Monday, 30 November 2015

The angry WASPIs

Back in 1995, the UK government made what was widely regarded at the time as a sensible and long-overdue change to state pension legislation. Since World War II, women had retired five years earlier than men, a sop to compensate them for their inability to clock up pensions of the same size as their spouses - and incidentally to enable men and women to retire at approximately the same time, since it was assumed that most men were older than their wives. But by the mid-1990s far more women were working, married women's income was taxed separately from their husbands', many were paying NICs large enough to qualify for pensions the size of men's, and - most importantly of all - they were outliving men. Many people, both men and women, believed that the earlier retirement of women was an anomaly which desperately needed eradicating. I was one of those people: when the Pensions Act 1995 raised women's retirement age to 65, I was pleased - even though it meant that I personally would have to work for five more years.

The timetable for raising the retirement age was extraordinarily generous. The change would be phased in between 2010 and 2020. Women born before April 1950 would retire at 60, but women born between April 1950 and March 1955 would retire at some age between 60 and 65, the retirement age gradually rising until 2020. The first cohort to retire on their 65th birthday would be born in April 1955.

In 2010, the Government announced an intention to raise the retirement age for men and women from 65 to between 66 and 68 depending on their current age. Women born from April 1953 onwards therefore suffered a further rise in their retirement age. Older women were at this point unaffected. But that did not mean they would retire at 60. The majority of those born between April 1950 and March 1953 were already scheduled to retire later than 60 under the existing transitional arrangements.

But in 2011, that changed. The government, under pressure from the EU, decided to shorten the transition to harmonised retirement ages for men and women. The first cohort to retire at the harmonised age would do so in 2018, not 2020, and their retirement age would be 66 not 65.  This steepened the transition for all women born from 1951 onwards.

Robert Leach has some handy charts showing how both the original transition schedule and the 2011 change affected the various age cohorts. As can be seen from this chart, the original schedule affected ALL women born after April 1950. Only those born before April 1950 would retire on their 60th birthday, and women born after February 1951 would not retire at 60 at all:

The fact that the original 1995 transition schedule meant that the vast majority of women born after 1950 would retire later than 60 seems to have been lost on many of them. Even women born as late as 1959 seem to have expected to retire at 60. I will return to this shortly.

The 2011 change had no effect on women born before April 1953. But as the chart shows, women born from April -November 1953 suffered sharp increases in their retirement ages. A woman born in November 1953 will now be two whole years older when she retires than a woman born in March of the same year. It is easy to see why she might regard this as unfair.

These are the original WASPI women - those born in 1953-4 who suffer an increase of up to 18 months in their retirement age as a result of the 2011 change. Their retirement ages have been extended by a total of between 3 and 5 years, mostly due to a transition schedule that was established in 1995.

However, women born in 1953-4 were also affected by the 2007 rise to 66 (68) for both men and women. Robert Leach's chart shows how:

This chart requires a little explanation. "Previous 2" is the date that a woman would have retired under the transition to the harmonised retirement age had there been no additional increase. "Previous 1" is the date that she would have retired had the Coalition government gone ahead with the increase as originally proposed in 2007. But in 2011, the Coalition government softened this transition. This was largely due to the effect on women born in 1953-4, some of whom would suffer a two-year increase in their retirement age because of the combination of this change with the tightened harmonisation schedule described above. The Government agreed with campaigners that no-one should suffer an increase of more than 18 months on top of the original harmonisation schedule. The transitional schedule for the 2007 increase was therefore amended to that shown in the "current" column.

However, despite this softening, many women born between 1954 and 1959 are furious. When they started work, they believed they would retire at 60. Now, most of them have to work until they are 66. Women born between 1951 and 1953 are also angry, even though they have not suffered such a steep increase in their retirement ages as their younger sisters. They have seen women only slightly older than them retire at 60, while they have to wait for up to another 5 years.

Many of these women say they did not know about the extension of their retirement ages until recently. The WASPI campaign claims that women have been given so little notice of the changes that they had no time to prepare. It is raising a petition to Parliament calling for "fair transitional arrangements" for women born from April 1951 onwards.

It is fair to say that the DWP's communication has been abysmal. The original 1995 change was not communicated at all: it was reported in the media at the time, but no attempt was made to contact the women affected. This is the main change that affects women born in the 1950s, since it adds up to 5 years to their working lives. However, it also affects younger women. In 1995, all women of working age would have expected to retire at 60. All of them have had increases of up to 5 years in their working lives, and none of them were contacted. It is not clear why WASPI women claim that the lack of notification made the transition unfair to them in particular.

DWP says that it has written to all the women affected, though it admits that it only started to write to them from April 2009 onwards. However, according to the BBC's Paul Lewis, many of the letters may have failed to arrive, apparently due to addresses being out of date as a result of appalling record-keeping by DWP and HMRC. And of course, notifying WASPIs of changes from 2009 onwards was utterly inadequate anyway. Many were already close to 60: since they had not been informed of the 1995 changes, they were expecting to retire shortly. Suddenly they discovered that they were not eligible for a state pension for - in some cases - another 5 or 6 years.

The Government now says that there will be 10 years' notice for future pension age rises. On the basis of this, WASPI women argue that they should receive compensation because they were given far less notice of the extension of their pension age. But if women born in the 1950s can claim compensation because lack of notification means that they have had insufficient time to prepare, so can younger women.  After all, a woman born in 1960 - outside the WASPI campaign's target age range - would now be 55. If she is expecting to retire at 60, having never been told otherwise, she faces a 6-year increase in her retirement age with only 5 years notice. In 2004, the DWP themselves produced evidence that younger people were less aware of the harmonisation than older ones (h/t Alan Higham). Given this, why is the WASPI campaign limited to women born in the 1950s?

