Friday, 30 December 2016

The essence of evil

I have a confession to make. I have been reading the Daily Mail.

No, I haven't gone over to the dark side. Rather, I have been true to myself. I have always tried to keep an open mind. And sometimes that means doing something of which my critical self does not approve. Like reading tabloid newspapers.

Reading is an important part of my life. I've always needed time to myself, to read and think. Without that space, my mind fogs and I become irritable. I suppose I am a bit introverted, really.  But shutting people out, even temporarily, can be difficult. Frances has her head in a book again? Just shout to get her attention. Works every time. And now that I have become my father's part-time carer, time for reading and thinking is hard to come by. The fog is slowly descending on my mind.

I discovered long ago that the easiest way of creating time to read and think is just to disappear for a while. So, over the years, I have collected some favourite boltholes. One of them, bizarrely, is Medway Service Station on the M2. Ten years ago, I used to stop there every week on my way to teach in Sittingbourne. It has a decent coffee shop with comfortable chairs. And it has newspapers. You just borrow them to read while you drink your coffee.

Most days now, I drive from my home in Rochester to my father's home on Sheppey, and back again. It's essentially the same journey as I used to do all those years ago.

So, a few days before Christmas, I was driving back from Sheppey to Rochester after helping my father with his shopping. Longing for some time to myself, I decided to stop at Medway Service Station for half an hour.

I ordered a coffee and went to look for a newspaper. The coffee shop was fairly busy, so most newspapers were already in use. There were only three on the stand - the Daily Express, the Daily Mail and the i newspaper. Disappointed, I reached for the i as the best of a bad bunch. But something stopped me. "Keep an open mind," said a voice in my head. And I thought to myself, "I have been critical of the tabloids - and especially of the Daily Mail - but I don't actually read them. I'm a snob."

So I picked up the Daily Mail and headed back to my seat.

It was the day after the Berlin terrorist attack. The first few pages consisted entirely of pictures and reports from people at the scene. I read them with interest. The eyewitness accounts were powerful: I, too, could feel something of the fear and horror that those people experienced, simply from reading their words.

But it was not the reporting of the terror attack that stopped me in my tracks. It was something entirely different.

The previous day, Rabbi Lionel Blue had died, one of many celebrities in the 2016 morgue. In his memory, the Daily Mail devoted an entire page to one of his reflections. In it, he described how he met God in a Quaker meeting - hardly the Holy of Holies for a Jewish man. I was reminded of my father saying he met God on a railway station. People find God in the strangest places....

Irreverent as always, Rabbi Blue dubbed his new friend "Fred":
It’s a friendly name and that’s how he popped up in my imagination.  Fred spoke back to me but his answers weren’t ones I expected.
They weren't what most of us would expect. We imagine God as controlling, not permissive: as dictating what we should believe, not allowing us to decide for ourselves. But Fred was different. Rabbi Blue continued:
‘Do I become Christian?’ I asked him. He was uninterested. ‘That’s your business,’ he said.
As I read this, a memory came to me. A 22-year-old music student standing in a Russian Orthodox church in Moscow, watching with horror the elderly women praying to the icons. "It's idolatry!" cried my younger self. And a voice in my head said, "Nevertheless, these are my children too".

At that time, I believed in God, but my faith was narrow and rigid, excluding others who did not conform to Christian evangelical norms. I was sure what those women were doing was evil. But God had a different opinion. Briefly, he gave me a glimpse of the world as he saw it - and it shocked me to the core. What I thought was evil, he considered unimportant. But condemning those women for their religious practices was a different matter. My version of Christianity was his idea of evil. Not that he was condemning me, mind. He just wanted to open my eyes.

That experience fundamentally changed my world view. To this day, I remain convinced that God is far more tolerant than we can imagine. Fred, utterly uninterested in Lionel Blue's faith choice, is the God that I know, the God I met in that church in Moscow.

We are all Fred's children, whatever faith - or none - we choose. I choose to be a Christian. Lionel Blue chose to become a Jewish Rabbi. Others choose to be Muslim, or Hindu, or Buddhist, or atheist. Our choices are driven by our cultural backgrounds, our temperament, our friends & family, our life experiences. But we have far more in common than the faith choices that divide us. The most important thing we share is our humanity. When we recognise another as a fellow human being, and share in their joy and their pain, we see the face of God.

And that brings me back to the Daily Mail. As I read on, I realised that it was all about people and their struggles. About their health, and their wellbeing. Six pages of eyewitness reports of a terrorist attack. A whole page report about elderly people with dementia being discharged from hospital in the middle of the night without support. Joyful reports about advances in healthcare that make people's lives easier. Angry reports about cost-cutting and meanness that diminish people's quality of life. And through it all, I heard the voice of God. The God who told me to keep an open mind. The God who meets us in the most unlikely places. The concern of my God for humanity shone through that paper that I had despised.

That said, I am not blind. The Daily Mail is partisan and divisive. It appeals to some and alienates others. And, more worrying, it promotes "othering" of those who are not "one of us" - migrants, Muslims, the very poor, the very rich. But I can see why God chose to use this very flawed medium to teach me a lesson. I was every bit as guilty of divisiveness and "othering". It is a lesson I shall not forget.

And it is a lesson that others too need to learn. As I look at the world today, I see fragmentation and discord, growing alienation, and a distressing tendency to divide people into "right" and "wrong", "us" and "them", Leavers and Remainers, Christians and Muslims, citizens and migrants, white and black, "ordinary people" and "experts", workers and bankers .....the list is endless. I find the religious divisions particularly distressing, perhaps because I lived through the years of violent religious discord in the United Kingdom, and I fear for the fragile peace in Northern Ireland. And perhaps also because I still hear "nevertheless, these are my children too" in my head.

When we divide people into "us" and "them", we deny the humanity of those we decide to exclude. And by denying their humanity, we open the door to terrible, terrible things. By convincing ourselves that they are less than human, we can justify to ourselves the torture, rape, slavery, imprisonment and murder of our fellow human beings. Acts of unthinking cruelty become commonplace, social deviants are treated increasingly harshly, false and exaggerated stories whip up the fear that justifies brutality towards those who are "not one of us". This is the essence of evil.

It is often said that for evil to triumph, all that is necessary is for good men to do nothing. But I would say that when we stop seeing our common humanity in the faces of others, the triumph of evil is already assured.

Related reading:

The extent of evil
Joseph Brodsky on the Greatest Antidote to Evil - Brain Pickings
What have we learned from history?
True patriotism

Image: Medway Service Station from the M2. Source: Geograph

Thursday, 22 December 2016

Market failure

I hate the term "neoliberal", but in this piece I am going to use it, simply for want of a better word.

Neoliberal economic dogma says that the public sector crowds out the private sector. So the public sector should only step in as a last resort to provide for those that the private sector cannot or will not serve. In recent years, we have interpreted this to mean that the public sector should only provide for the very poorest in our society. If people can afford to pay, the private sector will provide. 

Is this true? Well, true believers say it is. So, if an elderly man with a gold-plated defined benefit pension and substantial savings needs sheltered accommodation because he is no longer safe to live on his own, he should have no problem finding it, should he? 

I did an internet search for sheltered housing on the Isle of Sheppey, where the elderly man lives. This is what I found:

Only one of these enclaves is sheltered housing: the other is accommodation restricted to over-55s, but it does not have an on-site warden. So, for the whole of the Isle of Sheppey (about 38,000 people, of whom around 25% are over 60), there is one sheltered enclave with 38 units, all of which are currently occupied. It is run by Amicus Housing Association on behalf of Swale Borough Council. There is no private sector sheltered housing on Sheppey. 

Thinking I might have missed something, I checked with estate agents. They confirmed that there is no private sector sheltered housing on Sheppey. There isn't much in Sittingbourne, either. Better go to Faversham. Or Tunbridge Wells. Richer areas. There is lots there. 

