Archive for October, 2010
Congratulations this week to Mr Ross Walker of RBS. Of the 30 professional economists whose forecasts were listed on Bloomberg in advance of Tuesday’s release, he was the only one to anticipate the strength of UK GDP growth for the third quarter: +0.8%.
Cumulative growth over the last four quarters now stands at 2.8% – about average for the typical year, though leaving some way to recover the 6.7% lost over the course of the recession.
The strength of this performance raises a number of interesting issues. One of them – pace Mr Walker – is its seeming unpredictability. In his emergency Budget (June), the Chancellor cited GDP projections from the newly-formed Office of Budget Responsibilty of 1.2% for 2010 and 2.3% for 2011. At least one of those figures now looks comfortably overshot. Much more of the same and the age of austerity could be over sooner than we have been led to expect.
In the Bank of England’s August Inflation Report, the gnomic “fan chart” prediction for GDP growth seems a little closer to the mark: about 2.5-3% for both 2010 and 2011. But that brings us on to another point of interest – a trend rate of growth hardly suggests disinflationary pressures sufficient to warrant continued emergency levels of monetary looseness (as the Bank admits on p. 48 of its report, its track record of accurate growth predictions is complemented by a history of underestimating UK inflation rather dramatically).
Assuming that the last few quarters do not represent a false dawn, there seem to be two possible futures for the British economy. Either the government and the Bank accommodate themselves to the possibility of a more rapid recovery than expected, or they persist as if growth of 2.8% still represented the pitch of doom. In the first case, we should soon expect to see higher interest rates as part of a return to business as usual. In the second, we should expect to see higher interest rates rather later as a panicked reaction to the entrenchment of a serious inflationary problem.
This blog has observed before that the persistence of inflation presents the Bank with a tightrope walk, having to balance the risk of destabilising recovery against the reality of the erosion of incomes and wealth. The more data we get like we did on Tuesday, and it will look as though the Bank is not so much walking a tightrope as galloping towards a policy mistake.
In the UK this week, the news has been dominated by the austerity measures formalised in Wednesday’s Comprehensive Spending Review. In Europe, the French strikes against Sarkozy’s deficit reduction plan have been making headlines. So it has been easy to miss the subtle but important good news that has been emerging from the third quarter figures released by US banks.
On Monday, Citigroup posted results, reporting a healthy profit of $2.2bn for the quarter on the back of its exposure to growth in emerging markets and a reduction in the provision made for credit losses.
By itself this would not necessarily indicate anything, but results from its megabank peers suggest something of a pattern.
Tuesday saw Bank of America report results for the third quarter. Lacking Citi’s exposure to developing economies, and having to write down the value of its credit card business to reflect new rules on lending, it turned in a whopping loss. The situation would have been far worse, however, had the bank not made significant reductions to its provision for credit losses.
The very next day, Wells Fargo reported record Q3 profits that looked to have nothing in common with Bank of America’s results on the face of it – except that a key driver of the strong performance was a reduction in the provision made for credit losses. And to complete the picture for the Big Four, JP Morgan last Wednesday reported net profits that had grown strongly despite lower revenue because of a huge fall in its credit loss provision.
The consistency with which large American banks are revising down their expectations for credit losses is a bullish signal for the US economy. It underlines what has become a bit of a running theme for this blog: that although serious trouble spots remain, the world at large should be expected to heal itself over time.
And as the condition of the world’s banks improves from comatose to convalescent, we can expect all sorts of positive effects. The day after Citi reported, for instance, the US Treasury announced they were going to sell another block of shares. If completed at around the current market price this means that American taxpayers will have made a profit on their bailout, with the promise of more to come.
Let us hope that similar effects in Britain will outweigh the negative impact of our austerity drive, as planned.
Needs must as the deficit drives.
Reports over the weekend indicated that the government are considering a much more broadly based sale of state assets than had been envisaged by the previous regime. Ways of extracting value from government-owned property – whose worth has been estimated at some £370bn for some time and could be much higher – are apparently being examined with “fresh urgency”.
Let’s put that number into context.
Land Securities, Britain’s biggest property company by market cap, had just over £8bn of fixed assets on its March 2010 balance sheet. At the time of writing, the REIT sector of the FTSE All Share index, which contains Land and most of the other major players – British Land, Hammerson, Segro and the rest – has a combined market cap of a little under £23bn. And the 3,600-plus properties tracked by the Investment Property Databank (IPD), information wizards of the commercial property sector, are worth around £33bn according to their latest figures, which they estimate represents over 90% of the combined value of property assets held by UK unit trusts and investment funds.