And there is another mystery here. What on earth have pension providers (employers and private schemes) been telling people?. Annie Shaw tells me of professional women - nurses, teachers, even a head-teacher - who took early retirement in their fifties on final salary pensions, fully expecting to receive their state pension at 60. Some of my Twitter contacts told me that they had taken voluntary redundancy, or allowed their contracts to expire, on the understanding that they would receive a state pension at 60. One of my WASPI contacts told me her private pension provider had given her a pension statement which showed her state retirement age as 60. My own workplace and private pension providers, too (I have several), continue to show my retirement age as 60 even though my state retirement age is now 66 and I have never told them I intend to retire early. Preparing pension statements, or even advising people when they can safely retire from a financial perspective, on the assumption that people's state retirement date is years earlier than it is likely to be in reality is highly misleading. Surely we should expect the pensions industry to behave more responsibly?

Having said all this, though, I do not think these WASPIs are behaving entirely reasonably. The harmonisation of retirement ages for men and women was extensively debated prior to the 1995 Act, and the passing of the Act was widely reported in the media at the time. Many people I have talked to assume that I knew about the changes because I worked in banking. But the pensions industry is completely separate from banking, and working in finance does not imply knowledge of pensions legislation. I actually heard about it on Radio 4's Woman's Hour, which as a young mother in 1995 I used to listen to while my son was asleep. So although I was not notified until this year that my retirement age would be 66, not 60 as it was when I started work, I already knew about the extra 6 years. If I can pay attention to what is reported in the media, surely these professional women who retired in their fifties could do so too?

Additionally, what were these women thinking of, planning their retirements - including giving up their jobs - on the assumption of receiving a state pension at 60? Surely they should have checked their entitlement? DWP says that it has been possible to ask for a statement of entitlement, including pension age, since 2001. Planning retirement without checking looks like folly to me. Though DWP does not exactly make it easy for people: even now, the online entitlement checker couldn't tell me how much I will receive, apparently because the state pension is changing in April 2016, though it was able to tell me my retirement age.

I have some sympathy for less educated women who did not or could not read or listen to the sort of media where the pension changes were reported, and did not know how to check with DWP about their pension entitlement. But I have none at all for professional women who simply did not bother. They should know better.

However, there is a deeper issue. It is not at all clear exactly what the WASPI campaigners want. They say they want some kind of "transitional relief" for women suffering as a consequence of pension age extension, perhaps because they have given up work and now face the indignity of JSA or ESA claims and the hardship of living on benefits that are less generous than the state pension.  But in a recent interview on BBC Breakfast, the principal WASPI campaigner, Anne Keen, said his:
We are saying to the government, you have a moral obligation to put those women in the same financial situation that they would have been if they had been born on or before 5 April 1950. It's not a handout: we are asking for what is rightfully ours."
This muddies the waters considerably. In effect, Ms Keen wants the equality legislation rolled back so that she and other women born in the 1950s can receive the state pension at 60, which they consider their "right". If it is a "right" for them, why is it not for younger women? And what about the fact that reinstating their "right" would create a "cliff edge" for the next cohort of women? Those born in 1960 could legitimately complain about the unfairness of having to retire SIX YEARS later than women only a few days or weeks older. I must declare an interest here: I would be one of those women. It is hardly surprising that I am less than sympathetic to those WASPIs who simply want their pension entitlement reinstated.

Nor is it helpful to conflate the problems caused by the DWP's failure to communicate the extension of pension ages with the freezing of pensions to expatriates, the uprating of pensions in line with CPI instead of RPI, or the fact that a large proportion of women - especially older ones - will not qualify for full entitlement to the new state pension. All of these are important issues, especially the last, which I consider to be a major scandal in the making. But they are not the same as the WASPI problem.

And last but by no means least, it is absolutely wrong in my view to use the fact that some WASPI women are sick, disabled or in a caring role to justify reinstating retirement at 60. The support currently offered to sick, disabled and carers is a national disgrace and I for one want to see it vastly improved. Allowing WASPIs to use earlier retirement as a means of getting better support will set back even further the cause of older men and younger people in the same situation. And as for the notion that a pension age of 60 is justified to enable WASPIs to care for their grandchildren, I really don't see why the state pension should become a childcare subsidy.

So to conclude, I agree that the DWP has made a total hash of the extension of women's retirement ages, and because of this there probably is a case for some women receiving exceptional assistance to relieve short-term hardship. But this must be considered on a case-by-case basis. However angry the WASPIs are, no way is direct or indirect reinstatement of state pension rights at 60 for women born in the 1950s remotely justified. Ros Altmann, the Pensions Minister, is absolutely right to rule it out. There are far more important injustices to address than this.


It would have been tasteless to put an image of a swarm of wasps at the head of this post. But I couldn't resist adding a link to the Wasps overture by Ralph Vaughan Williams. Enjoy. 

The original image has been removed, along with all links to WASPI campaign material from both the post and the comments. I do not support this campaign and I will not promote it. 

Saturday, 28 November 2015

Those elusive welfare spending cuts

The Chancellor's Autumn Statement contained an apparent U-turn on the cuts to tax credits outlined in the July budget. Predictably, this was presented as the Chancellor "listening" to those concerned about the impact of sudden large falls in income for working families at the bottom end of the income spectrum. The Conservatives continue to position themselves as the party for "hard-working families".

