The IMF debt arrow warning misses the real target

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

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

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

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

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

The IMF Fiscal Monitor

Here is the opening salvo.

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

Later we get a breakdown of this.

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

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

Government Debt

Here is the IMF hammering out its beat.

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

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

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

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

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

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

Advanced Countries

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

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

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

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

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

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

What about interest-rates and yields?

There was this from Lisa Abramowicz of Bloomberg yesterday.

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

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

Comment

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

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

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

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

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

Me on Core Finance TV

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How soon will the US national debt be unaffordable?

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

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

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

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

US National Debt

It is on the up and up.

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

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

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

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

Deficits

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

Bond Yields

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

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

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

Inflation

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

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

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

Economic Growth

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

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

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

Comment

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

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

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

 

 

 

 

Germany also faces ever more unaffordable housing

The economy of Germany has been seeing good times as Chic would put it and this morning has seen an indicator of this. From Destatis.

 The debt owed by the overall public budget (Federation, Länder, municipalities/associations of municipalities and social security funds, including all extra budgets) to the non-public sector amounted to 1,965.5 billion euros at the end of the fourth quarter of 2017. ……..Based on provisional results, the Federal Statistical Office (Destatis) also reports that this was a decrease in debt of 2.1%, or 41.3 billion euros, compared with the end of the fourth quarter of 2016.

We talk of Germany being a surplus economy and here is another sign of it as it applies to itself the medicine it has prescribed for others.

 Net lending of general government amounted to 36.6 billion euros in 2017…….. When measured as a percentage of gross domestic product at current prices (3,263.4 billion euros), the surplus ratio of general government was +1.1%.

Of course all of this is much easier in a growing economy.

 For the whole year of 2017, this was an increase of 2.2% (calendar-adjusted: +2.5%),

Thus the national debt to GDP ratio will have declined and I am sure more than a few of you will have noted that the total debt is a fair bit smaller than Italy’s for a larger economy. This parsimony has of course been helped by European Central Bank purchases of German Bunds which means that even five-year bonds have a negative yield ( -0.07%). Of course there is a chicken and egg situation here but 469 billion Euros of bond purchases in a growing economy lead to yields which would lead past computer models to blow up like HAL-9000 in the Film 2001 A Space Odyssey.

Trade

Whilst we are looking at surpluses there is this ongoing saga which continued last year.

Arithmetically, the balance of exports and imports had an effect of +0.8 percentage points on GDP growth compared with the previous year.

Ironically Germany did actually boost its imports ( 4.8%) but its export performance ( 5.6%) was even better. This meant that the same old song was being played.

According to provisional results of the Deutsche Bundesbank, the current account of the balance of payments showed a surplus of 257.1 billion euros in 2017.

If we allow for the inaccuracies in the data and the latest “trade wars” debate mostly raised by President Trump has highlighted the issues here with some countries thinking they are both in surplus/deficit with each other the German surplus is a constant. This poses quite a few questions as of course on one line of thinking it was a cause of the credit crunch.

The International Monetary Fund (IMF) and the European Commission have for years urged Germany to lift domestic demand and imports in order to reduce global economic imbalances and fuel global growth, including within the euro zone.

As time has passed it is hard not to wonder about how much Germany could have helped its Euro area partners via this route. Of course a catch is that it would have to want what they produce which gets forgotten. Also I find a wry humour in organisations like the IMF and EC telling Germans to “spend,spend,spend” to coin a phrase and consume more and yet also warn regularly about climate change.

Labour Market

There is another sign of success if we note this.

The adjusted unemployment rate was 3.6% again in January 2018……….Compared with January 2017, the number of persons in employment increased by 1.4% (+631,000 people). Roughly 1.6 million people were unemployed in January 2018, 160,000 fewer than a year earlier.

So we see that the quantity numbers for the labour market are very good as the unemployment rate chases that of Japan. However if we move to the quality arena things look a little different. From Bloomberg.

