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Burnley and Asda are unlikely warnings of debt-driven troubles

Burnley and Asda are unlikely warnings of debt-driven troubles

It has been a week of mixed messages. Not just on the release from lockdown, but on the economy.

The Bank of England indicated that banks have been given six months to prepare for negative interest rates.

The Monetary Policy Committee was quick to clarify that this did not mean that they would necessarily cut their 0.1 per cent interest rate. It was just that, well, it sort of might be needed if the economy remained in recession. It was that kind of clarification.

Almost in the next breath, the Bank’s Governor, Andrew Bailey, opened up the vision of an economic boom as consumers emerge from lockdown.

Households have accumulated some £125 billion in extra savings during the lockdowns.  If this is translated into spending, the economy will roar away. The Bank will be looking at higher interest rates to cope with the inflationary pressures this would create.

The unlikely setting of Turf Moor, home to Burnley football club, shines a light on the future direction of interest rates.

Burnley, an isolated town in North East Lancashire, maintains a club in the Premier League.  Only a few weeks ago, they achieved a notable victory at Anfield, the home of Liverpool.

Since its inception in 1882, the club has been owned solely by local businessmen and Burnley supported.  Until the end of last year.

In its most recent published accounts, to June 2019, the club had no borrowings and £42 million in the bank.  But no longer.

An American consortium, ALK Capital, has bought the club and appears to have loaded it with debt. The precise details have not been made clear. But it seems that a loan has been taken out to pay off the previous shareholders, and secured on the stadium and the club itself.

On a far bigger scale, the tremendously successful Issa brothers, from nearby Blackburn as it happens, have revealed this past week that debt will be the principal instrument to finance their takeover of Asda.

Starting with just a single garage 20 years ago, they have built a huge and flourishing business empire and are shining examples of entrepreneurial success.

The details of the £6.8 billion acquisition of the supermarket chain are complicated. But they are in the public domain. Essentially, they involve raising debt and carrying out a sale and leaseback of some of the company’s assets.

So here are two newsworthy company acquisitions basically financed by debt.

For reasons which are perfectly understandable, central banks in the West have presided for years over a regime of very easy money.

It is now accepted much more widely than it was at the time that high and rising debt levels were the principal cause of the financial crisis of the late 2000s.

We are still a long way from this. But history tells us that a rising trend of debt-financed corporate acquisitions is not a good sign.

Once the recovery from the Covid crisis becomes established, the Bank needs to act to damp this down. And higher interest rates have to be part of the plan.

As published in City AM Wednesday 10th February 2021
Image: Asda Blackburn by Hassan Jawad via Geograph CC BY-SA 2.0
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Get the Bank of England focused on the real economy

Get the Bank of England focused on the real economy

Economic policy is returning to its usual position of prominence.

Fears of a major rise in unemployment are starting to worry the government more than fears around Covid-19.

The chancellor’s imaginative schemes concerning furlough and other measures to protect jobs create potential problems elsewhere. So much money is being borrowed that the ratio of public sector debt to GDP has soared above 100 per cent.

The last time we were here was at the end of the Second World War. Then, the debt ratio was a massive 250 per cent.

The Labour government of that time has a reputation for being the most left-wing in British history. It nationalised the mines and railways, and created both the modern welfare state and the NHS.

But it reacted to the massive level of public debt with impeccable orthodoxy. Between 1947 and 1951, Labour ran public sector surpluses to help pay off the debt. These were huge, averaging some £50bn a year at today’s prices.

Will Rishi Sunak be forced into similar levels of austerity, cutting spending and raising taxes?

A timely and fascinating Policy Exchange paper issued last week argues that this would be completely the wrong thing to do. The authors — Gerard Lyons, Warwick Lightfoot and Jan Zeber — are not noted for any previous enthusiasm for fiscal activism, which makes the treatise all the more interesting.

They note that there was a further, perhaps more important, way in which the public debt mountain was brought back under control, in addition to the immediate post-war austerity.

