taking large hits to its profit or capital because the long-dated interest rate derivatives are not toxic and have a predefined run-off plan, one of the people said.

If that were true they would have done it many years ago.

Also this feels like they are seeing if they can find a minimum they can get away with rather than really fixing the hole.

The final scale of the non-core unit has not been decided and the number “continues to oscillate”, but executives are discussing at least €30bn of risk-weighted assets with an eventual size of €40bn to €50bn most likely, two of the people said.


What this how procedure ignores is the rather devastating critique of the credit crunch provided by South Park with an episode based on the three simple words below.

And it’s gone

Whereas Deutsche Bank has been in denial ever since. This has created three main problems.The first is that those who have taken bonuses from the past deals have in my opinion got away with something that would be considered fraudulent in any other industry apart from “The Precious”. Next is that shareholders have stumped up more money for rights issues in return for promises that things could only get better, when they have in fact got worse. So there has been enormous value destruction, or if you prefer a financing of issue one. The third is the impact on the wider economy as Deutsche and the other zombie banks are in no fit state to support it.

The past point is intangible but important. Because in response to that problem we keep getting lower interest-rates and yields which makes the banks weaker and the whole cycle starts again.

This morning’s share price rally has faded a bit and the shares are up 2% at 6.15 Euros, probably because there are as many holes in the new plan as John Lennon sang about.

I read the news today, oh boy
Four thousand holes in Blackburn, Lancashire
And though the holes were rather small
They had to count them all
Now they know how many holes it takes to fill the Albert Hall

On the other side of the coin is the nagging issue that the banking business model has gone too.


Will fiscal policy save the US economy or torpedo it?

One of the features of the credit crunch era has been the shift in some places about fiscal policy. For example the International Monetary Fund was rather keen on austerity in places like Greece but then had something of a road to Damascus. Although sadly Greece has been left behind as it ploughs ahead aiming for annual fiscal surpluses like it is in a 2012 time warp. Elsewhere there have been calls for a fiscal boost and we do not need to leave Europe to see them. However as I have pointed out before there is quite a distinct possibility that President Donald Trump has read his economics 101 textbooks and applied fiscal policy into an economic slow down. Of course life these days is rarely simple as his trade policy has helped create the slow down and is no doubt a factor in this from China earlier..

Industrial output grew 5.0 percent in May from a year earlier, data from the National Bureau of Statistics showed on Friday, missing analysts’ expectations of 5.5% and well below April’s 5.4%. It was the weakest reading since early 2002. ( Reuters).

Also there has been another signal of economic worries in the way that the German bond future has risen to another all-time high this morning. Putting that in yield terms holding a benchmark ten-year bond loses you 0.26% a year now. Germany may already be regretting issuing some 3 billion Euros worth at -0.24% on Wednesday although of course they cannot lose.

US Fiscal Policy

Let us take a look at this from the perspective of the South China Morning Post.

The US budget deficit widened to US$738.6 billion in the first eight months of the financial year, a US$206 billion increase from a year earlier, despite a revenue boost from President Donald Trump’s tariffs on imported merchandise.

So we can look at this as a fiscal boost on top of an existing deficit. The latter provides its own food for thought as the US economy has been growing sometimes strongly for some years now yet it still had a deficit. In terms of detail if we look at the US Treasury Statement we seem that expenditure has been very slightly over 3 trillion dollars whereas revenue has been 2.28 trillion. If we look at where the revenue comes from it is income taxes ( 1.16 trillion) and social security and retirement at 829 billion and in comparison corporation taxes at 113 billion seem rather thin to me.

The picture in terms of changes is as shown below.

So far in the financial year that began October 1, a revenue increase of 2.3 per cent has not kept pace with a 9.3 per cent rise in spending.

If we look at the May data we see that the broad trend was exacerbated by monthly expenditure being high at 440 billion dollars as opposed to revenue of 232 billion. Marketwatch has broken this down for us.

