Category: Blog

           The Coalition government published a 60 month strategy in June 2010. The Chancellor increased spending and borrowing for the forecast 5 year  period by £34 billion in the March 2011 budget. How is it going now?

            Readers of this site will remember that the strategy is to increase total current spending by £93 billion a year in 2014-15 compared to 2009-10, and to increase tax revenues by £172 billion a year over the same period. This will bring the deficit under control by 2015. It entails borrowing an extra £485 billion over the five years.

           I have been looking at what could go wrong with the strategy.

          It is possible that spending will go up by more than planned. The last two years of the plan show relatively small increases, of 1.9% and 1.8% in spending, compared with the 5.3% last year. As these will be the years running up to the election, it is possible the governemnt will then want to spend more.

           If they allowed themselves 1% more in the last year that would be an extra £7 billion. If they allowed themselves an extra 1% in each of the last two years, that would be £20 billion extra.

           The tax forecasts assume rapid growth for the UK in the last three years of the strategy. If growth was 1% less in 2013, revenues would come in around £20 billion less over the full period. If growth was also 1% down in the penultimate year, revenues would then be around £30 billion down.

           Of course, things could work out better. Extra growth, on top of the 2.9% forecast for each of the end years, could add to revenues. If the government takes more cost out than planned in the second and third years, there will b e knock on benefits from that. Crucial to success is getting a more efficient and effective public sector as soon as possible.

               The danger is that if there are too many overruns swelling the deficit, the government will then face dearer borrowing costs for every pound borrowed on top of the hazard of the extra borrowing.

       The public sector was willing and ready to jump on the private whenever it thought it could claim something had been missold to the investing public. There were demands for compensation, reparations and confessions. The perpetrators had to face the wrath of the Regulators.

       I do not expect there to be so much censureship of governments for misselling their own  bonds. The one thing governments are usually good at is covering their tracks or deflecting anger. We are living through a government bond crisis of some magnitude.

        Holders of Greek, Irish and Portuguese sovereign bonds have already lost much of their money. They are now told that bonds they were sold as investment grade safe products are  downgraded. In the case of Greece their junk bond status is one where the markets assume the government will not be able to meet all the payments owing on these loans.

         Holders of US and UK sovereign debt have seen the value of their holdings cut by devaluation. When they get their interest and capital payments, they will no longer buy as many Chinese or Indian goods as the money they lent to the governments in the first place.

         There are many overborrowed governments. Some will succeed in cutting spending, boosting revenues and meeting their obligations. Some will succeed in making the payments necessary, but will do so by printing more money and repaying in devalued currency. Some will fail to meet all the repayments, and will default.

         The UK official forecast assumes losses on gilts held for the next four years, as they predict rising official interest rates. After a decade of positive returns on gilts as interest rates and yields were driven down, the next next few years may not be so benign.

        I wonder what all those will be saying who recommended large holdings of sovereign bonds as safe and matching assets for various funds? I wonder what the governments that issued these bonds will be saying and doing, if the losses mount, one way or another?

       I do not expect to see much action about the big sovereign  bond swindle, which is already engulfing Greece, and could spread much wider.

        The Credit Crunch is  now entering its next phase, the sovereign debt phase. They kicked the can down the road from the troubled banks, only for it land up in the state’s backyard. The sovereigns have built a banking system based on their own borrowings. If those same sovereigns can no longer meet all the repayments at all, or without devaluing, they are undermining the very banks they claim to be suporting and regulating well.

              The UK  political classes have been mesmerised by the Murdoch saga. The all party agreement to the  motion to ask Mr Murdoch to withdraw his bid duly led him to do so.

           Meanwhile, outside the pressurised atmosphere of the debating chamber, the EU’s power brokers are locked in battle with each other, and with the markets. This is a much more gripping and crucial battle for all our futures. At stake is the future prosperity of our continent, and the future rights and duties of citizens in the many countries likely to advance further towards a federal union.

           Today, late in the afternoon, we expect the authorities to publish the results of the EU  stress tests for banks. These will show that some EU banks, probably in Spain, Germany and Italy amongst others, have low levels of capital relative to the risks they are running. If the EU sets a fairly high bar, more will fail the tests, worrying people. If they set a low bar, more will doubt the validity of the tests, worrying people.

            The last EU stress tests, which were analysed here, failed to point out that holding government bonds could be hazardous in the current climate and could lead to substantial losses if marked to their market values.  They did not satisfy markets, as many commentators and investors thought them too easy. The Irish banks all passed, and promptly got into difficulties.

