Sunday, 9 August 2015

The Meaning of The Bank of England's Mixed Messages

Last week, Mark Carney and the Bank of England MPC, confirmed their reputation of being “an unreliable boyfriend”. That is, having given plenty of “forward guidance” over the last few weeks and months that official interest rates were about to rise, not only did the MPC not raise rates, but the vote not to do so rose from 7-2, to 8-1. On the one hand, Carney re-emphasised that the day of a rise in official interest rates was drawing closer, on the other he stated that the market rates of interest, which price in a rise in rates by May next year, were about right! Yet, more than a year ago, with unemployment already having fallen below the level at which they had said was necessary for rates to rise, the Bank's forward guidance had suggested that rates could rise by June last year!

Carney was asked about his comments, only a few weeks ago, that suggested that rates might rise by the turn of this year, but argued that he had only said that the question of raising rates might be more on the agenda by that time. Adding to the confusion, he stressed that his comments then, made in Lincoln, were his personal views, and not those of the MPC. He was also asked about the comments last week by Andy Haldane, about “capital eating itself”, one cause of which, as I pointed out recently, has been low yields, which encourage speculation, and a larger portion of profits to be paid out as dividends rather than being productively invested.

As I've argued previously, Haldane's comments are a reflection of a growing attack on fictitious capital, which by bringing about this situation of capital eating itself, is threatening the stability of the system in general. But, reflecting the fact that there is a battle between fictitious capital and productive capital going on, and between their respective conservative and social-democratic ideological representatives, Haldane was effectively slapped down by Carney, and Deputy Governor Ben Broadbent. They pointed out that contrary to what Haldane had said, capital investment had been rising recently.

Another contributor raised another point that I have made over recent months, which is the possibility that money printing was actually causing consumer price deflation not inflation, because it was promoting speculation and a hyper inflation of asset prices, whilst simultaneously draining liquidity from other sectors of the economy.

The Bank of England's comments and actions have to be taken in conjunction with the message and action coming out of the Federal Reserve. Just as, if the Bank had been taken at its previous word, official interest rates would have risen a year ago, so the same is true of the Federal Reserve. But, the Bank of England will not want to raise official rates ahead of the US. The UK is already suffering from a relatively high level of sterling compared to the Dollar and the Euro. That is both a reason for the UK's large and growing trade deficit, and for its low level of inflation, as a strong pound pulls in cheap foreign imports.

If the Bank raises official interest rates, ahead of the Federal Reserve, that will cause the Pound to rise strongly, and with the ECB engaged in money printing, and with the potential for a further strong devaluation of the Euro, as the Eurozone debt crisis resumes, the UK's trade deficit would soar, whilst low inflation or deflation would make it even more difficult to finance the resulting borrowing costs, sending the UK deficit even higher, and thereby frustrating Osbourne's budget plans. Carney cannot raise rates ahead of the US, but the Federal Reserve has itself backtracked, several times, on raising rates, which means Carney must be deliberately vague and contradictory, so as to leave open the door to raise or not raise accordingly. Broadbent has already confirmed that by saying they will give no notice of when they intend to raise.

In the US, as the latest jobs data again came in strong, and with US unemployment already way below the figure that the Fed said would cause them to start raising rates, there is still obfuscation. All bets are on a rise in September, but, in the Spring, everyone was ready for rates to have risen in June. With the Bank of England holding fast again, there is now talk about the US not raising rates until December or even 2016. Pundits on US CNBC on Friday were still speculating, which should probably be hoping, that the Bank of England would raise before the Federal Reserve.

As others have pointed out, the consequence of this is that market participants begin to believe that whatever the policy makers say, they will never raise rates, and so market rates will adjust accordingly. For the reasons I've set out elsewhere, this assumes that market rates are ultimately determined by official rates, and money printing, which they are not. In fact, already market rates are rising, mortgage rates and availability in the UK were tightened noticeably last week. Across the globe, market rates are tightening as emerging markets find their currencies dropping and inflation rising, and economies like Saudi Arabia, which formerly were large scale providers of loanable money-capital, have overnight become borrowers. Saudi Arabia issued bonds for the first time in eight years last week, and it now intends to be issuing further bonds, as it needs to borrow on a substantial scale to finance its budget, as the price of oil continues to collapse.

