UK National Debt and Student Debt are a toxic mix as Rents soar

Today gives us the first set of data for the UK Public Finances for the new Conservative government albeit that they cover a period when it was still in coalition with the Liberal Democrats. Of course it is heading forwards with one or two elements from its future plans still apparently missing in action. For example depending on you point of view we were threatened with or promised some £12 billion of cuts to the benefits bill which were unspecified and undefined. On that road the General Election was a case of deja vu as the main parties repeated promises which had gaps in their arithmetic. One way of filling such gaps is to sell off what is sometimes described as the family silver to get some one-off gains and at the CBI this week Chancellor George Osborne confirmed that this would be the tactic for now. From City AM.

The plan is to allow government experts to work together in order to realise the government plan of selling off a wide range of publically-owned assets, including the sale of shares in Lloyds Banking Group, UK Asset Resolution assets, Eurostar and the pre-2012 income contingent repayment student loan book.

Why? Well in spite of a recent better trend the overall picture for the UK Public Finances has disappointed over the credit crunch era as our fiscal deficit proved to be resistant even when the economy returned to growth. Thus to fulfill the manifesto pledge below we need to indulge in the sort of thing that Portugal has been criticised for.

debt as a share of national income will start falling this financial year.

The Numbers

Both the background problem and the recent improvement have been illustrated by today’s numbers. If we start with the background issue it is demonstrated here.

In the financial year ending 2015 (April 2014 to March 2015), public sector net borrowing excluding public sector banks (PSNB ex) was £87.7 billion (4.8% of Gross Domestic Product (GDP)) a decrease of £10.8 billion compared with the previous financial year.

Whilst it is good that the deficit fell the size of the fall is disappointing when you consider that the economy grew by 2.4% over that period. The responsiveness of our deficit to improved economic circumstances has been lower than history would suggest. Another credit crunch change and of course why the “family silver” is up for sale.

However over the past few months there has been glimmer of sunlight and hopes for a faster improvement and that was demonstrated again by the April numbers.

In April 2015, PSNB ex was £6.8 billion; a decrease of £2.5 billion compared with April 2014.

The revenue numbers were good with Income Tax,National Insurance and Value Added Tax receipts rising by more than 3% on the same month last year. In these troubled times for corporate taxation it was nice to see the Corporation Tax take rise by 11.3% or £600 million on a year ago. After yesterday’s strong retail sales numbers for April up by 4.7% on a year before you might think that the VAT take would be higher but of course much of the rise in that has been driven by disinflation or lower prices (-3.2% on a year before). No wonder establishments hate disinflation and instruct central banks to push inflation higher!

The expenditure figures are hard to read this month as there is so much reshuffling between central and local government but rather oddly we seemed to have got less spending rather than a traditional pre-election splurge. There was a reflection of the themes of low bond yields and lower inflation as for now this bit may continue.

debt interest decreased by £0.4 billion, or 6.9%, to £5.0 billion.

What about the National Debt?

As politicians like to pick and choose their numbers let me give you the headline number used in the UK and also the international standard as they are rather different!

At the end of April 2015, public sector net debt excluding public sector banks (PSND ex) was £1,487.7 billion (80.4% of GDP); an increase of £83.6 billion compared with April 2014.

At the end of April 2015, General Government Gross Debt (Maastricht debt) was £1,602.1 billion (86.5% of GDP) and General Government Net Borrowing (Maastricht deficit) in the financial year ending 2015 (April 2014 to March 2015) was £92.4 billion (5.1% of GDP).

What’s 6.1% of GDP or £114.4 billion between friends? Also you may note that the fiscal deficit is higher too under the international standard.

You need to look hard for the other national debt measure including banks but it is now £1768 billion or 95.5% of GDP.

Student Debt

This is an issue as student loans have many issues, after all if we are now richer as we keep being told why can we no longer afford to subsidise students as we did in my time at the LSE? Perhaps of course because we have expanded the number of students but whilst politicians were keen to take the credit for this they were predictably much less willing to take the hit in financing terms as the Higher Education Policy Instititute explains.

First, the big shift from funding universities via grants from Whitehall towards funding students via £9,000 loans occurred partly because loans do not score towards the deficit. This is also one reason why some people now want maintenance grants to be displaced by bigger maintenance loans.

This is of course an extremely familiar theme where appearances change much more than the underlying reality. That has happened with the fiscal deficit so it was only a matter of time before it happened more and more with the national debt too.

because student loans appear in the main measure of the nation’s debt, selling off the loan book now looks good even if it leads to less government revenue in the future.

We are running up quite checklist here as can-kicking makes an appearance too! According to the HEPI the numbers were going wrong so we changed the definitions retrospectively.

A major fiscal challenge was averted in 2013/14 via a retrospective change to the accounting and budgeting rules, which allows higher loan impairments to be smoothed out over the following three decades.

It all looks a rather familiar shambles and as student loan non-repayments are now estimated at 45% and the level of debt is long the lines of the song from Queen quoted below,what could go wrong?

I’m a shooting star leaping through the skies
Like a tiger defying the laws of gravity
I’m a racing car passing by like Lady Godiva
I’m gonna go go go
There’s no stopping me

Why Paul Johnson of the IFS was wrong

Today’s data release on the behaviour of UK rents proves that Paul Johnson was wrong to recommend CPIH as the main UK inflation measure. The numbers from LSL tell us this.

Residential rents have grown 4.6% year-on-year – the fastest rate of increase since November 2010

Using house prices as your measure of owner-occupied costs would have picked this up a couple of years ago proving yet again how much changes in rents lag house price changes. Mind you the establishment will lap it up as you may note even this record increase is lower that the house price rises we have regularly seen. Arise Sir Paul……?

Also in terms of real wages this is not so hot for those who rent and I covered this issue on April 27th.


