After a period where it has tried to increase bank reserve requirements to help control its overheating economy China raised her interest-rates yesterday for the second time in six weeks. The People’s Bank of China raised its one-year lending rate to 6.06% and its one-year deposit rate to 3%, so both rose by 0.25%. I have pointed out before that increasing reserve requirements was likely to have patchy success at best in restraining China’s inflation problem, if past experience is any guide so in principle I welcome the new strategy. Also in a week where there is at least some debate whether the Bank of England should raise interest-rates let me point out that China is responding to consumer price inflation of 4.6% and UK Retail Price Inflation is 4.8%. Admittedly it is not the officially targeted measure which is CPI at 3.7% but in my opinion it is a more accurate measure of the situation. Over to you Monetary Policy Committee!
Which is the command economy and which is the capitalist?
You could argue that by raising interest-rates and letting the Yuan drift higher against other currencies that China is behaving more like a capitalist economy. What then do you make of this? Consider another economy which recently announced the following. It plans to try to set central targets for bank lending to the business sector called Project Merlin and has a minister trying to set targets for mortgage lending. You could call these diktats. It has in effect nationalised two of its main banks and some more minor ones. It is imposing a bank levy on its banking sector as a type of punishment on “evil” bankers and wants to restrict bank bonuses. This sounds like an attempt to impose a type of command economy and it is being operated by the UK. So who is the command economy and who is the capitalist one? I would welcome readers thoughts on this. Before I move on I would just like to point out that the attempt to restrict bankers bonuses looks to be an utter failure which in fact makes it look even more like a command economy!
The rising trend in this area continued yesterday in spite of the Chinese move. As a big consumer of many metals and raw materials China’s economic expansion has been one of the driving forces behind the strong move in commodity prices that has occurred since late November 2010. But we did not see a fall and indeed the CRB spot index rose by 1.79 to 561.89 with the metals sub-index rising too by 3.17 to 1090.1. One of the main drivers of the unrest in North Africa and Arabia has been rising food prices and again we saw a rise yesterday as the foodstuffs component rose by 2.76 to 493.34. This means that the price of basic foodstuffs has risen by 23.3% since late November 2010.
The Peripheral Euro zone nations
Whilst the mainstream media has gone into reverse on this subject and bizarrely seems on occasion to be pointing out signs of “success” in fact last weekends meeting came up with no agreement at all and there are serious issues facing Greece, Ireland and Portugal.
There has been more honesty from the Bruegel think tank which has published a report pointing out the following. It feels that Greece is “clearly on the verge of insolvency” and that the swift restructuring of its debt, with creditors accepting a 30 percent “haircut,” should form part of a three-pronged strategy that would also include the strengthening of the euro zone banking system and policies to foster greater economic growth. It feels that at best Greece will soon have a debt burden equivalent to 150% of its economic output. Having run even very optimistic scenarios such as Greece maintaining an annual growth rate of 4% per year and her government bond interest rates falling by several percent the think tanks has concluded that it would take Greece around 20 years to get its national debt down to 60% of economic output as required by Euro zone rules. Accordingly it concludes this.
Our conclusion therefore, is that Greece has become insolvent and that further lending without a significant enough debt reduction is not a viable strategy.
Furthermore the think tank is critical of the current strategy which is to change the rules from 2013 and in effect allow debt haircuts from then. As it points out who will be silly enough to buy the new debt after 2013?
I hope that this report is a sign of a new more realistic view of what can be done to deal with Greece’s crisis. It remains to be seen whether Europe’s politicians are listening. However whilst it is an improvement I feel that the delay ( It is a year since I was suggesting debt haircuts for Greece) means that it is debatable whether one of 30% would be enough. It would need to be combined with a cut in the interest-rate that Greece is being charged for rescue funds to have a chance I think. If that route is blocked by fears of what the German Constitutional Court would rule on this then perhaps a haircut of more like 35/40% is required.