However, this isn't quite what it seems. The income cuts for low-income working families are not cancelled, they are merely delayed. The Chancellor has effectively hung his hoped-for reduction in tax credits expenditure on the roll-out of Universal Credit (UC). Because the UC changes announced in July have not been reversed in parallel with the tax credits climbdown, many new UC claimants will receive less than they would have received under the tax credits regime. As this chart from the Resolution Foundation shows, rollout of Universal Credit by 2020 would still mean the poorest losing a large proportion of their incomes:

But the Office of Budget Responsibility, in its latest Economic and Fiscal Outlook, identifies two problems with this. Here is the first:

The timetable for the rollout of UC is about as credible as the IMF's forecasts for the recovery of Greece. The latest revision shows a caseload below 6m in 2020-21. This is tiny.

The OBR's exasperation with the continual delays to UC rollout is evident:
Our forecast of the marginal cost of universal credit is based on a new assumption for the pace of rollout, which we have once again deemed necessary to push back.
And it is distinctly pessimistic about the likelihood of the current forecast proving any more accurate than previous ones:
....we have added our own forecast judgement of a further six-month delay to the managed migration phase of the UC rollout. As usual, we have considered evidence from DWP and the latest assessment of UC rollout by the Major Projects Authority. While this indicates greater confidence in the ‘transition phase’ rollout plan, considerable uncertainty remains over the ‘managed migration’ phase. And of course the transition phase rollout schedule has just been pushed back six months, just a year after the previous delay..... 
Forecasting the savings from UC has become something of a black art, largely because of the DWP's incompetence. Here's the OBR's somewhat caustic commentary on the consequences for their forecasts of the DWP's inability to provide estimates (my emphasis):
In our July forecast, we took the scorecard costings of the tax credit and UC measures (Tables A and B, line b) and added them to our pre-measures forecast (line a) to reach a post-measures forecast (line c). These costings took a bottom-up approach, whereby the effect on tax credits spending declined over time and the effect on UC increased over time as the UC caseload is assumed to rise (consistent with how the transition to UC will operate in practice). But because DWP is currently unable to produce a full bottom-up forecast of spending on UC and legacy benefits, this is not consistent with our forecast, which is based on adding the marginal cost of UC to a forecast of the legacy tax credits and benefit system.  
Correcting this means that the measures are now added into the forecast as though the legacy tax credit system continues indefinitely and only the marginal costs/savings are included in the UC forecast (line d). This results in a further fall in tax credit spending over the forecast period and an equal and offsetting increase to the marginal cost of UC. The net effect on spending is zero.  
The effect of the OBR's correction on their forecasts for the spending impact of replacing tax credits with UC is shown here:

But irritating though the enforced methodological change must be for the OBR, the production of these tables highlights a much bigger problem for the Chancellor. Even if the latest forecast for the UC roll-out timetable by some miracle proves accurate, these tables show that the tax credits change cannot be offset by the roll-out of UC. It just isn't being rolled out quickly enough.

This is the principal reason why the Chancellor is going to exceed his self-imposed welfare cap for most (or, more likely, all) of this Parliament. But as the OBR explains, the increase in tax credits is supposed to be offset by cuts in other benefits:
The Government’s policy decisions raise spending in the short term but reduce it by the end of the forecast. The near-term increase reflects the decision to reverse the main July Budget cuts to tax credits, which adds £3.4 billion to spending in 2016-17 alone. A variety of cuts to other benefits save increasing amounts over time and more than offsets the changes to tax credits by 2019-20. 
What benefits would these be, then?

Well, some of the savings are supposed to come from the migration of Disabled Living Allowance (DLA) to Personal Independence Payments (PIP). But the OBR has just revised its forecasts for disability benefits spending upwards:

Indeed, forecasts of disability benefit spending have been continually revised upwards:

The OBR expresses concern about the forecasts for disability benefit savings:
It is a concern to us that the revisions to our spending forecasts on DLA and PIP echo the pattern of revisions to our forecasts of spending on incapacity benefit and ESA during the reform of the incapacity benefits system.
They have reason. This chart is from the OBR's Welfare Trends report of June 2015:

Not only did the reform of ESA/incapacity benefit fail to deliver the expected savings, the cost of the new scheme is actually quite a bit higher. It turned out that there were nowhere near as many "incapacity benefit scroungers" as was reported in the Daily Mail. This does not bode well for DSA migration.

And it doesn't bode well for the Chancellor's welfare cap. Here's the OBR on the reasons why it has revised welfare spending forecasts upwards:
.....we have revised up our pre-measures forecast for spending subject to the welfare cap by increasing amounts from 2016-17 to 2020-21. The biggest change has been to disability benefits, including higher numbers of new claims to disability living allowance (DLA) and personal independence payment (PIP) and a slower pace of reassessments as cases are migrated from DLA to PIP. We have also revised up spending on incapacity benefits, assuming that 38 per cent of claims will be in the more expensive support group of employment and support allowance (ESA) in steady state (up from 30 per cent in our July forecast). New ONS population projections assume higher numbers of children, pushing up spending on tax credits and child benefit. 
So, more disabled, more ill, more children and a slower roll-out of UC. The welfare cap appears to be toast. But how then will total welfare payments be reduced by 2020? Once more, the OBR has the answer:
changes to spending outside the welfare cap have been small, with downward revisions to state pensions (from higher mortality at older ages in the new population projections and slightly lower triple-lock uprating reflecting our latest earnings growth forecast) offsetting upward revisions to jobseeker’s allowance (reflecting the higher outturns this year knocking through to the forecast); 
Brilliant. The new apprenticeship levy will keep a lid on earnings, thus reducing the triple lock on pensions as well as raising additional tax that might pay for those welfare spending overruns. And if all else fails, kill the old.

Tuesday, 24 November 2015

Grexit, Brexit and financial stability

On October 30th 2015, I gave a keynote speech at Birmingham University's Finance Forum on the implications of Grexit and Brexit for financial stability. I've now written this up as a paper.

