The IMF debt arrow warning misses the real target

Yesterday brought the latest forecasts from the IMF ( International Monetary Fund). Don’t worry I am not concerned with them as after all Greece would be now have recovered if they were right. But there is a link to the Greece issue and the way that it has found itself trying to push an enormous deadweight of debt which meant that Euro area policy had to change to make the interest-rates on it much cheaper. Here is the ESM or European Stability Mechanism on that subject.

1% Average interest rate on ESM loans to Greece (as of 28/04/2017)

That is a far cry from the “punishment” 4.5% that regular readers will recall that Germany was calling for in the early days and the implementation of which added to the trouble. Also if we continue with the debt theme there is another familiar consequence.

That is because the two institutions can borrow cash much more cheaply than Greece itself, and offer a long period for repayment. Greece will not have to start repaying its loans to the ESM before 2034, for instance.

So in the words of the payday lenders Greece now has one affordable monthly payment or something like that. As we note the IMF research below I think it is important to keep the consequences in mind.

The IMF Fiscal Monitor

Here is the opening salvo.

Global debt hit a new record high of $164 trillion in 2016, the equivalent of 225 percent of global GDP. Both private and public debt have surged over the past decade.

Later we get a breakdown of this.

Of the $164 trillion, 63 percent is non financial private sector debt, and 37 percent is public sector debt.

That is a fascinating breakdown so the banks have eliminated all their own debt have they? Perhaps it is the new hybrid debt being counted as equity. Also the IMF quickly drops its interest in the 63% which is a shame as there are all sorts of begged questions here. For example who is it borrowed from and is there any asset backing? In the UK for example it would include the fast rising unsecured or consumer credit sector as well as the mortgaged sector but of course even that relies on the house price boom for an asset value. Then we could get onto student debt which whilst I have my doubts about some of the degrees offered in return I have much more confidence in young people as an asset if I may put it like that. So sadly the IMF has missed the really interesting questions and of course is stepping on something of a land mine in discussing government debt after its debacle in Greece.

Government Debt

Here is the IMF hammering out its beat.

Debt in advanced economies is at 105 percent of
GDP on average—levels not seen since World War II.
In emerging market and middle-income economies,
debt is close to 50 percent of GDP on average—levels
last seen during the 1980s debt crisis. For low-income
developing countries, average debt-to-GDP ratios have
been climbing at a rapid pace and exceed 40 percent
as of 2017.

If we invert the order I notice that there are issues with the poorer countries again.

Moreover, nearly half of this debt is on
nonconcessional terms, which has resulted in a doubling
of the interest burden as a share of tax revenues
in the past 10 year.

This gives us food for though as you see one of the charts shows that such countries have received two phases of what is called relief, once in the 90s and once on the noughties. Is it relief or as Elvis Presley put it?

We’re caught in a trap
I can’t walk out
Because I love you too much baby

Next time I see Ann Pettifor who was involved in the Jubilee debt effort I will ask about this. Does such debt relief in a way validate policies which lead such countries straight back into debt trouble?

Advanced Countries

Here the choice of 2016 by the IMF is revealing. I have a little sympathy in that the data is often much slower to arrive than you might think but the government debt world has changed since them. Any example of this came from the UK only this week.

General government deficit (or net borrowing) was £39.4 billion in 2017, a decrease of £19.0 billion compared with 2016; this is equivalent to 1.9% of GDP, 1.1 percentage points below the reference value of 3.0% set out in the Protocol on the Excessive Deficit Procedure.

It is hard not to have a wry smile at the UK passing one of the Maastricht criteria! But the point is that the deficit situation is much better albeit far slower than promised meaning that whilst the debt soared back then now prospects are different.

In truth I fear that the IMF has taken a trip to what we might call Trumpton.

In the United States—where
a fiscal stimulus is happening when the economy is
close to full employment, keeping overall deficits above
$1 trillion (5 percent of GDP) over the next three
years—fiscal policy should be recalibrated to ensure
that the government debt-to-GDP ratio declines over
the medium term.

I have quite a bit of sympathy with questioning why the US has added a fiscal stimulus to all the monetary stimulus? I know it has been raising interest-rates but the truth is that it has less monetary stimulus now rather than a contraction. Those of us who fear that modern economies can only claim growth if they continue to be stimulated or a type of economic junkie culture will think along these lines. But also they lose ground with waffle like “full employment” in a world where the Japanese unemployment rate is 2.5% as to the 4.1% in the US. Oh and whilst we are at it there is of course the fact that Japan has been running such fiscal deficits for years now.

What about interest-rates and yields?

There was this from Lisa Abramowicz of Bloomberg yesterday.

While U.S. yields may still be rising, the world is still awash in central-bank stimulus. The amount of negative-yielding debt has actually grown by nearly $1.4 trillion since February, to about $8.3 trillion: Bloomberg Barclays Global Aggregate Negative Yielding Debt index

My point is that for all the talk and analysis of higher interest-rates and yields we get this.

Comment

There is a fair bit to consider here and let me open with a bit of tidying up. Comparing a debt stock to an income/output flow ( GDP) requires also some idea of the cost of the debt. Moving on an opportunity has been missed to look at private-debt as we note that US consumer credit has passed the pre credit crunch peak. Of course the economy is larger but there are areas of troubled water such as car loans. This matters because the last surge in government debt was driven by the socialisation of private debt previously owned by the banks.

If we note the debt we have generically then there are real questions now as to high interest-rates can go? Some of you have suggested around 3% but in the end that also depends on economic growth which is apposite because the slowing of some monetary indicators suggests we may be about to get less of it. Should that turn further south then more than a few places will see an economic slow down that starts with both negative interest-rates and yields. These are the real issues as opposed to old era thinking.