Most of the jump can be explained by June 1 occurring on a weekend, which forced some federal payments into May. Excluding those calendar adjustments, the deficit still would have increased by 8%, with spending up by 6% and revenue up by 4%.

In terms of a breakdown it is hard not to think of the oil tankers attacked in the Gulf of Oman yesterday as I note the defence numbers, and I have to confess the phrase “military industrial complex” comes to mind.

What will recur are growing payments for Medicare, Social Security and defense. Medicare spending surged 73% — mostly because of the timing shift, though it would have rose 18% otherwise. Social Security benefits rose by 11% and defense spending rose 23%.

So we have some spending going on here and its impact on the deficit is being added to by this from February 8th last year.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years,

Thus policy has been loosened at both ends and the forecast of the Congressional Budget Office that the deficit to GDP ratio would be 4.2% this year looks like it will have to be revised upwards..

National Debt

This was announced as being 22.03 trillion dollars as of the end of May, of which 16.2 trillion is held by the public. Most of the gap is held by the US Federal Reserve. Just for comparison total debt first passed 10 trillion dollars in the 2007/08 fiscal year so it has more than doubled in the credit crunch era.

Moving to this as a share of the economy the Congressional Budget Office puts something of a spin on it.

boosting debt held by the public to $28.5 trillion,
or 92 percent of GDP, by the end of the period—up
from 78 percent now.

The IMF report earlier this month was not quite so kind.

Nonetheless, this has come at the cost of a continued increase in the debt-to-GDP ratio (now at 78 percent of GDP for the federal government and 107 percent of GDP for the general government).

Where are the bond vigilantes?

They have gone missing in action. The financial markets version of economics 101 would have the US government being punished for its perceived financial profligacy by higher bond yields on its debt. Except as I type this the ten-year Treasury Note is yielding a mere 2.06% which is hardly punishing. Indeed it has fallen over the past year as it was around 2.9% a year ago and last November went over 3.2%.

So in our brave new world the situation is one of lower bond yields facing a fiscal expansion. There is an element of worries about the economic situation but the main player here I think is that these days we expect the central bank to step in should bond yields rise. So the US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt. The water here is a little murky because back at the end of last year there seemed to be a battle between the Federal Reserve and the President over future policy which the latter won. So much for the independence of central banks!

The economy

Let me hand you over to the New York Federal Reserve.

The New York Fed Staff Nowcast stands at 1.0% for 2019:Q2 and 1.3% for 2019:Q3. News from this week’s data releases decreased the nowcast for 2019:Q2 by 0.5 percentage point and decreased the nowcast for 2019:Q3 by 0.7 percentage point.

That compares to 2.2% annualised  for a month ago and 3.1% for the first quarter of the year. So the trend is clear.


As we track through the ledger we see that the US has entered into a new period of fiscal expansionism. The credit entries are that it has been done so ahead of an economic slow down and at current bond yields is historically cheap to finance. The debits come when we look at the fact that the starting position was of ongoing deficits after a decade long period of economic expansion. These days we worry less about national debt levels and more about the cost of financing them, although as time passes and debts rise that is a slippery slope.

The real issue now is how the economy behaves as a sharp slow down would impact the numbers heavily. We have seen the nowcast from the New York Fed showing a slowing for the summer of 2019. For myself I worry also about the money supply data which as I pointed out on the 8th of May looks weak. So this could yet swing either way although this from February 8th last year is ongoing.

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?


Help To Buy was really help for builders and bankers

A constant theme and indeed thread of the credit crunch era has been housing markets and more specifically the behaviour of house prices. The latter are treated by the establishment along the lines of “the spice must flow” of the novel Dune. They do not always put it like this as we peruse the Bank (of England) Underground blog. This is how it reviews the 4% cut in UK Bank Rate between October 2008 and March 2009.

Those holding large debt contracts with repayments closely linked to policy rates immediately received substantial boosts to their disposable income.