As it is a sunny day let us start with the good news which is that the recent trend for the UK Public Finances has improved so fingers crossed for the rest of 2015. However an underlying theme of misrepresentation of the numbers goes on. We have seen previously a net debt with the Royal Mail pension scheme presented as a reduction of £28 billion in the numbers and now we see that asset sales are en vogue. Yet we also see that our valuations on student loans which are one of the assets to be sold are in polite terms unreliable and unsure. Could this be like yesterday’s privatisation of profits and socialisation of losses like we have seen in the banking sector? I do hope that the Vampire Squid (Goldman Sachs) is not involved in all of this as we know then what will happen next.

Still at least we have an extra 318,000 people to help us pay it all off……..

Have our banks got better or instead have they got worse?

One of the fundamental issues of the credit crunch era is what to do about our banks? The Too Big To Fail or TBTF strategy has left us in a situation where the banking sector is one with a moral hazard at its core. Everybody now knows that there will be privatisation of profits and socialisation of any losses giving directors of banks something of a one-way bet. Heads they win and tails we lose (with them usually still winning). As this was implicit in the past rather than explicit as it is now we find that we may in fact be worse off contrary to all the official denials. After all we know what to do with official denials.

This privatisation of profits and socialisation of losses was most marked in the UK at Royal Bank of Scotland with its purchase of ABN-Amro as highlighted recently by Andrew Bailey of the Bank of England.

The low risk weights assigned to trading assets suggested that only £2.3 billion of core tier 1 capital was held to cover potential trading losses which might result from assets carried at around £470 billion on the firm’s balance sheet.

We know of course what happened next.

In fact, in 2008 losses of £12.2 billion arose in the credit trading area

This meant that for the rest of us a measure of the UK National Debt soared into the stratosphere. At the end of 2006/07 the UK’s National Debt to GDP ratio was an apparently fiscally conservative 36%. By the time we fully accounted for the various bailouts it was this in December 2010.

net debt excluding the temporary effects of financial interventions was £889.1 billion, equivalent to 59.3 per cent of gross domestic product (£2322.7 billion, equivalent to 154.9% including interventions).

First of all we have the impact on the headline figure and then boom! Apologies for those of a nervous disposition as our debt shot higher. I was one of the very few who covered these numbers and have written before of their many flaws but they give a ballpark idea of our potential exposure.

A Name Change

One of the most ominous developments in a situation is a name change as the Public Relations industry tries to solve the problem of a toxic brand by rubbing it out and introducing a shiny new one. On this road the leak prone nuclear reprocessing plant Windscale became the initially leak-free Sellafield. Well TBTF has made a similar journey as it is now called SIFI or Systemically Important Financial Institution.Do we feel better already?


These are of course fines but I think that the banks treat them as a bill just like the Destinys Child lyric or a cost of doing business. Yesterday saw Barclays and RBS  hit with these and we fined Barclays ourselves.

The Financial Conduct Authority (FCA) has imposed a financial penalty of £284,432,000 on Barclays Bank Plc (Barclays) for failing to control business practices in its foreign exchange (FX) business in London.

Whilst on the face of it seems like action there are various problems here. Current Barclays shareholders are paying for a problem which they really had no control over and of course may not even have been shareholders then. What about punishing those who did this? After all some were openly admitting to fraud.

“If you aint cheating, you aint trying”

Yet again there seems to be something of a shortage of criminal prosecutions as we wonder if any sort of banking financial crime would get a jail sentence. We do seem to treat other types of fraud such as benefits fraud much more harshly. From Poole Council’s website.

A Poole man was given a 12 month custodial sentence for stealing over £88,000 from the public purse.

Meanwhile there is the issue of whether the shareholders were in fact punished. From Adam Parsons of the BBC.

Shares then go up up 3.37% Means Barclays now worth £1.5bn more than it was before the £1.5bn fine.

Next if we look at the international issue is a wealth transfer from the UK to the United States as the fines from it to UK banks go on and on.

Barclays, which was involved from as early as December 2007 until July 2011, and then from December 2011 until August 2012, has agreed to pay a fine of $650 million;RBS, which was involved from at least as early as December 2007 until at least April 2010, has agreed to pay a fine of $395 million.

The US Federal Reserve fined them too for US $342 million (Barclays) and US $274 million (RBS). This is particularly awkward in the case of RBS which has of course the UK taxpayer as a majority shareholder. Exactly what guilt does the average UK taxpayer have?

Market Manipulation

Often forgotten in the melee is the impact on financial markets. We have seen that foreign exchange and interest-rate markets (LIBOR) have been rigged to the banks benefit which begs the question of what other markets have been? For example was it a coincidence that the oil price and indeed the price of several other basic commodities fell after many banks closed their commodity trading desks. By the time that central banks have manipulated so many markets too what is left.

Of course central bank market manipulation is treated as welcome rather than illegal but even Andrew Bailey of the Bank of England admitted that there seem to be “side-effects”.

On 15 October, 10 year US Treasury yields moved intra-day by around 8 standard deviations of preceding daily changes. On 15 January, the Swiss Franc moved by more than 30 standard deviations. For rough scale, an 8 standard deviation move should happen once every three billion years or so for normally distributed data.

Of course we had the flash crash in Euro area bond markets only recently.So what is proclaimed as making us safer is at best making markets more skittish.

What did governments do for revenue before they fined banks?

As the fine revenues pile up let us not forget that there were other type of fine imposed on the banks in the UK which were the bank payroll tax and the banks levy. As of the end of the 2103/14 tax year we had received some £8.8 billion. This has its issues as of course we were in some cases fining banks we then owned!