• First, high government debt can make countries
vulnerable to rollover risk because of large gross
financing needs, particularly when maturities are
short

In reality that will be QE’d away if I may put it like that and the real question is where will the side-effects and consequences of the QE response appear? For example the distributional effects in favour of those with assets. Perhaps the real issue is the continuing prevalence of negative yields in a (claimed) recovery………From the Fab Four.

You never give me your money
You only give me your funny paper
And in the middle of negotiations
You break down

Me on Core Finance TV

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How soon will the US national debt be unaffordable?

It is time to look again at a subject which has been a regular topic in the comments section. This is what happens when national debt costs start to rise again? We have spent a period where rises in national debts have been anesthetized by the Quantitative Easing era where central bank purchases of sovereign debt have had a side effect of reducing debt costs in some cases by very substantial amounts. Of course  it is perfectly possible to argue that rather than being a side effect it was the real reason all along. Personally I do not think it started that way but once it began like in some many areas establishment pressure meant that it not only was expanded in volume but that it has come to look in stock terms really rather permanent or as the establishment would describe it temporary. Of the main players only the US has any plan at all to reduce the stock whereas the Euro area and Japan continue to pile it up.

So let us take a look at projections for the US where the QE flow effect is now a small negative meaning that the stock is reducing. Here is Businessweek on the possible implications.

Over the next decade, the U.S. government will spend almost $7 trillion — or almost $60,000 per household — servicing the nation’s massive debt burden. The interest payments will leave less room in the budget to spend on everything from national defense to education to infrastructure. The Congressional Budget Office’s latest projections show that interest outlays will exceed both defense discretionary spending and non-military discretionary spending by 2025.

The numbers above are both eye-catching and somewhat scary but as ever this is a case of them being driven by the assumptions made so let us break it down.

US National Debt

It is on the up and up.

Debt held by the public, which has doubled in the past
10 years as a percentage of gross domestic product
(GDP), approaches 100 percent of GDP by 2028 in
CBO’s projections.

Those of you who worry we may be on the road to World War III will be troubled by the next bit.

That amount is far greater than the
debt in any year since just after World War II

As you can see the water has got a bit muddled here as the CBO has thrown in its estimates of economic growth and debt held by the public so let us take a step back. It thinks that annual fiscal deficits will rise to above US $1 Trillion a year in this period meaning that from now until 2028 they will total some US $12.4 billion. That will put the National Debt on an upwards path and the amount held by the public will be US $28.7 Trillion. Sadly they skirt the issue of how much the US Federal Reserve will own so let us move on.

Deficits

These have become more of an issue simply because the CBO thinks the recent Trump tax changes will raise the US fiscal deficit. The over US $1 Trillion a year works out to around 5% of GDP per annum.

Bond Yields

These are projected to rise as the US Federal Reserve raises its interest-rates and we do here get a mention of it continuing to reduce its balance sheet and therefore an implied reduction in its holdings of US Treasury Bonds.

Meanwhile, the interest rate on 10-year Treasury notes increases from its average of 2.4 percent in the latter part of 2017 to 4.3 percent by the middle of 2021. From 2024 to 2028, the interest rate on 3-month Treasury bills averages
2.7 percent, and the rate on 10-year Treasury notes,
3.7 percent.

Currently the 10-year Treasury yield is 2.83% so the forecast is one to gladden the heart of any bond vigilante. If true this forecast will be a major factor in rising US debt costs over time as we know there will be plenty of new borrowing at the higher yields. But here comes the rub this assumes that these forecasts are correct in an area which has often been the worst example of forecasting of all. For example the official OBR forecast in the UK in a similar fashion to this from the CBO would have UK Gilt yields at 4.5% whereas in reality they are around 3% lower. That is the equivalent of throwing a dart at a dartboard and missing not only it but also the wall.

Inflation

This comes into the numbers in so many ways. Firstly the US does have inflation linked debt called TIPS so higher inflation prospects cost money. But as they are around 9% of the total debt market any impact on them is dwarfed by the beneficial impact of higher inflation on ordinary debt. Care if needed with this as we know that price inflation does not as conventionally assumed have to bring with it wage inflation. But higher nominal GDP due to inflation is good for debt issuers like the US government and leads to suspicions that in spite of all the official denials they prefer inflation. Or to put it another way why central banks target a positive rate of consumer inflation ( 2% per annum) which if achieved would gently reduce the value of the debt in what is called a soft default.

The CBO has a view on real yields but as this depends on assumptions about a long list of things they do not know I suggest you take it with the whole salt-cellar as for example they will be assuming the inflation target is hit ignoring the fact that it so rarely is.

In those years, the real interest rate on
10-year Treasury notes (that is, the rate after the effect of
expected inflation, as measured by the CPI-U, has been
removed) is 1.3 percent—well above the current real rate
but more than 1 percentage point below the average real
rate between 1990 and 2007.

Economic Growth

In many ways this is the most important factor of all. This is because it is something that can make the most back-breaking debt burden suddenly affordable or as Greece as illustrated the lack of it can make even a PSI default look really rather pointless. There is a secondary factor here which is the numbers depend a lot on the economic impact assumed from the Trump tax cuts. If we get something on the lines of Reaganomics then happy days but if growth falters along the lines suggested by the CBO then we get the result described by Businessweek at the opening of this article.

Between 2018 and 2028, actual and potential real output
alike are projected to expand at an average annual
rate of 1.9 percent.

The use of “potential real output” shows how rarefied the air is at the height of this particular Ivory Tower as quite a degree of oxygen debt is required to believe it means anything these days.