The trouble with Sheppey is that it is not an attractive place for private sector providers. Compared not only with the national average but with the county of Kent, it appears to be poor:

Or - is it?

Umm, how does that work, then? Easy. Despite the fact that it is in the South East of England and only about an hour from London by fast commuter train from Sittingbourne, Sheppey's house prices are below the national average. The average house price in England & Wales is currently £216,674, but the average house price on Sheppey is £204,369. Population statistics show that the majority of people on Sheppey are in the 30-59 age bracket, so most of them will have bought their properties some time ago. So the slightly high home ownership rate does not indicate affluence, as the banner at the top of this chart says. Rather, it reflects the affordability of housing on Sheppey relative to the average for the South East - hence the high proportion of mortgages. 

And this also explains why there is no private sector sheltered housing, or indeed any private sector accommodation for the elderly other than a couple of care homes. The return on capital is not high enough to justify the property investment. What housebuilding there is on Sheppey is aimed at commuters moving into the area to take advantage of fast road and rail links to London. New housing developments are mostly two and three bedroom homes, plus some larger properties, built close to the roads that take the commuters off the island. I asked one property developer about flats in town centres, and she said "oh we don't do those". They aren't what the commuters want. 

So we have a total market failure. The private sector does not provide for the elderly on Sheppey. In fact it doesn't really provide for local people at all. It is entirely focused on attracting London commuters. 

Since I couldn't find private sector accommodation, I issued a preliminary enquiry to Amicus Housing Association about Davie Court. (I have redacted personal details, obviously, and added the red underline.) 

This was the response:

So, the need of a frail elderly man for sheltered accommodation is treated as a housing problem not a care problem. This is really going well, isn't it?

Swale Borough Council's criteria for housing say absolutely nothing about care needs or risk. But they do say a lot about money:

I knew he wouldn't qualify. He has too much money. But I emailed them anyway, reminding them of their duty of care:

The response was a slapdown:

Translation: ""F**k off. Rich bastards like your father are not our problem". 

So, the private sector won't provide, and neither will the public sector. And the third sector has sold out to the public sector. The really stupid thing is that my father is able and willing to pay. But no-one is willing to provide. I am unable to find the sheltered housing that my father needs in the area where he has lived fo 18 years. 

And so far, I am unable to find care support either. 

Swale Borough Council referred my enquiry to the Social Services department of Kent County Council. But I had already contacted them about care support - and they decided that because my father doesn't need help washing or dressing, he doesn't need any help at all. They interpreted their remit so narrowly that ensuring his safety simply didn't feature. 

So I have had to step up myself. I am currently spending several hours at my father's house nearly every day, a round trip of 60 miles, just to ensure that he is safe. And I am permanently on call: he has an assistive helpline, but the first person on the call list is me. I am trying to find support from private sector care agencies: there are a few, though their capacity is limited at present. Maybe, in the new year.....

Fortunately, my working hours are flexible, though my work is suffering: I didn't meet my Forbes mandate last month, I didn't write my Co-Op News column either, I have cancelled numerous singing lessons, and I finally completed my American Express assignments for this year yesterday, one month late. But nevertheless, I am fortunate. Most people do not have such flexible working lives. Many are forced to give up work to care for elderly relatives.  

Market failure like this has economic consequences. Government waxes lyrical about the need for affordable childcare so that women with young children can stay in the workforce, while simultaneously cutting back on the services needed to ensure that women with elderly relatives can stay in the workforce. I say women, because the burden of elderly care by families still falls principally on women, though of course some men are carers too. What is the cost to the economy of people leaving the workforce because neither the private nor the public sector will provide adequate care for their elderly relatives?

The next neoliberal cultist who tells me that the public sector should be slashed to the bone to make way for the private sector will receive a very dusty response. Get real, ideologues. The private sector only provides when it perceives that it is in its interests to do so. 

Market failures need public sector intervention. Local authorities that only provide for the poorest and fail to ensure that the rest of their constituents have adequate provision are not doing their job. In fact they are breaking the law. The Care Act 2014 specifically assigns to local authorities the responsibility for ensuring that there is a functioning market in social care provision. 

The rich in Faversham and Tunbridge Wells are provided for by the private sector. And the poor on Sheppey are provided for by the public sector. But the people in the middle - the in-betweeners - are on their own. No-one is meeting their needs. 

Related reading:

Friday, 9 December 2016

The in-betweeners

How effective is monetary policy?

Highly effective, according to the Governor of the Bank of England. In a speech earlier this week, Mark Carney robustly defended the Bank of England's record:
"Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work."
Well, lots of us might agree that monetary policy did help to offset the damaging effects of bank and household deleveraging in the aftermath of the worst financial crisis since the 1930s.

Carney suggested that monetary policy also dampened the effect of premature fiscal consolidation when everyone panicked about government deficits in the wake of the Greek crisis:
Fiscal policy quickly came under severe strain as tax revenues plunged, the costs of social benefits rose sharply, and the huge bills for too-big-to-fail banks came due. Since then sustained austerity has reduced the fiscal deficit from around 10% of GDP in 2010 to around 3 ½ % today. While necessary, this has, on average, subtracted around 1 percentage point from demand each year. Over that time, structural policies have boosted participation in the labour market but have been unable to return productivity growth to anything resembling its historic average. For seven years, in the face of severe headwinds to growth, monetary policy has been the only game in town. 
He is probably right. The counterfactual is the Eurozone, where severe fiscal consolidation has been undertaken by several countries without monetary policy support. Eight years on, unemployment remains distressingly high, growth is flat and inflation is negative, reflecting a massive collapse of aggregate demand. The ECB's monetary easing has been too little, too late for countries like Spain, where some of the unemployed have been out of work for over four years. Whole generations have been thrown on the scrapheap because of monetary and fiscal intransigence. Eventually, the price for such harshness will be paid politically.

But the most persistent criticism of monetary policy is that it has, in the words of HSBC's Stephen King, "unfortunate distributional effects". It benefits the holders of financial assets - primarily the rich - at the expense of those dependent on interest income, who are believed to be much poorer, though not necessarily the poorest.

Carney is having none of it. He rejected the distributional criticism of monetary policy on the grounds that savers are also asset holders:
Just 2% of households have deposit holdings in excess of £5,000, few other financial assets, and don’t own a home. So the vast majority of savers who might have lost some interest income from lower policy rates have stood to gain from increases in asset prices, particularly the recovery in house prices.  
Of course, realising those gains is not necessarily easy. Your house may have gone up in value, but you are still living in it. For those trying to live on declining interest income from savings, asset price rises are cold comfort.

But Carney is not having that either. He points to these two charts as evidence that the poor have done better than the rich from monetary policy:

These charts do indeed appear to show that the poorest have seen the largest rises in both wealth and income since 2006. But they are presented without explanation or notes, and they are opaque to say the least. The wealth chart, in particular, is something of a mystery.

The wealth increase of the top two quintiles is easily explained. These quintiles not only own property, they own financial assets - and monetary policy has increased the value of financial assets. But the rest of the chart is much less clear.

Firstly, it shows a very large increase in wealth for the poorest quintile, followed by a sizeable collapse and then a recovery. The Governor says that the wealth buildup for the lowest quintile after 2010 came from brutal deleveraging of property debt. I don't believe it.

This is the UK's wealth distribution in 2012-14, from the fourth and final "wave" of the Wealth and Assets Survey (WAS). The divisions are deciles: the Bank of England has used quintiles, but these are easy to derive from this chart.

Wave 4 of the WAS does say that the principal form of wealth for poorer people is property. However, the survey says that only 40% of those in the bottom half of the wealth distribution own property - i.e. P50 and below. That includes the lower-middle quintile and part of the middle quintile in the Bank of England's chart. Given that only about two-thirds of UK households own property, and the proportion of high-wealth households that own no property is vanishingly small, it is highly unlikely that the lowest quintile (P0 to P20) would include sufficient homeowners for property rises to have such a dramatic effect on net wealth for that quintile.

