Sunday, 31 October 2010

Mr Bernanke’s Gamble

Events are unfolding that could lead us interesting times. The US corollary to Mr Osborne’s gamble is a gamble by Mr Bernanke – of equal intent, but with far greater magnitude – to kick start the American economy. This is something of an untried experiment, to combine fiscal tightening with monetary easing in order to fine tune the economy, and we have yet to see how well it will go. There is a real danger of diminishing returns (QE2 will yield less stimulus per £ or $ injected) that may render the medicine unhelpful. More fiscal stimulus would do the trick, but there is little appetite for this at present.

The fears of QE2 inducing a bout of inflation still seem to be far fetched. That could be an effect, but the output gap is absolutely huge in the US. Economists might talk about the ‘output gap’ in an impersonal way, but in the US, ‘output gap’ means people living in cars, people without healthcare, people who have to give up their education. Perhaps economists, who are in no position to talk about moral hazard, ought to give some thought to the consequences of their trade a bit more?

© The European Futures Observatory 2010

America's economy: Not by monetary policy alone | The Economist

Friday, 29 October 2010

Anyone For Tea?

The forthcoming mid-term elections have taken on the hue of a referendum on the popularity of President Obama. A mere two years ago, the President was billed as a new and dynamic political force in America. His rally cry was ‘Hope’, his exhortation ‘Yes, we can.’ And yet, the programme seems to have come off the boil. ‘Hope’ now turns out to be ‘Hype’ and, in an unguarded moment on a TV show recently, he now says ‘Yes, we can. But, …’ If the polls are anywhere near to being correct, the President’s party is facing a substantial defeat in the voting next week. As an outsider looking in, I am interested in why America has fallen out of love with Obama? Why is it that his opponents are so hostile towards him? What exactly is driving the extreme views of the Tea Party opponents to the President?

I guess that the single word answer is ‘recession’. America is experiencing a recession that is at the worse end of the OECD experience, and this is exposing some of the fractures within American society. However, we like to take a longer view of these fractures in seeking an explanation.

According to Edward Luce of the FT, “the annual incomes of the bottom 90 per cent of US families have been essentially flat since 1973 – having risen by only 10 per cent in real terms over the past 37 years”. This is quite an interesting statistic because it also explains so much. If income has flatlined in this period, and living standards have been increasing, then how has the American Dream been paid for? By an increase in household debt. It would appear that American consumers have been borrowing to improve their living standards. A good part of this increase in debt was underwritten by a boom in the housing market, as households used their mortgages as credit cards.

Of course, there is nothing inherently unstable about this money-go-round until the music stops. Once that occurs, then everyone wants to ditch the parcel rather than being left with a dud asset. As the credit crunch – essentially a financial phenomenon – bled into the real economy, the resulting recession has had two important consequences. First, there is an acute shortage of credit to finance further expansion of consumer expenditure (more on this later), and second, there arises unemployment at sufficient volumes that the servicing of existing debt is called into question.

This is compounded by the composition of the borrowers. Many of those who have borrowed to finance their lifestyles are of the Boomer generation, and one thing that characterises the Boomers is their deep sense of entitlement. We now have a situation where a generational cohort, who are accustomed to being treated like spoilt children, have had their toys taken away from them. They are angry. They are angry enough to form Tea Party groups. They are angry enough to call into question whether their own President is American. They are angry enough to give credence to extremists such as Glenn Beck. And they may just be angry enough to vote into office someone like Christine O’Donnell, who is manifestly unfit for office.

It could be quite easy for Europeans to become smug over the discomfort of America. However, just an element of deep thought stops this train of thought. It is the angry, white, lower middle class who are giving electoral backing to the Neo-Nazi parties in the UK. It is the respectable burghers who are giving electoral support to the anti-Islamic parties in the Netherlands. It is the middle class establishment who are behind the hounding of the Roma in France and Italy. There are angry middle class voters across the developed world at the moment.

This is likely to be a feature of our near future. If recovery is sluggish (the best case scenario) or if recession makes a re-appearance (the worst case scenario), it is unlikely that middle class household balance sheets will be repaired quickly. In the past, the world has waited for American households to start borrowing to finance their consumption, thus kick-starting the world economy. This is unlikely to happen for some time – American households are simply too maxed out. This suggests that middle class anger will remain for some time to come, which will make our politics just a little more xenophobic and our economies just a little less globalised.