Comment

The issue of the affordability forecast is mostly summed up here.

CBO estimates that outlays for net interest will increase
from $263 billion in 2017 to $316 billion (or 1.6 percent
of GDP) in 2018 and then nearly triple by 2028,
climbing to $915 billion. As a result, under current law,
outlays for net interest are projected to reach 3.1 percent
of GDP in 2028—almost double what they are now.

This terns minds to what might have to be cut to pay for this. However let me now bring in what is the elephant in this particular room, This is that if bond yields rise substantially pushing up debt costs then I would expect to see QE4 announced. The US Federal Reserve would step in and start buying US Treasury Bonds again to reduce the costs and might do so on a grand scale.. Which if you think about it puts a cap also on its interest-rate rises and could see a reversal. Thus the national debt might remain affordable for the government but at the price of plenty of costs elsewhere.

 

 

 

 

What is the state of the UK Public Finances?

This afternoon the UK Chancellor of the Exchequer will stand up and give what is now called the Spring Statement about the UK public finances. It looks set to be an example of what a difference a few short months can make. But before we get to that let me take us back to yesterday when we were looking at the issue of falling house prices in London. That would have an impact on the revenue side should it be prolonged and the reason for that is the house price boom in the UK which was engineered back the Bank of England back in the summer of 2012 led to this. From HM Parliament last month.

In 2016/17 stamp duty land tax (SDLT) receipts were roughly £11.8 billion, £8.6 billion from residential property and £3.2 billion from nonresidential property. Such receipts are forecast to rise to close to £16 billion in 2022/23, or around £14.5 billion after adjusting for inflation.

That is a far cry from the £4.8 billion of 2008/09 when the credit crunch hit and the £6.9 billion of 2012/13 when the Bank of England lit the blue touch-paper for house prices. Although of course some care is needed at the rates of the tax have been in a state of almost constant change. A bit like pensions policy Chancellors cannot stop meddling with Stamp Duty.

Indeed much of this is associated with London.

Around 2% of properties potentially liable for stamp
duty were sold for over £1 million – these properties
accounted for 30% of the SDLT yield on residential
property.

In fact most of the tax comes from higher priced properties.

In 2016/17 the stamp duty yields on residential property
were split nearly 45:55 between those paying the tax for
purchases between £125,000 and £500,000, and those
paying for properties purchased at over £500,000.

So there you have it the London property boom has brought some riches to the UK Treasury as has the policy of the Bank of England.

The Bank of England part two

Yesterday brought something of a reminder of an often forgotten role on this front.

Operations to make these gilt purchases will commence in the week beginning 12 March 2018……..The Bank intends to purchase evenly across the three gilt maturity sectors.  The size of auctions will initially be £1,220mn for each maturity sector.

This is an Operation Twist style reinvestment of a part of the QE holdings that has matured.

As set out in the Minutes of the MPC’s meeting ending 7 February 2018, the MPC has agreed to make £18.3bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturity on 7 March 2018 of a gilt owned by the Asset Purchase Facility (APF)

So the Bank of England’s holdings which dropped to a bit over £416 billion will be returned to the target of £435 billion. So the new flow will help reduce the yields that the UK pays on its borrowings which has saved the government a lot of money. The combination of it and the existing holdings means that the UK can currently borrow for 50 years at an interest-rate of a mere 1.71%. Extraordinary when you think about it isn’t it?

The Office for Budget Responsibility ( OBR)

If we continue with the gain from the QE of the Bank of England then the OBR forecast that the average yield would be 5.1% and rising in 2015/16 back when it reviewed its first Budget. This gives us a measuring rod for the impact of QE on the public finances which is a steady drip,drip, drip gain which builds up over time.

If we bring in another major forecast from back then we get a reminder of my First Rule of OBR Club.

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014.

For newer readers that rule is that the OBR is always wrong! I return regularly to the wages one as it has turned out of course to be the feature of modern economic life as the US labour market reminded us last Friday. If you take the conventional view as official forecasts find compulsory then at this stage of the cycle non-farm job creation of 313,000 cannot co-exist with annual hourly earnings growth fading from 2.9% to 2.6%. At this point HAL-9000 from the film 2001 A Space Odyssey would feel that he has been lied to again. Yet today and tomorrow will see a swathe of Phillips Curve style analysis from the OBR and others regardless of the continuing evidence of its failures.

The Bank of England has kindly pointed this out yesterday.

The accuracy of such forecasts has come under much scrutiny.

Here for a start! But ahem and the emphasis is mine…..

Gertjan Vlieghe explains how forecasting is an important tool that helps policymakers diagnose the state and outlook for the economy, and in turn assess – and communicate – the implications for current and future policy. So achieving accuracy is not always the sole aim of the forecast.

For best really in the circumstances I think. Oh and as Forward Guidance turned out to be at best something of a dog’s dinner as promised interest-rate rises suddenly became a cut I think Gertjan’s intervention makes things worse not better.

Employment

Embarrassingly for the Forward Guidance so beloved by Gertjan Vlieghe this has been an area of woe for the credibility of the Bank of England but good news for the UK economy and public finances. This is of course how the 6.5% unemployment rate target which was supposed to be “far,far away” to coin a phrase turned up almost immediately followed by further declines leading us to this.

There were 32.15 million people in work, 88,000 more than for July to September 2017 and 321,000 more than for a year earlier…….The employment rate (the proportion of people aged from 16 to 64 who were in work) was 75.2%, higher than for a year earlier (74.6%).

As we look at that we can almost count the surge into the coffers directly via taxes on income and also indirectly via excise duties and VAT ( Value Added Tax). According to The Times more may be on its way.

