The UK plans to Spend! Spend! Spend!

There is something of an irony today as the UK faces a Spending Review which is not called a Budget but is set to be more significant than nearly all of the latter. Also we are reminded that previous to this phase we were in uncertain times but that has been squared or even cubed this year. Perhaps the biggest example of that affecting the public finances came with Lockdown 2.0 as the government announced this on Bonfire Night.

Today, we are extending the CJRS until the end of March for all parts of the UK. We will review the policy
in January to decide whether economic circumstances are improving enough to ask employers to
contribute more. The Job Support Scheme is postponed.
Eligible employees will receive 80% of their usual salary for hours not worked, up to a maximum of £2,500
per month.

Interestingly they switched to telling us the cost when the scheme for the self-employed was announced at the same time.

This is £7.3 billion of support to the self-employed through November to January alone, with a further
grant to follow covering February to April. This comes on top of £13.7 billion of support for self-employed
people so far, one of the most comprehensive and generous support packages for the self-employed
anywhere in the world.

The Resolution Foundation has calculated the costs this year as this.

The largest AME components of these increases are the estimated £56 billion spent on the Job Retention Scheme (JRS) and £23 billion on the Self-Employed Income Support
Scheme.

Having checked the numbers on Friday which covered the period until October some £61 billion or so has already been spent to the danger in those numbers looks set to be from the upside. In terms of a total they think this.

We estimate that in the region of £250 billion of additional Covid-related spending will take place in 2020-21. This, and the much smaller economy, combine to mean that the
size of the state relative to GDP is set to sky-rocket this year, from 40 per cent of GDP to around 60 per cent of GDP.

So there is an element of today being a bit after the Lord Mayor’s Party so let me lighten the atmosphere with some examples of the first rule of OBR Club.

GDP growth in the third quarter of 2020: the level of GDP was 7 per cent higher than the OBR had expected in July

That is a pretty spectacular fail and there is another.

Since that forecast, unemployment has risen
only slightly, as shown in Figure 4: unemployment in 2020 Q3 was 4.8 per cent, less than half that expected in the OBR’s central scenario.

There are two issues here which in my opinion the Resolution Foundation miss. They treat OBR forecasts seriously and hang their view on the future off them when as you can see the future is very unlikely to be as forecast. Also the unemployment definition has failed us and we should be looking at underemployment measures such as hours worked to get a much better view of the state of play.

What about today?

The Financial Times gives us an example of government by leak.

Rishi Sunak will on Wednesday set out a £4.3bn plan to tackle the threat of mass unemployment as the chancellor braces Britain for the brutal economic fallout from the coronavirus crisis. Mr Sunak will tell MPs in his spending review that his “number one priority is to protect jobs and livelihoods”.

What does this mean in practice?

Mr Sunak will announce £2.9bn of spending over three years on a “Restart” programme to help Britons find jobs, plus £1.4bn of new funding to increase the capacity of the Jobcentre Plus network to help more people back to work. The Restart scheme, offering regular and intensive “tailored” job support, is particularly aimed at older workers who are most likely to be left facing “the scarring effects” of long-term unemployment.

Let us hope that this works although it relies on there being jobs to go to. The Jobcentre Plus scheme has seen famine after 2015 but now is back to feast so I wonder how effectively it can be expanded? Sadly the FT continues the media obsession with the fairly useless unemployment numbers.

The latest official statistics show that an estimated 1.6m people were unemployed in the three months to September — 318,000 more than a year earlier. The unemployment rate stands at 4.8 per cent of the workforce.  With many companies pressing ahead with redundancy plans, unemployment is set to rise further in the coming months.

The BBC takes a wider view including other measures some of which have already been announced.

These include an extra £3bn for the NHS in England to help tackle the backlog of operations delayed due to Covid, an increase in defence spending and a £4.6bn package to help the unemployed back to work.

So whoever leaked this to the BBC has added some £300 million to the unemployment plan compared to the leak to the FT. Also there is something of a difference into the issue of future austerity. The FT suggests it is a can to be kicked into the future wheres the BBC gives examples of it already beginning.

The government is expected to announce a cut in the UK’s overseas aid budget to 0.5% of national income, down from the legally binding target of 0.7%……There have also been reports that the chancellor is considering a pay freeze for all public sector workers except frontline NHS staff.

There are even reports that this will extend to Members of Parliament.

Comment

The main issue here I think is what is the role of government? I am not particularly thinking of the size of it here. What I mean is what can it do about employment and unemployment? It can make a major difference if it can pock out which are the viable jobs that need support for say a year and can then thrive. We win out of that via future tax payments before we get to other issues. The problem is that the credit crunch was far from the best example of this as we ended up protecting the banks with a The Precious! The Precious perspective only for them to then retrench anyway and have a zombie business model. Along the way inflating the housing market was a consequence too, although that has become an international game.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 7.0% annual gain in September, up from 5.8% in the previous month.

As to whether we can afford it then as I pointed out as recently as Monday we can borrow very cheaply. We are paid to borrow at the shorter end and even the fifty-year yield is a mere 0.73%. So it has completely ignored the expected spending increases. That requires a so far,as back in the Gordon Brown days it used to wait until late afternoon on the day. Our reputation may be damaged by the announcement on the RPI that I reported on last week.

Massive day for the UK index-linked gilt market. Today we get the government’s response to the RPI Reform Consultation: likely that RPI will be aligned to CPIH from 2030, with no compensation for investors. Some even think this might be moved forward to 2025. ( @bondvigilantes )

If I was in charge I would scrap that plan and I would look to strengthen our position by issuing some one hundred year bonds. As Steve Winwood so aptly put it.

While you see a chance
Take it

 

The UK shopper strikes yet again!

This morning has brought an example of something which is both remarkable and familiar. You might argue that you cannot use those two words together but 2020 is a year that continues to defy convention. What I am referring too is more good news for the UK economy from this sector.

In October 2020, retail sales volumes increased by 1.2% when compared with September; the sixth consecutive month of growth in the industry.

This means that the annual picture looks really rather rosy too.

In October, the year-on-year growth rate in the volume of retail sales saw a strong increase of 5.8%, with feedback from a range of businesses suggesting that consumers had started Christmas shopping earlier this year, further helped by early discounting from a range of stores.

In recent times the pattern has changed with for example Black Friday being in a week’s time and there is also Cyber Monday. Some Black Friday offers seem to have already started, if the advertising I see is any guide. So the structure underlying seasonal adjustment has been changing and maybe there has been another shift this year. Thus there may be a hangover from these numbers but we simply do not know how much it will be?

If we try to compare we the period pre the pandemic we see another strong recovery and then boom.

Looking at October’s total retail sales values (excluding fuel), which is a comparable measure to our online series, sales increased by 7.9% when compared with February; driven by a strong increase in sales online at 52.8% in comparison to reduced store sales at negative 3.3%.

From all the deliveries I see happening the online numbers are hardly a surprise, but with Lockdown 2.0 now adding to the problems I fear for quite a bit of the high street.

So we do have a V-shaped recovery for one part of our economy and I guess the orders for the economics text books are already on their way to the printers.