We call this trend the ‘New Nationalism’.

© The European Futures Observatory 2010 / Reportage - The crisis of middle-class America

On the Way Down: The Erosion of America's Middle Class - SPIEGEL ONLINE

BBC News - Number of Americans living in poverty 'increases by 4m'

Glenn Beck Leads Religious Rally at Lincoln Memorial -

BBC News - Profile: Christine O'Donnell, Delaware Senate candidate

Growing Number of Americans Say Obama is a Muslim: Pew Research Center

Thursday, 28 October 2010

Ageing Europe

We often hear the argument that, over the next decade or two, the European economy is likely to come off the boil owing to the ageing of the population of Europe. This is, and always has been, stuff and nonsense. The forecast only makes sense if everything stays the same. Of course, it doesn’t.
To start with, the enlargement of the EU has brought into Europe tens of millions of young workers from Bulgaria and Romania – they will make an appearance in the European jobs market from 2014 onwards. Then there are the tens of millions of young Turks whose hopes are pinned to Turkish accession. And then, on top of that, there are tens of millions of youngsters in North Africa, who are awaiting the spread of Europe across the Mediterranean. All of these will swell the European workforce.
Of course, there are those who do not want to see an enlarged EU. Their answer to the impending labour crisis is to enlarge the workforce organically – mainly by raising the age at which Europeans retire. It is in this context that the recent raising of the French retirement age can be viewed. France is lukewarm about Turkish accession to the EU, which implies that French workers will have to retire later as a consequence.
© The European Futures Observatory 2010
BBC News - Q&A: French strikes over pension reforms

Wednesday, 27 October 2010

Ever Increasing Union

It is often argued that the fragmentation of the EU at the national level is one of the handicaps that is preventing Europe from achieving its full commercial destiny. The cause of integration is seen to be at the heart of the European project, which is why infrastructure projects take such prominence. During the industrial revolution, rail provided an integrating force, but at the national level. Rail is now set to provide an integrating force at the European level. The link between London and Cologne is really quite important – Cologne is the rail hub that opens Scandinavia, The Baltic, and Eastern Europe to traffic from Western Europe. I am sure that the Franco-German tiff will be resolved. They usually are. What excites me is the prospect of the pan-European service being available from 2013.
Of course, all this is saying is that I am a rail fan rather than a fan of flying. Guilty as charged!
© The European Futures Observatory 2010
A Franco-German train tiff: Ils ne passeront pas | The Economist

Tuesday, 26 October 2010

Bush III

So much for the hope create by Obama’s election. In one way, he is behaving like the third Bush. On coming to office, there was a solemn promise to close Guantanamo Bay within a year. That deadline came and passed. He is still pursuing with the Military Tribunals – a judicial black hole where ‘normal’ trial rights are suspended, where public reporting is suspended, where evidence based upon hearsay, coercion, and torture is admissible. There are those who argue that the pursuit of the military tribunals is a war crime in itself!
We now have the case of Omar Khadr. A young man from Canada who was coerced into a confession by the threat of being gang raped to death has now entered into a plea bargain with his US prosecutors. If he pleads guilty, which he has, he will be eligible to serve any remaining time in his native Canada. It is hard to see which injustice cries the loudest.
Is it the extraction of a confession under duress? Is it a plea bargain where a guilty plea brings a much lighter sentence? Is it his complete abandonment by Canada?
I have never thought highly of Obama – to me he is just another US President of the same mould, more hype than hope, perhaps – but I did used to think highly of Canada. I’m less inclined to do so now.
© The European Futures Observatory 2010
BBC News - Canadian militant pleads guilty at Guantanamo tribunal

