Is the US fiscal stimulus working?

One of the problems of economics is that reality rarely works out like theory. Indeed it is rather like the military dictum that tells us that a battle plan rarely survives first contact with the enemy. However we are currently seeing the world’s largest economy giving us a worked example of the policy being pushed by central bankers. Indeed it rushed to do so as we look back to the Jackson Hole symposium in the summer of 2017.

With tight constraints on central banks, one may expect—or maybe hope for—a more active response of fiscal policy when the next recession arrives.

Back on August 29th of that year I noted a paper presented by Alan Auerbach and Yuriy Gorodnichenko which went on to tell us this.

We find that in our sample expansionary government spending shocks have not been followed by persistent increases in debt-to-GDP ratios or borrowing costs (interest rates, CDS spreads). This result obtains especially when the economy is weak. In fact, a fiscal stimulus in a weak economy may help improve fiscal sustainability along the metrics we study.

Since then those two voices have of course been joined by something of a chorus line of central bankers and their ilk. But there was somebody listening or having the same idea as in short order Donald John Trump announced his tax cuts moving us from theory to practice.

Where are we now?

Led me hand you over to CNBC from two days ago.

The U.S. fiscal deficit topped $1 trillion in 2019, the first time it has passed that level in a calendar year since 2012, according to Treasury Department figures released Monday.

The budget shortfall hit $1.02 trillion for the January-to-December period, a 17.1% increase from 2018, which itself had seen a 28.2% jump from the previous year.

There is a sort of back to the future feel about that as the US returns to levels seen as an initial result of the credit crunch. If we look at the US Treasury website it needs a slight update but gives us an overall picture.

Year-end data from the September 2019 Monthly Treasury Statement of Receipts and Outlays of the United States Government show that the deficit for FY 2019 was $984 billion, $205 billion higher than the prior year’s deficit[3]. As a percentage of GDP, the deficit was 4.6 percent, an increase from 3.8 percent in FY 2018.

So the out-turn was slightly higher but we see something a little awkward. If the US economy was booming as the Donald likes to tell us why was their a deficit in the first place and why is it rising?

We see that on the good side revenues are rising.

Governmental receipts totaled $3,462 billion in FY 2019. This was $133 billion higher than in FY 2018, an increase of 4.0 percent,

But outlays have surged.

Outlays were $4,447 billion, $339 billion above those in FY 2018, an 8.2 percent increase.

Economic Growth

Three, that’s the Magic Number
Yes, it is, it’s the magic number
Somewhere in this hip-hop soul community
Was born three: Mase, Dove and me
And that’s the magic number

It turns out that inadvertently De La Soul were on the ball about the economic growth required to make fiscal policy look successful. So there was method in the apparent madness of President Trump proclaiming that the US economy would grow at an annual rate of 3% or more. In doing so he was mimicking the numbers used in the UK,for example, after the credit crunch to flatter the fiscal outlook. Or a lot more bizarrely ( the UK does at least occasionally grow by 3%) by the current coalition government in Italy.

Switching now to looking at what did happen then as 2018 progressed things looked okay until the last quarter when the annualised growth rate barely scraped above 1%. A brief rally back to target in the opening quarter of last year was followed by this.

Real gross domestic product (GDP) increased at an annual rate of 2.1 percent in the third quarter of 2019 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.0 percent. ( US BEA )

If we now move forwards there is this.

The New York Fed Staff Nowcast stands at 1.1% for 2019:Q4 and 1.2% for 2020:Q1.

News from this week’s data releases decreased the nowcast for 2019:Q4 by 0.1 percentage point and left the nowcast for 2020:Q1 broadly unchanged.

Negative news from international trade data accounted for most of the decrease.

Should this turn out to be accurate then it will be damaging for the deficit because the revenue growth we observed earlier ( 4%) will fade. There is a risk of the deficit ballooning should things weaken further and outlays rise to to social spending and the like if the labour market should turn.So far it has only signalled a slowing of real wage growth.

Cost of the debt

A rising fiscal deficit means that the national debt will grow.

