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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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Britain’s stagnant regions are stuck in a monetary union trap

Britain’s stagnant regions are stuck in a monetary union trap

The Economic Statistics Centre of Excellence created a bit of a stir at the end of last week with its estimates of growth in the regions of the UK.

Since the recovery from the financial crisis began during 2009, London’s economy has grown by 26 per cent.

At the other end of the scale, output in the north east has expanded by only six per cent, less than one per cent a year. Yorkshire has grown by just eight per cent, and the north west, which includes both Liverpool and Manchester, by 11 per cent.

The economies of the Eurozone show a similar pattern. Since 2009, Germany has expanded by 20 per cent, growth in Spain has only been six per cent, and the numbers for Portugal and Italy are even lower, at just two and one per cent.

The regions of the UK and the Mediterranean economies of Europe have an important feature in common: both groups are in a monetary union with more dynamic and innovative economies. Newcastle is in the sterling monetary union with London, and Portugal is in the euro with Germany.

The weaker economies are not sufficiently competitive to produce enough goods and services that others want to buy. They run a balance of payments deficit with the world outside their borders.

And in a monetary union, a balance of payments deficit translates into lower growth and higher unemployment. Standard trade theory in economics shows this clearly.

At least in the UK, the poorer regions get compensation in the form of large transfers of money from the more successful ones to finance their trade deficits.

London generates a fiscal surplus – the difference between income raised by taxes and public spending – of £3,700 per head, according to the latest Office for National Statistics estimates. But only two other regions – the south east and the east of England – run surpluses. The rest are in deficit – they spend more than they raise in tax.

Northern Ireland gets the biggest per capita subsidy, to the tune of £5,000 a year for every single person living there. The DUP might usefully contemplate the fact that the rest of us would be better off if we got rid of the province altogether.

A devaluation for the UK’s regions against London and for the economies of southern Europe would help to make them more competitive. In a monetary union, this is simply not possible.

The problem goes deeper than a simple lack of price competitiveness. The British regions just do not attract enough high-skilled workers to produce the quality goods and services which are in demand in the twenty-first century.

We might imagine that low housing costs would attract people, but the price mechanism works very slowly and imperfectly in this context. Over the past couple of years, there has been a trickle of people out of London to the regions, while the inflow from them to the capital has been halted. But there is a long way to go.

And that means that, whatever form Brexit takes, the economic trends of Britain’s monetary union are such that the future for Britain’s regions still looks grim.

As published in City AM Wednesday 29th November 2018

Image: Derelict Factory by Will Lovell via Geograph under CC BY-SA 2.0
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Brussels elites who fiddled while Rome burned may soon get their comeuppance

Brussels elites who fiddled while Rome burned may soon get their comeuppance

The new Italian government looks set to cause shock waves across Europe.

The two parties promise mass deportations of immigrants and huge increases in public spending.

Both the social and the economic policies of the Italian coalition clash directly with those of the European Commission, and Germany and France. They represent a decisive break with the consensual approach of the past.

The performance of the UK economy since the financial crisis of the late 2000s has been disappointing. But it has positively boomed in comparison with that of Italy.

Italian GDP, according to the OECD’s database, peaked in the first quarter of 2008. By the spring of 2009, it had collapsed by eight per cent. There was a feeble recovery, before it started to fall again in late 2011. Even now, GDP remains over five per cent below its value of 10 years ago.

It not only looks dramatic – it is dramatic. The failure of the Italian economy to recover for a whole decade breaks all records, not just in Italy itself, but across the western economies as a whole.

Angus Maddison spent many years at the OECD constructing estimates of GDP in the western economies going back to 1870. His database puts the recent performance of the Italian economy squarely in the spotlight.

Some capitalist economies have experienced truly devastating collapses: Austria, for example, when it was overrun by the Red Army in 1945, and Japan when it was subjected to massive nuclear and conventional bombing attacks in the same year.

But leaving the World War years and their immediate aftermath aside, we can identify, prior to the recent financial crisis, 191 instances of peacetime recessions in the western economies since 1870 from the Maddison database.

Across some 20 capitalist countries, GDP has fallen for a year (the data is annual) 191 times.

Out of these 191 examples, on 113 occasions GDP bounced back above its previous peak value the following year. Two years after a fall, the peak had been regained no less than 151 times. So most recessions are very short. Capitalism is a very resilient system.

The previous longest recession on record across the west as a whole was that of the United States. The collapse during the Great Depression of the early 1930s was so severe that, even with a boom later in the decade, it took until 1939 to recover the peak 1929 level.

That is the context in which we should view Italy’s decade-long recession. It is hardly surprising in the circumstances that the Italian electorate has supported parties which are pledged to overthrow the status quo. If they do what they say they will, the impact will be greater than that of Brexit.

Greece and Portugal are in the same position as Italy, with GDP in both economies still being below pre-crisis levels. But they are small.

The bureaucrats in Brussels, aided by Germany, have allowed Italy to be crushed by the longest peacetime recession in the history of capitalism. No wonder they may now get their comeuppance.

