Tag Archives: macro and politics

mike_riddell_100

Asian currency wars; is China really the ‘currency manipulator’?

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Ever since the Asian financial crisis in 1997, Asian economies have generally engaged in a policy of maintaining artificially cheap currencies in order to generate export-led growth. This led to substantial political pressure being placed on Asian countries, primarily from the US, to allow their currencies to appreciate.

The problem facing export dependent Asia is that this growth model has now broken. Firstly many of Asia’s currencies no longer appear that cheap (eg Indonesia is running its largest current account deficit since Q1 1997 and its reserves hit a two year low last month), and secondly, who is going to import all the exports given that the developed world is busy deleveraging?

These export dependent countries have been left fighting over a shrinking pie, or at least a non-growing pie. When countries are dependent on exporting tradeable goods, small changes in currency valuation can make a big difference to competitiveness. (As the UK has discovered, the flip side is that devaluation doesn’t make the blindest bit of difference when selling tradeable goods forms a very minor part of your economy.)

And that’s when you get currency wars. In the note I wrote in January (see why we love the US Dollar and worry about EM currencies), I mentioned that China’s devaluation in 1994 is widely cited as being one of the triggers for the 1997 Asian financial crisis. If you consider that Japan is currently more important to many Asian countries’ trade today than China was in 1993, could a big yen devaluation wreak havoc on the region in the same way?

The chart below shows the magnitude of Japan’s so far successful devaluation versus China, its biggest trade partner and global competitor. Some Asian currencies have weakened a little in sympathy, but more from investor expectations of action rather than from action itself. Chinese exports grew at a surprisingly strong 21.8% year on year in February, but it will be very interesting to see whether this can be sustained, whether other Asian countries can bounce from their current export slump, and if not, then what the region’s central banks and governments plan to do about it.

CNYJPY spot exchange rate

jim_leaviss_100

Should the people of Middle Earth have done Quantitative Easing to mitigate against Smaug’s tight monetary policy?

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Any blog that begins with the words “Smaug the dragon is typically viewed as a fiscal phenomenon…” has immediately got my attention. Please read The Macroeconomics of Middle Earth by Frances Woolley. Woolley compares the size of the dragon’s hoard with a picture of the gold reserves at the Bank of England – although it is likely that Smaug is the beneficial owner of his gold, rather than a custodian of gold for richer dragons elsewhere in Middle Earth. He concludes by suggesting that the peoples of Middle Earth should have abandoned the gold specie standard and adopted paper currency to reduce the deflationary drag that Smaug’s monetary tightness produced. Unfortunately though “the lack of a central bank, or indeed any but the most rudimentary monetary institutions, was a major obstacle to currency reform”. The comments are worth reading too – was Middle Earth an Optimal Currency Area? Before Smaug arrived, were the the Dwarves running Middle Earth like a petro-state?

*SPOILER ALERT* So Smaug dies in the end, and the gold was released into Middle Earth’s money supply. Was there hyper-inflation as a result? Or did Nominal GDP return to trend (i.e. the “catching up” theory that has been talked about by Central Bankers like Mark Carney lately) without longer term inflation problems? If there was hyper-inflation perhaps the political instability that resulted allowed the rise of Sauron as a leader, and the subsequent world war between Men and Elves, and Orcs?

jim_leaviss_100

Metroboom – Lessons from Britain’s Recovery in the 1930s by George Trefgarne. And win a copy!

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In my last blog, about the many positive signals for US housing and the massive potential for that to drive US growth over the next couple of years (see here). I mentioned that I’d met recently with George Trefgarne, the author of a Centre for Policy Studies booklet called Metroboom. In it he pointed out how important housing construction had been in the UK’s recovery from the “slump” of the 1930s – I suggested that house building would be a very powerful way for the UK to get out of our current growth problem. As we’ve pointed out before, the UK’s growth performance from the credit crisis onwards is actually far worse than it had been in the 1930s in terms of lost GDP.