Hiring confidence among British companies has reached its highest level in more than a year and recruitment is set to pick up as businesses shrug off downbeat economic projections, according to a closely watched study.

Manpower’s quarterly survey recorded that net optimism had climbed to +6 per cent in the latest quarter.

Comment

If we look for the situation I pointed out on the 2nd of this month that we are being led into a land of politics rather than economics. From the IEA ( Institute of Economic Affairs ).

New data shows that the Conservative government has finally hit its original target to eliminate the £100bn day-to-day budget deficit they inherited in 2010.

We get all sorts of definitions to make the numbers lower but whether they are cyclical or day-to day they are open to “interpretation” which of course is always one-way. But we have made progress.

the UK’s achievement of sustained deficit reduction over eight years should not be taken for granted.

This has been a fair bit slower than promised which leaves us with this.

The problem is the financial crisis and its aftermath saw public debt balloon from 35.4 per cent of GDP in 2008 to 86.5 per cent today – far higher than the 35 per cent average since 1975.

The consequences of that have been ameliorated by Bank of England QE and to some extent by QE elsewhere. Also it is time for the First Rule of OBR Club again.

The Office for Budget Responsibility projects that public debt will shoot up to 178 per cent of GDP in the next 40 years on unchanged policies, as demands on the state pension, social care, and healthcare rise.

The state of play is that public borrowing has finally benefited from economic growth and particularly employment growth. We are still borrowing but we can see a horizon where that might end as opposed to the mirages promised so often. There are two main catches. The first is that we need the view of The Times on employment to be more accurate that the official data. The second is that for debt costs not to be a problem then QE will need to be a permanent part of the economic landscape.

The certainty today is that the OBR forecasts will be wrong again. The question is why we have been pointed towards better numbers by the mainstream media? The choice is between more spending and looking fiscally hard-line ( which also usually means more spending only later….).

 

 

 

What is the true story behind the UK Public Finances being in surplus?

This week has brought news that should be far from a surprise to readers of my work. So without further ado let me present you this from the Financial Times.

Improvement in public finances puts day-to-day budget into surplus.

My regular reports on the machinations here will hopefully have had you all zeroing in on the “day to day” bit!

Britain has eliminated the deficit on its day-to-day budget, the target originally set by George Osborne when he imposed austerity on public services in 2010. The rapid improvement in the public finances over the past six months means that the former chancellor’s ambition for a surplus on the current budget, which excludes capital investment, has been met, albeit two years later than planned.

So one swerve is the way that capital investment is excluded as we mull how much current spending has been relabelled? Also there is the issue of the Financial Times being forgetful of what the original target was. From the Office for Budget Responsibility or OBR.

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.

Or of course the “day to day” bit might be relying on the Beatles arithmetic.

Eight days a week
I love you
Eight days a week
Is not enough to show I care

The OBR

The report by the Financial Times backfires in this respect as it is a fan of the OBR but sadly something has hit the fan as we have not one but two clear examples of my first rule of OBR club. For newer readers this is that it is always wrong.

The first is easy as if we avoid the ways a deficit is redesigned into a surplus above we still have one as opposed to the surplus we were supposed to have around 3 years ago. Next comes a more recent example of the genre. From the FT.

The rapid improvement in the public finances over the past six months

Was forecast by the OBR in March 2017 to be this.

So much so, in fact, that borrowing is now forecast to rise in 2017-18 before returning to a very similar downward trajectory to that we anticipated in November……….. We now expect the deficit to increase by £6.5 billion next year rather than shrinking by £7.2 billion (adjusted for a change in how the ONS records corporate taxes).

As you can see they made a policy change in that the improvement in the public finances was going to stop and get worse just as the numbers in fact got better! Actually they are still at this game as they forecast a rise in the UK deficit of £4.1 billion in the fiscal year which ends in April whereas according to the Office for National Statistics this is the present state of play.

Public sector net borrowing (excluding public sector banks) decreased by £7.2 billion to £37.7 billion in the current financial year-to-date (April 2017 to January 2018),

Misrepresenting spending

In my opinion this from the Financial Times is disappointing.

Paul Johnson, director of the Institute for Fiscal Studies, said the deficit reduction was “quite an achievement given how poor economic growth has been. They have stuck at it, but deficit reduction has come at the cost of an unprecedented squeeze in public spending”.

The reason why I think that is explained by the latest figures from the ONS which are for the fiscal year so far.

Over the same period, central government spent £598.3 billion, around 3% more than in the same period in the previous financial year.

As you can see the “unprecedented squeeze in public spending” is in fact a 3% increase. If we allow for inflation Paul Johnson is the man who wrote the review recommending CPIH which in January was running at an annual rate of 2.7% so there is a real terms increase albeit a small one. At this point it seems appropriate to remind you of my warning that it is a mistake to treat the IFS in the way that the media does as its reports are not the tablets of stone you might think.

Also if we step back for a moment we see my theme that the words Austerity and Stimulus are much more flexible for some than they should be. The truth is that we have had both as austerity has been represented by falling deficits but stimulus by the fact we continue to have deficits.

The actual data on public spending mean that the quote below is opinion dressed up as fact.

That squeeze is now showing up in higher waiting times in hospitals for emergency treatment, worse performance measures in prisons, severe cuts in many local authorities and lower satisfaction ratings for GP services.

Yes there are problems in the NHS and elsewhere but it is far from as simple as presented. The truth is due to factors such as the high rate of medical inflation such services require rises in real spending to stand still.

What about revenue?

This must be something that the Financial Times economics editor typed with gritted teeth!