The 1950s and early 1960s saw strong economic growth. A famous phrase coined in 1959 by the then Prime Minister Harold Macmillan was “you’ve never had it so good”.  This, plus a modest rate of inflation, helped erode the debt burden steadily and surely.

The point is that the debt which the government issues is denominated in money terms. If you buy a bond for £100 now and hold it to maturity in 10 years’ time, you get precisely £100 back.

During the 1950s, GDP grew in money terms at an average annual rate of seven per cent. The debt to GDP ratio is, quite simply, the outstanding stock of debt divided by GDP. There was essentially no net addition to debt in this period. But the growth in nominal GDP meant that the ratio was halved.

To tackle today’s debt, Lyons and colleagues call for a strategy of growth. Their most striking demand is to change the remit of the Bank of England from one of controlling inflation to one of controlling GDP in money terms — a combination of inflation and real growth in the economy.

The Federal Reserve in the US is also tasked with taking the real economy — output, jobs — into account, but others such as the European Central Bank remain shackled by a pure inflation target.

This proposal would certainly shake up the Bank of England after years of complacency under Mark Carney. Given the Prime Minister’s new-found interest in the economy, it could be an idea whose time has come.

As published in City AM Wednesday 10th June 2020
Image: Bank of England via Flickr CC BY-ND 2.0
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The unions stand on the precipice

The unions stand on the precipice

Len McCluskey, the leader of the trade union Unite, probably did as much as anybody to ensure Boris Johnson’s massive electoral victory last December.

A fervent supporter of Jeremy Corbyn, his grip on the Labour Party machine compelled Labour to fight the election with its most unpopular and inept leader in history.

McCluskey is up to his old tricks, this time with the support of other, usually more staid unions such as Unison and the GMB.

Their threat is to tell their members not to return to work unless there is a massive boost to spending on health and safety enforcement.

The various railway unions are making demands, much to the chagrin of London’s Mayor, Sadiq Khan. The teachers’ unions are itching to instruct their members not to go back to work.

In all of this, the unions are behaving exactly like the villain of the economic textbooks – the good old-fashioned profit maximising firm.

In this case, the “profit” which the unions are trying to maximise is the pay and conditions of their members.

For all the rhetoric of their leaders about social justice and world peace, this is the main reason why people join trade unions.

Union leaders believe that the government’s desire to gradually move Britain back to work has given them a strong bargaining chip.

Just like the most ruthless capitalist, they are acting rationally by seeking to maximise the benefits accruing to their members.

Or are they?

For those who remember the 1970s, there is more than just a touch of nostalgia about the current situation. Then, as now, trade unions leaders attempted to hold the country to ransom. In one infamous example, the railway workers turned down an offer of a 27.5 per cent pay increase on the grounds that it was inadequate.

But the eventual outcome was not the triumph of the unions, but their literal annihilation in much of the private sector under Mrs Thatcher. Only 13 per cent of workers in the private sector now belong to a union, compared to over 50 per cent in the public sector.

The economic textbooks themselves make a clear distinction between short-term and long-term profit maximisation. It is usually not sensible to try and exploit every short-term advantage.

Whenever the lockdown finally ends, the government will be faced with a massive gap between what it spends, and what is raised by taxation.

There is already strong pressure from within the Treasury to reduce and even eliminate this deficit. Big savings on public spending or increases in taxes are the only options.

Whatever the opinion polls may say now about the demands of the unions, it is most unlikely that the current privileged position of those in the public sector will survive for long. They have remained on full pay, not furloughed or made redundant, even when they have not been required to work.

With high unemployment and squeezes on pay and living standards in the private sector, sympathy for those cocooned from the rigours of the market economy is unlikely to last.

As published in City AM Wednesday 13th May 2020
Image: Len McCluskey via Flickr CC0 1.0
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Looking out for the next financial crisis? Keep an eye on spiralling debt

Looking out for the next financial crisis? Keep an eye on spiralling debt

Concerns are growing that another financial crisis is imminent.