What we used to do was tax banks via Corporation Tax but receipts have collapsed from £7.3 billion in 2006/07 to £1.6 billion in 2013/14. There is of course a much wider problem with corporate taxation as companies shuffle money around the globe to avoid it. I saw an odd BBC interview with Bono and the Edge from the band U2 who apparently approve of this,well for their own affairs anyway! But conventional revenues like this from the banks took a heavy knock. So we now fine them which is often a sort of fining ourselves. are we fining the profits they have made from the cheap funding given to them by the Bank of England in a form of “round-tripping”?

Of course we could follow the American model and mostly fine foreign banks….

What about the regulators?

One more time we face the famous latin phrase.

quis ipsos custodiet custodes (Juvenal)

Who watches the watchmen? This is a very relevant question as time and time again we see evidence of “regulatory capture”. This involves regulators later moving to banks for example. From Sky News.

Barclays has hired the former chief executive of the Financial Services Authority (FSA), Hector Sants, as its head of compliance.

We are continually told “this time is different” and yet more and more scandals emerge. Perhaps the “exhaustion and stress” from which the newly knighted Sir Hector suffered was from the emergence of all the scandals on his watch.

Frankly regulators seem to have more enthusiasm for suppressing scandals than investigating them.


The essential problem is how much has improved over that past eight years or so? We get regularly told this both openly and more subliminally.  Yet we remain in a situation where as I discussed yesterday where interest-rate rises seem impossible and the housing market has been pumped up one more time to improve the balance sheets of the banks. As so often before we find ourselves asking what happens if we go in a recession again? After all the numbers keep getting larger. From Andrew Bailey.

Financial market activity has grown rapidly. There are many statistics that could be quoted, so to choose one, over the last 15 years, global bond markets have grown from around $30 trillion in 2000 to nearly $90 trillion today.

I fear that we have gone backwards rather than forwards after all the cavalry of the Vickers Report will not arrive until 2019. That is of course assuming that the cavalry do not suffer from regulatory capture on their amazingly slow journey.

Can the United States Federal Reserve raise interest-rates?

This evening we will see the latest set of meeting Minutes from the Federal Reserve Open Markets Committee which is the interest-rate and indeed Quantitative Easing arm of the US central bank. Rather like the Bank of England the FOMC has been teasing everybody about a prospective interest-rate rise for some time now but just like it nothing has actually happened. It has remained a mirage in the distance that is apparently just out of reach. You might like to contrast that in these times with interest-rate cuts around the world which flash up across the various media with quite some regularity these days So far this year there have been 30 or so interest-rate cuts in 2015 including China, India,Korea, Australia and a host of others including Switzerland, Denmark and Sweden who have plunged into the icy cold world of either negative interest-rates or further into them. You may note that there is quite an asymmetry there!

What about the US economy?

The latest set of economic growth data were poor.

Real gross domestic product — the value of the production of goods and services in the United States, adjusted for price changes — increased at an annual rate of 0.2 percent in the first quarter of 2015, according to the “advance” estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 2.2 percent.

So there was not only a very weak reading but quite a slowdown from the end of 2014. This was quite a lurch downwards from the 3% annualised growth that had been doing the rounds in the financial markets not so long ago. Indeed as recently as February the Bank of England made yet another forecasting error.

much weaker than the 0.6% expected at the time of the February Inflation Report (or annualised ~2.5%)

Since then we have seen very poor trade figures thrown into the mix.

The U.S. Census Bureau… announced today that the goods and services deficit was $51.4 billion in March, up
$15.5 billion from $35.9 billion in February, revised

This meant that the quarterly picture for trade was now as follows.

Year-to-date, the goods and services deficit increased $6.4 billion, or 5.2 percent, from the same period in 2014.

Accordingly the latest estimates for that quarter are now in negative territory as we await the later updates. The only hope is that a more complete data set finds a positive nugget or two.

Also as we recall the way that central banks panic at the thought of negative inflation there was this tucked away in the data.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 1.5 percent in the first quarter, compared with a decrease of 0.1 percent in the fourth.

Ordinary workers and consumers will welcome lower energy and to a lesser extent food prices but of course central bankers are made very nervous by them. What about the banks? What about the debt?

What about now?

Something rather familiar has been happening and I shall take you over to the Atlanta Federal Reserve whose GDP tracker has been on form.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2015 was 0.7 percent on May 19, unchanged from May 13.

Over the past week the number had been pulled lower by weak industrial production data and then pushed back up by strong residential housing numbers. So there is the distinct possibility that over the first half of 2015 the US economy will see no growth at all. This is very different from what is calls the “Blue Chip consensus” which has gone from just above 3% per annum growth to just below it. Quite a gap! Just like last time.

Ominously perhaps today’s Bank of England Minutes remain optimistic for US economic growth.

These effects were likely to be temporary, pushing up on growth in Q2: Bank staff expected growth of 0.7%.

Ah that word temporary again! Has anything actually proved to be temporary after an official claim about bad data?

As recently as the middle of March the Federal Reserve told us that US GDP growth in 2015 would be between 2.3% and 2.7% which means that it will really have to charge ahead in the second half of this year.

Wage growth and productivity

This is a measure which most central banks are tracking closely right now. The latest employment report data is below.

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $24.87. Over the past 12 months, average hourly earnings have increased by 2.2 percent.

Hardly racing away is it as the last quarter of 2014 saw growth of 2% per annum? If we look back to the pre credit crunch period then depending on which measure you use you would estimate it at being 3-4% per annum.

Also somewhat ominous for possible wage growth is this research from the Atlanta Fed about productivity.

For example, over the past three years, business sector output growth averaged close to 3 percent a year. Labor productivity growth accounted for only about 0.75 percentage point of these output gains.

Thus it is not only the UK which has its concerns about labo(u)r productivity and the new pattern is very different from the past.