Metroboom is definitely worth a read. It certainly adds to the debate on the austerity vs fiscal stimulus debate, and (perhaps controversially) argues that it was a combination of spending cuts and tax cuts that helped to restore economic growth in the UK in the 1930s. The paper also argues that the view of the 1930s as universally gloomy in the UK is overstated. Areas that relied on shipbuilding and coal mining (the Special Areas) did remain depressed for much of the decade, and only re-armament ahead of the war stimulated growth again, but for much of the nation recovery came much earlier. Trefgarne claims that the UK was well ahead of most of the rest of the world in coming out of depression (only Germany grew faster), and that the period was one of industrial and technical innovation (and an obsession with world speed records!), an infrastructure and housing revolution, and improved leisure time (paid holidays, a cinema boom).

Perhaps one problem that we face today, that makes the UK’s 1930s solution difficult to implement today is that the tighter fiscal stance then could be offset with looser monetary policy – a policy tool that Trefgarne says was necessary to run alongside the austerity. As we approach the zero bound in interest rates around the western economies, and when the Bank of England hints that it finds diminishing returns from more and more Quantitative Easing, those monetary tools are unavailable. Olivier Blanchard, chief economist of the IMF, suggests that the reason for the negative fiscal multipliers being perhaps 3 times higher in this current downturn than they had expected them to be (1.5x versus 0.5x) is exactly this effect – monetary policy can no longer offset fiscal policy tightening. Additionally, when the UK came off the Gold Standard in 1931, the depreciation of sterling was very beneficial to UK exporters – I think that this currency depreciation was the most important factor in the UK’s eventually recovery. It’s also interesting to note that at the recent IMF/World Bank meetings in Tokyo (see my video here), Blanchard used the UK in the 1930s as an example of exactly why austerity failed, so the data from that period can be interpreted in very different ways!

I highly recommend you read Metroboom – it’s a short and concise economic history of the UK in that period with some great colour too (Neville Chamberlain at the time was regarded as a dynamic, media savvy “Man of the Year”, the Navy came close to mutiny following wage cuts, and 180 lidos were built in the decade). It’s interesting to have a different view to the commonly held one that the UK’s policies were disastrous whilst the New Deal Keynesian policies of the US proved to be the way to get out of Depression.

We have 20 copies of the Metroboom booklet to give away to the first names out of the hat with the correct answer to this question:

Which famous train broke the speed record between London and Edinburgh in 1938?

Terms and conditions here.  Enter here or email us at bondvigilantes@mandg.co.uk

Congratulations to the 20 winners named below – we will be in touch to get your copy of Metroboom to you. My question turned out to be a little ambiguous. I was looking for The Mallard as the answer to the question, as it hit a record speed of 126 mph at one point between London and Edinburgh in 1938. However, the Flying Scotsman set the record time for the entire journey between London and Edinburgh. In light of the confusion I generated, both answers were accepted. Thanks to everybody who entered, and good luck if you are attempting the annual Bond Vigilantes Christmas Quiz!

William Blake, Quilter
Chris Summers, FAMC Ltd
John McLaughlin, Brewin Dolphin
Nigel Farmer, Charles Stanley
Rachel Revesz, Citywire
Harry Rogers, Bentley Reid & Co
Joanna McIntyre, Standard Life Investments
John Slater, Medicas
Chris Spink, Thomson Reuters
Chris Rule, Kingfisher Financial
Herman Bakker, VSB
Jacob Nelson, BIS
John Topalian, Topalian Associates
Neil McHaffie, KM Financial
Mateusz Malek, Killick & Co
Mark Jones, Brewin Dolphin
Debbie Behrens, Charles Stanley
Richard List, J O Hambro Investment Management
Ian King, The Times
Bill Crowley, Independent IFA

richard_woolnough_100

What should Mervyn do with his QE gilts? Free finance.

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Jim recently discussed the merits of officially cancelling the gilts bought back through QE, so I thought I would discuss another option that maintains the status quo through the Bank of England (BoE) simply rolling over the QE gilts into new gilts at maturity.

In order to understand the results of this process it is useful to re-examine how QE works.

Simply, QE is the willing exchange of gilts for cash between the BoE and the private sector.