The scramble for qualified workers has become an existential issue for companies across Germany, which are offering enticements ranging from overseas sojourns and ski outings to subsidized housing and sausage platters.

Let us park the issue of whether the sausages are delicious and consider the cause of this.

After years of robust growth, unemployment has dropped to a record low of 5.4 percent, and the country has 1.2 million unfilled jobs—nearly equivalent to the population of Munich. Manufacturing, construction, and health care are particularly stretched, and 1 in 4 businesses may have to hold back production as a result of the labor crunch, the European Union reports.

So our HAL-9000 would predict wage growth and of course if it was in a central bank it would be flashing “output gap negative” and predicting stellar wage growth. Meanwhile back in the real world.

The corporate largesse hasn’t dramatically boosted salaries, at least so far. Compensation in Germany rose 13 percent in the last five years as unions moderated wage demands to help their companies maintain an edge in the face of growing global competition.

There is another similarity here with Japan in that the financial media have been telling us that wages are about to soar or sometimes that agreements have been signed. So they must spend their lives being disappointed as whilst the German figures are better than Japan’s they are not what has been promised.

If we look into the detail of the report we see that in spite of strong circumstances companies these days seem to prefer one-off payments rather than wage rises. Have we changed that much in response to the credit crunch as in being less certain about the future or not believing what we are told in this case about economic strength? There is some logic behind that in an era of Fake News stretching to diesel engines and indeed hybrid performance if we consider areas especially relevant to Germany, Maybe wages measures should switch to earnings per hour.

the country’s biggest union this year accepted a lower increase in salaries in exchange for the right to work fewer hours.

But America already does that and it has not changed the picture but maybe still worth a go.

House Prices

I note that in February the Bundesbank picked out house prices and told us this.

According to current estimates, price
exaggerations in urban areas overall in 2017
amounted to between 15% and 30%. In
the big cities, where considerable overvaluations
had already been measured earlier,
the price deviations are likely to have increased
further to 35%.

Price “exaggerations” is a new one but presumably is being driven by this.

According to figures based on bulwiengesa AG
data residential property prices in urban
areas in Germany continued to increase
sharply by around 9%, and hence at a
somewhat faster pace than in the three
preceding years, when the increase averaged
7½%.

Indeed there may well be issues similar to the British buy to let problem.

As in 2016, the rate of inflation for rental
apartment buildings in the towns and cities
as well as in Germany as a whole was markedly
higher than for owner- occupied housing.

Comment

So we have good times in many respects as after all many would see rising house prices as that too. Of course I do not and let me now throw in the impact of easy monetary policy at a time of economic growth.

The average mortgage rate, which had already hit
an all- time low in the preceding year, settled
at 1.7%, which was slightly above its
2016 level.

Interestingly the cost of housing is soaring relative to wages however you try to play it.

The continuing sharp price rises for housing
in urban centres were accompanied by a
significant increase of 7¼% in rents in new
contracts, which are chiefl y the outcome of
rent adjustments in the case of repeat occupancies.

This poses a question for what would happen if later in 2018 we see an economic slowing as suggested by weaker monetary data and some lower commodity prices? We will have to see about that but much further ahead is the issue of Germany’s demographics which combine a low birth rate, rising life expectancy ( economics is clearly the dismal science here) and an aging population. This leaves the intriguing thought that travelling towards it just like in Japan leads to negative interest-rates, low wage growth and a trade surplus…….Yet the public finances are very different.

Cash is King

Something else that Germany shares with the UK. From the Bundesbank March report via Google Translate.

The value of accumulated net issuance of euro banknotes by the Bundesbank rose between the end of 2009 and the end of 2017 from € 348 billion to € 635 billion. Since 2010
On average, the Bundesbank gave an average of € 35.8 billion in euro banknotes a year.
This corresponds to an average annual growth rate of 7.8%.

Yet we keep being told that cash is so yesterday whereas we may still be in the adventures of Stevie V

Money talks, mmm, mmm, money talks
Dirty cash I want you, dirty cash I need you, oho
Money talks, money talks
Dirty cash I want you, dirty cash I need you, oho

 

What is the state of the UK Public Finances?