Business sector labor productivity growth averaged 1.4 percent over the past 10 years. This is well below the labor productivity gains of 3 percent a year experienced during the information technology productivity boom from the mid-1990s through the mid-2000s.

If these productivity trends are now permanent then real wages are on quite a different path to what people hope they will be and of course the path for interest-rates changes too.

Business surveys

These are hard to read at the moment as highlighted by the latest purchasing managers report from Markit.

The seasonally adjusted final Markit U.S. Composite PMI™ Output Index (covering manufacturing and services) posted 57.0 in April, down from 59.2 in March and the lowest reading for three months.

It would be ominous if there was a slow down from the weak official economic growth data for the first quarter of this year. But as I am sure you have noticed the PMI report had economic growth charging forwards earlier this year!

Monetary Policy has tightened

There is much more to monetary policy than just official interest-rates especially these days. If we look at market interest-rates then the ten-year bond yield has risen from just above 1.6% in late January to 2.27% now. This has pulled mortgage rates back up again after the falls seen in 2014 and January of this year. Whilst the US Dollar is no longer at its highs the trade-weighted dollar index is at 95.5 compared to 80 a year ago which shows how much the US Dollar has risen.

Some care is needed because the US Dollar is the reserve currency and also because the US economy is in proportional terms less of a trade dependent nation than many. But if you were setting US policy you would be wondering if March’s poor trade figures were the beginning of a new weaker trend.


There are many ways of looking at the situation. I have thought for some time that a new version of Forward Guidance is in operation where the Fed (and the Bank of England) promise interest-rate rises but in reality do not actually mean to carry them out. They hope that “expectations” as in market behaviour will do the job for them and make actual rises unnecessary. They of course ignore the dangers of moral hazard and to credibility of crying wolf.

Added to this are signs of weakness from the US economy which are far from alone in the world. For example after a good start to 2015 the Euro area (h/t @markbartontv ) surprise index has not only reversed but gone negative recently. If matters are going so well in China why does it keep cutting interest-rates? Indeed why are so many cutting interest-rates. Now America is often quite insular and may be bothered less by the rest of the world than one might think but it will worry about how much higher the US Dollar would go if it raised interest-rates.

So this is a situation rather like the UK General Election as even those who say they will raise rates are likely to change course when it comes to actually doing so. As Change (with one Luther Vandross) put it.

But now I know
I don’t need you at all
You’re no good for me

I’ve changed my mind

The UK finds itself at peak deflation mania as house prices rise by 9.6%!

As 2014 moved into 2015 we saw one of the manias of our times develop and by this I mean the way that economists and the mainstream media started to scream and shout “deflation”. This was presented as one of the economic evils of our time in spite of the fact that below target inflation would of course be welcomed by consumers and workers and that an economic boost would be provided by a better trend for real wage growth. Indeed they seemed to have an outbreak of amnesia about the fact that the UK had just gone through a period of above target inflation. Odd that because there is plenty of economic literature arguing that inflation “shortfalls” should be made up which means that for symmetry surely so should overruns. The “deflation nutters” also ignored the fact that the UK economy was growing solidly and that if we looked at sectors of the UK economy unaffected by the oil price fall inflation seemed to be pretty much as before.

What has changed?

The “deflation nutters” have seen their economic bogeyman fade somewhat as 2015 has progressed. The price of a barrel of crude oil has risen by 14% in 2015 if we use the Brent Crude benchmark and it is up around US $20 since it hit its low of US $45 in Mid-January. So whilst in annual terms it still has an effect on inflation numbers due to the large previous fall in month on month terms we are now seeing rises. This is why the UK inflation bulletin has told us this.

motor fuels: prices, overall, rose by 1.6% between March and April 2015 compared with a fall of 0.1% between the same 2 months a year ago.

This poses an immediate problem for the “deflation nutter” theory where falling prices escalate and then we see falling wages and falling economic output in a downwards spiral. It is also a bit awkward that wages seemed to have picked up a little according to the latest data and of course other commodity prices such as Iron Ore have stabilised and rallied a little.

Also the UK has been experiencing this all along from the sector which remember is around 4/5 ths of our economy.

The CPI all services index annual rate is 2.0%, down from 2.4% last month.

Falling yes but as you can see it is on target and chugging along (not very) nicely.

The ordinary citizen will of course have struggled with the concept that buying cheaper fuel and energy was bad for them.

Today’s data

The deflation mania has gathered in force in the media after today’s data release.

The Consumer Prices Index (CPI) fell by 0.1% in the year to April 2015 compared to no change (0.0%) in the year to March 2015.

The UK Office for National Statistics has chosen to ramp up the shock effect of this.

This is the first time the CPI has fallen over the year since official records began in 1996 and the first time since 1960 based on comparable historic estimates….. Based on comparable historic estimates, the last time the UK saw consumer price deflation was in the year to March 1960, when prices fell by an estimated 0.6%.

The media has lapped this up ignoring the “comparable historic estimates” part. Presumably they are unaware of the fact that some of the required data was not collected as back then we used the Retail Price Index such that if it was an airplane it would have no tail fins. What could go wrong?

Oh and the Retail Price Index (RPI) went negative in 2009 for a few months which you might think merits a mention. Actually this was a really big deal as it is my view that the Bank of England panicked over this development as it slashed interest-rates and commenced QE (Quantitative Easing) in response. Back then the Bank of England was a “deflation nutter” which of course turned out to be an inflationary episode. How quickly we forget!

Problems with the deflation mania

Our old inflation measure called RPI gives a completely different answer.

The all items RPI annual rate is 0.9%, unchanged from last month.

So the UK establishment has achieved a success by getting the media to accept an inflation measure that is consistently lower and the scale of the “success” has increased as the gap is currently 1% per annum.

Also there is the issue of UK house prices which do not fit at all well with any deflation theme.

