Sunday, 20 March 2016

Interesting fall-out from the dogfight among Britain's Conservatives

The British conservative party is tearing itself apart over the EU referendum in June. The internecine fighting has reached new highs over the recent days and some quite interesting bits of information are contained in the intense exchanges.

Work and Pensions Secretary Iain Duncan Smith resigned last Friday over a particular line item contained in the budget just presented by Chancellor George Osborne, some cuts in spending for handicapped.

Duncan Smith is also known as a passionate proponent of Britain's exit from the EU, the Brexit, and obviously he is free to campaign for his views from outside the cabinet. The British press has over the weekend been full of all kinds of guesswork about his reasons to resign.

The most interesting in this exchange is in fact Duncan Smith's resignation letter, which contained the following statement:

"I am unable to watch passively while certain policies are enacted in order to meet the fiscal self imposed restraints that I believe are more and more perceived as distinctly political rather than in the national economic interest".

Please read this again. One of the uncompromising conservative politicians in the UK states that the economic policies are subject to "fiscal self-imposed restraints".

He is talking about the balance budget target zealously pursued by Osborne in close cooperation with Prime Minister Cameron.

In a few words Duncan Smith revealed what has been clear to economists for a long time: Pursuing a balanced budget at all times is simply a question of ideology rather than the "national economic interest".

In the days after the presentation of the budget, there was a discussion about what would happen if the optimistic growth projections behind the budget did not materialise.

Osbornes view was that it would then be hard to balance the budget, unless further public sector cutbacks were introduced.

So there it is: The British economic policy is driven by the same ideology as the fiscal policy in Germany - and which Germany does everything to stamp upon the rest of the Eurozone.

So at least it has become clear that there are no real economic arguments for the wish to leave the EU.

Former PM Sir John Major is trying to make the opposite point: that there are significant economic reasons for Britain to stay. Britain can not expect that EU should be rushing to give Britain a privileged status, as Britain needs the EU more than the EU needs Britain. Major is afraid the Britain will find herself “sleepwalking into antagonisms it cannot repair”.

I notice use of the word "sleepwalking". Major basically tells his party to wake up and try understand what is at stake.

I am afraid that given the intensity and the personal focus of the exchanges inside the conservative party, his words are likely not to be heard. A good personal jibe is easier to sell to the press than a long historic argument about the role of the EU.

Wednesday, 16 March 2016

Fed: everything normal, so go back to work

Writing about Federal Reserve's monetary policy is rarely exciting, same goes for reading comments about it.

I am sorely tempted to share my opinions about the Republican primaries instead. But since the situation on that front develops every day, I better hold back until things get more stable. There is one connection though.

The Republican party has since Obama's election set new standards in obstruction of the legislative process. It has had some bizarre side effects, such as "Government Shutdown" on a number of occasions.

The legislative gridlock has had one positive effect: any tendency on either side of the political spectrum to introduce "austerity" has been mostly curbed. The effect has been that the US as almost the only country has seen the public sector deficit develop according to the textbooks. As the crisis hit, government finances went deeply into red, providing stimulus to the economy. This stimulus has automatically been reduced as the economy recovered. No German-style destabilising "stability policy" here.

It does not mean that all is good, nor that I find political gridlock as a way to obtain an economic-political target is an idea to imitate.

Together with the timely (albeit rather distasteful) help to the banks, it does mean that the US today is in a better place than most of the other larger economies in the Western world. There has been a long period of economic growth, jobs that disappeared during the crisis are roughly re-created. Growth has been more subdued than seen in the years until 2007, but there has also been a significant improvement of the debt situation of the households, meaning that their savings have increased. That leads to slower growth in the short term.

Of course there are still a multitude of problems stemming from the fact that decisions on the fiscal policy are simply not taken. Still, the US economy is in a better state than the European economies.

