Tuesday, January 13, 2009

Surprise! Our Brian's new 'foot-in-mouth' outbreak

As stated in the Financial Times today (here):

"Brian Lenihan, the Irish finance minister, accused the UK authorities of, in effect, devaluing the pound by expanding the UK money supply, action that was causing “immense difficulties” in the Irish economy. “It is a question for all of us in the EU as to the extent to which a competitive devaluation can be used as any kind of weapon,” he said."

Oh, dear. Our Brian does not get it - British monetary policy is about British economy. It is not - and should not be - about some abstract idea of European solidarity (which seems to work for our Government only when solidarity means that others do something 'nice' for Ireland) or coordinated responses to the crises (if the UK were to coordinate things with Ireland, they would be rising taxes, squeezing consumers, issuing blanket guarantees and wasting billions on inefficient public sector).

Whether the UK is engaging in a competitive devaluation, or is simply conducting more pro-active monetary policy than 'we-don't-give-a-damn-if-you-are-in-pain' ECB is a moot point. Bank of England has a mandate to manage money supply for the UK. British Exchequer has a mandate to respond to the real needs of the UK economy. It is Brian Lenihan who has a mandate (if only theoretically) to sort out his own Government's response to the crisis in Ireland. Does the fact that the latter does not seem to be up to his job imply that the former two are obliged to help him finance his wobbling decision-making?

Oh, when one hears an ex-lawyer talking about Forex valuations, ...it sounds only half as bad than when one realises that he is in charge of our entire Exchequer!


Paul MacDonnell said...

Yes but look at this from today's WSJ...

We're All Keynesians Again
Nobody can accuse the government and the Fed of inaction.


In 1935, six years after the 1929 Crash, the U.S. remained mired in the Great Depression -- as it would be for five years more. At a congressional hearing, then Federal Reserve Chairman Marriner Eccles told Rep. Thomas Alan Goldsborough (D., Md.) that there was very little the Fed could do beyond what it was already doing to pull the country out of the doldrums.

"You mean you cannot push on a string," said the congressman.
[Commentary] AP

"That is a very good way to put it," replied Mr. Eccles. "One cannot push on a string. We are in the depths of a Depression and beyond creating an easy money situation through reduction of discount rates, there is very little, if anything, that the reserve organization can do to bring about recovery."

The Fed is in that position once again. With a federal-funds interest-rate target near zero, the Fed has pumped tons of newly created dollars into the economy over the last four months. This has doubled the monetary base (bank reserves and currency), a phenomenal increase that has shocked market watchers and raised fears of inflation. But all economic indicators are flashing recession.

Last week brought the dispiriting news that the U.S. suffered a net loss of 2.6 million jobs in 2008, the most since 1945. Now 7.2% of the work force is idle. New factory orders, housing construction and retail sales have shriveled. Mortgage foreclosures are rising.
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Last year's crash was caused primarily by the deflation of a real-estate bubble that those two government-sponsored behemoths, Fannie Mae and Freddie Mac, had a large role in inflating. As the Japanese demonstrated in 1990, real-estate crashes cause far more collateral damage than mere stock-market slumps. It's amazing that the U.S. policy makers chose to ignore the danger, despite repeated warnings from these pages.

Between 2002 and the fall of 2007, funds raised in U.S. credit markets nearly doubled. Talk about a credit explosion! Easy money, much beloved by politicians and Wall Street, is a sure recipe for an asset bubble.

So the Fed is again in the position of "pushing on a string" and finding that nothing happens. Some economists describe this as a "liquidity trap." Money creation loses its stimulative power -- vastly overrated even in ordinary times -- because public demand for loans is weak. Americans are too strapped financially, too short on investment opportunities, or too concerned about the future to borrow. They prefer to save instead.

Some economists argue that "trap" is an inappropriate description. The new money the Fed has pumped into the economy to replace the financial-sector liquidity wiped out by the collapse of the bubble has to go somewhere, they point out. It has to end up in someone's bank account and banks have to quickly convert deposits (liabilities) into investments or go broke even faster than some have by loading up on polluted, mortgage-backed securities. Maybe "liquidity malfunction" is a better term than "trap."

With 30-year mortgage rates now hovering near 5%, banks are spending a lot more of their time and resources responding to householder demands for refinancing at the lower rates. That doesn't do much for bank profits, but it does improve household balance sheets, cushioning to some degree the impact of the recession.

But what the Fed has mainly been doing since Black September has been transferring economic resources to government from the private sector on a massive scale. There is one thing the banks can do with their deposits if they can't find willing and qualified borrowers -- the word "qualified" was rather neglected when Fannie and Freddie stood ready to buy any cats and dogs offered. They can put those deposits into U.S. Treasury securities.

Banks and investors around the world fleeing for safety have been doing just that, holding down federal borrowing costs, at least temporarily. The global flight for the presumed safety of Treasurys has also shored up the U.S. dollar in foreign-exchange markets, sending crude oil prices plunging. Because of the Treasury mania, 30-year Treasury bonds were yielding only 3.06% and the popular 10-year bond 2.39%.

So the Treasury has a good deal. The Fed pumps money into the economy by buying Treasurys with checks written on thin air. The Treasury quickly spends those dollars on the huge ongoing expenses of a government running a trillion-dollar deficit. Recipients of its spending put the money into bank accounts and, presto, the money comes right back to the Treasury to finance yet more government spending.

The government is thus the main beneficiary of the phenomenal rise in the monetary base. The base remained relatively stable through the ups and downs of Fed interest-rate policies in this decade, until it went on its fourth-quarter skyrocket trip. For what it's worth, Fed Chairman Ben Bernanke, a student of the 1929 crash, has at least made sure that no one in the future will be able to accuse him of starving the economy into a Depression, as conventional wisdom has held that the Fed did 80 years ago.

