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Why more QE is the wrong policy option for the UK ...

The UK is in a liquidity trap, a situation where monetary policy is unable to stimulate the economy either through lowering of interest rates or increasing money supply.  Liquidity traps occur when rates are reduced to the zero bound or thereabouts and cannot be reduced further. In real terms UK rates (base rate minus inflation) are negative 4%.

The liquidity trap is compounded when expectations of adverse events, either deflation or in the current situation, a lack of aggregate demand, are manifest. Firms are loathe to invest, households are constrained to spend, government spending is limited by a desire to resolve the debt crisis. 

The first round of Quantatitive Easing was essential to improve liquidity in the banking system at a time of crisis. Inter bank lending was dessicated, LIBOR spreads were extending. The central bank was becoming not just the last lendor of resort but the only lender of resort. Action had to be taken to inject cash into the economy by undertaking a series of asset purchases predominantly gilts. The programme of some £200 billion almost 14% of GDP had to be done.

This is not an argument for more asset purchases, for the exercise came at a price. QE forces up bond prices, pushes yields lower, punishes savers, places more pressure on sterling, increases import prices, leads to higher inflation, greater pressure on real incomes, a reduction in household spending, reduces demand and leads to lower growth.

Ten year gilt yields have fallen to 2.4% and thirty year gilt yields have fallen to 3.5%. Policy makers assume that lower interest rates at the longer end of the curve will lead to a higher level of investment. This is not the case. Any return on investment or payback calculation is a function of cash flows from a determined demand horizon. Cost of capital does not feature in the basic model. Until the uncertainty about the forward level of demand and growth is cleared, investment plans will remain on the shelf. 

In 2008, I wrote :  Welcome to planet ZIRP. Unfortunately, we do not have a handbook, or fully understand the terrain. Our process of quantative easing, the plan to helicopter money may work but as a fire fighting option, it may be like dropping water into a desert, such are the fissures in the financial system."

In 2004 a Bernanke paper  “Monetary Policy Alternatives at the zero bound” concluded :

“Despite our evidence that alternative policy measures [QE} have some effect, we remain cautious about relying on such approaches. We believe that our findings go some way to refuting the strong hypothesis that nonstandard policy actions, including quantitative easing and targeted asset purchases, cannot be successful in a modern industrial economy.  The effects of such policies remain quantitatively quite uncertain”.

The Bank of England suggests that QE increased GDP by between 1.5% - 2.0% but also led to an increase in inflation of between 0.75% and 1.5%. Joyce M et al in the September Bank of England Quarterly Bulletin.

A QE2 round of £50 billion would kick growth by just 0.4% and inflation by over 1% on a pro rata basis according to the banks own figures.

One cannot be entirely confident in the bank’s hypothesis. QE led to a fall in gilt yields as a first round effect but thereafter the relationship betwen QE and the effect on growth and inflation is tenuous. The argument for further QE is intellectually weak and at best the potential economic impact minimal. The risks outweigh the return.

In fact we would argue that a further round of asset purchases would merely oil the liquidity trap, digging a deeper hole, increasing the inflationary impact and reducing growth as investment plans are reigned back and household incomes are placed under greater strain. Sometimes the correct action is to do nothing, especially when it is more of the same toxic solution. 

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

UK Economics : Is the march of the makers, a case of lions led by donkeys?

"Lions led by donkeys" is a phrase used to describe the British Infantry of the First World War and to condemn the generals who commanded them. The contention is that brave soldiers (lions) were sent to their deaths by incompetent and indifferent leaders (donkeys).

"The English Generals are wanting in strategy. We should have no chance if they possessed as much science as their officers and men had of courage and bravery. They are lions led by donkeys." According to the German Command Headquarters.

Strategy in business and in war is key. Which battles at which time, with what resource. SWOT profiling, constant benchmarking is key to success. Understanding this makes it more difficult to understand the present coalition strategy in expecting so much of the manufacturing sector and denying the contribution of the business, financial and professional services sector, especially banking,  to the British Economy

The march of the makers, rebuilding the workshop of the world to finance the big society is  a battlefield folly. The march is faltering, the trade deficit continues to expand. The analysis of forty years of UK trade amply demonstrates the UK needs a strong service sector to finance the trade in goods deficit.

According to a recent paper by Yiping Huang and Bijun Wang, 2011 China’s manufacturing sector accounts for 41% of output compared to just 12% in the UK. With a world average of 13% China’s relative share is 3.2 compared to the UK’s 0.9. That’s tough competition.

China’s revealed comparative advantage for manufactures is 1.13 compared to the UK’s 0.79. A larger competitor, tough competition, with a significantly higher competitive advantage will provide a difficult challenge.

