Its been
said that Mark Carney has been very lucky in taking over at the BoE
when he did. At the time of his appointment, the UK economy was not
just in a double but a triple dip recession. The fact that,
subsequent data from the ONS indicates that in reality it just
technically escaped that description is neither here nor there; the
fact is that the economy was very weak, and had been so since the
Liberal-Tories undermined it in 2010. It was so weak that he seemed
safe in offering to keep interest rates pinned to the floor for the
foreseeable future, or at least until the unemployment rate fell
below 7%, which at the time seemed to be the same thing. Yet, within
months of taking over, the UK economy appears to be in a completely
different position. It is apparently growing more strongly than many
other European economies, and even than the US. The unemployment
rate is coming closer by the day to the 7% limit, which poses Carney
with the problem of having to raise interest rates, or else change
his stated forward guidance, to avoid doing so. In fact, this is the
least of Carney's problems. The fact is that in the second half of
2014, he will face economic conditions that will present him with a
serious dilemma.

This would
seem to contradict the idea that falling or stagnant output did not
lead to bigger rises in unemployment. But, in fact, the two things
go together. As output stagnated, employers rather than laying off
workers were able to simply cut wages further, so the consequence was
that unemployment did not rise on official figures, but
underemployment did, and with it productivity dropped even further.
The fact that so many workers now are employed on a casual basis,
part-time, temporary, or on zero hours contracts facilitates this.
To an extent, this should operate in the opposite direction so that
when demand and output rises, the first response should be a
reduction in this underemployment, but it is always the case that,
where productivity is low, in certain industries it will require a
large number of additional people to be taken on, even if they are
taken on under those same unstable conditions rather than as
permanent, stable employees.

The reality
of the UK economic pick-up is that it takes place in the context of a
continuing global economic boom, but one from which the UK is failing
to greatly benefit because of the economic model put in place by
Thatcher in the 1980's. It ensures that whilst the global boom lifts
all boats, the UK economy sinks relative to many of its competitors.
The current pick-up has been driven by that boom, which has seen a
rise in growth again across the globe, as part of the three year
cycle. It has also been driven by a temporary rise in UK
consumption. For the last 30 years, there has been an increasing
trend towards consumerism. People have been led to see shopping not
as something you have to do to meet certain needs for food, clothing
and shelter, but as a leisure activity in its own right – retail
therapy. Its no wonder that its estimated that in the UK,
households throw away 30% of the food they buy.
Such
attitudes having been cultivated over so long a period are not easily
changed again, and the government and retailers have no desire to
change such attitudes. When David Cameron a couple of years ago
called on households to reign in their consumer debt, he was quickly
told to withdraw his comment, because had they taken his advice the
drop in consumption would have further cratered the weak economy. A
Government that came into office proclaiming its commitment to cut
debt has presided over its expansion, both at the level of the state
and of the individual. They have encouraged a further growth of
student debt, and now with the Help To Buy scam, they seek to
encourage yet more hapless individuals to go into penury to buy
grossly over priced property.
And, its on
this basis of a further fall in savings and increase in borrowing
that the recent rise in consumer spending that led to the rise in GDP
was based. A further example of that at a macro level was the sharp
rise in the UK trade deficit as it sucked in more purchases from abroad without the corresponding amount of income generation from exports. These are the
shaky grounds on which the bounce in the economy and Osborne's
crowing are based on.
But, in the
second half of this year many of these things will reverse presenting
Osborne and Carney with serious problems. Firstly, the borrowing has
only been possible because of very low interest rates brought about
by high rates and volumes of profits over the last 30 years. But,
the rate of profit is falling, and with it the supply of
money-capital. A look at the figures for global company profits,
shows that they continue to miss estimates that have themselves been
massaged downwards. At the same time, several years of avoiding
capital expenditure are now hitting the limits. Both firms and
states need to engage in large scale investments and capital
expenditure. Increased demand for money-capital at a time when the
supply of money-capital is declining means higher interest rates.
That will be the case whatever Carney and other central banks do as
far as printing money. In fact, global interest rates are already
rising. The US and UK 10 year Bond Yields have almost doubled in the
last year.
Rising
interest rates will both hit those states that remain heavily in
debt, as well as consumers with huge levels of consumer debt,
particular mortgage debt. It will necessarily hit banks to whom a
lot of that debt is owed. In Europe, the latest exercise in futility
that is the Bank Stress Tests and Asset Quality Review, has already
significantly lowered the bar the banks have to jump to show that
they are not bankrupt. The requirements of Basle III setting out the
amount of Capital the banks are required to hold has also been
lowered, because everyone really knows that the banks balance sheets
are a complete fiction, based on asset prices that are themselves in
the realm of Alice in Wongaland. Even with these much reduced
requirements, its estimated that European banks will need to raise
tens of billions of additional Euros in addition capital to shore up
their books.
Of course,
as global interest rates rise, and asset prices begin to fall,
central banks may continue to believe that they are Gods, and that
they can reduce rates by simply printing more money. They will be
wrong. The other day, CNBC's Steve Liesman said that the Monetarists
had been proved wrong, and essentially the Keynesians proved right
that it is the level of economic activity and not the amount of money
printed that determines inflation. In fact, both the Monetarists and
the Keynesians are wrong. If the value money or in reality money
tokens falls because more is printed, whether this results in
inflation depends upon what happens to the velocity of circulation,
which in turn as the Keynesians suggest may depend on the level of
economic activity. But, the fact of stagflation in the 1970's and
early 80's shows that there can be very high levels of inflation
alongside low levels of economic activity. If the huge volume of
money printing undertaken begins to circulate with a higher velocity,
then inflation will increase rapidly, and as it does so, the same
kind of inflationary spiral seen in the 1970's will ensue. At the
first whiff of such inflation, interest rates will rise sharply, and
central banks will be left way behind the curve.

Some of the
rise in UK GDP may have arisen from the effects of the Help to Buy
scam, which the government brought forward by 3 months to September
last year, because it was obvious that its previous money drugs were
no longer working on the UK's frothy property market. But, the
current drugs seem not to be working either. There seems to have
been no massive rise in property transactions in the last few months.
Of the 6,000 applications under HtB, only 750 were translated into
actual transactions, probably because the potential borrowers did not
meet the new requirements on being able to meet monthly repayments at
slightly higher interest rates. In fact, according to Rightmove,
even asking prices for houses fell in December by around 1.9% month
on month, and RICS have recently reported that an increased
proportion of their members have become negative on property prices.

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