UK house prices increased by 9.6% in the year to March 2015, up from 7.4% in the year to February 2015.

No longer is this just a London driven development.

Excluding London and the South East, UK house prices increased by 8.1% in the 12 months to March 2015.

As you can see there is raging inflation in the UK housing market which is the largest purchase that home owners are ever likely to make. How does that go with inflation which is officially negative? It does not as they exclude house prices from the numbers and have gone to a great deal of effort to do so as we were supposed to be aligning with Europe but are ignoring Eurostat’s advice that the housing version of CPI should include house prices. Presumably on the grounds that it gives too big a number.

Actually inflation is on the rise again

If we look at the numbers we do see signs of a turn higher in the UK inflation rate as shown below.

The all items CPI is 128.0, up from 127.6 in March

The underlying index has in fact been rising since January when it fell to 127.1 and since then it has risen by 0.3 in February,0.2 in March and now 0.2 in April. So if that were to continue it would not be too long before we found ourselves facing inflation back at its target level in yet another “surprise”.

A technical issue called Easter

A downwards push was provided by the timing of Easter this year and the impact it has on airfares.

transport services: prices, overall, rose by 2.4% between March and April 2015, compared with a larger rise of 7.9% a year earlier. The majority of the downward contribution came from air and sea fares. Price changes for these fares between March and April vary notably year on year, with the timing of Easter a likely factor.


So we arrive at what I consider to be peak deflation mania for the UK. If we review the situation strategically we see that the oil and commodity price falls have stopped for now and the UK Pound £ seems unlikely to keep rising at the rate it has been. The currency issue is complex because of the impact of the strength of the US Dollar but the UK Pound £ has been very strong against other currencies. Tactically I note that last May prices fell by 0.1% on the month before so we arrive at a period where the annual rate of inflation will get an upwards nudge unless anybody has spotted price falls this month.

One slightly odd result of the various machinations is that Euro area inflation at 0% is for once higher than that of the UK. So should it be the Bank of England with negative interest-rates and QE? Actually I think that this is a result of the UK Pound £’s strength but of course the Bank of England may not and could spring a Riksbank style surprise.

Meanwhile those who are buying a house or facing the inflation in the services sector will be singing along with the Who.

I said I can’t explain, yeah
You drive me out of my mind
Yeah, I’m the worrying kind, babe
I said I can’t explain

Which will morph into the perfect song for inflation statistics.

Then I’ll get on my knees and pray
We don’t get fooled again
Don’t get fooled again
No, no!

Apologies for the early version of this which got published by mistake.

Is the success of Juventus this season a metaphor for the economy of Italy?

One of the economic themes of these times is the struggle of the Italian economy which has been in evidence throughout the Euro area. This has been exacerbated by the credit crunch which saw the Italian economy plunge to an annual growth rate of -6.9% at the beginning of 2009 then see the beginnings of a recovery which sadly soon ended as the Italian economy began to contract again as 2011 progressed. So it has been a long hard road which one might reasonably hope should have turned for the better in early 2015. This is because of the oil price fall that took place in the latter part of 2014 and also the fall in the exchange-rate of the Euro.

How is Italy doing?

Looked at in football terms this is a story of two halves so let us open with the positive one.

In the first quarter of 2015 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.3 per cent with respect to the fourth quarter of 2014.

Whilst the UK was disappointed to produce that particular number for Italy it represents the best quarter since the opening one of 2011. The weaker second half comes when we see that in fact it was required to stop the Italian economy being smaller than a year before.

unchanged in comparison with the first quarter of 2014

Indeed if we look for some perspective we see that back in 2011 the first quarter saw a Gross Domestic Product of 405.4 billion Euros (2010 base) whereas the opening quarter of 2015 saw one of 385.25 billion Euros. This means that the economy has shrunk by 5% over this period which is why from time to time we read of public protests and indeed riots in places like Milan and Rome.

Looking Forwards

Is this a new dawn for Italy? Well the Bank of Italy tries to put a positive spin in its economic bulletin but the numbers below remain weak especially if we remember that next year is always bright in official forecasts!

Italian GDP growth should exceed 0.5 per cent this year and be around 1.5 per cent next year

Not much is it? Especially if we factor in the oil price fall and that the Bank of Italy is rather bullish about the impact of the 130 billion Euros of Italian government bonds that it expects to buy as its share of the European Central Bank’s asset purchases or QE program.

the expanded asset purchase programme could raise GDP by more than one percentage point in 2015-16.

So without the favourable winds currently blowing the Bank of Italy would have expected yet another contraction in 2015 and perhaps 2016. Indeed its new indicator the Ita-coin is in fact somewhat downbeat.

In recent months Ita-coin has improved gradually but remains negative, thus reflecting both the advances and the difficulties that have marked the start of the economic recovery.

Business surveys

These show hopeful signs for Italian manufacturing.

Growth in Italy’s manufacturing sector gained further momentum in April, with faster increases in output and new orders recorded. Job creation was sustained, and at a sharp and stronger pace.

The job creation element of this will be especially welcome considering Italy’s persistent unemployment problem. This was reinforced by a stronger performance from the service sector too.

Italy’s service sector enjoyed a positive start to the second quarter, seeing business activity and inflows of new work rise at the fastest rates for ten months. The pace of job creation among services firms meanwhile quickened for the second month in a row, hitting a multi-year high.

Thus we have entered a period where the private-sector surveys are more optimistic than the official forecasts.


This is a strength of the Italian economy as this mornings data release indicates.

The trade balance in March amounted to +4.0 billion Euros (+487 million Euros for EU area and +3,573 million Euros for non EU countries).