Hence it is no surprise that Fed in general are upbeat: the US growth has survived a visible strengthening of the dollar and a slowdown in China. So there is only one way of interpreting Feds inactivity: the Open Market Committee simply finds that they are on the right path and are waiting for inflation to begin crawling up towards the 2 per cent target. And obviously, Fed finds itself on tract for further interest hikes during the year.

Whether it is 2, 3, or 4 hikes is not that important. Important is what Fed's analysis shows about the US economic growth. FOMC was not in doubt. We are on the right track and further rate hikes will follow as prices begin to crawl upwards.

What the markets should be spooked about is the capacity limit. Inflationary pressures begin to build as a shortage of certain kinds of labour begins to build. Inflation could also begin to increase if US companies hit their production limits. The fact is that nobody knows where the inflationary limits are. We just know that an awful lot of productive capacity has been dismantled after 8 years of crisis.

So no, further interest rate hikes are not taken off the agenda going forwards.

Friday, 11 March 2016

ECB's Bazooka?

This time ECB delivered what the market expected in terms of easing. By some standards ECB even over-delivered by increasing the monthly bond purchases from 60bn € to 80bn € and by increasing the Targeted Long-Term Refinancing Operations or TLTRO for short. The lead interest rate was lowered to 0.4%

After an initial bout of optimism, the stock markets had second thoughts: By delivering that much, has ECB run out of ammunition for the "bazooka". Stock markets reversed sharply. The Euro also reversed parts of its initial loss.

Reactions from the stock market are largely irrelevant in this context, since they are mostly driven by day to day sentiment anyway. I also have some trouble believing the wisdom of stock market traders when it comes to assessing the effects of monetary policy in the medium and long term. I mean, stock market traders do not usually work on that kind of time horizon, right?

ECB's initative certainly created some angry comments, mainly from Germany, where "flooding" the banks with money is seen as a bad thing. For many German observers, the problem lies mainly in the clash between a macroeconomic reality and the deeply ingrained culture of saving among ordinary Germans. Obviously, negative interest rates removes the most important incentive for saving. And that is considered a very bad thing.

Germany has had a fantastic run of economic success. It has been built on strong exports of high quality industrial products. Germany has through its success in engineering been able to be competitive beyond expectations for decades, and even lived through the 55 years after the end of WWII with a steadily appreciating currency because of strong productivity gains.

Apart from strong productivity, this success was made possible by German savers, who provided the means for the investments necessary. In Germany it is still considered a virtue for households to save.

And of course the anger at ECB is because German newspapers and a great many politicians mistake household economics for macroeconomics. There is even a name for this misunderstanding. It is called the "thrift's paradox". If we all save, we will all get poorer.

Europe does not need any more savings. We need consumption and, in particular, investments to pull us out of the quagmire. The problem is that somehow the glut of savings does not translate into finance for consumption or investment.

The problem is that the intermediary, namely the banks, are badly out of order. Too many banks in Europe are still carrying too many dud loans on the balance sheets. So they remain unwilling or unable to boost their balance sheets with new lending.

And that is the rub. The TLTRO offers cheap liquidity to banks, and is targeting banks which have grown their balance recently. But the previous LTRO programmes have not been strong in inceasing bank lending, So I do not see why it should work this time. It seems that it is not the price of central bank money that stops the banks from lending. Instead it is their bad loans.

Since 2008 I have consistently claimed that in order to get out of the crisis we need to fix the banks and to increase public spending primarily on long-term infrastructure projects.

Markets fear that ECB is running out of ammo. Markets may be right. Markets, however, forget that it is not the responsibility of central banks to push the economy. Politicians must create  fiscal policies that will resolve this crisis. And the Germans have long time ago won a complete victory in pressurising other EU countries to not do what is needed. ECB is put in an uncomfortable position because of a wrong fiscal policy.

When it comes to fixing the banks, this is not the time to be moralists. The Euro-TARP is still needed after 8 years of crisis.

Think about this one: what happens to  banks all over Europe as long as they are afraid of charging clients negative interest rates? Well, they lose money on simple deposits. Certainly, it does not provide an incentive to lend.