What they omit are two other factors. One is that savers who had savings linked to policy rates will have seen their income cut. Those who have been with me on the full journey will recall Bank of England Deputy Governor Charlie Bean saying that savers should in effect suck it up as it would be temporary. Of course it has been anything but. The other is that this was the first move to support house prices and let me throw in the early phases of UK bond buying or QE which was to reinforce this.

However this did not do the trick so what is a policymaker to do? It took a little time to sink in but the Bank of England came sprinting out of the traps in the summer of 2012 with its Funding for Lending Scheme. This reduced mortgage rates pretty quickly by around 1% and according to the Bank of England the effect built up to a maximum of 2%. You may not be surprised to learn that after a 6 month response time lag UK house prices began to turn as monthly net mortgage lending became less negative and then positive.

Help To Buy

The UK government had a slower reaction function as it was not until April 2013 that Homes England started this.

Through the scheme, home buyers receive an equity loan of up to 20% (40% in London since February 2016) of the market value of an eligible new-build property, interest free for five years.

In terms of scale there is this.

The Department expects the scheme to support around
352,000 property purchases by March 2021, via loans totalling around £22 billion in cash terms.

National Audit Office

This has looked into Help To Buy and it has not held back. Let us start with what it did.

The Department’s independent evaluations of the Help to Buy: Equity Loan scheme show it has increased home ownership and housing supply.

Okay although it does make you think when you note that around 60% of recipients did not need it.

37% of buyers stated that they could not have bought without the support of the scheme. We estimate this to be around 78,000 additional sales of new-build properties
since the scheme started.

So was it to buy a home or the home you would like? But it did boost sales of new houses and thereby supply of them.

This did lead to a problem we have looked at on various occassions.

Five of the six developers in England that build most properties account for over half of all loans through the scheme. They sell a greater proportion of properties with the support of the scheme than other developers.
Between 36% and 48% of properties sold by these five were sold with the support of the scheme in 2018. The profits of all five developers have increased since the start of
the scheme.

That last sentence does some heavy-lifting does it not? The NAO shuffles uneasily away from being more specific so let me help out a bit from my article on the 22nd of October last year.

The boss of house building firm Persimmon has walked off in the middle of a BBC interview after being asked about his £75m bonus.

“I’d rather not talk about that,” Jeff Fairburn said, when asked if he had regrets about last year’s payout.

The £75m, which was reduced from £100m after a public outcry, is believed to be the largest by a listed UK firm.

I guess most people in the shoes of Mr. Fairburn would have been uncomfortable with the questions posed. This is because as I noted back then there are large arrows pointing at the cause.

We have looked before at how it helped them to make high profits on the sale of each house and it also boosted volumes in a double whammy effect. So it turned into help for housebuilders profits and bonuses.

So what on its own was welcome which was the rise in housing supply boosted a small number of builders or an oligopoly. How would economic theory expect an oligopoly to respond? By making excess profits, so for once economics 101 has worked which we fo not see that often. What it did not expect was the way in the modern era that this would feed into managerial and executive bonuses. In economic theory the excess profits go to shareholders and whilst as you can see below it did these days we see a fair bit siphoned off by the managerial class.

In particular we find ourselves looking at a bonus scheme set at £4 compared to a payout based on one of £24 in case you wonder how we got to such an eye watering amount.

If we look at the long-term chart for some perspective we see that there was a previous peak of around £13 in 2006 when the pre credit crunch housing boom was pumping it up. Whereas this time around it peaked over £27.

Taxpayer Risk

This was something shuffled down the list. After all what can go wrong investing in UK property? That was the impression given which of course ignores the early 1990s. But the UK taxpayer was taking on an equity risk and getting the grand sum of 0% per annum in return.

Factoring in the estimated rate of redemptions, the net amount loaned is forecast to peak at around £25 billion in 2023 in cash terms.

As to the cost of this that has varied a fair bit but back when the scheme started we were paying around 1% per annum more on the ten-year Gilt than the present 0.83%. So there has been a running cost of providing the money. Also there is this.

The Department expects to recover its investment in the medium term and make a positive return overall, although it recognises the investment is exposed to significant market risk.

