Yesterday saw developments on quite a few issues. There were some curious moves in Ireland in response to her escalating banking crisis and a response from the European Central Bank, in fact two responses by the European Central Bank. We also had some frankly rather bizarre behaviour from the Bank of Japan which had traders doing dry runs for currency intervention and told them to be ready to be at work at unusual hours. As you can imagine this led to expectations of some currency intervention which so far has not taken place. Accordingly the Yen remains at high levels, with it being at 83.63 versus the US dollar and 106.03 versus the Euro. This means that in 2010 it has risen by 11.2% against the US dollar and 26% against the Euro. It is not impossible that they have found a strategy that is even worse than currency intervention in my view. In terms of actual news Japanese consumer confidence fell slightly to 42.5 in August from 43.4 in July according to the Cabinet Office, reinforcing thoughts of an economic slowing.
In the hope that President Obama’s stimulus measures may help the US economy the Dow Jones Industrial Average managed a rally of 46 points after a triple digit fall the day before. One area where we are seeing some movement again is in the Commodity Research Bureau spot index where we are seeing signs of “agflation” again. It is now at 465.02 representing a rise of around 1% since I last reported on it on Monday and the main rises this week have been foodstuffs,fats and oils and livestock to add to a trend which is becoming somewhat familiar. The foodstuffs component has been the strongest component of the index over the last year and has risen by 25.5%.
The Federal Reserve’s beige book: What does it tell us?
What this document attempts to cover is the current state of the US economy and it is the Federal Reserve checking on economic conditions in each of its twelve districts. If you like it is the Fed’s weathervane for the US economy and it covers the six weeks to the end of August so it is about as current as economic measures get. So let us look at what it says.
Reports from the twelve Federal Reserve Districts suggested continued growth in national economic activity during the reporting period of mid-July through the end of August, but with widespread signs of a deceleration compared with preceding periods. Economic growth at a modest pace was the most common characterization of overall conditions,
Home sales slowed further following an initial drop after the expiration of the home buyer tax credit at the end of June, prompting a slowdown in construction activity as well. Demand for commercial real estate remained quite weak but showed signs of stabilization in some areas.
Manufacturing activity expanded further on balance, although the pace of growth appeared to be slower than earlier in the year
As you can imagine the Fed is likely to be guarded in its language but use of words such as deceleration,modest,slowed,weak and slower pretty much gives us the picture it is seeing I think. Does it matter? Yes it does as these are the forecasts used by the Fed when it sets interest rates. If you look further down the report there are some interesting and perhaps revealing references.
Several Districts noted an emphasis on necessities and lower-priced goods…….Spending on big-ticket items such as expensive consumer electronics was weak
This is a clear signal that for some times are hard. Such thoughts will increase the pressure on the Fed. to act at its next meeting. However I still feel that it should grit its teeth and hang on in the face of market pressure and do nothing. As it is likely to have to revise down its growth forecasts and raise its unemployment forecasts this will not be easy for an institution which has responded to pressure in the past.
A squeeze on real wages
There has been much talk of squeezing real wages in countries such as Greece, Spain, Portugal and Ireland as a way of regaining economic competitiveness there. Well the beige book reports that this looks like it is happening in the US too as “Wage pressures also were limited” but it also saw “higher prices for selected commodities such as grains and some industrial materials”. If you add to this the switching to basics as indicated above this is not a happy trend for US workers and the real value of their wages. So the rise in commodity prices is beginning to have an influence and it looks likely to increase.
A planned fiscal stimulus
I am not sure whether President Obama planned his announcement of further fiscal stimulus measure to coincide with a downbeat beige book or if it was more political as he wanted to pursue a more political agenda ahead of the mid-term elections in the US. In a move reminiscent for UK readers of something associated with Gordon Brown he re-announced some policies as well as providing some newer plans. Depending on whether you count the total announcement or just the new ones you come to a stimulus of 350 billion US dollars or 180 billion. The plan is as follows.
1. Tax cuts: companies will be allowed to write off all capital investments until the end of 2011. That would extend and increase a tax break that has allowed them to write off 50 per cent of such investments in 2008 and 2009. This would amount to almost 200 billion dollars in tax cuts over the next two years, the White House said, adding that all but 30 billion of this would be recouped by bringing forward tax benefits from future years. Of course they have kind of contradicted themselves there on their claimed numbers and we are down to just 30 billion dollars.
