The extraordinary economic experiment that is going on in Sweden

One of the features of the economic environment right now is the extraordinary economic experiment being inflicted on the Swedish economy by its central bank called the Riksbank. It was not so long ago (20th April 2014) that it was being described by Paul Krugman of the New York Times in the terms below.

Whatever their motives, sadomonetarists have already done a lot of damage. In Sweden they have extracted defeat from the jaws of victory, turning an economic success story into a tale of stagnation and deflation as far as the eye can see.

Their crime? In Paul Krugman’s eyes it was to raise interest-rates as they are only for cutting. The “tale of stagnation and deflation” was an odd description for an economy which had just had an annual rate of GDP growth of 1.7% and was just about to have one of 2.7%. Some people call that solid economic growth especially as it was followed by 2.6% and then 2.6% in the final quarters of 2014.

Inflation Targeting

Here there was an issue for those like Paul Krugman who do not like lower prices as the Swedish inflation rate or CPI had fallen to -0.6% in March 2014. Amazing is it not the fear generated by small falls in inflation as opposed to the treatment of overshoots? In fact since then it has often been below 0% but by small amounts and in April was -0.2%.  The Riksbank has seized on this as a reason to cut interest-rates in a manner in which Professor Wren-Lewis whom I referred to on Wednesday would adore. I will come to that in a moment but for the moment let me point out that as the inflation index is influenced by the interest-rate changes there has been positive feedback or something of an own-goal here. The index which takes out the interest-rate cuts is running at 0.4%. It is not a perfect measure as it has indirect taxes too but you get the idea.

The Swedish worker or consumer

The ordinary Swede is likely to be confused by all this as you see for them an inflation rate of -0.2% can be compared to this.

Compared to March 2014, labour costs have increased by 1.7 percent for wage-earners and 2.7 percent for salaried employees.

Not exactly the same time period but higher wages combined with falling prices leads to what is for these times is a substantial real wage boost. If we look at the underlying data we see that much of the real wage boost has been caused by the lower oil price as elsewhere. The transport inflation index fell by almost 6% between July of last year and January of this as it followed the oil price trend.

Sadly that ended in January and we have returned to a more familiar pattern of price rises as workers and consumers frown.

The Riksbank

Now you might think that solid economic growth and real wage gains provided something to please a central bank. After all if we look south from Sweden there are quite a few places which would regard it as an economic nirvana and ask it to “come as you are”. Not the Riksbank which had cut interest-rates into negative territory on February 11th and started Quantitative Easing as well. It is hard not to have a wry smile at someone who things that cutting interest-rates by 0.1% will have any effect but it will be unprovable as they cut again in late March to -0.25%. Enough? Not quite as in what can only be described as a type of panic they keep deciding to add to the amount of QE with the latest addition in April shown below.

the Executive Board of the Riksbank has decided to purchases government bonds for a further SEK 40-50 billion.

Actually bond yields were being driven lower by developments in the Euro area so it would be fascinating to be able to ask the Riksbank if this has made any difference at all so far. But in my view I wish that the Smiths had added Stockholm to the list below.

Panic on the streets of London
Panic on the streets of Birmingham

Today’s data

The latest economic growth numbers show little sign of the stagnation we were assured above.

Sweden’s GDP increased 0.4 percent in the first quarter of 2015, seasonally adjusted and compared to the fourth quarter of 2014. GDP increased 2.5 percent, working-day adjusted and compared to the first quarter of 2014.

Actually the annual rate of growth has been remarkably stable over the past year or so. It does not seem that there is panic in the underlying Swedish economic model either. From the Huffington Post yesterday.

Beginning in 2016, men in the country will be entitled to a third (yes, third) month of paid paternal leave based on a new government proposal.

Of course this time next year there will also be the economic boost from hosting Eurovision which Sweden has just won. If the country is in need of an economic boost via the music industry perhaps ABBA could be persuaded to reform, after all they were right about this.

It’s a rich man’s world

Side Effects

This is a clear issue in medicine so as central banks indulge in their own form of junkie culture we need to look for them in economies too. Sadly consumer inflation measures have often been neutered but such factors as household borrowing help. How has it responded to ever lower interest-rates and other monetary easing? From Sweden Statistics.

The annual growth rate for lending to households from Monetary Finance Institutions (MFIs) increased by 0.2 percentage points from 6.3 percent (revised) in March to 6.5 percent in April.

The main driver of this sort of thing is invariably the housing sector so let us drill down the numbers.

This is an increase of SEK 187 billion compared to the corresponding month last year, of which housing loans accounted for SEK 164 billion…….Households’ housing loans amounted to a total of SEK 2 541 billion at the end of April and had an annual growth rate of 6.9 percent.

The typical new mortgage interest-rate has fallen from 2.41% to 1.67% over the past year. According to The Local there has been the expected response.

Apartment prices have shot up in Gothenburg and Stockholm in recent months with one-bedroom properties in central locations regularly selling for more than three million kronor ($352,439).

Apparently even one of the Swedish banks has its concerns.

Researchers at Swedbank…. are warning that people living in the heart of the nation’s cities are facing growing “affordability problems” due to needing to fork out more than 30 percent of their post-tax salaries on mortgage payments and other related costs.

With wages up and mortgage costs down a lot we get something of a clue to what house prices must have done recently!

In May 2014 this issue troubled the Riksbank as shown below.

The analysis shows that the average debt ratio (debts in relation to disposable incomes) in July 2013 was 296 per cent for indebted individuals and 370 per cent for individuals with mortgages

If the borrowers who have reduced their debts over this period continue to reduce these debts at the same rate, on average they will be free of debt in about 100 years.

Ah free of debts in 100 years! Of course since then there has been quite a borrowing binge in Sweden (total borrowing has risen by 12.6%) mostly driven by the Riksbank. Will they now on average be free of debt in 112.6 years? What was that about inter-generational mortgages in Japan?

Even businesses seem to be getting in on the act.

Most of the loans to non-financial corporations comprised loans with multidwelling buildings as collateral.

Comment

The Riksbank seems to have taken its new policy from the lyrics of Sweden’s most famous pop music export.

Money, money, money
Must be funny
In the rich man’s world
Money, money, money
Always sunny

With a narrow money annual growth rate of 13.5% it is certainly doing the central banking equivalent of splashing the cash.  The economic experiment is to do this in an economy that is growing solidly. Even the argument of low and negative inflation will fade away if the price of crude oil remains where it is now. What will be left then? Well much higher house prices I would imagine which is of course where we find inflation these days. That is also why it is officially classified as a wealth gain although I doubt that first-time buyers in Swedish cities would agree. Another inter-generational wealth transfer is in play.

Meanwhile deep underground in economic terms a tectonic plate is rumbling. So far the Swedish response to negative interest-rates seems to be to save more. Regular readers will recall my contention that interest-rate cuts can be contractionary……

Meanwhile I do hope that the swings in mood in the Riksbank do not do to Sweden what happened when they changed which side of the road they drive on.

On Sunday, 3rd September 1967, Sweden changed from driving on the left to driving on the right. This is what happened http://t.co/m2r3LBszDP—
Historical Pics (@VeryOldPics) May 26, 2015

What will happen next to the UK housing market and house prices?

The latter stages of the UK coalition government involved various attempts to fire up the UK economy via the housing market. Or if you prefer economic plan A for the UK establishment as we wonder if plan B has ever existed! The political and media emphasis was on the Right To Buy policy but in fact the major driver was the action of the “independent” Bank of England in using its Funding for Lending Scheme to drive mortgage rates lower. This was something of a dream ticket for the Bank of England as it was able to give a further subsidy to UK banks via the provision of cheap liquidity and pump up the value of their balance sheets via house prices all in one go. Overall mortgage rates were pushed around 1% lower on average by this although as I discussed yesterday fixed rates often fell by more. Accordingly we are seeing record lows for mortgage rates as this from yesterday’s Mortgage Introducer indicates.

Offset rates have fallen to record lows with the average offset fixed rate now priced at 2.65%, over one percentage point lower than two years ago, research from Moneyfacts has revealed.