In financial services, the reverse is true, China’s revealed competitive advantage is 0.03, compared to the UK’s 3.01. The world average is just 0.5. The UK is the strongest player in the world of exports in financial services with the highest revealed comparative advantage. So why not promote and support the sector instead of suggesting an evil imbalance exists within the economy?

Why place so much hope in an ill equipped manufacturing sector in trend decline long before Gandhi promoted homespun? The renaissance just will not happen. Play to your strengths may sound facile in terms of strategy but it should be something even donkeys can grasp.

Notes
The revealed comparative advantage was first proposed by Balassa (1965).The comparative advantage of a country's industry could be revealed by the ratio of the share of an export sector's exports in total exports to that share  for the world. Balasa, Bela 1965 Trade Liberalisation and revealed comparative advantage" Manchester School of Economic and Social Studies Bulletin Vol 33 No 2 pp 99 - 117

Yiping Huang, Bijun Wang Chinese Outward Investment: Is there a China Model. China & World Economy Volume 19 No 4 Jul - Aug 2011

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

UK retail Sales June - slow death on the high street

The ONS released the sales figures for June on Thursday, retail values were up by 4% compared to June last year but underlying volumes were up by 0.4%. For the second quarter sales were flat at 0.3%. No wonder the sales signs are out all over the high street. A combination of high inflation, the VAT rise, real income falls, higher energy, utility bills and food costs are hitting consumers and retailers badly. 

Household goods store volumes were down by 3.7% but non store retail sales particularly on line internet sales were up by 24%. Retail is facing a “disruptive” challenge from the swing to more “clicks than bricks” in consumer buying patterns. Internet retail sales volumes accounted 9.9% of all transactions compared to 6.8% in June last year. 

What is happening to food retailing? Volumes were down by over 4.2% in the month (See inset). This has been a trend over the last two years. Either we are becoming a nation of slimmers are a greater and greater proportion of conventional food retailing is moving on line.

In the second half of the year, it is difficult to see why retail fortunes should change. It’s tough on the high street and it looks like this could continue for the rest of the year. Christmas cannot come early enough. For many, it will be too late.

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

Public Sector Borrowing in June - are we heading back to the brink of bankruptcy?

Public Sector Finance figures for June were released on Thursday, borrowing was actually up compared to June last year, are we heading back to the brink of bankruptcy? The Chancellor of the Exchequer was keen to herald the austerity measures as a move back from the brink of bankruptcy following the Labour profligate years. But are the figures really moving in the right direction? 

In the first three months of the year, borrowing was down by just £0.4 billion from £39.5 billion to £39.2billion. Extrapolate this for the year and the borrowing forecast would struggle to drop below £140 billion for the financial year. This would equate to 9% of GDP and well above the OBR forecast for the year.

 

The problem is that despite the austerity measures, total receipts have increased by  4.6% but spending over the first three months of the year has increased by 3.4%. The interest bill in the first quarter is up by 14% and social security payments are up by nearly 5%. Reducing spending in a low growth economy presents significant difficulty.

 

Revenues present a mixed picture. Mugging the high street with the VAT rise has yielded spectacular results with receipts up by 17% in the first three months adding £4 billion into the coffers. VAT receipts could contribute an additional £20 billion in a full year if the rate of gain continues. Income and capital gains receipts on the other hand are up by less than 2% at 0.5 billion and taxes on production are up by less than 3% at £1.4 billion,

 

At first glance the figures are a Keynesian delight. Rebalancing the economy by cutting spending and increasing taxes will result in low growth economy with resilient spending and sluggish revenues. It is difficult to balance the books when breaking the backbone of recovery. 

 

The Office for budget responsibility offers some hope by pointing out that revenues last year included £3.5 billion from the bank payroll tax which was not repeated last year. If this element is excluded revenues are up by 8% and “close to our full year forecast”. Sounds better but the BPT is not a surprise item and hardly a credible apologia.

 

Next week the GDP estimates for the second quarter will be released. They will make dismal reading with growth year on year likely to be less than 1%. The economy is slowing, the public finances are not recovering as planned, essential imports continue, there is no net export growth, no march of the makers, no rebalancing of the economy, we are a few steps further away from the brink of bankruptcy but the precipice is still in sight. 

 

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

UK inflation falls to 4.2% CPI basis, CPI-MK is on track

The rate of UK inflation fell from 4.5% in May to 4.2% in June according to latest ONS data. Despite a significant rise in food prices and transport costs. Recreation and culture prices fell to produce an overall slowdown in the headline rate by 30 points. RPI and RPIX inflation indices were up 5% year on year. Goods and service sector inflation were in line with the overall rate at 4.2%. 