I think the net wealth changes for the poorest quintile are much more likely to stem from rapid buildup and deleveraging of unsecured debt (credit cards and high-interest loans), followed by renewed saving. This is supported by this statement from Wave 1 of the WAS (2006-8):
25 percent of households had net financial wealth that was negligible: a large number of households at the lower end of the distribution had negligible, zero or negative net financial wealth. 
The poorest 20% didn't have mortgages, they had credit cards and payday loans. And in the deep recession after the financial crisis, many of them defaulted on them. Some had their possessions seized to pay off debts. The few that might have owned houses in 2006 don't, any more. Now, they are free of debt and are beginning to build up savings, perhaps with the help of charities such as Stepchange.

Can monetary policy take the credit for this? Absolutely not. If there had been no monetary policy support, far more of this group would have defaulted on their debts. Under UK law, if debt default results in personal bankruptcy, the individual is not left destitute. Possessions are seized, yes, but the individual is allowed to keep sufficient possessions to support a basic lifestyle. Writing off the debts therefore leaves the individual with net positive wealth. The Bank of England's chart is absolutely correct to show this as a noticeable increase in net wealth for the poorest 20%, but this is not due to monetary policy. It is due to the disastrous 2008 crash, the personal bankruptcies that resulted from it, and the determination of many of this group never to be so vulnerable again. Perversely, monetary policy has if anything impeded the deleveraging of this group and restricted improvement in net wealth.

That said, monetary policy has to some extent protected the poorest quintile from high unemployment and large income falls. So, indirectly, it has helped them to pay off problem debt and start to build up savings.

Now we have explained the wealth increases of the richest and the poorest on the Bank of England's chart. That leaves the lower-middle and middle income quintiles (P20 to P60) - what we might call the "in-betweeners".

These people were not as vulnerable as the poorest group in the 2008 crash. They had higher levels of property ownership than the bottom quintile, less unsecured debt and more savings. But the chart shows that as a group, they have apparently been largely unaffected both by the 2008-10 housing market crash and the subsequent housing market recovery. This cannot be explained by the fact that most homes are mortgaged. Mortgages are nominal, not real. They do not increase and decrease in response to house price changes. When the price of a mortgaged home rises, the homeowner's net wealth increases. So why have house price rises had so little effect on the wealth of the in-betweeners?

My reading of the chart is that it is the in-betweeners, not the poorest, that suffered distressed deleveraging of property debt. The WAS says that much of their wealth is tied up in property: Wave 2 tells us that the average value of their property fell sharply in 2008-10, in some areas by over 8%. But if the aggregate value of their mortgages also fell, because they were paying them off, then the net wealth of the group as a whole would remain the same even though house prices were falling.

Once the housing market started to recover, of course, the deleveraging stopped and new buyers entered the market, all of them mortgaged to the hilt. So although mortgages themselves don't adjust with property prices, rising property wealth for the "in-betweeners" is nonetheless offset by rising mortgage debt. Net wealth for these groups therefore does not rise as fast as it does for richer groups, who are much less likely to be mortgaged and for whom property wealth is less significant anyway. (The WAS says that pensions - notably defined-benefit pensions - are the most important part of the wealth of the top two quintiles.)

Can monetary policy claim credit for this? Not really. The US experienced a much worse property market crash than the UK despite drastic interest rate cuts and large amounts of QE. The reasons why the UK did not experience a housing market correction on the scale of 1990 are something of a mystery, but restricted supply, political support for the housing market through a variety of fiscal initiatives, and the rise of London property as an international safe asset are all important factors.

So now we have a full explanation for the wealth chart. Monetary policy supported the rich - we knew that. It supported the poor to some extent, though it was far from being the sole cause of the large increase in wealth evident from the chart. But it didn't help the in-betweeners much.

Now to the income chart. Once again, it shows a large increase for the poorest. Can monetary policy lay claim to this? No. This is mostly due to fiscal policy. The ONS observes that incomes in the lower half of the income distribution are extensively smoothed by benefit top-ups. Working-age benefits rose from 2007 to 2010, then were cut back sharply by the Coalition government. This should have caused aggregate income in the bottom two quintiles to fall, but the cutbacks were offset by rising payments to retirees and increases in the minimum wage. The resulting income stagnation from 2010-13 is apparent from the chart.

The income chart does show that the incomes of the higher quintiles have been squeezed. But when your own income is stagnating, you feel angry about the rich even if their incomes are falling. The position of the middle quintile is particularly stark: their income was flat from 2007 to 2013. They could be forgiven for thinking that monetary policy passed them by.

So, Governor, I remain unconvinced that monetary policy has been "highly effective". There are many moving parts in this particular machine, and you have ignored most of them.

It is all very well crowing that the poorest have been supported. They have, to some extent, though perhaps not quite as much as you claim. But it is painfully evident that the "in-betweeners" have had much less support. Relative to the rich, they have lost out both in wealth and in income. And relative to the poor, they have lost out too: they no longer qualify for many benefits and other public support, and they are seeing public money going to people not much poorer than them while they are left to struggle on their own. These are people who see themselves as having done everything right: they have worked hard, saved and paid into the system. Now, they think the system has abandoned them. And with reason.

To be fair, it is not the Bank of England that has abandoned them, though some of them blame you for their woes: "in-betweener" pensioners are those who have been hardest hit by very low interest rates. The real failures lie on the fiscal side, and are of very long standing.

The promise of "cradle to grave" support upon which the British welfare state was founded has been systematically dismantled. Now, only the poorest are supported. The neglected in-betweeners are on their own. And their anger is shaking our political establishment to its foundations.

Related reading:

Austerity and the rise of populism
Raising interest rates is not that simple, Lord Hague

Image: "A mouse in between", by Open Graphics.  

Monday, 28 November 2016

Brexit, trade and echoes of the past

Brexit supporters have been severely critical of the OBR for its grim outlook for the UK post Brexit. The OBR is by no means the most negative of the professional forecasting bodies, and historically its forecasts have tended to err on the side of optimism, as Duncan Weldon observes. But it struggles to find anything good to say about post-Brexit Britain. In particular, it is distinctly negative about the future for Britain's external trade.

Brexit is above all a shock to trade, since its primary impact will be on Britain's trading relationships, not only with the EU but with other countries too. At present, we have no real idea what these will look like once the UK has left the EU. The OBR is therefore forecasting under extreme uncertainty. If there is one thing we can be sure of when forecasting under extreme uncertainty, it is that the forecasts are even more likely than usual to be wrong. This does not indicate that the forecasters are biased. It just means they have little reliable information.

Because of the lack of clarity about the future, the OBR has applied three conditioning assumptions to its forecasts:

• the UK leaves the EU in April 2019 – two years after the date by which the Prime Minister has stated that Article 50 will be invoked
• the negotiation of new trading arrangements with the EU and others slows the pace of import and export growth for the next 10 years
• the UK adopts a tighter migration regime than that currently in place, but not sufficiently tight to reduce net inward migration to the desired ‘tens of thousands’.

For the purposes of this post, the second of these is the most significant. It is also the most controversial. The pro-Brexit group "Economists for Brexit" disagree with it. They think that when the UK leaves the EU - assuming that the government adopts their preferred unilateral free trade model - there will be a substantial boost to trade which will flow through to higher incomes and sustained GDP growth:

The OBR's forecast is substantially more gloomy:

The difference primarily arises from the fact that the OBR doesn't assume a consumer demand boost from unilateral abandonment of trade tariffs. In fact its underlying assumption is that trade tariffs rise, as leaving the EU exposes the UK to higher trade barriers in Europe, free trade deals take time to establish, and the UK is likely to apply (at least) WTO MFN tariffs to trade that was previously free. This is the primary cause of the contraction in gross trade evident in the greyed area of this chart:

However, it is not the only cause. Brexit will be implemented against the background of contracting global trade and rising protectionism. This is likely to hamper the UK's quest for new export markets considerably. The OBR forecasts that by 2020, gross trade will be lower than it was in the 2007-8 financial crisis.

