The victory for the Leave campaign in the UK’s referendum on EU membership has dominated financial news since 23rd June. It is of course a major event, not least because numerous forecasts of a mini-recession in the UK are now to be tested. The evidence so far is mixed, with the latest survey from the Confederation of British Industry (published a few days before 23rd June) reporting a rise in the balance of companies planning to expand output in the next three months. Elsewhere the main features are, first, in the developed countries continued growth of broad money at the almost ideal annual rate of 4%, and, second, in China and India signs of a slowdown in broad money growth. The slowdown in both China and India has come about suddenly, and may soon disappear from the data and not prove meaningful. On the other hand, the slowdown could last a few months, perhaps even more. Once a money slowdown/acceleration persists for six months or longer, it starts to matter to the cyclical prospect. My overall assessment is – despite the Brexit shenanigans – the global monetary background remains consistent with steady growth in world demand and output in late 2016 and into 2017. Far too much fuss is being made about Brexit. The UK’s share of world output (when output is measured on a so-called “purchasing power parity” basis) is modest, less than 2½ per cent. The credit downgrades faced by British banks have created possible funding strain for them, recalling the crisis of late 2008. The problem needs to be countered by the provision of long-term refinancing facilities from the Bank of England, just as Draghi handled a similar challenge in the Eurozone in December 2011
March and April have seen a marked 70% rebound in the oil price from the January lows of about $26 a barrel. The move owes much to the dynamics of the energy market itself, but it is being interpreted by financial markets as a sign that global demand should be sufficient to deliver at least trend growth (say, 3% - 3½%) in world output in 2016. The mood has changed sharply from January’s alarmist hysteria, much of it due to so-called “analyses” from the Bank for International Settlements, the International Monetary Fund and leading investment banks. (These organizations ought to have known better, bluntly.) The line taken in International Monetary Research Ltd. notes has been that recession in 2016 is extremely unlikely. Only hopelessly incompetent monetary policy decisions could cause a recession to start from a situation in which upward pressures on inflation have been and remains weak, and the price level has been and remains more or less stable. I don’t have much respect for the top brass in the major relevant institutions (i.e., the Fed, the ECB, etc.). But, to initiate a recession, they would have had to be yet crasser than they were in the last period of idiocy, in late 2008. In practice, the absence of upward pressures on the price level has allowed significant monetary-policy easing in China and the Eurozone. It seems that in China M2 growth has run about 1% - 1½% a month (i.e., at annualised rates of 13% - 20%) in early 2016. In the four major developed “countries” (i.e., taking the Eurozone as a country) – the USA, the Eurozone, Japan and the UK – the annual rates of broad money growth are currently 3.9%, 5.0%, 2.6% and 4.5%, and the three-month annualised growth rates are 5.1%, 4.4%, 2.8% and 5.0%. If asked for an ideal rate of money growth, Milton Friedman would typically reply – at least for the USA – “5% a year”. The Bank of Japan seems unable to see the light in the “broad money vs. monetary base” debate. But in truth money growth trends in the main countries are not far from perfection at present.
The UK Independence Party claims to be ‘changing the face of British politics’. The big support it received in the May 2013 county council elections certainly came as a shock to the three so-called ‘main’ parties, with one of these parties – the Liberal Democrats – receiving far fewer votes than UKIP. (The LibDems had 14% of the vote and UKIP 23%, and UKIP was in fact only 2% behind the Conservatives.) However, opinion polls tend to show UKIP support at only just into the double digits per cent and not much above the LibDems. Are the opinion polls telling the truth? UKIP is doing far better in local government elections than in the opinion polls. In the following note I compare opinion poll and local election results since late August. In the 47 local government elections analysed the UKIP vote share was 19.0% and its average result where it stood was 20.8%. (But note that this 20.8% was lower than the 2nd May figure! Admittedly, the difference is small.) By contrast, the UKIP share in the 59 opinion polls compiled by UK Polling Report in this period was 11.6%. On this basis, the opinion polls are seriously understating the size of the prospective UKIP vote in both the European elections of 2014 and the general election of 2015. It also needs to be emphasized that the UKIP share in local government elections has climbed from 3.1% in 2010 to 19% plus in 2013. If it continued to make gains at this sort of rate, it would certainly be ‘a major party’ in the 2015 general election and could even win it. For clarity, this is not what I expect, but for some years to come fluctuations in the UKIP vote share, around a rising trend, are likely to disrupt the thee-party, Lib-Lab-Con pattern of British politics which began in the 1980s. (This pattern began with the formation and rise of the Social Democrats, and their eventual absorption into the Liberal Party.) It is unclear whether a four-party pattern (Labour, Conservatives, UKIP and LibDems) or a three-party pattern will now develop, but a case can be made that UKIP will supplant the LibDems as the third party.