Actually the numbers are flattered by the fact that the oil price had fallen but Italy does have strong industrial sectors one of which had an especially good March as exports of vehicles rose by 28% in March. As it happens the UK did its bit for the UK trade figures as we imported some 7.2% more in the first quarter of 2015 than we had in the same quarter a year before.

What about deficits and debt?

The problem here for Italy is not the size of its fiscal deficit outright which as you can see is a fair bit smaller than that of the UK. From the Bank of Italy.

In 2014, despite the contraction of output, general government net borrowing was practically stable at 3.0 per cent of GDP.

However the “contraction of output” has meant that the hopes of achieving some form of balance and maybe a surplus in this area have been regularly dashed. This means that the size of the national debt has continued to increase.

The ratio of debt to GDP rose by 3.6 percentage points to 132.1 per cent, reflecting among other factors the virtual stagnation of nominal output.

You may note the emphasis on “nominal output” which is yet another hint that central banks want higher consumer inflation to help with public debt burdens. Whereas both the Italian consumer and worker will welcome lower inflation and cheaper prices for fuel and energy.

We can consider this in terms of the Stability and Growth Pact rules where Italy is adhering to the 3% per annum deficit limit. However in the early days of the Greek crisis  the Euro area used a national debt of GDP ratio of 120% as a threshold to avoid embarrassing Italy (and Portugal). For Italy 120% is long gone.

Putting it another way at the end of 2014 then Italy’s national debt at 2.135 Trillion Euros was some two and three-quarter times its annual government tax revenues.

North and South

The economic divergence between the North and South in Italy which I have analysed on here many times is quite marked. It provokes thoughts of its own Euro area style issues and is a reminder of how short its history as a united country actually is.  The Economist has added to the debate with numbers like this.

But the main source of the divergence has been the south’s disastrous performance since then: its economy contracted almost twice as fast as the north’s in 2008-13—by 13% compared with 7%. Themezzogiorno—eight southern regions including the islands of Sardinia and Sicily—has suffered sustained economic contraction for the past seven years.

I often wonder if Italy could split into separate parts after all we are seeing such pressure in both Spain and the UK right now.


There is a direct comparison with the world of football right now as Juventus have reached the champions league final after a drought since Inter Milan did so (and won) in 2009. Can both or either continue this new trend? For the economy it is good to see that the private-sector surveys look positive albeit that the official one is less so. But somehow Italy needs to throw off the shackles that are described by the Economist below.

between 2001 and 2013 GDP shrank by 0.2%.

That statistic gets even worse when you allow for the fact that the Italian population was expanding over that period by around 7% so per person the situation was even worse.

So whilst I cross my fingers for what is a delightful country and people there are plenty of doubts as to what will happen as the boost from the oil price fall fades.  Yet of course there is another perspective as Italy must look a land of gold and honey from the continent below it as otherwise so many would not be drowning in the Mediterranean Sea trying to get there. A very different perspective as they are obviously not bothered much by the clear risk of a default.

Two years on both Abenomics and QQE are developing a track record of failure

Yesterday I discussed the way that the Greek economy was struggling under the mountain of debt which ironically is described as a rescue package. Well I suppose for French and German banks it was. Today I wish to move onto another country with an enormous public-sector debt burden and that is the land of the rising sun or Nippon. This now amounts to 1.053 quadrillion Yen for central government as of the end of March according to the Ministry of Finance. However Japan retains control over its monetary policy and exchange rate in a way that Greece does not in that it sets its own interest-rate and has its own currency. In a way that is something more honoured in the breach than the observance because if you look at it both the Euro area and Japan have very low interest-rates and both are implementing Quantitative Easing to drive their currencies lower. In one way the Euro area has gone further as it has negative interest-rates which rather intriguingly Japan has consistently resisted.

Number Crunching the debt

The rather extraordinary number for Japan’s national debt if anything gets even worse if we compare it to Japan’s tax revenue which was 50.000 billion Yen or to put it another way Japan would take over 20 years to pay it off if all revenues were used solely for that purpose. That of course would assume that no interest was payable whereas in fact last year it estimates that it paid 23,270 billion Yen on Debt servicing. So if we allow for that we see that it would take well over 30 years to pay off the debt on current tax revenues.

Then we get another problem which is that Japan is still borrowing on a grand scale as expenditure is expected to be 96,342 billion Yen this fiscal year but revenues only 54,525 billion as the cycle goes on. So not only is the situation mind-boggling if you start putting the zeroes on these numbers as they fill the whole page line but you realise that each year it is as Paul Simon put it.

Slip slidin’ away
Slip slidin’ away
You know the nearer your destination
The more you’re slip slidin’ away

What about economic growth?

We await next week’s update but if we recall the promises of the economic and monetary policy being applied in Japan they certainly did not include this. From the IMF.

In Japan, after a weak second half of the year, growth in 2014 was close to zero, reflecting weak consumption and plummeting residential investment.

Now we get to the crux of the problem as economic growth was derailed by the rise in the Consumption Tax last year such that it turned out to be appropriate that it commenced on April Fools Day! Also on the scale of things even if we take the revenue from the total Consumption Tax which is expected to be 17,112 billion Yen you see the scale of the problem. Compared to its expenditures Japan is very under-taxed but when it tries to raise higher taxes the economy splutters.

Time is Running Out

A year ticking by means that Japan runs its deficit and raises its national debt. This might not matter if it was genuinely about to turn a corner in economic growth terms. I will discuss the near future in a moment but if we look further ahead we see the implications of this. The problem is that Japan’s population is shrinking and on the latest estimates that is happening fast as between November last and this April the population fell by 391,000 to 126,691,000. Also it is aging as the proportion of people over 65 rose from 26% to 26.4% over the same period.

