Archive for March, 2012
Among the burdens weighing on markets this month has been renewed concern over the prospect of a slowdown in China. In particular, the country’s growth target was revised down to 7.5%, data on exports and foreign investment were weaker than expected, and activity surveys have been a mixed bag. And there are many who await a catastrophic collapse of the property market following years of eye-watering growth.
Some of these concerns are more valid than others. Take the official growth target, for instance. This has been running at 8% for the past 8 years, during which time the pace of expansion actually averaged over 10%.
The property market is scarier. There have been signs of a slowdown in the official data for some time, which anecdote suggests could be far worse. (The reliability of Chinese statistics is a constant cause for concern.) But even here, the slowdown comes as a result of government action – action which at the level of monetary policy took the form of aggressive increases to the reserves required to be held against lending by the country’s banks. The credit crunch was so devastating in its effects partly because it took western policymakers by surprise. The same cannot be said of China.
Furthermore, an important side effect of hiking the required level of capital reserves in the banking system (currently 20.5%) is that it ought to prove more resilient in the face of write downs, limiting the impact of any property bubble on the wider economy. And taking a step further back, even if any banks do need bailing out this won’t be a problem for a nation with no government debt to speak of and over $3,200bn in reserves.
It is the foreign investment and export data, however, that reminds us just how remarkable the Chinese experience has been in recent years. While FDI last month was 0.9% lower than a year earlier, it contracted at rates of over 36% at the nadir of the credit crunch. At the same time, exports – rising at a “disappointing” 18% at present – fell by over a quarter. And amidst the wholesale collapse of its foreign markets, real growth in China’s GDP bottomed at +6.2%.
This was nothing short of incredible. It proved that China’s expansion had organic momentum, something which had disastrously eluded the “Asian Tigers” a decade earlier for example. And while China is the world’s second largest economy in terms of dollar output, if we divide that output by the country’s huge population we find that it remains quite poor in per capita terms – about 90th in the world rather than second, alongside the poorer parts of eastern Europe or the Caribbean. Growth in domestic demand should have a lot further to run.
This “year of the dragon” has got off to a rocky start. The bear case on China – and Chinese real estate in particular – has some merit. But the risks are known and are playing out against a constructive background. If the country could weather the international events of 2007-9 in the way that it did, markets may well be underestimating its resilience to a home-grown shock.
As some commentators have pointed out, this year’s Budget took place in the context of a threat to the UK’s AAA credit rating. Only last week, ratings company Fitch put the country on “negative outlook”, meaning that it sees a slightly greater than 50% chance of a downgrade over a two year horizon.
It was accordingly fortunate that some improvements in his economic forecasts meant that Chancellor Osborne was able to announce a slight fall in the projected peak of the UK’s national debt, revised down to 76.3% of GDP in fiscal 2014-15. He made specific mention of the figure in his statement. Fitch has since gone on the record to say that the reduction is modest and that their stance is unchanged: should the Chancellor deliver on his targets the AAA is likely to be affirmed, but in the meantime it remains vulnerable to shocks.
The number they cite, however, is a peak of 92.7% of GDP in 2014-15. At first glance this might appear confusing, or even incorrect. But in fact both numbers are right.
The government’s preferred measure of borrowing is “net debt” – the value of its liabilities less the value of its liquid assets (e.g. the cash it keeps in the bank to cover spending). This is where the 76.3% comes from. The 92.7% reflects the country’s “gross debt”: liabilities only.
That the difference is so large – 16.4% of GDP, or some £293bn in future cash terms – is interesting in itself. What is also interesting is that the UK reports the 92.7% figure (on p. 109 of the full Budget document for those interested) as the “Treaty debt ratio”: the treaty concerned being the Maastricht Treaty of 1992, under which the calculation of government borrowing statistics is governed across the EU.
In fact it is gross debt to GDP which is generally quoted in respect of Europe’s indebted economies. Italy’s fabled 120% debt-to-GDP ratio, for instance, falls to 100% on a net basis according to data from the IMF. In the case of Japan the difference is even more astonishing: the IMF projects a whopping 238% debt ratio for 2012, but on a net basis the figure is only 139%.
The real point, however, is that we must be careful to compare apples with apples. A casual listener on Wednesday might well have thought that the highlighted figure of 76% was directly comparable with the 120% for Italy, for instance. The truth is a little less flattering.
Nevertheless, progress is being made in Britain. This is underlined by yet more excitement from page 109: the figures for “Total managed expenditure” (government spending) as a % of GDP. On current policy this is projected to fall from 45.8% this year to 39% in five years’ time, at which time the budget is broadly expected to balance.
One final international comparison: 39% of GDP is about what Greece has been raising in revenue over the last few years. This may come as a surprise to those who believe the country somehow went broke through tax evasion. The problem for the Greeks was that while raising 40% of GDP, their government was consistently spending even more. Such evasion as undoubtedly takes place might be regarded as evidence of the Laffer curve: the economic theory stating that once tax rates reach a certain level, revenues stop increasing (and begin to decline if rates keep going up). Here in the UK, the disappointing results from the 50% rate of income tax provide a parallel illustration.