What this has done is out the switch to the online world on speed with food sales seeing a particular boom. That will be fed by the stories that Covid-19 is being spread by supermarket visits.

In October, we can see that online sales for all sectors increased when compared with February. Online food sales nearly doubled, with an increase of 99.2% in comparison with food store sales, which saw a fall of 2.1%. Overall, total food sales increased by 3.4% when compared with February.

Clothing stores, with an overall decline of 14.0% in value sales, increased their online sales by 17.1% but saw the biggest fall in store sales at negative 22.1%.

The area which has most struggled does not really have an option for online sales.

In October, fuel sales still remained 8.8% below February’s pre-lockdown level, while car road traffic reduced by an average 14.2%.

Looking at the overall picture it is also a case of Shaun 1 Bank of England 0 because my case that lower prices lead to growth has got another piece of evidence in its favour.

This was the sixth consecutive month of growth resulting in value and volume sales 5.2% and 6.7% higher respectively than in February 2020, before coronavirus (COVID-19) lockdown restrictions were applied in the UK.

With value growth or if you prefer expenditure in Pounds lower than volume growth there has been disinflation or price falls combined with volume growth. For newer readers I first made the point formally on here on the 29th of January 2015.

Looking ahead that boost may now fade as October gave a hint of a change of trend.

All measures in the total retail sales industry saw an increase in October 2020. The monthly growth rate for value sales was 1.4% and for volume sales 1.2%.

It may take a while to note anything like that as Lockdown 2.0 will affect the December and particularly the November numbers.

Public Finances

These too were numbers that the forecasters got wrong by quite a bit. So today was yet another failure as Retail Sales were supposed to flat line and borrowing be much higher.

Public sector net borrowing (excluding public sector banks, PSNB ex) is estimated to have been £22.3 billion in October 2020, £10.8 billion more than in October 2019, which is both the highest October borrowing and the sixth-highest borrowing in any month since monthly records began in 1993.

Of course, we are borrowing extraordinary amounts so this is relatively good news rather than being outright good. As you can see below a more than half of the rise is extra central government spending.

Central government bodies are estimated to have spent £71.3 billion on day-to-day activities (current expenditure) in October 2020, £6.4 billion more than in October 2019; this growth includes £1.3 billion in Coronavirus Job Retention Scheme (CJRS) and £0.3 billion in Self Employment Income Support Scheme (SEISS) payments.

Also revenues have fallen and some of that is deliberate with the VAT and Stamp Duty cuts.

Central government tax receipts are estimated to have been £39.7 billion in October 2020 (on a national accounts basis), £2.7 billion less than in October 2019, with falls in Value Added Tax (VAT), Business Rates and Pay As You Earn (PAYE) income tax.

You might think that the balancing amount was local councils especially after the blow up in Croydon, which for those unaware is below.

Cash-strapped Labour-run Croydon Council has imposed emergency spending restrictions with “immediate effect”, the BBC has learned.

The Section 114 notice bans all new expenditure at Croydon Council, with the exception of statutory services for protecting vulnerable people.

A document seen by the BBC said “Croydon’s financial pressures are not all related to the pandemic”.

It is under a government review amid claims of “irresponsible spending”.

Section 114 notices are issued when a council cannot achieve a balanced budget. ( BBC News)

However the main other recorded component was the Bank of England at £2.8 billion. This is really rather awkward as it has not actually borrowed anything at all! But a Monty Python style method records it as such and it is the first time I can recall an issue I have regularly flagged about the national debt so explicitly affecting the deficit as well.

National Debt

So without further ado here is the misleading headline that much of the media has gone with today.

Public sector net debt (excluding public sector banks) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, £283.8 billion more than in October 2019.

This is misleading because it includes the activities of the Bank of England which are not debt. I am no great fan of the Term Funding Scheme but recording its £120 billion as all being debt is quite extraordinary and is a major factor leading to this.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

It makes quite a difference especially for fans of debt to GDP ratios as we go from 89.5% to “around 100.8% of gross domestic product” on this really rather odd road.

Comment

The continued growth of UK retail sales is good news as we see an area that has recovered strongly. This comes with two caveats. The first is that with out enthusiasm for imports it poses a danger for the trade figures. The second is that in a tear with so many changes I doubt any survey is completely reliable so we are more uncertain that usual.

Switching to the public finances and taking a deeper perspective we are posting some extraordinary numbers.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

We seem set to keep spending more in some areas ( defence) but want to cut back in others ( public-sector pay) so all we can do at the moment is be grateful we can borrow so cheaply. Even the fifty-year Gilt yield is a mere 0.77% and as I have written before at these levels I would issue some one hundred year ones as the burdens are not going away anytime soon.

My theme that low inflation helps economies also gets support from the public finances.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

The Bank of England never gets challenged as to why it keeps trying to raise our debt costs in this area. Also you see another reason why the establishment wants to neuter the Retail Prices Index ( RPI)

 

 

 

 

 

What are the economic policies of Joe Biden?

We find ourselves in unusual but not completely unfamiliar territory as the US election has yet to declare a result.As we stand Joe Biden looks most likely to win although any such win seems set to go straight to the courts. But we need to address what changes he plans for US economic policy? The first step according to Moodys will be more fiscal expansionism.

Vice President Biden has proposed a wide
range of changes to the tax code and government spending. In total, he is calling for $4.1
trillion in tax increases and an additional $7.3
trillion in government spending over the next
decade.

Moodys have taken the current zeitgeist in favour of fiscal policy and projected this impact from it.

The government’s deficits will be
$3.2 trillion larger on a static basis and $2.6
trillion on a dynamic basis, after accounting
for the benefits to the budget of the stronger
economy resulting from his policies.

Of course the “stronger economy” mentioned is an opinion and we have seen in my time here quite a shift in the establishment view on fiscal policy. A decade ago the views was that a contractionary fiscal policy could expand the economy whereas now we are told an expansionary one will. There has been a shift in the cost of borrowing which I will look at in more detail later, but even so there has been more than a little flip-flopping.

Detailed Proposals

Interestingly the fiscal expansionism comes with tax increases for some.

The largest source of new tax revenue in
the vice president’s plan comes from increasing taxes on corporations. Of the $4.1 trillion
in total tax revenue collected under his plan
over the next decade on a static basis, more
than half comes from higher corporate taxes.
The bulk of this results from an increase from
21% to 28% in the top marginal tax rate paid
by corporations.

So he is reversing half of the Trump tax cuts in this area. Next comes a tax on higher earners.

Another large source of new tax revenue in
Biden’s plan is the 12.6% Social Security payroll tax on annual earnings of more than $400,000.
The current earnings cap subject to the payroll tax is almost $138,000………..This change will put
the Social Security trust fund on much sounder
financial footing, and it will raise close to $1
trillion in revenue over the next decade on a
static basis, about one-third of the total tax
revenue raised under Biden’s plan

The theme is of taxing the rich and wealthy and which continues with what might in the past have been called a soak the rich plan.

The vice president would roll back
the tax cuts that those earning more than
$400,000 received under Trump’s TCJA, tax
capital gains and dividend income like ordinary
income for those making more than $1 million
in total income.