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

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

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

Indeed much of this is associated with London.

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

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

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

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

The Bank of England part two

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

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

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

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

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

The Office for Budget Responsibility ( OBR)

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

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

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

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

The Bank of England has kindly pointed this out yesterday.

The accuracy of such forecasts has come under much scrutiny.

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

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

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

Employment

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

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

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

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

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

Comment

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

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

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

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

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

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

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

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

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

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

 

 

 

What is happening with fiscal policy?

A feature of the credit crunch era has been the way that monetary policy has taken so much of the strain of the active response. I say active because there was a passive fiscal response as deficits soared caused on one side by lower tax revenues as recession hit and on the other by higher social payments and bank bailout costs. Once this was over the general response was what has been badged as austerity where governments raised taxes and cut spending to reduce fiscal deficits. Some care is needed with this as the language has shifted and often ignores the fact that there was a stimulus via ongoing deficits albeit smaller ones.

Cheap debt

Something then happened which manages to be both an intended and unintended consequence. What I mean by that is that the continued expansion of monetary policy via interest-rate reductions and bond buying or QE was something which governments were happy to sign off because it was likely to make funding their spending promises less expensive. Just for clarity national treasuries need to approve QE type policies because of the large financial risk. But I do not think that it was appreciated what would happen next in the way that bond yields dropped like a stone. So much so that whilst many countries were able to issue debt at historically low-levels some were in fact paid to issue debt as we entered an era of negative interest-rate.

This era peaked with around US $13 trillion of negative yielding bonds around the world with particular areas of negativity if I may put it like that to be found in Germany and Switzerland. At one point it looked like every Swiss sovereign bond might have a negative yield. So what did they do with it?

Germany

This morning has brought us solid economic growth data out of Germany with its economy growing by 0.6% in the last quarter of 2017. But it has also brought us this.

Net lending of general government amounted to 36.6 billion euros in 2017 according to updated results of the Federal Statistical Office (Destatis). In absolute terms, this was the highest surplus achieved by general government since German reunification. When measured as a percentage of gross domestic product at current prices (3,263.4 billion euros), the surplus ratio of general government was +1.1%.

So Germany chose to take advantage of being paid to issue debt to bring its public finances into surplus which might be considered a very Germanic thing to do. There is of course effects from one to the other because their economic behaviour is one of the reasons why their bonds saw so much demand.

But one day they may regret not taking more advantage of an extraordinary opportunity which was to be able to be paid to borrow. There must be worthy projects in Germany that could have used the cash. Also one of the key arguments of the credit crunch was that surplus countries like Germany needed to trim them whereas we see it running a budget surplus and ever larger trade surpluses.

In the detail there is a section which we might highlight as “Thanks Mario”

 Due to the continuing very low-interest rates and lower debt, interest payments decreased again (–6.4%).

Switzerland

The Swiss situation has been similar but more extreme. Membership of the Euro protected Germany to some extent as the Swiss Franc soared leading to an interest-rate of -0.75% and “unlimited” – for a time anyway – currency intervention. This led to the Swiss National Bank becoming an international hedge fund as it bought equities with its new foreign currency reserves and Switzerland becoming a country that was paid to borrow. What did it do with it? From its Finance Ministry.

A deficit of approximately 13 million is expected in the ordinary budget for 2018.

So fiscal neutrality in all but name and the national debt will decline.

 It is expected that gross debt will post a year-on-year decline of 3.3 billion to 100.8 billion in 2018 (estimate for 2017). This reduction will be driven primarily by the redemption of a 6.8 billion bond maturing combined with a low-level of new issues of only 4 billion.

The UK

Briefly even the UK had some negative yielding Gilts ( bonds) in what was for those who have followed it quite a change on the days of say 15% long yields. This was caused by Mark Carney instructing the Bank of England’s bond buyers to rush like headless chickens into the market to spend his £60 billion of QE and make all-time highs for prices as existing Gilt owners saw a free lunch arriving. Perhaps the Governor’s legacy will be to have set records for the Gilt market that generations to come will marvel at.

