As we come to the end of a week what has had quite a few developments and issues it is time to try to take stock and look at where we stand. If one looks at the developments in China than after falls of 10% in the Shanghai Composite index over only 4 trading days we have seen closes of up 0.9% and 0.8%. So on a closing basis we have a bit of stability albeit at lower levels for the index,however, within the day there was still a fair bit of volatility. There will be ebbs and flows in this situation but the theme of inflationary pressure affecting China is unlikely to go away. There is also something of a feedback loop between China and commodity prices which can make the situation hard to assess at times as falls in China lead to falls in commodity prices. However as we stand commodity prices as measured by the Commodity Research Bureau spot index I follow are still up by 20% on a year on year basis, and this is after something of a setback for them.
The Irish Problem
This situation seems to be going on and on although in truth it is only this week when real negotiations have begun to take place. This in itself I consider to have been a failure because as the problem was plainly building for some time the relevant bodies should have had a generic plan ready and before inception only minor details should need to be sorted. A plan should have been ready for Sunday night and announced on Monday morning.
Moving onto actual details then the issue of Ireland’s low Corporation Tax rate (12.5%) seems to have become something of a stumbling block with Ireland wishing to keep it and both Germany and France wanting it to be raised. Of course as I have written before many organisations which include both Google and U2 use Ireland as a way of paying much lower tax rates than even the headline 12.5%. But the fundamental problem is that Ireland is asking for help from some countries which on a per capita basis are poorer than her whilst poaching international businesses from them with a lower tax rate. That must stick in some craws in the poorer countries in the Euro zone.
Going Forwards for Ireland
If we assume that at some time in the near future Ireland accepts an aid package from the IMF/EU/ECB one then has to face up to the problem of what happens next? My suggestion is that the most favourable route as I first argued on the 19th September is for the IMF to take primacy and I would to that with the thought that the IMF can help by ending the Croke Park Agreement. An outside body is likely to have more success in breaking down the cronyism that Ireland has suffered from than Ireland’s own politicians who have been a disappointment in this respect.
However even if we assume a favourable outcome we then hit a problem. Handing something of the order of 80 billion Euros to Ireland will help her in the short-term with her liquidity problems and help her oil the waters of her troubled banking system. As we look further forward we come to the issue of longer-term solvency and a bailout does help this but only marginally. If you look at the numbers you still come to the conclusion that Ireland looks insolvent in the longer-term. The only possible answer would be a quick return to Celtic Tiger levels of growth which as they were based on increases in debt which are now unfeasible seems unlikely.
Accordingly the aid given is likely to have to be for the longer-term and it is quite plausible that it will become permanent.
The UK and Irish aid
I was asked yesterday how we would finance lending money to Ireland. As the UK is heavily in debt and our own borrowing figures disappointed then we would have to borrow the money via our gilt-edged or government bonds. If you take my view that the aid may remain a feature of the economic landscape then it would be logical to borrow the money over a longer time period than the 3 years so far usually assumed by the Euro zone. If we borrowed at out current ten-year rate then it would cost us some 3.4% per year to borrow the money. We would then have to decide what to charge Ireland. If we charged her a similar rate to what the IMF is likely to charge then we might even make a small loss so I do not see that as viable. So perhaps we could charge around 5% and in effect make an annual profit. For Ireland currently there would be a considerable saving on the 8.1% her ten-year bonds yielded at last nights close.
The real danger for us however is the very real possibility that Ireland may be unable to ever pay the money back and this is one of the reasons I would be very cautious on this front. Put another way an interest rate of 5% may yet prove too high for Ireland’s longer-term future.
There has been new information on this front in both the United States and the UK this week and I would like to address them. I would have done so before but I have judged the Euro zone crisis to have been more of a priority.
Inflation in the United States
This matters because the US central bank the Federal Reserve has said that one of its objectives is to raise the inflation rate to what it considers to be a more normal level. It has embarked on a large monetary expansion scheme called QE2 to help achieve this. It would appear that the objective of the US Federal Reserve is to raise the US Consumer Price Index inflation measure to around 2%. Accordingly there were implications from the fact that the numbers for October were up 1.2% on a year on year basis. It is likely to mean that the Fed. will continue with its plans. Indeed its eyes my have fallen on this section in the report from the Bureau of Labor Statistics.