Spending

Here we are looking at a Spend! Spend! Spend! plan where the extra revenue above is spent and then some.

His proposal calls for additional spending of $7.9 trillion on a static basis, including on infrastructure, education, the social safety net, and healthcare, with the bulk of the
spending slated to happen during his term as
president in an effort to generate more jobs

Those who bemoan America’s infrastructure should welcome this effort.

Of all of Biden’s spending initiatives, the
most expansive is on infrastructure. On a
static basis, he would increase such spending
by $2.4 trillion for the decade—all of it to
be spent during his term.

Education too will be a beneficiary.

Biden is also calling for a large increase in
an array of educational initiatives. He proposes
to spend $1.9 trillion over 10 years on a static
basis on pre-K, K-12 and higher education (see
Table 3). Attending a public college or university would be tuition-free for children in families with incomes of less than $125,000.

I find the end to tuition fees for some to be intriguing as it is a reversal of the past direction of travel. Also there is this.

The social safety net would meaningfully
expand under Biden (see Table 4). He would
spend an additional $1.5 trillion over 10 years
on a static basis on various social programs,
with the largest outlays going to workers to
receive paid family and medical leave for up
to 12 weeks…….

And healthcare.

The healthcare system would also receive
a significant infusion of funding under a
President Biden primarily via the Affordable
Care Act…….. The 10-year static budget cost of the
proposed changes to the healthcare system
comes to nearly $1.5 trillion.

US Federal Reserve

There are a couple of streams of thought here. The first is that Federal Reserve Chair Jerome Powell has called for more fiscal expansionism.

Federal Reserve Chairman Jerome Powell called Tuesday for continued aggressive fiscal and monetary stimulus for an economic recovery that he said still has “a long way to go.”

Noting progress made in job creation, goods consumption and business formation, among other areas, Powell said that now would be the wrong time for policymakers to take their foot off the gas. ( CNBC on the 6th of October)

Thus he would presumably be happy to run policies to help this. He is already in the game.

At its September meeting, the FOMC directed the Desk to increase SOMA holdings of Treasury securities at the current pace, which is the equivalent of approximately $80 billion per month.

Also he has the ability to respond should he wish without a grand announcement as these days smoothing market operations cover quite a few bases.

The Desk is prepared to increase the size and adjust the composition of its purchase operations as needed to sustain the smooth functioning of the Treasury market.

We can now take that forwards to the next perspective because the market seems to have come to its own conclusion.In the past the bond vigilantes would have driven US bond yields higher but in fact the US bond market has risen and yields fallen.I established a marker on the day of the election and the ten-year Treasury Note yield was 0.87% but as I type this it is 0.73%

Comment

The caveat to today’s post is that is by no means certain that Joe Biden will win and even if he does he seems likely to face a Republican Senate. But we do seem set for a more expansionary fiscal policy which would be oiled and polished by the US Federal Reserve.That does link to the news from the Bank of England earlier when it announced an expansion of £150 billion in its purchases of UK bonds as it too is an agent of fiscal policy these days.

Looking at the economic impact we see from Moodys that the multiplier is back.What I mean by that is fiscal spending is assumed to grow the economy which then helps to pay for it. The catch is always when you do not seem much growth ( think Italy) or if the economy contracts over a long period ( think Greece). We do know that the US economy can grow and that it has been doing better than us in Europe in the credit crunch era but whether it will grow by enough is another matter. With the rise in the Covid-19 cases though it may be a while before it gets the chance to demonstrate that and for such calculations when and how long matter.

 

The UK National Debt is growing whilst the cost of it falls

The last 24 hours or so have brought a barrage of information on the UK public finances. As the new restrictions on activity began we have a background where economic activity will be lower meaning lower tax revenue and likely higher government spending. Next came the Chancellor’s Winter Economic Plan with the job support element looking like it will cost around £1.2 billion a month although of course that depends on the size of the take-up. The continuation of this will also have an impact on tax revenues.

The chancellor has announced the extension of a VAT cut for the hospitality and tourism sectors – some of the worst-hit by the pandemic.

Rishi Sunak said that the temporary reduction of VAT rates from 20% to 5% would remain in place until 31 March 2021, rather than 13 January. ( BBC ).

Indeed according to the Office for National Statistics the hospitality sector was seeing a reverse before the new announcements anyway.

The percentage of adults that left their home to eat or drink at a restaurant, café, bar or pub decreased for the second week in a row, following continued increases since early July. This week, less than one in three adults (29%) said they had done so, compared with 30% last week and 38% at the end of August (26 to 30 August) when the Eat Out to Help Out scheme ended.

Next we can move onto the actual figures for August as we note the cost of the response to the Covid-19 pandemic

Today’s Figures

We saw a reversal of the recent trend which had been for lower borrowing. Up until now we saw a peak of £49.1 billion in April which had declined to £15.4 billion in July.

Public sector net borrowing (excluding public sector banks, PSNB ex) is estimated to have been £35.9 billion in August 2020, £30.5 billion more than in August 2019 and the third highest borrowing in any month since records began in 1993.

July is a major tax collecting month ( such as it was this year) so maybe a better comparison is with June but even so it is up on the £28.9 billion then so let us investigate.

The first factor is that tax revenues have fallen heavily and part of that is a deliberate policy ( the VAT cut for some sectors I have already noted).

In August 2020, central government receipts are estimated to have fallen by 14.3% compared with August 2019 to £51.0 billion. Of this £51.0 billion, tax receipts were £37.3 billion, £7.5 billion less than in August 2019, with Value Added Tax (VAT), Corporation Tax and Income Tax receipts falling considerably.

Next expenditure is much higher this year.

In August 2020, central government bodies spent £82.4 billion, an increase of 34.7% on August 2019.

Of this, £78.5 billion was spent on its day-to-day activities (often referred to as current expenditure)……The remaining £3.9 billion was spent on capital investment such as infrastructure.

Of this the job scheme that is about to be replaced cost this.

In August 2020, central government subsidy expenditure was £14.0 billion, of which £6.1 billion were CJRS payments and £4.7 billion were SEISS payments.

The Fiscal Year

We can get more of a perspective from this.

In the current financial year-to-date (April to August 2020), the public sector borrowed £173.7 billion, £146.9 billion more than in the same period last year. This unprecedented increase largely reflects the impact of the pandemic on the public finances, with the furlough schemes (CJRS and SEISS) alone adding £56.0 billion to borrowing as subsidies paid by central government.

The change is mostly one of spending which has risen by £105.7 billion and the tax decline is a much smaller influence at £36.7 billion. The numbers do not add to the change because I am looking at the main factors and ignoring local government for example. Although there is something odd regarding local government which we keep being told is spending more but in fact has spent £1.5 billion less.

Switching to taxes the biggest faller is VAT which is some £13.5 billion lower. However in percentage terms we see that Stamp Duty on properties has fallen by £2.2 billion to £3 billion on the year so far as first the lockdown crunched activity and now we have the Stamp Duty cut. Also fuel duty has been hit hard being some £3.9 billion lower at £7.8 billion.

