Friday, 19 December 2008

German "Crass Keynesianism" Lesson

"All this will do is raise Britain's debt to a level that will take a whole generation to work off ... The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking ... When I ask about the origins of the crisis, economists I respect tell me it is the credit-financed growth of recent years and decades ... Isn't this the same mistake everyone is suddenly making again, under all the public pressure?"
Peer Steinbruck, German Finance Minister

It is very rare that economic sense is spoke in the mainstream media. All too often 'experts' are paraded in front of the media circus to explain what needs to be done to amend the current financial crisis. Sloppy Journalism has become all too common, with many of the main newspapers and television companies rarely exposing the truth. Peer Steinbrucks recent comments were a breath of fresh air and comments that expose how many governments of the world are now proceeding to make the crisis worse. Comments like these expose the policies for what they are, short term political popularity contests that have no benefit in the medium to the long term. The particular attack on Britain was fully justified and words that our leaders should take great alarm to. The markets have also begun shorting the UK, as McDonalds debt has become cheaper to insure against default. Peer Steinbruck is not the first German to expose the weaknesses of the UK economy. Back in October of last year, when the Credit Crunch was still in its infancy, a team of German Economists warned that the UK economic miracle was nothing more than a mirage, built on debt and short term consumption. At the time I remember a lot of the 'experts' deriding this report as nonsense, with the politicians ignoring these warning signs, but here we are 12 months down the line the Germans are spot on again. The UK is in dire shape, with Brown and Darling still with their fingers in their ears. Well I suppose Brown apparently saved the World recently.

Gordon Brown's popularity in the polls has perversely gone up recently, and he has begun capturing ground against the Conservatives. Could he be trying to call a Summer election in 2009, before the economy implodes in 2010 and beyond? Brown was originally going to call an election in 2007, as he knew the economy was about to nose dive off a cliff. He backed down in the end and decided to ride out the storm as he didn't want to loose his life's long ambition, of being Prime Minister. Of course these fiscal paternalistic policies are just more smoke and mirrors, eco-matrix policies to confuse the public. Peer Steinbruck views are a minority. Legitimacy is gained when Paul Krugman, a Nobel prize winning economist, praises the central banks and the fiscal polices of governments, stating that we can not repeat the mistakes of the past. A Nobel Prize winning economist who came out saying that during the Great Depression they didn't cut interest rates like we have now - it makes you wonder what history books he reads. These neo-Keynesian economists just know one thing, and that is too inflate, so its no surprise that governments galvanise these economists. Recently, unbelievably the media have begun mentioning the 'helicopter drops' of money, ones that Ben Bernanke remarked about in 2002, just as this bubble was being inflated. Yet no one from what I have seen has come out and said how stupid these ideas are. Printing money has never worked and never will. It has become so bad that for once I am actually worried what our leaders are doing along with the complicity the media and mainstream economists seem to be showing towards such dangerous actions. No currency seems safe these days, with everyone trying to inflate. Yet economics editors, people that you hope have been educated in finance, seem to think this is a good thing.

"It is not inconceivable that banks could start charging customers to hold their money – after all, their business model is predicated on positive interest rates"

Statements like these sum up the delusional state the UK has found itself in. What savings? Do you think the banks are going to start charging people for their money, when they are insolvent? Do you think members of the public will pay banks to store their money, when we get double digit inflation? There still seems to be a propaganda mission among some, that we are are entering a deflationary spiral that will last for years. However once this sell off period has ceased, inventories and stock have been sold off, production has been cut back and the government has printed up more money, can you really see deflation taking hold? The goods and services in the real economy will decrease, capital is running scared therefore there are no productive investments being made, yet the amount of paper money will increase - this is classic stagflation, the phenomenon that smashed Keynesian economics apart during the seventies.