Talking of the IPD figures – out yesterday – they show a continued drift lower in yields, to an annualised 6.9% in September down from 8.5% a year earlier. And capital growth has slowed too, with commercial property rising 3.9% in value over the first quarter of this year, 1.9% in Q2 and only 0.5% over the three months just gone.
It’s true that a rise is still a rise, and an income return of 6.7% doesn’t look at all bad right now (especially when glancing across at the bond market). But commerical property, like its residential counterpart, is in a relatively fragile state.
You can see where this is going. A mere 10% of the estimated value of the government’s estate is worth vastly more than the combined worth of our biggest property companies. Selling it in an 80s-style democratic privatisation – one of the options under discussion – would require investors to commit more additional capital to commercial real estate than they currently have invested in the asset class in toto.
So attempting anything on that scale looks impossible. The more manageable the size of the planned sale, however, the less point there is in the government bothering. It’s quite a tightrope to walk. And we still don’t know how much property the banks and the structured finance sector might have to offload at the same time.
Consider all this together with the Bank of England’s £200bn gilt overhang (and rising?), and you might be forgiven for thinking that our masters are trying to unnerve UK investors on purpose …
Three days ago, a member of the Bank of England’s Monetary Policy Committee called Adam Posen let slip in a speech that he favoured further asset purchases under the Bank’s programme of “quantitative easing” (QE). He backtracked somewhat on this yesterday, perhaps due to signs of sterling weakness following his comments. Nevertheless, he has given us the opportunity of assessing the effectiveness of quantitative easing so far.
The policy is not well understood (the Bank provides a somewhat rosy summary here). As they note, it consists mostly of purchasing government bonds in the open market, paid for by new money created by the Bank.
The idea is pure monetarism. Like Milton Friedman’s famous “helicopter drop”, the injection of money into an economy where the supply of goods and services is largely unchanged is expected to exert upward pressure on the price of those goods and services.
Even the money dropped by Friedman’s helicopter would need spending to have any effect, however. If those standing under the helicopter simply stashed the notes under their beds, prices wouldn’t be forced up.
This is where QE tends to get a little too much credit. The Bank undertook purchases of some £200bn worth of government bonds beginning in March 2009 before formally suspending the programme at that level in February of this year. Now by pure coincidence, from the end of February 2009 to end Feb 2010, the size of the UK government bond market, as measured by the nominal amount of gilts outstanding, increased by about £200bn.
In other words, just as the Bank waded in to the gilt market to swap bonds for its newly minted cash – which it hoped would then filter into circulation – the government waded in to swap the cash for bonds again.
Let’s return to the image of the helicopter drop. Imagine that you were in the crowd underneath the helicopter and had managed to scramble successfully for £50. Then, as the helicopter flies away and you are about to put the money into your wallet, you feel a tap on your shoulder. You turn to see a man standing in front of you with a knife, who mugs you for it. Would you feel like the beneficiary of a windfall and embark on an inflationary spending bonanza, or would you put your wallet away in bewilderment, feeling as if the whole exercise had been an elaborate distraction?
Of course in this case the mugger could go and spend the £50, but when it comes to QE the government did not expand their budget in response to the windfall: they would have borrowed and spent the same amount of money whatever the complexion of participants in the gilt market. The best that can be said is that the contribution of the Bank’s policy to a downward movement in gilt yields will have saved them some money in debt interest payments, but that will have amounted to a small fraction of £200bn.
This analysis may seem strange in light of occasional fevered commentary about hyperinflation. But QE’s lack of effectiveness can be confirmed by reference to the Bank’s own measures of success listed on its website under, “Assessing the Impact of Asset Purchases“:
The MPC … will pay close attention to the growth rate of broad money, the cost and availability of corporate borrowing, measures of inflation and inflation expectations, and developments in nominal spending growth.
So … The growth rate of broad money? 1.9% on the year to August, down from 17% when the Bank began QE. The cost and availability of corporate borrowing? Much improved if you look at the corporate bond market, but not so much if you go by the Bank’s periodic surveys of UK credit conditions. Inflation? Up 3.1% on the year to August on the CPI measure as against a near-identical 2.9% in March ’09.
In reality, then, what looks like a very dangerous policy has only had relatively minor, indirect effects. Which is not to say that a Bank keeping interest rates at emergency levels in the face of price behaviour that has already become problematic, and whose officers go about talking the currency down at the same time isn’t taking risks with inflation. Just remember that the next time a policymaker teases us with the prospect of more QE, it doesn’t necessarily do to get all that excited.