National Debt

I would call this a curate’s egg but these days it is more like Churchill’s description of Russia.

 “a riddle, wrapped in a mystery, inside an enigma,”

Let me explain why starting with the official numbers.

At the end of August 2020, the amount of money owed by the public sector to the private sector was approximately £2.0 trillion (or £2,023.9 billion), which equates to 101.9% of gross domestic product (GDP).

However that includes things which are not in fact debt relating to the activities of the Bank of England. The most bizarre part is where marked to market profits are counted as debt.

The BoE’s contribution to debt is largely a result of its quantitative easing activities via the BoE Asset Purchase Facility Fund (APF) and Term Funding Scheme (TFS).

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of BoE, public sector net debt excluding public sector banks (PSND ex) at the end of August 2020 would reduce by £218.0 billion (or 11.0 percentage points of GDP) to £1,805.9 billion (or 90.9% of GDP).

There could be some losses from the Term Funding Scheme so lets allow £18 billion for that to give us a round number of £200 billion. So if we keep this in round numbers the national debt is £1.8 trillion.

It really is something that feels like it should be in Alice through the Looking Glass as I note this. The Bank of England has driven Gilt prices higher meaning on a marked to (its) market basis it has a notional profit of £93.4 billion which is then added to the national debt. Each time I go through that I feel that I too have consumed from a bottle marked Drink Me.

Debt Costs

These are the dog which has not barked. Didn’t such a thing allow Sherlock Holmes to solve a case? For our purposes we see that the impact of all the Bank of England bond buying ( £672 billion at the time of writing) is that the government can borrow at ultra cheap levels and at some maturities be paid to do so. Putting it another way bond yields have been reduced by so much they have offset the cost of the extra debt.

Interest payments on the government’s outstanding debt in August 2020 were £3.6 billion, a £0.2 billion decrease compared with August 2019.

There is as well a bonus from lower recorded inflation on index-linked debt meaning that at £17.1 billion debt costs are some £8 billion lower than last year.

Comment

We find ourselves in extraordinary times and the public finances are under pressure in many ways. We will see much higher borrowing persist until the end of the year now as the economy gets squeezed again and public expenditure falls by less than we previously thought. How much is very uncertain but we can have a wry smile at this.

Figures published in the Office for Budget Responsibility’s (OBR’s) Fiscal Sustainability Report and summer economic update monthly profiles – 21 August 2020 (XLS, 201KB) suggest that borrowing in the current financial year (April 2020 to March 2021) could reach £372.2 billion, around seven times the amount borrowed in the financial year ending (FYE) March 2020.

Yes neither the Financial Times nor the Office for National Statistics have spotted that the OBR is always wrong. Curious when you note that so far this fiscal year it has been wrong by some £50 billion at £223.5 billion. Even in these inflated times this is a lot. The OECD has missed it as well.

According to the OECD external review the OBR has established itself as a fixed part of the UK’s institutional landscape, delivering high quality publications, reducing bias in official forecasts and bringing greater transparency to the public finances during its first decade.

I will have to update my definition of being wrong in my financial lexicon for these times to include being “high quality ” and “bringing greater transparency “. The first rule of OBR Club continues to be that it is always wrong!

The public finances themselves are suffering heavily right now due to their use of estimates which means they are a broad brush at a time of large change. I think that the August numbers overstate the deficit trend but only time will tell. As to the debt we are now dependent on continued purchases by the Bank of England to keep costs low which means that it is for all the protestations QE to infinity.

Number Crunching

I thought I would add this as it shows the numbers are very unreliable tight now.

This month, we have reduced our previous estimate of borrowing in the financial year-to-July 2020 by £12.7 billion, largely because of a reduction in previous estimates of central government procurement combined with a smaller increase in the previous estimate of central government tax receipts.

France decides to Spend! Spend! Spend!

Yesterday brought something that was both new and familiar from France. The new part is a substantial extra fiscal stimulus. The familiar is that France as regular readers will be aware had been pushing the boundaries of the Euro area fiscal rules anyway, This is something which has led to friction with Italy which has come under fire for its fiscal position. Whereas France pretty much escaped it in spite of having its nose pressed against the Growth and Stability Pact limit of 3% of Gross Domestic Product for the fiscal deficit. Actually that Pact already feels as if it is from a lifetime ago although those who have argued that it gets abandoned when it suits France and Germany are no doubt having a wry smile.

The Details

Here is a translation of President Macron’s words.

We are now entering a new phase: that of recovery and reconstruction. To overcome the most important in our modern history, to prevent the cancer of mass unemployment from setting in, which unfortunately our country has suffered too long, today we decide to invest massively. 100 billion, of which 40 billion comes from financing obtained hard from the European Union, will thus be injected into the economy in the coming months. It is an unprecedented amount which, in relation to our national wealth, makes the French plan one of the most ambitious.

So the headline is 100 billion Euros which is a tidy sum even in these inflated times for such matters. Also you will no doubt have spotted that he is trying to present something of a windfall from the European Union which is nothing of the sort. The money will simply be borrowed collectively rather than individually. So it is something of a sleight of hand. One thing we can agree on is the French enthusiasm for fiscal policy, although of course they have been rather less enthusiatic in the past about such policies from some of their Euro area partners.

There are three components to this.

Out of 100 billion euros, 30 billion are intended to finance the ecological transition.

As well as a green agenda there is a plan to boost business which involves 35 billion Euros of which the main component is below.

As part of the recovery plan, production taxes will be reduced by € 10bn from January 1, 2021, and by sustainable way. It is therefore € 20bn in tax cuts of production over 2021–2022.

That is an interesting strategy at a time of a soaring fiscal deficit to day the least. So far we have ecology and competitiveness which seems to favour big business. Those who have followed French history may enjoy this reference from Le Monde.

With an approach that smacks of industrial Colbertism

The remaining 35 billion Euros is to go into what is described as public cohesion which is supporting jobs and health. In fact the jobs target is ambitious.

According to the French government, the plan will help the economy make up for the coronavirus-related loss of GDP by the end of 2022, and help create 160,000 new jobs next year.  ( MarketWatch)

Is it necessary?

PARIS (Reuters) – French Finance Minister Bruno Le Maire believes that the French economy could perform better than currently forecast this year, he said on Friday.

“I think we will do better in 2020 than the 11% recession forecast at the moment,” Le Maire told BFM TV.

I suspect Monsieur Le Maire is a Beatles fan and of this in particular.

It’s getting better
Since you’ve been mine
Getting so much better all the time!

Of course things have got worse as he has told us they have got better. Something he may have repeated this morning.

August PMI® data pointed to the sharpest contraction in French construction activity for three months……….At the sub-sector level, the decrease in activity was broad based. Work undertaken on commercial projects fell at the
quickest pace since May, and there was a fresh decline in civil engineering activity after signs of recovery in June and July. Home building activity contracted for the sixth month running, although the rate of decrease was softer than in July. ( Markit)

We have lost a lot of faith in PMi numbers but even so there is an issue as I do not know if there is a French equivalent of “shovel ready”? But construction is a tap that fiscal policy can influence relatively quickly and there seems to be no sign of that at all.