This has happened recently in areas that you might not expect because we were told that high Loan To Value mortgages were a cause of the credit crunch and were to become a thing of the past. More latterly the MMR (Mortgage Market Review) of the Bank of England was supposed to tighten things up. Let us look at what high LTV (90%+) mortgage rates have been doing.

average best-buy fixed and variable mortgage rates fell by up to 0.88% between 11 November 2014 and 30 March 2015. On a mortgage of £150,000 this would save around £1,300 a year in interest payments..

Up is the new down one more time.

Where next?

The incoming Conservative administration faces a problem which is at least partially of its own making which is that house prices are now so high and mortgage rates so low there is not much room left. An idea of the scale of UK house price rises was given by a BBC 4 documentary on Reverdy Road in Bermondsey which I watched with my mother because she grew up in Bermondsey. A whole estate of 791 properties and 20+ shops was sold in 1960 for less than a refurbished house on the road would sell for now. Extraordinary isn’t it!? I guess the word exponential was developed for situations like this.

Back to the future

We are seeing the past being raided for ideas as the Right To Buy policy of the 1980s gets revived. From the BBC.

Plans to support home ownership and extend the right-to-buy scheme  to 1.3 million social housing tenants in England feature in a new Housing Bill. Under the plans, housing association tenants will be able to buy the homes they rent at a discount.

Also we get a continuation of the Starter homes policy.

There will also be help for first-time buyers, with 200,000 starter homes made available to under-40s at a 20% discount.

The fact that both plans are for people to buy at a “discount” is as near to a confession that we will ever get that house prices are too high and unaffordable for the majority. Also these plans have the issue of whether the government can legally force housing associations to do this and whether the latter is a form of age discrimination.

The Bank of England

I discussed only yesterday the way that at least part of the economics establishment was attempting to pressurize the Bank of England into an interest-rate cut. It however has been feeling the pressure and has decided it has been working too hard. From the Financial Times.

The MPC will continue to meet 12 times a year, but this will be reduced to eight if new legislation is passed.

It is quite a strain having to meet 12 times a year apparently! Also as MPC (Monetary Policy Committee) external members are paid some £133,091 per annum (2013/14) I await the Bank of England review of productivity in this area as by my maths we have gone from £11,090 per meeting to £16,636 which also provides quite an inflationary surge! Is this how the Bank of England plans to end deflation?

Also there is another example of inflation at the Bank of England.

This Bill would formalise changes to the Bank’s top team, by legislating to put the new Deputy Governor, Minouche Shafik, on the Court and the FPC.

This inflation of roles has been quite evident in the current Governorship and it particularly applies to what you might call “Carney’s cronies”. If we consider the issue of productivity this inflationary development poses its own questions as the performance of Ms. Shafik has been poor. Let me be clear that I welcome the appointment of women to the MPC but feel it is a shame we scoured the international organisations of the world for “Carney’s cronies” rather than appointing British women.

As the Bank of England has not actually changed Bank Rate for over 6 years it is rather a moot point as to whether 12 meetings of “masterly inactivity” provide more productivity than 8 as dividing by 0 has its problems. But in theory it should do. This issue is a counterpoint to the fact that today’s confirmation of UK GDP growth being 0.3% in the first quarter of 2015 implies yet more productivity issues for the UK economy as the labour market remains strong.

Today’s mortgage numbers

There was indeed something of a pre-election push. From the British Bankers Association.

There was a significant rise in the number of mortgage approvals in April……..which we would expect to continue in the coming months. House purchase approvals were higher than last month and 3% higher than in April 2014.

Whilst the BBA and the Bank of England would deny it there has been an easing in credit conditions overall in the UK.

Unsecured borrowing is growing at its highest annual rate, of 4.9%, since autumn 2010, reflecting strong consumer confidence.

A pre-election splurge? Well there do seem to have been some elements of that if we look at the retail sales and trade figures as well.

Although the actual mortgage lending figures were not as strong, were individuals willing to plan but less willing to actually trade pre-election?

Gross mortgage borrowing in April was £10.5 billion – 13% lower than in the same month last year but 2% higher than in March.

Comment

There is much to consider about the UK housing market and its interrelation with the UK economy. It was not long after the beginning of the Bank of England FLS in July 2012 that the UK economy picked-up. Whilst it was not the only cause of it the new government and the Bank of England will be nervous about the implications of turning the tap off especially as it would appear that the UK services-sector has been having a growth hic-cup.

The service industries grew by 0.4% in Quarter 1 2015 (Figure 3), revised down 0.1 percentage points from the previous estimate, marking the ninth consecutive quarter of positive growth. This follows a 0.9% increase in Quarter 4 2014.

That is its weakest effort in this new growth spurt. The problem for the UK is that so much has already been ploughed into the housing market what can they think of next? The moves are getting increasingly expensive as this estimate of Right To Buy costs from the National Housing Federation indicates. The emphasis is theirs.

This means that across the country there are 221,000 households that are eligible for the new proposal and able to afford the mortgage. And if all of these households decide to take up the scheme, it would cost £11.6 billion.

Is that £11.6 billion a type of helicopter drop of money?Then we have the issue that what will they do in say 3/4 years time to get us ready for the next election?  I am reminded of this from Alice In Wonderland.

My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.

I am open to suggestions….

Why would the Bank of England cut interest-rates right now?

Today sees the publication of the Queen’s Speech in Parliament which will deal with issues of fiscal policy but I wish to look at the consequences for monetary policy. After all monetary policy was something which did not get much of an airing in the election debates because it is accepted that this is now controlled by the Bank of England. Actually there is a technical problem with that as it needs permission from the Chancellor of the Exchequer for its QE (Quantitative Easing) program. Also it is rather a moot point as to how different UK monetary policy would be if we had politicians in charge as they would have eased policy considerably too. On that road you find yourself facing the fact that any argument for “independence” at the Bank of England involves them being able to ease monetary policy by more than politicians would have done! Was that the whole (political) plan all along?

The case for a Bank Rate Reduction

Regular readers will be aware that I have argued since December 2013 that a Bank Rate cut is as least as likely as a rise. This is of course against the consensus because the “Forward Guidance” of the Bank of England promises a rise. But I would like to visit the Ivory Tower of Professor Wren-Lewis to examine his case for a Bank Rate cut. His view is that we have a large output gap right now and that we should use monetary policy to help close it.

The most basic thing we know about the UK economy is that output is now something like 15% below where it should be if pre-recession trends had continued. For the UK that pre-recession trend had been remarkably stable………So it is possible that the scope for additional expansion is large. This is real uncertainty, but it is also one sided uncertainty. No one is seriously suggesting the economy is running at 5% above trend, let alone 15%!

We also have a discussion on inflationary trend where the good Professor seems to have confused himself so let us move quickly onto productivity which he also feels would improve with a demand boost via a rate cut.

but such improvements would come quickly if demand picked up enough (and labour became scarce). Again the risks here seem one-sided.

If we combine the two factors then it is clear as to why the Professor argues strongly for a Bank Rate cut now.

In these circumstances, the obvious thing to do, as well as the cautious and prudent thing to do, is to cut rates now to cover for the possibility that the output gap is actually much larger than estimated and inflation will therefore not return to target as hoped.

There you have it in a nutshell. There are other cases for a UK interest-rate cut which involve raising the inflation target to 4% per annum made by other Professors but I will respond to those by simply pointing out UK economic history.

Let me add a case which is not made by the Professor which is the strength of the UK Pound £ exchange-rate. He seems unclear about its impact so let me help him out. We have seen a surge in the value of the UK Pound since the nadir of March 2013 and in fact have even risen above the level it was at when Lehman Brothers collapsed. Using the old Bank of England rule of thumb the rise has been equivalent to a 3.5% increase in Bank Rate. Care is needed as it is only a rule of thumb but it does indicate a clear tightening over the past couple of years.

The argument against

The simplest is that if we move from an Ivory Tower world of official interest-rates to the world in which we live interest-rates have been falling since the implementation of FLS or the Funding for (mortgage) Lending Scheme in July 2012.  For example the 2 year fixed rate mortgage (90% LTV) fell from over 6% in early 2012 to 3.53% at the end of April according to the Bank of England. Which influences the economy more Bank Rate or mortgage rates? There is perhaps an answer in the fact that Bank Rate has not changed for six years.