No less important a figure than Kenneth Rogoff wrote last week that “the next major financial crisis may come sooner than you think”.

Rogoff, a former chief economist at the IMF, shot to fame with his 2008 book This Time Is Different, co-authored with his Harvard colleague Carmen Reinhart. The sub-title of the book, “eight centuries of financial folly”, effectively summarises its contents.

Reinhart and Rogoff take a broad historical sweep of financial crises, and conclude that their basic cause is debt. It is not usually that the interest payments on debt become too high to be sustainable. Rather, the cause is a crisis of confidence that debt has become too high to ever be repayable.

In a sentence, this is essentially the story of the global financial crisis of the late 2000s.

Such crises are very rare under capitalism. Indeed, over the last 150 years, the recession of the early 1930s is the only other example.

So if they are so infrequent, why worry? Unfortunately, that is not how rare events emerge.

Until last Saturday, Chelsea had not lost by six goals since 1991. It might be another 28, or even 128, years until it happens again.

But Chelsea’s defeat followed on from a 4-0 drubbing the previous week at Bournemouth, a club which has spent almost all its history bouncing between the third and fourth tiers of English football.

By their very nature, rare events do not follow regular patterns.

Rogoff’s view that we are nearing another crisis might seem to be supported by the slowdown which is taking place in Eurozone economies. Even Germany appears to be on the brink. One longs for a genuine English word to use in place of Schadenfreude.

Most recessions, however, are definitely not caused by financial factors. They are usually short, and simply reflect the rhythms of business confidence.

The debt data published by the august crises are very rare under capitalism suggests that Rogoff’s fears are not, in fact, well-founded in terms of advanced economies.

Household debt as a percentage of GDP in the west rose from 62 per cent in 2000 to 83 per cent in early 2008. This very sharp rise by historical standards in less than a decade represents nearly $17 trillion in terms of actual money.

Corporate debt increased by around the same amount.

As a percentage of GDP, company debts peaked at around 95 during the financial crisis. By 2015, this had fallen to the mid-80s. There has since been a modest rise, but we do not see a dramatic escalation.

Households have got an even tighter grip of their finances. Their debt hit 85 per cent of GDP in 2009, but is now down to the low 70s.

The main problem is undoubtedly China. Households and companies taken together had debt levels of around 100 per cent of GDP in the mid-1990s. This has since risen almost inexorable to 250 per cent.

A 6-0 defeat for the Chinese is certainly looking likely.

As published in City AM Wednesday 13th February 2019
Image: Spiral Staircase via Pexels under CC0
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Don’t believe the myths: Capitalism has performed well since the financial crisis

Don’t believe the myths: Capitalism has performed well since the financial crisis

Ten years ago, the financial crisis began to grip the Western economies. During the course of 2007, GDP growth slowed markedly everywhere. By the end of 2008, output was in free fall.

A key theme in economic commentary is the sluggishness of the subsequent recovery of the developed economies.

The picture is not quite as bad as it is usually painted. True, last week the Office for National Statistics announced a dip in UK growth in the first quarter of this year. But from 2009, the trough of the recession, to 2016, GDP growth averaged 2.0 per cent a year.  Not exactly a stellar performance. But from 1973, the year prior to the major oil price shock, to 2007, the British economy expanded by just 2.3 per cent a year on average. The contrast between the two periods in the US is slightly greater. From 1973 to 2007, growth averaged 3.0 per cent a year, and since 2009 it has been 2.1 per cent.

There is a very stark contrast with the experience of the 1930s, the last time there was a global financial crisis. This time is different, things have only got better. The recovery may be slower than desirable, but it has been much more widespread than in the years following the Great Depression of the 1930s.

