Can even concerted currency intervention by the G-7 work? And yet more signs of a weak UK housing market emerge

Just when you might think that it is time for something of a rest the flow of economic news has if anything accelerated further! After wondering yesterday where the Bank of Japan had been when the Yen surged to 77.18 against the US Dollar – and thank you to those who contacted me to suggest it had been suffering from a Tokyo power cut…- it finally gathered its thoughts and in line with its government asked for help from the G-7 group of nations and overnight they have announced this response.

at the request of the Japanese authorities, the authorities of the United States, the United Kingdom, Canada, and the European Central Bank will join with Japan, on March 18, 2011, in concerted intervention in exchange markets…… We will monitor exchange markets closely and will cooperate as appropriate.’

Once this was announced the Bank of Japan began to sell its own currency and buy the US dollar and market estimates are that it spent some US $3 billion in its first wave of currency intervention. The Yen rapidly weakened from 79.25 to around 81. As I type this article the Yen is now at 81.26 versus the US dollar which is down 3% in Yen terms on yesterday. Against the Euro it fell by around 4% to 115.3 although it has now retraced to 114.3.As the day develops we will expect to see the Bank of England and the European Central Bank act first followed later by the American and Canadian central banks.

Will it work?

In the short-term I believe that this intervention has a good chance of success. Although I would have preferred the Bank of Japan to have called for help and intervened when the surge in the Yen took place on Thursday morning Tokyo time when it reached around 76.25 (markets seem to have settled on this number now)  against the US dollar as it may have prevented the rise by so doing. I still am unsure why it did not do so as it was happy enough to intervene at a much worse level (83) back in September 2010. I do hope that the delay was not due to politician’s wanting to be involved and to in effect grandstand and feel important. Another factor which may help in the short-term is the fact that the G-7 group of nations has not intervened in this way since September 2007 and the fact that everybody can see that whilst there is potential for economic advantage for Japan in this the main motivation is a response to a severe natural (and with the nuclear reactors man-made) disaster.

In the longer-term the prospects are much less certain. If you analyse Japan’s economic situation it was already true pre-earthquake that there were more and more reasons for expecting the Yen to weaken over time. One US fund manager Kyle Bass believed in this story so much he took out a personal mortgage in Yen in order to benefit from its fall. However the truth has been that it has got stronger. Post crisis it is plain to see that there are more reasons to expect a weakening of the Yen. For example Japan will have to import more raw materials as she rebuilds and she will have to import more energy as the four troubled reactors will not be used again. In addition she will have to borrow more and this will add to already high levels of public borrowing which are around 220% of her economic output as measured by Gross Domestic Product. So yes the Yen should in the end weaken but the influence of the “carry trade” which I wrote about yesterday could yet lead to further Yen rallies as we simply do not know how much of this remains to be unwound. What we do know is an enormous amount of it appeared to take place.

Other Monetary Easing by the Bank of Japan

As well as its currency intervention the Bank of Japan has undertaken other measures which one might ordinarily expect to weaken the Yen. One clear example of this is its increase in the supply of money in Japan which has totalled some 37 trillion Yen (around US $450 billion although with such exchange rate volatility care is needed…) over the week of which some 3 trillion Yen was supplied last night. Conventional economic theory would suggest that an increase in money supply of this form is likely to lead to a fall in its price which could be via inflation or a fall in the exchange rate. However,in my opinion, caution is needed with such analysis as the velocity of money is likely to be falling maybe by as much or more as the increase in the money supply. Putting this into basic terms those in the earthquake zones are likely to hold more cash and the failure of one group of cash machines is likely to exacerbate such trends. I would imagine in this areas there is even some inflation as people bid for supplies of food and fuel which are in short supply. Inflation is rare in Japan but in its North-East I am sure it is present.

If it affected you

Imagine you were a foreign national working in Japan and for simplicity you are paid in US dollars. When the earthquake hit if you had just been paid you could exchange your money into Yen at 83 and if by some stroke of bad luck you were paid at the peak you would have got 76.25. This would mean you were around 8% poorer in less than a week! Please do not misunderstand me many in such a situation have more pressing concerns right now but the point still stands and it shows the impact of such economic volatility.

The Fukushima 50

I would just like to send my sympathies and admiration to the Fukushima 50. At a time of enormous personal risk these people are struggling to get the four troubled reactors under control and having read about the consequences and implications of what happened later to those who acted in similar fashion at Chernobyl they have my respect. For those who have been able to evacuate the area I think they owe them a bit more than respect and this is brought into focus by Japan announcing as I type that the disaster is now up to 5 on a scale which only goes to 7. Am I the only person who feels there is something Orwellian about measuring things in this way?