We've been here before of course. Back in 1973-74 the world was in a similar situation we find ourselves in now. There was a commodity bull market, oil price spikes, an expensive war, recently Iraq, back then Vietnam and a serious bust that was occurring during this time. Yet at the time there was no unified economic response to the above as the seventies credit crunch hit. Rates of inflation varied greatly in Europe through 1973-79, the years after the crunch, with the UK, Ireland, Spain and Italy averaging around 16% during this period while West Germany, Holland and the Swiss averaged around 5%. Yet history seems to be repeating. West Germany back then pioneered the monetarist approach and shyed away from reflation, opting instead to control government spending and the money supply, allowing the deflationary forces to amend the market during 1973-74. Meanwhile the UK chose reflation, by implementing the opposite polices to the above. It joined the other Western European basket economies at the time, by experiencing some of the worst inflation in the euro zone. Once again the Bundesbank are stating the principles they undertook in the past, but these policies are not populist polices politicians like to hear. Once again, the interpretations of history they use are inaccurate, thus they fail to see the causes of the Great Depression and the stagflationary seventies. Government intervention and inflationist policies caused the above, not the market, as what is commonly mis-perceived.

If we compare the current German economy to the UK, we see a stark contrast. Germany has a trade surplus, managed to balance the budget (thanks to Peer Steinbruck) before the downturn occurred, has much less personal debt and has savings of around 10% of income. The UK has none of the above and all its macroeconomic indicators are in bad shape. So essentially Germany is a producer nation, while the UK is the unsustainable consumer maxing out every credit card in sight. I'm not saying Germany won't be effected by the current downturn, there are very few economies in the world today who practice autarky in the globalised economy we live in. But the German economy has far better fundamentals than the UK. Don't be fooled by our governments spurious claims that we have 40% GDP public sector debt. It will soon be 50% then 60%, and keep rising further. With off book debts this figure is more like 200%, as just looking at pension liabilities with a conservative estimate, this would be around 100% of GDP alone, not mentioning other liabilities. Yet the UK economy will contract further - thus increasing these percentages. With the pounds recent slump, the worst since it experienced a run and was consequentially removed from its Gold backing back in 1931, external debt has in effect become more expensive (well at least until other currencies fall against the pound as will no doubt occur). To illustrate how bad this is the graph below indicates how exposed the UK is compared with the other G7 nations. This is public and private debt the UK owes to the rest of the world as a proportion of the economy. With the pounds devaluation recently, this has just got a whole lot more expensive to service, as quite substantial amounts are borrowed in other currencies.

Since Otto Von Bismark managed to unify Prussia with the other German states to form what we now know as Germany, Europe and indeed the World has always looked suspiciously at her. Victory in wars against Austria and then France, during the later part of the nineteenth century displayed early remnants of the economic powerhouse, that would become one of the main European powers. France and Britain today still cling to their old superpower status that has long gone, and will not accept Germany as the current European superpower. Germany took in huge numbers of Yugoslav refugees during the ethnic 'cleansing', much more than the UK, but as soon as they tighten their boarders we brand them as Fascists, showing our Deutschtum phobia. It seems that the UK along with other nations are unwilling to listen to the Germans. They ignore this advice at their own peril.

Saturday, 6 December 2008

UK Bubble RIP

"The City of London is pretty much finished ... and if you're alarmed by the recent slump in sterling, you ain't seen nothing yet. In a decade, you're going to be importing oil again - what's going to hold sterling up when you're a net importer of oil? You've already got a balance of trade deficit. I've sold all of my sterling ... there are no fundamentals to support sterling as far as I can see"
Jim Rogers, Chairman Rogers Holdings

"But if investors no longer think the UK's banks are at risk of collapse, they then look at our other vulnerabilities - such as public sector borrowing which is rising very sharply because of the costs of the bank rescues, dwindling tax revenues and the need to spend our way through the economic downturn ... If international investors fear our credit isn't what it was and are selling pounds, we should hardly be surprised."
Robert Preston, BBC Journalist

