How much do the rising national debts matter?

Quote

A symptom of the economic response to the Covid-19 virus pandemic is more government borrowing. This flows naturally into higher government debt levels and as we are also seeing shrinking economies that means the ratio between the two will be moved significantly. I see that yesterday this triggered the IMF (International Monetary Fund) Klaxon.

This crisis will also generate medium-term challenges. Public debt is projected to reach this year the highest level in recorded history in relation to GDP, in both advanced and emerging market and developing economies.

Firstly we need to take this as a broad-brush situation as we note yet another IMF forecast that was wrong, confirming another of our themes.

Compared to our April World Economic Outlook forecast, we are now projecting a deeper recession in 2020 and a slower recovery in 2021. Global output is projected to decline by 4.9 percent in 2020, 1.9 percentage points below our April forecast, followed by a partial recovery, with growth at 5.4 percent in 2021.

It is hard not to laugh. At the moment things are so uncertain that we should expect errors but the issue here is that the media treat IMF forecasts as something of note when they are regularly wrong. Be that as it may they do give us two interesting comparisons.

These projections imply a cumulative loss to the global economy over two years (2020–21) of over $12 trillion from this crisis………Global fiscal support now stands at over $10 trillion and monetary policy has eased dramatically through interest rate cuts, liquidity injections, and asset purchases.

Being the IMF we do not get any analysis on why we always seem to need economic support.

What do they suggest?

Here come’s the IMF playbook.

Policy support should also gradually shift from being targeted to being more broad-based. Where fiscal space permits, countries should undertake green public investment to accelerate the recovery and support longer-term climate goals. To protect the most vulnerable, expanded social safety net spending will be needed for some time.

Readers will have differing views on the green washing but that is simply an attempt at populism which once can understand. After all if you has made such a hash of the situation in Argentina and Greece you would want some PR too. That leads me to the last sentence, were the poor protected in Greece and Argentina under the IMF? No.

The IMF has another go.

Countries will need sound fiscal frameworks for medium-term consolidation, through cutting back on wasteful spending, widening the tax base, minimizing tax avoidance, and greater progressivity in taxation in some countries.

Would the “wasteful spending” include the part of this below that props up Zombie companies?

and impacted firms should be supported via tax deferrals, loans, credit guarantees, and grants.

Now I know it is an extreme case but this piece of news makes me think.

BERLIN (Reuters) – German payments company Wirecard said on Thursday it was filing to open insolvency proceedings after disclosing a $2.1 billion financial hole in its accounts.

You see the regulator was on the case but….

German financial watchdog #Bafin last year banned short selling in its shares, and filed a criminal complaint against FT journalists who had written critical pieces. .. ( @BoersenDE)

Whereas now it says this.

The head of Germany’s financial watchdog says the Wirecard situations is “a disaster” and “a shame”. He accepts there have been failings at his own institution. “I salute” those journalists and short-sellers who were digging out inconsistencies on it , he says. ( MAmdorsky )

As you can see the establishment has a shocking record in this area and I have personal experience of it blaming those reporting financial crime rather than the criminals. I raise the issue on two counts. Firstly I am expecting a raft of fraud in the aid schemes and secondly I would point out that short-selling has a role in revealing financial crime. Whereas the media often lazily depict it as being a plaything of rich financiers and hedge funds. Returning directly to today’s theme the fraud will be a wastage in terms of debt being acquired but with no positive economic impulse afterwards.

Still I am sure the Bank of England is not trying to have its cake and eat it.

Join us on 30 June for an interactive webinar with restaurateur, chef and The Great British Bake Off judge, @PrueLeith . Find out more and register for your place here: b-o-e.uk/2CsGokX

Debt is cheap

The IMF does touch on this although not directly.

monetary policy has eased dramatically through interest rate cuts, liquidity injections, and asset purchases.

It does not have time for the next step, although it does have time for some rhetoric.

In many countries, these measures have succeeded in supporting livelihoods and prevented large-scale bankruptcies, thus helping to reduce lasting scars and aiding a recovery.

Then it tip-toes around the subject in a “look at the wealth effects” sort of way.

This exceptional support, particularly by major central banks, has also driven a strong recovery in financial conditions despite grim real outcomes. Equity prices have rebounded, credit spreads have narrowed, portfolio flows to emerging market and developing economies have stabilized, and currencies that sharply depreciated have strengthened.

Let me now give you some actual figures and I am deliberately choosing longer-dated bonds as the extra debt will need to be dealt with over quite a period of time. In the US the long bond ( 30 years) yields 1.42%, in the UK the fifty-year Gilt yields 0.43%, in Japan the thirty-year yield is 0.56% and in Germany it is -0.01%. Even Italy which is doing its best to look rather insolvent only has a fifty-year yield of 2.45%

I know that it is an extreme case due to its negative bond yields but Germany is paying less and less in debt interest per year. According to Eurostat it was 23.1 billion in 2017 but was only 18.5 billion in May of this year. Care is needed because most countries pay a yield on their debt but presently the central banks have made sure that the cost is very low. Something that the IMF analysis ( deliberately ) omits.

Comment

So we are going to see lots more national debt. However the old style analysis presented by the IMF has a few holes in it. For a start they are comparing a stock (debt) with an annual flow (GDP). For the next few years the real issue is whether it can be afforded and it seems that central banks are determined to make it so. Here is yet another example.

Brazil may experiment with negative interest rates to combat a historic recession, says a former central bank chief who presided over some of the highest borrowing costs in the country’s recent history ( @economics)

That is really rather mindboggling! Brazil with negative interest-rates? Anyway even the present 2.25% is I think a record low.

If we go back to debt costs then we can look at the Euro area where they were 2.1% of GDP in 2017 but are expected to be 1.7% over the next year. Now that does not allow for the raft of debt that will be issued but of course a few countries will be paid to issue ( thank you ECB!). The outlier will be Italy.

Looking further ahead there is the capital issue as this builds up. I do not mean in terms of repayment as not even the Germans are thinking of that presently. I mean that as it builds up it does have a psychological effect which is depressing on economic activity as we learnt from Greece. Which leads onto the final point which is that in the end we need economic growth, yes the same economic growth which even before the pandemic crisis was in short supply.