Yet the path of fiscal policy changed little as indicated by this.

Or at least it would do if something like “on an annual basis” was added. Oh and to complete the problems we are still borrowing which increases the burden on future generations. The advice should be do not get a job involving numbers! Which of course are likely to be in short supply at a treasury………..

But the principle reinforces this from our public finances report on Wednesday.

Public sector net borrowing (excluding public sector banks) decreased by £7.2 billion to £37.7 billion in the current financial year-to-date (April 2017 to January 2018), compared with the same period in the previous financial year; this is the lowest year-to-date net borrowing since the financial year-to-date ending January 2008.

So we too have pretty much turned our blind eye to a period where we could have borrowed very cheaply. If there was a change in UK fiscal policy it was around 2012 which preceded the main yield falls.

Bond yields

There have been one or two false dawns on this front, partly at least created by the enthusiasm of the Bank of Japan and ECB to in bond-buying terms sing along with the Kaiser Chiefs.

Knock me down I’ll get right back up again
I’ll come back stronger than a powered up Pac-Man

This may not be entirely over as this suggests.

“Under the BOJ law, the finance ministry holds jurisdiction over currency policy. But I hope Kuroda would consider having the BOJ buy foreign bonds,” Koichi Hamada, an emeritus professor of economics at Yale University, told Reuters in an interview on Thursday.

However we have heard this before and unless they act on it rises in US interest-rates are feeding albeit slowly into bond yields. This has been symbolised this week by the attention on the US ten-year yield approaching 3% although typically it has dipped away to 2.9% as the attention peaked. But the underlying trend has been for rises even in places like Germany.

Comment

Will we one day regret a once in a lifetime opportunity to borrow to invest? This is a complex issue as there is a problem with giving politicians money to spend which was highlighted in Japan as “pork barrel politics” during the first term of Prime Minister Abe. In the UK it is highlighted by the frankly woeful state of our efforts on the infrastructure front. We are spending a lot of money for very few people to be able to travel North by train, £7 billion or so on Smart Meters to achieve what exactly? That is before we get to the Hinkley Point nuclear power plans that seem to only achieve an extraordinarily high price for the electricity.

One example of fiscal pump priming is currently coming from the US where Donald Trump seems to be applying a similar business model to that he has used personally. Or the early days of Abenomics. Next comes the issue of monetary policy where we could of course in the future see news waves of QE style bond buying to drive yields lower but as so much has been bought has limits. This in a way is highlighted by the Japanese proposal to buy foreign bonds which will have as one of its triggers the way that the number of Japanese ones available is shrinking.

Could US fiscal expansionism lead us to QE4?

The credit crunch era has been one where monetary policy has taken centre stage. There are many ways of expressing this but one is that technocrats ( central bankers) have mostly run the economic show as elected politicians have chosen to retreat to the sidelines as much as possible. Whatever you may think of President Trump he is not someone who is happy to be on the sidelines as he has exhibited publicly once or twice with some pushing and shoving. But more importantly we are seeing something of a shift in the balance of US economic policy as the monetary weapon gets put away at least to some extent but the fiscal one seems to be undergoing a revival.

A relatively small reflection of this was last night’s budget deal. We have become used to talk of a US government shutdown followed by an eleventh hour deal and no doubt there is a fair bit of both ennui and cynicism about the process. But as the Washington Post notes as we as giving the national debt can another kick there was this in the detail.

According to outlines of the budget plan circulated by congressional aides, existing spending caps would be raised by a combined $296 billion through 2019. The agreement includes an additional $160 billion in uncapped funding for overseas military and State Department operations, and about $90 billion more would be spent on disaster aid for victims of recent hurricanes and wildfires.

An increase in military spending was a Trump campaign promise so it is no surprise but spending increases come on top of the tax cuts we saw at the end of last year.