The worsening global trade outlook also seriously calls into question the assumptions made by Economists for Brexit regarding the economic effect of unilaterally abandoning trade tariffs. Positioning the UK as a beacon of free trade for the rest of the world is hardly likely to be an effective strategy for growth if the rest of the world is sticking two fingers up to free trade. When everyone wants to export and no-one wants to import, the country that unilaterally opens its doors to imports is inevitably flooded and its own supply side is crowded out. So UK businesses would face stiff competition from imports in addition to tariffs and other trade barriers for their exports. Economists for Brexit heroically assume that this would be entirely offset by improved export competitiveness from sustained sterling depreciation. But when a consumer boom from cheap imports is combined with challenging supply-side conditions which are resistant to the stimulus of a lower exchange rate (as I shall explain shortly), sustained currency depreciation can have only one outcome. Inflation, here we come.

To be fair, that is what Economists for Brexit forecast. Their medium-term estimates for CPI inflation are significantly above those of the OBR. Even so, I think they are not high enough, given the difficulties UK businesses face due to the worsening trade outlook. Economists for Brexit also appear to predict a wage-price spiral, since their forecast shows much higher wage growth than the OBR's. Unsurprisingly, they forecast higher interest rates. We haven't seen this combination of inflation, wage growth, falling sterling and rising interest rates since.....well, since the Volcker Shock. In fact Economists for Brexit's forecasts could be entitled "Back to the 1970s", apart from their amazing optimism about unemployment. Maybe I am scarred by my memories of the 1970s, but I don't regard their forecast as rosy.

Sterling depreciation is a double-edged sword. It would boost exports to some extent: the OBR's chart shows a small boost to exports from this year's fall in sterling. But it would also squeeze household incomes and business profits because of inflation in essential goods, notably energy and fuel. In the oil price shock of 2011-12, households cut back discretionary spending sharply, derailing a promising recovery. They would be likely to respond in the same way to energy and fuel price rises due to sterling depreciation: they might also defer or cancel spending on other imported goods. Consequently, OBR forecasts that imports will fall.

The OBR says that the combination of falling imports and increased exports will mean net trade turns positive in 2017-18 (I have circled this on the chart). However, the implied fall in domestic demand means lower, not higher, GDP growth than would have been the case without the Brexit shock. Fortunately, the shock is short-term and the OBR says the UK will return to growth of around 2% per annum thereafter, which is consistent with the views of other professional forecasters (though not, of course, Economists for Brexit).

The UK's share of world trade has been declining for the last two decades, and this trend is unlikely to reverse. This is due to the changing structure of the world economy, and in particular the rise of China. The OBR's longer view of the UK's export market share shows that the depreciation of sterling after the Brexit vote makes little difference:

In short, there isn't going to be an "explosion of international trade", as some Brexit supporters have suggested - at least, not enough to reverse the UK's secular decline as a major trading power. The boost to net trade from sterling depreciation will be short-lived if the OBR's assumptions hold. If the UK government adopted Economists for Brexit's unilateral free trade policy, there would be a boost to imports as trade barriers were lifted, but this would also be short-lived. After that, worsening inflation, tighter monetary conditions and a difficult external trading environment would cause both imports and exports to fall, just as they do in the OBR's model. Whichever forecast you look at, the outlook for trade is indeed grim. I don't know what planet Jacob Rees-Mogg inhabits, but it isn't one I recognise.

However, the outlook for the UK's external balance is not quite so grim.  The current account deficit has been in the headlines recently because of its (considerable) size. This worries some economists because of the risk of a "sudden stop", and annoys the economic illiterates who think the UK should "pay its way" in the world. But as I have explained before, the current account deficit doesn't necessarily say anything about UK competitiveness. You have to look at the component parts to understand what is going on.

The headline current account deficit is set to shrink, as investment income switches from deficit to surplus. The current investment income deficit arises mainly from sterling's appreciation versus the Euro due to the ongoing Eurozone depression and the ECB's negative interest rate policy and QE. This chart clearly shows the switch of investment income from surplus to deficit in 2012, when the Eurocrisis hit:

Now that sterling is falling, the investment income deficit is closing even though UK interest rates are still above EU rates, since the difference is lost in the exchange rate. The OBR predicts that investment income will return to surplus by 2019, entirely due to currency effects. This is the only significant effect of sterling depreciation on the UK's external position, since the OBR forecasts that the trade deficit will remain at around 4% of GDP. Those obsessed with manufacturing and trade in goods will no doubt sniff at this, since investment income arises principally from the financial sector. But income is income, however it is obtained.

This improvement in the UK's current account balance is reflected in my favourite chart - the sectoral lending chart:

Despite the improvement in the external position, this looks awful. The OBR forecasts a sustained 2% deficit for the household sector. That means rising debt. As the household deficit is partnered by a surplus for the corporate sector and closure of the fiscal deficit, the increased debt is likely to take the form of borrowing to fund consumption. This is anything but desirable.

The OBR says that a sustained household deficit of that size is unprecedented and probably unsustainable:
The persistence of a household deficit of this size would be unprecedented in the latest available historical data, which extend back to 1987. Other datasets extending back to 1963 also suggest little evidence of a large, persistent household deficit, with the household surplus moving into negative territory in only one year between 1963 and 1987. A household deficit of the size and persistence we expect over the forecast period might be considered consistent with the unprecedented scale of the fiscal consolidation and the extremely accommodative monetary policy upon which our forecast is conditioned. It nevertheless demonstrates that the adjustment to the fiscal consolidation is subject to very significant uncertainty, and alternative adjustment paths are quite possible. 
The OBR does not specify what the "alternative adjustment paths" might be, but these are all possibilities:
  • households choose to cut spending rather than taking on more debt, causing imports to fall more than forecast and sharply reducing the external deficit. This would be likely to be associated with a sudden slowdown in GDP growth, possibly amounting to a recession (the OBR's fan chart shows recession as an outside possibility)
  • sterling continues to fall, maintaining the improvement to exports beyond 2018 and increasing the net investment income surplus, thus reducing the external deficit
  • business investment increases, pushing the corporate sector into deficit (this could be "pump-primed" by government investment)
  • the government fails to close the fiscal deficit (or decides not to)
These are not mutually exclusive, and the eventual outturn could well be some combination of all of these. What is unlikely to happen is an export miracle. We are not Germany, and this is not the 1950s. It looks uncomfortably like the early 1930s, when countries put up trade barriers and devalued their currencies to steal export share from each other. That ended really well, didn't it?

Though of course, a miracle could still happen. For if there is one thing we can be certain of, it is that forecasts made under extreme uncertainty are unusually likely to be wrong.

Related reading:

Some unpleasant trade realities
The currency effects of Brexit
The dominance of Brexit

Image is a Stewart McCrae cartoon from the 1970s satirising the Australian government's struggle to manage the economy. Gough Whitlam, Jim Cairns and Frank Crean are pictured on a raft called 'Economy'. Source: ABC News

Thursday, 24 November 2016

True patriotism

Treason is popular. As the tide of protectionism rises around the world, the concept has come back into vogue. If you believe in the right of all people, whatever their colour or creed, to seek life, liberty and happiness for themselves and their children, you are unpatriotic. I am one of many who have been labelled a "traitor" for voting Remain in the EU referendum. But I have got off lightly. The same label cost Jo Cox MP her life.

Jo was a fervent Remain supporter. She believed strongly that Britain would be better off as a member of the EU. As Thomas Mair shot and stabbed her in June 2016, shortly before the EU referendum, he shouted "This is for Britain”, “Keep Britain independent”, and “Britain First”. Political assassination? No. Execution. Treason used to be a capital offence, and Mair regarded Jo as a traitor because of her support for Remain. To him, killing Jo was an act of patriotism.

