V's and W's

The media and politicians are currently doing a lot of speculating about when the recession is going to end in the UK. The government are forecasting that the 2nd half of 2009 will feature growth followed by strong (above trend) growth next year and beyond.

This is known as a V-shaped recession. Short and sharp followed by a quick recovery. In this instance, it is also accompanied by a group of flying pigs and songs from Elvis on the moon...

There are various other recession patterns, a popular one being a W-shape. This has the initial fall followed by a false recovery and then a 2nd dip as the economy actually heals itself. The early 80's is a good example of a W (or double dip) recession. The 2nd dip is where the pain is really felt - higher unemployment, major cutbacks, etc. Oh, and minor things like rioting and crime rising!

I might be overly pessimistic, but I think a W-shaped recession is a nailed on certainty despite what most of the media say! The Sunday Telegraph's Liam Halligan honorably excepted. The UK has a bit of a conundrum to solve, namely:

1. Borrowing this year: approx £200bn (artificial stimulation of economy)
2. GDP: approx £1400bn
3. Increasing total debt (increased interest payments)
4. Need to cut spending in future years
5. 3 & 4 shrinks economy = recession

Note that the bank bailouts that everyone gets hot and bothered about are excluded from these numbers. That's even more borrowing to cripple our economy!

Looking at (1.), borrowed govt money now forms 10-15% of the total economy. The UK government takes in approximately £500bn in tax revenue, but is spending close to £700bn. As a guide, you would have to raise the basic rate of tax to 70p (from the current 22p) to balance this budget. What a balls-up! If you're not angry about this, then you should be...

The added problem is that the £200bn of extra stimulus does actually stimulate the 'real' (private sector) economy. So more than £200bn of the £1400bn GDP is linked to government debt. Let's say £300bn as an example. To balance the economy by cutting spending, GDP would have to drop 20% - which would be a horrendous depression.

We are stuck between a rock and a hard place. Raising taxes is not an attractive option - it becomes self-defeating after a while, failing to increase govt income. But at the same time, drastic cuts is not attractive as it would devastate the economy. There are no easy options...

What should we do? My simple answer is that we should not have come here in the first place. Dodging the question I know, but it is the fundamental point.

The UK/US dropped rates drastically in 2001 in the 'recession that never was'. We stimulated our way out of it by borrowing (and dropping rates drastically). But then we did not put the brakes on the boom that followed. We had chances to knock the boom on the head in 2003 and 2005 but chose not to do so. In doing this we just made the problem bigger. Now it is so big that we don't have a viable solution.

2005 made me angry at the time as it was such a missed opportunity. The UK dropped rates when we should have risen them (BoE Governor Mervyn King voted against the cut) - while the economy was doing a controlled slowdown. This made the boom worse and distorted the economy more. Consumer borrowing was £1100bn then - it is now £1470bn and will cause a lot more human misery. The public sector has had 2-3 more years of unnecessary growth. Unwinding that is going to be much messier in 2011 and beyond than it would have been if we had applied sensible thinking in 2006.

But we couldn't have predicted this all, I hear you say. Rubbish! It was painfully obvious that we were heading for the buffers from 2003 onwards. We just chose to look the other way because the value of our houses were going up and we were all getting rich quick...

We've had a major failing in leadership, particularly since 2001. Gordon Brown maintaining that public sector spending increases are the right thing in future just shows he does not get it at all. Maybe we should give him a 'V' of disapproval...

Budget Basketcases

I haven't posted much of late. The main reason for this is that there are a couple of big topics that I've meant to post about, but knowing it would take a while I have never bothered to start writing them. So I didn't post anything...

The big topic in front of us at present is Government spending. Namely all those deficits and 'stimulus plans'. Our ever thoughtful governments taking it upon themselves to spend ever larger sums of unearned cash to stop the recession getting worse. How considerate.

Or not in my view...