 

How much extra will the UK government borrow?

A feature of our economic life going forwards will be much higher levels of national debts. This is being driven by much higher levels of government spending which will lead to a surge in fiscal deficits. That is before we even get to lower tax receipts a hint of which has been provided by Markit with its PMI reports this morning.

Simple historical comparisons of the PMI with GDP indicate that the April survey reading is consistent with GDP falling at a quarterly rate of approximately 7%. The actual decline in GDP could be even greater, in part because the PMI excludes the vast majority of the self-employed and the retail sector, which have been especially hard-hit by
the COVID-19 containment measures

I think you can see for yourselves what that will do to tax receipts and that will add to the falls in revenue from the oil market. After all how do you tax a negative price? As an aside Markit do not seem to have noticed that the economists they survey are wrong pretty much every month. They seem to have to learn that every month.

The UK in March

Whilst the world has moved on we can see that the UK government was already spending more before the virus pandemic fully arrived,

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in March 2020 was £3.1 billion, £3.9 billion more than in March 2019; the highest borrowing in any March since 2016.

A further push was given to an existing trend.

Borrowing in the latest full financial year was £48.7 billion, £9.3 billion more than in the previous financial year.

Because of the situation we find ourselves in let us in this instance peer into the single month data for March.

In March 2020, central government receipts fell by 0.7% compared with March 2019 to £67.2 billion, including £47.5 billion in tax revenue.

That is a change and the actual situation is likely to be worse due to the way the numbers are collected.

These figures are subject to some uncertainty, as the accrued measures of both Value Added Tax (VAT) and Corporation Tax contain some forecast cash receipts data and are liable to revision when actual cash receipts data are received.

By contrast spending soared.

In March 2020, central government spent £72.6 billion, an increase of 11.2% on March 2019.

Also one big new scheme is not yet included.

We have not yet included central government expenditure associated with the coronavirus job retention scheme, some of which is expected to relate to March 2020.

Tucked away in the detail was quite a shift in the structure of the UK public-sector.

In March 2020, central government transferred £13.6 billion to local government in the form of a current grant. This was £4.2 billion more than in March 2019, is mainly to fund additional support because of the COVID-19 pandemic, and represents the highest March transfer on record.

There was also a rise in social benefits from £8.2 billion to £9.2 billion in another signal of a slowing economy.

One warning I would make is that Stamp Duty receipts at £1 billion are supposed to be the same as March 2019, does anyway believe that?

Looking Ahead

This morning also brought some strong hints as to what the UK government thinks.

The UK Debt Management Office (DMO) is today publishing a revision to its 2020-21 financing remit covering the period May to July 2020. In line with the revision to the DMO’s financing remit announced by HM Treasury today, the DMO is planning to raise £180 billion during the May to July 2020 (inclusive) period, exclusively through issuance of conventional and index-linked gilts.

They are hoping that it will prove to be one higher burst of borrowing.

In order to meet the immediate financing needs resulting from the government’s response to COVID-19, it is expected that a significantly higher proportion of total gilt
sales in 2020-21 will take place in the first four months of the financial year (April to July 2020).

If we look back we can see that they planned to issue some £156 billion in the whole financial year previously whereas now we plan to issue some £225 billion by the end of July. This is because we are already issuing some £45 billion this month.

We can add to this flashes of examples of where some of that money will be spent. Here is the Department of Work and Pensions or DWP from yesterday.

Around 1.8 million new benefits claims have been made since mid-March – over 1.5 million for #UniversalCredit

Also the amounts are now higher.

We’ve increased #UniversalCredit, making people up to £1,040 better off a year and are doing all we can to make it as straightforward as possible for people to claim a benefit, easing some of the worry that many are facing right now:

National Debt

As we will not be seeing numbers this low again and we need some sort of benchmark here we go.

At the end of March 2020, the amount of money owed by the public sector to the private sector stood at approximately £1.8 trillion (or £1,804.0 billion), which equates to 79.7% of gross domestic product (GDP). Though debt has increased by £30.5 billion on March 2019, the ratio of debt to GDP has decreased by 1.0 percentage point, as UK GDP has grown at a faster rate than debt over this period.

As you can see the increase in debt over the past year will be happening each month now and with GDP falling the ratio will sing along with Fat Larry’s Band.

Oh zoom, you chased the day away
High noon, the moon and stars came out to play
Then my whole wide world went zoom
(High as a rainbow as we went flyin’ by)

Comment

We are seeing fiscal policy being pretty much dully deployed. If we consider this from economic theory we are seeing the government attempting to step in and replace private sector spending declines. That means not only will the deficit balloon but the number we compare it too ( GDP) will drop substantially as well. We should avoid too much panic on the initial numbers as the real issue going forwards will be the long-term level of economic activity we can maintain which we will only find out in dribs and drabs. One example has been announced this morning as the construction company Taylor Wimpey has announced it will restart work in early May.

Next comes the issue of spurious accuracy which has two factors. There are issues with the public finances data at the best of times but right now they are there in spades. To be fair to our official statisticians they have made the latter point. So messages like this from the Resolution Foundation are pie in the sky.

But the Government’s financing needs could reach as high as £500bn if the lockdown last for six months, or £750bn if it last for 12 months.

We struggle to look three months ahead and a year well it could be anything.

One thing we should welcome is that the UK continues to be able to borrow cheaply. Yesterday £6.8 billion of some 2024 and 2027 Gilts and had to pay 0.12% and 0.16% respectively. So in real terms we could sing along with Stevie Nicks.

What’s cheaper than free?
You and me

That brings me to the other side of this particular balance sheet which is the rate at which the Bank of England is buying Gilts to implicitly finance all of this. By the end of today it will be another £13.5 billion for this week alone. I have given my views on this many times so let me hand you over to the view of Gertjan Vlieghe of the Bank of England from earlier.

I propose that these types of discussions about monetary financing definitions are not useful. One person
might say we have never done monetary finance, another might say we are always doing monetary finance,
and in some sense both are correct.

Nobody seems to have told him about the spell when UK inflation want above 5% post the initial burst of QE.

 Instead, the post-crisis recovery was generally characterised by inflation being too weak, rather
than too strong.