I start by outlining the purpose of financial stability.
Since the 2007-8 financial crisis, “financial stability” has been all the rage. We must prevent another crisis: we must solve the problems that make our financial system “unstable”. 
But what exactly do we mean by “financial stability”? Most people would define a stable financial system as one which doesn’t fall over when it is hit by a major shock; doesn’t cost us huge amounts of money in repair bills when it is hit by a major shock; doesn’t draw in its horns and refuse to lend when the going gets tough; doesn’t become over-exuberant and lend far too much at too high a risk when times are good. 
But financial stability is not an end in itself. Rather, it is a means to an end. What we really want is a financial system that is stable, resilient and resolvable, so that it can support the real economy. 
I continue by summarising the measures taken since 2008 to ensure financial stability in the Western world, and particularly in Europe. I then go on to trace the history of the Greek crisis of 2010, the Eurozone crisis of 2011-12, and the second Greek crisis of 2015. I draw out some of the mistakes made and lessons learned from each of these. I then turn to the questions that the resolution of these crises have raised for the future of the Eurozone and of non-Eurozone countries within the EU. I conclude:
The 2008 financial crisis taught us that financial insitutions and markets cannot self-regulate; that finance is intrinsically bound up with people’s economic welfare; and that the price of failure adequately to supervise and regulate the financial system can be extremely high.

The 2012 Eurozone crisis taught us that central banks are the linchpins of financial stability. They have the ability to prevent or contain damaging runs and solvency crises; they also have the ability to create them. They are inherently political institutions, and none more so than the ECB, despite its supposed independence. And when they decide to act destructively – or do so out of ignorance – the economic fallout can be terrible. Central banks bear huge responsibility.
As we enter the third phase of the Great Financial Crisis – the ending of the Asian growth miracle - the lesson to be learned already appears to be – what are the limits of central banks, and what is the (new) role of fiscal policy in a low-growth, low-inflation, low-interest rates world?
I finish by outlining the responsibility of politicians and, ultimately, voters for making choices that promote financial stability and economic prosperity.

The whole paper is far too long for a blogpost, so I've linked it here as a pdf.

If we are terrified, the terrorists win

In this post, Tom issues a timely reminder that there are much worse threats to our freedom than terrorists. Like Tom, I remember as a child disappearing with my friends all day long, only coming home for lunch and tea - a freedom my own children never had. We seem much more fearful of loss (of all kinds) than our forebears. Perhaps that is because we are much less used to it. - Frances

Guest post by Tom Streithorst.

For the past four days, the city of Brussels has been on lockdown. The metro is closed, schools are shut, the authorities are telling citizens of the European and Belgian capital to stay home. They fear that “Eight to ten men”, armed and dangerous, might be planning a Paris style attack.

This is not the first time an entire city has been shut down because of a terrorist threat. After the bombing of the Marathon in 2013, Boston was under curfew as police searched for one man.

This is nuts. Charles Glass, after the 7/7 bombings in London went walking through Soho and noted that the streets were deserted. Yet during the Blitz, which killed considerably more civilians than ISIS has, Londoners went out, partied, drank and cavorted. They stood out on Hampstead Heath to watch dogfights between Spitfires and Messerschmitts. Today, a much, much smaller threat convinces us to cower in our homes.

One thing you learn in a war zone: proximity matters. A mortar round exploding 500 meters away poses a negligible threat. A small brick wall will save you. When I was living in Baghdad, a suicide bomber blew himself up less than a block from my house, killing a government minister and several of his bodyguards. Although we heard the explosion, it did us no damage. In terror, as in real estate, location is everything. Were a major terrorist attack to hit Kilburn in North West London, it would barely be noticeable in Kensal Rise, just a mile or two away.

I understand the motivation of the authorities calling for lockdown. If they have word of a possible terrorist attack and do nothing, and citizens are then murdered, they will be held responsible. The press would have a field day, lambasting their negligence. Safer, then, from their perspective, to make hundreds of thousands hole up in their homes than take the chance some of us might die.

We are far safer today than any humans in history. Homicide rates during the Renaissance were twenty times greater than they are now. The possibility of violent death was omnipresent for our ancestors, though deeply unlikely these days. And yet we seem more terrified than ever. You can see it in the way we mollycoddle our children. If you are my age, when you were a kid, you went out in the morning, played with your friends, came back for lunch and went out again, and your parents never gave a thought to where you were. Today, I always know where my ten year old is. He hardly ever even walks to a nearby park by himself, even though he knows the way, there are few busy streets and once there he is almost guaranteed to run into someone he knows. And the streets of our cities are considerably safer now than they were when I was a boy.

Life inherently has risk. When our hunter-gatherer ancestors chased gazelles, they took a chance that a tiger might eat them. When Marco Polo went to Xanadu, he accepted the possibility that brigands might kill him before he reached his destination. When immigrants left their homes to travel across the ocean to America, they understood the dangers such a voyage entailed. Last week, after the bombings in Paris, Erick Erickson, the editor of Red State, the influential Republican blog, said he wouldn’t be going to see Star Wars as “there are no metal detectors at American theatres”. You would think he would be embarrassed to be such a wimp. What would John Wayne say?

As a teenager in the 1970s, I lived in Buenos Aires with my foreign correspondent father. When I arrived, in 1973, urban guerrilla groups were kidnapping business executives, shooting up police stations, hoping to foment revolution. By the time I left, the police and military had responded in force, murdering tens of thousands suspected of sympathising with the leftist militants. The ERP, Montoneros and their ilk overestimated the power of revolutionary violence. Killing businessmen and policemen did not bring upon a socialist revolution, it merely caused their own destruction.