What is the difference between a gilt and cash? Both are denominated in the same common currency, the main difference to the investor is that gilts pay a coupon, usually until a specified maturity date when they funge into cash on a one for one basis. Cash on the other hand has a zero return, unlike a gilt, and exists in perpetuity. Both cash and gilts can be lent to a third party in return for a payment. But that payment is simply a transfer payment for borrowing the asset (cash or gilt) with no extra intrinsic returns being embedded in the cash or the gilt.

Therefore as an investor you have the choice of owning a gilt that pays you extra return until a set date when it turns into a cash security that pays you no return forever, or investing straight away in cash that pays you no return forever.

The holding of a gilt looks intrinsically superior. A buy to hold investor of a gilt with a positive yield will always end up with a higher cash balance than the investor holding cash. Why do investors therefore choose cash over gilts? Mainly, it is due to the fact that the price of a gilt can go up or down, while the price of cash never varies. This risk aversion means investors are willing to forego a positive return in order for certainty when they decide to hold cash.

From an issuer’s perspective this is wonderful and can be taken advantage of. If the government can exchange interest bearing securities for cash (QE) then they can swap interest bearing securities that need refinancing at maturity for non-interest bearing securities that never need refinancing.

If for example 25% of the national debt has been exchanged for zero coupon perpetual securities (cash), then an 80% debt to GDP ratio effectively gets transformed into a 60% debt to GDP ratio, as 20% costs nothing to finance, never has to be repaid, and so is therefore effectively free finance.

The more of your outstanding debt you can finance at zero cost forever, the more debt you can sustain. If this free financing is undertaken responsibly it can be used as a sensible economic tool. However, if the temptation of free finance results in a misallocation of resources via the state, then it can be very harmful to the economy. This is why many economies have introduced the concept of an independent central bank to remove some of the political process from the real economy.

So far, the BoE has convinced the market that QE is a responsible policy. The use of QE has neutered the bond vigilantes, whilst the next enemy of this policy, the currency vigilantes, remain dormant.

The BoE could officially cancel the gilts or could simply exchange its existing gilts at maturity for new gilts to maintain the windfall gain of free finance. This topsy turvy world of money printing, low bond yields and free financing is a new challenge for investors.

richard_woolnough_100

Paying the locusts – what the PSI means for Greek bond investors

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Early this morning it appears that at last Greece and the European authorities are at the final stages of  launching a bond swap with the private sector – known as the private sector involvement (PSI) procedure – which will aim to reduce Greece’s debt-to-GDP ratio to 120.5 percent by 2020 (currently 160 percent). The deal will receive blanket press coverage, we are going to focus on the PSI element.

The PSI ensures that the private sector will suffer a real loss while the public sector (national European central banks and the ECB) will not suffer any losses. Central banks have this privileged position as they are prepared to provide further finance to Greece (akin to a rescue rights issue diluting existing shareholders). Of course, it is not in the politicians’ interests for the central banks to bear any losses as a result of lending to Greece and of course it is the politicians that set the legal and regulatory framework. Not only can politicians change the goal posts, they can change the ball you are playing with. Politicians, and the authorities, are exercising their imbedded power.

This deal will cause the private sector to suffer a disproportionate level of losses both in absolute and relative terms to the public sector. This punishes the private sector investor in Greek debt relative to the private speculator who was short Greek debt. We noted in an earlier blog that governments perceived owners of their debt to be good investors, whilst investors holding short positions in government debt are evil speculators.

The problem with the PSI procedure is that it does not reward these economic agents accordingly. This PSI precedent means that in the future, should a government debt crisis occur, private investors will be less willing to support troubled government debt, and speculators will be rewarded for being short. Obviously this will impact the sustainability of government finances at precisely the time they would be seeking to generate confidence in their ability to service their debt obligations.

What does this PSI look like in pounds, shillings, and euro cents? Those investors that are short Greek debt will make money, the legal power of the state means the authorities suffer no damage, while the private sector will suffer losses. The locusts will feed well, the authorities will not eat less, and the private investor will waste away.

anthony_doyle_100

The hot money has flown south to Australia for the winter, but will it fly back in the summer?

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On Friday we had a Dumb and Dumber moment in the office when a colleague for a few seconds thought that Australia had lost its AAA rating.   The error was quickly realised (it was Austria that was downgraded) and Australia kept its AAA rating across the board that it has had with Moody’s and S&P since 2002 and 2003 respectively (although Fitch only upgraded Australia’s foreign currency rating to AAA in November 2011).