2. Infrastructure spending: He plans to fund a new 50 billion US dollar infrastructure plan to build roads, railways and airport runways. The plan would see 150,000 miles of roads and 4,000 miles of rail built-in the next six years and 150 miles of runway rehabilitated or rebuilt. I did note a fantastic comment on this section which called railways a nineteenth century solution to twenty-first century problems. Not entirely fair but it made me smile.
3. The third plank of Mr Obama’s new economic plans would call for Congress to expand and make permanent a business tax credit for research and development which would cost around 100 billion dollars over the next 10 years.
Will this help with America’s current slowdown?
In a word no as it will take too long to help us over say the next 6 months which are starting to look quite crucial. It might help if the US economy goes back into recession but would be too late to stop her so doing. Indeed this is a fundamental criticism of fiscal policy, that it takes so long to be enacted. Indeed this fundamental truth is one of the reasons it fell out of favour for fine-tuning economies as by the time it is passed by a national parliament and then a likely rather bureaucratic body has started to spend the money it has often just been in time for the recovery to have happened. Often it has made things worse by expanding economic demand just as it was rising anyway and contributing to inflationary pressures.
As to the numbers there has been some exaggeration as you can see in section 3 by the use of ten years of spending. If you took this to the limit and assumed the plan was now permanent you could claim almost any large number you liked if you extend this logic. So in the end it is politicking rather than economics and it is on such boundaries my articles stop as I only deal with the economics.
Innovation in Ireland’s banking sector
There have been some curious goings-on in Ireland’s economy over the past couple of days including quite an innovation. If we start with the simplest the Irish government decided to split Anglo-Irish bank into a good and bad bank. The good part will continue to take deposits and the bad will deal with the problem lending section. So far so good you might think,but as you think harder you are likely to come to the conclusion that this does not change anything if you are an Irish taxpayer. You are still on the hook for the problems at Anglo-Irish and these appear to be getting worse and now you have an implicit statement to this effect by the Irish government.
Indeed there are areas which it may make worse. You may question the point of the Irish government becoming a deposit-taker but as it will take in new deposits there is the danger of a squeeze on deposit funds for the rest of the Irish banking system,should this happen this is what is called an own-goal. Furthermore the bad bank loses the deposits of the good bank which i understand to be some 23 billion Euros so what will replace them?
Financial Alchemy from Irish Nationwide Building Society
This institution is one of those who has funding issues this month. It has come up with something which is simultaneously deeply disturbing and very innovative at the same time in response to this. To replace the expiring 4 billion Euros it has issued the same amount of bonds to itself. At this point the operation is rather circular but the next step is crucial as the existence of these bonds will allow it at a future date to get liquidity from the European Central Bank to tide it over the problem of expiring funding. At first this plan appeared to break the collateral rules of the ECB but as ever when faced with such problems a way has been found round it as the fact that Irish National has a sovereign guarantee can take advantage of the exclusion “where a debt instrument is guaranteed by a public sector entity which has the right to levy taxes”. So we have a type of quantitative easing for building societies now.
The real question here is why a government backed institution has to round-trip bonds with itself in order to cover a 6 month funding gap. Is the status of Ireland as a sovereign nation really that low? It is increasingly looking as if Ireland has made improvements in her public finances just in time for further problems with her banking sector to offset them and maybe be so bad they make it worse.
The European Central Bank
In response to such problems the ECB was spotted buying peripheral government debt again yesterday. Estimates of the amount vary but it was likely to have been concentrating on Ireland and Greece. There was also a change in its buying policy as it usually buys relatively short-dated securities but yesterday was also buying five and ten-year instruments. Of course the fact that it is buying again is also a change of policy of sorts. Despite its action Irish ten-year government bond yields remained above 6% closing at 6.02%% and Greek ten-year government bond yields crossed the 12% barrier closing at 12.04% according to Reuters. So I expect the bond buying desk at the ECB to remain busy for now.
On the subject of further commitments by the ECB, has anybody told the German taxpayer? And apart from the usual bureaucratic creep (they always want higher taxes as you have to pay for an expanding empire somehow….) is this a reason for the EU talking again of ending the UK’s rebate?