Indeed the total PMI picture was disappointing.

“The latest PMI data came as a disappointment
following the sharp rise in private sector activity seen
during July, which had spurred hopes that the French
economy could undergo a swift recovery towards precoronavirus levels of output. However, with activity
growth easing considerably in the latest survey period,
those hopes have been dashed…”

So the data seems to be more in line with the view expressed below.

It is designed to try to “avoid an economic collapse,” French Prime Minister Jean Castex said on Thursday. ( MarketWatch)

Where are the Public Finances?

According to the Trading Economics this is this mornings update.

France’s government budget deficit widened to EUR 151 billion in the first seven months of 2020 from EUR 109.7 billion a year earlier, amid efforts to support the economy hit by the coronavirus crisis. Government spending jumped 10.4 percent from a year earlier to EUR 269.3 billion, while revenues went down 6.3 percent to EUR 142.25 billion

I think their definition of spending has missed out debt costs.

As of the end of June the public debt was 1.992 trillion Euros.

Comment

I have avoided being to specific about the size of the contraction of the economy and hence numbers like debt to GDP. There are several reasons for this. One is simply that we do not know them and also we do not know how much of the contraction will be temporary and how much permanent? We return to part of yesterday’s post and France will be saying Merci Madame Lagarde with passion. The various QE bond purchase programmes mean that France has a benchmark ten-year yield of -0.18% and even long-term borrowing is cheap as it estimates it will pay 0.57% for some 40 year debt on Monday. That’s what you get when you buy 473 billion Euros of something and that is just the original emergency programme or PSPP and not the new emergency programme or PEPP. On that road the European Union fund is pure PR as it ends up at the ECB anyway.

The Bank of France has looked at the chances of a rebound and if we look at unemployment and it looks rather ominous.

However, the speed of the recovery in the coming months and years is more uncertain, as is the peak in the unemployment rate, which the Banque de France forecasts at 11.8% in mid-2021 for France……….Chart 1 shows that in France, Germany, Italy, and the United States, once the unemployment rate peaked, it fell at a rate that was fairly similar from one crisis to the next: on average 0.55 percentage point (pp) per year in France and Italy, 0.7 pp in Germany, and 0.63 pp in the United States.

There is not much cheer there and they seem to have overlooked that unemployment rates have been much higher in the Euro area than the US. But we can see how this might have triggered the French fiscal response especially at these bond yields.

But Giulia Sestieri is likely to find that her conclusion about fiscal policy is likely to see the Bank of France croissant and espresso trolley also contain the finest brandy as it arrives at her desk.

Ceteris paribus, the lessons of economic literature suggest potentially large fiscal multipliers during the post-Covid19 recovery phase

Mind you that is a lot of caveats for one solitary sentence.

Today’s Summer Statement is brought to you by the Bank of England

Today brings us to a set piece event for the UK economy. Due to the economic impact of the Covid-19 pandemic the summer statement will be more significant than many Budget Statements. One feature already is the way the media are cheerleading for ever more spending in ever more areas and dropping their usual “how will it be financed?” questions. As ever they have been somewhat slow on the uptake as we have been pointing out that UK debt costs have been doing this for some time now as they move on from the previous Status Quo.

Again again again again
Again again again and deeper and down
Down down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down

Perhaps the most extraordinary feature of this has been around for several weeks now as bond yields at the shorter end are negative. This means that next Tuesday we may well be paid to issue some £3.25 billion of a bond or Gilt which matures in 2026. At current prices it would yield -0.05%. Looking further ahead our benchmark ten-year yield is a mere 0.16% and the fifty-year on;y 0.44%. I would be issuing as many of the fifty-year Gilts as I could right now and I will return to that subject later.

Bank of England

The wheels of the price rises and yield falls I have just described have been oiled by the Bank of England. This was described by Bank of England policymaker Jonathan Haskel last week.

Since the onset of the crisis, the MPC has cut Bank Rate from 0.75% to 0.1% and expanded our asset purchase
programme by £200bn in March and a further £100bn in June. The majority of the initial £200bn in purchases is
complete, and we expect to complete the remaining announced purchases by around the end of the year.

Even in these inflated times setting out to buy £300 billion of something tends to move the price to say the least. Especially if you buy some £13.5 billion a week which was the initial pace set. It has now slowed to some £6.9 billion but even so if we switch to issuance the UK has so far issued some £6.9 billion of debt or bonds this week. There will be another £900 million of index-linked ( Retail Prices Index) Gilts tomorrow but as you can see the idea of investors choosing to buy UK Gilts is a relatively minor factor.

In terms of expectations take  look at another excerpt from that speech.

The first round of purchases aimed to prevent and stop in its tracks the financial market dysfunction resulting from
the significant financial market adjustment that occurred at the onset of this crisis in March…….. the UK government debt market was showing significant signs of strain.

He seems desperate to avoid saying falling prices were the driving influence here although he does get there.

This was apparent in falling and volatile prices

The next bit could only be written from a very high Ivory Tower.

These spikes we see in the panels, are highly unusual in what should be a deep and calm market for safe UK government debt.

I have worked through more than a few occasions where the opposite of that was true. Academics can be very unworldly but this rather takes the biscuit. After all the “deep” bit has been provided by the £300 billion he and his colleagues are in the process of buying! He continues in the same vein.

By stepping in and providing a reliably ample supply
of cash in the form of central bank reserves, the Bank of England was able to restore, almost immediately,
normal market functioning,

So “normal market functioning” is the Bank of England buying most of the supply? That is really rather Orwellian. It also turns a blind eye to the role of the US Federal Reserve which helped calm world markets by supplying US Dollars via its enhanced liquidity swaps operations. Indeed if we look ahead “normal market functioning” may even be the new “Whatever it takes.”

This, combined with an uncertain economic forward path, and in my view, risks skewed to the downside
concerning employment and more medium-term economic adjustments, prompted my vote and approval of a
further expansion of asset purchases in June to guard against any unwarranted future tightening and help
support the economic recovery as social distancing measures come off.

In other words he will do whatever it takes to keep Gilt yields low.

Whilst Jonathan is only one voter those thoughts have influenced Bank of England policy strongly and were, in my view, behind the plan for the Governor Andrew Bailey to address the 1922 Committee later today. This is the main grouping of backbench Conservative MPs and it seems plain that the Governor intended to turn up and say he has got their (spending) backs. This was unwise on various accounts of which the main would be opening him up to accusations of political bias which, let’s face it would be true.

House Prices

Much of the above is to put it mildly house price friendly as the UK establishment put Luther Vandross on their loudspeakers.

Is never too much, I just don’t wanna stop
Never too much, never too much
Never too much, never too much.

From the BBC

The chancellor is expected to announce changes to stamp duty on Wednesday to help cut costs for anyone buying a home.

It’s understood that the level at which the tax is charged could be temporarily raised to £500,000 to boost the property market and help buyers struggling because of the coronavirus crisis.

I have two main thoughts on this. Firstly it such “help” tends to move prices higher eroding and maybe eliminating the gain. Next we have been raising it for more revenue and now are chopping it? This seems rather confused. In the last financial year some £12,5 billion was raised by it.