As deficits have swelled, so has the national debt, which is now at $23.2 trillion. ( CNBC )

Or as the Congressional Budget Office puts it.

Debt. As a result of those deficits, federal debt held by the public is projected to grow steadily, from 79 percent of GDP in 2019 to 95 percent in 2029—its highest level since just after World War II. ( care is needed here as it only counts debt held by the public not the total)

But as I pointed out back in August 2017 the baying pack of bond vigilantes seem soundly muzzled these days.

 So we have seen central banks intervening in fiscal policy via a reduction in bond yields something which government’s try to keep quiet. We have individual instances of bond yield soaring such as Venezuela but the last few years have seen central banking victories and defeats for the vigilantes.

So as a consequence we find ourselves in an era of “Not QE” asset purchases and more importantly for today’s purposes a long bond ( 30 year) yield of 2.25% or less than half of what it was at times in 2011. So the debt has grown but each unit is cheap.

The government’s net interest costs are also anticipated to
grow in 2019, increasing by $47 billion (or 14 percent),
to $372 billion.

This means that the total costs are much lower than would have been expected back in the day.

Comment

Has it worked? Party so far in that the economic outcome in the US was better than that in the UK, Europe and Japan. But the “winning” as President Trump likes to put it faded and now we see that economic growth at an expected just over 1% is rather similar to the rest of us except the fiscal deficit and national debt are higher. So whilst it was nice now we look ahead to a situation where it could become a problem. I do not mean in the old-fashioned way of rising bond yields because let’s face it “Not QE” would become “Not bond buying” to get them back lower.

But if you keep raising the debt you need economic growth and should the present malaise continue then the US will underperform the CBO forecasts which expect this.

After 2019, consumer spending and purchases of goods and services by federal, state, and local governments
are projected to grow at a slower pace, and annual output growth is projected to slow—averaging
1.8 percent over the 2020–2023 period—as real output returns to its historical relationship with
potential output.

There is also another problem which the CBO has inadvertently revealed showing that the certainty with which some speak is always wrong.

The largest factor contributing to that change
is that CBO revised its forecast of interest rates downward, which lowered its projections of net interest
outlays by $1.4 trillion.

So the fiscal stimulus has helped so far but now the hard yards begin and they will get a lot harder in any further slow down. In the end it is all about the economic growth.

The Investing Channel

 

 

Some better news for the economy of Italy as it faces up to Carige and Alitalia

For once we have the opportunity to look at some better news for the economy of Italy so let us take it. This came yesterday from the statistics office.

In May 2019 the seasonally adjusted industrial production index increased by 0.9% compared with the previous month.

That is at least something and happened in spite of the fact that the transport production sector declined by 2.5% meaning that manufacturing fell by 0.9%. Unfortunately as we look deeper we see that even a better month has only improved a declining trend.

The percentage change of the average of the last three months with respect to the previous three months was -0.1.
The calendar adjusted industrial production index decreased by 0.7% compared with May 2018 (calendar
working days in May 2019 being the same as in May 2018).

So we see that a better May provides some hope as it also happened in the UK and France

Bond Yields

There has been some relief for Italy from this area too as we note that the benchmark ten-year yield is now 1.7%. This has more than halved since the yield approached 3.7% in mid-October last year and as you can see there has been quite a plunge. Many countries have seen big falls in bond yields but Italy is perhaps the leader of the pack with the size of the fall. Part of this was driven by the news below which was reported by the Financial Times last week.

The European Commission on Wednesday ended weeks of negotiations with Rome by deciding not to trigger a so-called “excessive deficit procedure”, which could ultimately have led to financial sanctions.Italy’s ruling coalition promised to trim back this year’s budget shortfall by €7.6bn, or 0.42 per cent of gross domestic product, pushing the deficit down to 2.04 per cent and ensuring the country does not breach eurozone rules.

Thus those looking for yield piled into the Italian market with such enthusiasm that the two-year yield went negative for a while in response to this. When you look at the potential risks that seems rather mad to me and even the 0.08% as I type this seems much too low as we wonder how much of this will happen?