A closer look at the sectors suggests the inflation watch is not yet over. Food inflation was up by 6.9%, alcohol and tobacco increased by 9.6%, transport costs were up by 7.9% restaurants, hotels and even household goods and services were up by 4.5%.

The biggest impact to the lower rate was the recreation and culture sector. Games, toys and hobbies, computer games, consoles, digital cameras, TVs and other electricals were the main contributors to a lower rate of inflation. 

As if three inflation indices were not enough to provide some confusion CPI-Y and CPI-CT also slowed. Only CPI-MK, the Governor’s favored measure of inflation remained constant and on target at 2%. 

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

UK Trade deficit : Jabberwocks, Jormungands and J Curves - but no march of the makers

This week the ONS released the UK trade data for May. So much for rebalancing the economy towards export led growth. The seasonally adjusted deficit in goods was £8.5 billion in May compared to 7.6 billion in the prior month. For the second quarter as a whole, the deficit is likely to be £23.6 billion compared to £22.2 billion in the first quarter and £23.1 billion in the second quarter last year.  

The trade situation is not getting any better. This is a further blow to lovers of devaluation and the J curve everywhere. Florence Nightingale would say of hospitals, the first requirement is they should do the sick no harm. The same should be demanded of economists in relation to the economy.

If devaluation were a cure for the ills of the British Economy, the UK would be one of the strongest economies in the world. There appears to be some thought than a further round of depreciation is required to resolve the trade imbalance. Heaven forbid, it would be to push the infant deeper in a desire to induce a swimming motion. 

Earlier this year, the agents of the Bank of England were despatched to the four quarters of the UK to understand why, despite the weakness of sterling, there had not been a resurgence of manufacturing, especially export led manufacturing to resolve the trade imbalance. No copper in Cornwall, no tires in Wolverhampton, no jabberwocks, jormungands nor J curves.  

Several months ago I held a long week -end e-debate with David Smith about this very subject. DS was gradually (but not completely) losing faith that weaker sterling would induce a trade miracle. Still waiting for the J curve to effect, like a Saturday night drunk waiting for the last bus long after mid night. Sometimes waiting is better the alternative reality ie the inevitable walk. In relation to trade, the reality is the J curve belongs in the dustbin of economic thought along with the march of the makers, gapology and inflation theory. 

There is no march of the makers, there is no export led growth, there will be no rebalancing of the economy unless more is done to stimulate banking, financial and professional services growth instead of driving service sector earners off shore. It is time to accept as far as a manufacturing resurgence is concerned, the last bus has long gone.

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

UK GDP - is there something horrible in the unemployment figures?

The labour market statistics were released on Wednesday. At first glance, the trends are in the right direction. The number of unemployed people fell by 26,000 over the three months to May to a level of 2.45 million. The unemployment rate was 7.7%. The number of unemployed for over one year fell by 37,000 to a level of 807,000. The economy continues to recover albeit more slowly.

The claimant count on the other hand increased by 24.5 thousand to a level of 1.52 million. In fact the claimant count has been increasing for the past four months. How can the unemployment figures be falling as the claimant count is rising? It is becoming increasingly difficult to read the data. 

The official explanation is the two datasets measure different things at different times. In addition, the Government is moving thousands of single mothers off income support onto unemployment benefit. The switch is causing the number of people on the dole to rise dramatically.

The claimant count remains a valuable indicator of the health of the economy. It is a coincident indicator. It used to be considered a lagging indicator, as layoffs reacted to a downturn in the economy. In fact chart 2 suggests it has become more of a leading indicator giving a clear indication of where the economy is heading. Claimant count lead the down turn in the GDP figures in 2008 and foretold of the recovery in 2009. It also warned of the slow down in the second half of 2010.

The message from the latest data is very worrying, growth year on year could be at best flat or even negative in the second quarter. The latest NIESR estimate suggests growth on the second quarter is just 0.8% year on year.  This looks to be too optimistic. The preliminary estimate of GDP is released later this month. It could look horrible. Our forecast for growth in the year will be downgraded yet again in the Q3 review. There may be no rush to put up interest rates this year. Real incomes are under severe pressure. Is government policy grinding growth out.

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

Producer Prices rise by 5.7%, input prices rise by 17%, it’s another blow to gapology

Producer output prices increased by 5.7% in June compared to 5.4% in the prior month. This is almost three times the CPI target rate and a further blow to gapologists everywhere. Economics is often beset by fashion and more beleagured by dogma. Inflation theory is no exception. In 1970 Milton Friedman would have us believe that inflation is always and everywhere a monetary phenomenon. The oil price rise of 1973 sort of downed the MF helicopter. 