Indeed the choice of 2048 seems to be an example of kicking something into the long grass.

Homes England expects total redemptions to equal the amount loaned by 2031-32, and to have made a positive
return on investment by the time all loans are repaid by 2048.

So it is punting the housing market. What could possibly go wrong?

Recent housing market data indicate that house
price growth is slowing down, and that there has been a recent fall in prices in some regions, notably London.


The NAO has covered many of the issues here but there is another one that it skirts. Let me illustrate by giving you the official number for the average house price when Help To Buy began in April 2013 which was £170.335, and the one this March which was £226,798. So quite a rise which has not been driven by real wages as they have ebbed and flowed. So the irony of the Help To Buy era is that it has seen house prices become even more unaffordable meaning that it was this version of Help.

Help me if you can, I’m feeling down
And I do appreciate you being round
Help me get my feet back on the ground
Won’t you please, please help me ( The Beatles )

It was not the only driver of the rise because as I pointed out earlier the Bank of England opened the credit taps with the Funding for Lending Scheme cutting mortgage rates. The combination of what was called “credit easing” by the then Chancellor George Osborne ended the couple of years of house price stagnation and replaced it with over 5 years of rises. Or even more “Help” is now required at the higher prices.

Of course it benefited existing homeowners who got higher values for their homes but at the expense of future buyers. Also the credit crunch era began with proclamations that we will not allow high loan to property value ratios which then became it is okay for the taxpayer to take the risk. That risk also helps “The Precious” which gets some protection in any downturn from the UK taxpayer.

If a home is repossessed, the mortgage lender gets their money back first because they are the first charge on the property; the equity loan is the second charge.

Me on The Investing Channel






Will it be a parallel currency or a parallel world for Italy?

A feature of the credit crunch has been the way that certain ideas keep popping back up and never seem to quite disappear. So let us step back in time to September 2017.

Three of Italy’s four largest parties – the anti-establishment 5-Star Movement, the right-wing Northern League and Silvio Berlusconi’s Forza Italia – propose introducing a parallel currency after an election due early next year. ( Reuters)

I think Silvio was more trying to take the wind out of the sails of his opponents as if he really believed the suggestion below he could have tried it when he was in power.

Investors sold off Italian government bonds last month after Berlusconi said he was in favor of printing a “new lira” for domestic use, to pump money into the economy. Under his plan euros would still be used for all international transactions and by tourists.

Bur back then Reuters reported on something that has had if not a rave from the grave made something of a reappearance over the past fortnight.

The Northern League’s Borghi said Italy “has to be ready for the euro’s collapse,” which he sees as only a matter of time.

He is the architect of the party’s proposal – which Berlusconi has also hinted he would support – called “mini-BOTs”, named after Italy’s short-term Treasury bills.

Borghi says initially some 70 billion euros of these small denomination, interest-free bonds would be issued by the Treasury to firms and individuals owed money by the state as payment for services or as tax rebates.

That was his proposal back then and if we stay with Reuters we can jump forwards in time to last Saturday.

The so-called “mini-BOT” scheme, named after Italy’s Treasury bills, was drawn up by the far-right, eurosceptic League party and was unexpectedly endorsed by parliament last month in a non-binding vote.

Money,Money Money

As it happens Abba summed up the plan rather well back in the day.

Money, money, money
Always sunny
In a rich man’s world
All the things I could do
If I had a little money
It’s a rich man’s world

You see another name for a “small denomination, interest-free bond” is a bank note. One more bit is required in that the Treasury Bill would need to be perpetual or much longer than the usual term ( often 90 days but sometimes of a year or so). Then you are mostly there and the government can then effectively take advantage of what is called “seigniorage”. This is where the ability to print money leaves you with a rather large profit as your 1000 Lira bill costs if we use US Federal Reserve data say 1% to print so 99% is profit. What’s not to like about that?

So at this point of the 70 billion Euros equivalent printed we have 69 billion or so left to spend, or rather the Italian government has.

What could go wrong?

