Monday 19 June 2017

Tory election campaign failed not only politically but also from an economic perspective

The reasons for the failure of the Tory election campaign have been well rehearsed. They include the decision to make PM Theresa May the focus of their campaign while stressing the need for "strong and stable" government against the incompetence and extreme policies of Corbyn. But May lacks charisma, is unable to think on her feet and does not have a common touch. And the strong and stable mantra was an insult to the electorate's intelligence.  In contrast Corbyn was grossly underestimated as it was forgotten he is a veteran campaigner and was very comfortable in the election campaign and able to convince a  very impressionable younger generation of his supposed sincerity and caring for the poor.

This was reinforced by the respective manifestos, with the Tories being too honest of the challenges ahead but also failing politically to realise the electorate has had enough of austerity and desperately wanted change. They also failed to mention the need for social justice that May had dwelt on when elected Conservative Party leader. In contrast Labour judged the mood of the country better and got its populist, anti-austerity and generally more optimistic message over better  - through social media in particular - that there was a way forward even if their sums did not add up. On top of this the reversal of the so called dementia tax did nothing for the Tories strong and stable message. Finally, Labour managed to sideline the issue of Brexit, the original reason for the calling of yet another election.

But the Tory manifesto also failed from an economic perspective. While the Tories were honest in acknowledging some of the key economic challenges ahead such as the need to tackle social care, the need to deal with an aging population and also to promote fairer intergenerational equity (see blog 22 October) it failed overall by not fully abandoning austerity (despite recent loosening of balanced budget targets) and promoting a fiscal stimulus.

In a previous blog on 10 October I talked about monetary policy having been overworked, of low interest rates providing the opportunity for fiscal stimulus and the positive side effect of increased government spending on aiding redistribution of income. It would also raise growth at a time when GDP growth is finally slowing without the risk of the economy "overheating", and by prioritising infrastructure spending boost the supply side of the economy and raise very low productivity growth.

International financial market developments are also very supportive of a good old-fashioned Keynesian stimulus. Global bond yields have dipped again leaving real bond yields of advanced countries in the US, UK, Eurozone and Japan low or even negative. The reason for this is attributed to the so-called "safe asset shortage". The idea is that there is a large excess global demand for safe, liquid and highly tradeable government debt for whatever reason. It is thus argued these countries can raise spending without pushing up their own government bond yields rapidly, a sort of " free lunch". Eventually though yields will creep up not least because the shortage will erode as bonds issued rise to fund higher budget deficits.

Another factor in weakening the case for continued austerity is the demolishing of the now-infamous 2010 economic paper 'Growth in a Time of Debt" by Reinhardt and Rogoff. It claimed that a 90% government debt to GDP ratio is a critical threshold at which a fiscal crisis like seen in Greece could occur. But the data was proven to be flawed and most now argue that Greece is a special case among advanced countries.

With a number of years fiscal austerity, front-loaded into the 2009-2011 period, the fiscal deficit was brought down to around a third of what it was in 2009 so that it stands today at some 3.5% of GDP.  This has greatly boosted policy credibility and given the scope for significant fiscal easing without the need to raise taxes and so able to take advantage of favourable market trends. This may not last and certainly the UK must be cautious not to raise spending too rapidly or much on current spending which could damage credibility. It should be noted that the UK has not run a surplus since 2001 and it is much easier to raise spending than cut it. Remember also that the UK's debt to GDP ratio is still rising and approaching 90%, notwithstanding the improved debt maturity profile. While there are signs that the global economy is picking up, the next crisis or downturn may not be far away. For the UK the concern is the uncertainty of Brexit. However, for the UK and other advanced countries fiscal stimulus will give more scope to raise interest rates which will give space to cut rates in the next downturn.

So there is both an economic and political case for fiscal stimulus in the UK.









Wednesday 17 May 2017

Economic madness to vote Labour

Only someone who is economically illiterate ( sadly the vast majority of the electorate) or supports the Marxist cause would rationally vote Labour these days. The release of the Labour manifesto for the general election on June 8th would take us back to the 1970s with hyperinflation, mass unemployment, regular strikes, an escalating debt burden, high interest rates and low or negative growth. In fact it would be worse than then. A fully fledged socialist agenda would be worse now in this globalised world when capital and labour can move where it wants. We saw in France, for example, how Hollande had to abandon his Socialist policies repeating Mitterand's mistakes in the 1980s.