Italy instead said it would reduce its deficit by collecting an additional €6.2bn in revenues.

But the new apparent deal plus the likelihood that the ECB will add to its 365.4 billion Euro holdings of Italian government bonds ( BTPs) has created quite a bull market.

As a generic this will be very welcome for the government which can issue debt more cheaply. We saw an example of this only yesterday.

More than 80% of the demand for Italy’s 50-year debt issue on Tuesday came from foreign investors, with Germany in the forefront, the head of the Treasury’s debt management office told Reuters.

The 3-billion-euro top-up of the 2.80% March 2067 bond drew bids of more than 17 billion euros, with a final yield of 2.877%.

This is an ongoing job on a large-scale.

Total medium and long-term issuance this year will amount to some 240 billion euros, Iacovoni said ( Reuters )

I am a little unclear as to why Italy is planning this.

Italy is strongly committed to issuing its first dollar bond since 2010 before the end of this year and is also eyeing private placements in other currencies, the head of the Treasury’s debt management office told Reuters.

Maybe it is some sort of response to the plan we looked at from some sections of the government to issue government bonds in a new currency.

Labour Market

There was also some good news earlier this month as we saw the unemployment rate fall into single figures.

The unemployment rate dropped to 9.9% (-0.2 percentage points), the youth rate decreased to 30.5% (-0.7 percentage points).

Also 2019 so far seems to be seeing a pick-up in employment.

In the period from March to May 2019, employment rose compared with the previous quarter (+0.5%, +125
thousand).

Economics lives us to its reputation as the dismal science as we note that with growth hard to find this has implications for productivity. Also as we note elsewhere employment may not mean what we night assume.

Employed persons: comprise persons aged 15 and over who, during the reference week:
worked for at least one hour for pay or profit;

The Outlook

Our positive spin took a bit of a pounding from the European Commission yesterday.

Amid a challenging external environment real GDP growth in 2019 as a whole is forecast to be marginal (0.1%).
In 2020, economic activity should rebound moderately to 0.7% in line with the gradual improvement of the
global trade prospects and benefiting from a positive carryover effect and a calendar effect, given that 2020 has
two working days more than 2019.

Those are small numbers and I note that any improvement next year seems to rely on a calendar effect which will wash out. As Italy grew by 0.1% in the first quarter that is it for the year if this forecast is accurate. Also the forecast was worried about prospects for the labour market and underemployment in particular.

But weak economic activity is likely to weigh on the
labour market as indicated by the rising number of workers supported by the wage guarantee fund (Cassa
Integrazione Guadagni, CIG), which compensates for the income lost due to reduced work hours, and firms’
markedly lower employment expectations.

I also note that the Bank of Italy’s surveys show that Italians fear that unemployment may rise again.

The Banks

This has been quite a saga in the credit crunch era and the travails of Deutsche Bank earlier this week show that the problem extends way beyond the borders of Italy. In fact DB was not the only bank in the news on Monday as an old friend returned. From Reuters.

Italy is struggling to pull together a rescue plan for Carige (MI:CRGI) which the troubled Genoa-based bank needs to avoid a liquidation, two sources familiar with the matter said………..The latest attempt to salvage Carige revolves around a depositor protection fund (FITD) financed by Italian banks which, one of the sources said, would provide some 520 million euros ($583 million) in fresh capital out of a total of 800 million needed to save the bank.

That last number is revealing because I think last time around we were told that it was 600 million. No wonder no-one has been willing to step in. Also I note that FinanzaReport.it suggests this.

although some rumors in the last hours have raised the bar up to 900 million.

Those who recall the Atlante bailout fund will recall that it ended up weakening the other banks and had to call for more cash or Atlante II as we go down a familiar road.

The real issue is that all the dithering and denial means that things do not get sorted and thus the banks continue to be a drag on rather than an aid for growth in the Italian economy. Also the denial problem extends beyood the borders of Italy as the EU Auditors Commission pointed out yesterday.