I have to confess that the efforts to attach what appears to be the equivalent of an extension cord to reactor number 2 on the site reminds me of an episode of South Park. There the world was in a panic over the end of the internet which was solved by a nine-year old boy walking up to it taking the plug out and putting it back in. Sadly we are unlikely to find anything like such an easy solution to this problem…..

Some perspective on the price of crude oil

I wrote earlier this week that I was surprised to see a fall in the price of crude oil. To my mind this was happening when there were two influences which in my opinion were likely to raise and not lower the price. These are the continuing crisis in North Africa and Arabia which are both oil-producing regions and the situation in Japan which will mean that as soon as things return to normality the world’s largest oil importer will need yet more oil to replace what was previously supplied by Fukushima nuclear reactors.

If we look at what happened the front month futures price of a barrel of Brent crude oil reached a low of US $107.35 on Wednesday. It started a surge on Thursday morning and rose by 4.15% on the day reaching US$ 114.9 as I was calculating some numbers last night. Now if we look back to see the potential inflationary impact of this we can see the following. In early 2009 the oil price was below US $50 and if we move forwards in time it was below US $80 in late September 2010 and started 2011 at US $95 per barrel. So overall we have seen quite a surge which will have inflationary implications. For example the price of a litre of diesel is now just under £1.40 at the garage around the corner from my home and the price of a litre of petrol is now just under £1.34. To the extent that people have fixed budgets the rise in the price of oil will have deflationary – as in a reduction in aggregate demand – impacts on the world economy too which reminds me of one of the themes I established for 2011.

Never Fear the FOMC is here!

I am reminded of the statement issued by the US central bank earlier this week and the emphasis is mine.

The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.

Phew! For a while I thought that we had real problems! More seriously they simply do not know this and British readers will be rather familiar with their central bank calling inflation “temporary” and “one-off” and again in the British case of the central bank proving to be a reverse indicator of inflationary trends as well as an abuser of definitions in the Oxford English Dictionary.

The UK Housing Market

I have written on several occasions that I feel that 2011 looks like it will be a difficult year for the UK housing market and that due to a technical move by the Bank of England a fall in house prices could become something of a rout. I see that weak mortgage lending figures for January have been followed by equally weak figures for February where gross mortgage lending was only £9.5 billion. No doubt the same excuses being used in January will be wheeled out but here are my thoughts from the 28th of January.

I wrote an article elsewhere back in December about the Bank of England’s withdrawal of its Special Liquidity Scheme and the impact I feel that withdrawal around £9 billion per month is likely to have on the availability of credit in 2011 and in particular on mortgage finance. I feel more and more that this move was and is a policy error.

I see nothing in the news that has emerged since I first wrote on this topic back in December 2010 to make me change my mind, in fact the news since then only confirms what I predicted.  I would be interested to see what evidence readers have from their own area on the state of the UK housing market.


13 thoughts on “Can even concerted currency intervention by the G-7 work? And yet more signs of a weak UK housing market emerge

  1. Would not a considerable fall in house prices be a good thing overall? It seems a terrible misallocation of capital to have them so high; it encourages rentier-type behaviour; and it make the cost of living (and so the cost of everything) in the UK unnecessarily high.


  2. I really hope there is a one-off adjustment to the UK house market, downwards that is. 25% would do. As a country we put far too much store in housing, a necessary good but one that has got really out of line with underlying value. Sure there will always be housing pressure in a small island, especially one with crazy one-sided planning laws, but far too many people believe that it’s perfectly OK to enslave the younger generation with monstrous mortgages to finance their cosy retirement or allow them to ‘release their equity’. If there was a bit less equity to release, the enslavement could be reduced and there would be a bit more fairness in our society.
    As for the current situation, I think the prospect of a significant rise in mortgage rates (itself likely to depress prices) is putting people off buying and of course there is an apparent credit squeeze.

  3. Hi Shaun and others
    Take a look at the baseline and adverse scenarios for the European Bank stress tests just announced. For the UK the baseline ( general recovery continuing) scenario appears to be no house price growth for 2011/12. The adverse scenario (combination of ECB estimated sovereign debt shock, a US led demand shock and dollar depreciation) is for a 7.7% fall this year, and a 10.4% fall next. What then for mortgage credit if that occurs, I wonder. Also, on inflation, they appear to be following the output gap theory ie financial shocks lead to disinflation – something being currently disproved in the UK. A 28 bps yield shift on UK gilts in an adverse scenario, but applied to both bank trading books and banking books?

    • Hi Shire

      After last year’s effort at banking stress tests in Europe you might have thought that the idea would be abandoned. For those who do not follow the issue closely what happened was that the 2 Irish banks tested were given a clean bill of health . They promptly collapsed within 3 months! This demonstrated the value of a clean bill of health from EU bureacrats ( just for the avoidance of doubt these were indeed EU bureaucrats with no banking experience).