Blowing stuff up is relatively easy, especially if you are willing to die in the process. Perfect safety is impossible, especially if we wish to maintain a modicum of civil liberty. But blowing stuff up, ultimately, is ineffectual. It did not bring on revolution in 1970s Argentina. It will not bring on sharia law today. The only purpose of terrorism is to provoke governmental repression that the militants hope will bring more people to their side.

If we recognize the essential impotence of terrorism, that they might be able to kill a handful of us but they cannot really effect political change, then they will likely stop. If we quake in fear, we encourage them and give them reason to attack. Let’s stop shutting down great cities, just in case something bad might happen. Remember, you are statistically much more likely to be murdered by someone you love than by a Jihadi. We have nothing to fear but fear itself.

Image: Belgian soldiers patrolling an empty shopping arcade under lockdown. Photo credit: New Yorker.

In a tribute to the defiant spirit of the Belgians, I am also posting a second image. This is more like it.

Sunday, 22 November 2015


In my last post, I warned about "siren voices" calling for tighter monetary policy while the Eurozone economy is stuck in a toxic equilibrium of low growth, zero inflation and intractably high unemployment. Specifically, the so-called "German Council of Economic Experts (GCEE)" has called for the ECB to reduce or unwind QE:
...the European Central Bank should slow down the expansion of its balance sheet or even phase it out earlier than announced.
Of course, the GCEE is only concerned with Germany. Perhaps, given that their focus is entirely national, they are justified in expressing concern about the continuation of monetary stimulus if the German economy doesn't need it?

Well, no, they aren't. The ECB's concern is the Eurozone as a whole, not one particular bit of it. If the Eurozone's overall economic performance justifies QE, then the ECB should do QE, and if that means Germans have to tolerate higher inflation and lower interest on their savings, well tough, frankly. That's what being a member of a monetary union means.

But actually, it is by no means clear that Germany's economic performance justifies reduction or unwinding of QE (i.e. raising interest rates) anyway. Here are the key indicators for Germany according to the GCEE:

The GCEE's own projection for HICP inflation (listed here as "consumer prices") is 0.3% in 2015 and 1.2% in 2016 - both far below the ECB's target of "below but close to 2%". On this measure - and remembering that the ECB's only mandate is price stability - monetary tightening is not justified. Nor do the GCEE's projections for growth and unemployment suggest an overheating economy: both are stable, GDP growth is low and unemployment appears slightly elevated compared to historical averages. In short, although Germany doesn't have the zero-growth, double-digit unemployment of say Italy, its economic performance is not exactly scintillating.

There appears to be no justification for monetary tightening in Germany. So why are a group of German "economic experts" calling not only for the ending of QE, but for its reversal? The clue is in the preceding sentences: :
Low interest rates pose risks for financial stability and erode the business models of banks and insurers over the medium term. Relying only on macroprudential regulation cannot solve these problems. 
Yes, as usual it is all about banks. Back in February 2015, my friend Tomas Hirst wrote an interesting post for Business Insider in which he highlighted the difficulties that low interest rates cause for Germany's little banks, particularly the public sector Sparkassen. This chart from his post (originally from the ratings agency Moody's) shows how net interest margins are being squeezed:

Things haven't got any better since then: in fact QE makes things even worse. In August 2015, Fitch Ratings discussed the problems that the ECB's QE causes for the Sparkassen (my emphasis):
...performance ratios at the Sparkassen are likely to fall in 2015 as their ability to sustain net interest margins, which drive overall profitability, is becoming increasingly strained. This is because competitors are encroaching on their traditional retail mortgage and deposit businesses. In addition, higher-margin loans and higher-yielding securities are maturing and being replaced by ultra-low-yielding German and foreign public sector bonds and newer, less profitable, lending in a highly competitive environment.
Sparkassen Finanzgruppe Hessen Thueringen (SFHT) and Sparkassen in Baden-Wuerttemberg and Lower Saxony all expect 2015 profits to fall short of those reported in 2014. We believe the groups will find it difficult to reverse dwindling net interest income. Greater lending volumes are failing to fully offset a squeeze in net interest margins, which SFHT believes could fall by as much as 5% in 2015. We do not expect this situation to improve in the near term as we see no immediate relaxation of the ECB's quantitative easing programme or any let-up in competitive pressures.
So small banks in Germany's retail banking sector are becoming increasingly unprofitable because of ECB monetary policy and competitive pressures. Normally we would expect such a situation to force consolidation in the sector, with weaker members either going out of business or merging with stronger ones. But the Sparkassen collectively have enormous political power. When they lobby, they expect to get what they want. And right now, they want the pressure taken off their net interest margins - and that means higher interest rates and an end to QE. Hence the considerable pressure being placed on the ECB by influential German voices including - but not limited to - the GCEE.

It is true that persistently low interest rates do reduce banks' net interest margins. So do the flat yield curves created by QE. But against that should be set the benefit for businesses who can obtain credit both from banks and from markets at much lower interest rates than would otherwise be the case. The ECB's bank lending survey somewhat surprisingly suggests that QE has had a significantly positive effect on credit conditions in the Eurozone. Yet even with QE, lending to businesses is still on the floor and lending to households only slightly positive. Without QE, lending could still be falling, to the further detriment of the Eurozone economy. Why should the problems of German banks dictate the direction of Eurozone monetary policy?

But embedded in the paragraph I quoted above is an even more poisonous script.* Not only does the GCEE want tighter monetary policy, it wants tighter fiscal policy too:
Further fiscal consolidation and structural reforms are essential to create a self-sustaining economic recovery.
Nor is this confined to the Eurozone periphery. The GCEE thinks Germany still has plenty of room for improvement:
Germany can only strengthen productivity growth if it focuses again on improving economic conditions.There is considerable scope for efficiency-enhancing economic policy, especially in areas like the labour market, education and training, competitiveness, energy, and taxation.
But why does Germany need further reform? After all, it is already running a fiscal surplus and a very large trade surplus.