The 2018 stress test imposed less severe adverse scenarios in countries with weaker economies
and more vulnerable financial systems. …. The
auditors also found that not all vulnerable banks were included in the test and that certain banks
with a higher level of risk were excluded.

I wonder which country was forefront in their minds?

Comment

Whilst there have been some flickers of better news we find ourselves in familiar “girlfriend in a coma” territory sadly. Italy is a lovely country but its economic problems can be symbolised by this from Corriere Della Salla

The government tries to close the game on Alitalia. The scheme is a veiled nationalization of the former flag company, focusing on the establishment of a new company where the majority of the capital will be in public hands. In practice, the process of re-launching the carrier, currently in the commissioning procedure, will have to be Ferrovie dello Stato, with a 35% stake, and the Ministry of Economy, through a 15% stake.

Still for an airline nicknames Always Late In Take-off Also Late In Arrival there was some more hopeful news in the report.

Last month Alitalia was also the most punctual carrier in Europe.

But as we look further ahead the weak birth rate will pose further problems should it continue.

Perhaps Italy should take the chance to claim it is rising to environmental and green challenges via this route

 

What if Italy slips back into an economic recession?

A feature of bond market and debt crises is not only how far the market falls but how long it lasts. This is because as the majority and sometimes vast majority of debt issued has a coupon ( interest) fixed for its term and so fluctuations in the meantime do not matter for them. The catch is that new deficits need to be financed and existing debt needs to be rolled over and it does matter for them. An example of that is provided by Italy which will issue 2 billion Euros of 5 year bond and 2.5 billion of a ten-year one next week and these will be much more expensive than would have been predicted not so long ago. According to the Italian Treasury or Tesoro some 200 billion Euros of maturities are due next year if we ignored the rolling over of Treasury Bills.

Thus you can see how it takes a while for the costs of a bond market decline to build but build they do. The exact amount varies as for example last Friday we were looking at the nadir for the market so far with a ten-year yield of 3.8% and as I type this it is 3.5%, but both spell trouble. We see regular examples of why this may be bad but let us move to an area where contagion is possible.

The Italian banking system holds €350 billion of government bonds. If 10-year government-bond yields hit 4%, banks’ equity capital will just about equal their nonperforming loans. ( Felix Zulauf in Barrons)

Did anybody mention the Italian banks?

You may not be surprised to read that the ECB press conference yesterday was pretty much a Q&A session on Italy and during it President Draghi told us this.

However we have now the bank lending survey of this quarter. It does say that basically, terms and conditions applied by Italian banks on new loans to enterprises and households for house purchases, tightened. Terms and conditions – so not standards – terms and conditions tightened in the third quarter of 2018, driven by a higher cost of funds and balance sheet constraints.

So things have got tighter for the Italian banks and they have passed it the higher costs to both personal and corporate borrowers. The subject did not go away.

On Italy, I don’t have a crystal ball; I don’t have any idea whether it’s 300 or 400 or whatever. So it’s difficult. But certainly these bonds are in the banks’ portfolios. If they lose value, they are denting into the capital position of the banks; that’s obvious, so that’s what it is.

This was in response to a (poor) question about at what level of the yield spread would the Italian banks hit trouble and the suggestion it might be 400? A better question would be based on Italian yields alone. Also central bankers are hardly likely to tell you a banking crisis is in its way! But you may note that Mario mentioned 3% as opposed to 4% to perhaps cover himself. Also as a former Governor of the Bank of Italy and the Draghi in the Draghi Laws which cover Italian banking his “crystal ball” should be one of the best around.

This brings me to the issue of the Atlante Fund where Italian banks essentially bailed out other Italian banks. We do not seem to get any updates on it now. Can anybody think what might be happening to a portfolio of non-performing Italian bank loans right now? I recall being told that the deals to take such loans were really good value and that my fears were over done. Now I note that the same Unicredit that I called a Zombie bank around 7 years ago on Sky News looks rather like a Zombie bank to me if you look at all the cash piled in since then and the current share price. This whole issue has been a banking crisis in slow motion so let me remind you of the latter parts of my timeline for a banking collapse.