      As to this year’s effort I think we have a problem way before we get to the many flaws in the operation and it is here.

      “121. The exact definition of capital and the threshold set up for the purposes of the exercise will be provided at a later date.”

      It is not possible to have a test with any credibility until you define your terms and I am trying hard to think of a more important one for a bank.

  4. I too think we owe The Fukushima 50 a bit more than just a passing respect!

    ‘’Advertised’’ house prices at the North end of England are being held up by vendors who think the market only goes one way! Lots of ‘for sale’ boards are now being replaced with ‘to let’ signs as non-habiting vendors realise they have costs to cover! Final public notice of offers for repossessed properties look to be running at around a 40% discount to ‘advertised’ prices.

  5. Shaun, west London is pretty much still at peak levels for anything good. Sometimes above peak by 10% or so. This is in part due to lack of anything good to buy so bad things stay on for months or years and good houses sell like hot cakes with all the pent up demand.

    Unlike many commentators, I have no idea where this is headed. London currently seems a little different due to all the foreign buyers who see a London home as a must have accessory, a safe haven asset or a place to send the kids for education.

  6. “To the extent that people have fixed budgets the rise in the price of oil will have deflationary – as in a reduction in aggregate demand – impacts on the world economy too which reminds me of one of the themes I established for 2011.” I am afraid that I have to completely disagree with this prognosis, Shaun. It is well established that any significant rise in the price of oil results in net inflationary pressures, not deflation, due to its cost-push effect. The difficulty is that all energy has become related to the price of oil. This thus quickly effects costs due to rising transport costs etc. This increase is then passed on in the form of price rises, increased wage demands result and the net effect is inflationary. We saw these effects previously in the UK economy for example in the 70s.

    I am assuming that you meant your statement in a true classical economic sense? If you were in fact using Orwellian speak, or the BoE equivalent rather than reality, then I withdraw my disagreement, since everything then would clearly be the other way up in an upside-down world (and would of course only be temporary in any case) !

    • Drf,
      If I am paying out more and more at the pumps, or in fact for heating and lighting, things which I have to consider necessities for getting to work, drop kids off at colleges etc. then I won’t be buying any new gadgets to balance my meagre budget. If the manufacturers put up prices then I can only reassess what I consider necessities as wage increases are not really available. In fact I can see manufacturers being squeezed hard, given the distribution chain.

      • Hi Mac; unfortunately, perhaps in some respects, that is not what actually happens. What you are neglecting is the cost-push effect which is produced as a result of increasing energy prices which thus results in other higher costs and resultant increased wage demands. This is not about supposed modern economic theories; this is about historical economic experience and evidence. If you were alive and old enough in the 70s you would be able to remember that experience which you went through, which would show you pragmatically what actually occurs with this change in parameters.

        If modern theoretical economics does not correlate with what actually happens pragmatically, then something is very wrong. An economist who was tutoring my daughter recently taught her that the most important thing he had learned in reading for his Masters degree was that modern economic theories do not actually work. He said that if they did work in practice then we would not be in the mess which we are now in! This resulted in my discussing this issue with him in more detail, since I was amazed that he had taught that. I had to agree with him! The proof of the pudding is in the eating.

        One of the biggest problems today, I believe, is the tendency to completely reject the lessons which our forefathers had already learned, and to reject historical evidence as if it were erroneous; the idiotic belief seems to be that this time it can be different if we take “the output gap” or some other fallacious newer theoretical pseudo-concept into account; but it never is. The same foundational laws still apply.

      • Drf,
        I completely agree about fundamentals, in fact I think replacing them with esoteric economics has resulted in our present situation. However there has to be room to inject contemporary effects into your illustration and I think there are a very wide range to consider. The 70’s had a very different workforce not only in application but also in perspective and aspiration so whilst the fundamentals will always remain the same there has to be room to take into account contemporary factors and the way those influence our present state of affairs. Isn’t that the realm of economic theorists?
        Again I have to agree just because someone somewhere comes up with a new buzz theory doesn’t make it correct; only time can really tell, but given the above I believe new economic theories have to be sought based on sound fundamentals.

      • OK Mac, I think what you may be trying to argue is that elasticity of demand will result in anyone, who is not able to demand an income increase, so as to offset such an increase in the price of generic energy, cutting back in their demand for other goods and services in the same proportion to the increase in the price of energy. That may or may not be true. It is impossible to predict. Such a consumer may change the proportion of their expenditure on energy instead or partly. However that will not result in the outcome you attempt to put forward as the only possible one.

        Regardless of any changes in contemporary effects, such as less Trade Union power, and the former this may possibly have a very short term effect. However, in the medium term workers who do not have Trade Union representation, as they did perhaps in the 70s, will just change jobs, in the same way increasing their income, because they otherwise cannot survive. The effect of this will thus still be inflationary.

