The Good, the Bad and the Ugly - Update on some Macro situations

First of all, apologies for not having posted more frequently. I have been quite busy recently on other matters.

In the current market environment, differences between countries are more marked than ever.

While in the Euro area clear divergences are showing, between the German power house and the weak peripheral countries, Greek, Ireland and Portugal sinking further, some countries are clearly doing better than some others.

Not everything is all Doom and Gloom.

It is become more paramount to carefully study in details the full macro pictures in this difficult investment environment, plagued by low yields, rising inflation and high unemployment. Are we moving towards stagflation? Not yet, but signals are getting stronger.

In this post we will review the Good, the Bad and the Ugly, highlighting the differences and reviewing the current market context and significances.

The Good:

We will start by Sweden:

"The Gross Domestic Product (GDP) in Sweden expanded 7.3 percent in the fourth quarter of 2010 over the same quarter, previous year. Unlike the commonly used quarterly GDP growth rate the annual GDP growth rate takes into account a full year of economic activity, thus avoiding the need to make any type of seasonal adjustment. From 1994 until 2010, Sweden's average annual GDP Growth was 2.68 percent reaching an historical high of 6.90 percent in September of 2010 and a record low of -6.70 percent in March of 2009."
Source - Trading Economics.

Furthermore, Sweden predicts a budget surplus and plans to tax cuts are economy beats Europe according to Bloomberg article from Johan Carlstrom.

"The largest Nordic economy will expand 4.6 percent this year, compared with the 4.8 percent predicted last month, the government said in its spring fiscal policy bill released today in Stockholm. The government raised its forecast for growth in 2012 and 2013 and predicted a widening surplus over the next four years as unemployment falls."

"The Swedish economy grew 5.5 percent in 2010, the most since 1970, as exports recovered from the global financial crisis."

Sweden is doing the right thing:
"Reinfeldt’s four-party government alliance had already revealed it will invest more money in the country’s railway infrastructure and that it wants to ease benefit rules for long- term sick leave. It’s also considering next year cutting income taxes for foreign nationals with “expert knowledge,” dividend taxes for some small businesses and allowing bigger write-offs for investments in research and development."

Applying recipes for expansion:
"The government has cut income taxes by 70 billion kronor ($11.1 billion), or about 2.1 percent of the economy, since coming to power in 2006. It has also reduced corporate and payroll taxes and abolished a levy on wealth."

The results, a booming economy and a fall in unemployment:

A History of Balanced budgets:

Leading to a rising GDP per Capita:

Finance Minister Anders Borg wants Sweden to introduce tougher rules on capital buffers than other countries.
The government is closely monitoring housing to avoid a bubble and already has introduced measures to contain rising household debt such as introducing a loan-to value cap of 85% for mortgage borrowing.

Sweden definitely sits in "The Good" camp, macro wise.

Canada.

I posted before on Canada as a leading example:

Canada, a great example of successful structural reforms and efficient banking regulation

Here is an update on the macro picture for Canada.

GDP Growth for Canada, January 2007 until January 2011:

Canada's budget was either balanced or in surplus, ensuring a reduction of Canada's debt to GDP and enabling them to face the financial turmoil in a much better shape than many other countries.

According to the IMF, Canada’s economy will grow by 2.8 per cent this year, up from an earlier forecast of 2.3 per cent.
The Canadian economy grew 3.1 per cent in 2010.

For the OECD, the forecast is that Canada’s GDP will grow by 5.2 per cent in the first quarter, and 3.8 per cent in the second. In comparison, the OECD has the U.S. economy growing at 3.1 per cent in the first quarter and 3.4 in the second.

http://www.thestar.com/business/markets/article/969530--oecd-bullish-on-canada

"Canada’s economy will grow faster than any other country in the G7 in the first two quarters of 2011."
“That’s full-steam ahead. 5.2 per cent would rank as the second-best quarter of the past 10 years,” said BMO deputy chief economist Doug Porter of the OECD’s Canadian outlook.

Unemployment is falling thanks to solid growth prospects:

Canada is clearly part of "The Good" section of our current macro review.

Another strong member of the group, Germany, the clear power house of Europe.

GDP growth is way above its European peers:

Consequences, unemployment is falling faster than in other EU countries:

What is very interesting is that, 10 years ago, France and Germany were at the same economic levels, both were the leading European power economic houses. Now France is clearly lagging behind. In a future post I endeavour to go into more details about this evolution which we witnessed in the last 10 years and the consequences for France in the not so distant future. Unless some major structural reforms are implemented, like they were in Germany, France will not move in the right direction.

