jka on economics UK

Why is the Euro so strong, given problems with the Olive branch?

Planning a trip to France or Spain this Summer? Ever wondered why the Euro is so strong against Sterling. With a spot rate around 1.12, one hundred pounds would buy around one hundred and five euros. Living on a fixed pension in Spain, the weakness represents a drop in income of thirty six per cent over ten years. Why is Sterling so weak against the Euro?

According to some the Euro is near collapse with reluctant Franco German support for the Olive branch of the Euro. The currency caution is “Beware of Greeks needing bailouts”, for they will soon be followed by the others in the PIG pen. Portugal, Italy, Greece, Spain are queuing at the trough, the system will collapse say some. From a macro economic and political risk perspective, a strong Euro doesn’t make sense. 

Monetary considerations offer some support given the interest rate disparity between the 50 basis points available in London compared to the 50 basis points deposit facility and a 1.25% available for main refinancing operations available in Euroland. Think of the 2% marginal lending facility from the middle of April and the capital pull makes some sense. 

But the fall in Sterling began long before the interest rate spreads opened up. The Sterling effective exchange rate has fallen by almost 25% since 2008. Examine the charts and the fall in Sterling is not universal. A cable rate (Dollar Sterling) of 1.62 isn’t that bad in 2011. It was actually 1.60 eleven years ago. 

A rate of 1.12 against the Euro is really mis priced. The problem is not Sterling against the Euro, it is the Euro rate against the Dollar. Compare the weakness of the Dollar. It has fallen from 1.18 to around 0.70. A decline of forty per cent. Against the yen, the fall has been almost sixty per cent.  

To understand, look back, in history to the dilemma of the Bank of France at the end of the 1920s. This was the “end of era” phase of Sterling as the world reserve and the last flap for Gold. France with significant sterling holdings had to divest but in a way which didn’t overly damage the exit price. 

Consider China with some $3 trillion of reserves. The Middle Kingdom has to diversify away from the imperilled dollar. The dollar is an end of era reserve currency. Hence the quest for a hybrid option in Special Drawing Rights, SDRs or a return of Keynesian Bancor from the Asean block.

It is estimated that already over 20% of China’s reserves are in the Euro. China has built the longest bridge in the world, not the Qingdao bridge, [pictured] but the financial bridge from Beijing to Berlin. China needs a strong Euro to delay the day when the renmimbi will rule. Hence the offer from Chinese premier Wen Jiabao to buy Euro bonds and landmarks in Greece. Parthenon not the Pound.

The strength of the Euro is a challenge to holiday makers, but it is the weakness of the dollar which is the challenge to policy makers. It is the strength of the Asian economies and China specifically that pose the real policy dilemma for the UK. A sterling recovery may take longer than we think. 

An extract from China - Return of the Middle Kingdom - The impact of China on the world economy. John Ashcroft 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.

 

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.

Rebalancing the UK economy is incoherent mishmash verging on codswallop says Tyrie

Incoherent “mish mash” verging on “codswallop” is how plans to rebalance the economy have been described by Andrew Tyrie, Chairman of the Commons Treasury Select committee according to an article in the Financial Times on Bank Holiday Monday.  “I don’t think ministers have used the term with sufficient precision” said the no nonsense MP for Chichester. I like Andrew Tyrie, he gained a formidable reputation following his aggressive cross-questioning of the bank bosses during the banking crisis and has twice been voted The Spectator’s back bencher of the year.

We used video clips of Andrew at the pro.manchester Business Conference in March and hope to have the real version with us next year.  “Rebalancing” has entered the lexicon of the coalition along with the “Big Society”. Margaret Thatcher, famously denounced the existence of society of any dimension, it would be interesting to note what the Baroness would make of this novel trope. As for “rebalancing” the economy and the “march of the makers”, this really is rhetoric from the debating room rather than a policy for action.

Roger Bootle of Capital Economics has suggested that rebalancing was acceptable rhetoric, “The idea of lifting manufacturing from under 12% of the economy to 15% in a few years was “plausible”. Blimey, that’s a 30% increase in output from a sector which is still recovering from a near 20% down turn during the recession.

As for march of the makers the government places great emphasis on the Dyson ‘Ingenious Britain’ report, this from a man who famously marched all of his makers to Asia to minimise production costs. 