        However, the other issue we have to consider is that most manufacturers have already been absorbing the successive increases in raw material costs (partly due to the increasing weakness of Sterling) and increases in other costs and overheads without increasing their selling prices, for some while. This cannot continue, and it only takes the last straw, like increases in the cost of energy, to result in them having to increase their selling prices to attempt to survive, because eventually they are making no ROI. In this sort of economic scenario, rather than, as you assume, these manufacturers reducing their prices because consumers do not have sufficient funds left, after suffering the increase in energy prices, to pay their increased product prices, some of those manufacturers will become insolvent and cease to exist. The market will then be fulfilled by a much smaller number of manufacturers who will continue to charge the higher price for that good. Inflation is thus the result – not deflation, and not “disinflation”.

        “I believe new economic theories have to be sought based on sound fundamentals.” Well, of course I agree essentially with that. However, this resolves itself down to what “sound fundamentals” actually means? In my view everything must in the end relate to pragmatics. Something either works or it does not ! So the determining criterion for any “new economic theory” must be does it work or does it not. So as an example, QE has now been shown to NOT work pragmatically, wherever it has been tried. (It is of course a deliberate deceit from the start, being really just an excuse to increase the money supply by debasement to generate inflation.) So why do they carry on using it and pretending that it can work when it did not in Zimbabwe? The answer I believe comes back to delusion and political expediency. Any new economic theory to be enforced on citizens and taxpayers should be determined to actually work prior to its enforcement. At present many economists are using economies, taxpayers and citizens as guinea pigs, and when their new theories are shown not to work they still persist, refusing to believe the pragmatic evidence in front of their eyes!

      • Drf,
        Obviously I am no economist , and half the time the more complex issues you guys talk about on here takes me quite a bit of cross referencing to get some basic understanding of, but I am an interested observer. Therefore I have to use my personal situation to see what bits of these questions are working for or against me so it’s not just theory it is pragmatics from my perspective. Myself and friends who have seen their fixed incomes decimated to maintain millionaire bankers have to take negative spending measures to balance budgets, at least until such times that new incomes can be achieved. On top of that the region where I live has unsustainable levels of public sector workers (50% of the workforce) and the majority of them have just had a wage reduction put through for the next 2 years as well as a cull of their jobs leaving none in positions of job security. So my take on ‘elasticity of demand’ isn’t theoretical it is what is happening here. The only thing holding it all up, and I have to include house prices, are the current artificial interest rates which are supplementing disposable incomes. You will in some way understand my scepticism when I read about job mobility and wage increases.
        As for manufacturing, and I have a great sympathy for that sector especially the SME bit, I can see inflationary effects in their goods inward I just wonder how much they can pass on into goods outward? Of course they have to for survival but that in itself might just make them uncompetitive in a global economy?
        Doesn’t this illustrate Shaun’s point about some of these price increases being inflationary and deflationary at the same time?
        As to the generalised point about economic theory, isn’t the proof of the espoused theory only apparent after the events? Therefore it is impossible to predetermine the validity of such philosophies it’s a case of suck it and see. The problem seems to be in the people who hold sway at any given point and the predilection to allowing political interference for expediency.
        The QE question is something I am not too sure about. I can see it’s a valuable weapon in the economic arsenal, in much the same way being in control of your exchange rates is at certain times. Doesn’t it boil down to how it’s applied? Had it been used to augment and sustain infrastructure rather than unsustainable borrowing wouldn’t that have been a valid use? I would rather have taken the ‘bust bet’ on trying to provide the next generation with 100% employment rather than foisting onto them a crazy borrowing requirement which they cannot hope to repay.

  7. As a Surveyor (albeit commercial not residential), a residential property investor, and with a daughter looking to buy her first house, my thoughts are:

    – house prices are over valued, and way over their long term average in terms of the average salary/average house price ratio, and it is likely that we will see a drop I would think of around 10-20% overall.
    – Clearly prices are being held up so far by low interest rates and a stand off between willing buyers and willing sellers. Personally I think this will largely continue until we see increases in interest payable as rates increase. It is also extraordinarily difficult to obtain a mortgage (full stop) irrespective of how much equity you have, and this is creating a totally moribund market.
    – however, average price changes are very misleading as clearly there are huge differences, depending on where you are located in the UK, and therefore I suspect that whilst in some northern towns prices will drop well over 20%, in London, they may well remain steady at the top end.

    So personally, I fear we will have a lot of ‘generalised statements’ on the market, and it will become even more polarised. However certainly, as mortgage rates increase, prices must fall, where properties are sold, and I suspect it will be a thinner market than we saw in the early 1990’s.

    Finally, residential rents are increasing but the rent/price ratio for buy to lets remains out of sync.

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