The main reason for the sudden improvement in the public finances has been that revenues this financial year have greatly exceeded expectations, particularly in the most important month of January when self-assessment bills for income tax and capital gains tax generally fall due.

the reason for this is that Chris Giles has told us time and time again that the UK economy is about to fall off the edge of a cliff. Yet if we stick with his own words those who use tax revenue as a measure of economic growth will be seeing this as evidence that we may have done better than the official measure which recorded a 1.7% rise in GDP between 2016 and 17.

Also I am unclear how the official data shows things “greatly exceeded expectations” unless your expectations were for an unexplained plunge.

Self-assessed Income Tax and Capital Gains Tax receipts (combined) were £18.4 billion in January 2018, which is £0.9 billion less than in January 2017: ( ONS).

Is up the new down again?

The details

The exact situation is described by the FT below.

Official figures show that in the 12 months ending in January, the current budget showed a £3bn surplus and it moved into the black on an annual rolling basis in November………No British government has run a surplus on the current budget since 2001-2002 and last had a surplus in any 12-month period since the year leading up to July 2002.

Comment

We have seen many attempts to misrepresent the UK Public Finances over the credit crunch era, for example the way only the assets but not the liabilities of the Royal Mail pension fund were counted initially. More recently we had the circa £60 billion hokey-cokey with the Housing Associations. Thus the numbers are open to quite a few questions and that gets quite a bit worse when you impose an opinion like current spending as the FT has done. If it includes any of the original “cyclically adjusted” then we are again grateful to Lewis Carroll for some advice.

Why, sometimes I’ve believed as many as six impossible things before breakfast.

Meanwhile I guess the FT will be hoping people do not go back to November 22nd 2016.

The Financial Times could not wait and told us this at the end of last week.

Philip Hammond will admit to the largest deterioration in British public finances since 2011 in next week’s Autumn Statement when the official forecast will show the UK faces a £100bn bill for Brexit within five years.

So in summary the UK public finances have improved steadily and we are now in better shape in terms of the fiscal deficit but we are still a way short of a surplus. We may be growing faster than we thought but the picture is complex especially for the OBR which serves one purpose which is to make anyone who agrees with them extremely nervous. Oh and here is something completely missing from the FT to complete the picture.

Public sector net debt (excluding public sector banks) was £1,736.8 billion at the end of January 2018, equivalent to 84.1% of gross domestic product (GDP), an increase of £55.7 billion (or 0.4 percentage points as a ratio of GDP) on January 2017.

Norway

Let me congratulate its Finance Ministry on recognising reality and reducing its inflation target from 2.5% per annum to 2% today. Especially as up in the clouds many Ivory Towers want inflation targets raised as they continue their attempts to square their circles.

 

 

 

 

 

 

The UK Public finances have sometimes believed as many as six impossible things before breakfast.

As we await the UK Budget which of course is showing all the signs of being a leaky vessel if not a sieve a lot is going on in the background. What I mean by this is that the goal posts are moving back and forth so much that the grounds(wo)man must be grateful they have wheels on them these days. Let me give you the first example which I mentioned last week. From the Financial Times.

Chancellor Philip Hammond is planning to shift the goalposts on the government’s borrowing limits in a move that will flatter the public finances and provide up to £5bn a year in additional public spending in the Budget on Wednesday. He will use a technical change in the accounting status of housing associations to reduce headline borrowing figures but will not make a corresponding change to his deficit targets in the Budget.

What the FT omitted to point out was the full-scale of the mess here. You see it was only a couple of years ago the housing associations were included in the national debt and now they are not. So overall we have not really gained anything it just looks like we have! Along the way the credibility of the numbers has been reduced again.

The danger for a Chancellor with an apparent windfall is that somebody spends it before he can and marathon man Mark Carney sprinted to the front of the queue to help his banking friends.

Consistent with this, I am requesting that you authorise an increase in the total size of the APF of £25bn to £585bn, in order to accommodate expected usage of the TFS by the end of the drawdown period.

What is happening here is that the Bank of England has got permission to increase the size of its bank subsidy called the Term Funding Scheme by another £25 billion to £140 billion. This is where banks get the ability to borrow from the Bank of England at or close to Bank Rate which is bad news for depositors as it means the banks are less interested in them. This has three consequences, Firstly as we are looking at the public finances today if this £25 billion is used then it raises the national debt by the same amount. Then there is an odd link because if things are going well why do we need to add an extra £40 billion ( there was an extra £15 billion in August) to this?

With the stronger economy and lending growth, TFS drawings reached a total of £91 bn at mid-November 2017.

We are in a pretty pickle if banks need subsidies in the good times. Sadly the mostly supine media are unlikely to ask this question or to wonder how all the downbeat forecasts and Brexit worries have suddenly morphed into a “stronger economy”. The next issue is where will the money turn up? It could be funds to give the car loans sector one last hurrah but as housing appears to be top of the list right now it seems more likely that the Chancellor would prefer another £25 billion to subsidise mortgage rates even further.

Rates on new and existing loans fell after the TFS was launched and have remained low by historical standards

If we move to Bank of England policy it has raised interest-rates on the wider economy but now plans to expand its subsidies to “the precious”. Frankly its opus operandi could not be much more transparent.

Number Crunching

Part one

Firstly there is the FT on the Office for Budget Responsibility or OBR.

But the mood has improved since then after the OBR made clear it would offset some of the “significant” productivity downgrade with more optimistic employment forecasts.

So much for being “independent” and please remember tomorrow when the media are treating its pronouncements with respect and grandeur which is that the first rule of OBR club is that it is always wrong. Unless of course wage growth and gilt yields actually are 5% right now.