Let me explain. In days gone by, we used to have something called an economic cycle, the main cycle often being 14-16 years in length. This had periods of expansion (where we lowered debt) and periods of stagnation or contraction (where we borrowed more). But now, following the inspired policies of intellectual heavyweights like Dubya Bush and our own Gordon Brown we are now trapped in a situation of ever-increasing debt.

The graph below of US spending (from http://www.mwilliams.info/images/obama-budget-deficit.jpg) illustrates the point. Governments (led by UK/US) now are just borrowing obscene amounts for which there is no plan to repay, despite what the spin doctors / idiot journalists say. If anyone dares question this, they are dubbed a doom-monger who does not understand the need to get out of recession. But there is a cost associated with debt, even if you don't repay it. The UK govt is likely to borrow £200bn this year (and probably the same again in 2010). At 5% bond rates (the current level) this is £10 bn of interest just to service. If rates went up to 10%, it would rise to £20bn. That is equivalent to 5-6p on the basic rate of income tax. Big sums. Now try multiplying it by 5-10 years of culmulative borrowing....

Problem is this can't go on forever. At some point time will be called on this nonsense. The likelihood of the above 10 year forecast coming true is low in my view. In the last couple of weeks, the UK has been put on notice of a debt rating downgrade. This is the equivalent of the bond markets telling us to get our house in order quick. Inspired policies like printing money (sorry QE) won't get us out of this pickle. Indeed they will make it worse as debasing our currency discourages bondholding, further driving up bond rates. At some point, we'll have to act - possibly drastically as in places such as Iceland (headline interest rates fluctuating in 10-20% range) or Ireland (drastic public sector cutbacks and 10% pay cuts). If we don't then we'll be consulting the Bob Mugabe book of fiscal discipline for ideas!

Meanwhile our leaders put off much needed activity - similar to my blogging really...

Bailout madness...

One concern I expressed earlier this year unfortunately seems to be crystallising.

http://theincognitoeconomist.blogspot.com/2009/01/good-bank.html

The problem is that the good businesses that should survive the recession are weighed down by the costs of bailing out the competition. The net result is that some good businesses go to the wall, whilst the bailed out (failing) businesses come through with their unfair competitive advantage.

The Nationwide BS published their results yesterday and they are weighed down by failed businesses that they have had foisted upon them and also a £241m 'bank bailout' fee. They're struggling whilst the bailed out banks now have a government guarantee to see them through the current mess. It's madness that the survivors are choked to death whilst the businesses (and people) that made the mistakes come through.

As the begging bowl goes ever wider into more industries, this will become more common. The headlines have now moved from banking to the automotive sector but the bailout problem (and moral hazard consequences) remain.

This is not the way to heal the economy. Let's help the strong companies (through incentives and tax breaks) and sod the weak ones. Much as Gordon thinks he can save the world by saving every large business, it just shouldn't happen. Harsh but it is needed...

GM...

...is 'friar tucked'. Hooray!!!

I tracked the GM share price for a while in 2005 and could never work out why anyone would want to invest in the auto maker as there was so much going against the business. If I shorted stocks (I don't) this would have been constantly in my top 10 shorters for the last 5 years.

GM is a microcosm of many of the problems faced by many economies at present. It operates on the never-never and urgently needs radical reform. The sooner it gets some harsh medicine, the better. It's 10 years overdue. Don't get me wrong, there are some good bits to GM, but they are dragged down (and drastically outnumbered) by the bad bits.

One to keep an eye on. I'm hoping Fiat takes GM Europe and wields the axe big time. That gives the business a fighting chance of succeeding.

Race to the bottom update...

One of my long held fears over the next few years is that we get into a situation of competitive devaluations of our currencies as countries try to either reduce the value of their debt or stimulate exports. The race is firmly on.

Early leader 'GB Pound' shot off into the distance initially with a substantial devaluation, but now the real deal (US$) is coming up on the outside.