Accordingly we already have a much more complex environment than the Ivory Tower simplicity of pulling a Bank Rate lever. For our trading companies life has got harder overall via a currency rise whilst for the housing and consumer sector it has got easier. Along this road of course we do get the worries about rising household debt and unsecured lending which I note do not get a mention in the case for an interest rate cut.

Next we have the issue that the economy is growing rather solidly right now and of course has just received a boost from the oil price drop.

GDP was 2.4% higher in Quarter 1 (Jan to Mar) 2015 compared with the same quarter a year ago.

It was not so long ago that such a rate of growth would have led for calls for a consideration of monetary tightening and not a cut! I wonder what rate of growth would now be enough?

Are we targeting inflation or economic growth?

I note the use of the “deflation” spectre by the Professor. This links to an article by David Blanchflower on the subject which seems to predict the end of the world as we know it on the basis of one monthly CPI annual print of -0.1%. What about the years of above target inflation? Or these issues?

The all items RPI annual rate is 0.9%, unchanged from last month.

UK house prices increased by 9.6% in the year to March 2015, up from 7.4% in the year to February 2015.

So on these measures we have a mild slow down in inflation and a rampant episode of asset price inflation. Are they the new definition of deflation? We should be told if so especially as the major price fall (oil) is one about which we can hardly defer purchases unless someone can show me a way of doing that with my car when it runs out of diesel or domestic heating?

So we have a clear issue which is that when economic growth is poor and inflation high we are told we need an interest-rate cut because of growth. Now we have low inflation and much better growth we need a rate cut because inflation is low. The Starship Enterprise would be on red alert with such asymmetry.

The Output Gap

In many ways this blog opened as an argument against the output gap and I was proven to be correct. Accordingly after the years of pain for its adherents when inflation was supposed to collapse and instead went above 5% per annum which was quite an anti-achievement in my opinion you might expect some revisions. For example an acceptance that some and worryingly much of the pre credit crunch boom was as the band Imagination put it.

Just An Illusion

Instead just like The Terminator it is apparently back! Sadly nothing appears to have been learned.In my opinion there is no trend anymore as the pre credit crunch period has gone and we need to adjust to that otherwise we run the risk of making the mistake that Japan made that somehow it might come back.

Another issue with saying output has a gap is this.

In quarter 1 January to March 2015, the UK’s deficit on trade in goods and services was estimated to have been £7.5 billion; widening by £1.5 billion from the previous quarter.

Inflation

Tucked away in the interest-rate cut analysis is a completely different view of the economic damage inflicted by bursts of inflation on the ordinary person, worker and consumer.

The worst that can happen if this is done is that rates might have to rise a little more rapidly than otherwise in the future, and inflation might slightly overshoot the 2% target.

Borrowing from the future as the can gets kicked again? However if I may just stick with the inflation point this is a repetition of the output gap error made in 2009/10/11 again as “slightly overshoot” became 5% per annum inflation and begat a collapse in real wages. That road forwards became this as real wage falls became a depressionary influence on the UK economy.

We’re on a road to nowhere

Anyway aren’t services four-fifths of our economy?

The CPI all services index annual rate is 2.0%……The all services RPI annual rate is 1.8%

Cutting interest-rates is a trap

The problem with cutting official interest-rates is that you end up in the situation described by Coldplay.

Oh, no, what’s this?
A spider web, and I’m caught in the middle,
So I turned to run,
The thought of all the stupid things I’ve done,

We cut from 5% to an emergency rate of 0.5% and now we need to cut again apparently. So is this a worse emergency? This would need quite an explanation right now! Especially if you throw in the fact that back then we got quite a boost from a lower pound too. Overall monetary policy is very loose and if you throw everything into the pot (QE etc) what would you say the Bank Rate equivalent is -5%?

Now we get to the difficult bit. The first part is that via the effect on savers interest-rate cuts here have only a small effect and may have a reverse effect. Secondly as we keep cutting and debt rises in response how can we ever raise rates again without a collapse?So we cut again as we find ourselves in the spider’s web described by Coldplay.

Comment

If Professor Wren-Lewis is correct and we can improve things by pulling a lever then it is time for one of the Beach Boys hits.

Wouldn’t it be nice

Maybe if we think and wish and hope and pray it might come true
Baby then there wouldn’t be a single thing we couldn’t do.

Except if pulling levers like that did work we wouldn’t be where we are would we?

An “accident” would be the best thing for Greece its people and its economy

Today as on so many days it is fair to say that Greece is the word to misquote the Gibb brothers. The situation seems to stumble on with both sides seemingly unable to comprehend the other as the deadline of June 5th for the next repayment to the International Monetary Fund (IMF) gets ever nearer. Over what was a holiday weekend in the UK and other parts of Europe the situation saw a couple of Greek ministers add to the rhetoric. First the Interior Minister give us his view on Sunday. From the Guardian.

The four instalments for the IMF in June are €1.6bn.This money will not be given and is not there to be given.

This began to look ever more like a part of the play Can’t Pay? Won’t Pay! By Dario Fo. The fevered atmosphere was added to by the Energy Minister Panagiotis Lafazanis who told us this.

It would not be a catastrophe to exit the euro, (nor) a terrorist act not to pay the next instalment to the IMF.

He and his Left Platform group took matters further by suggesting this according to the New York Times.

A faction known as the Left Platform proposed that Greece stop paying its creditors if they continue with “blackmailing tactics” and instead seek “an alternative plan” for the debt-racked country.

They lost 95-75 but that indicates that there is already a fair amount of support for such views.

The Euro area establishment

They have a type of push me pull me attitude to this. The push me is the way that they opened the bailout of Greece according to US Treasury Secretary Timmy Geithner. From the Financial Times Brussels Blog.

I said at that dinner, that meeting, you know, because the Europeans came into that meeting basically saying: “We’re going to teach the Greeks a lesson. They are really terrible. They lied to us. They suck and they were profligate and took advantage of the whole basic thing and we’re going to crush them,” was their basic attitude, all of them….

A completely different attitude to the “Shock and Awe” public proclamations of individuals like the then French Finance Minister Christine Lagarde is it not? Indeed even the fromer Treasury Secretary was surprised at how long this went on for.

I completely underweighted the possibility they would flail around for three years. I thought it was just inconceivable to me they would let it get as bad as they ultimately did.

The other side of Euro area policy is a strong pull towards federalism which has been seen overnight in the new Franco-German pact which has suddenly appeared. Another was of looking at it is the fact that it is the unelected European Commission President Jean-Claude Juncker currently negotiating with UK Prime Minister Cameron. Mind you with the election results in Spain and Poland the Euro area establishment is looking ever more like some form of Ancien Regime. Perhaps like the Irish the British,Spanish and Polish will be asked to vote again until they give the “right” result.

Panic at the IMF and ESM

Another factor at play is the bailout mechanisms themselves who are beginning to some to terms with the fact that the proclaimed genius of an “off-balance sheet” approach faces the IED (Improvised Explosive Device) of a default.  This is presumably why the head of the European Stability Mechanism Klaus Regling has been opining in Bild today.

Also a non-payment of a tranche to the IMF would be dangerous. That would have implications on other creditors like us.

As Klaus is a regular boaster about the lending given to Greece it will be a case of the biter bit if it does not repay.

So far, the EFSF has disbursed €141.8 billion in financial assistance to Greece. (as of February).

Back in February Klaus Regling gave Greece another four months as the can was kicked to June 30th. But now in his quieter moments Klaus will be mulling how he will explain to Euro area taxpayers he lost some or much of their money as he morphs from a self-proclaimed financial genius to more of a financial terrorist. Such news will be particularly unwelcome in  Italy (19.22%) which has its own risk of default which would be exacerbated by sourness in  the loans to Greece. On that day the word “Stability” in the European Stabilty Mechanism would become an oxymoron and might not need the oxy bit! As well as refining its entry in my financial lexicon for these times.

Still perhaps Klaus Regling can get some solace from listening to Muse as he told us.

Time is running out

Perhaps for you too Klaus.

A Strongly Worded Letter

Fan of the Yes Minister series will be aware that the response of the apocryphal civil servant Sir Humphrey Appleby to even the most dire circumstances was a strongly worded letter. Surely that was satire and jest?!

Here is the IMF response to non-payment

Staff sends a cable urging the member to make the payment promptly;

But wait there is more as after two weeks it sends this.