Why, because of refugees:
Given strong public finances and broad scope for efficiency-enhancing economic policy, foreseeable additional refugee-related expenditures appear manageable......
And what specific reforms will be needed because of refugees? Not investment, of course (apart from education and training). Dear me, no. Labour market reforms, of course:
In addition to accelerating the processing of asylum applications, the barriers to entering the job market should be lowered. Recognised refugees looking for work should be treated like long-term unemployed, who are temporarily exempt from the minimum wage. In addition, any increase in the minimum wage should be avoided.
So the GCEE's recipe for integrating refugees is repression of wages for German workers, coupled with further fiscal consolidation to offset the "additional direct public outlays" arising from the inflow of refugees. Yes, this will really make refugees welcome among Bild readers, won't it?

The German establishment seems hellbent on steering the Eurozone ship on to the rocks. I despair, I really do.

Related reading:

Euro depression, charted
Preposterous: Germany's demanding an end to Eurozone QE despite the slow growth - Forbes

*I am indebted to Andrew Duff for pointing this out.

Image: The Lorelei, 1900. Photo credit: Wikipedia. In Heinrich Heine's poem "Die Lorelei" (1824), the Lorelei rock is the lair of a beautiful witch whose singing lured sailors to their deaths - the German equivalent of the Greek Sirens. 

Friday, 20 November 2015

Euro area depression, charted

"The euro area economy is gradually emerging from a deep and protracted downturn. However, despite improvements over the last year, real GDP is still below the level of the first quarter of 2008. The picture is more striking still if one looks at where nominal growth would be now if pre-crisis trends had been maintained."

So said Peter Praet, Member of the Executive Board of the ECB, in a recent presentation to the FAROS Institutional Investors' Forum.

He's not wrong. From his presentation, here is a chart showing the difference between current output, current (estimated) potential output and projected output prior to 2007:

That is indeed a striking gap. It is reflected in this chart from Eurostat (August 2015):

So, the fall in GDP growth between 2007 and 2015 has resulted in a rise in unemployment of nearly 4 percentage points. Currently, across the Euro area as a whole (population about 340m), adult unemployment stands at 11% and youth unemployment about twice that. That is a LOT of wasted lives.

Since 2008, the Euro area has experienced a severe, extended double-dip recession from which it has not yet emerged:

Comparisons with previous recessions in Euro area countries (prior to the formation of the Euro, of course), as well as to the US's 2009 recession, show just how severe and prolonged this recession has been. It is probably reasonable to call it a depression.

If the Euro area continues on the path shown in this chart, it should emerge from depression by the end of 2016. But as Praet observes, the outlook for the global economy is not exactly bright, and the projected recovery path for the Euro area is by no means certain:
The risks around the evolution of the global economy have shifted downward, making the contribution of external demand to the recovery less assured. Domestic demand, though rising, also appears relatively weak if one considers that we are still in an early phase of the recovery and that there are important tailwinds supporting the economy – namely our monetary stimulus and lower oil prices.
These aren't the only tailwinds supporting the economy. Lending figures from the ECB for September  2015 show continuing weakness in private sector loan demand, largely offset by strong growth of general government borrowing (7.2%, up from 6.3% in August). Despite continuing attempts by Brussels/Berlin to squash government support in the name of "fiscal discipline", it seems that governments are still borrowing to spend - fortunately, since there is little support coming from anywhere else. Investment in the Euro area fell sharply in 2008 and again in 2012, and remains shockingly low:

Praet observes that:
investment has so far failed to perform its "accelerator" role for the recovery.  
He goes on to attribute this to the continuing overhang of private and public sector debt, and to the very poor returns on capital in some Euro area countries.

Importantly, Praet also notes that expectations of future growth in the Euro area are declining:

The debt overhang is undoubtedly a cause of the investment chill, but so are the low expectations of investors. After all, if you expect GDP growth 5 years hence to be a measly 1.4%, why would you bother to invest?

This is, of course, one of those nasty feedback loops that complicate macroeconomic forecasting. Low expectations cause low investment, which in turn depresses future growth prospects, causing expectations to fall further. It seems unlikely that private sector investment will improve any time soon. And because of this, inflation is unlikely to rise. This is therefore a matter of some concern to the ECB. Inflation (HICP) is currently far below target, and the latest ECB forecast predicts an extremely slow return to target - more than two years. Praet comments that inflation expectations are being affected by short-term supply-side effects (low oil prices), which suggests that they are becoming "unanchored" on the downside. Putting the two together, people expect growth to disappoint and inflation to remain below target for the foreseeable future.

Assuming that the Phillips curve remains negatively sloped - i.e. that there is an inverse correlation between inflation and unemployment - expectations of poor growth and very low inflation indicate that unemployment will remain stubbornly high for the foreseeable future.

The Euro area is stuck in a low-growth, low-inflation, high-unemployment equilibrium. It will take one heck of a big bazooka to knock it out of this toxic balance. The countries in the Euro area don't have that kind of bazooka. They are restricted by fiscal rules that make it impossible for them to do the large-scale investment spending that will be needed to restore growth. There is no Euro area federal government that could take on an investment programme of the necessary scale: President Juncker's plan is nowhere near adequate. The ECB is the only player with the necessary firepower, but it is insanely prevented by treaty directive from using its really big guns.

