Wednesday, March 3, 2010


All governments have had to take unusual, even relatively extreme, measures to cope with world-wide credit crunch, US-led (Anglo-Saxon) recession, and the ensuring domestic (and in international markets) inflammatory politics. Market traders chasing short term profits (profiting from both price rises and falls) love sovereign risks (where a country's total value is questioned) because if that is so then everything else is up for reconsideration and for portfolio churning. After broker-dealers, prime-brokers, money-brokers, FX dealers and equity-traders' profits have dried or been hit by some losses, nothing better restores the bonus-finances than a sovereign debt crisis, or better still a whole series of them! This is why what politicians say is not just about the story; it becomes the story. I doubt that politicians are sufficiently aware, especially just after a recession, how much what they say and do is at the centre of how financial markets behave! - the subject of this essay. Markets move on news-only some of the time. Politicians' statements on national debt and borrowing, and so on, are big news in the financial markets - why, because they can be exploited to get prices to gyrate more. Research has shown that at least 25% (60 days out of 250) it is only news (not numbers, results reporting, economic analysis, or chartism) that move market prices. In stock markets, daily price changes of 1.5% or less are normal vibration, what I call 'camera shake', but that means an individual stock can have a normal inter-daily price variation of 3%. It is easy therefore to associate company announcements, industry sector news, politician's and regulators', and other news, with a change in price, and when you trade at the heart of the markets to guess immediately the popular direction of a price change. It is only persistence of incremental price changes over several days that are meaningful. The long period falls of bank shares in 2008, and today the Greek 'debt crisis' are examples of that, helped very much by the feedback looping effects of follow-up instant news and then also next day's news and weekend press stories. This does not mean that there are fundamental-technical factors at work; it may only be the effect of political argument and prolonged disputes among analysts. Markets like arguments with at least two sides (bull and bear) pulling equally well because they need two-way markets to trade in. Hence there is a tendency for many to seek to prolong disputes about facts or to make them fuzzier, more uncertain. Big questions such as the direction of a currency rate or a whole market index are ideal, because no one can really be certain of what all drives price changes. Traders can individually, by sowing rumours, and collectively, by inspiring volatility, make end-investors nervous - rattle their cages. I recall a train ride some years ago from London to Cambridge with a LIFFE own trader - he may read this. It was a Friday. New York had opened and the US Treasury secretary made a speech in which he twice said the $ dollar was too high. The S&P500 fell a 100 points or more and my friend was up £300,000 by Bishop's Stortford, having I calculated made more than the first class ticket price of the journey every second. His office phoned three times to report and to ask whether to take the profit. He dithered thinking this is Friday; he has the weekend to analyse matters further. Then, when New York returned to trading desks after lunch (liquid lunches still de rigour then), the markets decided to rhetorically ask, "what does the US Treasury really know about the $ anyway?" and promptly bounced back. Within fifteen minutes, when alighting at Audley End, my friend was down $50,000!
This should be the markets response to OECD sovereign risk anxieties - what do they know? - and if Europe's Maastricht Criteria didn't exist or were set higher or turned off for a period fo 2-5 years, say, who would care about the ratios of today?
Yesterday, George Osborne, UK Con-servative opposition shadow chancellor, said that if the country re-elects Labour the UK will lose its sovereign debt AAA rating, which the ratings agencies would down-grade, and suggesting there would be a run on the pound and so on - nightmare scenario stuff! This kind of rhetoric or political grand-standing is irresponsible mis-direction, not what someone in power or close to gaining power should be indulging in - professional politics perhaps, but unprofessional for a budding Chancellor. Of course, the UK ratios look high, largely a reflection not of the domestic economy but of its size as a global financial centre. When the cross-border borrowing (matched by assets) is removed the UK ratio remains high, but this is also for reasons of the size of the finance sector and also the UK's above-average property values that are the collateral-security for much of UK private debt, up to 70% of what appears in UK banks' balance sheets. As the charts below show the US and UK economies' total debt levels are where they are today because of private sector borrowing - mainly by finance sector. These debts impact everyone more than the governments' shares, which however high these appear to be relative to GDP (annual national income), they are only a small and relatively stable part of the total - and by far the least risky of all of a country's debt - which is mainly owed internally not externally, except in poor emerging market countries.