Management sends a communication to the Governor for the member stressing the seriousness of the failure to meet obligations and urging full and prompt settlement.

Six weeks?

The Managing Director notifies the member that unless the overdue obligations are settled promptly a complaint will be issued to the Executive Board.

So it would appear that what was considered satire is in fact reality as the IMF would send a succession of ever more strongly worded letter to Greece. At this point the critique offered by Josef Stalin of the Pope comes to mind.

The Pope? How many divisions has he got?

As of the date of the IMF review of “overdue financial obligations” in August 2012 it has around 1.3 billion Special Drawing Rights of them. Greece according to the IMF website currently owes some 17.4 billion SDRs. Who wants to explain losses on those to places like China and India who in recent times have been taking a larger role in the IMF? As to the UK our share is 4.5% but the United States retains much the largest share at 17.7%.

What is happening today?

Greek Finance Minister Yanis Varoufakis is meeting his Euro area counterparts again. He must have a lot of frequent flyer and hotel booking points! But the situation seems as log jammed as ever. He has written an article in Italy’s Il Sole saying that austerity is out but Greece is willing to reform. On the other side of the coin the Euro area establishment seems to have been suggesting a rise in the rate of Value Added Tax to 23%. That is breathtaking when we consider the contractionary effect on the economy of past rises!

There is plenty of advice available as this from Louise Mensch indicates.

Greece after all is beautiful fertile and full of treasures. She has assets, if bought by Germany or others. Why not do that? Anyone?

When I enquired as to whether she could see any problems in Germany buying up Greece she replied thus.

@notayesmansecon well what could go wrong with Germany giving Greece loads of money for sod all?

Those “assets” depreciated fast!

Comment

This saga has so many contradictions with both sides simultaneously needing a deal and making efforts to make one impossible. To my mind the Euro establishment and the IMF are playing with a very weak deck of cards as they have lent the money and as the strongly worded letter episode indicates have no real way of enforcing it. The Euro area could expel Greece but that would represent a failure for its federal plans. Accordingly I expect it to blink first but then as that poor battered can gets another kick there is this.

The world is drowning in debt, warns Goldman Sachs

Well if somewhere is drowning in debt right now it is Greece with its national debt to GDP ratio of 175% and rising. After all Goldman Sachs should know that as it helped to put it there. But another episode of can kicking would put Greece in even more debt although it would allow the IMF to exit the scene and leave the debts in the Euro area.

Ironically therefore the best thing for Greece would be what would be called an accident as it would then be free to start again. After all you cannot run a country at weekly or fortnightly notice. But Syriza has also failed so far as if it was going to default it should have already done so. The status quo has involved everybody apart from the banks losing….

Meanwhile some form of capital controls appears ever more likely.

Varoufakis wants 15% tax on (interest) on deposits abroad. (h/t @TradeDesk_Steve )

UK National Debt and Student Debt are a toxic mix as Rents soar

Today gives us the first set of data for the UK Public Finances for the new Conservative government albeit that they cover a period when it was still in coalition with the Liberal Democrats. Of course it is heading forwards with one or two elements from its future plans still apparently missing in action. For example depending on you point of view we were threatened with or promised some £12 billion of cuts to the benefits bill which were unspecified and undefined. On that road the General Election was a case of deja vu as the main parties repeated promises which had gaps in their arithmetic. One way of filling such gaps is to sell off what is sometimes described as the family silver to get some one-off gains and at the CBI this week Chancellor George Osborne confirmed that this would be the tactic for now. From City AM.

The plan is to allow government experts to work together in order to realise the government plan of selling off a wide range of publically-owned assets, including the sale of shares in Lloyds Banking Group, UK Asset Resolution assets, Eurostar and the pre-2012 income contingent repayment student loan book.

Why? Well in spite of a recent better trend the overall picture for the UK Public Finances has disappointed over the credit crunch era as our fiscal deficit proved to be resistant even when the economy returned to growth. Thus to fulfill the manifesto pledge below we need to indulge in the sort of thing that Portugal has been criticised for.

debt as a share of national income will start falling this financial year.

The Numbers

Both the background problem and the recent improvement have been illustrated by today’s numbers. If we start with the background issue it is demonstrated here.

In the financial year ending 2015 (April 2014 to March 2015), public sector net borrowing excluding public sector banks (PSNB ex) was £87.7 billion (4.8% of Gross Domestic Product (GDP)) a decrease of £10.8 billion compared with the previous financial year.

Whilst it is good that the deficit fell the size of the fall is disappointing when you consider that the economy grew by 2.4% over that period. The responsiveness of our deficit to improved economic circumstances has been lower than history would suggest. Another credit crunch change and of course why the “family silver” is up for sale.

However over the past few months there has been glimmer of sunlight and hopes for a faster improvement and that was demonstrated again by the April numbers.

In April 2015, PSNB ex was £6.8 billion; a decrease of £2.5 billion compared with April 2014.

The revenue numbers were good with Income Tax,National Insurance and Value Added Tax receipts rising by more than 3% on the same month last year. In these troubled times for corporate taxation it was nice to see the Corporation Tax take rise by 11.3% or £600 million on a year ago. After yesterday’s strong retail sales numbers for April up by 4.7% on a year before you might think that the VAT take would be higher but of course much of the rise in that has been driven by disinflation or lower prices (-3.2% on a year before). No wonder establishments hate disinflation and instruct central banks to push inflation higher!

The expenditure figures are hard to read this month as there is so much reshuffling between central and local government but rather oddly we seemed to have got less spending rather than a traditional pre-election splurge. There was a reflection of the themes of low bond yields and lower inflation as for now this bit may continue.

debt interest decreased by £0.4 billion, or 6.9%, to £5.0 billion.

What about the National Debt?

As politicians like to pick and choose their numbers let me give you the headline number used in the UK and also the international standard as they are rather different!

At the end of April 2015, public sector net debt excluding public sector banks (PSND ex) was £1,487.7 billion (80.4% of GDP); an increase of £83.6 billion compared with April 2014.

At the end of April 2015, General Government Gross Debt (Maastricht debt) was £1,602.1 billion (86.5% of GDP) and General Government Net Borrowing (Maastricht deficit) in the financial year ending 2015 (April 2014 to March 2015) was £92.4 billion (5.1% of GDP).

What’s 6.1% of GDP or £114.4 billion between friends? Also you may note that the fiscal deficit is higher too under the international standard.

You need to look hard for the other national debt measure including banks but it is now £1768 billion or 95.5% of GDP.

Student Debt

This is an issue as student loans have many issues, after all if we are now richer as we keep being told why can we no longer afford to subsidise students as we did in my time at the LSE? Perhaps of course because we have expanded the number of students but whilst politicians were keen to take the credit for this they were predictably much less willing to take the hit in financing terms as the Higher Education Policy Instititute explains.

First, the big shift from funding universities via grants from Whitehall towards funding students via £9,000 loans occurred partly because loans do not score towards the deficit. This is also one reason why some people now want maintenance grants to be displaced by bigger maintenance loans.

This is of course an extremely familiar theme where appearances change much more than the underlying reality. That has happened with the fiscal deficit so it was only a matter of time before it happened more and more with the national debt too.

because student loans appear in the main measure of the nation’s debt, selling off the loan book now looks good even if it leads to less government revenue in the future.

We are running up quite checklist here as can-kicking makes an appearance too! According to the HEPI the numbers were going wrong so we changed the definitions retrospectively.

A major fiscal challenge was averted in 2013/14 via a retrospective change to the accounting and budgeting rules, which allows higher loan impairments to be smoothed out over the following three decades.

It all looks a rather familiar shambles and as student loan non-repayments are now estimated at 45% and the level of debt is long the lines of the song from Queen quoted below,what could go wrong?

I’m a shooting star leaping through the skies
Like a tiger defying the laws of gravity
I’m a racing car passing by like Lady Godiva
I’m gonna go go go
There’s no stopping me

Why Paul Johnson of the IFS was wrong

Today’s data release on the behaviour of UK rents proves that Paul Johnson was wrong to recommend CPIH as the main UK inflation measure. The numbers from LSL tell us this.

Residential rents have grown 4.6% year-on-year – the fastest rate of increase since November 2010

Using house prices as your measure of owner-occupied costs would have picked this up a couple of years ago proving yet again how much changes in rents lag house price changes. Mind you the establishment will lap it up as you may note even this record increase is lower that the house price rises we have regularly seen. Arise Sir Paul……?