One area where I disagree with the report is where it says that to foster economic growth there should be a “temporary refocusing of structural funds”. Since the subsidy culture helped to put Greece in her current situation then more of them may in the long-term make things worse rather than better.Reform is needed first. Also in the current economic situation where would the funds be refocused from? Ireland? Portugal?
Portugal: her long-term problem
My attention was drawn by the Portuguese economist Pedro Martins to a paper written by Oliver Blanchard who is now at the International Monetary Fund.
In the second half of the 1990s, the prospect of entry into the Euro led to an output boom and large current account deficits in Portugal. Since then,the boom has turned into a slump. Current account deficits are still large, and so are budget deficits. This paper reviews the facts, the likely adjustment in the absence of major policy changes, and examines policy options.
The Portuguese economy is in serious trouble: Productivity growth is anemic. Growth is very low. The budget deficit is large. The current account deficit is very large.
The problem is that this was written in 2006. So credit goes to Mr.Blanchard for being on the case but little credit can be given to those in charge of Portugal because in essence her problems remain the same and it is now 2011. It continues my theme that Portugal’s problems are much longer in duration than the credit crunch and that it has made things worse but not changed the fundamental picture.
There is an irony here that Portugal has a current account or balance of payments problem and yet remains unrescued! Of course using the word rescue implies that Greece and Ireland have been so perhaps it is better to use the phrase recipient of a package called a rescue. My point is that current account problems are the remit of the International Monetary Fund.Where is it? These days it seems much happier intervening in another role, when a country has a fiscal crisis. Perhaps Dominique Strauss-Khan who heads the IMF really does have his eye on the French Presidency and is pursuing what he considers to be appropriate policies for this objective such as bailing out other politician’s.
If we look at Portugal’s balance of trade for 2010 then we can see the problem. Exports of goods were 36.8 billion Euros whilst imports were 56.8 billion Euros. It is true that export growth at 15.7% exceeded import growth at 10.2% but because of the size of the gap this differential would have to persist to even start to reduce the trade gap as even on such a growth rate the gap would widen very slightly in 2011.
Portuguese government bond yields continue to head higher. At today’s daily fixing the number of bonds yielding more than 7% is spreading and if we use the 5.8% interest-rate of the Euro zone funds then Portugal’s threshold for this is 3 years away in terms of how far ahead she can borrow more cheaply than this. Whisper it quietly but much of this and even Portugal’s economists and leaders may be forced to ask for help even though they have realised that there are plenty of problems in so-doing.
UK Trade Figures
Because they turn out to be usually very inaccurate I am not a fan of analysing monthly trade figures. However the figures for 2010 as a whole for the UK do not show much of a sign of improvement as might have been hoped from the 2007/08 devaluation of sterling. We seem to have returned to our old pattern of a persistent large trade deficit although even annual figures are unreliable. Younger readers may be shocked to learn that markets used to move substantially on trade figures as today they are mostly ignored! For example the UK’s 1967 devaluation of the pound was finally decided to have been unnecessary a decade or two later…
One matter keeps coming up is that we run a large and persistent trade gap with the Euro zone and yet we are told again and again by our political leaders that trade with it is vital for us.For many it is like a mantra. I have to confess that I wonder about this. Do not misunderstand me we are geographically close to Europe and have many ties to it economically, but my point is that more of our attention should go elsewhere and our policies should reflect that. As we go forwards then the countries in the world that are likely to have the highest economic growth rates are not in Europe.
US Government Bond Auction goes poorly
Yesterday the United States Treasury auctioned some US $32 billion of 3 year bonds and it did not go well. The follow-on effect of this is that the US long bond (30 year maturity) now yields 4.76% which,if sustained, will have plenty of economic impact both in the US and around the world. The story is not over as other bonds are auctioned this week and bond auctions are like game theory in some ways but yesterday’s events did exacerbate a recent trend.