One of Labour's most popular policies would be a massive increase in spending on the NHS. Forgetting this is not necessarily the solution to its problems, the sad fact is there would not be the money available in all but the short-term.  Sadly this commitment along with extra spending elsewhere totalling nearly £50bn will not be matched by the increased revenues. As I have said many times, and is corroborated by the highly respected and independent Institute for Fiscal Studies, tax increases from corporation tax and on personal incomes on those earning over £80k will yield very little in the short-term and probably a negative amount over the medium-term. Both capital and labour is ever more internationally mobile and will go to where these rates are lowest. It may have escaped you for example that corporation tax revenues have rocketed in the UK recently despite the tax rate falling.

On top of this, the manifesto confirmed that a Labour government would renationalise the railways, the Royal Mail and the National Grid and even Water, undoubtedly a superficially attractive policy given the various problems and issues there have been in these sectors.  This is despite the overwhelming evidence that nationalisation is far inferior to privatisation. The answer is clearly better regulation. Such a renationalisation plan would be a massive undertaking akin to implementing Brexit. The biggest concern however would be how it would be funded. It seems by borrowing! This would only add to the national debt and result in massive increases in interest payments (and less money for public spending)  and a  'crowding out' of private investment through higher interest rates. Such tax, spend and borrowing policies would be especially bad as we leave the EU and need to boost our competitiveness.

The polls may well narrow as some of the electorate become seduced by some of these unaffordable policies, especially among the idealistic young that do not remember the 1970s. But while Corbyn managed by an abused election system to become leader of the Labour party, he is very unlikely to become PM. The issue of his lack of competence  and of his senior shadow cabinet has been there for all to see in this election so far. Related to this too is the lack of economic credibility that has been built up from the disastrous spending policies - but far more modest than is planned now - of the Blair/Brown government years that was the underlying cause of the bad public finances that the coalition government inherited. And if this is not enough, Corbyn's ambivalence on use of Trident even though he would spend the money on renewing leaves grave doubts of his suitability for the top job. The electorate votes typically on the relative suitability of a party leader to be PM and on its party's economic credibility. It is no contest.




Thursday 23 February 2017

Brexit and financial services

There is no sector more important to the prosperity of the UK economy than the financial services sector. Together with related professional services like legal, accountancy and management consultancy, the sector accounts for 12% of UK GDP and employs 2.2 million people. It also accounts for some £67bn or 11% of total government revenues, and generates £77bn in net exports - making UK the world's largest net exporter of financial services.

The realisation that the government is pursuing a hard or as I prefer to call it clean Brexit that involves the UK leaving the single market (and customs union) has raised fears that financial services will be severely damaged especially if also there are no transitional arrangements.

But it may surprise many to know that there is no single market for services and certainly not in financial services. There is no single banking market, no single insurance market, no unified capital market, and no European stock exchange.

The issue of passporting has received a lot of publicity when discussing financial services post-Brexit. Passporting was designed to overcome the lack of a single financial services market by allowing a financial institution authorised in one EU member state to market financial products in other EU countries. It is open to non-members states too in theory at least, and after Brexit, UK and UK-based banks and finance companies would be free to set up subsidiaries (if they have not done so already) in the EU to trade throughout, though the presence would have to be meaningful, something to be debated. Another route to maintaining business in London will be so-called "equivalence" of regulation. This will be useful for the City in any transitional arrangements agreed, though I do think we should not be tied to this in the longer run, particularly as we will have no say on the regulations, and also that we will likely go down the path of greater deregulation.

Even under this passporting system, retail financial services remain virtually entirely national and heavily protected. So leaving the EU will have no impact here for the UK. With respect to the wholesale sector, banks do not need a passport to access the City's foreign exchange market or it's interbank market, while companies can buy reinsurance at Lloyd's or do business with corporate financiers in London. It has been estimated that just 20% to 25% of wholesale business is related to the EU and only part of that is facilitated by passporting.

So what about the issue of the settlement and clearing of euro-denominated instruments I here you ask? The trading of such business would stay in London, as this is where the liquidity and infrastructure is. Europe is just not a credible competitor. But the eurozone has long coveted the euro-denominated clearing business which - along with non-euro clearing - is dominated by the LCH clearing house in London. The European Central Bank previously attempted to take such activity back in a failed landmark legal case in 2015. But there are now potentially renewed attempts to do so. Yet there are real dangers to moving the business within the eurozone. Many experts have noted a forced repatriation of the clearing would increase systemic risk and substantially increase the costs of clearing.  Economies of scale allow for so-called "netting", a process that reduces margins. Also such denying of London the right to clear euros would have to be applied globally, but this would likely lead to retaliation especially from the US.