Also in terms of real wages this is not so hot for those who rent and I covered this issue on April 27th.

https://notayesmanseconomics.wordpress.com/2015/04/27/is-the-true-crisis-in-the-uk-housing-market-a-rental-one/

Comment

As it is a sunny day let us start with the good news which is that the recent trend for the UK Public Finances has improved so fingers crossed for the rest of 2015. However an underlying theme of misrepresentation of the numbers goes on. We have seen previously a net debt with the Royal Mail pension scheme presented as a reduction of £28 billion in the numbers and now we see that asset sales are en vogue. Yet we also see that our valuations on student loans which are one of the assets to be sold are in polite terms unreliable and unsure. Could this be like yesterday’s privatisation of profits and socialisation of losses like we have seen in the banking sector? I do hope that the Vampire Squid (Goldman Sachs) is not involved in all of this as we know then what will happen next.

Still at least we have an extra 318,000 people to help us pay it all off……..

Have our banks got better or instead have they got worse?

One of the fundamental issues of the credit crunch era is what to do about our banks? The Too Big To Fail or TBTF strategy has left us in a situation where the banking sector is one with a moral hazard at its core. Everybody now knows that there will be privatisation of profits and socialisation of any losses giving directors of banks something of a one-way bet. Heads they win and tails we lose (with them usually still winning). As this was implicit in the past rather than explicit as it is now we find that we may in fact be worse off contrary to all the official denials. After all we know what to do with official denials.

This privatisation of profits and socialisation of losses was most marked in the UK at Royal Bank of Scotland with its purchase of ABN-Amro as highlighted recently by Andrew Bailey of the Bank of England.

The low risk weights assigned to trading assets suggested that only £2.3 billion of core tier 1 capital was held to cover potential trading losses which might result from assets carried at around £470 billion on the firm’s balance sheet.

We know of course what happened next.

In fact, in 2008 losses of £12.2 billion arose in the credit trading area

This meant that for the rest of us a measure of the UK National Debt soared into the stratosphere. At the end of 2006/07 the UK’s National Debt to GDP ratio was an apparently fiscally conservative 36%. By the time we fully accounted for the various bailouts it was this in December 2010.

net debt excluding the temporary effects of financial interventions was £889.1 billion, equivalent to 59.3 per cent of gross domestic product (£2322.7 billion, equivalent to 154.9% including interventions).

First of all we have the impact on the headline figure and then boom! Apologies for those of a nervous disposition as our debt shot higher. I was one of the very few who covered these numbers and have written before of their many flaws but they give a ballpark idea of our potential exposure.

A Name Change

One of the most ominous developments in a situation is a name change as the Public Relations industry tries to solve the problem of a toxic brand by rubbing it out and introducing a shiny new one. On this road the leak prone nuclear reprocessing plant Windscale became the initially leak-free Sellafield. Well TBTF has made a similar journey as it is now called SIFI or Systemically Important Financial Institution.Do we feel better already?

Bills,Bills,Bills

These are of course fines but I think that the banks treat them as a bill just like the Destinys Child lyric or a cost of doing business. Yesterday saw Barclays and RBS  hit with these and we fined Barclays ourselves.

The Financial Conduct Authority (FCA) has imposed a financial penalty of £284,432,000 on Barclays Bank Plc (Barclays) for failing to control business practices in its foreign exchange (FX) business in London.

Whilst on the face of it seems like action there are various problems here. Current Barclays shareholders are paying for a problem which they really had no control over and of course may not even have been shareholders then. What about punishing those who did this? After all some were openly admitting to fraud.

“If you aint cheating, you aint trying”

Yet again there seems to be something of a shortage of criminal prosecutions as we wonder if any sort of banking financial crime would get a jail sentence. We do seem to treat other types of fraud such as benefits fraud much more harshly. From Poole Council’s website.

A Poole man was given a 12 month custodial sentence for stealing over £88,000 from the public purse.

Meanwhile there is the issue of whether the shareholders were in fact punished. From Adam Parsons of the BBC.

Shares then go up up 3.37% Means Barclays now worth £1.5bn more than it was before the £1.5bn fine.

Next if we look at the international issue is a wealth transfer from the UK to the United States as the fines from it to UK banks go on and on.

Barclays, which was involved from as early as December 2007 until July 2011, and then from December 2011 until August 2012, has agreed to pay a fine of $650 million;RBS, which was involved from at least as early as December 2007 until at least April 2010, has agreed to pay a fine of $395 million.

The US Federal Reserve fined them too for US $342 million (Barclays) and US $274 million (RBS). This is particularly awkward in the case of RBS which has of course the UK taxpayer as a majority shareholder. Exactly what guilt does the average UK taxpayer have?

Market Manipulation

Often forgotten in the melee is the impact on financial markets. We have seen that foreign exchange and interest-rate markets (LIBOR) have been rigged to the banks benefit which begs the question of what other markets have been? For example was it a coincidence that the oil price and indeed the price of several other basic commodities fell after many banks closed their commodity trading desks. By the time that central banks have manipulated so many markets too what is left.

Of course central bank market manipulation is treated as welcome rather than illegal but even Andrew Bailey of the Bank of England admitted that there seem to be “side-effects”.

On 15 October, 10 year US Treasury yields moved intra-day by around 8 standard deviations of preceding daily changes. On 15 January, the Swiss Franc moved by more than 30 standard deviations. For rough scale, an 8 standard deviation move should happen once every three billion years or so for normally distributed data.

Of course we had the flash crash in Euro area bond markets only recently.So what is proclaimed as making us safer is at best making markets more skittish.

What did governments do for revenue before they fined banks?

As the fine revenues pile up let us not forget that there were other type of fine imposed on the banks in the UK which were the bank payroll tax and the banks levy. As of the end of the 2103/14 tax year we had received some £8.8 billion. This has its issues as of course we were in some cases fining banks we then owned!

What we used to do was tax banks via Corporation Tax but receipts have collapsed from £7.3 billion in 2006/07 to £1.6 billion in 2013/14. There is of course a much wider problem with corporate taxation as companies shuffle money around the globe to avoid it. I saw an odd BBC interview with Bono and the Edge from the band U2 who apparently approve of this,well for their own affairs anyway! But conventional revenues like this from the banks took a heavy knock. So we now fine them which is often a sort of fining ourselves. are we fining the profits they have made from the cheap funding given to them by the Bank of England in a form of “round-tripping”?

Of course we could follow the American model and mostly fine foreign banks….

What about the regulators?

One more time we face the famous latin phrase.

quis ipsos custodiet custodes (Juvenal)

Who watches the watchmen? This is a very relevant question as time and time again we see evidence of “regulatory capture”. This involves regulators later moving to banks for example. From Sky News.

Barclays has hired the former chief executive of the Financial Services Authority (FSA), Hector Sants, as its head of compliance.

We are continually told “this time is different” and yet more and more scandals emerge. Perhaps the “exhaustion and stress” from which the newly knighted Sir Hector suffered was from the emergence of all the scandals on his watch.

Frankly regulators seem to have more enthusiasm for suppressing scandals than investigating them.

Comment

The essential problem is how much has improved over that past eight years or so? We get regularly told this both openly and more subliminally.  Yet we remain in a situation where as I discussed yesterday where interest-rate rises seem impossible and the housing market has been pumped up one more time to improve the balance sheets of the banks. As so often before we find ourselves asking what happens if we go in a recession again? After all the numbers keep getting larger. From Andrew Bailey.

Financial market activity has grown rapidly. There are many statistics that could be quoted, so to choose one, over the last 15 years, global bond markets have grown from around $30 trillion in 2000 to nearly $90 trillion today.

I fear that we have gone backwards rather than forwards after all the cavalry of the Vickers Report will not arrive until 2019. That is of course assuming that the cavalry do not suffer from regulatory capture on their amazingly slow journey.

Can the United States Federal Reserve raise interest-rates?