The German discipline:

"The Good, the Bad and the Ugly" in the Eurozone per GDP Growth in 2010:

"The Good, the Bad and the Ugly" in the Eurozone per Government Budget Country Ranking in 2010:

"The Good, the Bad and the Ugly" in Scandinavia per Government Budget Country Ranking in 2010:

"The Good, the Bad and the Ugly" in Latin America per Government Budget Country Ranking in 2010:

"The Good, the Bad and the Ugly" in Major Economies per Government Budget Country Ranking in 2010:

Governmnent Yields 10 Year Notes - Source Trading Economics:

The Bad:

United Kingdom struggling to surge from the ashes of the financial crisis:

Inflation lower this month to 4% thanks to price war between major UK retailers:

I posted extensively on the effect QE in the UK would have on inflation on this blog. Previously, I commented that the Bank of England is facing a difficult situation, with the rise of inflation and its mandate of keeping it around 2%. At some point the Bank of England will have to raise rates, but, given the fact two thirds of UK mortgages are depending on short term rates and UK households are already massively leveraged (debt to income at a record level in the G7 countries club), the risk of a double-dip is massive and Mervyn King is fully aware of the difficulties that lie ahead. Mervyn King is trying to delay as much as possible the inevitable rise in interest rates and the March inflation figure at 4% clearly gave him some small room to breath.

UK budget deeply stretched:

UK unemployment levels not falling fast enough at the moment:

UK unemployment rate for the three months to February 2011 was 7.8 per cent of the economically active population, down 0.1 on the quarter. The total number of unemployed people fell by 17,000 over the quarter to reach 2.48 millions.

France is yet again, delivering below par performance which is clearly not helping its already strained budget.

A slow GDP growth below potential for France:

A sticky unemployment level due lack of structural reforms and flexibility in the labor market:

A decaying trade balance, January 2000 - April 2011:

As a comparison, France's closest and biggest trading partner, Germany has seen its trade balance soar, leading to a faster and more solid GDP growth.

Could France lose its coveted AAA rating? One thing for sure, the decoupling of the French and German economy has increased dramatically in the last ten years. I will post more on the subject in a future post.

Another member of "The Bad" group in the Eurozone is Italy.

"The Gross Domestic Product (GDP) in Italy expanded 1.5 percent in the fourth quarter of 2010 over the same quarter, previous year. Unlike the commonly used quarterly GDP growth rate the annual GDP growth rate takes into account a full year of economic activity, thus avoiding the need to make any type of seasonal adjustment. From 1982 until 2010, Italy's average annual GDP Growth was 1.45 percent reaching an historical high of 4.70 percent in December of 1988 and a record low of -6.50 percent in March of 2009. This page includes: Italy GDP Annual Growth Rate chart, historical data and news."

Italy GDP growth from January 2000 to April 2011:

While benefiting from a GDP boost following the introduction of the Euro after 1999, since then, Italy's GDP growth has been overall muted.

As The Economist posted in early April, Italy can be seen as the Achilles heel of Europe.

"ITALY’S public debt is the sleeping dog of the euro zone’s crisis. So far the markets have mostly let it lie. Although in 2010 it rose by three points, to 119% of GDP, Silvio Berlusconi’s finance minister, Giulio Tremonti, held the budget deficit to an impressive 4.6%, well below his target of 5%."

The article goes on:

"In fact the euro crisis has again laid bare the structural weaknesses in Italy’s economy. When euro-zone GDP falls, Italy’s falls by more; when it rises, Italy’s rises by less (see chart). The country has too few big firms. It is not generating jobs for the young: more than a fifth of the country’s 15- to 29-year-olds neither work nor study. Too few women have jobs (in the euro zone only Malta has a lower female-participation rate). The south remains a huge drag: in broad terms, GDP in the north may grow by as much as 3% a year, but in the south it shrinks by 2%, pulling the average down. Youth unemployment in parts of the south is 40%. And, as the Bank of Italy’s governor, Mario Draghi, has noted, Italian entrepreneurs have to cope with an unusually high level of organised crime. Police operations show that the ’Ndrangheta from Calabria has burrowed deep into the economic fabric of the north."

For the excellent The Economist interactive guide on the Eurozone spreading infection please use the below link:

Europe's economies - Spreading infection

Unemployment for Italy is still too high: January 2000 - April 2011.

But Italy's public finances were held tight thanks to its finance minister.
Italy Budget Deficit from January 2000 until April 2011:

Much tighter than France for instance.

The issue for Italy is that to meet the European rules on public debt, Italy will need annual economic growth of about 2 percent and a balanced budget. I do not see it happening in the near future.

ECB’s Draghi Says Italy Needs GDP Growth Near 2% for Debt Rule - Bloomberg

"The European Union last month reached an agreement on tougher economic oversight rules for member countries, including fines for governments that don’t cut overall debt fast enough. The accord came after Italy, with debt of 118.9 percent of gross domestic product last year, pushed for a broader definition of government borrowing that may offer a better chance of avoiding future sanctions for violators of the debt rules.