Comment

Let me start with a policy prescription which is that I would announce that the UK was going to issue some Century ( 100 year) Gilts. Say a £10 billion tranche to kick-off the idea. One of the ironies of the present state of play is that a UK strength ( the maturity spectrum of the Gilt market) tends to count against us as fewer bonds mature and get refinanced more cheaply than elsewhere. We can offset this and help reduce the burden for future generations of the borrowing being undertaken now.

As to how much borrowing? Well we know that the present state of play is this.

In the current financial year-to-date (April to May 2020), the public sector borrowed £103.7 billion, £87.0 billion more than in the same period last year.

Or rather I should say to around £10 billion as there is still a lot of uncertainty about the actual figures. As to looking ahead the Resolution Foundation has got really rather excited.

Our analysis not only provides a quantitative estimate of the overall size of the fiscal rescue package, which has to be larger – at around £200 billion, or around 10 per cent of GDP – than that seen in previous recessions.

They forecast lower debt costs but seem to have forgotten how much of our debt is inked to inflation. Care is needed here as whilst debt costs are low there is a burden from ever large amounts as Greece and Japan have shown.

Let me finish by assuring you I will be scanning the skies above Battersea for RAF Chinooks dropping money.

On the demand side, the Government should create a ‘High Street Voucher’ scheme to boost consumption in the hardest-hit sectors. This approach is more targeted and progressive than a VAT cut, and, unlike the flat-rate cash transfers employed in the US, could not simply be saved by higher-income households. We propose vouchers worth £500 per adult and £250 per child.

The Investing Channel

 

 

The USA will Spend! Spend! Spend! As we wonder whatever happened to the debt ceiling?

Yesterday evening there was a piece of news which created a stir even in these inflated times. So without further ado let me hand you over to the US Treasury Department.

During the April – June 2020 quarter, Treasury expects to borrow $2,999 billion in privately-held net marketable debt, assuming an end-of-June cash balance of $800 billion.  The borrowing estimate is $3,055 billion higher than announced in February 2020.

I have to confess the numbers did not look right so I checked the February release.

During the April – June 2020 quarter, Treasury expects to pay down $56 billion in privately-held net marketable debt, assuming an end-of-June cash balance of $400 billion.

This was to be quite an improvement on where it was at the time.

During the January – March 2020 quarter, Treasury expects to borrow $367 billion in privately-held net marketable debt, assuming an end-of-March cash balance of $400 billion.

So we return to the concept of some US 3 trillion dollars being borrowed in a single quarter. As to the higher cash balance which is in the process of being doubled that looks as though it is simply because the US is spending at such a rate it needs more to avoid the risk of a cash crunch. Indeed the process is well under way.

During the January – March 2020 quarter, Treasury borrowed $477 billion in privately-held net marketable debt and ended the quarter with a cash balance of $515 billion.  In February 2020, Treasury estimated privately-held net marketable borrowing of $367 billion and assumed an end-of-March cash balance of $400 billion. The $110 billion increase in borrowing resulted primarily from the higher end-of-quarter cash balance.

Where is the money going?

The US Treasury is light on some detail but the Paycheck Protection Program had spent some US $350 billion very quickly so we then saw this.

Washington (CNN)The Trump administration announced Sunday that 2.2 million small business loans worth $175 billion have been made in the second round of the Paycheck Protection Program……Treasury Secretary Steve Mnuchin and Small Business Administration Administrator Jovita Carranza said in a joint statement that the average size of a loan made under the second iteration of the program, which began Monday, was $79,000.

The original stimulus effort was described below by CNN.

Congressional lawmakers put the finishing touches on a $2 trillion stimulus bill to respond to the coronavirus pandemic, with cash and assistance for regular Americans, Main Street businesses and hard-hit airlines and manufacturers, among others……..Key elements of the proposal are $250 billion set aside for direct payments to individuals and families, $350 billion in small business loans, $250 billion in unemployment insurance benefits and $500 billion in loans for distressed companies.

We can see that like the small business loans the numbers are likely to have been climbing higher and higher. As to the new higher employment benefits they seem to be being paid to ever higher numbers.

The advance unadjusted number for persons claiming UI benefits in state programs totaled 17,776,006, an increase of 1,498,784 (or 9.2 percent) from the preceding week. The seasonal factors had expected a decrease of 648,558 (or -4.0 percent) from the previous week. A year earlier the rate was 1.1 percent and the volume was 1,647,874 ( Department of Labor)

I think we can figure out for ourselves what has been happening to tax revenues.

Treasury Bonds and QE

In ordinary times one might have expected this market to have cratered. I have worked through times when futures markets prices limits are employed ( it was initially 2 points and then moves to 3 points). But the surge in expected borrowing has provided nothing of the sort and these days eyes turn first to the US Federal Reserve and its Quantitative Easing programme. The emphasis below is mine.

To support the flow of credit to households and businesses, the Federal Reserve will continue to purchase Treasury securities and agency residential and commercial mortgage-backed securities in the amounts needed to support smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions. In addition, the Open Market Desk will continue to offer large-scale overnight and term repurchase agreement operations. The Committee will closely monitor market conditions and is prepared to adjust its plans as appropriate.

That is a sort of combination of “whatever it takes” and “To Infinity! And Beyond!” in my opinion. We saw purchases of US $75 billion a day in the height of the panic and we should not forget that in the heat of the “Not QE” phase some US $60 billion of US Treasury Bills were bought a month. So we see that it now owns some US $3.97 trillion of Treasury Securities which has risen by US $1.8 trlllion on the past year.

Thus although we are now seeing a much lower daily amount of QE purchases the surge of buying has anaesthetised the market. This week only US $8 billion a day is being bought and yet we see the benchmark yield for the ten-year Treasury Note if a mere 0.67%. The long bond ( 30 year) has responded a little but at 1.33% is less than half what it was this time last year.

Foreign Holdings

There is a long wait for such numbers but here is what the US Treasury thinks that they are.

The survey measured the value of foreign portfolio holdings of U.S. securities as of end-June 2019 to be $20,534 billion, with $8,630 billion held in U.S. equities, $10,991 billion in U.S. long-term debt securities [/1] (of which $1,417 billion are holdings of asset-backed securities (ABS) [/2] and $9,575 billion are holdings of non-ABS securities), and $913 billion held in U.S. short-term debt securities.

Comment

Remember the debt ceiling?

Congress has always acted when called upon to raise the debt limit. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. Congressional leaders in both parties have recognized that this is necessary. ( US Treasury )

Anyway the total national debt was US $23.7 trillion at the end of March and is about to go on something of a tear. On the other side of the coin economic output as measured by GDP or Gross Domestic Product is about to plunge.

The WEI is currently -11.58 percent, scaled to four-quarter GDP growth, for the week ending April 25 and -10.86 percent for April 18; for reference, the WEI stood at 1.58 percent for the week ending February 29. ( New York Fed )

Or if you prefer.

The New York Fed Staff Nowcast stands at -9.3% for 2020:Q2.