The Trump Tax Changes

According to the US Committee for a Responsible Fiscal Budget there was much to consider.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years, leading debt to rise to between 95 percent and 98 percent of Gross Domestic Product (GDP) by 2027 (compared to 91 percent under current law). However, the bill also includes a number of expirations and long-delayed tax hikes meant to reduce the official cost of the bill. These expirations and delays hide $570 billion to $725 billion of potential further costs, which could ultimately increase the cost of the bill to $2.0 trillion to$2.2 trillion (before interest) on a conventional basis or roughly $1.5 trillion to $1.7 trillion on a dynamic basis over a decade. As a result, debt would rise to between 98 percent and 100 percent of GDP by 2027.

This is a familiar political tactic the world over where the numbers depend on others taking the difficult decisions in the future! One rather sneaky move is the replacement in terms of income tax thresholds of inflation indexation by the US Consumer Price Index by the chained version which is usually lower. So jam today but more like dry toast tomorrow.

Won’t this boost the economy?

There are enough problems simply doing the direct mathematics of government spending and revenue but the next factor is how do they effect the economy? Well the US Congress has given it a go.

The Joint Committee staff estimates that this proposal would increase the average level of output (as measured by Gross Domestic Product (“GDP”) by about 0.7 percent relative to average level of output in the present law baseline over the 10-year budget window. That
increase in output would increase revenues, relative to the conventional estimate of a loss of $1,456 billion over that period by about $451 billion. This budget effect would be partially offset by an increase in interest payments on the Federal debt of about $66 billion over the budget
period.

The idea of tax cuts boosting the economy is a reasonable one but the idea you can measure it to around US $451 billion is pure fantasy. To be fair they say “about” but it should really be if you will forgive the capitals and emphasis “ABOUT“. Anyway for the moment let us move on noting that there is already a fair bit of doubt about the impact on the US deficit over time from US $1 trillion or so to a bit over US $2 trillion.

What is the deficit doing?

According to the US CBO ( Congressional Budget Office) it has been rising anyway in the Trump era.

The federal budget deficit was $174 billion for the first four months of fiscal year 2018, the Congressional
Budget Office estimates, $16 billion more than the shortfall recorded during the same period last year.
Revenues and outlays were higher, by 4 percent and 5 percent, respectively, than during the first four
months of fiscal year 2017.

As you can see revenues are doing pretty well and in fact are being led by taxes on income being up by 8%. However spending rose even faster at an annual rate of 5% which at a time of economic growth gives us food for thought. There was one curious detail and one familiar one in this.

Social Security benefits rose by $11 billion (or 4 percent) because of increases both in the number of beneficiaries and in the average benefit payment.

That seems odd at a time of economic growth but the next bit reminds us that the rise in inflation has a cost too due to index-linked bonds called TIPS.

Outlays for net interest on the public debt increased by $13 billion (or 14 percent), largely because of differences in the rate of inflation.

More Spending?

It looks as though we will find out more about the much promised infrastructure plan next week. From Bloomberg.

President Donald Trump expects to release on Monday his long-awaited plan to generate at least $1.5 trillion to upgrade U.S. roads, bridges, airports and other public works, according to a White House official.

How much of this will come from the government is open to debate. The modern methodology is to promise some spending ( in this case US $200 billion) and assume that the private-sector will do the rest. One of the more extraordinary efforts on this front was the Juncker Plan in the Euro era which assumed a multiplier of up to twenty times. But returning stateside we can see that there will be upwards pressure on spending but so far we are not sure how much.

Comment

In my opening I suggested that the United States was switching from monetary expansionism to fiscal expansionism. Let me now introduce the elephant in this particular room.  From the Atlanta Fed

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2018 is 4.0 percent on February 6, down from 5.4 percent on February 1.