Anyway I dread to think what The Sun would do if it got hold of this bit.

If we were the central bank of the Weimar Republic or Zimbabwe, the mechanical transactions on our
balance sheet would be similar to what is actually happening in the UK right now

The Investing Channel

 

 

UK Budgets end up having no fiscal rules

This morning has seen something of a think tank old reliable in play. The Institute for Fiscal Studies has put out a press release on the issue of fiscal rules in the UK so let us take a look. The emphasis is theirs.

On current policy borrowing next year could be £63 billion, £23 billion more than the most recent official forecast and £19 billion more than our estimate of borrowing this year. With borrowing not forecast to fall before 2022–23 it is not clear that the manifesto pledge to target current budget balance three years out would be met even under current policy.

The drama fades with the use of could which reminds me of this from Scritti Politti.

Nothing, oh nothing
Because baby, baooo
I’m a would be
W. O. O. D
I’m a would be would be
B. E. E. Z

Actually if you look at the numbers the situation has improved by £4 billion as one of my themes is in play.

If the pattern observed in the first ten months of the financial year continues for the next two, government borrowing will be £44 billion this year. This would be £3.5 billion lower than implied by the OBR’s restated March 2019 forecast.

Yes the first rule of OBR club is that the OBR is always wrong. In fact the accuracy of its forecasts is the exact opposite of the seriousness with which its missives are received by the chattering and think tank classes. The problem here is partly one of spurious accuracy as the numbers are far more doubtful than it implies. Also a collective one that it gives the impression that it knows things that it would be more honest to say are unknown and indeed unknowable. I did warn at its inception that it would turn out to be like the Congressional Budget Office which in theory is a great idea, but in practice I simply note that it has changed its forecasts recently by one trillion dollars due to lower US Bind yields and hence debt costs. Or the size of President Trump’s fiscal boost.

Indeed the IFS press release shows a clear case of theory crumbling in practice. So let us start with the theory.

Fiscal targets can help guide and constrain policy and ensure sustainability.

And now the practice.

 There have now been 16 fiscal targets announced over the last decade.

Actually it gets worse.

 If the target to balance the current budget were abandoned in this Budget it would be the shortest lived of them all. Abandoning it now would surely undermine any credibility attached to fiscal targets set by this government.

Now  the second sentence just looks silly after the one in bold above. Actually it has its problems even without that as there have been two major changes for the government. Firstly that Chancellor who set the rules has departed and secondly we have a government with a solid parliamentary majority as opposed to being a minority one.

Whilst I am looking at the problems here let me slay another beast.#

The Chancellor has a fiscal target to ensure that current spending is no higher than tax receipts, and so borrowing is for investment only.

Anyone with even a cursory knowledge of the public finances will know that “current spending” is a vague, vacuous beast hard to specify. Indeed both Goodhart’s Law and the Lucas Critique imply that under such a rule investment may not be what we think it is.Some bright spark will be dispatched to make sure that favourite schemes qualify.

The Trend

The IFS have picked out the nearest date to the EU Leave vote they can without being too indiscreet and calculated this.

Then, the Government was forecasting an overall budget surplus of £10 billion in 2019–20, whereas we are now on course for borrowing to run at around £44 billion: an increase of almost £55 billion.

Along the way they are kind enough to demonstrate again my first rule of OBR Club.

back in March 2016, the OBR was assuming that growth would by now have returned to the robust real growth rates of about 2% annually that were considered normal before the crisis.

There are all sorts of begged questions here. For example did the EU Leave vote reduce growth? Probably via the higher inflation that the Bank of England encouraged. But it is also true that we have seen growth slow downs elsewhere and more recently we have seen a fiscal boost.

Although I note the IFS is unable to avoid a point I have been making which is that another indicator tax revenues suggest the economy has been doing better than the GDP numbers imply.

Instead, revenues have held up remarkably well in the face of low growth since the 2016 referendum.

Indeed in one of its never-ending investigations into its own mistakes the OBR has been on the case too.

 They highlight that household spending has proved more robust than expected, boosting VAT revenues, and capital allowances have been used less, increasing corporation tax revenues.

Although care is needed as whilst bad is bad so can good be.

While this has actually worked to boost tax revenues in the short run, it will disguise a negative long-run effect as depressed investment now gradually feeds into lower growth and therefore reduced tax revenues in the future.

In fact in the IFS world good may be even worse than bad. I would simply point out that whilst in theory we want higher investment we learn again and again that such definitions can be unreliable in practice.

A Missing Piece

My jigsaw would start with this piece as opposed to it being tucked away towards the bottom of the monthly report and only 3 words in the press release.

On the other hand, the cost of servicing the UK’s debt has been lightened by enduring record-low interest rates. As a consequence, debt interest spending is on course to be over £4 billion lower than what the OBR forecast in March 2016. And this is despite higher than forecast borrowing in the intervening period.

Let me put this another way. I recall the original OBR forecasts and they would have the Gilt yield they use about 4% higher than what it is now. Typically they look at a 15 year yield which is 0.67% as I type this as opposed to more like 5%. Of course for infrastructure purposes we should be looking much longer but these days that does not make the difference it used to as the 50 year yield is 0.76%. Or if you prefer the yield curve is pretty flat.

Whatever happened to those who were all over social media about the yield curve?

We can out it another way which is the longest-dated UK Gilts yield the same as Bank Rate if you are willing to overlook 0.01% which is an extraordinary development when it is a mere 0.75%.

Comment

There are several lessons here and let me do a song from think tanks like the IFS and Resolution Foundation to government about fiscal rules.

Here I am, I’m playing daydreaming fool again
My favourite game
And you are the one who’s got my head in the clouds above
You’re the one that I love and
You’re my-i-i-i-i-i, baby, you’re my favourite waste of time
My-i-i-i-i-i, baby, you’re my favourite waste of time ( Owen Paul)

Next comes the extraordinary gift that “independent” central banks have given to governments and public finances. Both new borrowing and refinancing have been done on ever more favourable terms. Let me give you an example as in just over a week a UK Gilt with a coupon of 4.75% will mature and even if we borrow for 50 years we will pay 4% less than that for the £32 billion. Actually for the bit the Bank of England will buy even less but let’s not over complicate the issue.

