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
Brexit-lite and Brexit properPost-Brexit discussion suffers from a serious vacuum. Although the British people have voted by a narrow margin to leave the European Union, the next prime minister has not been appointed, and no one knows exactly how he/she and his/her team will organize the negotiations. Two main options (both with many potential variants) are emerging,
- Brexit-lite (“the Norwegian/Swiss option, plus or minus”. The government gives priority to maintaining access to the EU’s Single Market, although seeking (like Norway and Switzerland) to restore parliamentary sovereignty and judiicial supremacy (i.e., that the highest court in the UK is its own Supreme Court, not the European Court of Justice in Luxembourg). Control over new regulations would be with the UK Parliament, but EU regulation would have to be respected in much of the economy and not just on exports to the EU. The UK would pay some money (“danegeld”) to the EU. Given the politics of the situation, the UK would want significant concessions on “freedom of movement”, so that it did indeed control its borders, but something like “freedom of movement for workers only” night be devised.
- Brexit proper. The government says that access to the Single Market is not essential, as the UK can trade satisfactorily with the EU under World Trade Organization rules. It says this, even if UK exports would be subject to the “common external tariff”. Of course the UK restores parliamentary sovereignty and judicial supremacy. It also oversees all new business regulation, although exports to the EU must anyhow comply with EU regulation. The UK pays no money to the EU and recovers full control of its borders.
The UK economy is clearly recovering and now achieving above-trend growth. Survey evidence is clear-cut, with the Confederation of British Industry’s monthly survey (of manufacturing, mostly) showing the highest balance of companies expecting to raise output since the mid-1990s. Past experience is that above-trend growth can be maintained for several quarters without provoking more inflation, as long as the revival is taking place from a depressed condition in which the level of output started well beneath trend. (The September 2013 CBI balance on price-raising intentions was in fact very low.) Money growth is satisfactory, but not particularly high. M4x (i.e., broad money excluding balances held by intermediate ‘other financial corporations’ or quasi-banks) was 4.5% higher in July 2013 than a year earlier, but the annualized growth rate in the three months to July was only 3.3%. Reasonably strong growth rates of demand can be reconciled with these rates of money growth, which are modest by long-run standards, largely because interest rates are more or less at zero, and people and companies are finding ways of economizing on their holdings of unattractive non-interest-bearing money. (In other words, the desired ratio of money to expenditure may be falling.) The argument for ending ‘quantitative easing’ (not in effect since the July meeting of the Monetary Policy Committee anyway) and/or raising interest rates has more cogency than at any time in the last five years. However, analysis of data from the Bank of England shows that over the last year money growth would have been negligible in the absence of QE.
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.
The following note is work-in-progress. It is part of an attempt to bring to an end the great mass of confusions that have cluttered discussion of ‘quantitative easing’ in the UK’s monetary policy debate and indeed the monetary policy debates of many nations, in the last few years. Work on the note will resume next week…and perhaps in the following weeks.
Disillusionment with politics – or at any rate with the current political elite – is rife in Britain at present. The UK Independence Party has made astonishing gains in the last three years. In the 2010 general election it received about 3% of the vote, but opinion polls and canvassing returns show that in the Eastleigh by-election (result due on Thursday, 28th February) it should achieve more than 15% of the vote and its share may even approach 25%. British politics is in flux. In the following remarks, which are based on an e- mail distributed to UKIP supporters* earlier today, I analyse prime minister Cameron’s disastrous strategy to ‘modernise’ and ‘rebrand’ the Conservative Party. The result of that strategy has been to alienate support from an important Conservative constituency, namely the Cs and Ds (the lower middle class and working class) who – when they do not vote Labour – are often particularly ‘right-wing’ in their political orientation. (The ‘patriotic working class’, etc.) The Cameron strategy has been responsible for upsetting many true conservatives who dislike/deplore the prime minister’s politically-correct agenda on social issues. My surmise are that
i. the Conservatives will lose heavily in the 2015 general election and then split, with the majority of the party moving in favour of withdrawal from the EU, and
ii. the polarisation in British politics in the next few years will be less on class lines and increasingly on the European issue* I was runner-up in the 2010 UKIP leadership election and am therefore biased. I am of course not going to hide this.
Housing market developments are critical to the macroeconomic outlook. Although the level of housing investment is small relative to national output in most countries, it is very volatile and changes in housing investment can significantly affect the economy’s cyclical course. Perhaps more important, wealth in the form of housing equity is a large part of all wealth, often equal to 40% or more of total personal wealth. Housing inflation or deflation affects consumption, because of the resulting ‘wealth effects’. Finally, mortgage credit is also typically 40% or more of the banking system’s assets, and the rate of growth of mortgage credit therefore impacts on the rates of growth of bank assets and banks’ deposit liabilities (i.e., the quantity of money). Signs of a recovery in the US housing market are of great importance to the macroeconomic prospect in 2013. They matter partly because of the ‘wealth effects’ for consumption and the implications for housing investment, as mentioned above. But they also matter because of the likely strengthening of bank balance sheets, as delinquent loans are reinstated and mortgage credit starts to expand again. The latest Federal Reserve data on delinquency rates on US banks’ assets, for the second quarter of 2012, show only a glacial rate of improvement in asset quality. In fact, the delinquency rate for banks’ residential real estate loans rose in Q2, even as delinquency rates for most categories of bank loan fell. But the news of house price increases has come more definitely in recent months (i.e., Q3). In September last year I sent out a bullish weekly e-mail on the American banking system, against the consensus at that time. I would like to repeat the general message in this weekly e-mail and to warn that, if US broad money starts to grow at 5% plus in 2013 (as seems plausible), the Fed would be very unwise to leave its funds rate at zero. Also in 2013 there will be a widening contrast between a reviving USA on the one hand, and seemingly chronic macroeconomic malaises in both the Eurozone and Japan.