Patriotism is taking an ugly turn. We wear poppies on Armistice Day, honour those who have died in war and vow never to forget their sacrifice. But we are forgetting what their sacrifice was for.  As the two dreadful wars of the 20th century fade from living memory, the laying of wreaths and the Last Post are becoming merely empty rituals, while "patriotism" is hijacked by those who promote a creed of selfishness and brutality. The Union Jack, our symbol of unity, is adopted as their logo by groups intent on setting people of different faiths and colours against each other. Sometimes it is even displayed alongside the swastika as if we had never fought a war to end the evil of Nazism.

Christianity, too, has been forced into the service of this new patriotism. These words of Jesus feature on the website of the far-right political party Britain First (no, I'm not going to provide a link):
If the world hates you, keep in mind that it hated me first. If you belonged to the world, it would love you as its own. As it is, you do not belong to the world, but I have chosen you out of the world. That is why the world hates you.
Britain First describes itself as a "patriotic political party and street defence movement.". It is ferociously anti-immigration and has an official policy of banning Islam in the UK. Its leader famously refused to accept the election of a Muslim as London Mayor, turning his back on Sadiq Khan as he gave his acceptance speech. Shortly afterwards, it announced a campaign of "direct action" against Khan and other Muslims in elected office, saying that they would be treated as "occupiers".

For me, as a Christian, to see the words of Jesus used to justify such hatred is painful beyond belief. The Jesus I know from the Gospels famously engaged with people of despised races and faiths, to the horror of the religious establishment of his time. "We will restore Christianity as the bedrock and foundation of our national life as it has been for the last one thousand years," says the party's mission statement. No thanks. I would rather Christianity died out than such a hideous distortion become the bedrock and foundation of my country's national life.

Of course, Britain First is hardly a mainstream political party. But the hatred it spews has echoes in the UK Independence Party and even among some members of the Conservative Party. They may not express their hatred in such extreme terms, but the underlying beliefs are the same: Britain for the British, keep the foreigners out - or if we must let them in, make sure they understand they are only here under sufferance. This is a narrow-minded, borderline racist definition of "British" that denies the diversity and tolerance that is the hallmark of our open, liberal society. And it is deliberately spread by the right-wing press.

Thomas Mair's action was extreme. But the words he used came from the Daily Express, the Daily Mail, the Sun. They are the words of those who self-identify as "patriots", wave the Union Jack and call for the borders to be closed, immigrants sent "home" (even if they have lived in this country for many years), and refugees rejected.

True, the vast majority of those who describe those who disagree with their "patriotism" as "traitors" would never dream of murdering anyone. But their words incite others who have no such inhibitions. History tells us that the support of the many makes possible the violence of the few: even genocide is popular. The violent murder of Jo Cox was the misbegotten child of the verbal violence of the mass media and the right-wing "patriotic" political parties. The poison spreads, and where it takes root, it brings death.

Thomas Mair was sentenced to life imprisonment without parole for murdering Jo Cox. The judge's remarks should give us all pause for thought:
You affect to be a patriot. The words you uttered repeatedly when you killed her give lip service to that concept. Those sentiments can be legitimate and can have resonance but in your mouth, allied to your actions, they are tainted and made toxic.
It is clear from your internet and other researches that your inspiration is not love of country or your fellow citizens, it is an admiration for Nazism, and similar anti democratic white supremacist creeds where democracy and political persuasion are supplanted by violence towards and intimidation of opponents and those who, in whatever ways, are thought to be different and, for that reason, open to persecution. 
Our parents’ generation made huge sacrifices to defeat those ideas and values in the Second World War. What you did, and your admiration for those views which informed your crime, betrays the sacrifices of that generation. 
You are no patriot. By your actions you have betrayed the quintessence of our country, its adherence to parliamentary democracy.
Murdering someone in the name of Britain is not patriotic. Taking the law into your own hands is not patriotic. Branding someone a "traitor" simply for disagreeing with you is not patriotic.

Our liberal democracy is founded on the right to hold and express minority views without fear and to seek to change the opinion of the majority. And our Christian heritage, at its best, teaches concern for the poor, help for the downtrodden and a warm welcome to the stranger in our midst.

True patriots, like Jo Cox, defend the rights of minorities and promote the social values derived from our Christian heritage. The real traitors are those self-proclaimed "patriots" who seek to stifle opposition, create division and sow the seeds of violence.

Image courtesy of Brendan Cox. 

Related reading:

Austerity and the rise of populism
Grieving for a lost empire
When the world turns dark
Europe's Shame
In the bleak midwinter
When darkness falls - Pieria

Friday, 18 November 2016

Reinventing work for the future

We have a crisis of work. The secure, well-paid jobs of the past - many of them in manufacturing - are disappearing. What is replacing them is insecurity and uncertainty. Low-paid, part-time, temporary and seasonal work. The "feast or famine" of self-employment. The so-called "sharing economy", where people rent out their possessions for a pittance. The "gig economy", where people are paid performance by performance - or piece by piece. "Piecework", we used to call it. Perhaps we should rediscover this name.

Piecework has been the lot of most humans throughout history. Secure full-time jobs for wages have existed for less than a hundred years. And they were never available to everyone. In the post-war "golden age" of manufacturing to which many would like to return, most men had secure full-time jobs - but women did not. My father left school at 16 and went to work for an insurance company. He stayed with that company for his entire working life, finally retiring at 65. But my mother had a succession of part-time, low-paid jobs. Her educational level was higher than my father's, but her jobs were menial and insecure, while his was intellectual and secure. 

I have inhabited the "gig economy" for over thirty years. I listen with some amusement to the complaints of those for whom this is a wholly new way of working, since musicians and artists have always lived from performance to performance, and I have been a professional musician for half my life.  But even in my banking career, I often worked on short-term contracts, and on the odd occasion when I was employed, my job often lasted no longer than a contract. And now, as a freelance writer, I'm doing piecework.

I know what income insecurity feels like. I have experienced the embarrassment of having to borrow money from friends and family to pay essential bills, because payment for work done three months ago still has not arrived. I know how difficult it is to feed your family when you have less than £5 left in the bank and no prospect of extending your overdraft. I live with the ignominy of a wrecked credit rating because I was forced to default on a debt when a promised payment failed to arrive. True, I earn more than my mother ever did, and probably more than the majority of what Guy Standing calls the "precariat". But the problem is not the amount you earn. It is the mismatch between uncertain income and certain outgoings. 

When income is uncertain, but outgoings are certain, constant worry about where the money will come from to pay the bills eats away at the mind, destroying creativity and turning the intellect to porridge. It undermines relationships and erodes happiness. Ultimately, it wrecks physical and mental health. And yet we seem intent upon increasing income insecurity in the name of "efficiency". 

In the "dual labour markets" of Japan and southern European countries, older men have secure, skilled, well-paid jobs for life, while women and younger men have insecure, low-paid, low-skilled jobs. But in America and Britain, where labour markets are more deregulated, this distinction is fast disappearing as manufacturing jobs are outsourced to developing countries and routine skilled jobs are automated away. The labour market "reforms" beloved of institutions such as the IMF level the playing field for insecure workers not by making them more secure, but by destroying the security of those in employment. 

The scream of outrage from America's white working/middle class that led to the election of Donald Trump is to a large extent about the disappearance of men's secure, well-paid jobs and the erosion of comfortable middle-class lifestyles. And the scream is as much from women as men. Even today, despite the advancement of women's equality, many women depend on their men for financial support, especially when the children are young. They can cope with their own income insecurity if their menfolk have steady wages. Life is very tough for families when neither women nor men have certainty of income. 