The UK and the USA economies are intimately linked. Their debt profiles reflect similar responses to the credit crunch, with their central banks having greatly expanded their balance sheets to replace private sector funding of banks' medium term borrowings, as well as guaranteeing banking assets, mortgages especially. But, the size of their on-budget national debts (dark blue in charts below) is typicaly of all OECD countries. Politicians have a choice - to sound like they know only what the general public hears and then mirror back the public's anxiety, or they can sound as if they have privileged insider knowledge, the advantage of expert advice, and either way an Olympian view? Governments strive to sound like experts and opposition parties like Joe and Jenny Mainstreet. UK Conservative candidate to become the next UK finance minister (Chancellor of the Exchequer, Second Lord of the Treasury), the Right Honourable George Osborne MP, with his across-the-despatch-box, street-fighting, politician's rosette firmly pinned on, chooses to ignore the other side of the balance sheet, the professional economist's details, in order to rail about gross debt, not the net or comparative position relative to other credit-boom countries similarly striving to climb out of recession. Electoral politics, yet again, even now after forests of newsprint and €$£billions of airtime about the credit crunch, is not about debating tricky details; instead it chooses to shout and stump about, angrily, pronouncing on symptoms, as if there is nothing new or deeper to learn. As a possible future Chancellor, he should, may I suggest, re-orientate his posturing to look more like the Chancellor he intends to become - try to look like someone who can and does, pragmatically as well as judiciously, read balance sheets and economic statistics until he understands them? Instead, so far, he seems easy meat for simple theorems, as sadly Margaret Thatcher was too, such as the idea that rising national debt always pushes up interest rates, or that government action cannot ever truly reflate economies, or that borrowing today must mean higher tax and/or severe spending cuts tomorrow, that nothing government does is ever a free lunch. In his latest polemic, by drawing attention to the ratings agencies he vests in them too much 'hostage to fortune' power to hold countries to ransom - and at a time, as he ought to know, when governments and their new regulatory NGOs are investigating the ratings agencies to the extent of threatening their continued existence? It is also dangerous to vest power in the hands of credit ratings agencies whose models and behaviour through the credit crisis are under severest scrutiny by EC, US and other regulators, and have been disavowed by major banks.
Apart from that, the problems of borrowed debt, insofar as these are not adequately netted off by appropriate assets, the bulk of nations' debt is a private sector created, not directly a public sector created problem, and very clearly so in the US and UK, but elsewhere too. Osborne and the Conservatives, Republicans in the USA, and Christian Democrats in Germany, who are making a political mountain out of government indebtedness are surely conspiring in diverting public concern from private debt and the role of the banks, when the debt-mountain is mainly that created by the finance sector.Sovereign risk, whether about the UK, Spain, Ireland, Greece, or even the Euro Area or the USA is a matter of calculated confidence in a country's ability to service interest and redemptions and to sell its government bonds and bills at a price very close to face value. The very idea of any OECD country losing triple-AAA is shocking because it is extremely unlikely - even in the politically highly animated case of Greece. Its crisis is about compliance with Maastricht and Euro Area prudential ratio ceilings, not about whether it can absolutely service its debts, but about the discount and penalty margin the piranha-infested markets are exerting on it. It is also about the country's trade deficit financing, not whether it can finance that, but the now higher margin cost of doing so.