Monday, 25 October 2010

Productivity–vs- Competency

The public sector is pulling back in the expectation that the private sector will expand to fill the gap in terms of services and social care. The reasoning behind this is that the private sector has a higher labour productivity than the public sector. Normally it does. However, nothing is without cost. Higher productivity in private sector basically means that the job is done cheaper than the public sector could do it. We tend to think in terms of public sector waste (one source of productivity loss), but we should also think in terms of private sector incompetency (one source of productivity gain). One way in which higher productivity is delivered is through cutting corners in staff costs – usually by not training staff adequately to do the job.
The case of the poor man who was left brain dead by incompetent private sector agency staff who were not trained adequately for their outsourced public sector role provides a taste of what is to come in the next few years. It would be a shame if the cost savings from the outsourced social and health services were simply absorbed into higher lawyers fees resulting from the level of incompetence (and negligence) derived from swapping productivity for competence.
© The European Futures Observatory 2010
BBC News - Tetraplegic man's life support 'turned off by mistake'

Sunday, 24 October 2010

Globalisation Fast Tracked

The recent meeting of G20 Finance Ministers has actually achieved something worthy and tangible. In a bid to avoid a looming trade and currency war between the surplus and the deficit nations, the G20 Finance Ministers have agreed to rebalance the voting rights at the IMF. This may sound a bit arcane, but it does have a tangible impact. If globalisation is to continue as it has in the recent past, if we are to avoid a retreat into economic nationalism, then the global economy has to be rebalanced, which includes reform of the institutions, such as the IMF, that direct the global economy.
The detail of the reforms is interesting. 6% of the voting rights will be passed from European nations and given to the emerging economies. This reflects the change in global economic power. However, the US still retains 17% of voting rights, thus giving it a de facto veto over all decisions (an 85% majority is needed for decision-making). I wonder how long that will last? I guess that the loss of the US veto would suggest that the Dollar would no longer be the global reserve currency. I can see that coming, but not just yet.
© The European Futures Observatory 2010

Saturday, 23 October 2010

When The Well Runs Dry

What is the structural weakness in the US economy? Some might point to the flight of manufacturing, some might point to duff mortgages, but I would point to the parlous finances of the various States Governments. A recent article in The Economist considers the impact of retiring Boomers (along with their sense of entitlement), State finances, and the lack of funding for State pension schemes. Apparently, 7 out of 50 States will have exhausted their pension assets by 2020, and half will have run out of money by 2027. The impact of this on the State tax revenues makes even more interesting reading. It would seem that current employees are working under an illusion that the promises made are affordable, whereas they quite possibly are not, as the following table suggests.

Of course, the bond markets will intervene well before this scenario occurs, but it does suggest that, towards the end of this decade, a crisis in State funding – along the lines of the crisis in the Eurozone – will befall the Dollar.

Ooops … it looks as if we can’t afford to retire!

© The European Futures Observatory 2010

Friday, 22 October 2010

Mr Osborne’s Gamble

The news in the UK this week has been dominated by the Comprehensive Spending Review. This is the first attempt within the OECD to match financial planning with the rhetoric of deficit reduction. There is much that still has to come out of the review, but the broad shape of the deficit reduction can now be discerned.

To start with, there has been the decision to place a far greater reliance upon cuts in public spending than tax increases to eliminate the deficit. In measures previously announced, about £20 bn tax increases will start to have an effect in the current fiscal year. Of those, the greater proportion will be increases in taxes on consumption rather than on income and savings. A ratio of 4:1 (£4 in spending cuts for every additional £1 raised in taxes) is a bit unusual. Normally we would expect a ratio of 3:1.

The Chancellor of the Exchequer (our quaint title for our Finance Minister) announced about £80 bn in spending cuts. Whilst all departments will face some degree of financial restraint, the bulk of the spending reductions have been directed to the welfare budget (the old and the poor) and spending on local public services (social care, local education, the police, libraries, and climate resilience). Leaving on one side whether the politics of these makes sense, the objective of the cuts is to enhance our future prosperity and the more pressing question is whether or not the policy will work.

In a paper delivered to the Post Keynesian Study Group at the University of Cambridge, Victoria Chick presented evidence to suggest that for every 1% reduction of government expenditure as a percentage of GDP, there would be a corresponding rise of 0.6% in the level of public debt as a percentage of GDP. The mechanism by which this happens is quite obvious. As government expenditure falls, employment levels fall (over 80% of public expenditure is on salaries). As employment levels fall, income tax receipts fall and unemployment benefit payments increase, leading to an increase in the deficit. We can see why the government’s own Office for Budget Responsibility have warned that there is a 40% chance that more deficit reduction measures will be needed in the near future.

