UK on track


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Brown’s Keynesianism is bankrupt- and will bankrupt us

Almost three months ago, this column described Prime Minister Gordon Brown, and his Chancellor Alistair Darling as “Keynesian”. The last decade of Brownite policy, after all, has featured high public spending, irresponsible borrowing and an ever-growing tax-burden.

by Liam Halligan

Until recently, though, Brown and his entourage have played down their “big government” tendencies – stressing prudence, private enterprise and the joys of lower tax.

But now, with the UK in the grip of the credit crisis New Labour has revealed its true statist colours. “We are spending more to get the economy moving,” said Brown last week. “That’s the right thing to do.”

Agreed.

Well, actually, it isn’t. The last 50 years are riddled with grim episodes of Western governments trying to spend their way out of recession. Every attempt has gone wrong – resulting in spiralling national debts, soaring inflation and a plunging currency.

Those are the financial outcomes, not real outcomes. And the last one was from a failed attempt at a fixed exchange rates- the ERM policy.

In 1976, then Labour Prime Minister Jim Callaghan made a passionate speech to his party conference, telling comrades “in all candour” that the option of reversing a downturn by “deficit-spending” simply “doesn’t exist”.

Callaghan was in a position to know. His Keynesian policies had destabilised the UK economy so seriously we were forced to go cap in hand to the International Monetary Fund.

The UK was forced to the IMF to borrow foreign currency to support the failed fixed exchange rate policy of the firm.

That’s right – the UK’s mid-1970s IMF bail-out, the indisputable nadir of this country’s post-war economic history, was the direct result of Keynesian policy.

No, it was a direct result of the failed ERM policy.

Yet, here we are 22 years on. The young left-wing firebrands who sneered at Callaghan’s brave admission now run the country. To gain power, they had to bury their beliefs, shave off their beards and parrot a faith in free markets.

Since 1997, despite this pretence, New Labour’s “soft Keynesian” concoction of high spending, loose credit controls and more tax has contributed mightily to our current predicament.

Not at all. In fact, tight fiscal have been the rule, and contributed to the current downturn.

But faced with a crisis, and with their backs to the electoral wall, the Brownites are reaching for the intellectual comfort blanket of their youth – the “hard Keynesian” solution of ramping up spending sharply.

Yes, and rightly so. This time with no ERM to trip over.

Because we’re in a crisis, though, Brown’s Keynesian declaration has raised barely any protest. That’s why the letter in today’s Sunday Telegraph is so important – which makes clear Keynesianism is a “misguided and discredited as a tool of economic management”. The economists who signed it cannot be dismissed as parti pris. The economic consensus against Keynesianism is based on evidence, not ideology.

For now, the airwaves are full of economists from investment banks and accounting practices whose firms stand to do quite nicely from a big dollop of extra public infrastructure spending.

These are the type of firms that benefit from the growth and strength of an economy.

Keynesianism? Bring it on, they say.

As should the citizens.

But there are many, many dismal scientists with serious misgivings – but who don’t have “media strategies”, and who perhaps lack the courage to voice their concerns, given that millions of people are frightened about their jobs.

And who doesn’t understand non-convertible currency with floating FX policy.

No one is denying the UK economy is in a bad place. New preliminary data shows the first quarterly output drop for 16 years. Between July and September, GDP fell 0.5 per cent, pushing annual growth down to 0.3 per cent.

Good thing they are looking to spend their way out of it.

As the signatories to our letter make clear, it is “inevitable government expenditure and debt rise in a recession” – as the “automatic stabilisers” kick in, the tax-take falls and benefit spending rises.

Yes, if you don’t do it proactively first.

But Brown’s plan goes way beyond that, posing huge dangers – not least as we’re starting from a position of extreme fiscal weakness.

What difference does that make???

Even last year, when growth was near trend, the Government borrowed £36bn – almost 3 per cent of GDP. And in only the first six months of this financial year, before the slowdown had really begun, we’ve already borrowed £38bn – a colossal 75 per cent up on the same period the year before.

And not nearly enough to support output and employment at the moment more is called for.

Even without Brown’s misty-eyed Keynesian adventure, the public finances are set to deteriorate rapidly. But imagine how bad the numbers will get.

‘Deteriorate’ and ‘bad’ are indicative of his backwards thinking.

as Brown, as he said last week, “brings forward” public spending from future years.

A mistake from Brown to say it that way. Spending is not operationally constrained by revenue. Brown isn’t quite there yet.