This starts at the central bank as seigniorage is usually their preserve. Looked at like that they are one of the most profitable institutions in the world. Of course politicians spotted that long ago and thus the cash flows to the national treasuries with a deduction for expenses as for example the cake trolley does not fill itself.

Thus it was no surprise to see ECB President Mario Draghi saying this at the last press conference.

Now about the mini-BOT, I think I’ve answered this question in the past when the possibility was raised; they are either money and then they are illegal, or they are debt and then that stock goes up. I’ll stop here.

So he is pointing out that there is supposed to be only one form of money in the Euro area, which is the Euro itself. What he did not say but was clearly referring to it as being legal tender as in you can always settle a debt using a Euro. Also he points out that if they are debt then they will be added to the calculation of the national debt, which is what the proposal is trying to dodge.

Oh and he did not stop there he could not resist something of a dig.

Certainly the reading that people have and markets have of this mini-BOT doesn’t seem to be very positive, but I’m only just stopping at what I said; it’s either money or debt. I don’t think there is a third possibility.

Later he did explain his position in an answer to a different question.

Well, it’s very difficult to foresee hypothetical events where you assume that the President of the ECB doesn’t behave in a way to preserve the euro.

So he and his successor ( as his term ends in October) will always look to protect the Euro and will therefore always be against any such scheme. After all it is in his job description.

The debt issue

The problem is that Italy has such a large public debt, which is also large relative to its economy. The 2.32 trillion Euros is 132.2% of annual economic output or GDP. Those who have followed my “Girlfriend in a Coma” articles will know that rather than being an over spender Italy has arrived at this situation mostly because its has failed to grow its economy. In the good times it rarely grows at more than 1% per annum but sadly in the bad times it falls as much as its peers, so ground is lost. That is highlighted by the current position where over the last year GDP has fallen by 0.1%.

Thus even what is not a relatively high deficit for the public finances leads to trouble. The 43.1 billion Euros borrowed in 2015 fell to 37.5 billion in 2018 but we find that it breaks the Euro area rules. Back to Mario Draghi.

The Commission has concluded that Italy must reduce its debt-to-GDP ratio and this opinion will go to the Council. By then the Italian Government will produce – and that’s what’s been asked – a medium-term plan for reducing debt-to-GDP ratios.

Bond Yields

There are two ironies here. Let me give you one which is there was an even better situation in late 2017 and early 2018 as Italy was being paid to issue some short-term debt. Some of that will be maturing soon and investors have escaped although in terms of risk/reward they have had a shocker. The latter irony is that the current “enemy” Mario Draghi headed an organisation which bought some 366 billion Euros of Italian government bonds known as BTPs. So he made debt issuance very cheap.

In spite of the current impasse and debate Italy can still borrow cheaply in historical terms with its benchmark ten-year yield being 2.37%. The problem is that in its current malaise that starts to look rather expensive.


This is one of those situations where the phrase stuck between a rock and a hard place applies virtually perfectly. Also there is an element of denial on both sides. This is because the real issue is the inability of Italy to grow its economy and whether that can be changed? If not then all the stimuli you can think of will not change things much. Indeed Italy could be worse off as whatever the presentation of it this new plan will leave it with more debt than before. Or a higher effective money supply which when we have seen it elsewhere in places like Ukraine has ended up in trouble.

On the other side of the coin the Euro establishment needs to face up to the fact that the promises of convergence which in this instance would mean towards the economy of Germany were false. In fact there has been divergence. We will never know how Italy would have performed if it had not joined the Euro but we do know that it has not been an answer to its lack of economic growth. The latest proposals via what are called “sauces” and some words from Olli Rehn are for more bond purchases and further interest-rate cuts. But if they worked we wouldn’t be here would we?

So we are definitely seeing parallel worlds, one of which may yet have a parallel currency




Bank of England Forward Guidance ignores the falls in UK real wages

Yesterday evening Michael Saunders of the Bank of England spoke in Southampton and gave us his view on our subject of today the labour market.

 the output gap is probably closed……….. The labour
market continued to tighten, and the MPC judged in late 2018 that the output gap had closed, with supply
and demand in the economy broadly in balance.