This evening we will see the latest set of meeting Minutes from the Federal Reserve Open Markets Committee which is the interest-rate and indeed Quantitative Easing arm of the US central bank. Rather like the Bank of England the FOMC has been teasing everybody about a prospective interest-rate rise for some time now but just like it nothing has actually happened. It has remained a mirage in the distance that is apparently just out of reach. You might like to contrast that in these times with interest-rate cuts around the world which flash up across the various media with quite some regularity these days So far this year there have been 30 or so interest-rate cuts in 2015 including China, India,Korea, Australia and a host of others including Switzerland, Denmark and Sweden who have plunged into the icy cold world of either negative interest-rates or further into them. You may note that there is quite an asymmetry there!

What about the US economy?

The latest set of economic growth data were poor.

Real gross domestic product — the value of the production of goods and services in the United States, adjusted for price changes — increased at an annual rate of 0.2 percent in the first quarter of 2015, according to the “advance” estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 2.2 percent.

So there was not only a very weak reading but quite a slowdown from the end of 2014. This was quite a lurch downwards from the 3% annualised growth that had been doing the rounds in the financial markets not so long ago. Indeed as recently as February the Bank of England made yet another forecasting error.

much weaker than the 0.6% expected at the time of the February Inflation Report (or annualised ~2.5%)

Since then we have seen very poor trade figures thrown into the mix.

The U.S. Census Bureau… announced today that the goods and services deficit was $51.4 billion in March, up
$15.5 billion from $35.9 billion in February, revised

This meant that the quarterly picture for trade was now as follows.

Year-to-date, the goods and services deficit increased $6.4 billion, or 5.2 percent, from the same period in 2014.

Accordingly the latest estimates for that quarter are now in negative territory as we await the later updates. The only hope is that a more complete data set finds a positive nugget or two.

Also as we recall the way that central banks panic at the thought of negative inflation there was this tucked away in the data.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 1.5 percent in the first quarter, compared with a decrease of 0.1 percent in the fourth.

Ordinary workers and consumers will welcome lower energy and to a lesser extent food prices but of course central bankers are made very nervous by them. What about the banks? What about the debt?

What about now?

Something rather familiar has been happening and I shall take you over to the Atlanta Federal Reserve whose GDP tracker has been on form.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2015 was 0.7 percent on May 19, unchanged from May 13.

Over the past week the number had been pulled lower by weak industrial production data and then pushed back up by strong residential housing numbers. So there is the distinct possibility that over the first half of 2015 the US economy will see no growth at all. This is very different from what is calls the “Blue Chip consensus” which has gone from just above 3% per annum growth to just below it. Quite a gap! Just like last time.

Ominously perhaps today’s Bank of England Minutes remain optimistic for US economic growth.

These effects were likely to be temporary, pushing up on growth in Q2: Bank staff expected growth of 0.7%.

Ah that word temporary again! Has anything actually proved to be temporary after an official claim about bad data?

As recently as the middle of March the Federal Reserve told us that US GDP growth in 2015 would be between 2.3% and 2.7% which means that it will really have to charge ahead in the second half of this year.

Wage growth and productivity

This is a measure which most central banks are tracking closely right now. The latest employment report data is below.

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 3 cents to $24.87. Over the past 12 months, average hourly earnings have increased by 2.2 percent.

Hardly racing away is it as the last quarter of 2014 saw growth of 2% per annum? If we look back to the pre credit crunch period then depending on which measure you use you would estimate it at being 3-4% per annum.

Also somewhat ominous for possible wage growth is this research from the Atlanta Fed about productivity.

For example, over the past three years, business sector output growth averaged close to 3 percent a year. Labor productivity growth accounted for only about 0.75 percentage point of these output gains.

Thus it is not only the UK which has its concerns about labo(u)r productivity and the new pattern is very different from the past.

Business sector labor productivity growth averaged 1.4 percent over the past 10 years. This is well below the labor productivity gains of 3 percent a year experienced during the information technology productivity boom from the mid-1990s through the mid-2000s.

If these productivity trends are now permanent then real wages are on quite a different path to what people hope they will be and of course the path for interest-rates changes too.

Business surveys

These are hard to read at the moment as highlighted by the latest purchasing managers report from Markit.

The seasonally adjusted final Markit U.S. Composite PMI™ Output Index (covering manufacturing and services) posted 57.0 in April, down from 59.2 in March and the lowest reading for three months.

It would be ominous if there was a slow down from the weak official economic growth data for the first quarter of this year. But as I am sure you have noticed the PMI report had economic growth charging forwards earlier this year!

Monetary Policy has tightened

There is much more to monetary policy than just official interest-rates especially these days. If we look at market interest-rates then the ten-year bond yield has risen from just above 1.6% in late January to 2.27% now. This has pulled mortgage rates back up again after the falls seen in 2014 and January of this year. Whilst the US Dollar is no longer at its highs the trade-weighted dollar index is at 95.5 compared to 80 a year ago which shows how much the US Dollar has risen.

Some care is needed because the US Dollar is the reserve currency and also because the US economy is in proportional terms less of a trade dependent nation than many. But if you were setting US policy you would be wondering if March’s poor trade figures were the beginning of a new weaker trend.

Comment

There are many ways of looking at the situation. I have thought for some time that a new version of Forward Guidance is in operation where the Fed (and the Bank of England) promise interest-rate rises but in reality do not actually mean to carry them out. They hope that “expectations” as in market behaviour will do the job for them and make actual rises unnecessary. They of course ignore the dangers of moral hazard and to credibility of crying wolf.

Added to this are signs of weakness from the US economy which are far from alone in the world. For example after a good start to 2015 the Euro area (h/t @markbartontv ) surprise index has not only reversed but gone negative recently. If matters are going so well in China why does it keep cutting interest-rates? Indeed why are so many cutting interest-rates. Now America is often quite insular and may be bothered less by the rest of the world than one might think but it will worry about how much higher the US Dollar would go if it raised interest-rates.

So this is a situation rather like the UK General Election as even those who say they will raise rates are likely to change course when it comes to actually doing so. As Change (with one Luther Vandross) put it.

But now I know
I don’t need you at all
You’re no good for me

I’ve changed my mind

The UK finds itself at peak deflation mania as house prices rise by 9.6%!

As 2014 moved into 2015 we saw one of the manias of our times develop and by this I mean the way that economists and the mainstream media started to scream and shout “deflation”. This was presented as one of the economic evils of our time in spite of the fact that below target inflation would of course be welcomed by consumers and workers and that an economic boost would be provided by a better trend for real wage growth. Indeed they seemed to have an outbreak of amnesia about the fact that the UK had just gone through a period of above target inflation. Odd that because there is plenty of economic literature arguing that inflation “shortfalls” should be made up which means that for symmetry surely so should overruns. The “deflation nutters” also ignored the fact that the UK economy was growing solidly and that if we looked at sectors of the UK economy unaffected by the oil price fall inflation seemed to be pretty much as before.

What has changed?

The “deflation nutters” have seen their economic bogeyman fade somewhat as 2015 has progressed. The price of a barrel of crude oil has risen by 14% in 2015 if we use the Brent Crude benchmark and it is up around US $20 since it hit its low of US $45 in Mid-January. So whilst in annual terms it still has an effect on inflation numbers due to the large previous fall in month on month terms we are now seeing rises. This is why the UK inflation bulletin has told us this.

motor fuels: prices, overall, rose by 1.6% between March and April 2015 compared with a fall of 0.1% between the same 2 months a year ago.

This poses an immediate problem for the “deflation nutter” theory where falling prices escalate and then we see falling wages and falling economic output in a downwards spiral. It is also a bit awkward that wages seemed to have picked up a little according to the latest data and of course other commodity prices such as Iron Ore have stabilised and rallied a little.

Also the UK has been experiencing this all along from the sector which remember is around 4/5 ths of our economy.

The CPI all services index annual rate is 2.0%, down from 2.4% last month.

Falling yes but as you can see it is on target and chugging along (not very) nicely.

The ordinary citizen will of course have struggled with the concept that buying cheaper fuel and energy was bad for them.

Today’s data

The deflation mania has gathered in force in the media after today’s data release.

The Consumer Prices Index (CPI) fell by 0.1% in the year to April 2015 compared to no change (0.0%) in the year to March 2015.

The UK Office for National Statistics has chosen to ramp up the shock effect of this.

This is the first time the CPI has fallen over the year since official records began in 1996 and the first time since 1960 based on comparable historic estimates….. Based on comparable historic estimates, the last time the UK saw consumer price deflation was in the year to March 1960, when prices fell by an estimated 0.6%.

