Archive for March, 2016

Nobody Knows

During the summer of 2015 this blog dedicated a post to “Brexit”. The discontinuation of the United Kingdom’s European Union membership had become a possibility on the strength of a wafer-thin 12-seat governing majority won in May of that year by the only political party offering a referendum on the subject. Back then, it looked likely that

The economic consequences will equally obviously be argued over with increasing volume as the date for the Breferendum approaches. There is little to be gained by getting into that argument now as the actual consequences would depend on the options available to the UK should the decision to leave the EU be taken.

Lately, however, several analysts have been putting out research pieces making market calls on Brexit. This week the Chancellor himself joined the fray, trying to make it seem during his Budget speech that the Office for Budget Responsibility were all for “remain”. So what has changed? Do we know any more now about the economic or market consequences should Britain vote on 23 June to regain full political self-rule than we did the previous summer?

Mr Osborne said to the House of Commons on Wednesday that such a vote could entail “an extended period of uncertainty” which could depress “business and consumer confidence” and might mean greater volatility in markets. Couched itself in uncertain terms, it was damaging uncertainty which thus formed the substance of the Chancellor’s argument for the UK’s continued adherence to Brussels, and which forms the substance of those of others on his side of the discussion.

Dealing with what ought to be the most obvious point first: markets are quite capable of exhibiting volatility without political assistance. Just look at the past 18 months. First, tumbling oil took 90-day historic volatility on the S&P 500 to its highest level since mid-2012. Then the turmoil over the summer and into the end of last year pushed it up further, into a range not seen since the panic over eurozone sovereign debt and the attendant market crashes of 2011. A Brexit vote might well ginger markets up a bit, but this is nothing new: it has nothing to contribute to the argument one way or another.

The point about business confidence specifically, as opposed to the impact of any future post-Brexit agreements on international trade, needs to be addressed in two different ways.

Firstly, there is now evidence on this subject from business leaders themselves, and they are divided: as the referendum has drawn closer, British executives, entrepreneurs and spokespeople have come out on both sides of the debate. Foreign investors, too, have given conflicting guidance. JP Morgan and Goldman Sachs announced donations to the “remain” side back in January, and other Wall Street firms have considered throwing in their lot, hinting at their preparedness to move to Frankfurt or similar. On the other hand, overseas car firms with UK plants began indicating a strong willingness to look through the vote and stay invested in Britain as far back as the autumn. So far, then, there has been uncertainty, but no more concerted gloom from businesspeople than there was several months back.

Secondly, as with markets, the corporate sector – including financial services – must have an eye to considerations beyond the political. Skill sets, regulations, tax, costs – including relocation costs – and other factors all enter the mix. Again, this is nothing new: whatever the decision in June, Mr Osborne and his successors at the Treasury are arguably more important in this context.

Consumer confidence is driven by earnings, employment, house prices, inflation and interest rates. The more secure we feel in work, the more we have to spend and the more stable the required level of our spending on goods and services, the greater our confidence in the economy and the more aggressive our activity within it. The impact of Brexit on those factors is no clearer today than it was after the general election.

Finally, much of the economic analysis of Brexit has centred on the pound. The consensus seems to be for devaluation to one degree or another (20% from Goldman Sachs earlier in the year). Yet when Scotland looked like it might vote to leave the United Kingdom back in September 2014 the most significant one day fall in the trade weighted sterling index was -0.9%. The splitting up of the currency’s economic area was a real prospect at that time yet it hardly budged. Again, this analysis is purely speculative, and for the same, over-arching reason: it is trying to analyse something which doesn’t exist.

Should the UK “vote leave” this June, then, there may be market turbulence attributable to this. Nobody knows – just as nobody knew back in the summer.

Brexit would be a historically significant political event, not an economic one. And should it occur, then whether it would present more of a threat to or opportunity for the country’s economy would depend on the political response.

Readers may well have their own opinions on how confident, or otherwise, to feel about this.

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18/03/2016 at 5:28 pm

Mountain Or Molehill?

As market bears know all too well, one of the world’s crushing problems at present is China, and everything connected thereto. At the height of the panic which made for such an enjoyable start to 2016, one specific pointer towards China’s imminent and terminal doom was identified as her debt “binge”. Only this Wednesday, this very same binge headlined a blog post from The Economist magazine which warned:

“DEBT in China is piling up fast. Private debt, at 200% of GDP, is only slightly lower than it was in Japan at the onset of its lost decades . . . and well above the level in America on the eve of the financial crisis of 2007-08 . . . The value of non-performing loans in China rose from 1.2% of GDP in December 2014 to 1.9% a year later. . . .”

Specifics such as these betoken credibility. Yet they also invite questions. What does “private debt” mean? Which matters more: the 1.9%, or the 200%? What are the equivalent numbers for the other economies mentioned?

Let us start with the components of “debt” in China. First of all the only one which the bears seem not to want to mention: sovereign debt. This is estimated at 43% of GDP by the IMF on a gross basis for 2015. At the same time, however, China has huge sovereign reserves – about $3.2trn at the moment, again on IMF numbers, which is about 31% of 2015 GDP. With the country targeting a fiscal deficit of 3% this year and reserves trending downwards since 2014 it is true that the country’s sovereign debt position is deteriorating on a net as well as a gross basis but it should be obvious that it is nobody’s idea of a crisis. (UK sovereign debt was 88% of GDP on the same, gross basis in 2014, the eurozone’s over 90%, the USA’s over 100% and Japan’s approaching 250%.)

The “private debt” figure mentioned in the quote comprises a corporate (non bank) debt ratio of 165% and household ratio of 40%. That sounds a lot scarier than 43%. But it is not far off similar figures in other places. Only yesterday the Federal Reserve published America’s balance sheet for last year showing non-bank corporate and household debt of 74% and 82% respectively, making “private debt” of 156% altogether. Lump in sovereign and financial sector debts too and the total comes out at a cool $63.4trn, or 364% of US GDP. (The equivalent figure for China is 247%.)

The UK’s balance sheet comes out even worse than this on a broad basis due to the massively distorting impact from the financial sector. According to our own balance sheet, our total financial liabilities for 2014 came out at a nice, round £30trn, or about sixteen and a half times our GDP that year. Use net figures for the financial sector, however, and this plunges down to a much less startling 487% of output, of which a mere 349% is that “private debt”.

These sorts of numbers are esoteric territory, and not usually visited by relevant parties such as ratings companies. There are reasons for this. Vast swathes of the figures are prone to uncertainty and conceptual artificiality, for instance. We can look at government budgets, and bond yields, and arrive at a view on the sustainability of a country’s debt position. But what is the household sector surplus, or deficit?

Let us draw a line under these “private” or “total” debt to GDP arguments now and move on to non-performing loans. The banking system NPL ratio did rise from 1.5% to 1.6% in 2014 and will have risen further last year. The government is working on new measures to convert NPLs into equity stakes in struggling companies and one can read this bearishly. Whatever the final announcement and accompanying figures on this front, however, we do know that the required reserve ratio for major banks stands at 17% despite recent monetary loosening, up from 7.5% a decade ago. We must, as always, wait and see. The time bomb expected from Chinese trust investments two years ago failed to detonate, but bond defaults have been making headlines. Perhaps this time the country’s banking system, strongly capitalised as it is, will blow up in the face of an NPL crisis the government is already taking measures to manage.

The Chinese economy, like all economies, has its problems. And like the problems of other countries, some of these are local in nature. But in talking up a catastrophic debt burden where none really exists the bear case overreaches itself. There is enough out there to worry us in the real world – we do not have to look for phantoms.

11/03/2016 at 4:22 pm


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