While countries with debt over 60 percent of GDP will be required to make annual cuts equal to 1/20th of the excess, progress will be judged against a range of “relevant factors,” the ministers agreed. Italy has pushed for private debt levels, which are low in Italy compared with the EU average, to be included in the gauge."

Analysis: Marchionne offers reform model to stagnant Italy - Reuters

"There is no doubt Italy is in dire need of reform."

According to this article from Reuters by Gavin Jones and Lisa Jucca

"Its economic growth consistently lags its euro zone partners and, according to International Monetary Fund data, it was the world's fourth most sluggish economy between 2000 and 2010, ahead of Zimbabwe, Eritrea and Haiti. Real disposable income has been stagnant since 1990 and the average hourly wage, adjusted for the cost of living, is 30-40 percent below that of its three main European peers, Germany, France and Britain. It is the only euro zone country where per capita output is lower now than it was in 2000.

Of course there are many reasons for this state of affairs, but analysts agree that one factor is the rigid and centralised system of industrial relations and an inability to increase productivity in line with its competitors."

But it is not too late for reforms. Germany remain's Italy’s largest trading partner. Germany is purchasing 12.7 per cent of Italian exports.

What is currently plaguing Italy's economy remain its ongoing North-South divide. Italy is a two zones economy and it is hindering its growth dramatically:

It is not too late for France either.

Both Italy and France, need to become probably more like Germany. In order to do so, they have to go through much needed structural reforms: Productivity and competitiveness were key to Germany's recent success.

The Ugly - Peripheral Europe:

Ireland has been the subject of quite a few posts on this blog.

Ireland debt status is now closer to junk following another round of downgrades from the rating agencies:
Moody's downgraded Ireland to Baa3 status with a negative outlook.

The Irish economy contracted for the third year running in 2010. GDP growth of 0.9% and 2.2% is forecast for 2011 and 2012.

As I posted previously, the Irish financial sector sunk the country.
Allied Irish Banks latest financial results is a good indication on how the country's public finances were deeply put into the red. AIB used to be Ireland's largest lender. AIB revealed additional losses recently: 10 billion Euros in 2010 from 2.3 billion Euros in losses a year earlier.

Now AIB, which is almost totally owned by the Irish government.

So far AIB has received 7.2 billion Euros in government aid to date and we know now it needs an additional 13.3 billion Euros in capital, following the latest Irish banks Stress Tests. On its own, AIB's capital injections so far represents an incredible 12.5% of GDP. And this is just for AIB, I am not including, Anglo Irish or Bank of Ireland.

There is only one explaination for the high losses in the Irish financial sector: High concentration of risk in property lending. Anglo Irish's loan book was on 10 promoters only as indicated previously.

Since Ireland embarked on its fiscal austerity programme two years ago, the Irish economy has contracted by at least 11%, and, 16% in three years in total. Consumer spending is down 14 percent since 2008.

"Commercial property prices have plunged 60 percent since peaking in 2007, while rents have fallen an average 50 percent, according to real-estate agent CB Richard Ellis Group Inc. (CBG)"

Source Bloomberg: Irish Retailers Fight Investors Over Rents After Economy Sinks

For the IMF, Irish growth will be "Ugly" in 2011, a miserable 0.5% according to there latest forecast.

In comparison:

"Growth for the Euro Area is estimated to be 1.6%. In advanced economies worldwide, growth is estimated at 2.5%, with developing world growth put at 6.5%."

The employment in Ireland is as well, a truly "ugly" picture:

Ireland Unemployment: January 2000 - April 2011

The blame for financial crisis is not all our own
We need to draw attention to punitive stance on financing of bank resolution, writes Colm McCarthy

"Holders of Irish bank bonds should take losses instead of the Irish Government footing the bill for their bailout," European Central Bank governing council member Axel Weber said.

Mr Weber added:
"To save a country's banking system, it is not necessary to write a blank cheque for the total balance sheet of the banking system."

"'In Ireland, the question is whether the banking sector has to be saved as a whole,' he added. 'Would it not be a better route to isolate deposits, to minimise losses to Irish taxpayers and to find a complete solution . . . with private sector participation instead of buying them out.'"

"Mr Weber echoes the consistent editorial position of the Financial Times, the Wall Street Journal and the Economist magazine among others."

This is the difficult dilemna, Ireland is facing, haircuts or more austerity for its taxpayers.

As for Portugal, last time it received an IMF package in 1983, the result was higher productivity and exports. Is it going to be different this time?
The key element for Portugal, as well as Spain to some extent, lies in a major structural reform of its labor market. Portugal needs to become more competitive again. Competitiveness is a key factor of success as highlighted by the German economic situation.