Since the end of the First World War, Britain had been in a state of terminal decline. Recently, however, the worlds financial markets were loosing confidence in Sterling as the Treasury could no longer balance the books, with ever increasing government spending that could no longer be paid for. By Autumn the pound was plunging, inflation was rampant and the Prime Minister was trying to keep his party together after just recently obtaining the job. The year was 1976. The UK in the end had to go cap in hand to the IMF to avoid economic collapse, the first Western Nation to do so, and only Western nation up until Iceland's recent decline. It ushered in a wave of right wing Thatcherist economic policies which prevailed up until the present day and changed British politics and society forever. The Labour party after the crisis subsequently split between the old left who remained, and the Social Democrats, who later abandoned the Labour party and joined forces with the Liberals to form the Liberal Democrats. Labour also morphed in subsequent years, from the early eighties the 'loony left' politics of Michael Foot, all the way to 'New Labour' a 'Third Way' led by Tony Blair, who won power in 1997 and for the first term emulated Tory spending plans.

Without North Sea Oil and Gas as the seventies came to an end, the UK could have become an economic wreck, and Margret Thatchers monetarist policies in all probability would have failed putting the final nail in the coffin. The UK's trade of balance would have collapsed without the support from the Oil and Gas revenues. In the end, the UK experienced a renaissance and shook itself out of the terminal decline it had found itself in. However in 2008, the UK again showed strains with investors questioning a new generation of Labour Politicians, wondering if history was repeating itself again. Expansive fiscal measures had been announced, with huge government deficits being forecast and the balance of trade in once again, a perilous state. The UK bubble had burst and with it, she resumed her long decline after the illusionary reprieve of the last 25 years.

Over the past 11 years the Labour government has won successive elections, which no other Labour government in history could achieve. Tony Blair won a historic third term and with it, the party had gained the trust of the people regarding economic affairs. It was no surprise that there was a reversal in opinion regarding the economic competence between the Conservatives and Labour which had once favoured the former, now favoured the later. 'New' Labour was nothing more than a Thatcherist project, one that the Iron Lady herself would jokingly remark was her greatest achievement. Labour had increased the Plutocracy that was seen under Thatcher, with little change in the social apparatus of the country. They continued with Tory Policies, such as PFI, the selling of state assets or Privatisation and the push towards the services industry, in particular the over zealous belief in financial services. Yet this 'Third Way' obtained some false perception among the British public, that social responsibility or progress was greatly enhanced under 'New Labour policies', even though it was evidently Thatcherism but under these new false social pretensions. Of course like all socialist governments they were tied to their socialist dogmas, with the incessant need to 'help' people under the guise of the states apparatus. Their spending deficits became more prominent after the honeymoon period, with needless spending and increasing bureaucratic waste. As the global economy began its historic downturn, the government was now exposed for all its true colours. Relative poverty was as bad as ever, hospital deaths from new super bugs had increased with some of the worst standards in Western Europe. The decline in state pensions had not been reversed since Thatcher pegged them to CPI rather than average earnings, which had now become officially the worst in Western Europe. No real social progress had been made, and the economy had become even more imbalanced with government finances in a dire shape with all the one time privatisation cash cows now all but gone. It would soon be 1976 all over again.

So why did the UK have such an extraordinary post 1970's renaissance? The biggest free gift which gave a healthy revenue stream was the North Sea Oil and Gas that had been discovered during the Sixties. This in effect saved the UK from a perilous plight. It enabled Thatcher to follow in the lead of Federal Chairman Paul Volcker and implement Monetarist Policies in order to contract the money supply and cut government spending, suppressing inflation that was causing havoc in the UK's ability to conduct trade. Without the Oil and Gas revenue stream it is very hard to say if she would have been successful, as even with this, there was still huge unemployment and civil unrest. With sound monetary policies Thatcher could then next turn her attention to the Unions who had held successive governments to ransom during the stagflationary seventies. A move towards a more dynamic workforce was critical in positioning Britain for the global challenges that would evolve over the coming decades. The battle against the 'Shock trooper' Union, specifically the miners lead by Arthur Scargill, was subsequently won by Thatcher and meant that the Unions were subdued. The reformation of tax, meant external capital was once again flowing back into Britain, fueling further economic expansion. With tax cuts came the problem of raising sufficient government revenues and Thatchers solution was privatisation, the selling of state assets for dirt cheap prices giving the government a once only large cash flow. Without getting into the flaws or the advantages of privatisation, this is what happened in the UK, but it is a once and once only money machine. The state was slowly selling off its family estate. In 1986 the 'Big Bang' policy deregulated the financial markets and in came the all conquering US Investment Banks, along with further external flows of capital. Thatcher had begun reinvigorating London as the financial center of the World once more, like the bygone age of British hegemony at the turn of the century.