They may well be somewhat excitable but if we look at the 3.2% predicted by the New York Fed the view is for pretty solid economic growth. So the fiscal position should be good especially if we add in the fact that for all the media hype treasury bond yields are historically still rather low. Yet none the less the fiscal pump is being primed. Or to put it more strictly after a period of pro-cyclical monetary policy we now seem set for pro-cyclical fiscal policy.

There are obvious implications for the bond market here as there will be increases in supply on their way. No doubt for example this has been a factor in pushing the thirty-year bond yield above 3%. You might have expected more of an impact but I am increasingly wondering about something I suggested some time ago that the path to higher interest-rates in the United States might be accompanied by QE4 or a return to bond buying by the US Federal Reserve. Should the economy slow at any point which would boost the deficit on its own then we could see it. Also this could be a factor in the weaker US Dollar as in is it falling to reflect the risks of a possible return to Quantitative Easing?

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?

Me on Core Finance TV

 

 

 

The UK Public Finances hint at a strong underlying economy

Yesterday saw the IMF join the chorus expecting better economic times ahead.

The cyclical upswing underway since mid-2016 has continued to strengthen. Some 120 economies, accounting for three quarters of world GDP, have seen a pickup in growth in year-on-year terms in 2017, the broadest synchronized global growth upsurge since 2010…….Global growth for 2017 is now estimated at 3.7 percent, 0.1 percentage point higher than projected in the fall. The stronger momentum experienced in 2017 is expected to carry into 2018 and 2019, with global growth revised up to 3.9 percent for both years (0.2 percentage point higher relative to the fall forecasts).

Part of this was due to revising the US economy upwards( ~0.4%) due to the Trump tax cuts. This was obviously so painful to the IMF that it could only get some relief by revising the UK down a little in 2019. In reality the UK is likely to be pulled higher too by the global upswing as even Lord O’Neil formerly of the Vampire Squid now admits. From the BBC.

Britain should prepare for a much more economically optimistic 2018 because global growth is better than predicted.

That’s the argument of Lord Jim O’Neill, the former Conservative Treasury minister and Remain supporter.

He said Britain’s growth forecasts are likely to be upgraded as China, the US and Europe show increased activity.

Fair play to him for having the courage to correct past mistakes and the only worrying part of all this is that too many establishment groups and figures are telling us the future is bright! Just look at their track record……

PFI

Moving to the public finances there has been a fair bit of news on the Public Finance Initative or PFI front post the Carillion liquidation which I looked at on Monday last week.  The National Audit Office pointed out the scale of the issue late last week.

There are currently over 700 operational PFI and PF2 deals, with a capital value of around £60 billion and annual charges for these deals amounted to £10.3 billion in 2016-17. Even if no new deals are entered into, future charges which continue until the 2040s amount to £199 billion.

These schemes have brought some benefits but they have also brought problems mostly because the real rationale as I have pointed out many times was this.

However, most private finance debt is
off-balance sheet for National Accounts purposes.

The politicians doing this in effect get a benefit such as a new hospital but shift the burden of paying for it into the future and thus worsen the future public finances.

Unlike conventional procurement, debt raised to construct assets does not feature in government debt figures, and the capital investment is not recorded as public spending even though it is for the public sector.

In essence the projects are driven by the rules of our national accounts ( more specifically avoiding being measured….) rather than any economic gain.

PFI can be attractive to government as recorded levels of debt will be lower over the short to medium term (five years ahead) even if it costs significantly more over the full term of a 25–30 year contract.

You don’t say!

Today’s Data

The news opened in positive fashion.

Public sector net borrowing (excluding public sector banks) decreased by £2.5 billion to £2.6 billion in December 2017, compared with December 2016.

There were strong performances on the receipts side with Income Tax receipts up by £700 million and VAT ( a sales tax) up by £600 million. There are hints there of underlying economic strength and of course the higher VAT receipts give a rather different picture to what we were told by the retail sales numbers. On the expenditure side there was something to give a wry smile in the circumstances.

In December 2017, the UK’s net contribution to the European Union (EU) was £1.2 billion lower than in December 2016.

Okay why?

