Why are central bankers so afraid of the truth?

We find ourselves in an era where central bankers wield enormous power. There is something of an irony in this. They were given the ability to set monetary policy as a way of taking power out of the hands of politicians.This led to talk of “independence” as they set interest-rates to achieve an inflation target usually but not always of 2% per annum. Actually this is the first falsehood because we are regularly told this.

The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%

They could also tell me the moon is full of cheese but I would not believe that either. I am amazed how rarely this is challenged but price stability is clearly an inflation rate of 0%, The usual argument that this stops relative price shifts collapsed when the oil price fall of 2015/16 gave us inflation of around 0% as plainly there was a relative price shift for oil and indeed other goods. Perhaps the shrieks of “Deflation” were a type of distraction.

Next has come the way that claimed independence has morphed into collusion with the political establishment. This moves us away from the original rationale which was to take monetary policy power out of the hands of politicians to stop them manipulating it for the electoral cycle. What had apparent success which was technocratic control of interest-rates has morphed into this.

  1. Interest-Rates around 0%
  2. Large-Scale purchases of sovereign bonds
  3. Large-Scale purchases of private-sector bonds
  4. Credit Easing
  5. Purchases of equities ( for monetary policy and as a consequence of exchange-rate policy)
  6. Purchases of commercial property so far via Exchange-Traded Funds or ETFs

Not all central banks have gone all the way down the list with the Bank of Japan being the leader of the pack and who knows may go even further overnight at its unscheduled meeting? I should add as people regularly look at my back catalogue that by the time anyone in that category reads this we may see many central banks at step 6 and maybe going further. But back to my collusion point here is some evidence.

I also confirm that the Asset Purchase Facility will remain in place for the financial year 2020-21.

This is almost a throwaway sentence in the inflation remit from the Bank of England but it is in fact extremely important in two ways, and in tune with today’s theme neither of which are mentioned. The Chancellor Rishi Sunak is reaffirming that Her Majesty’s Treasury is backing the QE ( Quantitative Easing ) policies of the Bank of England which currently are steps 2 to 4 above. Next comes the issue of the amount which is huge even for these times.

The Committee voted by a majority of 7-2 for the Bank of England to continue with the programme of £200 billion of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, to take the total stock of these purchases to £645 billion.

The 2 dissenters voted for “More! More! More!” rather than less and I expect the extra £100 billion they voted for to be something sung about by The Undertones.

Happens all the time
Its going to happen – happen – till your change your mind
Its going to happen – happen – happens all the time

So we have a doom loop for supporters of independence as the politicians via backing any losses from QE become the masters again and the central bankers become marionettes. As so often we see Japan in the van by the way the Abenomics of Shinzo Abe appointed Governor Kuroda to the Bank of Japan pretty much as they would appoint a minister. It is the most exposed in terms of monetary policy via its 31.4 trillion Yen of equity holdings with a break-even it estimates at around 19,500 in terms of the Nikkei 225 index. Also of course an individual company in which it holds shares could fold.

Forward Guidance

This had a cacophony of falsehoods as we were promised interest-rate rises which failed to happen. In my own country it became laughable as an unemployment rate of 7% was highlighted and then unemployment rates of 6% and 5% were ignored. Then at Mansion House in June 2014 Governor Mark Carney said this.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

In fact a bit over 2 years later he cut them whilst promising to reduce them further than November to 0.1% before economic reality even reached Threadneedle Street and the latter was redacted. It is hard to believe now but many were predicting interest-rate rises by the ECB in 2019 based on Forward Guidance. Of course the US Federal Reserve did actually give it a go before retreating like Napoleon from Moscow and as we recall the role of President Trump in this I would remind you of my political collusion/control point above.

Negative Interest-Rates

This area is littered with falsehoods. In Beatles terms it took only a week for this.

Bank of Japan Governor Haruhiko Kuroda said he is not thinking of adopting a negative interest rate policy now,

to become this.

The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank.1 It will cut the interest rate further into negative territory if judged as necessary.

As Hard-Fi put it.

Can’t believe it
You’re so hard to beat
Hard to beat

The new Governor of the Bank of England seems to be on the same road to Damascus. From Sky News yesterday.