Part two

Then there is the possible/probable Brexit bill which is being reported as rising from £20 billion to £40 billion by places which told us it would be either £60 billion or £100 billion. So is that up or down? You choose.

Part three

I am sad that what was once a proud national broadcaster has sunk to this but this is finance from the BBC.

http://www.bbc.co.uk/news/av/uk-politics-42059439/loadsamoney-norman-smith-on-the-brexit-divorce-bill

Today’s data

The news did not give any great reasons to be cheerful.

Public sector net borrowing (excluding public sector banks) increased by £0.5 billion to £8.0 billion in October 2017, compared with October 2016.

The driver here was increased debt costs as the interest bill rose from £4.8 billion last October to £6 billion this. As conventional Gilt yields are broadly similar then most if not all of this has been caused by higher inflation as measured by the Retail Prices Index. The actual amount varies as they pay on a lagged inflation basis which is not always the same but as a rule of thumb the measure has been ~2% per annum higher this year.

Looking beyond that there is a little more optimism to be seen as revenues are not to bad if we switch to the fiscal year to date numbers.

In the current financial year-to-date, central government received £394.3 billion in income, including £292.7 billion in taxes. This was around 4% more than in the same period in the previous financial year.

This means that we are doing a little better than last year.

Public sector net borrowing (excluding public sector banks) decreased by £4.1 billion to £38.5 billion in the current financial year-to-date (April 2017 to October 2017), compared with the same period in 2016; this is the lowest year-to-date net borrowing since 2007.

There has been a trend for a while for the numbers to be revised favourably as time passes so even including the debt interest rises we are edging forwards. As the inflation peak passes that will be less of an influence. The next major factor will be the self-assessment season in January and February when we will find out how much last years numbers were flattered by efforts to avoid the rise in dividend taxation.

National Debt

On the theme of moving goal posts we produce quite a lot of numbers on this front and here is the headline.

Public sector net debt (excluding public sector banks) was £1,790.4 billion at the end of October 2017, equivalent to 87.2% of gross domestic product (GDP), an increase of £147.8 billion (or 4.5 percentage points as a ratio of GDP) on October 2016.

Most of the rise in the last year can be attributed to Mark Carney and his colleagues at the Bank of England.

Of this £147.8 billion, £101.7 billion is attributable to debt accumulated within the Bank of England. Nearly all of it is in the Asset Purchase Facility, including £89.9 billion from the Term Funding Scheme (TFS).

By chance our headline number is quite close to international standards as Eurostat has our national debt at this.

general government gross debt was £1,720.0 billion at the end of March 2017, equivalent to 86.8% of gross domestic product (GDP); an increase of £68.1 billion on March 2016.

Comment

The accident of timing that brings our public finance data up to date a bit over 24 hours before the Budget gives us some perspective. Firstly if you recall some of the numbers from yesterday how wrong the OBR has been which never seems to bother the media along the lines of Alice through the looking-glass.

‘I could tell you my adventures–beginning from this morning,’ said Alice a little timidly: ‘but it’s no use going back to yesterday, because I was a different person then.’

Let me offer a policy prescription for the OBR

The mad Queen said, “Off with his head! Off with his head! Off with his head!” Well… that’s too bad… no more heads to cut.”

As to the Budget it would seem it is arriving with a housing obsession. Even the Governor of the Bank of England has got in on the act with yet another banking subsidy to reduce mortgage rates. The way we are told that was ending but in fact is being expanded feels like something out of Alice In Wonderland. Perhaps we will seem some more bribes in addition to the cheap railcards for millenials also.

As to the public finances if we skip the incompetent blunderings of the Bank of England which surely could have designed a scheme which did not raise the national debt we see a situation which is slowly improving. It is not impossible once the inflation peak passes that our debt to GDP ratio could fall but care is needed as you see the only question in the number crunching here is are there only 6?

Why, sometimes I’ve believed as many as six impossible things before breakfast.

 

 

 

 

 

What is austerity and how much of it have we seen?

The subject of austerity is something which has accompanied the lifespan of this blog so 7 years now. The cause of its rise to prominence was of course the onset of the credit crunch which led to higher fiscal deficits and then national debts via two routes. The first was the economic recession ( for example in the UK GDP fell by approximately 6% as an initial response) leading to a fall in tax revenue and a rise in social security payments. The next factor was the banking bailouts which added to national debts of which the extreme case was Ireland where the national debt to GDP ratio rose from as low as 24% in 2006 to 120% in 2012.  It was a rarely challenged feature of the time that the banks had to be bailed out as they were treated like “the precious” in the Lord of the Rings and there was no Frodo to throw them into the fires of Mount Doom.

It was considered that there had to be a change in economic policy in response to the weaker economic situation and higher public-sector deficits and debts. This was supported on the theoretical side by this summarised by the LSE.

The Reinhart-Rogoff research is best known for its result that, across a broad range of countries and historical periods, economic growth declines dramatically when a country’s level of public debt exceeds 90% of gross domestic product……… they report that average (i.e. the mean figure in formal statistical terms) annual GDP growth ranges between about 3% and 4% when the ratio of public debt to GDP is below 90%. But they claimed that average growth collapses to -0.1% when the ratio rises above a 90% threshold.

The work of Reinhart and Rogoff was later pulled apart due to mistakes in it but by then it was too late to initial policy. It was also apparently too late to reverse the perception amongst some that Kenneth Rogoff who these days spend much of his time trying to get cash money banned is a genius. That moniker seems to have arrived via telling the establishment what it wants to hear.