That can only lead to much higher taxation,

Maybe, but the same automatic stabilizers usually automatically do that, and usually too much so.

hobbling the private sector and increasing the danger of a drawn-out Japanese-style slump.

Yes, if they raise taxes to cut the deficit like Japan repeatedly did!

Extra Government spending won’t help anyway. Most of it will simply fuel state-sector wage growth – winning Brown a few trade union votes, but boosting wage inflation elsewhere.

‘Wage inflation’ as used here is pathetic. The question is whether demand increases translate into higher sales, output, and employment. If higher wages somehow don’t get spent they don’t contribute to higher output prices.

This is instead a statement against higher wages per se.

The broader macro-economic implications are also alarming. If we keep borrowing, in the end the gilts market will simply dry up.

While possible that they yield could creep up, it’s inaccurate and baseless to predict the market for gilts to dry up.

Japan is a good example, as is Turkey, of two nations at opposite ends of the spectrum, neither constrained by securities sales.

Already, the UK government faces massive age-related liabilities that will undermine our credit-rating over the next few years – before Brown’s final spending spree.

Credit rating is not an issue. UK spending in local currency is operationally not constrained by revenues.

And anyone who tells you inflation isn’t a problem is ignoring that borrowing itself is inflationary,

Huh??? Only spending can be inflationary, particularly if supported by higher costs (including interest rates)

and that the latest bank bail-outs will see the Bank of England printing money on a scale unprecedented in modern times.

The BOE is only exchanging one financial asset for another. It’s ‘printing money’ only if you include some financial assets and not others in the ‘money supply’.

This is the first serious slowdown under Labour – since 1976 – and a moment of acute economic danger. A wounded, desperate Prime Minister is making a final roll of the dice.

Fortunately the right one.

Faced with a desperate electorate, he is reaching for Keynesianism. It serves, also, as a fig-leaf for his previous profligate spending and as a bone to the Labour left.

But it is, indisputably, an immensely dangerous and counter-productive idea. That’s why economists must stand up and be counted.

Yes, especially the ones who support it!

The dismal scientists must speak out.


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Aussies buy their own currency


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“Australia’s central bank has intervened to support the tumbling Australian dollar, but failed to prevent its slide to five-year lows against the U.S. currency and its deepest-ever trough against the yen. “

This intervention has two purposes.

One is to keep the decline orderly, the other is anti-inflationary, as the apparent collapse in the currency is immediately passed through to import prices, which play a major role in domestic consumption.

The problem in using intervention to support one’s own currency is that reserves get depleted before the desired level of the currency is achieved.

One core issue is declining real terms of trade due to falling prices of Australia’s exports vs. the prices of their imports.

The other issue is internal distribution.

Australia digs and exports coal, for example, and the boats return full of consumer goods.

A falling currency alters distribution of consumption to those residents in export industries and away from the rest of the population.

The recent US history:

Over one year ago Paulson successfully got foreign CBs to stop buying dollars.

That, along with rising crude prices, sent the dollar to its subsequent lows.

He did this by calling CBs buying dollars currency manipulators and outlaws, insisting they let markets decide currency values.

This was a thinly veiled ploy to get the dollar down to spur exports, as articulated by the Fed chairman in subsequent congressional testimony.

It ‘worked’ as US exports grew at record pace and US GDP muddled through at modestly positive numbers. (A nation net imports exactly to the extent non residents realize their desire to accumulate its net financial assets, as discussed in previous posts)

It also caused a punishing decline in real terms of trade for the US and a decline in the US standard of living, but that was less important to policy makers than ‘pretty trade numbers’ and sustaining domestic demand via sufficiently supportive fiscal policy.

This all caused demand to fall overseas, as governments were (and for the most part remain) in the dark as to sustaining domestic demand, and their economies were directly or indirectly connected to exports to the US.

After Q2 this year rising US exports and falling non-petro imports broke the back of world economies and it has all come crashing down.

Falling crude prices due to ‘the great Mike Masters sell off’ (that I’m still waiting to run its course, and which last week’s OPEC cuts may be signaling), also made dollars a lot tougher to get and created a dollar squeeze on a world that had quietly gotten strung out on dollar borrowings.

Accumulating USD by non-residents to pay off debt in the private sectors is working to strengthen the USD the same way foreign CB accumulation had done.

It is bringing down their currencies and will eventually support foreign exports (at the expense of their real terms of trade, but that’s another story).