The media has lapped this up ignoring the “comparable historic estimates” part. Presumably they are unaware of the fact that some of the required data was not collected as back then we used the Retail Price Index such that if it was an airplane it would have no tail fins. What could go wrong?

Oh and the Retail Price Index (RPI) went negative in 2009 for a few months which you might think merits a mention. Actually this was a really big deal as it is my view that the Bank of England panicked over this development as it slashed interest-rates and commenced QE (Quantitative Easing) in response. Back then the Bank of England was a “deflation nutter” which of course turned out to be an inflationary episode. How quickly we forget!

Problems with the deflation mania

Our old inflation measure called RPI gives a completely different answer.

The all items RPI annual rate is 0.9%, unchanged from last month.

So the UK establishment has achieved a success by getting the media to accept an inflation measure that is consistently lower and the scale of the “success” has increased as the gap is currently 1% per annum.

Also there is the issue of UK house prices which do not fit at all well with any deflation theme.

UK house prices increased by 9.6% in the year to March 2015, up from 7.4% in the year to February 2015.

No longer is this just a London driven development.

Excluding London and the South East, UK house prices increased by 8.1% in the 12 months to March 2015.

As you can see there is raging inflation in the UK housing market which is the largest purchase that home owners are ever likely to make. How does that go with inflation which is officially negative? It does not as they exclude house prices from the numbers and have gone to a great deal of effort to do so as we were supposed to be aligning with Europe but are ignoring Eurostat’s advice that the housing version of CPI should include house prices. Presumably on the grounds that it gives too big a number.

Actually inflation is on the rise again

If we look at the numbers we do see signs of a turn higher in the UK inflation rate as shown below.

The all items CPI is 128.0, up from 127.6 in March

The underlying index has in fact been rising since January when it fell to 127.1 and since then it has risen by 0.3 in February,0.2 in March and now 0.2 in April. So if that were to continue it would not be too long before we found ourselves facing inflation back at its target level in yet another “surprise”.

A technical issue called Easter

A downwards push was provided by the timing of Easter this year and the impact it has on airfares.

transport services: prices, overall, rose by 2.4% between March and April 2015, compared with a larger rise of 7.9% a year earlier. The majority of the downward contribution came from air and sea fares. Price changes for these fares between March and April vary notably year on year, with the timing of Easter a likely factor.

Comment

So we arrive at what I consider to be peak deflation mania for the UK. If we review the situation strategically we see that the oil and commodity price falls have stopped for now and the UK Pound £ seems unlikely to keep rising at the rate it has been. The currency issue is complex because of the impact of the strength of the US Dollar but the UK Pound £ has been very strong against other currencies. Tactically I note that last May prices fell by 0.1% on the month before so we arrive at a period where the annual rate of inflation will get an upwards nudge unless anybody has spotted price falls this month.

One slightly odd result of the various machinations is that Euro area inflation at 0% is for once higher than that of the UK. So should it be the Bank of England with negative interest-rates and QE? Actually I think that this is a result of the UK Pound £’s strength but of course the Bank of England may not and could spring a Riksbank style surprise.

Meanwhile those who are buying a house or facing the inflation in the services sector will be singing along with the Who.

I said I can’t explain, yeah
You drive me out of my mind
Yeah, I’m the worrying kind, babe
I said I can’t explain

Which will morph into the perfect song for inflation statistics.

Then I’ll get on my knees and pray
We don’t get fooled again
Don’t get fooled again
No, no!

Apologies for the early version of this which got published by mistake.

Is the success of Juventus this season a metaphor for the economy of Italy?

One of the economic themes of these times is the struggle of the Italian economy which has been in evidence throughout the Euro area. This has been exacerbated by the credit crunch which saw the Italian economy plunge to an annual growth rate of -6.9% at the beginning of 2009 then see the beginnings of a recovery which sadly soon ended as the Italian economy began to contract again as 2011 progressed. So it has been a long hard road which one might reasonably hope should have turned for the better in early 2015. This is because of the oil price fall that took place in the latter part of 2014 and also the fall in the exchange-rate of the Euro.

How is Italy doing?

Looked at in football terms this is a story of two halves so let us open with the positive one.

In the first quarter of 2015 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.3 per cent with respect to the fourth quarter of 2014.

Whilst the UK was disappointed to produce that particular number for Italy it represents the best quarter since the opening one of 2011. The weaker second half comes when we see that in fact it was required to stop the Italian economy being smaller than a year before.

unchanged in comparison with the first quarter of 2014

Indeed if we look for some perspective we see that back in 2011 the first quarter saw a Gross Domestic Product of 405.4 billion Euros (2010 base) whereas the opening quarter of 2015 saw one of 385.25 billion Euros. This means that the economy has shrunk by 5% over this period which is why from time to time we read of public protests and indeed riots in places like Milan and Rome.

Looking Forwards

Is this a new dawn for Italy? Well the Bank of Italy tries to put a positive spin in its economic bulletin but the numbers below remain weak especially if we remember that next year is always bright in official forecasts!

Italian GDP growth should exceed 0.5 per cent this year and be around 1.5 per cent next year

Not much is it? Especially if we factor in the oil price fall and that the Bank of Italy is rather bullish about the impact of the 130 billion Euros of Italian government bonds that it expects to buy as its share of the European Central Bank’s asset purchases or QE program.

the expanded asset purchase programme could raise GDP by more than one percentage point in 2015-16.

So without the favourable winds currently blowing the Bank of Italy would have expected yet another contraction in 2015 and perhaps 2016. Indeed its new indicator the Ita-coin is in fact somewhat downbeat.

In recent months Ita-coin has improved gradually but remains negative, thus reflecting both the advances and the difficulties that have marked the start of the economic recovery.

Business surveys

These show hopeful signs for Italian manufacturing.

Growth in Italy’s manufacturing sector gained further momentum in April, with faster increases in output and new orders recorded. Job creation was sustained, and at a sharp and stronger pace.

The job creation element of this will be especially welcome considering Italy’s persistent unemployment problem. This was reinforced by a stronger performance from the service sector too.

Italy’s service sector enjoyed a positive start to the second quarter, seeing business activity and inflows of new work rise at the fastest rates for ten months. The pace of job creation among services firms meanwhile quickened for the second month in a row, hitting a multi-year high.

Thus we have entered a period where the private-sector surveys are more optimistic than the official forecasts.

Trade

This is a strength of the Italian economy as this mornings data release indicates.

The trade balance in March amounted to +4.0 billion Euros (+487 million Euros for EU area and +3,573 million Euros for non EU countries).

Actually the numbers are flattered by the fact that the oil price had fallen but Italy does have strong industrial sectors one of which had an especially good March as exports of vehicles rose by 28% in March. As it happens the UK did its bit for the UK trade figures as we imported some 7.2% more in the first quarter of 2015 than we had in the same quarter a year before.

What about deficits and debt?

The problem here for Italy is not the size of its fiscal deficit outright which as you can see is a fair bit smaller than that of the UK. From the Bank of Italy.

In 2014, despite the contraction of output, general government net borrowing was practically stable at 3.0 per cent of GDP.

However the “contraction of output” has meant that the hopes of achieving some form of balance and maybe a surplus in this area have been regularly dashed. This means that the size of the national debt has continued to increase.

The ratio of debt to GDP rose by 3.6 percentage points to 132.1 per cent, reflecting among other factors the virtual stagnation of nominal output.

You may note the emphasis on “nominal output” which is yet another hint that central banks want higher consumer inflation to help with public debt burdens. Whereas both the Italian consumer and worker will welcome lower inflation and cheaper prices for fuel and energy.

We can consider this in terms of the Stability and Growth Pact rules where Italy is adhering to the 3% per annum deficit limit. However in the early days of the Greek crisis  the Euro area used a national debt of GDP ratio of 120% as a threshold to avoid embarrassing Italy (and Portugal). For Italy 120% is long gone.

Putting it another way at the end of 2014 then Italy’s national debt at 2.135 Trillion Euros was some two and three-quarter times its annual government tax revenues.

North and South

The economic divergence between the North and South in Italy which I have analysed on here many times is quite marked. It provokes thoughts of its own Euro area style issues and is a reminder of how short its history as a united country actually is.  The Economist has added to the debate with numbers like this.