Very early in its development the Great Recession was described by Daniel Yergin as ‘a crisis in search of a narrative’. In an article in the Financial Times of 20th October 2009 he complained that, despite a mass of commentary, few accounts had put together a convincing analysis of cause and effect. The Yergin article had some great insights, but I didn’t agree with it then and I don’t agree with it now. In my view the Great Recession, and the associated Great Financial Crisis, can be readily interpreted with the aid of the monetary theory of the determination of national income and wealth. Indeed, the events of the last few years have much the same features as many earlier cyclical upheavals, except that they have been on a larger and more dramatic scale. (I also believe that the supply-side performance ‘of the leading economies’ has been surprisingly bad by the standards of the previous 20 or 30 years, and this is more puzzling.) My purpose in establishing International Monetary Research Ltd. in early 2009 was to provide a platform for the monetary – or, if you wish, the monetarist – analysis of the Great Recession/the Great Financial Crisis. It came as a profound shock to me to realize – in late 2008 and early 2009 – that key policy-makers (in the UK, the USA and elsewhere) had no understanding whatsoever (I mean that) of the implications of the regulatory bank-bashing then under way for the rate of growth of the quantity of money. Even in mid-2012 many top officials continue to applaud rapid bank recapitalization and deleveraging as the answers to the crisis, without seeing that the result will be a contraction in the quantity of money. So the current e-mail sets out a quick and rather brief ‘Monetarist explanation of the Great Recession’, as background to an article by Professor Steve Hanke in Globe Asia. The article seems to me of the first importance, because it shows that this type of analysis is beginning to gain traction and influence. I don’t agree with every one of Steve’s words, but I warmly commend his analysis to the clients of International Monetary Research Ltd.
Mario Draghi became president of the European Central Bank on 1st November, 2011, at a critical moment for the euro. Banks – particularly banks in the Club Med countries (i.e., Italy, Spain, Greece) – were having difficulty rolling over their inter-bank lines. As the lines matured with little prospect of renewal, the banks were being forced to sell liquid assets. As these included bonds issued by Club Med countries, the price of the bonds fell and their yield increased. A surge in Italian and Spanish government bond yields was taken to constitute “the Eurozone sovereign debt crisis”. The media were full of talk of “a bazooka” of some sort to bring the crisis to an end. In October last year such talk usually focussed on the expansion of the European Financial Stability Facility, a back-up fund with resources provided by all Eurozone member states and able to extend credit to particularly hard-pressed governments. A widely-held view was that the EFSF might need to exceed 900b. euros, or even 2,500b. euros, if it were to have the fire-power to meet the crisis. In the event, negotiations for the EFSF have not got far enough, while its credibility in financial markets has been undermined by the credit rating agencies’ downgrading of several member states. But Draghi has found a big, powerful bazooka and aimed it with precision. Between 4th November 2011 and 20th January 2012 the ECB’s lending to banks has jumped from 580.0b. euros to 831.7b. euros, or by over 43%. The new lending has taken the form mostly of three-year facilities at 1%, which – on the face of it – are extraordinarily privileged loan arrangements for the banks. Further large expansion of such lending is to be envisaged. The banks have stopped selling government bonds, the yields on Italian and Spanish bonds have fallen, and the sovereign debt crisis is over, at least for the time being. This weekly e-mail analyses the effect of the Draghi bazooka on Eurozone M3 growth, because of the importance of money to macroeconomic outcomes more generally.
George Osborne’s 2011 ‘Budget for Growth’ contained a range of stereotyped headline-grabbing ‘growth’ initiatives. But the notion that they will make much difference to the UK’s medium-term growth prospect is fantasy. In this note I review the UK’s economy’s long-run growth and productivity performance, in order better to assess the current underlying trends. The conclusion is disappointing, that the annual trend growth rate of output per head is in the 1% - 1 ½% area. Since growth rate of the working-age population is now virtually nil because of wider demographic trends, the underlying annual growth rate of the UK economy is about 1% - 1 ½% a year. This does not allow for a number of major negatives, including the likely departure of a chunk of high-value-added international financial services sector in the next few years, the drop in productivity due to the imposition of renewables and environmental objectives in energy supply and high-energy-using heavy industries, and the disincentive effects of a large state sector and burdensome taxation. (UK taxation is now high by the standards both of the past and of the rest of the world at present.) The present coalition government deserves praise for its determination to bring the public finances back under control. But it has inherited and kept from the previous government a number of anti-growth policies which are of huge importance in undermining the supply side of the UK economy. The assortment of supposedly pro-growth goodies in the Budget is of marginal significance. They are spin, not substance, and cannot disguise the UK’s extremely poor ‘growth’ outlook at present.