Mr Bailey told MPs it was now studying how effective that cut had been as well as “looking very carefully” at the experience of other countries where negative rates had been implemented.

On the prospect of negative rates, he said: “We do not rule things out as a matter of principle.

Curious because that is exactly what people had thought he had done several times in this crisis.

Comment

There are other areas I could highlight as for example there is the ridiculous adherence to the output gap philosophy that has proved to be consistent only in its failures. But let me leave you via the genius of Christine McVie the central bankers anthem.

Tell me lies
Tell me sweet little lies
Tell me lies, tell me, tell me lies
Oh, no, no, you can’t disguise
(You can’t disguise, no, you can’t disguise)
Tell me lies
Tell me sweet little lies

Me on The Investing Channel

 

What are the economics of Scottish independence?

Yesterday saw the First Minster of Scotland fire the starting gun for a second vote on independence from the UK for Scotland as the pace of possible change ratchets up yet another notch. With it came am intriguing view of how long a lifetime is these days! Although I am also reminded of the saying that “a week is a long time in politics”. However as ever I look to steer clear of the political melee and look at the economics. So how is the Scottish economy doing?

Economic growth

The Scottish government has published this data.

When rounded to one decimal place, at 2016 Q2 annual GDP growth in Scotland was 0.9 percentage points lower than in the UK. At 2016 Q3, annual GDP growth in Scotland was 1.2 percentage points lower than in the UK. Between 2016 Q2 and 2016 Q3, the gap between annual Scottish and UK GDP growth increased by 0.3 percentage points in favour of the UK (when rounded to one decimal place).

As you can see the recent performance has been around 1% per annum slower than the UK and may well be accelerating. With the UK economy overall having grown by 0.7% in the last quarter of 2016 that seems likely to have continued but of course there are always dangers in any extrapolation. If we look back we see that in the pre credit crunch period GDP growth was similar then Scotland did worse and then better as presumably the oil price boom benefited it ( although the oil sector itself is excluded). Then until the recent phase Scotland did mildly worse than the rest of the UK.

Looking ahead

The Scottish government plans to improve this and with an eye on future policy has set a European Union based objective.

To match the GDP growth rate of the small independent EU countries by 2017.

How is that going so far?

The latest data show that over the year to 2016 Q3 GDP in Scotland grew by 0.7% whilst GDP growth in the Small EU was 3.5% (measured on a rolling four quarter on four quarter basis). When rounded to one decimal place, this resulted in a gap of 2.8 percentage points in favour of Small EU. This compares to an annual increase in GDP to 2016 Q2 of 1.0% in Scotland, and an increase of 4.2% in the Small EU – resulting in a 3.3 percentage point gap in favour of Small EU (when rounded to one decimal place).

As you can see the gap here is much wider and leaves Scotland with a lot of ground to recoup. If you look at the list that may well get harder.

The small independent EU countries are defined as: Austria, Denmark, Finland, Ireland, Portugal and Sweden. Luxembourg has been re-included in the newest update due to a change in availability of data.

Ireland is proving a hard act to follow.

Preliminary estimates indicate that GDP in volume terms increased by 5.2 per cent for the year 2016. GNP showed an increase of 9.0 per cent in 2016 over 2015.

It is an awkward fact that the 21% economic growth registered by Ireland in the first quarter of 2015 lifted the target away from Scotland and it continues to offer something hard to catch. Of course such large moves also challenge the credibility of the Irish data series.

What about employment?

Good but not as good as England currently.

Scotland’s employment rate of 73.6 per cent for Q4 2016, is the second highest across all UK countries, 1.3 percentage points below England. This indicates a worsening position compared with a year ago when Scotland had the highest employment rate across all UK countries, 0.2 percentage points above England (the second highest).

Natutral Resources

Crude Oil and Gas

Plainly Scot;and has considerable resources here although unless there are new discoveries these seem set to decline over time. There have also been big changes in the crude oil price as FullFact reported last October.

It is correct that crude oil prices are currently at around $50 a barrel. Back at the time of the first Scottish independence referendum in September 2014 oil was selling for just over US $90 a barrel.