In 1970, manufacturing accounted for almost 30% of UK GDP. It was the year in which I graduated from LSE and joined almost one hundred graduates on an eighteen month management training scheme with Tube Investments, one of the largest manufacturing conglomerates in the UK. 

The initial three months were spent at Oldbury Technical College in the West Midlands. We did welding, metal work, patent making and casting as well as a stream of management training classes. Each week, we would visit a company within the group, British Aluminium, Bacofoil, Raleigh Bicycles, Creda cookers, Stainless Steel manufacturers, Exhaust manufacturers, tube makers. There can be nothing more dramatic than the Pilger process, aluminium extrusion or steel production to impress a social scientist graduate.

One of the highlights of the three months was a visit to Round Oak Steel works, where we did see steel being poured in what is now probably the lingerie section of Marks and Spencers in the Merry Hill Shopping centre. So many of the Tube Investment names and processes have disappeared from the UK.

Manufacturing now accounts for around 11% of output compared to almost 30% in 1970. Manufacturing is experiencing above trend growth as it always does at this stage in the cycle. It’s like falling off a cliff and recovering from a coma, a recovery of sorts but still a long way off the top. An industry struggling to find its feet again is a rebalancing of sorts, but it is more like a prize fighter staggering to his feet after a near knock out punch. It is rebalancing George but not as you mean it.  That's verging on codswallop.

Financial Times : UK Economy Plans branded incoherent 30th June 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.

Will UK inflation (4.5%) be back to target before the Governor of the Bank of England retires?

Mervyn King completes his second term as Governor of the Bank of England in June 2013. Will inflation be on track by then? It could be a close run thing? 

The inflation figures were released last week but I was a little preoccupied and didn’t get to pass comment at that time. Just as well because in the Sunday Times, an article on Andrew Sentance “The rate hawk who rocked the bank” featured a great mock up of Andrew, renowned guitarist and Led Zeppelin fanatic and the Governor of the Bank of England, on song lyrically if not in economics think. Too good to miss.

The photo can be discerned under the graph of the inflation chart, denoting the separation of goods inflation and service sector inflation. Service sector inflation has averaged 3.6% for almost twenty years and goods inflation has averaged 0.8%. This is why we are sceptical the inflation target will return to 2% in the medium term as the Bank and the OBR insist. 

So what of the inflation figures in April? They are pretty bad with inflation CPI basis at 4.5% up from 4% in March. RPI inflation was 5.2% and RPIX was 5.3%.

For those lovers of the inflation alphabet, CPI-Y and CPI-CT were also heading towards 3%. Only inflation CPI-MK and GPI-GOV (i.e. core inflation eliminating anything above and below the inflation target) is on track.

Earlier this month, the Bank were warned of the potential, if not imminent, risk of the loss of credibility if inflation continues to rise towards 5% CPI basis. To strip outliers and identify core inflation, as the Bank is wont to do, offers little consolation to motorists, filling the tank and housewives undertaking the weekly food shop. 

Biggest contributors to inflation in April were transport costs and alcohol and tobacco. Food, education, household services, restaurants and hotels were in line with the overall CPI figure. Service sector inflation was 4.9% and goods inflation was 3.9%. The ONS publish a figure for CPI inflation excluding, energy, food, alcohol and tobacco. Why? Even this figure was 3.7% almost twice the level of the target.

The Governor had to write another letter to the Chancellor of the Exchequer explaining that VAT, energy and import prices were the culprits in the inflation acceleration. All external to the control of the MPC. In the medium term within two to three years everything will be OK.  

As the letter said “The MPC expects inflation to fall back through 2012 and into 2013, by which time the chances of inflation being above or below the target were broadly balanced.”

Mervyn King completes his second term of office in June 2013. Will inflation be on track by the end of the second term? It could be a close run thing? 

Robert Plant, (vocalist and lyricist of Led Zeppelin) and the Governor were both born in 1948 and were both educated in the West Midlands. Plant was born in Kidderminster and The Governor was educated at Wolverhampton Grammar School. “When I was a kid, I used to hide behind a curtain at Christmas and pretend I was an economist” said Plant. [citation needed]. Things could have been so different. JKA 

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The views expressed are my own. 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 Manufacturing - no rebalancing, a hit and run victim regains consciousness

The  manufacturing figures for March were released this week. After growth of 6.6% in January and 5.0% in February manufacturing growth was just 2.7% in March. In the month, capital goods and engineering were up 7%, metal bashers were up by 4% but consumer durables were down by 3%. So is the manufacturing miracle over? What will happen to growth this year? 