Over the last 12 months, the index for all items less food and energy has risen 0.6 percent, the smallest 12-month increase in the history of the index, which dates to 1957.
This is what economists call the core inflation level and some use it as an indication of future price trends. At this point I just wish to point out that I feel that the importance of core inflation measures is over-stated. However I show it because I believe that it is an influence on thinking at the US central bank which is not only likely to feel that this justifies its current policy but may also consider an expansion if such numbers are sustained.
I wrote an article back on the 2nd of July explaining my views on what I feel are some of the problems with the way that America measures inflation. I feel that her CPI measure is unsatisfactory. This acquires a new significance when raising it has become a policy aim. In that article I pointed out that numbers are calculated for a harmonized index of consumer prices (HICP) which is the full name of the Euro zone and UK measure. It is published with more of a delay but the September figure was 1.8%. As the CPI measure rose this month then probably so did this one raising the prospect of it being 2%. If that should be so then rather than new measures to achieve the inflation target we would already be there.
On such a view the future path of US Federal Reserve policy would look quite different and the QE2 could sail back to port.
This has been a problem for some time and the figures for October were no exception to this trend. This is in spite of that fact that the Monetary Policy Committee of the Bank of England keeps telling us that rises in inflation have been caused by temporary factors.
Consumer Price Inflation or CPI rose to 3.2% on an annual basis in October. This is 1.2% over its stated target and meant that the Governor of the Bank of England had to write yet another letter to the Chancellor of the Exchequer explaining why this is so. He appears to have forgotten that the letter is supposed to include what the MPC intends to do about it as his mantra of “inflation will fall in the medium-term” has less and less credibility as time passes.Those who remember the Retail Price Index of which the RPIX was our inflation target until 2003 will no doubt have spotted that the situation here is even worse as it was running at an annual rate of 4.5% in October which exceeded its target by some 2%.
Inflation for older consumers in the UK: The Silver RPI
There has been some debate on this subject and the charity Age UK has combined with Fathom Consulting to come up with an inflationary index for older consumers in the UK. It concluded the following.
The Silver RPI shows that since the beginning of 2008, those aged over 55 have experienced price rises at almost two per cent above that suggested by headline RPI figures. This rises to four per cent above headline RPI for those over 75. The gap between real and headline inflation over that period has cost the average 60-year-old £620 a year, rising to over £700 for someone aged between 65 and 69.
Should such a situation persist then those over 75 are currently suffering from an inflation rate of around 8.5%. In case you are wondering the main influences were as follows. Older people have benefitted less from the falls in mortgage rate because at their age they have often paid them off. In terms of their consumption patterns they tend to consume more of the following holidays,household insurance,utilities and intriguingly sugar and preserves! So they have a sweet tooth!
I think that this offers some food for thought. Now Age UK certainly has a vested interest in producing such numbers but I feel that this research should be looked into further as there does appear to be some basis to it. I would have expected there to have been more of an influence from medical costs (which escalate at an alarming rate) but perhaps there is some influence here from the role of the NHS.
What this does do is directly challenge the claims of the UK government which is going through a process of trying to tie increases in pensions to the CPI index of inflation and trying to claim that it represents pensioners.The significance is that CPI is lower than RPI.
UK Producer Prices
In October UK Producer Prices rose as follows. Output prices rose by 4% and input prices rose by 8%. You might if you had followed them feel that there has been an improvement. However you are in danger of being misled as they have been rebased. According to the Office for National Statistics.
Figures for PPI this month are the first based on Standard Industrial Classification 2007.
This seems innocent enough but I have looked at the numbers for 2010 and this is its impact on the headline output number for produced price inflation for the months of this year so far. They are -0.3%,-0.4%,-0.5%,-1%,-0.5%,-0.7%,-0.8%,-0.5% and -0.6%.
If I allow for this as best I can then in fact on the old basis output producer price inflation did not fall in October it probably rose to 4.6%. The input measure has been more volatile but was probably 8.8% rather than 8%.
I will let readers decide for themselves on the likely impact of this move concerning producer price inflation. I am also intrigued by the new research on a “Silver RPI” which on the face of it directly contradicts official UK government policy. I will point out that month after month our inflation figures disappoint and that rather than falling as the Bank of England has promised we have seen a rise again. I make no apologies for repeating my suggestion for improving the situation.