Moreover, as Mark Zandy pointed out on CNBC on Friday, it looks inevitable now that the US will overshoot, that it will face labour shortages, and inflation above its 2% target. In order to reduce unemployment, the US needs to create around 150,000 jobs each month. But for a long time now, the US has been creating an average of around 250,000 jobs per month. That is why its unemployment rate has dropped faster than expected. In some specific areas, it already faces labour shortages, and this is behind a rise in wages in those areas, as well as rising minimum wage levels, as large employers seek to ensure they retain labour. The same thing can be seen in the UK, a recent report indicates that not only is their a shortage of bricks for the construction industry, but as was the case at the start of the century, there is again a shortage of skilled construction workers, with two out of three construction firms in London saying they are having to turn work down, for lack of skilled labour.

Zandy pointed out that with job creation exceeding the required level by 100,000 per month, the US will be way past the non-inflationary rate of unemployment (NAIRU) by next year, and because it takes two years for monetary policy to affect inflation levels, the already evident rise in US inflation is likely to rise further, with monetary policy unable to reduce it, because they will not go from 250,000 new jobs per month to 150,000 jobs per month at the turn of the tap. In fact, as Michael Roberts has indicated, and as I have been suggesting, for the last couple of years, would be the case, productivity growth is slowing, which means that job growth may actually strengthen, as production continues not only to expand, but expands more rapidly, as rising wages causes increased level of consumer spending, and a rise in aggregate demand. These are the same kinds of conditions that existed in the previous long wave summer phase, in the 1960's, which led to rising wages and prices, and a profits squeeze, which intensified during the 1970's.

Both the Bank of England and Federal Reserve are way behind the curve. Their confused messages over the last year or so, have led market participants to believe that rates will not rise, and will only rise very gradually. As with the taper tantrum, when rates actually do rise, even by a small amount, it will be a shock to that mindset, particularly for all those with mortgages, who have never seen a mortgage rate rise, and will find that even a small rise, at these levels, turns into a large percentage rise in their monthly repayments. As fictitious capital prices sell off that will add to the disruption of the current suspension of disbelief.

Part of the reason given for the Federal Reserve not raising rates by now has been the low level of labour force participation, or U6 measure of unemployment. On this measure, the Federal Reserve argues there are a lot of workers who could return to the labour market, so slack is greater than the nominal unemployment rate suggests. But, this doesn't take into consideration the changed structure of society. Many of the people who are currently of working age, but not in the labour market are, almost by definition part of the baby boomer generation, that is people in their 50 and 60's. These are people who are still of working age, but coming close to retirement. Where they have lost jobs, particularly where they have collected reasonable redundancy payments, they are unlikely now to be seeking further employment. In fact, many will not only have collected redundancy payments but will have also been able to start claiming from their company and private pension schemes.

Many of the people I worked with, in that category, so by no means affluent people, had, during the 1980's, 90's and early 2000's, been paying money into additional voluntary contributions (AVC's) to their pension, as well as taking full advantage of taking up their full allowance to pay into PEP's, and then ISA's. Most of the people I worked with in that category, were keen to be able to take early retirement, and release their Council pension, from 55 onwards, especially for those who had been gardeners, or such like, who often added to their pension by doing a couple of half days at the local B&Q.

Some analysis I did a few years ago indicated that even to be in the top 10% of wealth owners, in the US, required a net worth of only around $3 million, or about £2 million. The largest proportion of the people in this category were people over 55, which reflects the fact that much of this wealth, for the majority, was in the form of their family home, their pension, and mutual fund savings built up over their lifetime. There is a sharp division between the wealth of those in this top 10%, compared to those in the top 1%, and even more so with those in the top 0.001%!

The point is that a large proportion of the inactive members of the labour force, in both the US and UK, are comprised of such baby-boomers, who have built up these resources, not necessarily to the extent of being in the top 10%, of course, and are now able to fall back on them. We are part of the hippy generation, who put a high value on leisure-time. Those who dropped out in the 1960's, are now dropping out again in their 60's, having dropped back in during the 1970's – 2000's. Policy makers should not count on members of this cohort being driven to re-enter the labour market in search of additional income, to purchase ephemera, in the same way they can with the Millennials – whoever they might be.  With leisure time you can speak to people face to face without the need for an £800 iPhone to do so remotely!

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