But the main source of the divergence has been the south’s disastrous performance since then: its economy contracted almost twice as fast as the north’s in 2008-13—by 13% compared with 7%. Themezzogiorno—eight southern regions including the islands of Sardinia and Sicily—has suffered sustained economic contraction for the past seven years.

I often wonder if Italy could split into separate parts after all we are seeing such pressure in both Spain and the UK right now.

Comment

There is a direct comparison with the world of football right now as Juventus have reached the champions league final after a drought since Inter Milan did so (and won) in 2009. Can both or either continue this new trend? For the economy it is good to see that the private-sector surveys look positive albeit that the official one is less so. But somehow Italy needs to throw off the shackles that are described by the Economist below.

between 2001 and 2013 GDP shrank by 0.2%.

That statistic gets even worse when you allow for the fact that the Italian population was expanding over that period by around 7% so per person the situation was even worse.

So whilst I cross my fingers for what is a delightful country and people there are plenty of doubts as to what will happen as the boost from the oil price fall fades.  Yet of course there is another perspective as Italy must look a land of gold and honey from the continent below it as otherwise so many would not be drowning in the Mediterranean Sea trying to get there. A very different perspective as they are obviously not bothered much by the clear risk of a default.

Two years on both Abenomics and QQE are developing a track record of failure

Yesterday I discussed the way that the Greek economy was struggling under the mountain of debt which ironically is described as a rescue package. Well I suppose for French and German banks it was. Today I wish to move onto another country with an enormous public-sector debt burden and that is the land of the rising sun or Nippon. This now amounts to 1.053 quadrillion Yen for central government as of the end of March according to the Ministry of Finance. However Japan retains control over its monetary policy and exchange rate in a way that Greece does not in that it sets its own interest-rate and has its own currency. In a way that is something more honoured in the breach than the observance because if you look at it both the Euro area and Japan have very low interest-rates and both are implementing Quantitative Easing to drive their currencies lower. In one way the Euro area has gone further as it has negative interest-rates which rather intriguingly Japan has consistently resisted.

Number Crunching the debt

The rather extraordinary number for Japan’s national debt if anything gets even worse if we compare it to Japan’s tax revenue which was 50.000 billion Yen or to put it another way Japan would take over 20 years to pay it off if all revenues were used solely for that purpose. That of course would assume that no interest was payable whereas in fact last year it estimates that it paid 23,270 billion Yen on Debt servicing. So if we allow for that we see that it would take well over 30 years to pay off the debt on current tax revenues.

Then we get another problem which is that Japan is still borrowing on a grand scale as expenditure is expected to be 96,342 billion Yen this fiscal year but revenues only 54,525 billion as the cycle goes on. So not only is the situation mind-boggling if you start putting the zeroes on these numbers as they fill the whole page line but you realise that each year it is as Paul Simon put it.

Slip slidin’ away
Slip slidin’ away
You know the nearer your destination
The more you’re slip slidin’ away

What about economic growth?

We await next week’s update but if we recall the promises of the economic and monetary policy being applied in Japan they certainly did not include this. From the IMF.

In Japan, after a weak second half of the year, growth in 2014 was close to zero, reflecting weak consumption and plummeting residential investment.

Now we get to the crux of the problem as economic growth was derailed by the rise in the Consumption Tax last year such that it turned out to be appropriate that it commenced on April Fools Day! Also on the scale of things even if we take the revenue from the total Consumption Tax which is expected to be 17,112 billion Yen you see the scale of the problem. Compared to its expenditures Japan is very under-taxed but when it tries to raise higher taxes the economy splutters.

Time is Running Out

A year ticking by means that Japan runs its deficit and raises its national debt. This might not matter if it was genuinely about to turn a corner in economic growth terms. I will discuss the near future in a moment but if we look further ahead we see the implications of this. The problem is that Japan’s population is shrinking and on the latest estimates that is happening fast as between November last and this April the population fell by 391,000 to 126,691,000. Also it is aging as the proportion of people over 65 rose from 26% to 26.4% over the same period.

I spoke to the Pink Shoe Club (female entrepeneurs) at the House of Lords last night and the subject of care of the elderly came up. Well the Japanese make a much better job of it than we do and for the individuals concerned greater longevity is welcome. But if you project that onto an economy that needs to be dynamic and innovative you see the problem. It has fewer people who on average are getting older. Also Japanese society is quite homogenous and resistant to immigration so that route is closed for now at least.

Consumer Price Inflation

According to the philosophy of Abenomics the cure for this is a good dose of inflation involving a fall in the value of the Yen. A compliant Governor of the Bank of Japan Mr. Kuroda was installed to do this so to bring things right up to date he would have looked at today’s producer price index numbers with dismay as they showed an annual rate of -2.1%. As he spoke earlier today at the Yomiuri International Economic Society  let me use his words.

The last time I addressed this meeting, in April 2013, was immediately after the Bank of Japan’s introduction of Quantitative and Qualitative Monetary Easing (QQE). Two years have passed since then, and the economic and price situation has improved substantially under QQE.

You may note quite a bit of hype here so let me concentrate on inflation alone which is now supposed to be running at an annual rate of 2%.

Although the year-on-year rate of increase in the consumer price index (CPI) had declined, due mainly to the effects of the substantial decline in crude oil prices since last summer, and recently has been about 0 percent, the underlying trend in inflation has steadily been improving

So if you ignore the actual numbers things are going very well?! Some of you may have spotted that QE in Japan has become QQE which can be thought of as why Windscale changed its name to Sellafield. Failure needs a fresh start at least in terms of a name. Indeed after a complex passage we do get a confession of sorts.

That said, when trying to express such expectations in terms of numeric figures, a single figure cannot be easily found…

Ah so things are really good but I cannot put it into numbers (because they do not back this up). We do however get an estimate of what the Bank of Japan thinks it has done.

the policy effects of QQE are such that they are roughly equivalent to those that would arise from making almost ten 0.25 percent cuts in short-term interest rates in one shot under conventional monetary policy.

So it thinks that its policies are equivalent to cutting interest-rates to  below -2% and perhaps to -2.5%.

But then we get to the crux of Kuroda’s problem which is why I have emphasised this bit.

While the decline in crude oil prices exerts positive effects on Japan’s economy……..a favorable environment of inexpensive crude oil prices.

Thus we see exactly the opposite of official policy boosting the economy. If only I was there to ask if higher inflation boosts the economy and lower inflation also boosts it why Japan had a “lost decade” as all it has to do is avoid zero inflation?

You might like to recall at this point that Japans’ economy did not grow at all in 2014 as you probably will not pick that up from these quotes.

Looking ahead, Japan’s economy is expected to continue its recovery trend

Despite these unexpected events, the mechanism of QQE has been operating as intended.

Comment

In a nutshell you could say that Japan’s establishment has stuck its collective head in the sand one more time. Yet right now it should be receiving an extraordinary boost via the fall in oil prices and indeed other commodities. This is a subject I have discussed before and the Wall Street Journal added to it yesterday by pointing out it imports more than 90% of its fossil fuels. Of course this lack of natural resources is also the road to Pearl Harbour and how it got into world war two. But the economic point is that its economy should be leaping forwards right now but instead it has an economic policy called Abenomics which is trying to push prices higher.

If we look at real wages I note the number of references in rising wages in Governor Kuroda’s speech. Except real wages fell by 2.6% in the year to March which means that they have fallen in every month of the two years of QQE now. On that road the policy looks very familiar does it not? Pretty much everywhere real wages are struggling and government policy is invariably to push them lower whilst proclaiming the opposite. Two years on the only record is one of failure. Or as the Japan Times puts it.

Now that economic growth has plateaued, Hirayama says such life cycles have become a thing of the past, with an estimated 36.6 percent of those under 35 now plagued by hiseiki, or irregular employment.

Having raised the issue of world war two it is hard to avoid noticing this from the Japan Times.

Prime Minister Shinzo Abe tried to brush off concerns Thursday that Japan could be dragged into a war involving the United States, saying the envisioned security legislation would enable the Self-Defense Forces to address every situation in a seamless manner to protect Japanese citizens.

As has been pointed out before those “helicopter destroyers” look awfully like aircraft carriers. What could go wrong?