Keynesians were banished in the 1980s by Reaganomics but made a comeback years ago and again control U.S. levers of power. They argue that massive deficit spending by the federal government is the right policy for these times. Paul Krugman of the New York Times has asserted that the Great Depression lasted 10 years because the New Deal didn't spend enough. Japan tried to spend its way out of its postbubble malaise in the 1990s but ended up with a mountain of debt and a "lost decade" of little or no economic growth. Nevertheless, the incoming Obama administration is promising close to a trillion dollars in fiscal stimulus, and the Bernanke Fed seems to believe the way to deal with a collapsed bubble is to reinflate it. That of course takes no account of how we got the bubble in the first place.

Well, there's a lot of high-powered money out there in the huge monetary base the Fed has created. It's at the Treasury's disposal. All that can be said to the Keynesians is, "better luck than last time."

Mr. Melloan is a former deputy editor of the Journal's editorial page.

Paul MacDonnell said...

And then there's this from Money Week...

How Gordon Brown can help us all – cut taxes and stop spending

Let’s remind ourselves of why it doesn’t pay to pay attention to ‘official’ economic forecasts.

A year ago, a few people were still debating whether there would actually even be a recession in the UK. Even if there was, the general feeling was that it would be a short-lived little affair.

But now, apparently, this recession is already worse than the one in the 1990s, according to the British Chambers of Commerce. The manufacturing and services sectors had a dreadful fourth quarter, while retailers have just seen their worst December on record (although bear in mind that the records in question only stretch back 14 years). According to the British Retail Consortium, like-for-like sales fell 3.7% year-on-year.

How much worse can it get? Oh, there’s a fair bit of room to fall yet...

More job losses are on the way

The front page of the Telegraph business section this morning surveys the carnage of the British economic slump. Manufacturers and retailers are seeing activity collapse. The situation in the property market became even worse in December – something few people thought possible – with average sales per estate agent hitting a fresh all-time low of less than one home a week, according to the Royal Institution of Chartered Surveyors (Rics).

Bear in mind that an estimated 32,000 estate agents have lost their jobs since the start of this crisis. I’m not entirely sure how this impacts on the Rics figures, but presumably it casts the sales per agent figure in an even worse light – a huge amount of competition has been taken out of the market, and yet even the agents who are still standing are seeing sales fall.

Unsurprisingly, all this economic misery is not good for jobs. Rising house prices have supported spending and construction activity for years. Now that they are falling, spending is too, and no one can afford to build anything any more.

A total of “almost 4,000 jobs were cut or placed in immediate jeopardy yesterday,” says The Telegraph. Jobs went at Waterford Wedgwood, Waterstone’s and logistics group Wincanton, among others, while furniture retailer Land of Leather fell into administration. Digger maker JCB cut 684 jobs, saying that “the lack of available credit from banks had meant that its customers had been unable to afford new diggers.”

This last comment is interesting. It continues to push this idea that if only the banks would lend money, people would be buying stuff. But why would anyone want to buy a digger right now, credit or no? What exactly would they build? ‘Luxury’ city centre flats? Got a few too many of those already. Office space? Maybe not. Shopping centres? You get the picture.

Why the latest efforts to prop up the job market won't work

Meanwhile, the Government’s latest efforts to prop up the job market are just plain stupid. Gordon Brown unveiled a new initiative to get the “long-term unemployed” back to work. From April, companies will be paid £2,500 to recruit and train people who have been out of work for more than six months.

This would be hilarious if it wasn’t so depressing. If the long-term unemployed couldn’t manage to get themselves back to work during a boom period when unskilled Poles and hard grafters of all other nationalities flocked to our shores to snap up jobs, why on earth does he expect them to do so now?

We’re entering a period where decent new jobs will be like gold dust. Companies are not going to be hiring willy-nilly. When they do, they will be swamped with applicants. So the prospect of getting £2,500 to train a low-calibre candidate should not be very tempting, when they can easily pick up highly-skilled, eager-to-work casualties of the downturn instead.

Of course, it fulfils Mr Brown’s mission to be seen “doing something.” Yesterday he argued that “failure to act now would mean a deeper and longer recession” which would mean “lasting damage to our economy and a bigger bill to pay in the future. That will not happen on my watch.” They’re his usual macho soundbites. But they conveniently ignore the fact that the sum total of Mr Brown’s actions over the past decade have been to lead us into this financial crisis – quite possibly the worst in living memory. If only he had simply spent the past decade “doing nothing”, we might all be a lot better off now.

Cutting taxes is what would really help the economy

If it really has to, the Government could still do something - it could cut taxes. That would put more money in people’s pockets, which they could use as they wished. It could cut spending on unproductive non-jobs to pay for it – there are arguably plenty of people in quangos and in public sector middle-management posts who would cost the taxpayer far less and do far less damage on the dole than in their posts.

But this won’t happen. Rather we’ll get a load of high-profile, high-spending, wasteful initiatives that will drive us deeper into the hole we’re in. Don’t bet on a rapid recovery for the British economy – Mr Brown will see to that.

TrueEconomics said...

Both are excellent contributions, Paul, but I like the second one most. This is right - cutting UK VAT was the UK help to Ireland, because it gave Irish consumers, at least within 100 miles distance from the N Irish border a chance to save some of their dwindling incomes from the hands of our public sector sharks. In effect, Gordon Brown, unintentionally gave Irish economy a boost -
* in retail sector: a boost to the case for more price and cost competitiveness;
* in consumer sector: a boost to households balance sheets.

The only thing the UK can do more to help us in Ireland now is to cut VAT even further and, may be, provide free buses from the Republic to Newry so people without cars can get to cheaper goods and services in the North.