There were however some disturbing figures that came out of Australia on Friday – foreign investors bought a record AUD$23.9bn (=US$23.9bn) of Australian government bonds in Q3 2011, resulting in foreign ownership soaring to 80.4%, which is also a record.  Judging by the price action on Aussie bonds and the Aussie Dollar in Q4, foreign ownership is likely to have jumped further in Q4.  For us, this is worrying as heavy foreign ownership of government bonds can be very dangerous, particularly when this is combined with a country running a current account deficit (i.e. the country is reliant on capital inflows from abroad).  Ireland and Portugal, which saw similar levels of foreign ownership before the crisis hit, are great (or poor?) examples of how this combination can leave a country’s exchange rate and solvency very exposed if the country hits a crisis.

Of course, Australia does have some big advantages over the Ireland of 2006. Australia has the ability to print its own currency and set its own interest rates (just ask the Irish how much they would like this power right now). Secondly, despite the massive expansion in credit and house prices that Australia has experienced over the last two decades, Ireland’s was comparatively greater. The run up in Australian house prices since 1990 is reflective of a massive increase in household debt (fuelled by the Aussie banks) and is not the product of more fundamental factors such as population changes or rental income equivalents. Additionally, there is likely to have been a change in demand, as years of rising prices that have made the Australian housing market one of the most expensive markets in the world on price-to-income and price-to-rent ratios (as The Economist pointed out last November) have probably changed household formation dynamics.

Australia’s current account deficit is currently only 1.5% of GDP which is far from alarming. However, on a cumulative basis, Australia has averaged a deficit of 4.8% since the beginning of 2003 which should have investors’ alarm bells ringing.  The credit bubble in Australia (credit bubbles usually accompany large credit account deficits) has never really popped (we wrote about Aussie housing market here). The end of a bubble is always difficult to predict and identifying the trigger for such an unwind is similarly fraught with difficulty. Given that markets are extremely sensitive to the potential for asset price bubbles bursting and with the effects of such events still in mind, the Australian housing data are key to AUD maintaining its lofty levels.  Something else that is worrisome is that the Australian banking sector dwarfs the size of Australia’s economy at 3.5 times nominal GDP (Ireland’s banking sector was 4.4 times GDP in 2008).  The key challenge facing the Australian banking sector is its exposure to the housing market, with about two thirds of assets on the banks books consisting of housing loans.

The following chart shows the AUD/USD currency rate versus foreign ownership of Australian government bonds going back to 1989.  It appears that there is a positive correlation which makes a lot of sense – obviously if foreigners are buying government bonds in large size then the currency should strengthen.  In fact, we think this is precisely why the British Pound has been surprisingly strong over the last six to nine months as the UK government is one of the few AAA sovereigns still standing and has been the beneficiary of a huge safe haven bid.  Of course, if this safe haven status gets called into question, which could easily happen in both Australia and the UK, then capital outflows would leave their respective currencies extremely vulnerable.  On this front the UK’s current account deficit of 4% of GDP recorded in Q3 2011 wasn’t exactly encouraging – since 1955, it has only been worse in Q2 1974 (which preceded sterling’s 1975-76 collapse and IMF bailout) and from Q4 1988 to Q2 1990 (which was a symptom of the UK’s housing bubble and preceded the pound’s sharp fall after it was booted out of ERM in 1992)

The obvious catalyst for the popping of the great Aussie bubble is China, as that’s essentially all that matters if you’re taking a view on Australia’s economy. Almost 70% of Western Australian and Queensland mining exports go to China.  If China has a hard landing then Australia is in serious trouble, and even if it has a soft landing then Australia may be in trouble anyway. If China wobbles or the Australian housing market starts to correct, the RBA would be forced to cut interest rates as it did late last year, reducing the Aussie Dollar’s appeal as a higher yielding currency. The Aussie Dollar is only just over 3% below its strongest ever on a trade weighted basis, and we think that leaves it looking very vulnerable. With the market pricing in a reduction in the RBA cash rate of 1% to 3.25% by August, will the hot money fly away from Australia in the summer?

ben_lord_100

Beware the wealth tax movement

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I saw a very interesting article in this weekend’s Financial Times discussing the London property market. Ed Hammond cited data showing that Greek and Italian citizens have accounted for more than 10% of London property purchases so far in 2011. In fact, Greeks and Italians have so far this year spent more than £400m on prime London property, up from £245m in 2010. Much of this has been into the most exclusive parts of London such as Mayfair and Knightsbridge. It looks like there is a real urgency amongst rich southern European citizens to protect their wealth in this environment of soaring government bond yields.

