Louise Cooper Finance economics markets retail business

The Three Wise Monkeys? Or the Three Stooges?

Friday, June 23rd, 2017

And now onto my macro musings after the three speeches this week of the Chancellor, the Governor and the Economist (Phillip Hammond, Mark Carney and Andy Haldane).  I am not sure if I should compare them to the Three Wise Monkeys or the Three Stooges…

Firstly after my blog last week about the growing politicalisation of the Bank of England, I warm to my theme.  It is only the monetary policy of extreme low interest rates and QE that allows the government to run up debts and deficits.  Monetary Policy is supporting Fiscal Policy.  Hence the Bank of England has become political.

And this has some pretty dire outcomes long term.  If the Bank of England’s low interest rate policy enables the government to rack up huge amounts of debt, how can the central bank ever put up rates?  

It can’t, which is pretty much the conclusion of the financial markets which are not predicting base rates ever get to 2% and will only get to 1% by 2023.  And that’s because by putting up interest rates, that debt burden becomes unsustainably high – the interest charges alone might bankrupt the country.

According to the National Archives, http://webarchive.nationalarchives.gov.uk/20160105160709/http://www.ons.gov.uk/ons/dcp171766_386187.pdf
the UK’s interest bill was just over 3% of GDP during the 1990s.  Its a bit lower now (see chart below). But interest rates charged on that debt have collapsed.  The ten gilt yields (the interest rate for the government to borrow for 10 years in the bond market) during the 1990s ranged between 11% and 5% (BofE figures).  Currently the government pays just 1% a year interest charge to borrow for ten years. 

If the interest bill on the UK’s debt merely doubled, it could potentially take the interest bill to over 5% of GDP – a level never seen since 1955 (see chart below).  A tripling of the debt interest costs, say on ten year yields from 1% to 3% (for context in 2010 it was 3.6%), could bankrupt the state. 

House of Commons chart:

int bill as % gdp

Because the Debt Management Office issues debt with different maturities, its not that simple, but you get the point.  The cost of servicing our mammoth £1.7tn debt pile (pretty much highest ever in peacetime) is only made possible by the Bank of England’s QE and almost ZIRP.

And we are still adding to our pile and will be so for many years. 

Which leads me to the conclusion that I cannot see how this will end well.   Either we turn into Japan and rates stay at almost zero for ever. Or the economy recovers, rates go up and we are bankrupted by our debt burden. Neither of those options is appealing. 

And on top of that, the General Election showed the electorate fed up of “austerity” (or as a German friend calls it “prudence” or “living within your means”). Chancellor Hammond said this week “Britain is weary after seven years of hard slog repairing the damage of the great recession.”

Well its going to take much longer than seven years to repair the UK’s balance sheet (and always was).   Its going to take a generation at least.   

And it is the very generation that voted for Corbyn that will be paying for the excesses of spending from this crisis.  As Chancellor Hammond pointed out: “higher discretionary borrowing to fund current consumption is simply asking the next generation to pay for something that we want to consume.”

And he goes on to add “Stronger growth is the only sustainable way to deliver better public services, higher real wages and increased living standards.  I thought we had won that argument.  But I learned in the General Election campaign that we have not.”

So often I read about the importance of financial education in schools.  I am beginning to think basic economics and fiscal policy also should also be an essential part of the National curriculum.  

All three speeches from Mark Carney, Phillip Hammond and Andy Haldane included references to the great wage squeeze: 

Chancellor Phillip Hammond “an economy that truly works for everyone…  fears about job security and about wage levels.. (globalisation must) deliver clear benefits for ordinary working people in developed economies.”

Andy Haldane: “Wages have been surprisingly weak for much of the period since the global financial crisis”

Mark Carney: “dramatic fall in the real incomes that UK households have experienced in the decade since the crisis”

Weak wage growth is a huge challenge for politicians and policy makers.  And here I thought what Andy Haldane said about the Phillips Curve was fascinating.  I’ll leave others to try and unpick from Carney and Haldane when rates will rise.  I am far more interested in wages (both personally and professionally!)

All over the developed world, wages have not risen as unemployment has fallen.  If the provision of work is like any other good, when it becomes scarce, its price (wages) should increase (a bit like the shortage of Bananarama CDs on Amazon after they announced their reunion).  This relationship between wages and unemployment is described by the Philips Curve.

phillips curve

As you may (or may not) be able to read from Haldane’s chart above, pre industrialisation, the Phillips curve was flat – low unemployment didn’t lead to higher wages.  (although I always thought the Plague caused shortage of peasant labour which helped them to get better wages?)

What is interesting is how Haldane looks at the modern workplace and thinks there are parallels to how we used to work in those times.  He concludes that maybe the Phillips Curve is turning flat again and that lower unemployment, a shortage of workers, doesn’t lead to wage rises. Now that is a depressing thought.

And finally let’s go onto What Mark Carney had to say..  I particularly liked the slightly sour grapes comment “Before long, we will all begin to find out the extent to which Brexit is a gentle stroll along a smooth path to a land of cake and consumption.”  Aka, Carney may have got it wrong predicting Armageddon but it will happen eventually.

He is also telling governments what fiscal policy to adopt.  Explicitly he said 
“Deficit countries should loosen monetary policy and tighten fiscal policy.”
The UK is a deficit country, thus fiscal policy should be tightened.  That’s not what Corbyn thinks…. 

And he adds that “Surplus countries should do the reverse”  So Germany should loosen fiscal policy and spend.  Hh then basically says that Germany should also spend more to help the rest of the Eurozone (“Given the heavy burden on European monetary policy, the still sizable amount of slack in the euro area, low European borrowing costs and aggregate fiscal space, it is difficult to avoid the conclusion that if the euro area were a country, fiscal policy would play a greater role in promoting internal and external balance and the world would be better off accordingly.”)

And he criticises Germany for failing to help drive demand: “the real world reluctance of surplus countries to share the adjustment burden”.

Which returns us nicely to be theme – the growing politicalisation of central bankers.

Happy weekend to you all…


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