Portugal benefited as Italy in a short boost to its GDP growth after 1999, but since then, its GDP growth has not been stellar to say the least:

Portugal GDP Growth: January 2000 - April 2011

"The Gross Domestic Product (GDP) in Portugal expanded 1.20 percent in the fourth quarter of 2010 over the same quarter, previous year. Unlike the commonly used quarterly GDP growth rate the annual GDP growth rate takes into account a full year of economic activity, thus avoiding the need to make any type of seasonal adjustment. From 1989 until 2010, Portugal's average annual GDP Growth was 2.16 percent reaching an historical high of 6.50 percent in March of 1995 and a record low of -3.70 percent in March of 2009."
Source Trading Economics.

Austerity is biting even more Portugal's employment levels:
Portugal Unemployment Rate Jan 2000 - April 2011

As a reminder, CDS for financials are deeply correlated to Sovereign CDS levels as of the 7th of April 2011.

In regards to Greece, the writing is on the wall and a restructuring seems to be the most likely outcome:

Greek Government bonds run on the 14th of April 2011:
Price Yield

GGB 4.6 05/20/13 78.4410 17.8539
GGB 5 1/2 08/20/14 68.2760 19.1830
GGB 6.1 08/20/15 67.1960 17.3838
GGB 3.6 07/20/16 58.9710 15.5923
GGB 4.3 07/20/17 59.1350 14.7267
GGB 4.6 07/20/18 59.2450 13.8444
GGB 6 07/19/19 61.2950 14.257
GGB 6 1/4 06/19/20 64.1660 13.1971
GGB 5.3 03/20/26 58.6110 11.0967
GGB 4.6 09/20/40 53.6850 9.2031

Greece Sovereign CDS 5 year spreads reached a record on the 14th of April 2011 to 1164 bps, implying a Cumulated Probability of Default of 60% according to CMA.
CDS 5 year levels for Peripheral countries as of the 14th of April 2011:

Conclusion:
A real recovery in productivity is the only way for a sound economic recovery.

An interesting article as a follow up on European Banks financial woes:

Euro vs. Invasion of the Zombie Banks

By Tyler Cowen in the New-York Times

Are we seeing the application of Gresham's law in current market turmoils and hot money pouring into Emerging Markets? I will discuss on this subject in a future post.

Gresham's law as per wikipedia:
"Gresham's law is an economic principle "which states that when government compulsorily overvalues one money and undervalues another, the undervalued money will leave the country or disappear into hoards, while the overvalued money will flood into circulation."

"It is commonly stated as: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law."

Robert Mundell believes that Gresham's Law could be more accurately rendered, taking care of the reverse, if it were expressed as, "Bad money drives out good if they exchange for the same price."

"the more it changes, the more it's the same thing" - Review of the ongoing economic issues

"plus ça change, plus c'est la même chose"—"

Jean-Baptiste Alphonse Karr (November 24, 1808 – September 29, 1890)
French critic, journalist, and novelist.

Ireland 10 year bonds are trading now north of 10% for the first time since December 1992.
As I previously posted, we are in a time machine and just made a quick trip to the past:

European Government Bonds - Back to the Future?
"From 1991 until 2010 Ireland's Government Bond Yield for 10 Year Notes averaged 5.72 percent reaching an historical high of 10.47 percent in December of 1992 and a record low of 3.06 percent in September of 2005."

The yield on Ireland’s two-year securities rose 57 basis points to 10.44 percent. The 10-year yield exceeded 10 percent for the first time since the euro was introduced in 1999.

The problems is that the Irish financial sector troubles are just too big now for the Irish Government to cope with.

According to a recent article in Bloomberg by Joe Brennan published on March 18, "Ireland Said to Weigh Allowing Banks to Set Up Asset Warehouse"
Ireland is finally giving in setting up an Irish "Resolution Trust Corporation".
Joe Brennan commented:

"Irish authorities are considering allowing the country’s debt-laden lenders to set up a company to warehouse more than 60 billion euros ($84.8 billion) of loans that would be wound down or sold over time, according to three people familiar with the matter."

The reality behind this move is that the deposit outflows experienced by Irish banks since last year is making them increasingly dependant on funding from the ECB.
From the same article:
"Irish central bank Governor Patrick Honohan said the ECB wanted to accelerate deleveraging, Ireland has “put in the condition of no fire-sale losses because the state cannot afford it,” he said."

On the 31st of March we will get the results from the capital and liquidity stress tests on Irish Banks.

Joe Brennan added:
"So-called viable lenders, including Bank of Ireland Plc, Allied Irish Banks Plc (ALBK), Irish Life & Permanent Plc and EBS Building Society, need to cut their loan-to-deposit ratios to 122.5 percent, “which is acceptable to Europe,” Finance Minister Michael Noonan said March 14. The average loan-to-deposit ratio is currently about 170 percent."

From TBTF (Too Big To Fail) to TBTB (Too Big To Bail)...