To me the dollar is the main event for the next few years as the US seems hell bent on undoing a hundred years of effort to build up value in the hope of keeping the party going a little longer. The key for all currencies are the deficits - namely the trade, current account and fiscal (government) deficits. When a country runs deficits in any (or all 3) of these, they are effectively losing wealth in the long-term. The US (& UK) are experts in maxing out the credit card and the events of the last 2 years have just made things worse. Despite all the pain of the recession, big deficits are still there - which suggests the worst of the pain is still in front of us...

The chart above (from the ever-great timingcharts.com) is of the dollar index for the last 3 years. It shows the last wave down along with the recovery. In the last week, it has broken through technical support and now has the potential to suffer another substantial drop. It's early days but the pieces are in place for a big dollar fall.

It's amazing how ignorant the media is of this. In the UK, they're talking about the '£' showing strength. But the GBP is not strengthening against other currencies, just the dollar. Without doubt this is a dollar event, but since the dollar is the global reserve currency it will affect everyone.

What are the side effects of the dollar dropping? Biased as I am, I go for commodities - namely REAL things. Oil is the obvious one. It has quietly gone from $40 to $65 in a couple of months. Where does it go from here? If the dollar keeps tanking it will go higher. The same goes for my old friends the monetary metals (in particular gold and silver). Gold is setting up a retest of the all-time high from last year. If it goes past $1000 I would expect it to break decisively above. Time will tell...

How will the dollar affect the UK? Expect us to make another special effort to debase our currency! I've got a clever idea - why don't we just print the money to pay for our £200bn unsustainable government overspend? Straight out of the Robert Mugabe book of clever ideas...

Mainstream economists are lauding the US and UK for leading the race to the bottom. But history tells us that the short-term winner always ends up being the long-term loser. We really are thick as a nation...!

Three and a half months on....

Oh. 3.5 months since I last posted here. That's what happens when you get out of a routine with things.

What's changed in the macroeconomic world? Remarkably little in my view. There seems to be very little sign of either returning to 'normal' or economies 'healing' - despite what the mainstream media let on.

I'll maybe make my points in specific posts, because I can!!

Would the real Barclays please stand up?

I don't really like commenting on day-to-day news as I subscribe to the view that most of it is noise that distracts from what is really going on. Why bother wasting your time and effort when it doesn't really matter?

For example, who cares if the FTSE goes up 1% one day due to 'reason x' only to fall 2% the next due to 'reason y'. All that matters is what happens in the long term. So why bother trying to understand 'reason x' when it is just the opinion of some random journalist?

But the story of Barclay's profits is an interesting example of the current economic situation. Robert Peston did a piece on it in his blog yesterday. The numbers are totally barmy!

It is clear as mud what is going on with Barclays. They haven't taken any bailout money (yet!) but have probably secured some of the assets with the BoE, but that's not really clear either at present.

They announced £6.1bn of profits yesterday at a time when most of the competition are suffering either heavy losses or total collapse. Impressive - you'd have to make 3,050,000,000 ironing boards to generate that much profit. The equivalent of 50 ironing boards for every person in the UK!

But the profits suggest Barclays should be valued at 5-10 times their current share price (the price earnings ratio is something like 1.3 compared with an average around 10). But they're not, suggesting the market has doubts about how 'real' their earnings really are. So something doesn't stack up. 'No smoke without fire' springs to mind...

But what really confuses me are the assets held by Barclays. They've gone up from £1,227bn to £2,053bn in the last year. So they hold the equivalent of 205 billion ironing boards of stock - that's a BIG warehouse! Or the equivalent of 3,400 ironing boards per UK person. That's a big number...

But this is at a time when assets have generally lost value - but the profits suggest their value has gone up. What are these magical assets? I realise they have been boosted by the aquisition of some of (collapsed) Lehman Brothers, but it still does not make sense. There just is no transparency...

It's mad. But we'll have to wait for the history books to be written to know how this story finishes...