Also the US Federal Reserve is about to get rather popular as we note how this trend will change in 2020.

In 2019, the Federal Reserve remitted a total of $54.9 billion to the Treasury, less than the $65.3 billion remitted in 2018, owing primarily to a decline in net income resulting from a decrease in average SOMA domestic securities holdings.

I guess both the US Federal Reserve and Treasury will be singing along with Prince for a while.

Money don’t matter to night
It sure didn’t matter yesterday
Just when you think you’ve got more than enough
That’s when it all up and flies away
That’s when you find out that you’re better off
Makin’ sure your soul’s alright
‘Cause money didn’t matter yesterday,
And it sure don’t matter to night

 

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

 

 

Spend! Spend! Spend!

The weekend just passed was one which saw one of the economic dams of our time creak and then look like it had broken. This was due to the announcements coming out of Germany which as regular readers will be aware has a debt brake and had been planning for a fiscal surplus.

Under Germany’s so-called debt brake rule, Berlin is allowed to take on new debt of no more than 0.35% of economic output, unless the country is hit by a natural disaster or other emergencies. ( Reuters)

Actually the economic slow down in 2019 caused by the trade war was pulling it back towards fiscal balance and what it taking place right now would have caused a deficit anyway. But now it seems that the emergency clause above is being activated.

Germany is readying an emergency budget worth more than 150 billion euros ($160 billion) to shore up jobs and businesses at risk from the economic impact of the coronavirus outbreak, the finance minister said on Saturday.

Government sources told Reuters hundreds of billions in additional backing for the private sector would be raised, as Finance Minister Olaf Scholz said a ceiling on new government debt enshrined in the country’s constitution would be suspended due to the exceptional circumstances.

Putting that into context it is around 5% of Germany’s GDP in 2019 and I am stating the numbers like that because we have little idea of current GDP other than the fact there will be a sizeable drop. It then emerged that there was more to the package.

According to senior officials and a draft law seen by Reuters, the package will include a supplementary government budget of 156 billion euros, 100 billion euros for an economic stability fund that can take direct equity stakes in companies, and 100 billion euros in credit to public-sector development bank KfW for loans to struggling businesses.

On top of that, the stability fund will offer 400 billion euros in loan guarantees to secure corporate debt at risk of defaulting, taking the volume of the overall package to more than 750 billion euros.

As you can see we end up with intervention on a grand scale with the total being over 22% of last year’s economic output or GDP. This will lead to quite a change in the national debt dynamics which looked on their way to qualifying under the Stability and Growth Pact or Maastricht rules. This is because it was 61.2% of GDP at the end of the third quarter of last year which now looks a case of so near and so far.

Bond Market

There were times when such an audacious fiscal move would have the bond market creaking and yields rising. In fact the ten-year yield has dropped slightly this morning to -0.37%. Indeed even the thirty-year yield is at -0.01% so Germany is either being paid to borrow or is paying effectively nothing.

This is being driven by the purchases of the ECB or European Central Bank and as the Bundesbank seems not to have updated its pages then by my maths we will be seeing around 30 billion Euros per month of German purchases. Also let me remind you that the risk is not quite what you might think.

This implies that 20% of the asset purchases under the PSPP will continue to be subject to a regime of risk sharing, while 80% of the purchases will be excluded from risk sharing. ( Bundesbank)

The situation gets more complex as we note Isabel Schnabel of the ECB Governing Council put this out on social media over the weekend.

The capital key remains the benchmark for sovereign bond purchases, but flexibility is needed in order to tackle the situation appropriately.

That will be particularly welcomed by Italy as other ECB policy makers try to undo the damage created by the “bond spreads” comment of President Lagarde. Although you may note that most of the risk will be with the Bank of Italy.

Also as a German she did a bit of cheer leading for her home country.

The success of our measures hinges on what happens in fiscal policy. This is a European issue which needs a European solution. No country can be indifferent to what happens in another European country – not only because of solidarity, but also for economic reasons.

Some might think she has quite a cheek on the indifference point as that is exactly how countries like Greece described Germany. Still I also think the ECB has plenty of tools but maybe not from the same perspective.

The ECB is in the comfortable position of having a large set of tools, none of which has been used to its full extent

QE

It was only last Thursday that I was pointing out that I expected QE to go even more viral and last night it arrived at what is in geographical terms one of the more isolated countries.

The Monetary Policy Committee (MPC) has decided to implement a Large Scale Asset Purchase programme (LSAP) of New Zealand government bonds……..The Committee has decided to implement a LSAP programme of New Zealand government bonds. The programme will purchase up to $30 billion of New Zealand government bonds, across a range of maturities, in the secondary market over the next 12 months. The programme aims to provide further support to the economy, build confidence, and keep interest rates on government bonds low.

You can almost hear the cries of “The Precious! The Precious!”

Heightened risk aversion has caused a rise in interest rates on long-term New Zealand government bonds and the cost of bank funding.

Which follows on from this last week.

“To support credit availability, the Bank has decided to delay the start date of increased capital requirements for banks by 12 months – to 1 July 2021. Should conditions warrant it next year, the Reserve Bank will consider whether further delays are necessary.”

This reminds me of one of my themes from back in the day that bank capital requirement changes were delayed almost hoping for something to turn up. Albeit of course they had no idea a pandemic would occur.

Let us move on noting for reference purposes that the ten-year All Black yield is 1.46%.

The US

There are some extraordinary numbers on the way here according to CNBC.

Administration statements over the past few days point to something of the order of $2 trillion in economic juice. By contrast, then-President Barack Obama ushered an $831 billion package through during the financial crisis.

Indeed they just keep coming.

That type of fiscal burden comes as the government already has chalked up $624.5 billion in red ink through just the first five months of the fiscal year, which started in October. That spending pace extrapolated through the full fiscal year would lead to a $1.5 trillion deficit, and that’s aside from any of the spending to combat the corona virus.

At the moment we know something is coming but not the exact size as debate is ongoing in Congress but we can set some benchmarks.

A $2 trillion deficit, which seems conservative given the current scenario, would push deficit to GDP to 9.4%. A $3 trillion shortfall, which seems like not much of a stretch, would take the level to 14%.

Comment

The headline today for those unaware was from Viv Nicholson back in the day after her husband had won the pools. But we see something of a torrent of fiscal action on its way oiled by an extraordinary amount of sovereign bond buying by central banks. For example the Bank of England will buy an extra £5.1 billion today in addition to its ongoing replacement of its holdings of a matured bond.

On the other side of the coin is the scale of the economic contraction ahead. Below are the numbers for the German IFO which we can compare with the fiscal response above albeit that I suggest we treat them as a broad brush.

“If the economy comes to a standstill for two months, costs can range from 255 to 495 billion euros, depending on the scenario. Economic output then shrinks by 7.2 to 11.2 percentage points a year, ”says Fuest. In the best scenario, it is assumed that economic output will drop to 59.6 percent for two months, recover to 79.8 percent in the third month and finally reach 100 percent again in the fourth month. “With three months of partial closure, the costs already reach 354 to 729 billion euros, which is a 10.0 to 20.6 percentage point loss in growth,” says Fuest.

