Tuesday, 27 July 2010

Should rates stay where they are for an extended period?

The Telegraph today have an article putting across the view of the Ernst & Young ITEM club, who believe that the Bank of England should keep the base interest rate at the current low level of 0.5% for years to come -- until 2014 in fact. This view is not shared by the government's new Office for Budget Responsibility (OBR), who forecast a similar level of economic growth over that period but they foresee the base interest rate going up steadily to around 3% over that time. Here.

Who are the ITEM club? Well, they're a bunch of economic thinkers paid by big business to come up with forecasts about what the future economic policies of the government should look like. They share the same model of the economy as used by the Treasury and also the OBR. So, you would think that all three parties ought to end up singing from a very similar song sheet at the end of the deliberations. But they don't. Could this be because ITEM's forecasts are spun in favour of the interests of big business, rather than the wider economy, do you think?

It seems to me that there is a significant body whose views have not been represented in the Telegraph article: the global bond market. These are the parties that will be buying (or not) the government's bonds at the paltry rates ITEM would offer. My feeling, and I am quite sure it is also the feeling of the Treasury and the OBR because they would never suggest raising rates if they didn't feel it was strictly necessary, is that the bond market will not buy our bonds at these rates for much longer. They are simply not being compensated for the risk they are taking, especially with the inflation rate in the UK unexpectedly being stubbornly high. If the bond market participants steer clear of our government bonds, we can't fill the budget deficit any more. Not unless Quantitative Easing (printing money to buy our own bonds from ourselves) is resumed in earnest, but at this point in time this approach would likely have dire consequences for confidence in the Pound, and therefore its exchange value. We would then be looking at a much worse problem than simply trying to keep the base interest rate down for political gain at home.

Tuesday, 20 July 2010

So much for fiscal austerity, eh?

If you believe the media, the Con-Dem coalition government are deadly serious about cutting the budget deficit, and will quickly make serious in-roads on the national debt too. Apparently, they're so serious that they are going to kill the economy with their rabid devastation of the public budgets.

However, according to National Statistics (via the BBC), I read today that last month our beloved government ran a deficit of £14.5bn, which they had to borrow from international investors and which thereby increased the national debt by this amount. This is a VERY large amount of money, only just short of that which was needing to be borrowed a year earlier when we were still in crisis and money was being sloshed about by New Labour like it was sweetie-water.

Anyone who believes the line that (a) the Con-Dems have already taken a hatchet to the economy with their "cuts", and (b) that thinks the long term results would have been better if only they would just spend even MORE money that they don't have, is just plain crazy -- but would you care to buy London Bridge from me for a very large sum of money perhaps..?

(A) the "cuts" so far are just cuts to Labour's planned increases, as far as I can see

(B) if you think taking on more debt will be the way out of a massive debt problem, then you really should seek professional assistance immediately because you will quickly find yourself bankrupt. The laws of mathematics are not different for governments than they are for individuals, the numbers are just bigger. There is, however, one slight difference between individuals and the government these days -- you can't print up the money you need to pay your debts, but they can. They call it "quantitative easing", but really it's just a counterfeiting operation. The more money they create, the less each of the Pounds in circulation is worth. This is inflation. This is how the debts will be taken care of, eventually. This is how governments believe "deficits don't matter". This is why "the rich" don't have a lot of cash, but they do have a lot of assets bought with debt -- they know that cash will only go down in value over the long term, and so will the real cost of repaying debts.

However, there are good times to get rich by taking on debts, and there are good times to go broke from doing the same thing. Before we get to "eventually", where all currently heavy debt loads then seem trivial, we have to survive through a period of serious credit destruction, which will be a highly deflationary force. So tread carefully.


Tuesday, 13 July 2010

UK government credit rating downgrade is still a serious concern

In May 2009 I put up a post where I wholeheartedly agreed with Stuart Cheek, head of UK Government bonds at BGC Partners, that the UK's credit rating being downgraded to anything but AAA would be a very, very big deal. Here

At the time, the rating agency S&P were saying that the UK government had too much debt, but even more importantly, they were running too big of a deficit so the debt was growing much too quickly. They said that if the incoming government (this was way before the UK general election of course) were not able to demonstrate they were going to very quickly deal with and reduce the deficit and also the outstanding debt level, then the credit rating would be downgraded.