             These new tests will draw attention yet again to one of the fundamental areas of weakness in the Euro scheme. Banks in weak countries have been made to buy and own too many domestic governemnt bonds, which are now sitting at large losses. EU banks generally have not been regulated to strict capital requirements. The European Central Bank has offered substantial assistance, as a Central Bank has to do, but some fear it will be held back when it needs to offer more bank  liquidity, and if it needs to continue its government  bond buying programme. If the regulatory authorities overdo the demands for more capital, it just slows the growth rates even more. This in turn cuts tax revenues and makes deficits worse.

          The enthusiaists for the Euro are now demanding that the EU makes more rapid strides to having an EU Finance Minister, proper enforcement of budget limits on each member state, and use of the EU credit card to borrow more money for individual countries using the credit status of the whole area. There are also frantic calculations of how much money should be transferred between the richer and poorer regions of Euroland to try to balance things up a bit.

           On Monday there were power failures and considerable service disruption on the Victoria line. Worried about getting back to the Commons in time, I got out at Oxford Circus. It was 6.30pm. The pavements were so crowded I could not walk quickly or even go in the direction I wished to go in. There were thousands of shoppers out and about.

           Someone drew up in a taxi at Hamleys, so  I grabbed the taxi. The driver told me that business was  good – strong positive words in answer to a question I often ask about how busy they are. He explained that most of the people he carries are foreign visitors.

            It’s another part of the growing evidence that central London has detached from the rest of the UK economy. Large number of overseas visitors are swelling the retail sales. Large numbers of visitors are making longer term commitments, paying ever higher prices for flats and houses, and renting office space.

            Whilst the typical UK High Street languishes, Oxford Street booms. Whilst provincial property markets wallow, with plenty of empty space and falling rents, central London space is filling up quickly and rents are rising. The devalution of the pound has stimulated central London. Financial and political troubles elsewhere in the world are also helping.

     Yesterday morning I attended a breakfast seminar. Professor Henkel from Germany told us how he had been a keen exponent of the Euro in the 1990s. As Head of the German equivalent of the CBI he had come to the UK to urge our membership of the currency.

        He has recently  published a book explaining why he  thinks he was wrong. He now sees the force of criticisms of the scheme which we sceptics put forward at the time. He is worried about the future of the single currency, and is now urging his fellow countrymen and women to think again.

 He believes the best fix would be for Germany, Finland, Austria and Holland to leave the Euro and create a new stronger currency, which would revalue against the Euro. France would remain as the leader of the Euro group, and that currency could devalue against more successful economic areas, relieving some of the competitive pressures.

He thinks the formation of a transfer union, sending more grants and gifts to the poorer areas, the more likely outcome of EU deliberations.   He thinks the German people will grow increasingly unhappy about this, whilst most of their elite leadership will remain fully behind the Euro project.

He thinks the Euro is now worsening German relationships with the weaker countries. He finds resentment of German government lectures on the need for belt tightening in countries like Greece. He thinks the guarantees and support for Euroland now add up to €5000 for every man, woman and child in Germany.

All the time France and germany disagree about the solution, and all the time there are big differences of view between Germany and the European Central Bank, the ride will be rough for the single currency.

              No-one denies that the UK needs to build some more power stations. Some of the nuclear ones are old and need to be retired. We  could also do with some extra capacity to cut imports and to provide us with the extra power we will need if the drive to increase industrial activity is successful.

              There are two big questions that Mr Huhne needs to answer. The first is are we going to retire fossil fuel  stations as well to comply with EU regulations, or will he negotiate some extension of our time to use these stations to cut the costs of supplying power? I think we can assume he will wish to shut the fossil fuel stations. The second is what will we replace the power stations with? Mr Huhne will probably recommend much more in renewables, also to comply with EU current measures. He is said also now to accept that  nuclear replacement of nuclear is  possible.

                What the market needs to know is what subsidy regime will apply to the carbon dioxide  light or carbon dioxide free ways of generating power? The subsidy may be expressed as  guaranteed carbon price, and or as a premium price for the power they generate from these differing systems. Either way it means dearer power for the UK. To get people to put in the power generation we need requires detailed, consistent and believable subsidies or carbon pricing to make it worthwhile to produce this power. It also means the UK will be carrying an additional cost burden for anyone running an industrial undertaking in the UK, to say nothing of the impact of all this on consumer inflation and everyone’s personal budget.

