Month: January 2011

                A number of bloggers have in recent months referred to the Bank of England’s interesting decision to switch most of its pension fund into Index linked securities at a time when  it was in public worrying about deflation and possible falling prices. By the Annual Pension fund report in February 2010 the reorganisation of the fund was complete. The fund showed:

UK gilts (fixed interest loans to HM government)                £108 million                         4.6%

Index linked gilts (loans to HMG)                                               £1915.9million                     81.8%

Other Index linked securities                                                          £330.4 million                   12.9%

Total assets                      £2357 million

                   Their investment strategy, which looked smart when share markets were falling in 2008-9, looked less rewarding in a year of share market recovery. The fund managed a return of 12% to February 2010, well below returns on funds with substantial investments in real assets. The authors of the Report, aware of possible criticisms of the performance, stated   ” It should be noted that the investment strategy now being followed is not designed to maximise return, but rather to maximise the probability that the Fund will be adequate to meet its liabilities in all future economic and financial conditions”.

                  This concentration on managing risk and cutting the deficit on the fund  also resulted in an agreement to pay into the fund 55% of pensionable earnings of all the full members of the scheme in employment from March 2010, a very high contribution level. The £2.357 billion of assets provides for a total of 13,300 members and their dependents.

                   Some have raised eyebrows that the Bank, agonising about too little inflation and worrying about deflation and double dips, should at the same time be putting in such extensive and expensive inflation proofing to its own pension assets. The Pension trustes and their advisers have had the better of the argument over inflation than the Monetary Policy Committee. The MPC  tasked with curbing inflation have consistently underestimated it or refused to take it seriously. The Trustees in contrast have made it the one risk they wish to cover fully, so they  have been less good at pursuing better returns on this large sum of public money in the better asset market conditons of 2009-11.

                 Meanwhile the Bank’s own balance sheet shows just what quantitative  easing does to the financial shape of an old lady placed on a crash binge. The balance sheet has shot up from £44 billion in Janaury 2007 before the crisis, to £246 billion today. The £246 billion balance sheet is supported on just £4.2 billion of share capital and reserves. This maans the Bank is now more than 58 times geared. It’s a good job Central Banks have full government support and play by different rules from commercial banks. No commercial bank today would be allowed to gear like that.

                We all look forward to the Bank delivering on its inflation target. The trouble is there will be some more rough months ahead before it starts to do so, owing to past decisions.

              I have always thought the oil companies miss an important presentational trick. They should put on the pump and on the receipt for fuel how much is UK tax. When almost two thirds of the fuel price is tax, people might like to know that so much of their very large bill is going to their local hospital or school, not to the fat cats of the oil company.

              All western governments tax petrol and diesel heavily, though the UK is one of the highest chargers whilst the US is still relatively low. The G7 countries take more money from the fuel consumer than OPEC or the other oil producers  who supply the raw material. The UK government takes almost twice as much  in tax as  OPEC gets from the sale.

             The VAT rise is tax on tax, and has taken UK fuel prices to new highs at the pump. Meanwhile the oil price itself is around $90 a barrel, compared with a high of over $140. It is time for the UK government to dust down its idea of a fuel price stabiliser operated through variable taxes on fuel, starting now with a reduction, to take some of the inflationary pressure of this latest move out of the system.

              Anyone from the US reading this might spare a thought for all those of us paying more than $9 a gallon.

           By yesterday afternoon the price of borrowing ten year money for Portugal had risen to 7.24%, up from 6.75% at the end of last year.  The Spanish borrowing rate rose too, to 5.53%. The Irish one is still at 9.28%, post the “rescue”.

           Given the large sums these countries need to borrow it is going to prove expensive. They will get into that vicious circle where interest costs take an ever rising proportion of the budget, and make controlling total public spending that much more difficult.

            I wonder how much longer, before Euroland politicians want to talk about this, and end up with another “bail out” to try to lower the costs of borrowing for a distressed country or two?

    Last n ight on Newsnight the French Finance Minister gave an accomplished interview. She understood poorly worded questions and spoke well in a foreign language. Her message was perfect spin. She told us all current members of the Euro would remain members. She said there will be no more bail outs. She was sure no country within the zone would have difficulties financing itself in the year ahead.  It was a “Crisis, what crisis?” moment, a “Let them eat cake” interview.