Perhaps predictably, Praet deflects criticism of the ECB for the Euro area malaise, arguing that restoring growth requires "structural reforms" from governments, not a more active role for the ECB. Yet this is the ECB that triggered the double-dip recession by failing to do its job of lender of last resort, allowing the Euro to fragment and sovereign yields to spike due to fears of Euro breakup and redenomination. And although Draghi's "whatever it takes" in 2012 ended fears of redenomination risk, the ECB then allowed M3 growth to fall for over a year, which was completely unwarranted - and very damaging - monetary tightness for an economy as depressed as the Euro area:

source: ECB statistical data warehouse

It is very hard to excuse the ECB for these errors.

It is not reasonable to claim, as Praet does, that restoring growth in the medium term is solely the responsibility of governments. To the contrary, it is extremely difficult for governments to undertake structural reforms when money is unjustifiably tight. M3 growth has improved, but as the chart shows it is now flatlining at the 2004 level. If unemployment and growth were at their 2004 levels, this level of M3 growth would be appropriate. But for a depressed economy with high unemployment, no inflation and a substantial output gap, it is way too low. Further stimulus is unquestionably needed.

Unfortunately there are influential voices arguing not only that further monetary stimulus is not necessary, but that the stimulus applied so far should be removed. For the sake of the unemployed, and those suffering from income restrictions, tax rises and benefit cuts, I hope these siren voices are resisted. The combination of tight money and fiscal restriction entrenches depression and unemployment.

I know I've said this before (and been criticised for saying it), but there is an uncomfortable historical precedent here. A similar toxic equilibrium was reached in certain European countries in the 1930s. It resulted in the rise to power of nationalistic governments, autarky and extremism, and eventually war. I do not forecast this, but we should not forget it. A war is certainly a big bazooka, and as long as people perceive it as politically justified, it is unlikely to be opposed on economic grounds.

But war, however justifiable, is terribly destructive. It would be far better for the Euro area to risk fiscal profligacy and monetary irresponsibility than travel that road again. So let's ditch the ridiculous rules and directives, spend a lot of money - ideally by means of helicopter drops, since increasing the fiscal burden on highly-indebted countries in a dysfunctional monetary union is not a sustainable solution - and get people working, and the economy growing, again.

Related reading:

The Slough of Despond
The dangers of historical taboos
The ECB is not doing its job. Again.
A terrible stability - Pieria
Structural destruction - Pieria

Monday, 16 November 2015

The European Union must reform before it's too late

At the Bank of England's Open Forum in London's Guildhall on Wednesday 11th November, an increasingly desperate-sounding Mario Draghi said this:
As the majority of money is issued by private banks - bank deposits - there can only be a single currency if there is a single banking system. For money to be truly one, it has to be truly fungible, independent of its form and independent of its function.
This is far from being the first time that Signor Draghi has pushed the case for common supervision of banks, common deposit insurance and a common resolution mechanism. He has warned repeatedly that fragmentation of the monetary system along national lines undermines the fabric of the common currency and threatens its very existence.

But in reality, Europe does not have a common currency. Indeed it has never had one. The price of money is different in the various nations of the Eurozone. The "Euro" in Greece does not have the same value that it does in Germany, and this is reflected in the higher cost of borrowing for households and businesses in Greece over Germany. There remains a noticeable wedge between borrowing costs in the Eurozone periphery and borrowing costs in the core.

Between the Euro's creation in 1999 and the 2008 financial crisis, the price of money gradually converged across the Eurozone. Market participants believed that risk sharing was a current reality, and full union was inevitable. Money in weaker countries still carried a higher price than money in stronger countries, but the gap was narrowing and, it was believed, would eventually disappear completely. This belief was fostered by the ECB, which treated all Eurozone sovereign risks as equal for the purposes of collateralised lending to banks, and Basel capital adequacy rules which weighted all sovereign risks at zero.

Market participants flooded into the narrowing gap to take advantage of what was seen as a relatively short-term profit opportunity, secure in the belief that risks were effectively shared across the Eurozone and the ECB would act as backstop. They borrowed cheaply in core countries and lent at higher rates in the the periphery, creating bubbles in consumer credit, household and business mortgages, construction lending, commercial lending and sovereign debt. In short, they created what was possibly the world's largest carry trade. These enormous flows of credit were facilitated by the EU's principle of free movement of capital: nation states, deprived of control of monetary policy and locked into an EU-wide paradigm of light financial regulation, lacked effective means of slowing or reducing them.

The utter inadequacy of light financial regulation was exposed in the financial crisis of 2007-8. In his speech at the Guildhall, Mario Draghi went on to explain the terrible consequences for the Eurozone:
Trust was weakened by the crisis, causing finance to retreat behind national borders. This manifested in some countries as a "sudden stop" of capital flows, and the resulting fragmentation led to the transmission of the single monetary policy being impaired. 
We can summarise this as Balkanisation of the financial system and fragmentation of the single currency.

As the financial bubble burst, the illusion of risk-sharing and mutual support in the Eurozone was shattered. Far from backstopping each other, the member states blamed each other for the crisis. The cost of preventing the European banking system from collapsing was disproportionately borne by the states that had experienced the "sudden stop" of capital inflows, to the considerable detriment of their populations. As Paul McNamara of GAM said at the FT Alphaville conference earlier this year, "the Greek bailout was intended to prop up the European banking system and make the Greeks pay for as much of it as possible". Even more could this be said of Ireland.

Since then, there have been moves from EU institutions promoting integration and eventual union. There is a fledgling banking union, an underdeveloped bank resolution mechanism and the beginnings of a mutual backstop for distressed banks. There is an action plan for a capital markets union. The "Five Presidents" plan issued at the height of the Greek crisis earlier this year proposed further mutualisation, including Eurozone-wide reinsurance for national deposit insurance schemes. As a result of these moves, market participants are starting to believe, once again, that there will be risk sharing and mutual support. Sovereign bond spreads over Bunds are falling, and the wedge between the price of money in the core and periphery is narrowing.