Heavy net immigration into the UK has occurred in the last 15 years, reflecting the impetus of mostly administrative changes at the start of the last Labour government in 1997. (No major announcement was made and no public debate was held on the desirability of this new development in British life.) A particularly important new trend was inaugurated about a decade ago. Following a decision by the then prime minister, Tony Blair, the UK would not impose any restrictions on the inward movement of workers from eight East European countries when they joined the European Union in May 2004. Since spring 2004 UK-born employment in the UK’s labour market has fallen, whereas foreign-born employment has increased by about 1.8 million. Roughly half of the 1.8 million come from the so-called ‘EUA8’ countries, i..e, the eight accession countries of May 2004. The mere recital of figures does not demonstrate a causal connection, but more detailed work (such as on regional employment patterns) does suggest that UK workers have lost jobs because of the influx of foreign workers. On 1st January 2014 people from Bulgaria and Romania – which together have a population of about 30 million people – will be free to come to the UK, and to live and work here. The following note – which is chapter 4 of the 2013 edition of my study for the UK Independence Party on How much does the European Union cost Britain? – discusses these developments in more detail.
From a constitutional standpoint, the European Union is a monstrosity. Powers have been ceded to EU institutions that place them above the member nations in the constitutional hierarchy. These institutions are, in effect, federal bodies that constitute a ‘government’ for the EU as a whole. Nevertheless, the member nations have retained trappings of statehood, and in particular continue to have their own military forces, their own legal systems and their own fiscal prerogatives. Critically, most taxes are raised and most public expenditure is administered at the national level. EEC expenditure was a mere 0.03% of member states’ aggregate gross domestic product in 1960, and had climbed to 0.53% of that figure in 1973 on the UK’s accession. The ratio has subsequently risen to slightly more than 1% of EU GDP, as we saw in the last chapter. But it is striking that Germany – the main sponsor of European integration – has over the last 20 years been one of the member states most opposed to additional spending in the union’s name. At the Edinburgh meeting of the European Council in 1992 Germany actively supported a spending ceiling of 1.27% of aggregate member nations’ GDP.1 On the face of it the EU has two layers of government, one at the national level and the other for the union as a whole. But the word ‘layer’ implies, falsely, that a clear and definitive understanding has been established on the proper relationship between the two. In fact, EU member states are in the dysfunctional situation of having two distinct governments, one in the national capital and the other in Brussels, with their relative powers and responsibilities largely unsettled. The EU bureaucracy has been unable to wrench the key fiscal prerogatives, the powers to tax and spend, from the member states. To compensate for this failure, it has tried to expand its influence by pressing for more European ‘laws’. The heart of the process is that the European Commission proposes new ‘directives’ and ‘regulations’ to the Council of Ministers. Successive treaties have weakened the power of individual nations to block new EU legislation that they dislike. Particularly since the Single European Act of 1986 the nation states have become increasingly feeble in restraining the EU juggernaut. Over the 55 years of its existence the European Commission has authored thousands of directives and regulations that have the force of law across the EU. At the last count the EU’s various legislative enactments – which are termed the acquis communitaire – covered over 120,000 pages. As far as the EU is concerned, the acquis is sacrosanct and must be adopted by all new member states without cavil. Directives and regulations are the main expression of EU authority, and nowadays infiltrate every nook and cranny of national life. In the words of Lord Denning over 20 years ago, ‘Our sovereignty has been taken away by the European Court of Justice…No longer is European law an incoming tide flowing up the estuaries of England. It is now like a tidal wave bringing down our sea walls and flowing inland over our fields and houses—to the dismay of all.’2
Press reports have suggested that the International Monetary Fund has become unhappy with the Greek government’s austerity measures, since it felt not enough was being done to maintain fiscal solvency. Anyhow the latest tranche of money has been credited to the Greek government and life goes on, although Greece’s international creditors are watching the budget numbers month by month. The following note recognises that the Greek government is not far from achieving a ‘primary budget balance’ (i.e., non-interest public expenditure is only slightly above tax revenues). In that sense, much has been done to restore the creditworthiness of the Greek state. However, the cost has been calamitous, with falls of about a quarter in real terms in both national output and government expenditure. Even worse, it is not clear that the big austerity drive so far will be sufficient. Two points have to be emphasized. First, output has fallen so heavily from the peak (i.e., in 2007), and is still falling at such a rate, that a budget surplus would be needed to stop the debt/to/GDP ratio from rising further. There is no sign of that. Despite the defaults to private sector creditors, IMF data show the debt-to-GDP ratio now at about 175%. Second, the drop in output has of course a large cyclical element and, sooner or later, a cyclical recovery must surely happen. However, a deeper problem is now emerging, that international investors are shunning Greece and the trend level of output may be going down. To halt the rise in the debt-to-GDP ratio, Greece therefore needs an overall budget surplus over a series of years and not just a primary surplus in an emergency period Again, there is no prospect of that in any relevant planning horizon.