During the course of the recession, manufacturing fell by 15% from peak to trough. The strong growth in the recovery is not unusual at this stage in the cycle. Manufacturing is some eight per cent higher than the low but still some 9% off the peak achieved in the first quarter of 2008.

The growth in manufacturing is not evidence or a “rebalancing” of the economy, it is more like evidence of a hit and run victim regaining consciousness. It’s a recovery not a manufacturing miracle.

JCB manufacturers of those lovely big yellow diggers, recently announced output increases from 36,000 units to 51,600 units, a recovery of over 40%. Great news but this still leaves output down by almost 30% from the 72,000 unit sales achieved at the peak. The JCB peak to trough fall was 50%.

On Wednesday, at a Business Briefing Session with Chris Barry and Business Desk, Fred Ellis of Storey Manufacturing, supplier of metal components to JCB and Caterpillar, explained that output had fallen by 75% during the slow down. Fred was still not sure how their company had survived at all. Quick response to shed staff with little bank debt undoubtedly helped.

JCB is responding to “booming markets” by expanding capacity in Brazil and India as the overseas recovery gains pace rather than adding capacity in the UK. 

At the Bank of England and the Treasury, talk continues of a manufacturing resurgence, export growth and a rebalancing of the economy. In a recent review the Bank of England Agents were dispatched around the country to explain why import growth remained so strong and why manufacturers were not responding to the weakness of Sterling by expanding capacity as their 1960 textbooks and economics models suggest. 

It is amazing to think, the Bank of England Agents were in operation when Rothschilds runners brought early news of the defeat of Napoleon. Now CNN, Sky and PMI Markit can do the job much more efficiently for Canary Wharf but not for Threadneedle Street apparently.

We expect manufacturing output to grow by 5% this year but this will still leave output down by 5% from the 2008 peak. This is not resurgence and it is not rebalancing in response to the devaluation of Sterling. Unless we are able to analyse what is happening realistically, we will never be able to shape policy effectively.

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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.

 

pro.manchester economics review Q2 - what colour are the eyes of a Yeti?

The pro.manchester economics review for the second quarter of 2011 is available on line. Rates are expected to remain on hold until the Autumn. The economy is expected to grow by 2% in 2011 but any base rate rise will be postponed into early Autumn. Growth will be a tough grind in 2011.

Through last year, I was suggesting that growth would be above trend, inflation would remain stubbornly high and interest rates would have to rise to offset the inflation threat and mitigate the impact of import prices, particularly dollar denominated commodity prices.

Since then, inflation has been well above target, commodity prices have been rising but the growth of the economy has been below trend. 

The preliminary estimate for growth in the first quarter of the year was 0.5% quarter on quarter and 1.8% year on year. This was just enough for Ed Balls to claim the economy is flat lining and and for George Osborne to hail growth of sorts. For the year as a whole, the economy is expected to grow by 1.7% according to consensus and our own forecast is revised down to 2.1% in this review. As for rates, the GDP figure will do little to convince the doves on the MPC to fly the Governors coop and vote for a rate rise. The earliest estimate is for a modest rate rise in the early Autumn.

The risks to the GDP figure are to the down side but the second quarter GDP growth will be of key concern. Capital Economics, NIESR and The Chamber of Commerce are flagging growth of just 1.4%.

A full copy of the pro.manchester economics review “Grinding Out Growth” is available as a free download. JKA

Check out : "What colour are the eyes of the Yeti? Trogs and the Yeti" page 20.

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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.

Apple Case Study - from the iPod to the iPad - iPad and the Androids, why the iPad will hold share

Apple has shipped some 20 million iPads in the first twelve months since launch to capture the first mover advantage in the tablet market. Already into the second generation iPad 2.0 the Apple mantra of constant improvement along the Key success factor (KSF) lines is evident. Smaller, faster, better battery life more facilities, more apps, the infinite loop of product development persists. Available in six models 16GB, 32Gb 64Gb wifi and wifi 3G, the price range is from $499 - $829. First mover advantage with Kaizen is a strong combination.