If there is one lesson for governments to draw from the recent crisis it is that spending must have its limits. Europe has been forced to acknowledge this in the most brutal manner. In Britain we have had an easier ride from the markets but the arithmetic points to the same conclusion.
There are still plenty of commentators who see fiscal consolidation – “austerity” – as some kind of demand-dampening mistake. The fact is that there is a limit to what states can raise in tax and borrowing. Sometimes spending cuts are all that is left. Sometimes there is, to coin a phrase, no alternative.
Yesterday afternoon, the following three items topped the list of worldwide headlines on the Bloomberg terminal:
- Initial Jobless Claims in U.S. Declined Last Week to Match a Four-Year Low
- Wholesale Prices in U.S. Rose by Most in Five Months on Higher Fuel Costs
- New York Area Manufacturing Expanded in March by the Most Since June 2010
There, in three lines, was a neat overview of the US economy: strengthening recovery, growing employment and rising prices.
Now compare this to the so-called “dual mandate” of the Federal Reserve, which as well as inflation is supposed to keep an eye on unemployment. As detailed on its website:
The Congress established the statutory objectives for monetary policy – maximum employment, stable prices, and moderate long-term interest rates – in the Federal Reserve Act.
In practical terms, maximum employment is taken to mean an unemployment rate of 5.2-6% and price stability to mean 2% inflation in the personal consumption expenditure component of GDP. Nobody talks much about the “moderate long-term interest rates” part (though technically as we see the Fed actually has a “triple mandate”). But – just for fun – if we look at the 10-year US government bond yield, it has averaged a shade under 5% for the last twenty years. It now stands at 2.3%.
This is of course down to the emergency monetary policy framework that has been in place for over three years now and that has among other things seen the Fed’s target rate set close to zero and substantial intervention in government bond markets by the central bank.
Over recent months, however, the unemployment rate has fallen from a high of 10% to 8.3%, and this week’s continued strength in the jobless claims numbers suggests further falls to come. In other words, the rate is about half way between its 2009 peak and the 6% level identified by the Fed itself as being consistent with its mandate to accomplish “maximum employment”.
Similarly, the rate of inflation attaching to personal consumption expenditure was measured at 2.4% on the year to January, a little higher than the long run 2.1% average (and the 2% level recently settled on by the Fed).
The obvious question is: with growth, price behaviour and employment consistent with or returning to normal levels, for how much longer will monetary policy remain the odd one out?
In recent statements, Fed Chairman Bernanke has emphasised the employment part of the central bank’s mandate, remained very guarded in his assessment of the US economy and affirmed the Fed’s view that near-zero rates will be with us until late 2014. Futures markets are no longer quite so dovish, pricing in a 50bp increase or so over the next two years.
Obviously Mr Bernanke doesn’t want to frighten the horses. But with the US economy behaving as it has done in recent months, 2014 seems a long time to keep interest rates at their lowest ever levels.
The average target rate for the Fed over the last twenty years, to the nearest quarter point, is 3.25%. It’s not an especially high level. It is, however, very far from being priced in by markets over the next few years, and from where we stand today the increase required to get back there looks like quite a climb.
Another year, another headline about record petrol prices in Britain. A combination of higher oil prices and a weaker dollar exchange rate is conspiring to cause the usual misery at the pumps.
Indeed, the price of oil as measured by the near Brent crude future had risen by 17.5% into yesterday’s close since the beginning of the year. This has been a tough act to follow. The MSCI World Index of developed-economy equity markets has put on only 10.3% in price terms over the same period; most major government bond markets have sold off, and corporate bonds of varying stripes have turned in performances lying somewhere in between.
Part of oil’s shine can be attributed to fear. Iranian sanctions and the possible threat of supply disruption through war have loomed large in the market’s mind. At the same time, however, Libya has begun to produce again. Production had almost halted as the Gaddafi regime finally collapsed over the summer, but by last month, OPEC estimates put Libyan crude supply at over 1.1m barrels per day. As well as fear, therefore, it seems that greed has had its part to play as financial markets have become somewhat less averse to risk in recent weeks.
We have already seen that such behaviour is not without foundation. Economic data from the US in particular has been strong, and European policymakers are once again enjoying that most valuable of commodities, the benefit of the doubt. Now the data has not been unequivocally positive and as ever we should be careful not to get ahead of reality. But it is worth remembering that a rise of some 25% would be required for the S&P GSCI index of spot commodity prices to recover its 2008 peak.
Weaker commodities, until recently, furnished the eurozone crisis with a valuable silver lining. Even in the UK, price inflation has fallen back to an unpleasantly elevated level (from the economically damaging rates seen during the recent period of explicit and de facto rises in indirect taxation). But much more of the kind of performance we have seen from commodities this year and inflationary pressure from rising energy and input costs will be back with us.