Joe Brennan also indicated in Bloomberg news the following sobering fact:
"Irish Credit Bureau Chief Executive Officer Seamus O’Tighearnaigh said that 9.5 percent of loans registered with the company are at least one month in arrears, up from 0.75 percent in 2006, the Sunday Times reported."

The example of Ireland clearly showed the issue, where Ireland's public finances were put in disarray due to the massive bail out need of its financial sector (please see previous posts on that subject: The European Vortex, The Irish Black Hole, Ireland in the need of a lucky Shamrock).

5 years CDS on Portugal stands at 536 bps and Ireland 5 years CDS increased by eight basis points to a seven-week high of 625 bps, according to CMA.

Portugal's government as well is collapsing, given parliament is not willing to bite the bullet and to accept the latest austerity measures proposed by the government. Another EU member bites the dust as I type this latest post. You can expect another bumpy ride in the Eurozone.

The housing hangover issues are still the biggest problems plaguing not only the Irish economy but the US economy as well.

U.S. New-Home Sales fell to the lowest level on record:

Yes indeed, the more it changes, the more it stays the same...

Bank of America CEO Brian T. Moynihan said:
"The problem of delinquent mortgages and falling home values is the most stubborn, entrenched and damaging economic problem our country faces today."
Bank of America's CEO is correct. I touched on the subject of the impact of real estate on the US economy in my post "Extend and Pretend" - Banks bloated balance sheets and the Impact of Real Estate crisis.

January home prices in the U.S. fell 0.3 percent from December, according to the Federal Housing Finance Agency. Prices nationwide fell 3.9 percent in the 12 months ended in January.

So big is the issue that Bank of America had to segregate almost half of its mortgages Into ‘Bad Bank’ according to Bloomberg report from Dawn Kopecki published on the 8th of March:

"The legacy portfolio will hold 6.7 million loans with outstanding principal balance of about $1 trillion."

"Of the 13.9 million loans Bank of America services, about 3.5 million are held by the company on its balance sheet. The rest are owned by other investors."

Reminder:
"Bank of America services 14 million mortgages, or one out of every five in the U.S., and its loan-servicing portfolio exceeds $2.1 trillion in size. Of its mortgages, 10 million came from its 2008 acquisition of troubled California lender Countrywide Financial Corp. More than 80% of its delinquent loans were acquired through Countrywide."

Bank of America is also actively selling its exposure to commercial real estate:
BofA Is a ‘Very Active’ Seller of Commercial Real Estate to Limit Losses
The US Treasury is as well reducing its portfolio of Mortgage Backed Securities, looking at selling 142 billion USD worth of MBS guaranteed by Fannie Mae and Freddie Mac at the tune of 10 billion per month.

As I wrote in "Resolution Trust Corporation II - the unavoidable Sequel", 1 out of 4 US Household is already in negative equity, "Desperate times need decisive action and setting up a new RTC would definitely be the right move in the right direction".

For more on the difficult situation for the US economy and the impact of households in negative equity please look at the following post:

The end of the American Dream, the call for trade barriers and the rise in populism...

So far 25 banks failed in the US in 2011. 157 banks failed in 2010 according to FDIC. Increasing loan losses on commercial real estate are expected to result in hundreds of bank failures in the coming years.
The Unofficial Problem Bank list on the 19th of March stands at 982 institutions with assets of 430.4 billion USD, up from 964 institutions with assets of 420.7 billion USD as per the excellent CalculatedRisk blog.

For Robert Burney, a banking and finance professor at Coastal Carolina University:
"It's a race between deteriorating portfolios and recovering economies,"
Read more: http://www.thesunnews.com/2011/03/20/2047287/undercapitalized-banks-struggling.html#ixzz1HRrvO1fK

The US need more job creation but negative equity weights heavily on job mobility:
Non Farm Payrolls from 1992 onwards.

At the same time inflation in the UK keeps creeping up, no surprise there. It was expected previously on numerous posts on this blog.

UK inflation from January 1989 until March 2011:

Mervyn King at the Bank of England doesn't seem to be able to keep the ink dry, yet another letter to the Chancellor.

The Bank of England purchased around 165 billion GBP of assets by September 2009 and around 175 GBP billion of assets by end of October 2010.

Any coincidence with the rise in inflation in the UK is of course purely fortuitous given QE started in March 2009...

As a reminder of the risk of QE:
"Quantitative easing may cause higher inflation than desired if it is improperly used, and too much money is created. It can fail if banks are still reluctant to lend money to small business and households in order to spur demands. Quantitative easing can effectively ease the process of deleveraging as it lowers yields. But in the context of a global economy, lower interest rates may contribute to asset bubbles in other economies."

Consumer confidence in the UK is still at the lower end:
January 1992 - March 2011

Are we seeing asset bubbles in other economies? China? Brasil? Etc.
Most certainly. QE is exporting inflation first in emerging markets then back to developped countries:

Both the UK economy and the US economy are in "The Hurt Locker".

