A combination of Egyptian poverty and “Premiership” wealth disfigures our world and will the ECB raise interest-rates?

Yesterday was a day which illustrated the financial extremes which are present in our world and which are playing their part in the world economy at the same time. I wrote yesterday about the sufferings of the poor in Egypt and the fact that the poor there must have been going hungry as the recent rises in food prices must have made feeding themselves unaffordable. On the same day we saw the last day of the transfer window in the UK (football) Premiership. Here there was in several quarters no lack of money as the UK  transfer record was raised to £50 million for Fernando Torres which meant that Liverpool were able to pay £35 million for an English striker Andy Carroll who has played only half a season in the premiership. In a surge of cash and liquidity which must have left Ben Bernanke feeling jealous Andy Carroll was suddenly worth more than David Villa for example! So we have poverty and great wealth side by side on the same day and this dislocation is to my mind one of the great problems of the post credit crunch era.

Unfortunately there are examples of this in the political world and I am sad to report that more than a few politician’s have sided themselves with great wealth. For example a former Prime Minister of the UK popped up on television to remind us that he is a peace envoy to the Middle East. Having started at least one war there this was already a curious appointment but Tony Blair has risen to great wealth since he retired as Prime Minister. If politician’s follow this trend when they retire one has to question their motivation when in it. So I am afraid salvation from the dichotomy I am describing today is unlikely to come from them. Another example of the extremes was the retirement of Ireland’s Taoiseach Brian Cowen and it was not only because his rather corpulent physique contrasts strongly with the starving Egyptians. He will retire with a rather large pension and because of the way his decisions have led to Ireland’s problems this is wrong as such wealth is likely to be denied to the vast majority of people suffering from his failures. My suggestion is that he should voluntarily hand half his pension back.

Problems in the Euro zone economy: A headache for the European Central Bank

I have written over the course of this blog quite often about headaches facing the European Central Bank and hidden in the football and Egyptian news yesterday was another one which came from Eurostat.

annual inflation is expected to be 2.4% in January 2011 according to a flash estimate issued by Eurostat, the statistical office of the European Union. It was 2.2% in December 2010.

The problem is that the European Central Bank targets inflation of 2% or less. So last months rise was already a problem and led to the President of the European Central Bank doing the equivalent of the troop manoeuvres of the Grand Old Duke of York. He had boasted of the ECB’s success against inflation at the December meeting which was rapidly followed by a threat to raise interest-rates at the January meeting as inflation rose! He does at least seem rather immune to embarrassment which if you think about what has happened over the past twelve months is probably a good thing. The further rise in inflation reported yesterday leaves Mr.Trichet with a slightly bigger headache.

The Problem

We are back to dichotomy’s again. As inflationary pressure rises the ECB may feel it is necessary to raise interest-rates. However it is also providing vast amounts of liquidity at low interest-rates to places like Ireland Greece and Portugal to help them with their economic and fiscal difficulties. A rise in short-term interest-rates here would be unwelcome to say the least. After all financial markets have already raised longer-term interest-rates for these countries.

As you can see the ECB Governing Council is likely to be starting to feel it is between a rock and a hard place. One clear signal of this is that last week purchases of peripheral government bonds under the Securities Markets Programme ceased. With this move the ECB is attempting to kill two birds with one stone , in my opinion. It is clearing the decks in case it needs to raise the official interest-rate from 1% and it is also sending a signal to Euro zone politician’s that they need a new strategy or perhaps a strategy. In terms of images they are trying to give Euro zone politician’s a kick up the backside in the hope that it will stop them kicking the can down the road again.

The ECB’s view on inflation: Lorenzo Bini Smaghi

In a thoughtful speech given last week by Governing Council Member Lorenzo Bini Smaghi  we learnt this about his view on inflation

In summary, to a greater extent than in the previous decade, the strong dynamics of the rest of the world are likely to result in a higher inflation rate for imported goods, whether commodities or manufactured goods and services………………the process of reducing the prices of manufactured goods imported from developing countries seems to have ended, particularly in respect of products imported from China.

If we translate this from central bank speak to plain language he is worried about inflationary trends. Of the world’s main central banks the ECB is the nearest to a rise in interest-rates to try to combat inflation.

Regular readers will not be surprised to read that my eyes alighted also on this point in his speech. “Since the output gap cannot be measured”. In many respects he is heading towards my criticism of it and I find it welcome. To often have we seen analysis based on the output gap regarding it as something set in stone when in fact it is an unmeasurable theoretical concept.

Inflationary pressure in the United States is building too

It is not only in Europe that there are price pressures. Whilst the disappointing US Consumer Price Index that I reported on yesterday tends to avoid showing inflation a couple of other reports showed that a problem may be brewing. For example the Dallas Fed index report told us this.

The raw material price index jumped from 43 to 62, reaching its highest level since mid-2008. The share of manufacturers who saw an increase in input costs surged to 64 percent, compared with only 2 percent who saw a decrease.

Meanwhile the Chicago Purchasing Managers Index told us this and for these reports a number above 50 indicates expansion.

Prices Paid, at 81.7, compared to 78.0 previously, indicated increased inflation, increasing to the highest level since July 2008……..Some suppliers are holding prices to remain competitive, but others who have little to no competition in their sector are talking some significant increases in 2011.

Meanwhile the US Federal Reserve’s preferred measure of inflation core CPI shows hardly any inflation at all as it tries to shout, move along here nothing to see…..