In 2010, Apple shipped 15 million iPads to register a market share close to ninety per cent of the tablet market. But the Androids are coming. Samsung Galaxy emerged as the first to make significant sales as total Android sales jumped to 2.0 million units in the final quarter of 2010. New products from ACER, Advent, and HTC will join forces with the Motorola Xoom and the Blackberry Playbook in 2011 to challenge the Apple hegemony.

Android devices captured 22 percent of global tablet shipments in the three months to Dec. 31, up from 2.3 percent in the preceding quarter according to Strategy Analytics,  the Boston-based researcher. The iPad accounted for 75 percent of shipments in the period, down from about 95 percent, it claimed.

The despatch statistics include pipeline sales rather than consumer purchases, so the estimates of market share flatter the Androids in the final quarter. Let’s not forget the early claims of 8% market share for the MS Zune in the iPod market on launch, quickly falling to 4% then 1%, three years post launch. 

Google gives away Android for free to boost revenue from services such as mobile advertising and expand the market for its search engine. A wider range of cheaper devices will probably erode the iPad’s market dominance, said Neil Mawston, director at Strategy Analytics.

However, we believe that Apple will sustain a 75% share of market over the medium term despite the Android challenge, following the iPod MP3 market share model. First mover with constant improvement is a powerful combination and Apple is never afraid of cannibalistion of own product sales in the process.

How big will the market be? iPad sales in the first quarter of the year fell to 4.7 million units in the first quarter of 2011 down from 7.3 million units in the Christmas quarter. Apple claims to have sold all they could get as supply restrictions failed to meet strong demand.  

Still Apple iPad sales in 2011 are likely to be between thirty to forty million units, with Android sales restricted to around ten million units. This would give total segment sales of forty to fifty million units and feed an Apple market share of 75% to 80%. 

In 2012, the market will increase to one hundred million units with the potential to double in the following year 2013 and double again by 2015. This would create a market worth well over $150 billion dollars retail by the close of the five year outlook. 

In 2011 Apple sales will soar to over $100 billion compared to $5 billion in 2001 the launch of the iPod. The potential prize with the emergence of the Tablet sector is huge and Apple is well placed to meet the challenge of the Androids. First Mover advantage, Kaizen and Key Success Factors the key. 

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Author of the Apple Case Study from the iPod to the iPad. Available as a FREE download here.

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. Author of the Apple Case Study from the iPod to the iPad part of which is published in Johnson Scholes Whittington Exploring Strategy 9th edition 2010.

Puzzles at the Bank of England as the economy doesn't fit the models

Writing in today’s Daily Telegraph Roger Bootle makes the point that economics is too important to be left in the care of academics. The emphasis on mathematics and econometrics at the expense of economic history and pragmatic interpretation of events is evident. 

“Pick up the leading journals today and even many economists cannot understand the titles, never mind the articles. Open the pages, littered with algebra, and you could be forgiven for thinking that you were looking at a musical score. The mathematicians have taken over.”

“Students of economics today are force-fed theoretical models of startling banality and irrelevance, leavened only by doses of econometric techniques of dubious validity and near-zero intellectual interest. Typically, they complete their course knowing nothing about the British economy and untrained in how to think.” 

I do like Roger Bootle. I once went on a course to understand GARCH modelling. This is a modelling technique involving Gaussian or general autoregressive conditional heteroskedasticity. I didn’t understand a word as the lecturer began to chalk obscure hieroglyphics onto a blackboard from 9:00 am in the morning. There were only six of us in the room and was feeling more than a little overwhelmed. As time moved on 11:30 in fact, the lecturer realised he had made a mistake in the chain process at around ten minutes passed ten and a full hour and ten minutes were wiped off the board. We broke for coffee and I didn’t go back. 

If you read the minutes of the Bank of England Monetary Policy committee for last month you begin to think that RB has a good point. The Bank of England is puzzled that theory isn’t working. A depreciation of sterling according should lead to an improvement in the Balance of Payments. Exports are cheaper and imports are more expensive. There should be a reduction in import volumes but the bank noted :

“It was puzzling that import growth had remained so robust, despite the substantial depreciation of sterling. It was possible that domestic substitutes for some imported goods and services were not available. It was also possible that UK firms in some industries lacked the plant or capacity to expand production rapidly in response to the past depreciation of sterling and it would take time for them to install it."