Podcast

 

 

Fiscal Policy will now take centre stage as France has shown

One of our themes is now fully in play. We have observed over the past year or two a shift in establishment thinking towards fiscal policy. This had both bad and good elements. The bad was that it reflected a reality where all the extraordinary monetary policies had proved to be much weaker than the the claims of their supporters and even worse for them were running out of road. The current crisis has reminded us of this as we have had, for example, two emergency moves from the US Federal Reserve already, in its role as a de facto world central bank.

A more positive factor in this has been the change we have been observing in bond yields. We can get a handle on this by looking back at the world’s biggest which is the US Treasury Bond market. Back in the autumn of 2018 when worlds like “normalisation” ans phrases like “Quantitative Tightening” were in vogue the benchmark ten year yield saw peaks around 3.15%. Basically it then spent most of a year halving before rallying back to 1.9% at the end of last year and beginning of this. But this move took place in spite of the fact that we have the Trump Tax Boost which was estimated to have an impact of the order of one trillion US Dollars. I mention this because as well as the obvious another theme was in play which was that the Ivory Towers were wrong-footed yet again. The Congressional Budget Office has had to keep reducing its estimate of debt costs as the rises it expected turned into falls. Also whilst I am on this subject I am not sure this from January is going to turn out so well!

In 2020, inflation-adjusted GDP is projected to grow by 2.2 percent, largely because
of continued strength in consumer spending and a rebound in business fixed investment. Output is
projected to be higher than the economy’s maximum sustainable output this year to a greater degree
than it has been in recent years, leading to higher inflation and interest rates after a period in which
both were low, on average.

Best of luck with that.

Meanwhile we have seen a fair bit of volatility in bond yields but the US ten-year is 0.8% as I type this. Even the long bond ( 30 years) is a relatively mere 1.4%.

Thus borrowing is very cheap and only on Sunday night the US Federal Reserve arrived in town and did its best to keep it so.

 over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion.

Step Forwards France

There was an announcement yesterday evening by President Macron which was announced in gushing terms by Faisal Islam of the BBC.

The €300 billion euro fiscal support package announced by Macron for the French economy, to ensure businesses dont go bust and taxes/ charges suspended, is worth about 12% of its GDP – in UK terms that would mean £265 billion…

This morning the French Finance Minster has given some different numbers.

French measures to help companies and employees weather the coronavirus storm will be worth some €45bn, the country’s finance minister Bruno Le Maire said on Tuesday. ( Financial Times)

He went on to give some details of how it would be spent.

He told RTL radio the package of financial aid, which includes payments to temporarily redundant workers and deferments of tax and social security bills, would help “the economy to restart once the corona virus epidemic is behind us”. Previously he had referred to “tens of billions of euros”.

Now let us look at the previous position for France. We had previously note that France was in the middle of a fiscal nudge anyway as the first half of 2019 saw quarterly deficits of 3.2% and 3.1% of GDP respectively, The third quarter was back within the Maastricht rules as it fell to 2.5% of GDP but we still had a boost overall and as you can see below the national debt to GDP ratio went over 100%

At the end of Q3 2019, Maastricht’s debt reached €2,415.1 billion, up €39.6 billion in comparison to Q2 2019. It accounted for 100.4% of gross domestic product (GDP), 0.9 points higher than last quarter. Net public debt increased more moderately (€+15.0 billion) and accounted for 90.3 % of GDP.

Of course debt to GDP numbers have gone out of fashion partly because the “bond vigilantes” so rarely turn up these days. There was a time that a debt to GDP ratio above 100% would have them flying in but they restricted their flying well before the Corona Virus made such a move fashionable. The French ten-year yield is up this morning but at 0.27% is hardly a deterrent in itself to more fiscal action. However whilst it is still as low as it has ever been before this stage of the crisis a thirty-year yield of 0.8% is up a fair bit on the 0.2% we saw only last week. Another factor in play is this.

Third, we decided to add a temporary envelope of additional net asset purchases of €120 billion until the end of the year, ensuring a strong contribution from the private sector purchase programmes. ( ECB )

Whilst only a proportion of the buying we can expect monthly purchases of French government bonds to rise from the previous 4 billion Euros or so and accordingly the total to push on from 434.4 billion. Also whilst President Lagarde was willing to express a haughty disdain for “bond spreads” I suspect the former French Finance Minister would be charging to the rescue of France if necessary.

One feature of French life is that taxes are relatively high.

The tax-to-GDP ratio varies significantly between Member States, with the highest share of taxes and social
contributions in percentage of GDP in 2018 being recorded in France (48.4%), Belgium (47.2%) and Denmark
(45.9%), followed by Sweden (44.4%), Austria (42.8%), Finland (42.4%) and Italy (42.0%). ( Eurostat )

Short Selling Bans

France along with some other European nations announced short-selling bans this morning which stop investors selling shares they do not own.

#BREAKING French market regulator bans short-selling on 92 stocks: statement ( @afp )

I pointed out that these things have a track record of failure

These sort of things cause a market rally in the short-term but usually wear off in a day or two.

The initial rally to over 4000 on the CAC 40 index soon wore off and we are now unchanged on the day having at one point being 100 points off. Of course some policy work will be writing a paper reminding us of the counterfactual.

Comment

I am expecting a lot more fiscal action in the next few days. The French template is for a move a bit less than 2% of GDP. That will of course rise as GDP falls.

The French government was assuming the economy would shrink about 1 per cent this year, instead of growing more than 1 per cent as previously predicted, Mr Le Maire said. ( Financial Times)

Frankly that looks very optimistic right now. The situation is fast moving as doe example Airbus which only yesterday expected to remain open announced this today.

Following the implementation of new measures in France and Spain to contain the COVID-19 pandemic, Airbus has decided to temporarily pause production and assembly activities at its French and Spanish sites across the Company for the next four days. This will allow sufficient time to implement stringent health and safety conditions in terms of hygiene, cleaning and self-distancing, while improving the efficiency of operations under the new working conditions.

Let me now shift to the other part of the package.

Mr Le Maire said ammunition to prop up the economy also included €300bn of French state guarantees for bank loans to businesses and €1tn of such guarantees from European institutions. ( FT )

The problem is how will this work in practice? The numbers sound grand but for example the Bank of England announced up to £290 billion for SMEs only last week which everyone seems to have forgotten already! One bit that seemed rather devoid of reality to me at the time was this.

The release of the countercyclical capital buffer will support up to £190bn of bank lending to businesses. That is equivalent to 13 times banks’ net lending to businesses in 2019.

Returning to pure fiscal policy I am expecting more of it and would suggest it is aimed at two areas.

  1. Supporting individuals who through not fault of their own have seen incomes plunge and maybe disappear.
  2. Similar for small businesses and indeed larger ones which are considered vital.

Just for clarity that does not mean for banks and the housing market where such monies have a habit of ending up.

Meanwhile a country which badly needs help is still suffering from the “ECB not here to close bond spreads” of Christine Lagarde last week as its ten-year yield has risen to 2.3%. Her open mouth operation has undone a lot of ECB buying.