Also there is the issue that we are entering a phase which may be ever more uncertain than usual. What I mean by that is that a pick-up in the UK economy looks set to be overrun at the pass by the impact of the Corona Virus. Of course the latter is extremely uncertain by virtue of being new. The only thing we can be reasonably certain of is this.

While taxes are already high by UK historical standards, they are often increased in the first year of a parliament. ( @IFS )

 

The UK public finances finally accept that many student loans will never be repaid

The present UK government seems to be much keener on public spending than its predecessor. From the Evening Standard.

Up to £1 billion of the aid budget will be made available to scientists inventing new technology to tackle the climate crisis in developing countries, Boris Johnson is to announce……..Putting an emphasis on technology’s potential to answer the climate emergency, he will also announce a further £220 million from the overseas aid budget to save endangered species from extinction.

Although of course as so often there is an element there of announcing spending which would have happened anyway. Also the government did avoid bailing out Thomas Cook which seems sensible as it looked completely insolvent by the end as Frances Coppola points out.

Dear@BBC

, you should not believe what you read in corporate press releases. The rescue plan for Thomas Cook was not £900m as the company said. It was £900m of new loans PLUS new equity of £450m PLUS conversion of £1.7bn of existing debt to equity (with a whopping haircut).

It is very sad for the customers and especially the workers. Well except for the board who have paid themselves large bonuses whilst ruining the company. Surely there must be some part of company law that applies here.

UK Public Finances

There have been a lot of significant methodological changes this month which need to be addressed. They add to the past moves on Housing Associations which had an impact on the National Debt of the order of £50 billion as they have been in and out of the numbers like in the Hokey Cokey song. Also there was the Royal Mail pension fund which was recorded as a credit when in fact it was a debit. Oh well as Fleetwood Mac would say.

Student Loans

For once the changes are in line with a view that I hold. Regular readers will be aware that much of the Student Loans in existence will not be repaid.

This new approach recognises that a significant proportion of student loan debt will never be repaid. We record government expenditure related to the expected cancellation of student loans in the period that loans are issued. Further, government revenue no longer includes interest accrued that will never be paid.

This brings us to what is the impact of this?

Improvements in the statistical treatment of student loans have added £12.4 billion to net borrowing in the financial year ending March 2019. Outlays are no longer all treated as conventional loans. Instead, we split lending into two components: a genuine loan to students and government spending.

Whether the £12.4 billion is accurate I do not know as some of it is unknowable but in principle I think that this is a step in the right direction.

Pensions

There are larger changes planned for next month but let me point out one that has taken place that will be impacted by Thomas Cook.

We now also include the Pension Protection Fund within the public sector boundary.

Other changes including a gross accounting method which means this in spite of the fact that the PPF above will raise the national debt or at least it should.

These changes have reduced public sector net debt at the end of March 2019 by £28.6 billion, reflecting the consolidation of gilts and recognition of liquid assets held by the public pension schemes.

I will delay an opinion on this until we get the full sequence of changes.

The Numbers

The August figures were better than last year’s

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in August 2019 was £6.4 billion, £0.5 billion less than in August 2018.

There was a hint of better economic performance in the numbers too.

This month, receipts from self-assessed Income Tax were £1.7 billion, an increase of £0.4 billion on August 2018. This is the highest level of August self-assessed Income Tax receipts since 2009……..The combined self-assessed Income Tax receipts for both July and August 2019 together were £11.1 billion, an increase of £0.7 billion on the same period in 2018.

At first the numbers do not add up until you spot that the expenditure quoted is for central government which is flattered by a £900 million reduction in index-linked debt costs. Something which inflationoholics will no doubt ignore. Also local government borrowed £1 billion more. So I think there was some extra spending it is just that it was obscured by other developments in August.

In the same period, departmental expenditure on goods and services increased by £1.8 billion, compared with August 2018, including a £0.5 billion increase in expenditure on staff costs and a £0.9 billion increase in the purchase of goods and services.

If we switch to the fiscal year so far the picture looks broadly similar to what we have been seeing in previous months.

In the latest financial year-to-date, central government received £305.4 billion in receipts, including £226.0 billion in taxes. This was 2.1% more than in the same period last year……Over the same period, central government spent £325.1 billion, an increase of 4.1%.

The essential change here is that central government has spent an extra £9.1 billion on goods and services raising the amount spent to £121.5 billion in a clear fiscal boost.

The Past Is Not What We Thought It Was

Although it does not explicitly say it we were borrowing more than we thought we were, mostly due to the new view on student loans.

In the latest full financial year (April 2018 to March 2019), the £41.4 billion (or 1.9% of gross domestic product, GDP) borrowed by the public sector was around a quarter (26.1%) of the amount seen in the FYE March 2010, when borrowing was £158.3 billion (or 10.2% of GDP).

We know last year was affected by £12.4 billion but the effect is smaller the further we go back in time. For example on FYE March 2010 it was £1.5 billion.

The National Debt

This continues to grow in absolute terms but to shrink in relative terms.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of August 2019 was £1,779.9 billion (or 80.9% of gross domestic product, GDP), an increase of £24.5 billion (or a decrease of 1.5 percentage points of GDP) on August 2018.

However the Bank of England has had an impact here.

Debt at the end of August 2019 excluding the Bank of England (mainly quantitative easing) was £1,598.7 billion (or 72.7% of GDP); this is an increase of £37.4 billion (or a decrease of 0.6 percentage points of GDP) on August 2018.

For those of you wondering my £2 billion challenge to last month’s data on Bank of England transactions has not been resolved as this from Fraser Munroe of the Office for National Statistics from earlier highlights.

We should have some APF detail for you soon. Sorry for the delay.

Comment

We travel forwards although sometimes it feels as though we have just gone backwards. Although there is one constant which is the first rule of OBR club ( for newer readers it is always wrong).

These March 2019 OBR forecasts do not include estimates of the revisions made in September 2019 for student loans and pensions data. The OBR intends to reflect these changes in their next fiscal forecast.

In a way that is both harsh although they should have know of the plans and fair in that their whole process is always likely to be wrong and frankly misleading.