9. Debt costs of the relevant sovereign nation or nations rise.

10. Consequently that nation finds that its credit rating is downgraded.

11. It is announced that due to difficult financial times public spending needs to be trimmed and taxes such as Value Added Tax need to be raised. It is also announced that nobody could possibly have forseen this and that nobody is to blame apart from some irresponsible rumour mongers who are the equivalent of terrorists. A new law is mooted to help stop such financial terrorism from ever happening again.

12. Some members of the press inform us that bank directors were both “able and skilled” and that none of the blame can possibly be put down to them as they get a new highly paid job elsewhere.

13. Former bank directors often leave the new job due to “unforseen difficulties”.

The Budget Plan

If we move on from the “doom loop” that exists between the Italian economy and its banks we get the current fiscal plan which is to run a deficit of 2.4% of GDP ( Gross Domestic Product). Some number-crunching has been undertaken on this by Olivier Blanchard at the Peterson Institute with some intriguing results.

So, take 0.8 percent of GDP to be the relevant measure of expansion………..To give the government the benefit of the doubt, take a multiplier of 1.5. Then, one would expect an increase in output of 1.5 * 0.8 = 1.2 percent on account of the fiscal stimulus.

So we are in the world, or at least what is left of it, of economics 101 where the extra fiscal stimulus will increase GDP by 1.2%. However there is a catch.

Turn to the other half of the story, the increase in interest rates. Since mid-April, Italian bond yields have risen by about 160 basis points……….Recent estimates of the effects of the OMT suggest slightly lower numbers for Italy, in the region of a 0.8 percent output contraction for a 100-basis-point increase in bond rates.

Some of you may have already completed the mathematical implication of this.

Putting fiscal multiplier effects and contractionary interest rate effects together—and being generous about the size of the multiplier and conservative about the effect of the interest rate increase—arithmetic suggests that the total effect on growth will be 0.8 * 1.5 – 0.8 * 1.6 ≈ –0.1. While this number comes with a large uncertainty band, the risks are skewed to the downside.

So via his methodology up is the new down. Or more formally the fiscal expansion seems set to weaken and not boost GDP.

One cautionary note is Olivier’s own record in this area as he was Chief Economist at the IMF when it was involved in the disastrous fiscal experiment in Greece which he sweeps up in this paper as “many politicians and economists argued”. This is of course one of the longest running feature of the credit crunch era as encapsulated by point 12 of my banking crisis time line above.

Comment

The issues above are brought into sharper focus if we note this Mario Draghi and the ECB yesterday.

while somewhat weaker than expected

That rather contradicted the by now usual “broad-based expansion” line which was backed up by some misleading analysis of the monetary situation. The minor swerve was the claim that M3 growth had risen by 0.1% which is true but only because August had been revised lower. The more major omission was the absence of a reference to it being 5.1% last September,

So if we add the expected slow down to the already troubled Italian situation we get a clearer idea of the scale of the problem. If we look back we see that GDP growth has been on a quarterly basis 0.3% and then 0.2% so far this year and the Monthly Economic Report tells us this.

The leading indicator is going down slightly suggesting a moderate pace for the next months.

They mean moderate for Italy.So we could easily see 0% growth or even a contraction looking ahead as opposed some of the latest rhetoric suggesting 3%  per year is possible. Perhaps they meant in the next decade as you see that would be an improvement.

 

 

Are improving UK Public Finances a sign of austerity or stimulus?

One of the features of the credit crunch era is that it brought the public finances into the news headlines. There were two main reasons for this and the first was the economic slow down leading to fiscal stabilisers coming into effect as tax revenues dropped. The second was the cost of the bank bailouts as privatisation of profits turned into socialisation of losses. The latter also had the feature that establishments did everything they could to keep the bailouts out of the official records. For example my country the UK put them at the back of the statistical bulletin hoping ( successfully) that the vast majority would not bother to read that far. My subject of earlier this week Portugal always says the bailout is excluded before a year or so later Eurostat corrects this.