In the case of the UK, the markets see that there is are political accusations flying at the government propelled by the upcoming general election. The anxieties manufactured are a boon to traders profiting in volatile markets who can also themselves add to that volatility. The Conservatives want to invoke memories of the sterling crisis of 1976 and Labour can recall Black Wednesday 1992, which statements about sovereign risk by George Soros make us worry that once the hedge funds have finished staking out the Euro, the £ is the next target! Currency exchange rates are relative to other currencies, but I cannot see a technical or fundamental reasons currently for why sterling should be targeted by the markets, by hedge funds, and not after it has already fallen last year. Hedge Funds ought to be politically more cautious at a time when there remains a strong impetus towards making them more transparent and subject to closer regulatory oversight. An estimated $12.1bn of short positions are outstanding against the Euro, according to the Commodity Futures Trading Commission. At the beginning of February, there was just over $7bn of short positions against it. Some hedge funds, thinking the better of it,have closed out their positions against Greek debt. other hedge funds raised their bets against the debt of Greece and other troubled Euro Area economies and then had to raise their bets too against the euro. But, they must also assess how far they can go and not fear a regulatory backlash. The biggest hedge funds are very concerned about fierce criticism by US and European politicians especially that their sovereign risk bets add to the crisis of confidence in sovereign markets. Lord Turner, chairman of the FSA, the UK micro-prudential regulator, is one of several heavyweights to call for investigations of speculative positions in financial instruments that gain from a fall in prices of sovereign and corporate debt. In his case he can not only call for a review but implement one and then devise limits and penalties.
Is there a solid UK financial accounting anvil for all the verbal hammering of sovereign debt - No! It is partly long-established market lore that following recession shocks these should be followed by sovereign debt crises. Recessions are real enough, but sovereign debt crises very rarely are among OECD countries. And, given that the recent/current recession shock was triggered by banking insolvencies and the great increase in size of central bank balance sheets this necessitated, the popular expectation is therefore for the mother of all sovereign debt crises. But, central bank balance sheets are precisely that, balanced. In the case of UK government debt balance it too is very robust, with £600bn in government liquid assets plus banking bail-out investment gains to come, plus that its debt and fiscal deficit are not much out of kilter with its peers - somewhere within the mixed range, and employment/unemployment and property values have retained unexpected resilience, how much of the debt (at least one third) is internal to government, and much else including first phase of recovery in GDP and tax revenues, the gross position of government finances should not be technically worrying at all, in my and others' considered view; the net position and the macro-economics of the government's stance should be celebrated as prudent and efficient.
But, of course, that does not satisfy party political need. Labour unfairly accused the Conservative Government in 1997 of financial mismanagement when fiscal deficits had been the main recovery weapon from the recession in '91 and a brief anxiety attack in '95 when the US economy stumbled due to a very harsh winter that propelled the UK Chancellor Ken Clarke to break his fiscal stance forecast, which he sensibly regularly did anyway. The Conservatives are not slow this year to return the same jibes they failed to defend in '97, something they could not do convincingly in the last three general elections when there was no recession and Chancellor Gordon brown had maintained a fiscally prudent (conservative) stance.
This time Chancellor Alistair Darling is talking politely back to explain his necessary recovery measures - to which the opposition parties are, of course, deaf.