Next we are reminded that things we really should know in fact we do not.

The error mainly relates to the treatment of Corporation Tax credits, which are included within total Corporation Tax receipts as well as within total central government expenditure.

In terms of impact that peaked at £3.8 billion in 2017/18 declining to £1.9 billion in the last fiscal year. That is a lot in my opinion.

As to more fiscal spending well that just got harder as we conclude we were spending more anyway. But it remains very cheap to do so as the UK thirty-year Gilt yield is back below 1%.

 

 

What is the UK economic situation and outlook?

The UK is an example of so much going on in some areas albeit with so far no result but apparently not much in others. The latter category includes the real economy if the latest set of Markit PMI business surveys are any guide.

UK service providers indicated that business activity growth lost momentum during August and remained subdued in comparison to the trends seen over much of the past decade. The latest survey also revealed slower increases in new work and staffing levels, which was often linked to sluggish underlying economic conditions.

The slowing of the services sector added to contracting manufacturing and construction sectors to give us this overall result.

At 49.7 in August, the seasonally adjusted All Sector Output
Index dropped from 50.3 in July and registered below the
50.0 no-change mark for the second time in the past three
months……….t, the lack of any meaningful growth in the service sector raises the likelihood that the UK economy is slipping into recession. The PMI surveys are so far indicating a 0.1% contraction of GDP in the third quarter.

There are two elements of context here. The first is that this survey is not accurate enough to tell to 0.1% or to say 49.7 is any different to unchanged. Also we now that as a sentiment index it had a bit of a shocker during the last period of political turmoil in late summer 2016. Thus our conclusion is that the economy is weak and struggling but contracting? We do not yet know.

Car Registrations

There was some interesting news here summarised by Samuel Tombs of Pantheon.

Good news – car registrations were strong in August. The 1.7% y/y drop is consistent with a big seasonally-adjusted m/m% rise, as sales in Aug 2018 jumped ahead of new emissions testing rules. This points to car sales boosting q/q% GDP growth by a non-trivial 0.05pp in Q3.

So whilst the numbers were down on last year they were a solid improvement on July.

A Fiscal Boost

In perhaps the least surprising development this year the Chancellor Sajid Javid announced this yesterday.

The Chancellor has announced an increase in spending on public services for next year. Day-to-day spending on public services will grow by 4.1%, or around £13.8 billion, between 2019−20 and 2020−21 in real terms. This represents of a top-up of £11.7 billion to the provisional spending plans Mr Javid inherited from his predecessor, alongside a £1.7 billion top up to existing capital spending plans for 2020−21, meaning that total spending will be £13.4 billion higher next year than was planned in the spring. ( IFS )

If we switch to GDP as our measure then the planned increases were of the order of 0.6%. As we borrowed 1.1% of GDP in the fiscal year to March that points at 1.7% although as we were already spending more maybe more towards 2% of GDP. That is a little awkward for the Institute of Fiscal Studies which told us over the weekend the fiscal rules would be broken. Mind you as nobody else cares about them it is not that big a deal. Also the IFS seems quite keen on fantasies.

Making major spending decisions without the latest economic and fiscal forecasts is a risky move for the Chancellor. On the basis of forecasts from the spring, extra borrowing to fund today’s announcements could – just – be accommodated within the government’s fiscal targets. But the next set of forecasts from the OBR, due later this year, are likely to reflect a deterioration in the near-term outlook for the UK economy and public finances.

Just as a reminder the first rule of OBR club is that the OBR is always wrong. How has the IFS not spotted this? Mind you their head Paul Johnson was enthusiastically plugging the RPI news yesterday hoping that his 2015 Inflation Review might get pulled out the recycling bin and that it might have 17% of it made up of fantasy rents.

After all that I am not sure we can trust their view on austerity but for what it;s worth here it is.

This is enough to reverse around two thirds of the real cuts to day-to-day spending on public services – at least on average – since 2010, and around one third of the cuts to per capita spending.

Bank of England

Governor Carney was giving evidence to Parliament yesterday and it included this.

The negative impact of a no-deal Brexit will not be as severe as originally thought because of improved planning by the government, businesses and the financial sector, the Bank of England has said.

Governor Mark Carney told the Treasury select committee that the Bank now believes GDP will fall by 5.5% in the worst-case scenario following a no-deal Brexit – less than the 8% contraction it predicted in last November.

The Bank’s revised assessment of the possible scenarios also says unemployment could increase by 7% and inflation may peak at 5.25% if the UK leaves the European Union without a deal. ( Sky News )

Who could possibly have though that people and businesses would plan ahead? Of course when your own Forward Guidance has been so woeful maybe you have something of a block on that sort of thing. Also if I was Governor Carney I would have avoided all mention of a 7% Unemployment Rate after the 2013 Forward Guidance debacle on that subject.

Perhaps this is why some want to delay Brexit because in 2/3 years time at the current rate of progress the Bank of England will be forecasting growth from a No-Deal.

Also although he does not put it like that in the quote below is a confession that I am right about how falls in the Pound £ impact inflation.

It is likely that food bills will rise in the event of a no-deal Brexit, that is almost exclusively because of the exchange rate impact. Movements are quickly translated onto the shop shelf, and domestic prices, imperfect substitutes, also increase. That impact has lessened because of the new tariff regime the government has put in place.

Another goal I have slipped past their legion of Ivory Tower economists.

There was something else that was really odd from him via Bloomberg.

Mark Carney says there’s almost no chance of the Bank of England intervening in the foreign-exchange market to control swings in the pound

So why has the UK been building up its foreign exchange reserves then? They are now £66.8 billion.

Comment

The UK economy has been remarkably resilient in 2019 so far. We have had all sorts of Brexit and non-Brexit plans, the trade war and much else. Somehow we have got by. Financial markets are in flux as no sooner had the Financial Times started to cheer the way the UK Pound £ fell below US $1.20 it reversed and is now above US $1.23.

The FT has a problem because 1% moves lower in the UK Pound £ are a plunge and yet the 9% fall in the 2068 Index-Linked Gilt yesterday was described like this by economics editor Chris Giles.