Despite the jostling among European cities including Paris, Frankfurt, Berlin, Luxembourg and Dublin, there is no real rival in Europe to London as a global financial centre. It's dominance is only threatened by New York as one can see in more detail From Z/Yen's excellent Global Financial Centres Index report. London is supported by its expertise and knowledge in financial services and key support services such as Law and accountancy; by the use of the dominant English language and the attractions of living in a vibrant and exciting city; by its infrastructure; by low taxation; and the sheer size, depth and liquidity of its financial markets. The biggest challenge remains from New York which is supported by a larger domestic economy, and could get a boost from new US President Trump's plans for greater deregulation including getting rid of Dodd-Frank which was imposed seven years ago, and by lower taxes.

There is a growing realisation in some quarters of the continent that trying to hurt the only large financial centre in Europe will damage the EU perhaps as much as the UK. Germany's finance minister Schauble warned against punishing the UK generally not least because of the unrivalled London financial centre. A leaked European report warned that failing to protect the City would indeed hit Europe's economy.

The City of London is very resilient, agile and great at adapting. It survived the 1930s and two world wars. It prospered after Big Bang and was unaffected by the UK's decision to not join the Euro, becoming the undisputed financial centre of Europe despite the fears of many. I remain optimistic even if the EU does its best to undermine it, that the City will remain pre-eminent being highly innovative and doing what is necessary to retain its competitiveness perhaps through lighter regulation and lower business taxation. It can escape EU regulation on Bankers' bonus caps and the financial transactions tax and perhaps impose lower capital buffers. It will be important however to remain open and in particular retain full access to talent overseas which has been acknowledged by the government, with even the Labour opposition realising this with its purported plans to introduce regional immigration plans.

There will certainly be some shifting of business but it will be on a small scale compared with the impact of other developments and evolving new areas of business and new products eg renminbi-related products or in the already thriving fintech (financial technology and innovation) industry.  London will remain one of the two global financial centres.




Thursday 2 February 2017

UK economic growth prospects rosy in the short-term and in the long-term

Late last year I wrote that UK GDP would grow by nearly 2% a figure that compared with a consensus of some 1.2% then and as of yesterday about 1.3%. My optimism surprised many. Today I am a little nervous as the notoriously inaccurate/pessimistic Bank of England revised up its forecast to 2% also, having forecast it at 1.4% in November and just 0.8% in August. Who knows they might even hike it back to the pre-referendum forecast for 2017 to 2.3%! And now watch the consensus forecast rise too because of the classic group mentality.

My own optimism that growth would barely slow if at all in 2017 was based on a number of factors:

Firstly, consumer spending will undoubtedly slow somewhat as a result of the squeeze in real personal disposable incomes from higher inflation via a weaker exchange rate but not as much as expected. Consumers not surprisingly remain pretty confident in this new pre-Brexit world and continue to spend as we have seen from Q4 data. Expect consumer borrowing to rise and the savings ratio to fall back even more, while unemployment will remain close to current lows, facilitating a rise in consumer spending close to 2% from 2.8% last year.

Secondly expect the weaker pound to have a significant impact in raising net exports. Competitive devaluation can still be effective in driving export volumes up and I believe we can see the same positive impact as in 1991. This is likely to be reinforced as a result of only a weak upturn in inflation here and a pick up in global growth. Indeed business surveys have reported strengthening export order books.

Thirdly the drag from a tight fiscal stance was eased a little in the Autumn Statement which loosened the fiscal rules. We are seeing a modest increase in infrastructural investment spending.

Fourthly,  the monetary policy stance will remain easy with base rates unlikely to be raised from their ultra low 0.25% anytime soon. The Bank is likely to remain wary of going too soon in hiking rates fearful of the consequences, and is reinforced by its relaxed views about inflation, particularly with respect to any feed-through into wages or inflation expectations.

Finally, the economy had a strong growth momentum going into 2017 with Q4 GDP up a preliminary 0.6% y/y. Simple base effects will leave average growth higher this year than if we had seen a slowdown as others expected for H2 2016.

In a future blog I will look at our longer term growth prospects which I believe are good.