In the early 1980’s, Lawson and others had us believe that government borrowing led to an increase in M3 and M4 money supply directly impacting on the inflation rate, a rational justification for dramatic spending cuts. I could never get by head round that and struggled with a paper on the subject for weeks.

In the mid eighties, the Bank of England believed that interest rates had no direct impact on consumer spending, the “monetary mechanism impacted on the economy via the investment cycle.” The problem was the BOE models had not adjusted to the Thatcher generation of mortgage laden home owners. An increase in interest rates was as as subtle as a pickpocket lifting the wallets of the vulnerable home owners.

In the early 1990s the relationship between the output gap and inflation rate was flagged by Goldman Sachs. It isn’t that GS have the best economists, they are just better at marketing them. For several blissful years, the relationship held, then started to break down. Apologists tried to explain the failure by “loss of capacity in the downturn”, the debate for me has long been exhausted and futile. It really is time to move on. Service sector economies don’t really have limits to capacity.

So back to the produce prices data for June. The headline rate hit 5.7% driven by increases in petroleum prices (16.5%), food (8.9%) and chemicals. The headline rate for input prices hit 17% with staggering increases in oil (40%), metals, (18%) chemicals (13%)  and food (13%). 

Input and output prices are coincidental and highly correlated (.851) with some evidence of a one month lag to impact (.854). They are also highly volatile and vulnerable to oil price shocks as the spike in 2008 attests. The Bank of England believe the spike in commodity prices will pass and inflation will return to target in the due course of time. 

The MPC are beginning to look like a bunch of economists huddled in a storm shelter in Kansas hoping the tornado will pass by. It really is time to face the storm. In 2008, oil prices were driven higher by speculative trading and large derivative positions. The subsequent fall, reflected the closing of short positions pushing oil underground to $40 a barrel. The trend is for higher and higher prices as the high growth nations and China in particular places great demands on finite resources. Gapology is dead and monetary policy needs to reflect that. The increase in output prices to almost 6% with a trend output gap of the same dimension should be adequate evidence.

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.

 

Groupon IPO - things going well - send more money - the burn rate is back.

“The Groupon IPO filing is out, and, as expected, it’s hugely entertaining. The risks section alone is more than 13,000 words, or around the length of a decent-sized novella” says Paul Kedrosky, blogging with Bloomberg this week. He even encloses a word cloud of the risks section. 

The filing is worth a read. It begins with a caveat : “If we fail to retain our existing subscribers or acquire new subscribers, our revenue and business will be harmed.”

You can see the problem. Groupon lost $389.6 million in 2010 on revenues of $713.4 million. In the first quarter of 2011, revenues had soared to $645 million but the losses were over $100 million. The marketing spend in the first three months was $400m that’s around 60% of revenues. With a gross margin of 40%, it creates something of a problem for the bottom line. The accumulated deficit was $522.1 million as of March 31, 2011. 

Revenues have increased from $30 million in 2009 to $713 million in 2010 and in 2011 could hit $2.5 billion (pro rata basis). Subscribers have increased from 50 million in 2010 to 80.1 million in the first quarter of 2011. 

The company turned down a $6bn approach from Google in December. There was speculation earlier this year that Groupon could raise as much as $1bn in an IPO, which could value the daily deals site at between $15bn and $20bn.

The value is in the database of 100 million plus subscribers which should be achieved this year. The issue is the sustainability of the model once the cost of acquisition or transaction is trimmed. The average subscriber revenue in 2010 was $14.10 and in the first quarter of 2011 was $7.75. The acquisition and marketing cost per subscriber was $8.64 in 2010 and $4.83 in the first three months of 2011.

The chart illustrates the revenues per subscriber in Chicago, Boston and London. The trend is to just over $12 over time. It is a huge churn of a low average subscriber value and an average transaction value of $22.00.

As a chief exec of a large organisation, the one message from the front line we used to dread was “Things going well send more money.” The dot.com boom has been and gone but the “burn rate” is back.

The risks are weighty and fully explained in the 13,000 word risk section.

"We anticipate that our operating expenses will increase substantially in the foreseeable future as we continue to invest to increase our subscriber base, increase the number and variety of deals we offer each day, expand our marketing channels, expand our operations, hire additional employees and develop our technology platform."

"These efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenue sufficiently to offset these higher expenses. Many of our efforts to generate revenue from our business are new and unproven, and any failure to increase our revenue could prevent us from attaining or increasing profitability." 

"We cannot be certain that we will be able to attain or increase profitability on a quarterly or annual basis. If we are unable to effectively manage these risks and difficulties as we encounter them, our business, financial condition and results of operations may suffer.................." You have been warned.

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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.