The current situation

The UK Shadow Chancellor John McDonnell wrote an op-ed in the Financial Times ahead of Wednesday’s UK Budget stating this.

The chancellor should use this moment to lift his sights, address the immediate crisis in Britain’s public services that his party created, and change course from the past seven disastrous years of austerity.

If we ignore the politics the issue of austerity is in the headlines again but what it is has changed over time. Before I move on it seems that both our Chancellor who seemed to think there were no unemployed at one point over the weekend and the Shadow Chancellor was seems to be unaware the UK economy has been growing for around 5 years seem equally out of touch.

Original Austerity

This involved cutting back government expenditure and raising taxation to reduce the fiscal deficits which has risen for the reasons explained earlier. Furthermore it was claimed that such policies would stop rises in the national debt and in some extreme examples reduce it. The extreme hardcore example of this was the Euro area austerity imposed on Greece as summarised in May 2010 by the IMF.

First, the government’s finances must be sustainable. That requires reducing the fiscal deficit and placing the debt-to-GDP ratio on a downward trajectory……With the budget deficit at 13.6 percent of GDP and public debt at 115 percent in 2009, adjustment is a matter of extreme urgency to avoid the debt spiraling further out of control.

A savage version of austerity was begun which frankly looked more like a punishment beating than an economic policy.

The authorities have already begun fiscal consolidation equivalent to 5 percent of GDP.

But the Managing Director of the IMF Dominique Strauss-Khan was apparently confident that austerity in this form would lead to economic growth.

we are confident that the economy will emerge more dynamic and robust from this crisis—and able to deliver the growth, jobs and prosperity that the country needs for the future.

Maybe one day it will but so far there has been very little recovery from the economic depression inflicted on Greece by the policy prescription. This has meant that the national debt to GDP ratio has risen to 175% in spite of the fact that there was the “PSI” partial default in 2012. It is hard to think of a clearer case of an economic policy disaster than this form of disaster as for example my suggestion that you needed  a currency devaluation to kick-start growth in such a situation was ignored.

A gentler variation

This came from the UK where the coalition government announced this in the summer of 2010.

a policy decision to reduce total spending by an additional £32 billion a year by 2014-15, including debt interest savings;

In addition there were tax rises of which the headline was the rise in the expenditure tax VAT from 17.5% to 20%. These were supposed to lead to this.

Public sector net borrowing falls from 11.0 per cent of GDP in 2009-10 to 1.1 per cent in 2015-16. Public sector net debt is forecast to rise to a peak of 70.3 per cent of GDP in 2013-14, before falling to 67.4 per cent in 2015-16.

As Fleetwood Mac would put it “Oh Well”. In fact the deficit was 3.8% of GDP in the year in question and the national debt continued to rise to 83.8% of GDP. So we have a mixed scorecard where the idea of a surplus was a mirage but the deficit did fall but not fast enough to prevent the national debt from rising. Much of the positive news though comes from the fact that the UK economy began a period of sustained economic growth in 2012.

Economic growth

We have already seen the impact of economic growth via having some (  UK) and seeing none and indeed continued contractions ( Greece). But the classic case of the impact of it on the public finances is Ireland where the national debt to GDP ratio os now reported as being 72.8%.

Sadly the Irish figures rely on you believing that nominal GDP rose by 68 billion Euros or 36.8% in 2015 which frankly brings the numbers into disrepute.

Comment

The textbook definitions of austerity used to involved bringing public sector deficits into surplus and cutting the national debt. These days this has been watered down and may for example involve reducing expenditure as a percentage of the economy which may mean it still grows as long as the economy grows faster! The FT defines it thus.

Austerity measures refer to official actions taken by the government, during a period of adverse economic conditions, to reduce its budget deficit using a combination of spending cuts or tax rises.

So are we always in “adverse economic conditions” in the UK now? After all we still have austerity after 5 years of official economic growth.

What we have discovered is that expenditure cuts are hard to achieve and in fact have often been transfers. For example benefits have been squeezed but the basic state pension has benefited from the triple lock. Also if last years shambles over National Insurance is any guide we are finding it increasingly hard to raise taxes. Not impossible as Stamp Duty receipts have surged for example but they may well be eroded on Wednesday.

Also something unexpected, indeed for governments “something wonderful” happened which was the general reduction in the cost of debt via lower bond yields. Some of that was a result of long-term planning as the rise of “independent” central banks allowed them to indulge in bond buying on an extraordinary scale and some as Prince would say is a Sign O’The Times. As we stand the new lower bond yield environment has shifted the goal posts to some extent in my opinion. The only issue is whether we will take advantage of it or blow it? Also if we had the bond yields we might have expected with the current situation would public finances have improved much?

Meanwhile let me wonder if a subsection of austerity was always a bad idea? This is from DW in August.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

 

 

The problems of the Private Finance Initiative mount

The crossover and interrelationship between the private and public-sectors is a big economic issue. I was reminded of it on Saturday evening as I watched the excellent fireworks display in Battersea Park but from outside the park itself. The reason for this is that it used to be council run and free albeit partly funded by sponsors such as Heart Radio if I recall correctly. But these days like so much in Battersea Park it is run by a company called Enable who charge between £6 and £10 depending on how early you pay. You may note that GDP or Gross Domestic Product will be boosted but the event is the same. However there is a difference as the charge means that extra security is required and the park is fenced in with barriers. I often wonder how much of the charges collected pays for the staff and infrastructure to collect the charge?! There is definitely a loss to public utility as the park sees more and more fences go up in the run-up to the event and I often wonder about how the blind gentlemen who I see regularly in the park with his stick copes.