One of the reasons apart from the foolish war or foolish post-war management why Tony Blair had to resign was a public feeling cheated by, and now intolerant of, political spin meistering. Ironically, when economic crisis hit, the same public appeared to miss the glossy spinning of hard facts. It was frightened and wanted feel-good assurances. PM Gordon Brown, after a decade of poker-facedness (necessary, and expected of, Chancellors), provided assurances, but earnestly without smiling, groaning with solidity, not sparking with exuberance of rising to a great challenge - he read the situation as requiring trust in sound policy, and in public again buttoned up his natural humour - yes, it exists! His smile can seem churlishly sweet rather than seious and sunny. Blair's smile for years seems stitched to his face like The Joker. He eventually mastered seriousness in public, but, ever embulliant, cast that off at the slightest opportunity until the consequences of the war got to him too. Brown had far less opportunity to practise a Sunny Jim look, (possibly remembering that it didn't work for Callaghan when PM). Chancellor Alistair Darling, Brown's very close friend (if not quite the collegiate buddy that Ed Balls became and who wants his job), has a most highly evolved sense of humour, but felt he must, above all, tell the precise truth, believing that when the public tired of spin they wanted truth, straight facts, something expected of Chancellors, and that led to his statement (that reportedly angered Brown according to Andrew Rawnsley's book) saying that this is (was) the longest deepest recession for 80 years etc. They both said we will get the economy out of the mire and restore prosperity. I don't buy Rawnsley's take on this because it is possible to quote Gordon Brown having described the profundity of the credit crunch and recession many times, if perhaps less nationally and more globally! Either which way, the public is still not getting happy-smiling positive news. Instead, the politics of spin, as now led fearlessly by the Conservatives is to be prophets of doom and gloom unless 'you vote for us!', blackmailing (not bribing) the electorate how to vote. is this not spin of the wrong kind demanded. Her Majesty's Opposition, led by David Cameron's idea of what is a patriotic choice, seeks to insinuate itself into power (a most apt phrase) by any negative means including telling the public it has a patriotic duty to vote the Labour government out of power - a dangerous form of stump, or sump, politics - populism in a multi-party democracy. The beleaguered US and UK governments try to reassure their electorates with 'steady as she goes' and 'trust us to finish our job' messages. When electorates are jaded and cynical and hurting, they need facts as much as assurances. They also need to see the major parties agreeing on some key aspects of economic recovery if they are to gain confidence in that. How can anyone trust politicians in general when they so mercilessly, emotionally, even satirically, condemn each other in such serious matters as where the economy is heading short term? Instead, an uncompromising disputatious political anxiety-making currently prevails in the bite-sized media (and in sloganising that advertisers promote). This is damaging to political recovery as it is also damaging to voter participation. UK and the USA political public punch-ups would have been unpatriotic in the global war of WW2; is it not so in the present global economic crisis - or is that a totally unrealistic expectation, to expect that at least in matters of economic policy when economies are in crisis globally? It is an election year in both UK and USA, and, of course, taking economics out of other issues like health and education would leave only moral ethics and not all politicians are comfortable with that?And this political anxiety takes its toll on consumer confidence (lower consumer spending) - acting as an additional drag on economic recovery. The faltering economies of UK and USA, and fear of double-dip in the Euro Area, embolden the FX, bonds and money markets in pursuit of short term profits, for whom, especially short-sellers, 2010 promises to be a bumper year. It was the '92 attack on sterling, when Norman Lamont was Chancellor, and which was preceded and succeeded by attacks on some European currencies that propelled the EU into creating the Euro in place of the EMS currency snake, to provide a defensive scale to Europe's currency in the world. When the UK Bank of England was forced into extreme measures to defend the pound in '92 all the pressure was off by simply withdrawing from the EMS, and within a year or sooner the UK's foreign currency reserves had been restored. When the 1976 sterling crisis triggered by IMF negative outlook reports the UK Chancellor Denis Healey had to negotiate borrowing rights with the IMF none of which were in the end required, but there had to be spending cuts.
Healey, Lamont and Darling share an unusual hirsute distinction of highly distinctive 'caterpillar eyebrows'. Such irrelevant coincidences are no less fatuous than other coincidences that markets like to fuss over to rumble the tummies of everyone's risk appetites. I would not be surprised by some brokers' notes headline of "the eyebrows have it!" and "caterpillar risks!"Our three caterpillar eyebrow chancellors experienced desperate exchange-rate crises, and also share a chest-beating need to announce sharp spending cuts - though I do not see how government spending was or is to blame directly for these crises. In past post-recession periods, such spending cuts as often a not did not amount to much, and may not do so now. Budgets were re-balanced by recovery more than by spending cuts. President Clinton balanced his budget by economic growth supplemented by a regular $10bn cut in defence spending and by delegating major programmes to the 50 states. Reagan and both Bushes talked and walked spending cuts but never looked like balancing their budgets. Today, if California was a country, it would be the biggest sovereign debt crisis, but spending cuts wouldn't solve it.