Manufacturing was in solid decline, indeed recession, for the subsequent two decades. The turn towards services was deemed to be Britain's area of strength after the fiasco of Nationalising the Car Industry during the seventies which ended in disaster. An age of retail had begun, consumerism ruled Britannia, with Marks and Spencer becoming the darling of British Retail. Margret Thatcher had a very conservative childhood with strong family values and thrift. Ironically she presided over Britain's largest credit boom of its day, a new consumerism had taken over the nation. Of course all credit induced booms end in bust and this was no different. After unpopular polices such as the Poll tax, and mutiny within the party, Thatcher was ousted and replaced by John Major. As the bust continued Sterling collapsed as it was ejected from the ERM. The subsequent years of 'Tory sleaze' and their old tired public image lead to the publics rediscovery of the opposition. Under Tony Blair Labour had become 'respectable' once more and with amendments to the party manifesto, mainly the abolishment of Clause IV regarding nationalisation, and a pledge not raise income taxes, Labour were voted in on a landslide.

Once in power Labour initially adhered to the policies of Tory tax and spend. They continued with further privatisation of state assets. They ramped up the PFI projects they had once opposed while in opposition, with further increase in off book government debts. During their time North Sea Oil and Gas reached its peak production, with the UK exporting it in ever greater quantities. With the abandonment of Coal during the political clashes of the eighties, the UK drew more of its power now from Gas fired power stations rather than turn to Nuclear options like the French. While in Norway they kept a substantial portion of their Oil and Gas revenues in the Government Pension Fund, for future generations to enjoy and to smooth out the coming decline, Britain in typical Anglo Saxon consumerism spent it all. Debt began its exponential climb upwards as the UK reached its economic peak, as people racked up further debts just at a time the UK would be ill equipped to pay them in the future. More external investors flooded the island with capital, from Russia the Middle East or Asia, London was the nations financial artery, directing more money into a heavy debt laden economy. This further fueled more credit expansion, with the need for less internal savings. The financial liberalisation of the 1980's from the Big Bang came to a pinnacle as British banks expanded more and more, with traditional conservative Building Societies moving into the realm of risk. Northern Rock, with 125% mortgages, or the 'Together Plan', became the dynamic dynamo of London, what would soon be the Enron of the UK.

During this time the Labour government had been increasing spending ever more, running continual budget deficits, with ever more rosy growth projections from the 'prudent' chancellor Gordon Brown. As Oil and Gas production began to decline and with ever increasing reliance on imports, Britains trade of balance deteriorated further. Warning signs were there, but few wanted to acknowledge them. This was after all the new dynamic Britain, who its people believed had become a strong economy with solid foundations. However as the American housing market bubble began to unwind, so did many financial instruments and institutions. Britain had uniquely positioned itself precariously reliant on finance, only Iceland had an even more foolish model. With the global slowdown, came a collapse in the main British Industries, finance, housing and retail. The service economy where we could all become sales people, skills and trades had been outsourced, with everyone getting cuts and no real value being created, was beginning to unwind. Sterling was beginning its decline. Unfunded government borrowing was beginning to occur once more. The UK was not bankrupt, but began on the path towards it.