      The BBC’s Economics correspondent afterwards told us the Euro political classes are in denial about the troubled  universe of the bond traders, bankers and business people who have to work with the results of the broken banks and the overborrowed states that stay within the Euro zone. He could have added that the politicians have to keep spinning through whatever the odds. If they once suggested there could be another bond crisis, or another bank shake up, or further deterioration in one of the struggling economies, they would hasten just such an event. Loose talk about reneging on bond obligations and seeking repayment of loans by the ECB to Irish banks was sufficient to cause the last phase of the crisis.

         The Euro, just like the Exchange Rate Mechanism before it, forces politicians either to fly in the face of reality or to keep quiet. Markets want to go in the opposite direction to the politicians. In such circumstances careless talk can cause great economic and financial damage. The French Finance Minister had to say what she said. She might have shown greater wisdom by declining to comment at all. A defence few believe is no defence.

  Great batting, great bowling, brilliant fielding. This team has it all. More importantly, they had the grit and determination to win, saving the first test when it seemed lost, and bouncing back after  defeat in another. Their story shows you can live your dream if you work hard, take nothing for granted, and never give up.

              Worldwide inflation is quite rapid. Food prices have been especially lively in recent months. China has hoisted interest rates to 5.81%, Brazil to  10.75% and India 6.25%. Australia and Canada too have started to increase theirs. In the UK mortgage rates and lending rates to small business are nothing like the official 0.56% base rate. Mortgage rates have been going up recently.  Only the Bank of England keeps on driving by looking in the rear view mirror. It remains more worried by the past recession than the looming inflation.

                    Yesterday the Chancellor advised the EU to get its house in order by stress testing banks more strenuously and doing more to deal with the problems of Euroland. He said “The affirmation of the UK’s triple A credit rating and the fall in market interest rates shows that it is possible to earn credibility with a convincing deficit reduction plan.” 

                   He is right to remind us that the UK’s top credit status was at risk on the previous policy. Lenders have taken some heart from the goverment’s expressed intention to cut the rate of increase in borrowing. However, his comments on the movement of interest rates are now a little dated. The 3.4% yield on ten year government bonds at the time of the budget did fall below 3% at its best. Today the rate has gone back up to 3.57%.  There has been a general shift up in EU government  bond rates, including Germany’s, as a result of the Euro crisis of late autumn. Some modest contamination did rub off on the UK, despite our non membership of the Euro.

            It makes it more important than ever that the UK should decline any future involvement in financial bail outs and show it  can now earn a dividend from staying outside the Euro. Meanwhile, we await decisive leadership from France and Germany from within the Euro area, as they move to sort out the problems of their currency. Chancellor Kohl always saw political union as an important complement to monetary union. The present German government both wants there to be more discipline over the other member states, and for the union to remain a union of independent countries where each one takes responsibility alone for its own budget and borrowing.

              Senior Germans do not like the idea of bigger transfer payments around the union to allow the rich and successful to help the poorer and less enterprising. They do not want to pool their sovereignty over budgetary matters. They do, however, wish to impose substantial controls over the budget freedom of other states. This could prove to be a sticking point when it comes to hammering out practical proposals to put a sovereign behind the currency.

          It was good to see the Prime Minister talking the economy up, and some evidence of briefing in the press to point out that UK manufacturing is growing again. There is a recovery underway, and that is most welcome.

          Worldwide the news is considerably better than it is in the West. In Asia and parts of Latin America they are already having to put up interest rates to  try to slow things down to control inflation, so fast has the growth and recovery been. Indeed, the Credit Crunch slump was largely a phenomenon of  the EU and the USA. Monetary and budgetary policies were better conducted in much of the emerging world than it was in the advanced world, with better results. The factories of the East still rule the roost in many export markets.

        The world exconomy as a whole expanded at more than 4% last year and may do so again this year. The digital revolution continues apace, bringing many more people into the world of the web, social networking and rapid communication. The internet allows enterprising people in China, India and similar countries to start up a business with relatively little capital, and to gain immediate access to the worldwide market. Millions are being lifted out of poverty by enterprise capitalism operating ever more widely throughout the developing world. The web itself is something of leveller for business as well as for governments. It can help bring the prices of services down, and strengthens worldwide competition in many markets.

       The success of the private sector, of individual and family enterprise and access to the global market in providing opportunity to the jobless and higher living standards to the badly off is obvious to anyone who visits cities like Mumbai and Shanghai. It is all happening so quickly. The global market also means that countries which penalise enterprise, saving and effort too much can be shunned equally quickly in the rush to locate and grow in the more tolerant jurisdictions.

