Yesterday was a day where many markets simply reversed what they had done the day before. For example the Dow Jones Industrial Average in the United States rose by some 129 points to 11,107 and European equity markets followed this trend. It was as if Chinese interest rates had not risen and “foreclosuregate” had not worsened. Oil rallied by some 3% and the US dollar began to fall again. Indeed overnight the US dollar fell to a new fifteen year low of 80.84 versus the Japanese Yen, giving me a wry smile as I saw a research note which said that Japan’s intervention had gone reasonably well on the grounds that it has weakened against the Euro. It was published just in time for the new high against the US dollar for the Yen! Oh well back to the drawing board….
There were rumours overnight of more monetary easing by the Bank of Japan which led to a sharp fall in its value at one point to 81.82 but it did not last and is now at 81.08, although it is sustaining a weaker level against the Euro at 113.24 which is where in was in late July early August. Of course the weakness against the Euro is partly caused by Euro strength and it is pushing towards 1.40 versus the US dollar and has just pushed above 1.13 versus the pound.
With the Yen under pressure again it is perhaps not a surprise that the Japanese Nikkei 225 equity index failed to follow the performance of other equity markets and in fact fell by 5 points to 9376. This means that the notional spread I follow between it and the Dow Jones has now risen again to 1731 points or 18.5%. Well might this be looked upon with woe in Tokyo.
The US Foreclosure Scandal: Now other government agencies are looking to sue the banks as well
I reported on Friday about the deepening foreclosure or repossession scandal in the United States and added to this yesterday by pointing out that a letter to Bank of America threatening legal action had been signed amongst others by the Maiden Lane subsidiary of the Federal Reserve Bank of New York. So the US central bank has added a its authority to the claim, such as it is. Well according to the Wall Street Journal other US government organisations are joining in.
The federal regulator overseeing Fannie Mae and Freddie Mac hired a law firm specializing in litigation as the agency considers how to move forward with efforts to recoup billions of dollars on soured mortgage-backed securities purchased from banks and Wall Street firms.
So the situation continues to develop even if markets sometimes ignore it. According to the Wall Street Journal estimates of the repurchase demands sent to US banks vary between US $24 billion and US $179 billion so there is still doubt over the scale of the problem.
I saw in the Financial Times a reference to this article from CNN news.
Rampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an “epidemic” of financial crimes which, if not curtailed, could become “the next S&L crisis.”
The crucial point is that it was dated the 17th September 2004! I will leave you to draw your own conclusions as to what was actually done about it…
UK Public Spending Cuts
There is some debate over the exact break-down of the cuts announced yesterday by the Chancellor George Osbourne but in general they turned out pretty much in overall terms to be as promised in his Emergency Budget back in June. I pointed out yesterday my view that the ring-fencing of the NHS and overseas aid is a policy error and will lead to inefficiency. Today I wish to look at the economics of the estimates as the most important factors behind them are the estimates for inflation and economic growth that are used.
To illustrate my point let me give you the figures for total managed expenditure for 2010/11 which was £696.8 billion and the estimated expenditure under the new plans for 2014/15 which is some £739.8 billion. So expenditure will in fact rise by some £43 billion,which is not quite the cuts screaming from today’s newspaper headlines is it?
By the time you allow for the Chancellor’s growth and inflation forecasts you get a different picture where our public expenditure falls from around 48% of Gross Domestic Product to 41% if events unfold as he hopes. The Office for Budget Responsibility feels that growth will be around or slightly above 2.5% over the next few years and official forecasts of inflation may be above 2% in the short-term but are invariably assumed to fall back to it.
So in essence the Chancellor is only with his £81 billion announcement of cuts is only reducing the rate of growth of public expenditure and is in fact relying on economic growth and inflation to do the job of reducing the size of the public sector for him. So here is the real danger for his plans if growth or rather ironically in this instance inflation under-perform.