Of course, this begs the question of how the deficit reduction plan is supposed to work. The workings all hinge around expectations. If, it is supposed, the public were to believe that the policy would work, and that they see as credible a permanent reduction in taxes, then they would increase their consumption expenditures accordingly. The private sector – having been crowded out by the public sector – would then increase to satisfy this demand, triggering further growth. The key to this plan is an improvement in household and business confidence. Unfortunately, recent evidence points in the opposite direction. Businesses are confident that their sales will fall as public sector workers are made redundant. Households are confident that a better use of their resources is to build their precautionary balances, and so the savings rate rises.

And this is Mr Osborne’s Gamble. He has bet that the recovery in household and business confidence will trigger growth at a rate to offset the deflationary impact of public sector redundancies. The Chancellor estimated that just under half a million public employees would be displaced by 2014-15. However, there will also be a knock on effect in the private sector. The OBR estimates that a further half million private sector jobs will be lost as a direct result of the spending reductions (much of the public sector is currently delivered by the private sector). If we add to that the half million jobs lost since the onset of recession, for the plan to work, the private sector will need to create at least one and a half million jobs within four years. The Treasury calculates that the private sector has the capacity to create two million jobs in this time frame. However, having the capacity to create jobs is one thing and actually creating them is another.

We shall see how Mr Osborne’s Gamble plays out. If he is right, then we will have a muted recovery for half a decade. If he is wrong, we may well have a muted recovery for at least a decade. Either way, when I look at scenarios with a ten year horizon, I will need to look for the assumptions about Mr Osborne’s Gamble. This will take on a greater significance with an international dimension when it is recalled that the UK is the first actor in OECD to detail the cuts. As other economies in Europe follow suit, so the process will gather momentum internationally.

The position of the US is more interesting than usual. At present, the White House is disinclined towards fiscal tightening. However, if the polls are correct and the Tea Party candidates rise to prominence in the Mid-Term Elections, then deficit reduction plans will take a more central role in the US. However, that is a story best left for another week.

© The European Futures Observatory 2010

Thursday, 21 October 2010


As we stand on the verge of the second round of Quantitative Easing (QE2), the twin questions of how it works and what it achieves remain to be answered. Some have attempted to answer the question in terms of orthodox economics. These answers have failed - mainly because the assumptions upon which QE is based are quite alien to orthodox economics. In orthodox economics, if you flood an economy with liquidity, then inflation will follow. That has happened to a minor extent, but nowhere near as much as has been previously suggested. Instead, we are experiencing a relatively mild recession (for now). This is explained in QE terms by the output gap - the difference between what we can produce and what we are actually producing. With an output gap in excess of 10%, monetary easing can still go quite some way before conditions in the real economy start to become inflationary.

QE is also being used to fine tune the economy. I rather suapect this to be something of a blunt instrument. The policy of fiscal tightening and monetary loosening is novel, but I do fear that the tightening might be overdone. For example, for Mr Osborne's plans to work, the private sector needs to generate something like a million jobs in the next four years in order to soak up that half million recently unemployed during the recession and the half million displaced public sector workers created in the recent spending review. This seems like a tall order at a time when GDP growth will be, at best, muted. A million jobs over the decade might be a more reasonable prospect.

Which brings us to Faisal Islam. His article for Prospect Magazine rather reflects conventional thinking. Stuck in the grip of a neo-classical base for his economics, he fails to grasp the key points of QE. In my view, this reflects the failure of economics more than anything else. Perhaps what we need is a new economics?

The Great Money Mystery – Prospect Magazine « Prospect Magazine

© The European Futures Observatory 2010

Wednesday, 20 October 2010

US inquiry into China rare earth shipments

Is this a story about the 'Age of Scarcity', or is it a story about the locus of Geo-politics shifting eastwards, or is it a story about the New Nationalism? The truth is, that it is all of them at once. Futurists have a knack of describing trends and scenarios as if they were separate and discrete views of the future. For analysis, it is better to assume that they are. In practice though, reality is a bit more messy. Many trends and scenarios inter-act with each other and need to be disentangled. The story of Rare Earth Elements is one such case in hand.

BBC News - US inquiry into China rare earth shipments

© The European Futures Observatory 2010