The next tactic was to forecast that the future would be bright and in the UK that involved a fiscal surplus that has never turned up! It is now rather late and seems to have been abandoned but under the previous Chancellor of the Exchequer George Osborne it was always around 3/4 years away. This meant that we have had a sort of stimulus austerity where we know that some people and at times many people have been affected and experienced cuts but somehow the aggregate number does not shrink by much if at all.

If we move to the economy then there have been developments to boost revenue and we got a clear example of this yesterday. Here is the official retail sales update.

Compared with August 2016, the quantity bought increased by 2.4%; the 52nd consecutive month of year-on-year increase in retail sales.

As you can see we have seen quite a long spell of rising retail volumes providing upward momentum for indirect taxes of which the flagship in the UK is Value Added Tax which was increased to 20% in response to the credit crunch. Actually as it is levied on price increases too the development below will boost VAT as well.

Store prices increased across all store types on the year, with non-food stores and non-store retailing recording their highest year-on-year price growth since March 1992, at 3.2% and 3.3% respectively.

There is one cautionary note is that clothing prices ( 4.2%) are a factor and we are at a time of year where the UK’s statisticians have got themselves into a mess on this front. In fact much of the recent debate over inflation measurement was initially triggered by the 2010 debacle on this front.

Public Sector Pay

One area of austerity was/is the public-sector pay cap where rises were limited to 1% per annum, although we should say 1% per annum for most as we saw that some seemed to be exempt. However this seems to be ending as we start to see deals that break it. In terms of the public finances the Financial Times has published this.

 

The IFS has estimated that it would cost £4.1bn a year by 2019-20 if pay across the public sector were increased in line with inflation from next year rather than capped at 1 per cent……….Figures published in March by the Office for Budget Responsibility, the fiscal watchdog, suggest that if a 2 per cent pay rise were offered to all public sector workers rather than the planned 1 per cent cap, employee numbers would need to be reduced by about 50,000 to stay within current budgets.

Today’s Data

The UK data this week has been like a bit of late summer sun.

Public sector net borrowing (excluding public sector banks) decreased by £1.3 billion to £5.7 billion in August 2017, compared with August 2016; this is the lowest August net borrowing since 2007.

This combined with a further upgrade revision for July meant that we are now slightly ahead on a year on year basis.

Public sector net borrowing (excluding public sector banks) decreased by £0.2 billion to £28.3 billion in the current financial year-to-date (April 2017 to August 2017), compared with the same period in 2016; this is the lowest year-to-date net borrowing since 2007.

Revenue

There was good news on the income tax front as the self-assessment season was completed.

This month, receipts from self-assessed Income Tax were £1.3 billion, taking the combined total of July and August 2017 to £9.4 billion; an increase of £0.4 billion compared with the same period in 2016. This is the highest level of combined July and August self-assessed Income Tax receipts on record (records began in 1999).

So we had an increase of over 4% on a year on year basis. This seems to be the state of play across overall revenues.

In the current financial year-to-date, central government received £280.4 billion in income; including £209.4 billion in taxes. This was around 4% more than in the same period in the previous financial year.

There is one area which continues to stand out and in spite of the talk and comment about slow downs it remains Stamp Duty on land and property. So far this financial year it has raised some £5.9 billion which is up £0.9 billion on the same period in 2016. A factor in the increase will be the rise in Stamp Duty rates for buy-to lets.

Expenditure

This rose at a slower rate which depending on the measure you use close to or blow the inflation rate.

Over the same period, central government spent £302.7 billion; around 3% more than in the same period in the previous financial year.

The subject of inflation remains a topic in another form as the UK’s inflation or index linked debt is getting expensive. This is due to the rises in the Retail Price Index which will be the major factor in UK debt interest rising by £3.8 billion to £26.3 billion in the financial year so far. So much so there is an official explainer.

Both the uplift on coupon payments and the uplift on the redemption value are recorded as debt interest paid by the government, so month-on-month there can be sizeable movements in payable government debt interest as a result of movements in the RPI.