As you can see we quickly go from it being “probably closed” to “had closed” and there is something else off beam. You see if there is anyone on the Monetary Policy Committee who would think it is closed is Michael via his past pronouncements, so if he is not sure, who is? This leads us straight into the labour market.

In general, labour market data suggest
the output gap has closed. For example, the jobless rate is slightly below the MPC’s estimate of equilibrium,
vacancies are around a record high, while pay growth has risen to around a target-consistent pace (allowing
for productivity trends).

Poor old Michael does not seem to realise that if pay growth is consistent with the inflation target he does not have a problem. Of course that is before we hit the issue of the “equilibrium” jobless rate where the Bank of England has been singing along to Kylie Minogue.

I’m spinning around
Move outta my way
I know you’re feeling me
‘Cause you like it like this

In terms of numbers the original Forward Guidance highlighted an unemployment rate of 7% which very quickly became an equilibrium one of 6.5% and I also recall 5.5% and 4.5% as well as the present 4.25%. Meanwhile the actual unemployment rate is 3.8%! What has actually happened is that they have been chasing the actual unemployment rate lower and have only escaped more general derision because most people do not understand the issue here. Let’s be generous and ignore the original 7% and say they have cut the equilibrium rate from 6.5% to 4.25%. What that tells me is that the concept tells us nothing because on the original plan annual wage growth should be between 5% and 6%.

What we see is that an example of Ivory Tower thinking that reality has a problem and that the theory is sound.  It then leads to this.

This would reinforce the prospect that the
economy moves into significant excess demand over the next 2-3 years, and hence that some further
monetary tightening is likely to be needed to keep inflation in line with the 2% target over time.

Somebody needs to tell the Reserve Bank of India about this excess demand as it has cut interest-rates three times this year and also Australia which cut only last week. Plus Mario Draghi of the ECB who said no twice before the journalist asking him if he would raise interest-rates last week finished his question and then added a third for good measure.

Wage Data

We gain an initial perspective from this. From this morning’s labour market release.

Including bonuses, average weekly earnings for employees in Great Britain were estimated to have increased by 3.1%, before adjusting for inflation, and by 1.2%, after adjusting for inflation, compared with a year earlier.

If we start with the economic situation these numbers are welcome and let me explain why. The previous three months had seen total weekly wages go £530 in January, but then £529 in both February and March. So the £3 rise to £532 in April is a welcome return to monthly and indeed quarterly growth. As to the number for real wages it is welcome that we have some real wage growth but sadly the official measure used called CPIH is a poor one via its use of imputed rents which are never paid.

Ivory Tower Troubles

However as we peruse the data we see what Taylor Swift would call “trouble, trouble trouble” for the rhetoric of Michael Saunders. Let us look at his words.

Wage income again is likely to do better than expected.

That has been something of a hardy perennial for the Bank of England in the Forward Guidance era where we have seen wage growth optimism for just under 6 years now. But whilst finally we have arrived in if not sunlit uplands we at least have some real wage growth there is a catch. Let me show you what it is with the latest four numbers for the three monthly total wages average. It has gone 3.5% in January then 3.5%, 3.3% and now 3.1%. Also if we drill into the detail of the April numbers I see that the monthly rise was driven by an £8 rise in weekly public-sector wages to £542 which looks vulnerable to me. Was there a sector which got a big rise?

Thus as you can see on the evidence so far we have slowing wage growth rather than it picking up. That would be consistent with the slowing GDP growth yesterday. So we seem to be requiring something of a “growth fairy” that perhaps only Michael is seeing right now. This is what he thinks it will do to wage growth.

Pay growth has recently
risen to about 3% YoY and the May IR projects a further modest pickup (to about 3.5% in 2020 and 3.75% in 2021). That looks reasonable in my view: if anything, with the high levels of recruitment difficulties, risks may
lie slightly to the upside.