A decisive indicator is the length of time it took not just for growth to resume, but for the previous peak level of GDP to be regained.  So in the UK, for example, the economy started to grow again in 2010. But it was not until 2013 that there had been enough growth for the economy to get back to its 2007 size.

Looking at a group of 18 developed economies, which includes all the main and medium sized ones, GDP had regained its previous peak within 3 years in no fewer than 8 of them. By 2016, everyone in the group except Finland, Italy and Spain had a GDP which exceeded its previous peak.

Three years after output began to fall in 1930, not a single economy had managed to regain its 1929 level of output. Even by 1938, output was below its 1929 level in Austria, Canada, France, the Netherlands, Switzerland and Spain.

Perhaps Keynes’ most powerful insight was why the slump was so prolonged. He developed the concept of “animal spirits”, which are not a mathematically based prediction of the future, but the sentiment of the narratives which companies form about the future. He wrote: “the essence of the situation is to be found in the collapse of animal spirits…. this may be so complete that no practicable reduction in the rate of interest will be enough.”

Zero interest rates and low growth! Keynes got there before us.

Still, capitalism has performed much better in the aftermath of the financial crisis of the late 2000s than it did in the crisis of the early 1930s. Animal spirits may not be buoyant, but they are in much better shape than in the 1930s.

As published in City AM Wednesday 2nd May 2017

Image: Day 20 Occupy Wall Street by David Shankbone is licensed under CC by 2.0
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Government debt addiction means you can be sure of one thing: Stealth taxes will rise

Government debt addiction means you can be sure of one thing: Stealth taxes will rise

Elections create uncertainty. But we can be sure of one thing. Regardless of the result, during the course of the next Parliament, stealth taxes will rise. This week, we have a sharp rise in speeding fines. Even doing between 31 and 40mph in a 30mph zone can now land you with a penalty of 50 per cent of your weekly income.

Governments across the West are running out of ways to pay for the spending levels which the electorates appear to demand.

A key way in which public spending has been financed over the past 40 years has been through debt. Almost everywhere, the level of public sector debt relative to GDP has risen sharply.

A few years ago, the International Monetary Fund (IMF) published long runs of historical data on the public debt to GDP ratio for countries across the globe. The Bank of International Settlements (BIS) updates the ratio regularly.

In 1977, gross public debt in the United States was 39 per cent of GDP. In 2016, it was 98 per cent. Over the same period, the UK, using the IMF and BIS definitions, the rise was from 49 to 115 per cent of GDP. In France, the ratio went up from 15 to 115 per cent. Even in debt-wary Germany, there was an increase from 27 per cent in 1977, to 78 per cent in 2016.

There are different ways of defining public debt, and no two measures are the same. But regardless of how we put the figures together, the conclusion is clear.

Public sector debt has risen massively. The simple fact is that most governments in most years now routinely spend more than they dare raise in taxes. The resulting deficit has to be financed by issuing debt. But the limits are now being reached, a lesson the Greeks have learned so harshly in recent years.

Over the course of history, public sector debt, relative to the size of the economy, has been at much higher levels than it is now, with no apparent serious consequences. In 1946, for example, UK public debt was 270 per cent of GDP.

But in the past, governments with high debt levels typically did one of two things. They either defaulted, or they tried to pay it off. The left wing Labour government of Clement Attlee ran huge budget surpluses in the late 1940s, peaking at around £100bn a year in today’s terms.

Most debt used to be incurred as a result of war. In 1861, US public debt was less than 2 per cent of GDP. The Civil War bumped this up to 30 per cent. In the late 1810s, as a result of the Napoleonic Wars, the first truly global conflict, British debt was 260 per cent of GDP. It took decades to get it down to sustainable levels, but governments did succeed and pay it off.

In stark contrast, debt has been built up in the late twentieth and early twenty-first century to finance the services provided to voters. It is simply unsustainable.

As published in City AM Wednesday 26th April 2017

Image: Speed Trap by Peter Holmes is licensed under CC by 2.0
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