But I'm afraid this is another illusion. Despite the efforts of the institutions, there is no more political commitment to risk sharing and eventual union than there was in 2012. Even though President Juncker's plan for deposit reinsurance still left the first losses falling to the sovereign, envisaging support from the rest of the Eurozone only when national deposit insurance was exhausted, it was too much for the Germans. On 5th November, the Bundestag rejected President Juncker's reinsurance scheme.

The present situation is untenable. We have a "single currency" in name, but not in reality. The price of money in the Eurozone depends not on the creditworthiness of businesses and households, but on the creditworthiness of the sovereign in the country in which they happen to be located. So businesses and households in Germany can obtain finance at lower rates than businesses and households in Italy. This gives Germany an enduring credit advantage over weaker countries, making it all but impossible for weaker countries to close the competitiveness gap. The Eurozone monetary system is a simply massive "postcode lottery".

Despite their fine words about breaking the toxic link between sovereigns and banks, the Eurozone authorities have abjectly failed to do this. Indeed, at times the actions of Eurozone institutions have actually strengthened this link, rather than resolving it: the ECB's LTROs, for example, were openly used to finance bank lending to governments in Spain and Italy. The failure to mutualise the costs of resolving failed banks leaves individual sovereigns on the hook for Europe-wide, and even global, financial disasters: while the principle of creditor bail-in simply exposes sovereigns in a different way. In 2012, the Greek PSI blew large holes in the balance sheets of Greek banks and pension funds, holes which were plugged by the Greek sovereign at a cost of yet more unsustainable borrowing, because the welfare costs to the Greek population of allowing the banks and pension funds to fail were far too great.

It is an insult to genuine monetary unions, such as those in the US, Canada, the UK and Switzerland, to call this a "monetary union". The Euro is a common name for member state currencies, not a common currency. Politicians pay lip service to the idea of a common currency, insisting on independence of monetary policy and free flows of capital - when it suits them. But when it no longer suits them, they impose capital controls and pressure the ECB into doing their bidding. Successive crises have demonstrated that the coherence of the union comes a very poor second to national interests - along with notions of fairness, justice and social cohesion.

Perhaps understandably, the Eurozone institutions have persistently used smoke and mirrors to conceal the lack of political unity among the nation states. But the smoke is clearing, and the mirrors are cracking. We now can see this monetary union for what it really is: a fair-weather alliance. When conditions are calm, we pull together: but when the storm comes, it is every nation for itself.

And storms are coming - storms big enough to overwhelm not just the fragile "common currency", but the entire EU. For the EU, too, is not really a union.

The Schengen agreement suffers from the same problems as the Euro: it works well in good times, but when the pressure is on, the razor wire goes up. The refugee crisis is worsened by the expectation that "gateway" countries such as Greece and Italy - already weakened by financial and fiscal crises - will single-handedly police the EU's external boundaries and manage flows of migrants from outside the EU; while the standoff with Russia over Ukraine, and the inadequate response to the Syrian disaster, has exposed the EU's lack of a coherent foreign policy.

The EU not only lacks coherent policy, it lacks leadership. Currently, everyone looks to Germany to provide leadership: but this is to forget the post-war consensus that Germany should never again be hegemon in Europe. The weakness of France, the political chaos in Italy, and the UK's abdication forces Germany's Angela Merkel into an EU leadership role for she was not elected, to which she is not suited and which for important historical reasons she should not have.

Of the three founding principles of the EU, two are already compromised. The principle of free movement of capital was destroyed when capital controls were imposed first in Cyprus, then in Greece. The principle of free movement of people has become a hollow sham, as country after country has responded to inflows of refugees and migrants with border controls, detention centres and violence. All that is left now is free movement of goods and services. But this principle, too, is under threat.

Fiscal rules in the Eurozone are so tight that weaker countries can only grow by means of an export-led growth strategy. But the EU is home to one of the biggest export engines in the world, and the whole world is becoming less tolerant of trade deficits. As global trade contracts, export-led recovery in the Eurozone periphery will be exposed as the pipe dream it has always been. How long will it be before weaker countries in the Eurozone, deprived of the option of devaluing to support export-led growth, start to put sand in the gears of the German export machine by imposing import tariffs in one form or another?

The future not only of the Euro, but of the whole EU, depends on the willingness of nations to put aside narrow national interests and embrace risk sharing and mutual support, while respecting national characteristics. In the words of Alexandre Dumas, the motto must be: "All for one, and one for all".

This implies radical reform of the EU, including unwinding the Euro in its present form and rethinking the treaty directives that institutionalise power imbalances and create different "classes" of nations. Unfortunately, the current push is for conformity and adherence to dysfunctional rules as a protection against disintegration: but conformity is not union, and forced conformity eventually results in disintegration. I fear that "muddle through" may eventually become simply muddle, and the much-kicked can may become an unrecognisable tangle of metal shards all over the road.

I must emphasise that although I am becoming increasingly gloomy about the prospects for the EU, and I think the Euro is unsustainable in its present form, I remain a fervent supporter of the European dream of peace, freedom and cooperation between nations. And I have a message for the UK's Prime Minister, David Cameron. The UK has historically been the country that has spearheaded important reforms in the EU. It can, and should, take a leading role in today's EU. But it cannot do this from a semi-detached position. To be credible as a force for change, the UK has to be wholeheartedly committed to the EU.

Brinkmanship, Mr. Cameron, is not leadership.

Related reading:

The ECB is irrelevant and the Euro is a failure - Pieria


Mario Draghi speaking at the Guildhall - Guardian
Migrants crossing razor wire on Hungary's border - IB Times