Many people want to restore the secure waged jobs of the past - to resurrect manufacturing and bring back mining. So, Donald Trump promises to rescue the American coal industry. "I love those people", he cries. But just as the Luddites were wrong in the nineteenth century, those who want to turn back the clock are wrong now. Holding back technological progress by preserving the jobs and the industries of the past only creates the illusion of security - and it is not sustainable. Just as the prehistoric inhabitants of Doggerland were unable to stem the rising tide that would eventually inundate those lands, forcing the people to leave, so the tide of technology will eventually swamp all barriers. 

Robots will indeed take many of our jobs. Mind-numbing, repetitive jobs. There is a lot of that sort of work around, and we seem to like forcing people into jobs like this rather than allowing them to look for - or create - work that better suits their skills and abilities. But manufacturing no longer needs armies of drone workers on production lines, all doing the same thing day in, day out. Robots can do this far better than humans.  It is economically inefficient for humans to do jobs that could be better done by machines, and it is a shocking waste of human talent. People excel at activities that involve communication, imagination and problem-solving. They add more value to society - though not necessarily in monetary terms - in their spare time than they ever do at work. So bring on the robots, and let the humans go to the pub. That's where new ideas are generated, new connections made, new enterprises started. 

Other industries will be superseded. Renewable energy sources, for example, are fast replacing fossil fuels: Trump's beloved coal industry is already obsolete, and apart from those who work in that industry, few will regret its passing. Mining is a dangerous, dirty and degrading industry which has killed thousands of people. Why do we want to preserve an industry like this, just because it has historically provided secure jobs for men?

To my mind, the real issue here is not what jobs people do, but how they can have the security they so desperately need. If we are to embrace technological change, we need to take seriously people's need for a financial "anchor", a rock, a safe place, an income which will ensure that they can survive regardless of the work they do.  

Security of income does not have to come from work. Indeed, as work becomes ever more uncertain and insecure, more and more people will need some other sort of anchor. For the elderly, this is a state pension - yet the right to that is being eroded. For younger people, it is various forms of in-work benefits - yet the right to those, too, is being undermined. We are progressively shredding the safety net that provides people with some protection from instability of income. 

No attempt is being made to quantify the cost of the damage to health, wellbeing and relationships caused by rising insecurity. But those whose relationships break down under financial stress end up in the divorce courts, and for many - particularly women - that means material poverty and a life on benefits. Those whose health is wrecked by overwork end up in doctors' surgeries or hospitals: many find themselves living on sickness and disability benefits with the support of long-term prescription drugs. And those whose mental health is undermined by constant worry may end up in prison, since chronic underfunding of mental health services means that the prison service has become the backstop for the mentally ill. All of this adds up to increased costs for health and social services, not to mention the prison service, the police and the courts. 

Our crisis of work is causing a crisis of welfare. But all we see is the welfare crisis, and we try to solve it by inventing ever more draconian ways of forcing people into unsuitable and insecure work, rather than by addressing the root cause of the problem: disappearing traditional jobs and growing income uncertainty.

By implementing a universal basic income, we can end the necessity of human drudgery and the wasteful mismatching of people to jobs. We can restore security to the millions who live with uncertainty. 

Universal basic income should not be seen as welfare. By itself, it is inadequate to meet all needs: for example, the very disabled need more support than a universal basic income can provide and are less able to top up their income with work.  Other measures are needed as well to ensure that those who are marginalised by their inability to work are properly supported. Rather, we should see universal basic income as the foundation on which everything else is built - the level below which no-one will ever have to fall. By solving the problem of income insecurity with a universal basic income, we can end this costly and damaging epidemic of distress. 

Providing everyone with a basic income would also help to end the fear of technology that is holding back progress. We do not know what the jobs or the industries of the future will look like. But if we go about this the right way, there could be an explosion of productivity and entrepreneurial activity when humans are freed from drudgery. Universal basic income not only clears the path for robots to take over the jobs that humans don't want to do (and are not particularly good at), it also supports those who want to take the risk of trying out something new. People will be more willing to start new enterprises if they know that they will not lose everything if it all goes horribly wrong. The great businesses of the future will be born out of this explosion of experimentation, and they will create products and services we cannot yet imagine.

The way to prosperity is to invest - not only in robots, but in humans too. If we invest in robots but leave humans to scrape an uncertain living from increasingly insecure and poorly paid jobs, it would hardly be surprising if humans rebelled against the robots and their owners. But setting up such unhealthy competition would be destructive both of robots and humans. We don't want robot wars - we want robot colleagues.

I am amazed when people say we cannot afford universal basic income. To my mind, we cannot afford not to have it. The challenge of technology demands a fundamental reordering of society - a new social contract. By explicitly breaking the link between work and survival, we can free up humans to embrace this wonderful opportunity to reinvent work in our own image.

When we are no longer afraid of losing our prosperity, we can look forward to an exciting future, fully using the creativity and ingenuity that is the birthright of all humans and working productively in happy collaboration with our robot colleagues. 

This piece is a shorter version of my presentation at the Meaning Conference on Thursday 16th November. A video of the presentation itself will be on YouTube in due course. I will post a link here when it is available. 

Related reading:

The wastefulness of automation - Pieria

Image from NBC News. 

Sunday, 30 October 2016

The dangerous scheming of stupid politicians

There is growing speculation that the Governor of the Bank of England, Mark Carney, will not extend his term. Carney originally agreed to a five-year term, which would end in 2018, but it had been thought he might extend to the more usual eight years for a Bank of England governor. This is now looking increasingly unlikely.

Carney has come under fire from pro-Brexit politicians for warning that Brexit is likely to increase inflation and unemployment and reduce economic growth. They accuse him of "talking down" the UK. This is some chutzpah, from politicians whose incompetence and arrogance has stunned the world. If anyone is "talking down" the UK, it is the Three Clowns currently running the Brexit project, and their baying packs of supporters.

I have been severely critical of Bank of England policies. I don't like the over-reliance on QE: I think it is a useful crisis tool, but far too much has been expected of it. I think that the independence of the Bank of England was undermined by George Osborne's expectation - stated openly even before Mark Carney arrived on the scene - that the Bank of England would provide monetary support to offset the effects of fiscal consolidation. I disagreed with the Bank of England's support for the Help to Buy scheme: this scheme was blatantly intended to buy votes, and the Bank should not have touched it with a barge pole. The FLS scheme was also suspect for the same reason. Under Carney, there has been too much playing second fiddle to a very political Chancellor, and not enough flexing of independent muscles.

That said, Carney has been an effective Governor in many ways. He understands banks and markets, and has taken a personal interest in measures to promote financial stability. Perhaps his moves to regulate banks don't go far enough, but at least he has taken them seriously, unlike his predecessor. I was frankly astounded when the Brexit camp on Twitter lauded Mervyn King as a far better Governor than Carney. How on earth could the man whose inattention to financial stability allowed dangerous imbalances to build up in the UK financial system be a better Governor than the man who has spent most of his term putting in place measures to prevent such imbalances building up again?

But the Brexiteers have extremely short memories. Not only have they forgotten the disaster that Mervyn King helped to cause, they have forgotten the near-disaster that their own actions caused. After the Brexit vote, both UK political parties went into meltdown. The Prime Minister resigned, the Labour party disintegrated, and the Brexiteers - visibly shocked by their unexpected victory - went into hiding, fearful that they would now have to deliver on their promises. The election process for a new Conservative party leader became a toxic charade of backstabbing and poisonous lies.

In the middle of this maelstrom, one man remained standing. That man was Mark Carney. On 24th June, as sterling slid and bank stocks fell, he stepped forward to calm the markets. Here is part of his statement:
The people of the United Kingdom have voted to leave the European Union. Inevitably, there will be a period of uncertainty and adjustment following this result. There will be no initial change in the way our people can travel, in the way our goods can move or the way our services can be sold.And it will take some time for the United Kingdom to establish new relationships with Europe and the rest of the world.
Some market and economic volatility can be expected as this process unfolds. But we are well prepared for this.  The Treasury and the Bank of England have engaged in extensive contingency planning and the Chancellor and I have been in close contact, including through the night and this morning. The Bank will not hesitate to take additional measures as required as those markets adjust and the UK economy moves forward.
In which parallel universe is this "talking down" the UK economy?