The Eurozone resembles a vast dyke which is full of holes and liable to disintegrate at any moment. This note concentrates on Portugal, where the recent resignation of the very able finance minister, Vitor Gaspar, was a huge disappointment. (It must be said that the Eurozone’s holes in Greece, Spain, Italy and France also remain large and conspicuous, despite international officialdom’s attempts to patch them.) Portugal’s problems arise partly because the economy’s trend rate of growth is now very low, perhaps even zero or negative. Gross domestic product per head is lower than ten years ago. With inflation almost zero, nominal GDP is at best flat. As a result, any deficit leads to an increase in the ratio of public debt to GDP. A May 2011 bailout negotiation with the ‘troika’ extended €78b. of loan and other financing, to help the Portuguese government and banking system. It must be acknowledged that Portugal has tried hard, with Gaspar at the finance ministry, to meet the conditions attached to the bailout plan. The cyclically-adjusted budget deficit fell from 9.0% in 2010 to 4.0% in 2012. Nevertheless, the debt-to-GDP ratio has kept on rising and is now over 120%, the kind of figure that was associated with the Greek dégringolade in 2012. (A fair verdict is that a debt-to-GDP ratio of 120% is sustainable when the nominal interest rate on the debt is 5% or less, but – once the interest rate goes into double digits – the debt interest burden runs amok like a Frankenstein monster.) The Portuguese people are apparently weary with austerity, and it has to be said that – without a resumption of growth and particularly of asset price appreciation, which would help banking solvency – the danger has to be that further deficit-reduction measures would not restore fiscal sustainability or national solvency. Holders of Portuguese banks’ bond liabilities and depositors with Portugal’s banks, you have been warned! PEXIT (Portuguese exit from the Eurozone) is – almost certainly – a better option than staying in.
Mario Draghi denies that he is an actor. But in July last year he is reported to have paused, with great effect, between two sentences in an interview for the Financial Times. The two sentences were, ‘Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And, believe me, it will be enough.’ On the basis of these two sentences, which were followed by a spectacular rebound in the euro on the foreign exchanges and in European share prices, the FT made Draghi its ‘Person of the Year’ for 2012.* But Mario Draghi, like King Canute, is not omnipotent. He cannot break the laws of arithmetic and the principles of accountancy which depend on those laws. He cannot – by mere pronouncement – conjure up the real resources required to fill the hole in Cypriot banks’ balance sheets. Equally, if that hole is €17b. (or about 80% of Cyprus’s GDP of €22b.), the Cyprus Parliament cannot by rejecting the terms of an international bail-out make the people of Cyprus richer in any meaningful sense. The cost of filling a hole of €17b. is the cost of filling a hole of €17b. It was supposed to be met by an increase in Cyprus’s public debt of over €10b. and the highly controversial deposit haircut of €5.8b. The Cyprus Parliament’s unanimous rejection of the haircut does not mean that – automatically, immediately, magically and finally – the €5.8b. has fallen like manna from heaven. We have a stand-off. The ECB has indicated that, on the provision of the appropriate collateral (Greek government bonds?), it will lend to the central bank of Cyprus sufficient amounts for it to meet cash calls from the commercial banks. These banks would then have enough cash to repay depositors with legal-tender notes. But do Cyprus’s banks have appropriate collateral in sufficient amounts? Do they, in Draghi’s terms, have ‘enough’?
The following note sets out the results of UK by-elections from the start of 2012, a period in which a (predictable) swing to the main opposition party, Labour, and an (unpredictable) swing to a less-than-20-year-old one-issue party, the UK Independence Party, have occurred. Averaging all the by-elections and excluding the March 2012 Bradford West by-election, the swings are of about 10% from both Conservatives and Liberal Democrats, and of about 10% to both Labour and UKIP. If the Bradford West result is included, the swing to Labour is reduced substantially, to about 5%. The explanation is the large swing to Respect, a breakaway political force under Mr. George Galloway
The Greek government recorded a surplus on its finances in January, an apparently heartening development in the continuing Eurozone melodrama. The surplus was the result of huge cuts in expenditure combined with the seasonal pattern of tax payments, which has the effect of making January a month of unusually high tax receipts in every financial year. (Greece had a budget surplus in January 2010, also.) Key decisions on Greek public finances are now being taken by the troika, the group of international bodies (the International Monetary Fund, the European Commission and the European Central Bank) acting more or less in unison to ensure that financially distressed Eurozone countries can honour (some of) their international debts. Can these organizations at last start celebrating? Is austerity having the desired effects? In fact, the wider macroeconomic background in Greece remains appalling. The January outturn is unsustainable, and reflects both desperation and severe fiscal trauma. Needs must when the troika drives. Tax revenues were lower, by over 9%, in January 2013 than a year earlier. The surplus was ‘achieved’ only by a fall of over 20% in expenditure, from €5,362m. in January 2012 to €4,239m. last month. It should also be emphasized that in January 2011 expenditure was €8,408m. In other words, Greek government expenditure at the start of 2013 was half (yes!) the level of two years ago. The Greek state is having difficulty controlling its borders, with immigrants widely reported to be responsible for a crime wave. There is still a high risk that Greece and/or Cyprus will leave the Eurozone.