Private Finance Initiative

Elements of the fireworks changes apply here as PFI is a way of reducing both the current fiscal deficit and the national debt as HM Parliament explains here.

National Accounts use the European System of accounts (ESA) to distinguish between on and off balance sheet debt. If the risks and reward of a project is believed to be passed to the private sector, it is not recorded in the government borrowing figures, and remains off balance sheet. Approximately 90% of all PFI investment is off balance sheet, and is not recorded in National Accounts. Public
spending statistics, such as the Public Sector Net Debt, also follow ESA.

I like the phrase “believed to be” about risk being passed to the private-sector as we mull how much risk there actually is in building a hospital for the NHS which will then pay you a fee for 25/30 years? However we see why governments like this as what would otherwise be state spending on a new hospital or prison that would add to that year’s expenditure and fiscal deficit/national debt suddenly disappears from the national accounts. Perfect for a politician who can take the credit with no apparent cost.

Problems

The magic trick for the public finances does not last however as each year a lease payment is made. So there is a switch from current spending to future spending which of course is the main reason why politician’s like the scheme. However the claim that the scheme’s offer value for money gets rather hard when you see numbers like this from a Freedom of Information reply last month.

The Calderdale and Huddersfield Hospitals NHS Foundation Trust entered into a PFI with a company called Calderdale Hospitals SPC Ltd. Prior to May 2002, the all in interest rate in respect of bank loans that the company had
taken from its bankers was 7.955% per annum. After May 2002, when the PFI Company refinanced its loan, it was 6.700% per annum.

As you can see the politicians at that time in effect took a large interest-rate or more specifically Gilt yield punt and got is spectacularly wrong. Even with the refinancing the 6.7% looks dreadful especially as we note that we are now a bit beyond the average term for a UK Gilt. So if a Gilt had been issued back then on average it would be being refinanced now at say 1.5%. Care is needed as of course politicians back then had no idea about what was going to happen in the credit crunch but on the other hand I suspect some would be around saying how clever they were is yields were now 15%! On that note let me apologise to younger readers who in many cases will simply not understand such an interest-rate, unless of course they venture into the world of sub-prime finance or get a student loan.

In terms of pounds,shillings and pence here is the data as of 2015.

The total annual unitary charge across all PFI projects active in 2013/14 was £10bn. The cumulative unitary charge payments sum to £310bn: of this £88 billion has been paid (up to and including 2014/15) and £222 billion is outstanding. The unitary charge figures will peak at
0.5% of GDP in 2017/18.

Inflexibility

This is not only an issue on the finance side it is often difficult for the contracts to be changed as the world moves on. Or as HM Parliament puts it.

It can be difficult to make alterations to projects, and take into account changes in the public sector’s service requirements.

Are supporters losing faith?

Today the Financial Times is reporting this.

Olivier Brousse, chief executive of John Laing, which invests in and manages PFI hospitals, schools, and prisons, said PFI had lost “public goodwill” and needs “reinventing” with providers subject to a “payment by results” mechanism where money is clawed back for missed targets.

That is true although he then moves onto what looks like special pleading.

“The market in the UK is going away so we need to get back around the table and agree something acceptable,” said Mr Brousse. “The UK’s need for new infrastructure is significant and urgent. The private sector stands ready to deliver this . . . If the current PFI framework isn’t fit for purpose — then let’s completely rethink it to make it work.”

Indeed we then seem to move onto the rather bizarre.

“The problem with PFI isn’t transparency. It is outcomes,” he said. “I’m a citizen and if a school is built under PFI I also want it to commit to reducing bullying and violence.”

Surely the school should be run by the Governors rather than the company that built it? Perhaps he is trying to sneak in an increase in his company’s role.

There were also mentions of this which as I note the comments to the article seems set to be an ongoing problem whether it s in the public or private sectors.

In August John Laing agreed to hand back a lossmaking £3.8bn 25-year PFI waste project in Greater Manchester for an undisclosed sum. One of Britain’s biggest PFIs, the Greater Manchester waste disposal authority bin clearance, recycling, incinerator and green power station project had struggled to remain profitable. Manchester council said it would save £20m a year immediately from access to cheaper loans and £37m a year from April 2019.

Comment

To my mind the concept of PFI conflated two different things. The fact that private businesses can run things more efficiently than the public-sector which is often but not always true. For that to be true you need a clear objective which is something which is difficult in more than a few areas. The two main dangers are of missing things which turn out to be important as time passes and over regulation and complexity which may arrive together. Then we had the issue that whilst it was convenient for the political class to kick expenditure like a can into the future this meant a larger bill would eventually be paid by taxpayers. Even worse they have ended up trapping taxpayers into deals at what now seem usurious rates of interest.

Pretty much all big contracts with the private-sector seem to hit trouble as this from the National Audit Office on the Hinkley Point nuclear power project points out.

The Department has committed electricity consumers and taxpayers to a high cost and risky deal in a changing energy marketplace. We cannot say the Department has maximised the chances that it will achieve value for money.

There is of course the ever more expensive HS2 railway plan to add to the mix.

Thus we see that some of the trouble faced by UK PFI is true of many infrastructure projects. Yet some of it is specific to them and frankly it is hard to make a case for it right now because of some of the consequences of the credit crunch era. Firstly governments are able to borrow very cheaply by historical standards and secondly because adding to the national debt bothers debt investors much less than it once did especially if it is also simply a different form of accounting for an unaltered reality.

One of the arguments of my late father was that the UK needed an infrastructure plan set for obvious reasons a long way ahead. In many ways now would be a good time because the finance would be cheap but sadly we just seem to play a game of tennis as the ball gets hit from the private side of the net to the public side and back again.