Largely because the Bank of England was seen to be in control, the fact that the UK had no effective government for the entire summer did not cause major problems. Sterling stabilised, gilt yields fell and stock markets rose.

In August, the Bank of England cut interest rates and re-started QE in anticipation of lower growth and rising unemployment due to the Brexit shock. Markets responded positively - but the right-wing press took it badly, once again accusing Carney of "talking down" the UK. They pointed to the comments of Mervyn King, who criticised the policy decision and the Governor's forward guidance that further easing might be necessary, saying that the decision was panicky and Brexit could make the UK better off.  But why we should we give King's views any credence? Or, for that matter, those of Lord Lawson, the architect of the 1980s housing bubble, who is now calling for Carney's resignation? These two men presided over two of the worst financial crises ever to hit the UK, though the slimy Lawson got out before the brown stuff hit and has since rebuilt his credibility among the gullible. They are  hardly reliable witnesses.

Apart from the accusations of political bias, Brexiteer criticisms of Carney's performance are frankly ignorant. Firstly, it is not the job of the Governor of the Bank of England to "talk up" the economy. That is the job of politicians - a job that they have spectacularly failed to do. The Governor's job is to present a fair and balanced analysis of the state of the UK economy using forecasts produced by Bank of England staff. This is what Carney has done.

Secondly, the Governor does not make interest rate decisions. That is the job of the MPC. The Governor is only one member of the MPC, though obviously an important one. He can be overruled.

Thirdly, on forward guidance, since when have economists been clairvoyant? Forward guidance is information provided to the markets about the expected path of future policy - but it is not a guarantee. If conditions change, the policy changes and the forward guidance is therefore wrong. This is a feature, not a bug.

Now the summer of calm is over and a new government is in place. And we are facing chaos again. The reason is, once again, the utter stupidity of politicians.

The Conservative MP and arch-Brexiteer Jacob Rees-Mogg has been pursuing a sustained campaign to have Carney removed from office. Rees-Mogg claims that by not being more positive about Brexit, Carney has "politicised" his job and undermined the independence of the Bank of England. Other prominent Brexiteers, such as Daniel Hannan, have repeated this claim.

This might have been dismissed as Brexiteer imagination had it not been for the new Prime Minister Theresa May's comments at the Conservative party conference. She appeared to criticise the Bank of England's monetary policy and indicate that a change of regime might be on the cards. In fact, the term "A change has got to come" was a strap-line that she repeated at intervals throughout her speech: it was not aimed at the Bank of England, let alone its Governor. But it was seized upon by those who want to undermine Mark Carney.

Now, legitimised by May's comments, the campaign against Carney is intensifying. The right-wing press is awash with articles criticising his actions, questioning his competence and repeating the allegations of political bias. Some openly call for his replacement. And, in the most insane twist of all in this psychotic fantasy, the Spectator has fingered Jacob Rees-Mogg as Carney's successor. Rees-Mogg, whose degree is in history and whose only qualification for this job is that he worked for a Hong Kong wealth management firm. Plus his extreme right-wing views and hardline support for Brexit, of course.

It is hard not to conclude that Rees-Mogg's support for Brexit is the real qualification - and indeed the Spectator explicitly says this. Brexiteers wanted a Brexiteer Prime Minister. They didn't get one, though May seems to be trying to out-Brexit the Brexiteers. So now they are trying for a Brexiteer Bank of England Governor. Political bias in a Bank of England Governor is fine as long as it is in the right direction, it seems.

Today, the Daily Mail - which has been vilifying Carney for months - gleefully reported that Carney could announce his resignation "within days". This was a repeat of The Times's allegation that Carney could use the inflation report due out on Thursday this week as an opportunity to announce his departure. The Sunday Times, more balanced and thoughtful, says that this is unlikely, but that Carney will make his position clear before the end of the year.

I have no doubt that a suitable replacement for Carney could be found, if there is sufficient political will. By "suitable" I don't mean the insufferable Rees-Mogg. I mean another senior financial economist with a spotless track record and a reputation for neutrality. These rare beings aren't easy to find and they don't come cheap. But the Bank of England is among the world's premier central banks, and the top job there is prized.

However, I now wonder whether the political will to maintain the Bank of England's independence is diminishing. Philip Hammond, the Chancellor, has defended Mark Carney, saying that he would welcome him extending his term to 2021. But Hammond himself has come under pressure from hardcore Brexit supporters on the right wing of the Conservative party: after the awful Daily Express scented blood, May was forced to express her "full confidence" in her beleaguered Chancellor. This does not bode well.

The Chancellor's weakened position further weakens Carney, since it will be hard for a Chancellor suspected of trying to "water down" Brexit plans to support a Governor suspected of trying to derail the whole thing. And worse, it increases the likelihood of a political replacement. The government may find it very difficult to resist Brexiteer demands that the next incumbent should have pro-Brexit views. May herself seems to want a more hawkish monetary policy stance to please Tory core voters. The pressure to appoint a political Governor may become too intense for Hammond to resist.

It is very worrying indeed that the future of the Bank of England as an independent, non-political institution rests in the hands of an already weakened Chancellor. The populist surge in the UK is dangerous beyond belief. If Carney is forced out, and is replaced with a right-wing, pro-Brexit politician, the consequences for sterling, gilt yields and the UK economy don't bear thinking about.

Related reading:

Defend Central Bankers, Even If You Think They Shouldn't Exist - Forbes
Hands Off - The Economist

Image from Huffington Post. 

Monday, 24 October 2016

Raising interest rates is not that simple, Lord Hague

The present period of very low interest rates is widely assumed to be temporary, a consequence of the 2008 financial crisis and subsequent central bank action. Because of this, as the financial crisis fades into the mists of time, there is growing political pressure for "normalisation" of interest rates. Here, for example, is William Hague warning that central banks must start to raise rates or face losing their independence:
The only way out is for the US Fed to summon the courage to lead the way to higher interest rates, and others to follow slowly but surely. If they fail to do so, the era of their much-vaunted independence will come, possibly quite dramatically, to its end.
Hague gives ten reasons why low interest rates are a bad idea. His points can be summarised thus:

  • the "reach for yield" by savers who want higher returns drives up the price of assets
  • higher asset prices increase wealth inequality, fuelling popular anger
  • pension funds are struggling, forcing businesses to put more money into them
  • banks are struggling to make a profit
  • people are struggling to save enough for their retirements
  • companies would rather buy back shares than invest productively
  • low interest rates support zombie companies
  • pumping up asset prices could result in an almighty crash
  • "emergency measures" shouldn't still be in place after nearly a decade anyway

  • Few would disagree that these are the adverse effects of very low interest rates. But unfortunately none of them necessarily mean that interest rates should rise. If interest rates were naturally very low, rather than being artificially depressed by central banks as Hague implies, these effects would still occur. As Larry Summers has pointed out (pdf), asset price bubbles are a feature of "secular stagnation", where the economy becomes stuck in a low-growth, low-inflation, low-interest rate equilibrium:
    Let us imagine, as a hypothesis, that this decline in the equilibrium real rate of interest has taken place. What would one expect to see? One would expect increasing difficulty, particularly in the down phase of the cycle, in achieving full employment and strong growth because of the constraints associated with the zero lower bound on interest rates. One would expect that, as a normal matter, real interest rates would be lower. With very low real interest rates and with low inflation, this also means very low nominal interest rates, so one would expect increasing risk-seeking by investors. As such, one would expect greater reliance on Ponzi finance and increased financial instability.
    Raising interest rates above their natural rate is ultimately unsustainable, since it means that the productive sector is slowly drained to provide rents to the unproductive sector. The problem therefore is identifying what the "natural" rate is. Is this just a blue funk by central banks, as Hague thinks - or are there other reasons why interest rates are still so low?