US TIPS or inflation-linked government bonds

I often see articles stating that these represent inflation trends for the United States. A lot of care is needed here as they follow the official consumer price index and as Shakespeare once observed “Ay,there’s the rub”. Imagine how popular they would be if the index was on the basis that it used to be as I described yesterday and as reported by John Williams!

More problems for the Greek economy

I have regularly found myself at odds with the official optimism on the Greek economy as I fear that the effect of the austerity package will be to further depress economic growth. I report with sadness that Greece still has enormous economic problems as these figures released by EL-STAT yesterday show.

The volume of retail trade (i.e. turnover in retail trade at constant prices), excluding automotive fuel, decreased by 13.6% in November 2010, compared with November 2009. The Index in November 2009 recorded a decrease of 8.7% compared with November 2008.

As you can see there are real problems here as if anything the slowdown is accelerating. I fear for economic growth figures based on this and I also worry about the impact on tax revenues as sales tax revenues must be hurt by this. Also we can see that Greece is also afflicted by the price pressures affecting the rest of the world.

The Producer Price Index in Industry (PPI) in December 2010 compared with December 2009 recorded a rise of 7.6%. The index in December 2009 had recorded an increase of 5.0% compared with December 2008. The PPI in December 2010 compared with November 2010 recorded a rise of 1.8%.

This contrasts with an annualised rise of 5.9% in November so again the problem is deteriorating. Putting the two together does not a pretty mix. Rising price pressure does not go well at all with falling retail sales. I am reminded at this point that the ECB is beginning to look like it is considering an increase in its official interest-rate which would impact on the weaker Euro zone nations such as Greece most of all. The new orders index did at least so some growth so let us hope for Greece’s sake that there are some signs of a recovery building in the background.

A Possible Rescue?

The Greek newspaper To Vima has published this possible plan which seems to be gathering some momentum.

1. A haircut of 35%. Technically, this will be an exchange of existing bonds with bonds of 65% of their value.

2. A bond swap to 30-year bonds with low-interest rates. ( I discussed talk about this possibility yesterday).

 3. A new loan package of 25% of the previous volume.

Comment

This plan is at least a coherent strategy and has various things to commend it. For example finally we get some haircuts on Greek government bonds which I have been calling for since this crisis began,although now due to events the size of the haircut is higher that what was required then. It may help return Greece to future solvency whereas current plans do not with any credibility.

However the tactics which have been deployed up until now leaves the European Central Bank and possibly Europe’s taxpayers who back it with a problem. It has been the ECB which has been buying Greek government bonds to support the market whilst politician’s dither. It has lots of them perhaps 20% of the market and on these there will be a 35% haircut! You may be beginning to see the problem. Now for longer-dated bonds depending when they were bought there may be losses but some will have been bought when prices had fallen anyway. Unfortunately the ECB has mostly bought shorter-dated bonds which have fallen by less because of the hope of receiving par or 100 at redemption. On these bonds Europe will be haircutting its own central bank quite severely.

Of course the bankers who sold these bonds to the ECB will be rather grateful for this intervention if this plan takes place…………do we have the prospect of them being bailed out again?

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4 thoughts on “A combination of Egyptian poverty and “Premiership” wealth disfigures our world and will the ECB raise interest-rates?

  1. “Unfortunately there are examples of this in the political world and I am sad to report that more than a few politician’s have sided themselves with great wealth.”

    And “…they need a new strategy or perhaps a strategy. In terms of images they are trying to give Euro zone politician’s a kick up the backside in the hope that it will stop them kicking the can down the road again.”

    Hi Shaun, good to see you expressing some significant disdain against politicians in general! Of course ultimately it is only them that can stem real inflation, since unless in each nation or sector they get their excessive government spending under control inflation will inevitably continue to increase.

  2. As a taxpayer, I feel unbelievably angry about all this. We bail out the banks, which then repay the compliment by profiting from quantitative easing which boosts bond and share prices, refusing to lend to business and, now, dumping bonds on us. Just why do the politicians let this happen? It seems that they are getting us deeper into the mire by the day…

  3. Hi Shaun, I agree very much with the view that politician’s face a choice between siding with people (‘the people’?) or with money (‘great wealth’) and appear mostly to be siding with money. I see a number of reasons for this:

    – People expect to be paid. Consequently, ‘great wealth’ can mobilise people in its defence. (for the moment this mans armies of lobbyists, apologists, economists etc rather than armies – but who knows?) People do not mobilise themselves, for other reasons, unless and until they are desperate.

    – Economists, in particular, have built an ideology in which everything is given a monetary value – and therefore nothing has any value except money.

    – Politicians (like everyone else) generally mind their own interests: and these are linked, however imperfectly, to the public (people’s) interests through the electoral system. They will side with the people when the people put a value on something other than money.

    – For the time being, rightly or wrongly, people think that the pre-crisis World was normal and the lifestyle we enjoyed was ours as of right. We want to believe that humpty dumpty can be put back together again and, therefore, are not prepared to crash and reboot the system that created it: particularly when we are being told that we don’t have to.

    • Hi ChrisSW, I think you just about sum it all up! Most people DO want to believe that the previous delusions can be put back together, and they are not prepared to have the system rebooted because they fear that it would not reboot as it was!

      Politicians (and some Economists) delude the people into believing that things CAN be put back together as they were and that their life will then be the same or better. So as you rightly infer, it is all down to politicians as to what will happen, and they as ever will put their own personal and political interests first.

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