As a reminder from previous post The Endgame - Fin de partie:

Inflation, Not Deflation, Mr. Bernanke
By Andy Xie 08.16.2010 18:12

http://english.caing.com/2010-08-16/100171139.html
"The globalization reality is that developed economies like Europe, Japan, and the U.S. will suffer slow growth and high unemployment. Stimulus is the wrong medicine for solving problems. Believing this will lead to excessive stimulus, which causes inflation and bubbles in emerging economies first and inflation in developed economies later. The wrong policy prescription pushes the global economy through unnecessary gyrations, stagflation and possibly another major financial crisis in the emerging economies. It's high time for Mr. Bernanke to wake up from his stimulus obsession."

Can we expect QE3?

Fixed Income - Floating Expenses - Inflation still creeping up in the UK

Inflation in the UK is still on an upward trend and Mervyn King is getting more and more nervous now than before, conceding inflation will be high for the next two to three years. His hand must start to be tired given he has to write yet another letter to the Chancellor. Inflation for January is now at 4% in the UK.

I don't want to sound like a broken record but there are more than enough posts on my blog dealing with the UK inflation problems where I argued QE in the UK would be inflationary down the line:

http://macronomy.blogspot.com/2011/01/uk-inflation-for-december-37-qe-is.html

Mr King testified today: "Inflation is likely to continue to pick up to somewhere between 4 per cent and 5 per cent over the next few months, appreciably higher than when I last wrote to you."

Dear Mervyn, as I remember last time didn't you forecast inflation pressure falling from January 2012 onwards in your last letter to the Chancellor?

"King in his last open letter to the Chancellor of the Exchequer indicated that inflation will "probably" (most likely if you ask me...) stay above the bank's target of 2% till the end of next year."

Given the already high leverage of households in the UK, it comes to no surprise that the Bank of England is trying to buy as much time as possible to avoid hiking rate. The consequences would clearly be a double-dip.

Deflating debt via inflation is the name of the game dear Mervyn.

As I previously wrote:

"The great bank robbery runs unabated...Inflation is purely and simply theft on a large scale."

Truth is, Mervyn King has no choice.

Just the facts:The UK had one of the worst household debt to GDP ratios and debt to disposable income ratios in Europe.

and in the entire G7:

For an additional visual approach on the UK debt problem please have a look at the below link:

http://www.moneydebtandcredit.com/debt-information/debt-problem-2010Q4-98.aspx

46% of personal debt in the UK is on Credit Cards.

Average UK household debt: 57,706 GBP per household.

Total Earnings VS Total Debt: Debt = 126% of average earnings.

Total personal debt in the UK - 1,454 Billion GBP: Individuals owe more in personal debt than the country's annual output.

Now with VAT to 20% in January and the high rate of inflation, household budgets are being stretched even further. Reduced income due to benefit cuts and continued redundancies only add to the current problem.

Two thirds of UK Household Debt is tied directly to the Bank of England’s short term interest rates, therefore Mervyn King has no choice but to try to delay as long as possible a rise in interests rates as indicated in the below WSJ article by Alen Mattich:

http://blogs.wsj.com/source/2011/02/11/bank-of-england-loses-control-of-inflation/


"CreditSights, an independent research house, outlined the stark facts the Bank of England is confronting in a note this week.

Between 2000 and 2008, U.K. households’ total debt burden rose by 133%, with borrowing rising to 161% of gross household disposable income from 99%.

The Bank of England’s emergency rate cuts reduced the amount of interest payments U.K. households make to just £2.2 billion, from £19.4 billion in 2007. CreditSights estimates that just a 50 basis point hike in the Bank’s base rate would increase borrowers’ interest costs by £7.5 billion."

Not only would a rate hike be very difficult for UK Households but would also have a serious impact on public finances to the estimated tune of 15 Billions GBP for a 100 bps increase in Gilt Yields over the next five years.

So there you have it, the quiet inflation robbery game will continue. Mervyn King won't have the time to let the ink dry given the additional letters he is going to have to write to the Chancellor in the near future.

Welcome to Stagflation redux à la 70s...

UK inflation for December: 3.7% - QE is creating inflation as I expected.

In the post I published on the 16th of November 2010: "Another Letter from the Governor to the Chancellor - UK CPI at 3.2% in October", I continued to argue that inflation would keep rising in the UK. This post was the continuation of what I foresaw back in February 2010, that QE in the UK would be inflationary. It has been a recurring theme in my posts (see previous posts in April and May as well on why QE is inflationary).

I advised the following in February 2010, the need to track the movements of the CRB index, which could be done via the LYXOR ETF denominated in Euros.
I wrote:
"You need to closely monitor commodities prices because they are steadily going up again as the CRB index is showing. Lyxor CRB ETF denominated in Euros displays this increase: FR0010270033 is the ISIN."