Price of the 2068 index-linked gilt dropped today, but complete stability in market and prices still higher than a month ago – – showing those who claimed changing the RPI would kill the market to have exagerated wildly

I will ignore the second straw(wo)man bit and simply point out it has now fallen 13%. The losers will not be the “Gnomes of Zurich” as Chris claimed at the Royal Statistical Society but the ordinary pensioner looking for safety. It gives us a new definition for “complete stability” in my financial lexicon for these times.

The Investing Channel

UK Austerity and the next Governor of the Bank of England

Today brings into focus an area that has brought good news for the UK over the past couple of years. This has been the improvement in the public finances which rather curiously lagged the period where the economy recorded its fastest economic growth by around 2 years. Also some of the detail along the way has hinted at a better economic situation than that suggested by economic growth measured by Gross Domestic Product or GDP data. This swings both ways in my view as what were called the bond vigilantes will be happier with the state of play. But also those on the other side of the coin who would like more government spending and/or lower taxes would have fiscal room to do so.

Austerity

This has been a matter of debate for some time and let me start by saying there are several ways of looking at this. The harshest would be to actually cut government spending which we have not seen in the UK. Let me add more detail by pointing out that some areas clearly have but overall the story has nor been that as other areas spent more. The more realistic version seems to be restricting government spending in real terms which we have seen some of overall. If we look at it in terms of years then we have recorded on here two main phases firstly from around 2010 when the brakes were applied and from 2012/13 when the pressure on the spending brakes was loosened.

Also there was some tightening on the other side of the fiscal ledger of which the standout was the rise in Value Added Tax or VAT. There was a relatively brief cut from 17.5% to 15% but then a rise to 20% where in spite of the claims of a return to normal it is still at the supposedly emergency rate.

Having established some perspective let us look at this from the IPPR which compared us to these countries “This comprises Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Spain and Sweden.”.

We find that on average these countries spend 48.9 per cent of GDP on public spending, compared to just 40.8 per cent in the UK. Furthermore, whilst the UK’s spending has fallen by 7 percentage points – from around 47 per cent of GDP to 40 per cent of GDP – since the onset of austerity, the comparable fall across these countries is just 3 percentage points. Moreover, if the UK were to match their current levels of spending tomorrow it would be worth £2,500 per person per year, of which £1,800 would go towards social spending; meaning health, education and social security.

Okay if we break this down we see that the picture is more complex. Let me show you this by looking at the Euro area in total for 2018 for which we got figures yesterday. There the fiscal deficit was a mere 0.5% of GDP with spending at 46.8% and revenue at 46.3%. Furthermore many of the countries in the IPPR list ran fiscal surpluses in 2018

Germany (+1.7%), the Netherlands (+1.5%), Sweden (both +0.9%), Denmark (+0.5%). Austria (+0.1%).

So on that measure they are more fiscally austere than the UK which ran a deficit. As you can see things are more complex than they argue which is hinted at by the way they use tax revenue as a benchmark rather than total revenues which changes the numbers quite a bit. We have numbers for different periods but my 46.3% for the Euro area is rather different to the 41.1% for their sample and looks a swinging rather than a straight ball to me.

Of course spending is not a free good either. Could we match the spending tomorrow? Yes we could if we wished and for a while with bond yields where they are it would at first be no big deal, but even the IPPR realises it would have to come with this.

But in the UK, as IPPR has previously recommended, significant additional revenue could be raised through increasing the rate of corporation tax in line with the European average, reforming income tax but in a way that protects those on low and middle incomes, and changes to the way in which we tax wealth.

As to Corporation Tax I am dubious as one thing we have learned in the credit crunch era is the way multinationals pretty much choose where they pay tax or if you want the issue in one word, Ireland.

Moving on we see this and again the catch is that in the credit crunch era such Ivory Tower calculations are fine up in the clouds but down here at ground level they have often crumbled.

They find that the cumulative effect of austerity has been to shrink the economy by £100bn today compared to what it would have been without the cuts: that is worth around £3,600 per family in 2019/20 alone.

Today’s Data

The overall picture presented continues to be a strong one.

In the latest full financial year (April 2018 to March 2019), central government received £739.4 billion in income, including £558.6 billion in taxes. This was 5% more than in the previous financial year.

This again hints that the economy has been stronger than the GDP data suggests and follows the labour market theme of rising employment and higher real wages.

On the other side of the ledger the throwing around of the word austerity makes me uncomfortable when we are increasing spending in real terms.

Over the same period, central government spent £741.5 billion, an increase of around 3%.

Well unless you use the RPI as your inflation measure but even then it is roughly flat.

The combination meant this.

Borrowing in the latest full financial year (April 2018 to March 2019) was £24.7 billion, £17.2 billion less than in the previous financial year; the lowest financial year borrowing for 17 years.

Or if you prefer our credit crunch era journey can be put like this.

In the latest full financial year (April 2018 to March 2019), the £24.7 billion (or 1.2% of gross domestic product (GDP)) borrowed by the public sector was less than one-fifth (16.1%) of the amount seen in the FYE March 2010, when borrowing was £153.1 billion (or 9.9% of GDP).

As a single month March was not one for austerity as it looks like departments made sure that they spent their annual budgets so if some potholes were filled in around your locale that is why.

 while total central government expenditure increased by 5.7% (or £3.5 billion) to £65.7 billion.

The explanation is rather bare but if we look at the ledger we see spending on goods and services was up by £1.9 billion. So maybe there was some Brexit stockpiling too.

Comment

The last decade has seen a lot of debate over the concept of austerity involving quite a lot of goalpost moving, so much so that it is fortunate designers give them wheels these days. Whereas we do know what real austerity has been as @fwred made clear yesterday,

Today’s craziest chart goes to Greece, with a primary surplus of 4.4% of GDP in 2018, beating an already insane target of 3.5%. Jaw-dropping for those of us old enough to remember the whole story.

Or as The Nutty Boys put it.