I spoke to the Pink Shoe Club (female entrepeneurs) at the House of Lords last night and the subject of care of the elderly came up. Well the Japanese make a much better job of it than we do and for the individuals concerned greater longevity is welcome. But if you project that onto an economy that needs to be dynamic and innovative you see the problem. It has fewer people who on average are getting older. Also Japanese society is quite homogenous and resistant to immigration so that route is closed for now at least.

Consumer Price Inflation

According to the philosophy of Abenomics the cure for this is a good dose of inflation involving a fall in the value of the Yen. A compliant Governor of the Bank of Japan Mr. Kuroda was installed to do this so to bring things right up to date he would have looked at today’s producer price index numbers with dismay as they showed an annual rate of -2.1%. As he spoke earlier today at the Yomiuri International Economic Society  let me use his words.

The last time I addressed this meeting, in April 2013, was immediately after the Bank of Japan’s introduction of Quantitative and Qualitative Monetary Easing (QQE). Two years have passed since then, and the economic and price situation has improved substantially under QQE.

You may note quite a bit of hype here so let me concentrate on inflation alone which is now supposed to be running at an annual rate of 2%.

Although the year-on-year rate of increase in the consumer price index (CPI) had declined, due mainly to the effects of the substantial decline in crude oil prices since last summer, and recently has been about 0 percent, the underlying trend in inflation has steadily been improving

So if you ignore the actual numbers things are going very well?! Some of you may have spotted that QE in Japan has become QQE which can be thought of as why Windscale changed its name to Sellafield. Failure needs a fresh start at least in terms of a name. Indeed after a complex passage we do get a confession of sorts.

That said, when trying to express such expectations in terms of numeric figures, a single figure cannot be easily found…

Ah so things are really good but I cannot put it into numbers (because they do not back this up). We do however get an estimate of what the Bank of Japan thinks it has done.

the policy effects of QQE are such that they are roughly equivalent to those that would arise from making almost ten 0.25 percent cuts in short-term interest rates in one shot under conventional monetary policy.

So it thinks that its policies are equivalent to cutting interest-rates to  below -2% and perhaps to -2.5%.

But then we get to the crux of Kuroda’s problem which is why I have emphasised this bit.

While the decline in crude oil prices exerts positive effects on Japan’s economy……..a favorable environment of inexpensive crude oil prices.

Thus we see exactly the opposite of official policy boosting the economy. If only I was there to ask if higher inflation boosts the economy and lower inflation also boosts it why Japan had a “lost decade” as all it has to do is avoid zero inflation?

You might like to recall at this point that Japans’ economy did not grow at all in 2014 as you probably will not pick that up from these quotes.

Looking ahead, Japan’s economy is expected to continue its recovery trend

Despite these unexpected events, the mechanism of QQE has been operating as intended.


In a nutshell you could say that Japan’s establishment has stuck its collective head in the sand one more time. Yet right now it should be receiving an extraordinary boost via the fall in oil prices and indeed other commodities. This is a subject I have discussed before and the Wall Street Journal added to it yesterday by pointing out it imports more than 90% of its fossil fuels. Of course this lack of natural resources is also the road to Pearl Harbour and how it got into world war two. But the economic point is that its economy should be leaping forwards right now but instead it has an economic policy called Abenomics which is trying to push prices higher.

If we look at real wages I note the number of references in rising wages in Governor Kuroda’s speech. Except real wages fell by 2.6% in the year to March which means that they have fallen in every month of the two years of QQE now. On that road the policy looks very familiar does it not? Pretty much everywhere real wages are struggling and government policy is invariably to push them lower whilst proclaiming the opposite. Two years on the only record is one of failure. Or as the Japan Times puts it.

Now that economic growth has plateaued, Hirayama says such life cycles have become a thing of the past, with an estimated 36.6 percent of those under 35 now plagued by hiseiki, or irregular employment.

Having raised the issue of world war two it is hard to avoid noticing this from the Japan Times.

Prime Minister Shinzo Abe tried to brush off concerns Thursday that Japan could be dragged into a war involving the United States, saying the envisioned security legislation would enable the Self-Defense Forces to address every situation in a seamless manner to protect Japanese citizens.

As has been pointed out before those “helicopter destroyers” look awfully like aircraft carriers. What could go wrong?

Would even complete debt monetisation do Greece much good?

A continual feature of the Greek economic crisis has been the official claims that the economy is just about to turn the corner. What can forget the promise in the original Euro area documents that there would be economic growth of 2% in 2012? This was replaced by a reality where the year on year growth rates in Greece in 2012 varied between -4.4% and -7.8%. At that point the bailout was doomed but the fantasists who are responsible for official Euro area programs soon switched to the concept of what became called “Grecovery”. This too did not happen when they promised but there was a little flicker last year when there was positive economic growth in the first three-quarters of 2014.

Economic theory

If you look at the plunge of the Greek economy where the annual rate of contraction of the economy rose as high as 9.9% then in the normal course of events you would expect also a sharp bounce back when the situation stabilises. This is what is called a “V shaped” recovery and again there were promises of this in the Grecovery theme. So as 2014 developed we saw the annual rate of economic growth reach 1.5% in the third quarter of 2014 and that should have been the launchpad for much better things.

A cold hard reality

Instead the last quarter of 2014 saw yet another quarterly contraction in Greece’s economy. This was ominous as in fact at -0.4% it was a larger decline than the same quarter in 2013 and yesterday it was followed by this announcement.

Available seasonally adjusted data indicate that in the 1st quarter of 2015 the Gross Domestic Product (GDP) in volume terms decreased by 0.2% in comparison with the 4th quarter of 2014, while it increased by 0.3% in comparison with the 1st quarter of 2014..