Energy policy, and how oil revenue would be invested, was part of  the Scottish government’s vision for an independent Scotland……….”With independence we can ensure that taxation revenues from oil and gas support Scottish public services, and that Scotland sets up an Energy Fund to ensure that future generations also benefit from our oil and gas reserves. “

I think that FullFact were being very fair here as there were forecasts from Alex Salmond that the oil price would rise towards US $130 per barrel if my memory serves me right. Whereas it is now US $51 or so in terms of Brent crude oil. So the oil sector has seen something of a recession affecting areas like Aberdeen although there would have been gains for other Scottish businesses and consumers from lower prices.

The Fiscal Position

This has been affected both by the lower oil price and also by the recent trend to lower economic growth than the rest of the UK. The former was highlighted by this from the 2015-16 data.

Scotland’s illustrative share of North Sea revenue fell from £1.8 billion in 2014-15 to £60 million, reflecting a decline in total UK North Sea revenue.

This led to these numbers being reported.

Excluding North Sea revenue, was a deficit of £14.9 billion (10.1 per cent of GDP).

Including an illustrative geographic share of North Sea revenue, was a deficit of £14.8 billion (9.5 per cent of GDP).

For the UK, was a deficit of £75.3 billion (4.0 per cent of GDP).

This adds to an issue I reported on back in my Mindful Money days in November 2013.

So there is something of a shark in the water here. If we add in the fact that Scotland spends more per head than the rest of the UK then the IFS ( Institute for Fiscal Studies) considers that the fiscal position is more dangerous. Both the UK and Scotland spend more than they get in from tax but the Scottish position is more reliant on a fading source of tax revenue. This is what leads to the following conclusion.

As it turns out that source of revenue has ended at least for now and seems to be capped by the shale oil wildcatters for the next few years. All rather different to this.

But a current strength of the numbers is revenue from North Sea oil which was 18.6% of tax revenue in 2011-12 for Scotland.

Of course there would be quite a debate over the share of the UK national debt that would belong to Scotland but the fiscal position is presently poor.

What currency?

This poses a few questions so let me repeat the issues with using the UK Pound.

1. The Bank of England will presumably set interest-rates to suit England (and Wales and Northern Ireland). This may or may not suit Scotland.

2. The value of the pound will mostly be determined by the much larger English economy in some respects similar to the way that Germany dominates the Euro. That has not worked out well for many of the Euro nations.

3. This is to say the least awkward, if further bank bailouts are required. Will the Bank of England be the “lender of last resort” in Scotland? How does this work when it has an independent treasury? Just as a guide, individual nations in the Euro area had their own central banks which survive to this day partly because of this issue.

4. There is also the issue of currency reserves and intervention which presumably also stay with the Bank of England.

5. What about the money supply of Scotland which will again presumably be controlled by the Bank of England and set for the rest of the UK?

6. Has anybody bothered to ask the citizens of the rest of the UK if they are willing to take the risk of having Scotland in a currency but not a political or fiscal union? This would take place just as the Euro is demonstrating many of the risks of such an arrangement. But added to it for the rest of the UK would be new oil or gas discoveries pushing up the value of the pound and thereby making their businesses and industry less competitive.

Comment

Scotland plainly has economic strengths with its natural resources and financial services industry. However since the last vote there has been a deterioration in economic circumstances as we have seem growth fall below that of the rest of the UK. This has led to a problem with the fiscal deficit and it is hard not to think of the criteria for joining the European Union.

New Member States are also committed to complying with the criteria laid down in the Treaty in order to be able to adopt the euro in due course after accession.

We do not know what the national debt would be but the fiscal deficit is around treble the 3% of GDP target per annum in the Euro accession rules. Of course Euro members have often ignored it but they have been much stricter on prospective entrants. Quite a Euro area style austerity squeeze would seem likely and that has been associated with recessions and quite severe ones at that.

Charlotte Hogg’s Resignation

Back on the 1st of March I pointed out the lack of competence on monetary policy she displayed in front of the UK Treasury Select Committee. Today it was announced that she offered to resign last week but Mark Carney would not take it. Now he has.

Click to access charlottehoggletter130317.pdf

 

Click to access 028.pdf