Hello! It’s a wake up call for the Bank of England. The Bank has over two hundred economists educated to Masters or PhD standard. They produce much research and analytical papers. Two of my favourites from last year are :

“How non Gaussian shocks affect risk premia in non-linear DSGE models”. (No. 417) and “An efficient method of computing higher order bond price perturbation approximations.” (No 416). Very helpful to policy makers everywhere, I am sure.

Someone should commission a paper and send it to the MPC, on why depreciation has never worked, be it 1931, 1947, 1967 or 1992. Peter Spencer of the ITEM club points out the manufacturing has been in decline since the 90’s. I presume he meant the 1890’s. In 2011 there is little manufacturing capacity in the UK and this is likely to remain the case. There will be no rebalancing of the economy towards net trade surplus.

In 1983 the UK went into deficit in manufactured goods following the Howe Thatcher pogrom. The trend decline is getting worse not better. Only in one manufacturing sector, chemicals does the UK trade at a surplus the rest is in serial deficit. 

The Bank seems to think that in pubs around the UK discussions are taking place about the merits of open hearth steel making versus Bessemer and the electric arc furnace. Resurrection of tube making facilities using the pilger process is also on the agenda presumably but where to buy the equipment? Back to the darts with a pint and a packet of pork scratchings the only option. Import substitution - buy real ale. Devaluation isn’t working but then it never did.

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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 - this is no time to be bashing the banks!

In 1931, the deficit on balance of trade in goods and services amounted to -2% of GDP. The import bill for food, beverages and tobacco amounted to 8.6% of GDP. Add in the raw materials bill, and a manufacturing surplus of just £72 million could do little to offset the 12.3% GDP bill for essential imports in food and basic commodities. Invisible earnings, which would normally finance the import bills had been hit by a fall in revenues particularly shipping revenues as world trade collapsed.

The UK government faced a crisis which was to lead to Sterling leaving the Gold standard and a devaluation from the level of $4.86 to the dollar. Eat less and export more was the call to remedy the problem.

In 1948, A net trade deficit of just under 2% precipitated the devaluation of Sterling from $4.20 to $2.80. As always the mantra, eat less, export more was prevalent. A food bill of some £450 million amounted to just under 4% of GDP. Including raw materials, the total amounted to 7% of GDP. The UK was struggling to finance the deficit either in terms of manufacturing surplus or invisibles surplus.

By 1950, according to Coutts and Rawthorn, the UK was a great industrial power with more than a third of its labour force employed in the manufacturing sector. There was a trade surplus in manufactured goods equal to 10% of GDP and the country was a net exporter of energy. All appeared to be well, the overall deficit was less than one half of one per cent.

In 1967, seventeen years the Labour government was obliged to run cap in hand to the IMF as a result of a balance of payments crisis. This lead to a further devaluation of the currency. The actual balance of payments numbers were inconsequential, confidence was everything and the Wilson government offered little. The pound in your pocket was unaffected as the devaluation from $2.80 to $2.40 was to unfold. The run on the pound had been triggered by a balance of payments deficit less than 1% of GDP.

Forty three years later in 2010, the UK had a deficit on food of just 1.2% of GDP, add in the bill for raw materials and the deficit amounted to less than 1.5%. Yet the overall deficit on trade in goods amounted to 6.7% of GDP. Since 1983, the UK has been running a persistent deficit on manufactured goods which has compounded the trade deficit problem. In 2010, the trade deficit on manufactured goods amounted to -4.6% of GDP.

The surplus on invisible account could not cover the trade deficit. The overall deficit in goods and services was -3.3% of GDP. In Q4 alone the deficit was -4% of GDP.  The situation is worse than 1931, 1948 and 1967. How did the UK get into this situation?

The paper “Forty years of UK Trade” analyses the deterioration in the UK Balance of Payments position. It will be published sometime next week. For those expecting to see the rebalancing of the economy towards net export growth following the devaluation of the currency once again, it should be an interesting read. The UK needs a strong banking and financial services sector to offset the manufacturing deficit. This is no time to be bashing the banks.

Prospects for the UK balance of Payments : Coutts, K. and Rowthorn, R. 2010 Civitas 

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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.