Real Wages

There is a deeper problem here as whilst the recent history has been better the credit crunch era has been a really poor one for UK real ages. Our official statisticians put it like this.

£468 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£459 per week), but £5 lower than the pre-recession peak of £473 per week for April 2008.

As you can see even using their favoured ( aka lower) inflation measure real wages are in the red zone still. I noted that they have only given us the regular pay data so I checked the total wages series. There we have seen a fall from the £512 of January 2008 to £496 in April so £16 lower and just in case anyone looks it up I am ignoring the £525 of February 2008 which looks like the equivalent of what musicians call a bum note.

We see therefore that the closed output gap measured via the labour market has left us over a decade later with lower real wages!


If we view the UK labour market via the lenses of a pair of Bank of England spectacles then there is only one response to the data today.

Between February to April 2018 and February to April 2019: hours worked in the UK increased by 2.4% (to reach 1.05 billion hours) the number of people in employment in the UK increased by 1.1% (to reach 32.75 million).

From already strong numbers we see more growth and this has fed directly into the number they set as a Forward Guidance benchmark.

For February to April 2019, an estimated 1.30 million people were unemployed, 112,000 fewer than a year earlier and 857,000 fewer than five years earlier.

It is hard not to have a wry smile at falls in unemployment like that leading to in net terms the grand sum of one 0.25% Bank Rate rise. Also even a pair of Bank of England spectacles may spot that a 2.4% increase in hours worked suggests labour productivity is falling.

But the Forward Guidance virus is apparently catching as even the absent-minded professor has remembered to join in.

BoE’s Broadbent: If Economy Grows As BoE Forecasts, Interest Rates Will Probably Need To Rise A Bit Faster Than Market Curve Priced In May ( @LiveSquawk )

My conclusion is that we should welcome the better phase for the UK labour market and keep our fingers crossed for more in what look choppy waters. Part of the problem at the Bank of England seems to be that they think it is all about them.

Second, why should growth pick up without any easing in monetary or fiscal policies? ( Michael Saunders)

Of course that may be even more revealing…..



How can UK GDP be reported as rising and falling at the same time?

Let us open the week noting an area which is one part of something where the UK is strong. From the UK PPL.

In 2018 Ed Sheeran was once again the most played artist in the UK, according to data from music licensing company PPL. He has held the top spot in three of the last four years – 2018, 2017 and 2015 – and since his first album was released in 2011 he has been in the top five most played artists five times.

Whilst Ed may single-handedly be doing a good job there is far more to it than that.

The PPL said nine of the top 10 most-played artists were British, with Pink being the exception.

The charts were revealed ahead of at its AGM, where the society is due to announce that it collected £246.8 million on behalf of 105,192 performers and rights holders over the last year.

Seven of the top ten tracks also feature British talent, cementing a successful year for the UK industry.

Also let’s here it for the girls.

Her rise ( Jess Gynne) has contributed to a new milestone for the charts; 2018 was the first time that the majority of most played acts were, or featured, women, taking six out of the top ten spots.

Whilst these are domestic numbers according to UK Music much of the success is repeated abroad.

UK Music have today revealed our 2018 Measuring Music report, revealing that UK music industry exports rose by 7% to a record £2.6 billion last year. The UK music industry grew by 2% in 2017 to contribute a record £4.5 billion to the economy – up by £100 million on 2016, a new report by UK Music reveals today.

We do not know the figures for 2018 as we note that the world industry seems finally to be coming to terms with the issue of people in effect hiring or renting rather than buying their product. Trying to criminalise your consumers and customers was a non too bright strategy.


The topic reminded me of the way that the UK film industry has been booming. Although I do not need much reminding because Battersea Park is regularly used by the film industry these days. From the British Film Industry or BFI.

The UK film industry’s GVA in 2016 was £6.1 billion. According to data published by the government in November 2017,
the GVA for all UK creative industries in 2016 was £91.8 billion, so film accounted for almost 7% of all creative
industries’ value added.
As Figure 4 shows, since 2007 GVA for film has increased by over 140%. In 2016 for the film industry as a whole,
distribution accounted for 50% of the total value added, production 40% and exhibition 10%.