So Grecovery has in fact morphed into yet another recession in Greece and if we look at the overall pattern it is clear that rather than a V-shaped recovery the economic depression has continued. It could be a form of a L-shaped recovery which as you can see from the shape of the letter itself is extremely disappointing to say the least. It just gets worse when you realise that the Greek economy in spite of the chorus of Grecovery claims was some 26.6% smaller in the first quarter of this year than it was at the peak for Greece in the second quarter of 2007. Some recovery!

A Lost Decade and Some

The latest bulletin does take us back to 2005 and from it we can see that Greece has indeed experienced a “Lost Decade” . However the lost decade that Japan experienced was more of lost opportunities as the economy stagnated whereas the Greek experience has been much worse as the economy is some 18% smaller than it was then. Who could possibly have foreseen that back in 2005? They would have been derided as some form of Cassandra.


Due to its highly elevated status this is quite a problem for Greece and last week’s update highlighted the scale of the continuing problem.

The seasonally adjusted unemployment rate in February 2015 was 25.4% compared to 27.2% in February 2014 and 25.6% in January 2015.

Whilst the numbers are improving they are doing so slowly and if we factor in an economy which is now in recession there are fears it could rise again. Let us hope for a situation like the UK one where the labour market outperforms the economic growth numbers.

More than half of young people (50.1%) are still unemployed as we consider the implications of not only a lot of long-term unemployment but that it is applying to youngsters whose knowledge of what it is to work must be very limited or perhaps zero.

The Greek banks

These are being kept on a life support system by the Greek central bank as funding from it replaces the deposits which have fled. The total funding on the Bank of Greece balance sheet was 112.8 billion Euros at the end of April of which 74.4 billion Euros was of Emergency Liquidity Assistance. As this rises and deposits fall then there is a clear risk that they will cross-over.

Bloomberg has reported that some 7 billion Euros of deposits left the banking system last month and we know that on Tuesday the ECB raised the ELA limit to 80 billion Euros. Accordingly the beat goes on in this area although not according to Daniele Nouy the chairwoman of the ECB’s bank supervisory department. From the Wall Street Journal.

“These banks have gone through important restructuring, important recapitalizations and a redefinition of their business models,” Ms. Nouy said. She added that, even though the lenders are going through a difficult period, “they have never been better equipped to go through this kind of stressful situation.”

I guess she took the red pill.

The International Monetary Fund

The Bank of Greece balance sheet shows assets of 1.02 billion Euros in respect of the IMF. These were presumably what were partly used to help make the repayment to the IMF  earlier this week. I wait to see if on the next balance sheet update if some of these funds appear on the other side of the balance sheet as well!

What happens next?

Raiding the IMF Special Drawing Rights poses its own problems. You see if Greece was going to play a game of chicken with its creditors in the manner in which Syriza is proceeding 2015 is not a good year as there is a continual stream of repayments to be made. There are repayments to the IMF to be made on June 5th 12th,16th and 19th as well as on July 13th. They total just over two billion Euros and as Greece has recently been raiding both municipalities and the IMF the portents are not good. Even if it somehow scrapes together the cash it needs some 3.4 billion Euros to repay the ECB on the 20th of July.

The only way Greece can do this is by a form of round-tripping where its creditors give it more money which enable it to repay past borrowing. Could you imagine trying that with your bank manager? We can link in the economic failures discussed above with this because these repayments are the original bailout borrowing. It was all supposed to be better now with Greece able to repay its borrowings which sadly became like this from Earth Wind and Fire.

Every man has a place
In his heart there’s a space
And the world can’t erase his fantasies
Take a ride in the sky
On our ship, fantasize

Finance Minister Varoufakis

It has been a troubled period for the Greek Finance Minister and it escapes me why he thought appearing in Paris Match would improve anything. However he has this morning spotted the issue with the looming ECB repayments. From Reuters.

About 27 billion euros of those bonds are still left, which should be repaid in the next months or years. These bonds should be pushed back to the distant future. This is clear.

How far into the distant future as this sounds like “Too Infinity And Beyond” to me? according to Bloomberg he carried on.

Quantitative easing would have been especially positive for the facts of the Greek debt-deflationary problem if we were participating in it,” Varoufakis told lawmakers in Athens Thursday. “It essentially would have allowed us to return to markets faster. Of course, Mr Draghi is not proceeding with quantitative easing to solve our problem.”

An odd description of returning to markets is being provided here. You issue something and then buy it back does not quite fit with a markets solution at all. Also there is something of a lie at the bottom of this which is that the troika bond purchases which began in May 2010 were in fact QE. As some 80% of Greek debt is now in such hands Greece has in fact had much more QE than anyone else! Does Varoufakis want all of Greece’s debt to be subject to QE as that would be clear debt monetisation. Maybe the clearest form of all as who right now can project any time when Greece can even begin to repay such borrowings?


This sad story has covered pretty much the lifespan of this website and today sees a repeat of a familiar attempt to cloud and obscure the real issue. Finance Minister Varoufakis has ironically mimicked the Euro area establishment by saying that Greece has a “liquidity” issue when the truth is that it is a matter of solvency.

Nearly five years ago to the day (May 17th 2010) I discussed the analysis below from Daniel Gros has turned out to be on the button.

His analysis leads him to believe that  for each 1% of GDP decline in Greek government spending, economic output in Greece will fall by 2.5% of GDP. So if you put in a fiscal adjustment of 10% you get a fall in GDP of 25%. Now the analysis is a little simplistic but it is revealing as to the depths of recession we can expect and I feel it will be worse much worse than is being factored in now.

That is why Greece cannot repay and that is why despite the occasional flickering of life such as the March industrial production figures Greece is insolvent by pretty much any definition you choose. After all the overall Euro area has responded to the combination of a lower Euro exchange rate and lower oil prices so why not Greece?To return to my original question a complete debt monetisation would clearly clear up a lot of liquidity issues but solvency also require a lot of economic reform and if they were going well we would not be where we are now.