It may be reasonably obvious that such forecasts depend on growth but not quite so obvious that inflation has benefits too. Clear examples of this would be the VAT take which is boosted by inflation and as many thresholds are currently not being indexed or if they are only indexed by the rather inadequate CPI measure then fiscal drag has a beneficial impact too. So governments benefit from inflation in many ways but their subjects usually do not. It is one of the reasons I expect our inflation performance to continue to disappoint there is a clear moral hazard in that our government benefits from higher inflation as it not only gets more taxes but also benefits from the real size of its debts being reduced.
The Public Finances deteriorated just before the Chancellor spoke
Before the Chancellor spoke we got news that the recent improvement in public finances has slowed and may even be reversing which must be worrying for him. The Office for National Statistics makes it hard to find the figures which exclude financial interventions but I have tracked them down on its statistical bulletin and we borrowed £15.6 billion in September 2010 which was more than the £14.8 billion of 2009. Seeing as we are supposed to be retrenching and recovering these were not reassuring figures.
As a more technical issues regular readers will be aware that I do not like the official use of the word temporary. I hope that the UK financial interventions will be temporary but I no more than anyone else do not know so and accordingly I always try to use figures which include it. I suspect their lack of enthusiasm is based on the fact that it worsens our public debt to GDP ratio by some 7.4%.
The Monetary Policy Committee Minutes
These revealed yesterday that the MPC is openly split in three directions. Adam Posen voted for more Quantitative Easing ( I analysed a recent speech of his on the 29th September which explains his and my views), and Andrew Sentance voted for a rate rise to 0.75% as he has done recently and the other 7 voted for no change. In the minutes there is a hint that Mr.Posen’s views may get some more support over time but only a hint.
Some of those members felt the likelihood that further monetary stimulus would become necessary in order to meet the inflation target in the medium term had increased in recent months. But, for them, the evidence was not sufficiently compelling to imply that such a course of action was necessary at present.
Mervyn King speaks
There had been a speech from the Governor of the Bank of England on Tuesday which I referred to in passing yesterday and I want to touch on a couple of important points from it. The Governor has developed the habit of being a decent judge of world events but a rather poor one of UK events so he would be much better suited to say a job at the IMF. However if we look at his analysis of the UK we got the following.
Firstly we got the usual reverse mea culpa i.e it wasn’t my fault. “In searching for a solution, some ask who is to blame. But that misses the point”. This fits slightly oddly with the praise he gives himself for his remarks in the earlier part of the last decade…
But then we got some real gems and the emphasis is mine.
I find myself in the opposite situation having to explain that there is too little money in the economy. But, in the wake of the financial crisis, and the sharp downturn that followed the amount of money in the economy as a whole – broad money – is now barely growing at all. That is restraining activity and pushing down the outlook for inflation.
So we are back to the output gap theory again and he indicates one of 10% in this speech. If he actually believes this theory then as inflation is above target and above its previous target by a wider margin then any recovery would surely only push it higher. But this theory seems to have become something of a belief or religious experience which is clung to whatever the evidence.
This was followed by something which was deliberately misleading I feel.
In 1998, before he joined the Bank, Charlie Bean estimated that the normal variation in the economy would lead inflation to be more than 1 percentage point away from target for around 40% of the time. And in the past three years, inflation has been more than 1 percentage point away from target in 17 months, or 47% of the time.
It must have slipped his mind to point out that all the variations have been in the same direction or higher than 1% over the inflation target he is supposed to aim at. That is not quite my definition of volatile, as volatility is reduced if the moves are in the same direction.
He likes acronyms so he introduced a new one.
So the next decade is likely to be a sober decade – a decade of savings, orderly budgets, and equitable rebalancing.
The savings part sits rather oddly with the recent interview given by Charlie Bean to Channel 4 which I discussed back on the 28th September as he appears to want people not to save. Perhaps they could give a joint interview and it might be best if it was given to someone who is not prone to laughing at discrepancies.