The US trade gap will fall substantially for a while as crude prices work their way into the numbers.

But then, should world private sector dollar ‘savings’ get rebuilt via USD debt reduction, make foreign goods cheap enough for US imports to once again start to grow.

A substantial increase in US domestic demand via deficit spending (which should be forthcoming with an Obama presidency and democratic control in both houses of Congress.) can restore domestic output, employment, and US imports, to restore our standard of living to pre-Paulson levels.

If we have a policy that drops energy imports, otherwise we can give it all back in short order.

But that’s all getting ahead of one’s self.

For now, the strong dollar seems to be giving foreign CBs, like the RBA in Australia, an inflation scare even as their economies weaken, housing prices sag, and unemployment rises.

This is typical of emerging market economies- external debt burdens high inflation due to weak currencies (due to debt service from the external debt- they need to sell local currency to meet their external debt payments) high unemployment deteriorating real terms of trade as export prices fail to keep up with import prices.

Again, sorry for the earlier mix-up. Need to get my eyes checked!


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Japan Daily


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This means they will accept it as collateral for the unlimited USD loans from the Fed.

This will not end well.

BOJ to Accept Asset-Backed Commercial Paper as Collateral from Tuesday

TOKYO (Dow Jones)–The Bank of Japan said Monday it will accept as collateral asset-backed commercial paper guaranteed by the bank’s counterparty financial institutions, starting Tuesday. This is a temporary measure until the end of April 2009 to ease tension in the short-term money market, the BOJ said.

Earlier this month, The BOJ announced a number of steps to ensure the smooth functioning of the country’s money markets, including providing greater access to U.S. dollar funds through a swap agreement with the U.S. Federal Reserve Board, and broadening the kinds of collateral the BOJ would accept for repurchase agreement transactions.


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2008-10-27 CREDIT


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Stocks may have nowhere to go until these spreads narrow

IG On-the-run Spreads (Oct 27)

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IG6 Spreads (Oct 27)

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IG7 Spreads (Oct 27)

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IG8 Spreads (Oct 27)

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IG9 Spreads (Oct 27)


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IMF Ukraine loan and conditions counterproductive


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UPDATE 3-IMF, Ukraine agree $16.5 bln loan with conditions

By Sabina Zawadzki and Lesley Wroughton

KIEV/WASHINGTON, Oct 26 (Reuters) – The International Monetary Fund and Ukraine said on Sunday they had reached an agreement in principle for a $16.5 billion loan package to ease the effects of the global financial crisis.

But analysts said politicians would have to set aside differences to adopt a set of financial measures needed to clinch the deal and secure the loan.

The IMF statement said nothing about the conditions it sought from Ukraine. But a joint central bank and finance ministry statement said the government would have to draw up a balanced budget and introduce measures to support banks.


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Interview with the BBC


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(email exchange)

Dear David:

Let me refer you to what I call “Mosler’s Law”: There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it.

But the European problem is, who can borrow? who can spend?

Solving that problem is the key – the only key – to resolving the crisis.

Regards, James

>   
>   Professor Galbraith,
>   
>   This is David … I’m a BBC Spanish listener. You told that the European
>   Central Bank has not the same solid structure as the banking system in
>   the States. I want to ask you what does Europe has to do to recover
>   from this crisis? Ok, deliver less credits and mortgages maybe, I don’t
>   know, you know it much better than me. But how the recovery will be
>   seen through a decrease in unemployment? what does Spain has to do?
>   
>   Call me David (only 43)
>   Yours sincerely,
>   
>   David …
>   


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2008-10-27 USER


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New Home Sales (Sep)

Survey 450K
Actual 464K
Prior 460K
Revised 452K

 
Small blip up from very low levels.

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New Home Sales Total for Sale (Sep)

Survey n/a
Actual 394.00
Prior 425.00
Revised n/a

 
Inventories low enough to cause a shortage if things do pick up.

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New Home Sales MoM (Sep)

Survey -2.2%
Actual 2.7%
Prior -11.5%
Revised -12.6%

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New Home Sales YoY (Sep)

Survey n/a
Actual -33.1%
Prior -35.6%
Revised n/a

 
Also moving up a bit.

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New Home Sales Median Price (Sep)

Survey n/a
Actual 218.40
Prior 220.40
Revised n/a

 
Down some but not in collapse.

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New Home Sales TABLE 1 (Sep)

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New Home Sales TABLE 2 (Sep)


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