    There is a growing body of research that suggests that not only are very low interest rates the "new normal", they have further to fall. And the reasons have little to do with the financial crisis.

    In an important new paper (pdf), Federal Reserve researchers blame demographic factors not only for the falling equilibrium real interest rate, r*, but also for declining GDP growth:
    We find that demographic factors alone can account for a 1.25 –percentage-point decline in the equilibrium real interest rate in the model since 1980—much, if not all, of the permanent decline in real interest rates over that period according to some recent time-series estimates, such as Johannsen and Mertens (2016b) and Holston et al. (2016). The model is also consistent with demographics having lowered real GDP growth 1.25 percentage points since 1980, primarily through lower growth in the labor supply; this decline is in line with changes in estimates of the trend of GDP growth over that period.
    And they add that the apparent correlation between the financial crisis and low interest rates is an illusion:
    Interestingly, the model also implies that these declines have been most pronounced since the early 2000s, so that downward pressures on interest rates and GDP growth due to demographics could be easily misinterpreted as persistent but ultimately temporary influences of the global financial crisis.
    Gavyn Davies identifies three reasons why r* will remain low:

  • falling labour supply growth rate
  • rising dependency ratio
  • rising longevity

  • Together, these add up to an environment in which there is a growing propensity to save, a rising capital share and sustained downwards pressure on interest rates. Admittedly, as the US baby boomers retire, their propensity to save should diminish. But the rising dependency ratio will force working-age people to save a larger percentage of their incomes in order to support the growing number of elderly. This is the case regardless of the method of saving, as John Eatwell pointed out.

    Just how severe the demographic pressures will be in future is evident from these "beehive" charts produced by researchers at Cambridge University:

    The researchers identify the introduction of the contraceptive pill in 1967 in Western countries as the principal cause of this striking demographic change. I would probably add to that liberalization of abortion services at around the same time. The effects are particularly pronounced in Germany:
    .....the fertility rate fell from 2.5 in 1967 to 1.4 in 1970. In the long run, this will lead to a decline of the steady state population growth from 1.5% to -0.5% per year. However, during the transition to the new steady state, the age composition of the population will deviate strongly from its steady state structure. The fall in fertility led to substantially smaller cohorts born just after the introduction of the pill, with an echo-effect when the first, smaller, post-pill cohort of women starts giving birth themselves. The last cohorts born before the introduction of the pill are therefore much larger than the cohorts born before and after. For Germany, the cohort born in 1995 is just half the size of that born in 1968.
    In China, where the fertility shift lags the others, the cause was undoubtedly the one-child policy. Interestingly, the US does not show such a dramatic fall in cohort sizes: the researchers don't discuss the reasons for this, but I suspect it is due to immigration. But even in the US, increasing longevity will mean a rising dependency ratio.

    The researchers go on to discuss the effect on saving and spending patterns of this demographic shift:
    People initially borrow to finance their education; next they enter the labour force and begin saving, at first to repay this loan and then to save for retirement; finally they deplete these savings during retirement. For this reason, the desired stock of assets is at its maximum just before retirement. The current demographic profile, with large cohorts approaching retirement, means that the population is disproportionately biased towards saving.  As the large cohort desires to hold a large stock of savings, there is a surplus of savings. At the same time, the absorbers of savings – the young cohorts who borrow to finance their education – are in short supply. This implies that the real interest rate will be low, in fact even negative.
    The researchers omit to note that in many Western countries the young borrow to buy property, not just to finance their education. In theory, demand for housing should help to support the interest rate. But most people buy houses with mortgage loans. As property price rises outstrip wage rises, mortgage demand pushes up the price of property, putting additional downward pressure on interest rates. Rising property prices mean the young must take on ever larger mortgages, and rising mortgage debt relative to household income is unsustainable unless interest rates fall. When the acquisition of assets is generally financed by debt, asset price bubbles provide only short-term relief to the problem of falling interest rates. Over the longer term, they make the problem worse.

    This striking chart shows the sharp decline in the real interest rate since the 1980 peak:

    Worryingly, this chart shows that the real interest rate still has further to fall. By 2035, if the researchers are correct, the real interest rate will have fallen to minus 1.5%, purely due to demographic factors. I suppose we should be relieved that it will gradually rise after that, eventually stabilising at minus 0.5% by the end of this century. But unless something changes, it will never be positive again.

    Permanently negative real interest rates have huge implications for the structure of finance. Firstly, banking as we know it will become impossible, since credit intermediation reverses when rates are negative. Secondly, maturity transformation would become unprofitable: although in theory yield curves could still be positively sloped when rates are permanently negative, they would be very flat. There would have to be a major rethink of the way in which financial intermediaries whose job is maturity transformation (banks, pension funds, insurance companies) work.

    More importantly, permanently negative real interest rates fundamentally affect the ordering of society. They do not support debtors at the expense of savers, as is popularly believed: rather, they favour those who own assets (mainly the old) at the expense of those who do not (mainly the young). This potentially sets up a highly damaging intergenerational conflict. The older people who expected higher returns on their savings than they will receive are already angry, and their anger is likely to increase. The younger people who see their hopes of owning their own home receding into the distance are also angry, and their anger is likely to increase too. And when younger people face confiscation of growing amounts of income, either in the form of taxes (even if disguised as social security contributions) and/or compulsory saving (auto-enrolment springs to mind - there are already calls for the percentage contribution to be increased), in order to support a rising number of elderly, they will become even angrier.

    So what is the solution? Sorry, Lord Hague, it certainly isn't raising interest rates. That would simply transfer still more from young to old, and it would put financial stability at risk. When the supply of savings exceeds the demand for them, the returns on them must fall. However angry the baby boomers are, they have to accept that the high interest rates of their youth are gone forever, and their future is consequently poorer than they expected. This is not because they have been robbed by governments or screwed by central banks: it is largely because of their own failure to produce enough of the next generation to support them in their old age.

    Rather, we need to find ways of raising the real interest rate. The risks associated with NOT doing so are simply too great. So, since the real problem here is a structural imbalance between the supply of safe assets for retirement saving and the demand for them, the obvious thing to do is to improve the supply of safe assets. The Cambridge researchers point out that sovereign bonds, state pension schemes and asset price bubbles are logically equivalent:

    In an economy with perfect foresight, bubbles, PAYG, and sovereign debt are perfect substitutes for trade in bubbly assets. Whether resources are transferred from the young to the old by the trade of bubbles, by a government enforced PAYG pension scheme, or by a government that sells bonds to the young to repay the last period’s bonds held by the old, the outcome is the same in all three cases.
    Asset price bubbles put financial stability at risk, and government enforced PAYG pension savings sufficient to provide pensions for all those elderly are likely to worsen intergenerational conflict. So the solution is sovereign debt. Lots of it. Enough to meet the saving needs of the entire population. Or, if you prefer, government savings schemes - safe high-interest savings accounts such as those provided by NS&I. Lots of them.

    And, at the other side of the government savings bank, investment of those savings in productive enterprises. After all, the structural imbalance is not just a problem of supply but also of demand. It is not central banks that are in a blue funk, but the whole world. Everyone is terrified of loss, no-one wants to take any risk, and the productive enterprises of the future are being starved of investment at the same time as savers are being deprived of returns. The effect of this will be to depress wage growth and productivity far into the future. If investment doesn't improve, the future for both young AND old is an impoverished one.

    As I have pointed out many times before, the primary purpose of sovereign debt is not to finance government, but to enable people to save. And when the private sector is too scared to invest, government must step in. In a world of ageing populations, growing need for saving and fear of loss, the political obsession with reducing sovereign debt/GDP must end.

    Related reading:

    Rethinking government debt
    Bond yields and helicopters
    Keynes and the Quantity Theory of Money
    The Great Yield Divergence
    The safe asset scarcity problem, 2050 edition
    Weird is Normal - Pieria
    The broken contract - Pieria