Today, in the UK, despite higher year on year deficit spending, some cuts are already in train - about £15bn worth before the recent political furore about whether to cut more now or later? The current savings being pursued are in efficiency savings, offset by bringing some spending programmes forward. Sizeable spending cuts are not desirable in the teeth of recession or the early stages of recovery, but that is not to say restructuring of government spending, not least to be more tax efficient, is not a great idea - where some areas are cut and others boosted. This was part of governments' Keynesian thinking before the 1980s. Since then, such thinking was replaced by a decades-long presumption that however much government spending is described as 'tight' to, at the same time, assume government spending in general can always make room for substantial cuts even in a crisis; £90bn is currently an oft-quoted figure in the UK. What is missing is a more subtle and more realistic idea of redirecting spending to benefit recovery, doing so at least risk of requiring tax hikes. This line of thinking is opposed to another politically fashionable presumption that there are no 'soft choices', only 'hard choices'. Choices are not in practice so two-sided, more bi-pedal. A classic example of a hard choice that was also hard and soft either way) was Edward VIII's decision, prompted by political pressures, to choose his private duty over his public duty. Politicians over-indulge a belief in public duty to favour 'hard choices' as if economic survival and progress has only ever been secured by always preferring hard over soft bedsprings. There is also a delusion that private business success is always based on taking hard decisions. In truth, such decisions are often the product of one-sided analysis of the balance of facts. An example of such one-sidedness in macro-economics is to no longer look at differences between gross and net of tax cost of different public spending. That practical view was outlawed (by convention) at The UK's HM Treasury after 1979, for reasons entirely political - not logical in economic house-keeping terms. Similar blinkers became similarly popular among US legislators, and extremely so at the Congressional Budget Office. Making anything sound sensible is a matter of how tightly drawn (simplified) the wider context is. A major context today is that our banks, for their own (internal) house-keeping reasons, are cutting back on customer loans (by about 8% in the UK in 2009) that may continue for much of this year (I predicted a total cutback of c. 15% in USA and UK). Banks see this as a necessity forced on them by their balance sheets as cross-border interbank lending shrinks (in Europe) and by the economics of funding gap finance that are only now beginning to return to a near-normal economic cost - if not yet an attractively viable market cost - and that is despite the boon to corporate debt of the Bank of England and US Treasury QE measures of buying in $200bn and £200bn of government bills and bonds (by using off balance sheet assets). In the UK QE equates to a quarter of UK National Debt, and as much as the Government is expected to issue in new bonds in 2010. Hence the fiscal deficit stance by the UK Government of 8-12% ratio to GDP (similar to that in the USA) is wholly appropriate - and no less than any super-hero economists recommend when asked. Of course, banks, who now have for regulatory reasons to hold much more of new government bonds themselves, are keen to lever what discounts they can in the primary issue market by exploiting sovereign debt anxiety-making, and, as traditional Conservatives, there is an additional motive: the kneejerk tendency to rattle Labour's cage in an election year. But, this is also further evidence of banks not waking up fully wide-eyed to the new political-economic realities, failing to acknowledge fully the hatred and mistrust of them by business and household customers, and by the general voting public. Banks cannot be certain of how much better or worse off they will be depending on which party wins or whether the UK election outcome is a hung parliament - or in the USA a handicapped White House? They should fear the possibility that one thing everyone can agree upon is resentment and suspicion of banks - the mob will have its pound of flesh. Banks should duck low, hide their arrogance, behave obsequiously humble, and conscientiously do their best to shoulder the burden with government of ensuring speedier economic recovery. If they did that they'd be super-heroes too - an unlikely story?

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