December can see atypical payments between member states and the EU. December 2017 saw a credit to the UK of £1.2 billion following the adoption of agreed amendments to the 2017 EU budget which reduced the size of the 2017 budget and adjusted member states’ contributions to reflect updated economic forecasts.

Or maybe someone has a sense of humour as it will all come out in the wash anyway. Also we need to note that a regular feature was still there as debt costs were higher by some £500 million which will be mostly driven by higher payments on index-linked Gilts affected by the fact that the Retail Prices Index has pushed over a 4% annual rate of growth.

Perspective

This too as you might imagine was given a boost by the December data.

Public sector net borrowing (excluding public sector banks) decreased by £6.6 billion to £50.0 billion in the current financial year-to-date (April 2017 to December 2017), compared with the same period in 2016.

This means that the first rule of OBR Club had yet another good year in 2017 as you will note from its November review of the state of play. The emphasis is mine.

That said, the public finances have performed better than expected. The ONS has revised borrowing in 2016-17 sharply lower, relative to its initial estimate and our March forecast. And the deficit has continued to fall in the first half of 2017-18. We have revised borrowing down by £8.4 billion to £49.9 billion for the full year,

Thus the OBR is left in the awkward situation of hoping that the UK Self-Assessment season for Income Tax is a poor one. Such a view will not be helped by the December data being good although the data can be erratic.

Here is a breakdown of both sides of the ledger.

In the current financial year-to-date, central government received £504.0 billion in income, including £376.8 billion in taxes. This was around 4% more than in the same period in the previous financial year.

Over the same period, central government spent £538.9 billion, around 3% more than in the same period in the previous financial year.

As some of the expenditure increase is caused by the rise in inflation via its impact on index linked Gilts then we do indeed have austerity if you define it as expenditure rising by less than the rate of inflation.

What about the National Debt?

We come into the real lies, damned lies and statistics section here. But let me try and shin a little light. Over the past year it has risen but mostly that has been due to some credit easing ( Term Funding Scheme) by the Bank of England. Over the past year it has raised the National Debt by £89.1 billion and as you can see below this makes a difference to whether it is going up or down.

Public sector net debt (excluding both public sector banks and Bank of England) was £1,591.4 billion at the end of December 2017, equivalent to 77.2% of GDP, a decrease of £26.8 billion (or 3.6 percentage points as a ratio of GDP) on December 2016.

Sadly there is still a lot of manipulation and misrepresentation going on as the main cause of the fall is what happened to the Housing Associations.

As of the end of October 2017, English HAs’ net debt amounted to £65.5 billion, which from November 2017 is no longer to be counted as public sector debt.

It is rarely reported that we use a completely different system to that used by the ratings agencies and the Maastricht criteria so here is the latter.

general government gross debt was £1,720.0 billion at the end of March 2017, equivalent to 86.7% of gross domestic product (GDP); an increase of £68.1 billion on March 2016…general government deficit (or net borrowing) was £46.9 billion in the financial year ending March 2017 (April 2016 to March 2017), equivalent to 2.4% of GDP; a decrease of £29.0 billion on March 2016.

It is like a numerical equivalent of alphabetti spaghetti isn’t it?

Comment

As we try to peer through all the attempts to deceive us about the UK public finances then we get a perspective on this announcement from the UK government. From The Times.

Theresa May is set to authorise the creation of a rapid response unit to stop fake news spreading online.

The team, which will be based in the Cabinet Office, will be tasked with monitoring social media to identify and challenge disinformation.

Time for some Depeche Mode.

It’s too late to change events
It’s time to face the consequence
For delivering the proof
In the policy of truth

Never again
Is what you swore
The time before
Never again
Is what you swore
The time before

The reality is that things are getting better albeit we are still a fair way away from the “promised land” of a surplus which we should be used to by now. As ever it is just around the corner. As to the underlying economy even the CBI seems optimistic looking ahead.

The survey of 369 manufacturers revealed that optimism about both business conditions and export prospects improved at an above-average pace.