As published in City AM Wednesday 24th May 2018

Image: Vatican Sunset by Giorgio Galeotti is licensed under CC Attribution 4.0
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Cautious corporates sitting on hoards of cash are to blame for our slow recovery

Cautious corporates sitting on hoards of cash are to blame for our slow recovery

The slow recovery since the financial crisis remains a dominant issue in both political and economic debate.

The economy has definitely revived since 2009, the depth of the recession, in both Britain and America. The average annual growth in real GDP has been very similar, at 2.0 and 2.1 per cent respectively. This is much better than in the Mediterranean economies, where growth over the 2009-2016 period is still negative. Even so, the Anglo-Saxon countries have not expanded as rapidly as they have done in previous recoveries.

A key reason for this is the lack of vision being shown by the corporate sector. True, highly innovative companies like Facebook have emerged over the past decade, and start ups continue to proliferate.

But the longer standing major firms in both the UK and the US have become real stick in the muds. Caution, safety first and an increasingly stultifying bureaucracy envelop them.

The contrast in the behaviour of the corporate sector in the two major financial crises of the 1930s and late 2000s makes this clear. The US national accounts only have data going back to 1929, the year before the Great Recession. But in that year, the net savings of non-financial companies was 3.5 per cent of GDP.

When the recession struck, firms ran down their accumulated cash. Between 1930 and 1934, their net savings were negative, averaging -2.4 per cent of GDP. That amounts to a shift during the recession from a surplus of $650 billion in 1929 to an annual overspend of $450 billion in today’s prices.

In the United States, during the decade prior to the crash, 1998-2007, companies on average had net savings of 2.6 per cent of GDP each year. Since 2009, this has averaged 4.0 per cent. So instead of spending their assets, as they did in the 1930s, companies this time round have simply saved more.

To be fair, American firms are gradually moving back towards their savings patterns prior to the crisis. From 5.4 per cent of GDP in 2010, net savings in 2016 were back down to 3.1 per cent. They are gradually getting their confidence back, their “animal spirits” as Keynes called it.

There are signs of this happening in Britain as well. Between 1998 and 2007, net savings by non-financial companies averaged 1.3 per cent of GDP.  From the trough of the recession to now, the annual average has been 2.7 per cent. As in the US, the figure has come down from 2009-2011, when it averaged 3.8 per cent. But firms remain cautious.

But in both the UK and the US, companies are sitting on piles of cash and lack the entrepreneurial spirit to spend it. Boards obsess about fashionable concepts such as lean and agile processes and management. At the same time they set up procurement systems more suited to the old Soviet Union in terms of the tick box mentality which prevails.

Capitalism must be seen to be delivering the goods, and many of our major companies are simply not doing this.

As published in City AM Wednesday 12th July 2017

Image: London Construction by Bonny Jodwin is licensed under CC by 2.0
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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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The OBR shouldn’t be expected to forecast so far into the future

The OBR shouldn’t be expected to forecast so far into the future

Economic forecasts have become a political hot potato. The Office for Budget Responsibility’s (OBR) predictions, presented as part of the chancellor’s Autumn Statement, have put the government under pressure. The OBR has revised down its forecast for GDP growth over the next four years by 1.4 percentage points.

The real controversy is that their gloomy projections for GDP and government finances have been put down to Brexit. In the simple phrase of the OBR: “Any likely Brexit outcome would lead to lower potential output”. Lower output leads to lower tax receipts, and worse government finances.

To be fair, the OBR does say that “in current circumstances the uncertainty around the forecasts is even greater than it would be in normal times”. But just how great is this uncertainty?

Studies are published from time to time about the accuracy of economic forecasts. The best set of records is kept in America, though less systematic evidence for the UK shows that the track records are very similar in the two countries.

The Survey of Professional Forecasters (SPF) collects the forecasts on variables such as GDP growth and inflation from a wide range of forecasters. Its database goes back almost 50 years to 1968. Just one quarter ahead, the predictions are on average completely accurate. “One quarter ahead” means the next three months, so it would currently refer to the period January to March 2017.

This average accuracy conceals errors in most forecasts for any particular quarter, the errors cancel out over time. For example, the quarter from July to September 2008 marked the onset of the major recession of the financial crisis. At an annual rate, GDP fell by 1.9 per cent compared to the previous quarter. But the SPF predictions made in the April to June period for July to September were for growth of 0.7 per cent.

The SPF predictions account for only 25 per cent of the variability around the average. When we go four quarters ahead – just one year – the predictions are even worse. Negative growth, for example, has never been predicted, even though there have been 26 quarters of negative growth since 1968.

The track record, which has not got any better over time, shows that in relatively calm times, forecasts just one year ahead have a reasonable degree of accuracy. But when major changes are taking place, just when they are really needed, they have none.

The OBR cannot be blamed for producing predictions four years ahead when the track record of the forecasting community shows them to be of no value. That is what George Osborne mandated it to do when he set the independent body up in 2010. But four years ahead, almost any set of predictions is just as good – or bad – as another.

It would be much better to abolish the OBR and restore responsibility to the Treasury and, ultimately, to the politicians. If they get it wrong and are too optimistic, we can at least kick them out.

Paul Ormerod 

As published in City AM on Wednesday 30th November 

Image: Psychic by clairewinterphotography is licensed under CC by 2.0 

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