         We have three worlds. The advanced world, in danger of resting on past laurels; the emerging world, growing quickly and agressively; and the opt out countries like North Korea who choose autocratic economic systems to match their stifling political systems, and who confine their people to loss of liberty and an absence of prosperity.

        The West needs to understand the dynamics of this rapdily changing world. The Prime Minister was wise to highlight enterprise and opportunity, the chance to set up a business and to swap work for enforced lesiure yesterday. Ministers need to ensure the tax and regulatory regimes they set reinforces the fine words. The EU needs to switch from bail out to work out to sort out its problems, and needs to roll back some of the big government that gets in the way of prosperity.

            What passes for political debate about the deficit and how to reduce it struggles to inform, because it is based on  the strange proposition that most of the reduction is occurring through spending cuts. The numbers show otherwise. Whilst there are cuts in planned spending, total  spending carries on rising in cash terms, so all the deficit reduction planned happens through increased tax revenues. The increases in VAT and National Insurance are an important part of delivering this tax based approach. As we have seen, the main reason increased cash spending delivers some unpleasant cuts  is the rising inflation. Bad public sector management in some Councils and quangos adds to the stresses.

            The poor public debate is made worse by many people misunderstanding the difference between debt and a deficit. A deficit means the debt is going up – the country has to borrow more money each year to pay for the excess spending, on top of the huge debts already built up. A lot of people including  media interviewers and commentators, seem to think that reducing the deficit is the same as paying debt off – if only!

            Last night on Channel 4 News the Snow interviews left the impression that increased VAT could be a short term measure to ” pay down the deficit”, and that once that was done the tax  could be cut again. The increased VAT on the government’s strategy is needed to meet some  of  the costs of rising cash spending that otherwise would have to be borrowed. Increased VAT pays off no debt. It does not even stop the debt increasing. It merely slows the rate at which the debt is increasing. The £13 billion a year increase in VAT is considerably less than the planned cash increase in spending over this Parliament.

              Labour’s approach is to say that even more of the job of deficit reduction should be achieved by increased taxes. As all the deficit reduction is being achieved by increased taxes this in effect means Labour wishes to increase spending more rapdily than the Coalition, and use extra tax revenue to pay for the extra spending. Labour wants extra National Insurance on top of the the planned increases the government is putting in. Of the two plans on offer, the Coalition one is preferable because it cuts the deficit more quickly, and avoids even higher taxes which would be job destroying. Better control of public spending, as often discussed on this site, would help the recovery. There is no substitute for the public sector doing more with less.

               The UK’s economic policies carry a strong family resemblance to EU policy generally. That does not make them  wrong, but it is worth examining similarities, both where they might help and where they will hinder.

                The EU correctly thinks high government deficits are unsustainable and need to be brought down. It recommends a 3% ceiling on annual borrowing, and a 60% ceiling on the stock of  state debt, as proportions of National Income.  This is prudent and sensible. It will take the UK a long time to get back to these levels on current forecasts, but the intended direction of travel is clear.

               Most EU countries are embarked on deficit reduction policies. One of the most popular ways of doing this is through increasing VAT.  In the last couple of years the Czech republic and  Estonia have lifted their rates to 20%, as has the UK. Latvia, Lithuania,  Finland, Greece, Spain, Ireland and Hungary have also raised their rates.  VAT is of course an EU required tax, and the EU draws a stated  proportion of the VAT revenues from each country to support its own expanding budget. Cutting public spending at the EU level, which would be a better economic option for deficit reduciton, is not on the agenda, despite the UK government’s attempts to pursue this.

                 The EU has put in place a dear energy policy, requiring expensive developments of renewables and imposing carbon penalties on energy users. The EU as a whole will find increasing amounts of heavy industry investment go elsewhere, as energy costs are an important part of total manufacturing costs, expecially in cases like the  steel industry, foundries and castings. There is a danger that the EU’s energy policy will not succeed in curbing world carbon dioxide emissions, but will succeed in accelerating the transfer of heavy industry away from Europe.

                  The EU is advocating  more trans European rail investment, preferring rail links to other forms of air or surface transportation.  This makes hitting deficit reduction targets more difficult, as railways are extensively subsidised throughout Europe.

                  The EU advocates European level bank and financial service regulation, in addition to global regulatory standards and national regulatory activity. The Uk may find that bringing more of its successful financial service industry under EU control makes London a less desirable location for such  businesses, helping the transfer away to Hong Kong, Singapore, Shanghai  and other emerging centres.