Since then of course we have elected the coalition Con-Dem government. There has been much noise and fanfare about the "cuts" they are imposing on the public sector finances. My own view is that actually all they are proposing to "cut" so far is the size of the spending increases -- I don't think you will find on close inspection that the public spending bottom line is going to be smaller at all. Most certainly, it is not going to be MEANINGFULLY smaller, such that there will be not only no deficit (some hope!) but actually some kind of dent being made into the outstanding national debt. We will still be running a significant budget deficit (adding to the national debt), no matter how savagely the Con-Dem government take the axe to the public budgets. Labour have simply run the finances into the ground and there is no way in hell we can ever pay off these levels of debt, with honest money.

No, I still see us running a large budget deficit, quantitatively easing more Pounds into the financial system to help paper over the problem, and receiving a credit rating downgrade to something below AAA. This will still be a massive problem, as many investment funds must hold securities that are only of AAA credit quality. Those investment funds will have no choice but to sell off the non-AAA government bonds if this downgrade does indeed come to pass, and more supply = lower prices. When it comes to bonds, lower price = higher yield. Higher yield is just another way to say higher interest rate.

It's instructive to also today see the Chinese already having downgraded our credit rating, along with almost all of the developed world. (See the link to that article on the Facebook fan page.)

It seems today that S&P wish to reiterate what they said a year ago, according to an article in the Telegraph (link follows). Perhaps it is a simple reminder that the government needs to be extremely serious indeed about dealing with the out of control public sector budget. Perhaps it is a matter of maintaining their own credibility, in the face of the Chinese rating agency now already having taken this action.


Recently I was asked by friends what I thought the economic future might be like

They were asking of course because they were concerned about their personal financial well-being, and they are all currently trying to figure what is the best thing to do for their specific circumstances. They have varying current circumstances and short/long term desires, as you would expect. They were all smart people, and they all have their own opinions of how things are. I guess they asked me for the sake of conversation, perhaps they already knew from past experience that I would tell them something they probably won't like and maybe they feel it wouldn't do them so much harm to hear an alternative opinion they probably won't find in the newspaper or on TV.

My view of the concensus that appeared to form around the table was that they saw we have experienced a V shaped recovery to date, but there appeared to be a good chance of it turning into a W shaped "double dip recession". So far, you can get this from TV and the papers of course.

My own view that I expressed was we had not had a real recovery since 2008, nothing has been fixed but money has been printed by governments to buy up bad debts and paper over the problems, transferring the problem debts onto government balance sheets. This has resulted in a "recovery" to some extent when measured in nominal asset valuation terms, but the reality is that monetary inflation has taken place to cause those nominal asset price recoveries around the world. The REAL, inflation-adjusted values (try pricing items in ounces of gold, like we did in the not-so-very-distant past) of those assets is actually still far down from the 2008 peak. So, to my mind, any talk of a double-dip recession is pointless -- this is still the same dip, but I agree that things are set to get worse again from here. That's not a description of a V or a W shape. That's a lightning bolt shape I am talking about. Perhaps a downward slanting reversed Z, if you must assign it a letter(?). Going forward, unfortunately, the way I see it the problem assets are still problematic now they are held by the governments, they have not been "fixed" somehow. If there are more problems that need dealing with any time soon, the governments have all already fired their bullets dealing with the last round. There is no way we can rely on them to take on the problem assets again, if a problem materialised in the next few years. Unfortunately, there are a rash of financial problems set to explode over the course of the next few years, so times are only going to get more interesting, unfortunately.

In a piece of rather fortunate timing for me, today I came across an article on FinancialSense.com, by Krassimir Petrov. In it he articulates, much better than I have here, roughly how I too envisage things unfolding. He has looked outside of the standard alphabet, and found what he was looking for within the Greek alphabet -- the letter is called "eta", and it looks like this: ɥ

Here is the article, if you are interested to find out more. http://www.financialsense.com/contributors/krassimir-petrov/the-eta-recovery

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