Madness, madness, they call it madness
Madness, madness, they call it madness
I’m about to explain
A-That someone is losing their brain
Hey, madness, madness, I call it gladness, yee-ha-ha-ha

We have seen nothing like that but now face choices ahead as do we copy the Germand and go for a surplus? Or do we now pick out areas where we can spend more? With borrowing so cheap with our ten-year Gilt yield at 1.2% it is not expensive. As ever some care is needed as we have spent in some areas as I note in the IPPR paper than at 7.4% of GDP we spend the same on health as the countries they compare us too which completes something I recall Tony Blair aiming at back in the day.

Meanwhile this has hit the news. I have floated two candidates in Andrew Sentance and Ann Pettifor, but who would you suggest?

Although if Yes Prime Minister has its usual accuracy the choice has already been made and this is just for show

What are the economic consequences of a Donald Trump victory?

This morning has seen an event which some will describe as a victory for anti-establishment hopes and others as the end of the world as we know it. The victory of Donald Trump adds to the UK vote to leave the European Union as events which only just before they happened were supposedly not far off unpossible. As an ex options trader my first thought is that the media and dare I say/write it experts understanding of probability has had a simply shocking 2016. One of the things I learned back in the day was that when you make investments you need to wipe you own wishes,wants and likes from you mind science fiction style and maximise objectivity. Also the era of “big data” is not going so well is it?

This has some economic consequences in itself as much of the media has damaged itself in 2016 by being so consistently wrong. How that combines with an age where we consume so much more news is not crystal clear but I expect the main organisations to lose viewers and readers and for newer forms to emerge. There will be one minor relief which is that the one track mind exhibited by the Financial Times this summer and autumn will be replaced by choosing whether to blame Brexit or Trump!

Let me also throw in an issue for the banking and financial centre. After all we have been told that the victory of New York as a banking centre or rather the banking centre was nailed on by the UK EU leave vote. Yet @madamebutcher points out this.

Suddenly, all the American bankers want to stay in London.

We could perhaps do an exchange where our bankers go there and theirs come here. This would mean that everyone would be simultaneously wrong and right!

Economic policy

Has there been an election campaign where there was so little emphasis on the economics? The one main hint along the way as we have discussed on here was that both candidates were likely to have some form of fiscal stimulus. However there were elements of other policies which will affect the economics of which the main one was the protectionist rhetoric and promises of Donald Trump. From the FT.

Mr Trump has campaigned on his pledge to build a wall on the Mexican border, called for a ban on Muslim immigration and the deportation of 11m unauthorised immigrants.

There was also this.

Mr Trump has opposed the proposed Trans-Pacific Partnership deal and called for fundamental changes to the Nafta pact with Mexico and Canada……He has also threatened to impose punitive 45 per cent tariffs on goods from China, stoking fears of a trade war.

And this.

Mr Trump has promised the biggest tax revolution since Ronald Reagan, pledging to cut taxes across the board. He says no American business would pay more than 15 per cent of their profits in tax, compared with a current maximum of 35 per cent. The top rate of tax would fall from 39.6 per cent as the Republican reduces the number of tax brackets.

So there was in fact a fair bit but it was covered by a smokescreen on other issues including the obvious personality clash. It was there but often a secondary element rather than primary. There was no “It’s the economy, stupid!” like the original Bill Clinton campaign.

Fiscal Policy

There was already an element of fiscal expansionism in the tax cutting plans highlighted above. For younger readers this is very similar to what Ronald Reagan promised and did as President and back then it went well. Advocates of Arther Laffer were pleased to see the economy strengthen and as it did so tax revenues do well too. Of course that was then and now is a post credit crunch world where many old relationships have broken, but it did look to have worked back then.

On the spending front there was this clear hint.

We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals. We’re going to rebuild our infrastructure, which will become, by the way, second to none, and we will put millions of our people to work as we rebuild it.

That is very reminiscent of the “New Deal” of F.D Roosevelt from back in the day or at least it feels like it. Of course we should apply some sort of filter to an acceptance speech likely to be given at a time of a combination of high emotion and much tiredness but some of that will need to be done now I think. It was also backed up by this.

I will harness the creative talents of our people and we will call upon the best and brightest to leverage their tremendous talent for the benefit of all. It is going to happen. We have a great economic plan. We will double our growth and have the strongest economy anywhere in the world.

We have quite an odd combination of free market promises on taxes and apparent central planning on infrastructure spending. There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

What about monetary policy?

The US Federal Reserve has been on the wires and media outlets in the last week yet again promising us an interest-rate rise in December. If we apply logic then the apparent fiscal expansionism expressed by President-Elect Trump should make that even more likely. However there is in reality doubt on two fronts now. As fans of the economic effect of bond yields then a persistent rise ( remember this one is not even a day old) in the 30 year yield will make them less likely to rise. Next central bankers love to use uncertainty as an excuse and 2016 has provided quite a lot of that.

So whilst an interest-rate rise in December should be more likely I suspect it has become less likely now.

Other central banks

The Bank of Japan has been on the wires because the Yen has strengthened to 103 versus the US Dollar and the Nikkei dropped over 900 points to 16,251. But apart from it promising “bold action” for about the 1000th time it is quiet. However I suspect one thing will change which is the constant uses of Brexit as a scapegoat will mostly be replaced by the election of Donald Trump.

Comment

You may be wondering why I have not referred to financial markets more and that is simply because many of them have calmed down apart from those I have mentioned. There is of course one other. The Mexican Peso has fallen some 10% and at times more today as we wonder how much a wall can cost? I have a Mexican neighbour and wonder what to say to her?

Meanwhile fiscal expansionism may well lead to a change in US Federal Reserve policy. I have wondered in the past if future interest-rate increases could be combined with (even) more QE so are we now singing along to Sweet.

Does anybody know the way, did we hear someone say
(We just haven’t got a clue what to do)
Does anybody know the way, there’s got to be a way
To Blockbuster

Should you be feeling down today it could be worse as Newsweek has proven.

The UK economy gets a fiscal boost ahead of the Brexit referendum

The UK Public Finances have become something of a political football during the Brexit referendum campaign. The Chancellor of the Exchequer George Osborne has been quite vocal on the subject. From the Business Standard in India.

“I would have a responsibility to try to restore stability to the public finances and that would mean an emergency budget where we would have to increase taxes and cut spending.”

Osborne warned that leaving the EU would create a 30-billion pounds ($42.4-billion, 37.9-billion-euro) hole in national finances.