           This summer we will see dearer energy push our inflation rate up. Gas and electricity prices are soaring. The increase in gas prices is bad enough.   The more we move away from gas generated power, the dearer our electricity is going to get.

     Last night Parliament voted by 274 to 246 votes in favour of increasing the UK’s contribution to the IMF by £9.3 billion.  That implies more than 80 Conservatives were unavailable, abstained or voted against the government. Many Labour MPs were also unavailable or abstained, when their party recommended voting against. I will check the voting lists later today.

     Some of us want the UK government to use the influence it says it has at the IMF to halt the futile bail outs of Eurozone members. The debt markets show the markets do not believe that Greece can repay all its debts in full and on time. Yesterday was a day when market worries spread beyond Greece, Ireland and Portugal to Italy. Those in  charge of the Euro scheme need to get a grip. It is doing a great deal of financial and economic damage, and they no longer seem to be in control of their project. The IMF should decline to bail out rich countries that have shackled themselves to a currency scheme that was badly put together and needs a thorough re think.

              This week-end has seen various economists claim there was no growth in the second quarter of 2011. The British Chambers of Commerce thinks export led manufacturing did well enough to ensure 0.3% growth for the second quarter.

            I find it surprising that people are surprised that growth is slow. It all goes back to the misunderstanding about which sector, public or private, took the hit last year. If it had been cuts for the public sector and stimulus for the private sector, growth would have been higher. The private sector is still a lot bigger than the public  sector, even after the years of large increases in public spending.

                Instead, as readers of this site will know, the first Coalition year saw continued growth in overall public spending, along with substantial tax increases (imposed by both Labour and the Coalition governments) and a big surge in inflation. The continuing large fiscal stimulus did not work. We need a private sector stimulus, not more public spending. Constantly increasing public spending and borrowing can increase the squeeze on the private sector, as it is allied to present and future tax rises to pay for it all. The smaller increases in cash public spending  in the later years of the strategy should be directed to the government’s spending priorities like health and education.

                Wage growth remains very subdued. As a result of tax rises and inflation, consumers have been badly squeezed as forecast. The inflation was easy to forsee, as too much printed money depressed the value of  the pound and led to a large increase in import prices. Now higher energy is doing the damage, partly designed by the policymakers as part of their drive to get us all to use less of it. This site called for anti inflation measures in 2009 including higher interest rates then to stop the pound’s fall. The authorities decided against. This site has also called for an energy policy which meets demand with more efficient and cheaper supply – we will return to this later this week. We need more cheaper energy if the manufacturing revival is to take wings, as manufacturing is energy intensive.

               The government’s deficit reduction strategy relies heavily on tax revenue rises, which in turn depend heavily on accelerating growth. If the government is to hit these exacting targets in 2013-15 it needs to cut selective taxes and reduce the overall regulatory cost burden soon, to give some uplift to a struggling private sector. It can’t all be done by exports. If it doesn’t, it will end up borrowing even more than the £485 billion extra  forecast for the 5 years. This will mean higher interest rates, a further depressant for enterprise.

The intensity of the coverage of the press issues is matched only by the ferocity of the language used by politicians and others to condemn largely unnamed malefactors.

I agree that it is in bad taste and hurtful to listen to the phone messages of victims of tragedy, as well as being against the law. Let the law be enforced, by bringing charges where there is evidence. I also agree that it is a crime to bribe a police officer. Again, let charges be brought where there is evidence. These incidents may not be confined to the employees of just  one newspaper. All newspapers try to listen in to the more private thoughts of people with power or fame, though we hope they usually do so legally.

What is extraordinary is the handwringing and confessions coming from senior politicians of the mistakes that have been made cosying up to newspaper figures.  Some of us have said for years that there was too much spin. We added that politics based on too much spin was neither healthy nor necessarily popular. As we now see from these cases, the Spin Doctor can become too prominent and can become the problem. Mr Cameron now has to spend time explaining  his relationship with Mr Coulson. There is a lot to be said for politicians who tell Parliament by speaking in the  Chamber, and expand to  the media in a subsequent press conference  what they want to say.

The problem with Spin doctors is they “interpret” what the politicians has said. They may do so accurately, often in a way which hurts a colleague of the politician. We are told a given sentence was an attack on x or a signal about y. They may sometimes do so inaccurately, carried away by their own position to ascribe to the politician thoughts and feelings he or she does not share. Either way it leads people to distrust politicians more, as the public learns they always speak in code, and it damages relationships within a government or party by stressing or creating divisions.