Just like the seventies where key manufacturing industries were nationalised, the UK government had once again made the same costly errors, this time with the Banking system. RBS, Bradford and Bingley, Northern Rock and further shareholdings in other banks will paralyse the sector for years to come. Without the luxury of being the worlds reserve currency or a major currency such as the Euro, Sterling can't afford to be exposed the way it has. Even with Sterling falling week on week the politicians continue to make more mistakes, recently with the policy of paying the nations mortgages if there is personal loss of income. This will Compound the issues with the battered banks they have nationalised. More money will be needed to pay peoples mortgages and as the banks can't liquidate their assets, will need further government capital injections - a double disaster as the economy tailspins out of control. Indeed, the UK is even beginning on the road to loosing its triple A credit status. It will just be a matter of time before it does. External capital flows are drying up, with Sovereign Wealth Funds questioning their Investment strategy in the once 'dynamic' island. Rather than waiting for the Pound to collapse, Gordon Brown has begun looking for alternatives to try and shelter the UK from the coming decay.

The current government, just like the populace, are in a state of denial. Over optimistic growth forecasts are continually used, with Growth projected to rebound sharply to 2% at the end of 2009. A quite fundamentally flawed figure. I'm not sure the leaders truly appreciate the risks they are currently running with increased government debt, and a further deteriorating economy with no credible plans to reverse these current conditions. The suggestion that they won't be able to balance the books until 2016, shows what a mess we are in, as it uses these optimistic forecasts. With ever decreasing options the Bank of England has begun with suggestions of the nuclear option, namely the printing press, as the options addressed above used by previous governments have all been exhausted. The media are under the illusion a Japan like scenario could occur, however we are not the worlds largest creditor nation like Japan was then, and do not have a trade surplus. Japan tried to inflate like we are now, but failed due to these reasons. We however will succeed and face years of stagflation once again, just like the seventies. The governments are continually propping up the private sector, but no one is asking the real questions. Who will prop up the government? Even mainstream commentators understand the implications, as Robert Preston states just before the Nuclear Option was announced,

"Some analysts see this as the start of the money printing-presses being turned on with a vengeance, a deliberate attempt to stoke up inflation to reduce the real value of all those excess debts. I'm not sure we are there yet - though it's probably only a matter of time."

UK Government debt is set to explode over the next few years, with off book debts being realised as unfunded pension liabilities, Bank Loans, PFI and declining energy revenues further impair Britain's finances. Central Banks and governments have begun explaining the false dangers of deflation, however they know perfectly well they are preparing for inflation, one that will make the seventies mild in comparison. The reduction of interest rates is further evidence of this, by giving no incentives to save, just the further encouragement to spend and upkeep the velocity of money. Victorian thrift has long gone.

Of course there are no economic fundamentals to support the UK, as the quote at the start states. All of the above, PFI, nationalised finance, unfunded government spending, privatisation, pension liabilities and off book debts, will now go into reverse. Just as they exacerbated the boom on the way up, they will exacerbate the bust on the way down, all compounding with one another over the coming decade.

However, when history is examined Britain has a long and successful functioning liberal democratic system, one that was able to survive the excessive debts obtained during the wars with France, and with it rose as the global power. With debts in excess of 200% of GDP, the UK did not default like many other nations did. It instead paid all the bond holders even in a period of extraordinary deflation during the pioneering phase of the Industrial Revolution. She rose to become the greatest creditor nation the world had seen, spearheading what we now associate as modernity. As Europe succumbed to Fascism during the crisis in capitalism throughout the 1930's, Britain maintained its traditional liberal democracy. These historical factors alone won't prevent the decline of Britain. It involves a painful transitionary period, which politicians are notorious for preventing. Even with this there are no guarantee's as Britain is not what it once was in 1815 and the world is a much different place. We may have seen a high in the UK in our lifetimes. We may be witnessing the beginning of terminal decline.