As to can see the numbers from the industry do not yet fully reflect the growth we have seen.

Today’s Data

In the circumstances of the numbers reflecting what was supposed to be the post Brexit period we opened the batting solidly.

Rolling three-month growth was 0.3% in April 2019, down from 0.5% in March, but on par with growth rates at the start of 2019.

We can break that down.

The services sector had a positive contribution to rolling three-month growth in April 2019, increasing by 0.2%. The production sector increased by 0.7%, within which manufacturing grew by 1.2%, making it the second-largest contributor to rolling three-month growth. Construction also had a positive contribution, growing by 0.4% in the three months to April 2019.

Every sector was growing with services making GDP rise by 0.16% and construction by 0.02% and production by 0.09%. As we will be looking it in detail I will note that manufacturing was 0.11% ( so other parts of production were weak).

As this included March 29th when businesses had expected us to Brexit that was okay. However it came with a bad number for April.

Monthly GDP growth was negative 0.4% in April 2019, as the production sector and manufacturing sub-sector contracted.

If we look into this we find that we should have been expecting it.

Monthly growth in production was negative 2.7% in April, driven by manufacturing, which contracted by 3.9%.

Why? Well the UK motor industry or SMMT had already told us this.

UK car production falls -44.5% in April with 56,999 fewer units built in extraordinary month. UK commercial vehicle manufacturing declines -70.9% in April, with 2,162 units produced. British engine manufacturing falls -23.4% in April as UK car plant Brexit shutdowns affect demand.

These fed into the wider data and were half the April fall in manufacturing. Actually nearly all the manufacturing categories fell with only wood and paper and electrical equipment showing some growth and they were small amounts.

If we look at the trend we see a different perspective.

Rolling three-month growth in the production sector was 0.7% in April 2019, while manufacturing increased by 1.2%. Within manufacturing, the two largest positive contributors to growth were manufacture of food products and pharmaceutical products. Monthly growth in production was negative 2.7% in April, driven by manufacturing, which contracted by 3.9%.

Or to put it another way it fits this nursery rhyme.

Oh, The grand old Duke of York,
He had ten thousand men;
He marched them up to the top of the hill,
And he marched them down again.

And when they were up, they were up,
And when they were down, they were down,
And when they were only half-way up,
They were neither up nor down.

Are the numbers inconsistent?

Yes they are as the quarterly and monthly numbers are more different than you might think for two reasons.

high growth into February 2019 raised output significantly above the level of output seen in the months November 2018 to January 2019. Despite the declines in March and April, the average output of the current three months is still above that of the previous three months.

Also the quarterly numbers ( Q1,  Q2 etc.) benefit from the other two ways of calculating GDP which are the income and expenditure data.  So it might be better to call them Gross Value Added to distinguish them.


We have learnt quite a bit today. The first point is the the failure of the UK government and Parliament over Brexit has real word consequences. Remainers will argue we should not be leaving and Brexiters will say we would now be getting on with it. This way round we have had the side-effects headlined by the motor industry changing the date of its annual shut downs without in the end there being any reason for it. So it just looks incompetent.

Moving to the broad trend that remains in line with my argument that the trajectory is of the order of the UK growing by about 0.3% to 0.4% per quarter. The danger is that the trade war issue and signs of slow downs elsewhere build up. For example last week saw interest-rate cuts from two of the competitors at the cricket world cup, with India and Australia playing yesterday. Also there is a warning as economic growth in the services sector seems to have slowed.

Maybe we are seeing the beginnings now of a response to the lower bond yields. As I have been suggesting they will impact fixed-rate mortgage costs.

The average two-year fixed rate has fallen by 0.03% from 2.52% in January 2019 to 2.49% this month, while the average five-year fixed rate decreased by 0.09% from 2.94% to 2.85% over the same period. ( Moneyfacts )