The next area where there has been something of a surge raises a wry smile. Contributions to the European Union have risen by £1 billion to £4.6 billion this financial year so far.

Comment 

We can see the UK’s journey below.

Current estimates indicate that in the full financial year ending March 2017 (April 2016 to March 2017), the public sector borrowed £45.6 billion, or 2.3% of gross domestic product (GDP). This was £27.6 billion lower than in the previous full financial year and around one-third of that borrowed in the financial year ending March 2010, when borrowing was £152.5 billion or 10.0% of GDP.

We seem so far this year to be borrowing at the same rate as last year. So you could easily argue we have had a long period of stimulus ( fiscal deficits). Yet only an hour after today’s numbers have been released we seem to have moved on.

Chancellor should have room to ease austerity in November Budget, says John Hawksworth

Oh and remember the first rule of OBR ( Office of Budget Responsibility) Club? From the Guardian.

Back in March, the OBR forecast that the budget deficit would rise to around £58 billion this year, but the latest data suggest that it may be similar to the £46 billion outturn for 2016/17.

So let us enjoy a week where the data has been better as we mull the likely consequences of a minority government for public spending. Meanwhile here are the national debt numbers and as I pointed out earlier they omit £300 billion ( RBS).

Public sector net debt (excluding public sector banks) was £1,773.3 billion at the end of August 2017, equivalent to 88.0% of gross domestic product (GDP), an increase of £150.9 billion (or 4.8 percentage points as a ratio of GDP) on August 2016.

Oh and £108.8 billion of the increase is the “Sledgehammer” QE of Mark Carney and the Bank of England. On that subject here is Depeche Mode.

Enjoy the silence

Me on Core Finance TV

http://www.corelondon.tv/central-banks-infinity-beyond/

.

The General Election and its impact on the UK Public Finances

Firstly let me start today by expressing my deepest sympathies to those affected by last night’s dreadful attack at Manchester Arena. I do understand some of the feelings of those affected as I was just around the corner from the IRA Bishopgate bomb in the City many years ago. This time around though things are even worse with the apparent targeting of children at a music concert.

Today I wish to do a different form of travelling in time as it will be helpful to remind ourselves of the state of play some 7 years ago as we approached a General Election. From April 29th 2010.

If you look at the three published manifestoes there is a hole in each of them of a similar size, £30 billion. So in truth none of them are being transparent and honest in their spending pledges. So the answer to the question what are they not telling us? Is in economic terms £30 billion. This is just over 2% of our Gross Domestic Product (GDP). Put another way it is around a quarter of the annual cost of the National Health Service.

So is the standard of debate, manifesto and honesty any better this time around? In terms of scale maybe a little as we see the woeful efforts from back then.

The worst offender is the Liberal Democrats who have not explained where they will find £79 billion of spending cuts which is 5.4% of national income.The Conservatives plan spending cuts but have not explained where they will find £71 billion of them which is 4.8% of national income. Labour plan spending cuts but have not explained. Labour have £59 billion of spending cuts which they have not explained which is 4.1% of national income.

What about now?

We can permit ourselves an opening sigh of relief as the numbers are much lower now as this is what we thought was the situation back then.

Our fiscal deficit for the last year was £163 billion which is 11.6% of our economic output (Gross Domestic Product or GDP).

That compares with £48.7 billion last year. So we have in fact made quite a lot of progress although much more slowly than promised as we were supposed to be in surplus by now. Oh and in a sign of how reality changes over time we now think we borrowed £151 billion in the peak year.

As to the situation post election there is more smoke than clarity but I think whoever wins the Institute of Fiscal Studies have this right.

A balanced budget can apparently now wait until the middle of the next decade.

In political terms that is beyond the furthest star! As to the detail here is the IFS again.

Labour promised £75 billion a year in additional spending and £50 billion of additional taxes. The Liberal Democrats are also aiming for tens of billions of pounds in extra spending partially funded by more tax. Yesterday’s Conservative manifesto was much more, well, conservative………The Conservatives do not appear to have felt the need to spell out much detail. But they have left themselves room for manoeuvre.