Wednesday, 3 December 2008

A Ringing Endorsement

An article has been published recently on the Internet which I found very interesting. It was a monetary statement published by Dr Gono the Governor of the Bank of Zimbabwe earlier this year in April. I have included snippets from the article below.

"As Monetary Authorities, we have been humbled and have taken heart in the realization that some leading Central Banks, including those in the USA and the UK, are now not just talking of, but also actually implementing flexible and pragmatic central bank support programmes where these are deemed necessary in their National interests."

"That is precisely the path that we began over 4 years ago in pursuit of our own national interest and we have not wavered on that critical path despite the untold misunderstanding, vilification and demonization we have endured from across the political divide."

"Here in Zimbabwe we had our near-bank failures a few years ago and we responded by providing the affected Banks with the Troubled Bank Fund (TBF) for which we were heavily criticized even by some multi-lateral institutions who today are silent when the Central Banks of UK and USA are going the same way and doing the same thing under very similar circumstances thereby continuing the unfortunate hypocrisy that what’s good for goose is not good for the gander."

"Our economy is and has been in trouble for over ten years and our extraordinary interventions by whatever name have helped to keep the wheels of this economy moving."

"Of course, in the short-term such interventions are without doubt inflationary but in the medium to long-term they trigger and propel economic growth and development that everyone craves for."

For those of you not in tune with the modern economic collapse of Zimbabwe, inflation is a big problem over there. Well it's more than a problem so much as the currency is worthless with the rate inflation running in the millions. As the currency has no stability the economy can't function, as prices can't find a stabilisation point, subsequently businesses can't invest as trying to predict future costs is impossible. Add to that disastrous policies such as price controls and you have a recipe for product shortages as retailers actually loose money by trying to sell the products below market value.

This rate of inflation did not happen over night. It happened after years of mismanaged fiscal and monetary policy. Robert Mugabe and his Kleptocratic regime ran up government debts that could not be paid, thus resulting in the use of a printing press to pay the bills.

As we can see in the chart below inflation was in its infancy less than 10 years ago. When the government began printing money to try pay their bills and implemented a lot of disastrous policies inflation began to take off. The problem with inflation, is once it has emerged its very hard to contain, as prices rise, people demand more pay which puts further strains on the governments costs, so they have to print more money, as the vicious cycle continues. Capital Investment collapses as the currency has no stability, in turn a flight of foreign capital ensues.

In the above graph, Inflation also drops briefly as the government implement a host of policies that stifle markets forces such as pricing by having "Price Controls". Of course the deflation effect is short lived as market forces should never be distorted by governments and bureaucratic institutions. From 2005 inflation exploded and now stands in the millions. In the short time of writing this article inflation has probably increased in a magnitude of 10's.

The reason the UK had such a bad recession in the early eighties was not due to Thatcherism, as many populist anti establishment figures proclaimed at the time such as Ben Elton in the Young Ones. It was due to the inflationist policies that were perpetrated by the Labour government in the seventies, as they spent money they didn't have and funded the difference with inflation. Thatcher came to power and inflation was rampant, as she begun to implement her monetarist policies to tame inflation, in effect contracting the money supply. As painful as this was and as high as unemployment became, it was completely necessary as the economy could not progress until currency stabilisation had been achieved. I'm not a Thatcher fan, it was her policies after this that created the divisive nation we now live in and decimated communities, but returning Britain to a more stable footing allowed the eighties boom, and the subsequent boom we have just been through.

Again, just like the seventies, the UK has begun tampering with market forces and running up deficits they can not pay, trying to inflate their way out of the current credit collapse. Like any previous government that has tried this, it will fail in disaster. Don't be fooled by talk of deflation. When you look at the underlying economic picture it is inflation we will get. It might not be next year or in two years, but it will happen at some point in the future and with it the devastating effects that it causes. As one of the quotes mentions above "keep the wheels of the economy moving" has an eerie ring to it, like a statement from Gordon Brown at the present time. We have been told at all costs we must keep the economy moving. Even if it leads to even worse economic hardship for the medium to long term.