All previous governments had spent some time on thinking what to say and how to say it to the press to present themselves.  New Labour took the arts of spinning and elevated them into a kind of political religion. It was Mr Blair who flew half way round the world to pay homage to Mr Murdoch. It was Mr Blair who appointed a Spin Doctor as the most senior official at Number 10. Mrs Thatcher’s Press Spokesman was not the most senior official, and Mr Ingham did not intervene in policy and Cabinet matters in the way Mr Campbell did. It was the New Labour government that changed many of the Press officials in Whitehall. That same government  appeared to tell its Ministers to concentrate more on trying to manage the press than on managing their departments.  Modern politicians are all to a considerable extent under the cloud of modern spinning that was created after 1997.

What should now be clear is that too much spinning can damage the politicians who think it helps them. I read that politicians can now breathe a sigh of relief that the power of the Murdoch press is broken, and they can now behave more as they would like. How extraordinary that they felt like that. I have never knowingly changed my views of a problem because a newspaper has taken a different view to the one I express. I have often tried to persuade newspapers and their journalists of my view, or at least get them to cover it.  I have relied for my views on the facts I read, my analysis of what might work, and my judgement of the public mood, including my own constituents.  My first thought is what is in the national interest, what might achieve the aims we have? My second thought is how do you express this judgement, given the range of  views that the public holds. Quite often I have to advance an argument or an explanation of the facts first before proposing a remedy, because the facts are often ignored or misunderstood in the media. Many in the media rely on the two main  sources of spin, Number 10 and the Leader of the Opposition’s office. These two bodies may not know the shape and size of a problem, or may not wish us to know it.

My advice to those colleagues who have been cowed by the media is twofold. Just because the News of the World has gone and the Murdoch papers are having to deal with a hostile press and investigations does not mean politicians suddenly have a new licence to behave badly free of  press censure. Perhaps “modern politicians” can  now understand what some of us have long said. The important thing is to govern well, and then the spinning almost takes care of itself. The best advocates of the government’s course of action should be the Ministers themselves who approved it. If they can explain and defend it to the Commons they should be able to do so anywhere. The argument used to justify all this spin is that we now live in a 7 by 24 news round. Yes, but that does not mean Ministers have to entertain the media 7 by 24. If they refused to perform at all hours of the day and night, the media would attend Parliament and hear what they had to say.

            Financial regulators are busily looking for the next crisis with a new intensity, as so many of them missed the last one before it hit them.

           As some of you have pointed out, there is still a large overhang of derivatives out there in the market. Maybe they should look again at  that.

       Sensibly run, these financial instruments help people cut their risks. Someone who has borrowed at a variable rate can protect themselves from rising interest rates. A company receiving revenues in a foreign currency can protect that money against future exchange rate losses. A business needing to buy or sell commodities as part of its activities can protect themselves against adverse  future price movements. All this is good news. Properly used, it helps stabilise things.

           Portfolio investors too can use these instrument to cut risk. If you have a lot in shares, but fear the market may have a temporary set back, you can insure yourself against it without having to liquidate all your holdings. If your shares are in good companies, but in currencies that could weaken, you can protect the value of the currency you bought to invest in them.

          So far so good. Yet at the end of 2010 there were $600 trillion of notional amounts outstanding on the full range of these derivative contracts. That is more than ten times the total value of world output. Many of these contracts are on bank balance sheets somewhere. For everyone insuring themselves against a bad movement in interest rates, currencies or commodities, there has to be someone taking the opposite view. Quite often that will be a bank.

          Some users do not want them to cut their risks, but to gear their risks. They allow institutions, funds and companies to invest in more of the underlying commodity or currency than they can afford to buy, or to go short with the potential for substantial losses if they bet the wrong way. If this gets out of control in volatile markets, one or more of the larger users could go under. Then you have the knock on effects, as contracts are unwound in a hurry and others might come unstuck.

           It is interesting that the world total at $600 trillion is still the same as at the end of 2008. Within this total credit default swaps amount to some $30 trillion. These are the contracts that pay out if a big lender like a country fails to meet its obligations to pay all the interest and capital repayments owing.

          The ability of the world to gear its positions through this large amount of liquid contracts needs careful prudential controls. Banks can be controlled through the balance sheet rules over much cash and capital they need to put behind this type of activity. Financial regulators need to ensure adequate  rules of prudence on all the big users of these instruments.