The LYXOR CRB ETF was around 19.5 Euros in February 2010 when I previously posted:

Now the same LYXOR CRB ETF index is at around 24 Euros, a nice 24% increase nearly year on year (if you put the trade on that is...), reflecting the surge in commodities. The Thomson Reuters/Jefferies CRB Index (TR/J CRB) is currently made up of 19 commodities as quoted on the NYMEX, CBOT, LME, CME and COMEX exchanges. These are sorted into 4 groups, each with different weightings. These groups are:

Petroleum based products (based on their importance to global trade, always make up 33% of the weightings)
Liquid assets
Highly liquid assets
Diverse commodities.

In my book we have Stagflation in the UK, inflation, low growth, high unemployment.

"In economics, stagflation is the situation when both the inflation rate and the unemployment rate are persistently high. It is a difficult economic condition for a country, because when inflation and economic stagnation are occurring simultaneously, a policy dilemma results since actions that are meant to assist with fighting inflation might worsen economic stagnation and vice versa."

Keynes wrote:

"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some."

How do you stop inflation creeping up in the UK? Very simple, the Bank of England will be pressured to raise rates sooner than later, because Mervyn King must be tired of having to write a letter to the Chancellor regularly.

Reminder:
The governor must write to the chancellor every three months when the inflation rate deviates more than a point from the central target in either direction...

The RPI figure for the whole of 2010 was 4.6% - the highest rate since 1991.

Below inflation from 2000 to 2010 in the UK:

The Bank of England is indeed in a very difficult quagmire.

The risk of a double dip in for the UK economy is alive and real.

This is what I wrote on the subject on the 16th of November 2010:

"There is still a very real risk of a double-dip recession in the UK. At some point the Governor of the Bank of England Mervyn King will have to raise rates to counter the rise in prices. This will put additional pressure on housing prices as well as mortgages and put more households into trouble, which would impair even more the damaged balance sheets of many UK banks."

And yes, you can have inflation in a deflationary environment:

"The inflation debate or why you can have inflation in a deflationary environment"

Another Letter from the Governor to the Chancellor - UK CPI at 3.2% in October

In the UK, Inflation has exceeded 3 percent this year in every month apart from February.

Another fourth letter from Mervyn King to the Chancellor...(The governor must write to the chancellor every three months when the inflation rate deviates more than a point from the central target in either direction).

King in his open letter to the Chancellor of the Exchequer indicated that inflation will "probably" (most likely if you ask me...) stay above the bank's target of 2% till the end of next year.

He explained that inflation might (will...) increase further over the coming few months as the VAT will increase to 20.0% in January and commodity prices are rising, yet "the MPC believes that the spare capacity in companies and labor market would put downside pressure on prices till it shore it back to the target", adding that "inflation prospects remain uncertain".

In February, I argued that QE in the UK would fail and that inflation would be creeping up. I added to this analysis in April also, sating the results of QE would be inflation down the line in the UK. In May, I posted the reasons why QE was failing in the UK. It has been an ongoing theme on my blog. There is more and more a higher risk of Stagflation, low growth, high unemployement and rising commodity prices à la 70s style as I posted in July.

http://noir.bloomberg.com/apps/news?pid=20601087&sid=aicpQZswD66U&pos=3

“With continued increases in the headline rate of inflation well above target, the bank is facing an unenviable communication challenge to try and explain why further easing would be needed,” London-based Nomura International Plc economist Philip Rush said in a telephone interview today.
Source: Bloomberg article written by Svenja O'Donnell as indicated in the link above.

The temptation of reducing the debt burden by increasing inflation is clearly in the mind of our politicians, I discussed in July. Is it the game being played in the UK at the moment?

Savers are still being punished, that's the hard reality.
Pensioners in the UK are struggling. They are the hardest hit by the rise in inflation because:
-they spend less on consumer goods that have fallen in price.
-they spend more on basics and insurance where price rises have been much higher. (British Gas has just announced a 7% price hike...).
–they have seen a dramatic fall in their savings income as interest rates have been cut to the bone...

By the way CPI does not include housing or heating costs...

There is still a very real risk of a double-dip recession in the UK. At some point the Governor of the Bank of England Mervyn King will have to raise rates to counter the rise in prices. This will put additional pressure on housing prices as well as mortgages and put more households into trouble, which would impair even more the damaged balance sheets of many UK banks.

The great bank robbery runs unabated...Inflation is purely and simply theft on a large scale.

The best way to destroy the capitalist system is to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.
John Maynard Keynes

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.
Alan Greenspan

Stagflation à la 70s redux?

"Bank of England's Mervyn King warns over inflation."

No way? Really...