The “room for manoeuvre” has been at least partly used over the issue of social care and what has become called the Dementia Tax.Which is currently unchanged or very changed and was always intended to have a cap or has a new one depending on your point of view. Personally I think the official denials of any change are the clearest guide. As to Labour there are clear plans to spend more of which an example from its Manifesto is below.

we will establish a National Investment Bank that will bring in private capital finance to deliver £250 billion of lending power.

This sounds rather like the Juncker Plan from the Euro area but we do not know how much public borrowing there will be or why private sector capital is not supporting such investment already? There are also plans for rail and water nationalisation which as the Guardian points out would work if the UK was/is a hedge fund.

At Severn Trent, for example, the dividend yield is 3.4% at the current share price. Borrowing at 1.5% to buy an asset yielding 3.4% is not the worst trade in the world. And the state, if it wanted to act like a supercharged private equity house, would be able to juice up returns by refinancing the companies’ debt at a lower rate.

In case some of you read the piece the author was somewhat confused about UK Gilt yields but somehow ended up near the right answer. We can presently borrow at 1.6% for fifty years ( for some reason they looked at 10 years) so the doubt in the issue is whether the public sector could get the same rate of return as the private sector. But the elephant in the room is the £60 billion or so required to buy the companies in the first place. They could of course just take them but that would presumably scupper the private capital for the National Investment Bank.

As to the NHS then there seems to be little variety about.

While precise comparisons are hard, there is strikingly little difference between Labour and the Conservatives in their funding promises for the NHS.

The Conservatives are promising a real increase of £8 billion over the next five years. That sounds like a lot but it won’t go far. Nor will Labour’s only slightly less modest offering.

Although the Liberal Democrats do offer something of an alternative.

Increasing spending on the NHS and social care, using the proceeds of a 1p rise in Income Tax.

Actually in a groundhog style way the latter part of that sentence does take us back our 7 years again as the musical theme for whoever is in government next comes from the Beatles.

If you drive a car, I’ll tax the street
If you try to sit, I’ll tax your seat
If you get too cold I’ll tax the heat
If you take a walk, I’ll tax your feet

Today’s data

Let us open with the good news.

Since the previous bulletin, the provisional estimate of central government net borrowing for the full financial year ending March 2017 has been revised down by £3.5 billion

Much of this was from higher tax receipts which particularly in the case of VAT may hint we did a little better than previously thought.

current receipts were revised upwards by £2.4 billion; VAT receipts were revised up by £1.7 billion between January and March 2017, largely due to higher than forecast cash receipts in April 2017; and Income Tax and National insurance contributions received in March were revised upwards by £0.5 billion and £0.3 billion respectively

As to April itself it was not so good.

Public sector net borrowing (excluding public sector banks) increased by £1.2 billion to £10.4 billion in April 2017, compared with April 2016;

Tax receipts were higher but in a potentially worrying signal it was debt costs which moved the numbers as we spent an extra £2.1 billion in this area this April. We are not told why but I expect it to be the rise in inflation and in particular the rise in index or inflation linked Gilts driving this especially as they are linked to the Retail Price Index.

Comment

As we look back that is much that is familiar about the UK Public Finances in a General Election campaign. The reality is that our politicians do not think we are not capable of accepting or dealing with the truth so we get presented with what they think we will take rather than what they think might happen. There are more holes in the various manifestoes than in a Swiss cheese!

However since the 2010 election we have made a fair bit of progress in reducing the level of annual borrowing although the concept of balance or a surplus was a mirage at best. This means that you might like to sit down as you read the change in another set of numbers. First back then it was £1.03 trillion or 65.7% of GDP. And now.

The amount of money owed by the public sector to the private sector stood at just above £1.7 trillion at the end of April 2017, which equates to 86.0% of the value of all the goods & services currently produced by the UK economy in a year (or gross domestic product (GDP)).

We should be grateful that the cost of borrowing is so low as this has provided an enormous windfall over the period to our public finances. Odd that the Bank of England does not explicitly present that as a gain from its £435 billion of Gilt purchases is it not?