In response, the basic rate of income tax would be raised, inheritance tax would be hiked, and the budget for services including the National Health Service (NHS) would be cut, he said.

Wasn’t the 2010 Emergency Budget supposed to be one to end future emergency budgets? If we look back we were told this about now.. From the Office for Budget Responsibility which had back then just been created by Chancellor Osborne.

public sector net borrowing (PSNB) to fall from 11.0 per cent of GDP in 2009-10 to 1.1 per cent in 2015-16;

 

public sector net debt (PSND) to increase from 53.5 per cent of GDP in 2009-10 to a peak of 70.3 per cent in 2013-14, falling to 69.4 per cent in 2014-15 and 67.4 per cent in 2015-16;

If only! If only! Anyway today’s figures will allow me to see how badly we have done on that front but we can say the objective below is in tatters.

the cyclically-adjusted current budget deficit of 5.3 per cent of GDP in 2009-10 to be eliminated by 2014-15 and reach a surplus of 0.8 per cent of GDP in 2015-16.

The whole “cyclically-adjusted” game is mostly a political ruse and frankly is more like a cynically adjusted number. The cycle is adjusted again and again to find a convenient phase. But the silence on the subject these days is rather eloquent.

Favourable trends

There have been two major trends which have benefited the public finances which were not foreseen. Ironically the Chancellor has tried to take credit for the one which has very little to do with him and said much less about the one the UK establishment has driven. The latter is the boom in revenue from Stamp Duty and taxes around the boom in house prices which began after the Bank of England Funding for Lending Scheme lit the blue touch-paper for the housing market (my subject of yesterday). It went from £6.1 billion in 2011-12 to £10.7 billion in 2014-15 and the latest Buy To Let boom has given it another push higher in the two months of this financial year so far.

Stamp Duty on land & property increased by £0.4 billion, or 21.0%, to £2.1 billion

The other force has been the fall in debt costs. By this I mean the way that UK Gilt yields have fallen making it much cheaper for us to issue each unit of debt and also the fall in even RPI (Retail Price Index) inflation which means a lower annual cost for our index-linked debt as well. Back in June 2010 the UK OBR predicted that average Gilt yields would be 5.1% when in fact they are more like 1.5%. Hapless and it almost seems cruel to point it out, but what it does teach us is the lack of value in such forecasting in these times. However in spite of all the extra borrowing the UK has undertaken this is the state of play in the latest full financial year,

debt interest decreased by £0.3 billion, or 0.7%, to £44.9 billion;

More Disappointment

Whilst we had an improvement in the public finances in May it was nothing to write home about.

Public sector net borrowing (excluding public sector banks) decreased by £0.4 billion to £9.7 billion in May 2016, compared with May 2015.

When you consider that the economy has been growing those are thin pickings and even they disappear if we look at the financial year so far.

In the financial year-to-date (April to May 2016), public sector net borrowing excluding public sector banks (PSNB ex) was £17.9 billion; an increase of £0.2 billion, or 0.8% compared with the same period in 2015.

We find ourselves mulling a theme of this blog which is that what people claim as austerity often turns out to be a fiscal boost.

Central government expenditure (current and capital) for the financial year-to-date (April to May 2016) was £119.7 billion, an increase of £2.4 billion, or 2.1%, compared with the same period in the previous financial year.

This is also a real terms boost of nearly the same size according to the UK establishment as of course they are the people who are so keen on the CPI inflation measure which tells us we have only a smidgen of inflation.  So we are in fact seeing something of a fiscal boost which is odd when we see people asking for a fiscal boost. What they mean is more of a fiscal boost! These days austerity for some means slowing the rate of growth of government spending rather than cuts.

If we move to the revenue side for the fiscal year so far we see something that has become familiar.

Stamp Duty on land & property increased by £0.4 billion, or 21.0%, to £2.1 billion

We will have to see how that goes as we look at the Buy to Let sector but there is a troubling number below.

Income Tax-related payments increased by £0.3 billion, or 1.4%, to £23.6 billion

Perhaps it has been affected by the rise in the tax-free Personal Allowance. If so we will find out in the months ahead.

Then and Now

If we look at the 2015/16 financial year we can compare it to what we were promised back in the day. So here we go.

In the financial year ending March 2016 (April 2015 to March 2016), public sector net borrowing excluding public sector banks (PSNB ex) was £74.9 billion; a decrease of £16.7 billion, or 18.2% compared with the previous financial year.

So we made some progress but not a vast amount considering the economic growth and good luck to those who can turn that into a “cyclically-adjusted” surplus! Even Sir Frank and Sir Humphrey from Yes Prime Minister would be defeated by this.

The consequence is a much higher national debt than forecast.

Public sector net debt (excluding public sector banks) at the end of May 2016 was £1,606.9 billion, equivalent to 83.7% of gross domestic product (GDP); an increase of £49.6 billion compared with May 2015.

These are the numbers for May which should of course benefit the official view as it is supposed to be shrinking now and that has been forecast on a variety of occasions.

Would it be rude to point out that we hope that people do not spot we use a convenient as in lower definition for the size of our national debt?

general government gross debt (Maastricht debt) at the end of March 2015 was £1,601.3 billion, equivalent to 87.4% of GDP; an increase of £79.9 billion compared with the end of the financial year ending March 2014

Comment

We find that the UK Public Finances continue to disappoint and the theme here sings along with the Whispers.

And the beat goes on
Just like my love everlasting
And the beat goes on
Still moving strong on and on

A surplus is in sight around 3/4 years ahead but when we get there it turns out to be a mirage in a desert. After 3 years of solid economic growth and a beneficial reduction in the cost of our debt to boot the excuses are thinning out to say the least. Even the rise in National Insurance has not turned the trend.

Social (National Insurance) Contributions increased by £1.5 billion, or 7.9%, to £19.9 billion (fiscal year so far )

Mind you as something’s stay the same others do change. Back in 1992 George Soros cleaned up from a fall in the UK Pound £ as we were ejected from the ERM. These days he does not seem to want to sing the same old song. From the Guardian.

The only winners will be speculators

Or of course he has placed his bets elsewhere.