This is a title from an article published today's in the Telegraph as per below's link.

http://www.telegraph.co.uk/finance/economics/7914326/Bank-of-Englands-Mervyn-King-warns-over-inflation.html

“There will come a point when we will certainly need to ease off the accelerator and return Bank Rate to more normal levels,” Mr King told MPs today.

Given the very weak saving rate in the UK and the high level of private debt and the still ongoing deleveraging, this would lead to another double dip and additional pressure on housing prices to the downside. Mr King is fully aware of the risk but given his current mandate, at some point he will have no choice but to raise rates. It cannot be avoided.

Back in April an even in March I stated that the only result that would be gained by the use of QE would be inflation down the line.

http://macronomy.blogspot.com/2010/04/results-of-qe-will-be-increase-in.html

It was obvious then and more obvious now.

Mr King also added the following in this article:

Mr King also suggested the US has been wrong to prioritise growth over cutting debt levels.

"All countries need to have a credible medium term plan within which they can demonstrate that they will get back to a position in which structural deficits are eliminated and there is a sustainable path for the long-term public finances," he said.

Structural deficits need to be tackled now, not only in the US but in the UK, France, Portugal, and all European countries which have been living beyond their means for too long, relying on cheap credit and the complacency of the markets. Make no mistake, the bond vigilantes are still out there and although some of the problems have been kicked down the road, for Greece for example, the problems are yet to be solved as highlighed by the sour recent discussions between the IMF and Hungary in relation to their proposed austerity measures which are not enough.

As a reminder:

http://macronomy.blogspot.com/2010/03/importance-of-branding-in-economy.html

MV=PT as per Irving Fisher's equation. The Bank of England bought 200 Billions worth of long dated Gilts with QE. The BOE by pumping M (M4) is expecting T to rise and it is not really happening...
MV = PT. M is the stock of money in the economy,V is the velocity of circulation or the speed at which money flows around the economy. P is the price level and T the value of transactions, or gross domestic product (GDP). Hence by
increasing ‘M’, QE aims to increase ‘T’.

The main risk of QE was that the money pumped into the system would not result in higher
spending and economic activity. Banks are currently using all these additional funds to help repair balance sheets. Increased availability of credit is not resulting in more lending. Many companies and individuals do not want to increase borrowing during a period of economic uncertainty and this is the reason why savings are going up and people are trying to repay their debt.

Therefore the initial MV = PT equation means that a rise in ‘M’ leads in reality to a fall in ‘V’ leaving no net benefit.

On the 30th of January I warned about the risk of Stagflation 70s style.

Keynes clearly understood the risk of QE and the effects of debasing your currency.

The temptation of reducing the debt burden by increasing inflation is clearly in the mind of our politicians.

We are still in a deflationary environment.

Deflation then inflation. Low growth and high unemployment whith a rise in inflation will led to stagflation at some point. No doubt about it.

It is not only a UK problem.

As highlighted as well by Ambrose Pritchard-Evans in the Telegraph recently, it is affecting India as well:

http://www.telegraph.co.uk/finance/globalbusiness/7909557/India-warned-of-stagflation-risk-as-price-of-food-soars.html

India's current inflation stands at 11%.

"Maya Bhandari from Lombard Street Research said New Delhi had been far behind the curve in tackling price pressures. The central and regional budgets are heavily in deficit and this is being "monetised" by central bank policy. The inflation rate for primary articles has reached 16pc. "This is not far from British inflation just before the bitter stagflation years of the later 1970s," she said."

China is also facing similar prospect due to overcapacity and price controls.

Back in January I quoted Keynes in relation to the negative effect price controls can have on triggering inflation:

Price controls discourage production.

"The presumption of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself, however, the seeds of final economic decay, and soon dries up the sources of ultimate supply. If a man is compelled to exchange the fruits of his labors for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbors as a favor, or relax his efforts in producing it. A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but leads finally to the waste and inefficiency of barter."

Stagflation can not only happen because of the rise of short supplies of commodities like oil in the 70s, but can be caused by a rise in the money supply, due to QE for example.

To conclude I encourage you to read the latest article published by Doug Noland in Asia Times in Credit Bubble Bulletin:

http://www.atimes.com/atimes/Global_Economy/LG27Dj02.html

Enjoy the summer and enjoy the read!

You cannot bring about prosperity by discouraging thrift.
You cannot strengthen the weak by weakening the strong
You cannot help the poor man by destroying the rich.
You cannot further the brotherhood of man by inciting class hatred.
You cannot build character and courage by taking away man's initiative and independence.
You cannot help small men by tearing down big men.
You cannot lift the wage earner by pulling down the wage payer.
You cannot keep out of trouble by spending more than your income.
You cannot establish security on borrowed money.
You cannot help men permanently by doing for them what they will not do for themselves.

written in 1916 by the Rev. William J. H. Boetcker, a Presbyterian clergyman and pamphlet writer