Pickles, the run on the Pound and the Sterling crisis.

In 1931 the UK faced a balance of payments crisis and a run on the pound sterling which in the end led to a negation of the Gold peg and the dollar pricing of $4.86. By modern standards the deficit was no big deal. In 1929, the country had a credit balance (current account) of some £100 million falling to £30 million in 1930. In 1931 there was an estimated debit balance of £90 to £120 millions. It was this anticipated deficit on current account that led to a run on Sterling and a repatriation of assets particularly to France and the USA.

The problem for the balance of payments was a deterioration in the net receipts from invisible exports largely as a result of the fall in international trade and collapse of shipping revenues. Furthermore, the government was unwilling to raise interest rates to defend the currency given the overwhelming concern re unemployment.

The visible account had long been in substantial deficit, despite a surplus on manufactures and semi manufactures. Imports of raw materials and food, particularly food, meant that exports of manufactures and a surplus in invisible earnings had to finance the food bill of the UK population.

In 1931, food exports totaled £39 billion but the import bill was £377 billion producing a deficit of £338 million. The proposition to remedy the balance of payments problem was to eat less, import fewer manufactures and export more. Food drink and tobacco imports should be reduced by 7%, manufactured goods imports should be reduced by 25% and exports of manufactures increased by 25%.  A combination of import tariffs and duties would assist in the process.

Certain items were considered to be non-essential including shell fish, game, pickles and pickled vegetables, precious stones, feathers, flowers, plants and bulbs. The category of non essentials, totaled £13 million. The “pickled imports” alone cost the UK £6,000 such was the level of detail in the analysis. In some small way Pickles contributed to the run on the Pound.

In 1930 and 1931, the deficit on merchandise trade was £386m in both years and this was offset by invisible receipts of £400m - £420m in 1931 but falling to £285m to £315m in 1931 largely as a result of the fall in income from overseas investments. In 1930, the visible deficit was equal to almost 9% of GDP but thanks to the surplus on invisible account the current account was in balance.

It was argued there is no problem of the balance of trade so long as the “£ is free to move” as, if the balance is adverse, sterling will automatically fall to the point necessary to maintain equilibrium. “The real problem is to secure such a balance of payments as is consistent with a reasonable exchange values of the £.” 

(Committee on the Balance of Trade - report January 19th 1932). 

In September 1931 the British Government suspended obligations due under the Gold Standard Act of 1925 which required the bank to sell gold at a fixed price. As the statement from the Prime Minister Ramsay MacDonald explained. 

“In the last few days the international financial markets have been “demoralised” and seem intent on liquidating their foreign assets in a sense of panic. Since the middle of July, funds amounting to more than £200 million have been withdrawn from the London market. The withdrawals have been met partly from gold and foreign currency held by the Bank of England, and short term credits of £130 million from the USA and France.” 

By September 1931, reserves were exhausted. In a chilling note from the Bank of England to the Prime Minister, the Deputy Governor E M Harvey reported : 

Gentlemen,

I am directed to state that the credits for $125,000,000 (£25.7m)  and FFs. 3,100,000,000,  (£25m) arranged by the Bank of England in New York and Paris respectively, are exhausted, and that the credit for $200,000,000 arranged in New York by His Majesty's Government, together with credits for a total of FFs. 5 millions negotiated in Paris, are practically exhausted also. The heavy demands for exchange on New York and Paris still continue. 

Under these circumstances, the Bank consider that, having regard to the above commitments and to contingencies that may arise, it would be impossible for them to meet the demands for gold with which they would be faced on withdrawal of support from the New York and Paris exchanges. The Bank therefore feel it their duty to represent that, in their opinion, it is expedient in the national interest that they should be relieved of their obligation to sell gold under the provisions of Section 1 subjection 2 of the Gold Standard Act, 1925. I am, Gentlemen, Your obedient Servant.

And so it was, the UK abandoned the Gold Standard, the Pound was left to float, to a level which will automatically produce equilibrium. The rest “as they say” is history. 

In Q4 2010, the UK visible deficit was 7% of GDP and the pound traded at $1.56. The current account recorded a deficit of £10.5 billion in the fourth quarter of 2010, equating to 3 per cent of GDP. UK reserves amounted to £40 billion. 

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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.