It struck me that it was, though, a strange situation. Two countries that are on their knees, unable to finance at sustainable rates, that at the same time find themselves very high up the global wealth league tables. Italy, for instance, in 2010, sat in the top 10 of countries with the highest average wealth per adult (according to Credit Suisse). In another study, the Human Development Report 2011, Italy comes out as the 24th wealthiest country in the world while Greece sits at 29th. The UK came just above Greece, at 28th, for purposes of context. Norway and Australia come first and second, respectively.

In these markets that are being totally dominated by what we call the sovereign debt crisis, the market has become fixated on debt to GDP ratios, as corporate bond investors have always paid close attention to companies’ net debt to EBITDA ratios (an income statement approximation to cash earnings). Both ratios very simply look at the level of debt relative to earnings, and thus give some indication of how easily a country or company can service their debts.

Going into this crisis, countries (not companies) were paying out more in spending than they were taking in tax revenues. And as the bond markets have become not just concerned, but obsessed with starting to reduce debt levels relative to GDP, we have seen austerity budgets passed all over Europe (not the US, but that is something we will all worry about at a-not-that-much later date). These are a direct attempt to bring primary budgets back into balance, where spending is financed through tax revenues rather than increased borrowings. A secondary aim of this is to start to bring down the all-important debt to GDP ratio.

But governments are finding it very difficult to bring in the necessary budgetary reforms due to political unrest. And now, the few reforms that have been brought in to cut spending have met with what looks like being a global slowdown. Perhaps even a global recession. So governments are not only struggling to bring the primary budget back into balance, but are now seeing GDP growth fall, whether by coincidence, or by actually contributing to the decline in growth (more likely). And if GDP starts to fall, then debt to GDP ratios deteriorate unless total debt levels are being reduced by a faster amount. You won’t find many, if any, examples of states that are actually cutting their total debt levels in Europe yet.

It is worth observing, in passing, that there are several countries that have pretty terrible debt to GDP ratios that also have historically low interest rates (witness the US, the UK and Germany, amongst others). The implicit message here is that debt to GDP is not the be-all and end-all in terms of the cost of that debt.

So what is needed, if growth continues to slow and the threat of renewed recession spreads across these over-indebted nations?

The evidence of the Greeks and the Italians coming and spending such large sums of money on prime London property suggests that these people fear a new wave of fiscal approach to this crisis. As growth in both these states continues to plummet, thereby worsening traditional debt to GDP ratios (bar a haircut or default, both synonymous as far as we’re concerned) a new approach by policymakers may start to take hold. Austerity isn’t going to help in this environment. Perhaps even the opposite. What is needed is an ability to stimulate the economy, so as to generate jobs and growth. And what is all too clear from the last couple of years is that the bond markets will no longer lend to finance these budgets aimed at growth. So the resource needs to come from somewhere else. Is it time for Robin Hood to come to the rescue in the form of a wealth tax? It appears that many citizens of peripheral Europe are starting to fear exactly that.

mike_riddell_100

UK inflation jumps most in one month since 1993 – cue mass hysteria

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A 1% jump in UK CPI in December meant that the year on year inflation rate in the UK soared from 3.3% to 3.7% year on year, once again beating consensus expectations of 3.4%.  No doubt we’ll have the newspapers tomorrow full of talk of a return to the 1970s, and no doubt we’ll also have various MPC members continuing to come out over the next few weeks and months explaining that this inflation problem is (still) temporary.

Two charts which I think are interesting. This one shows that the bond market is taking the inflation number seriously, and is now pricing in almost 3 lots of 0.25% rate hikes by the end of this year.  The first rate hike is now fully priced in for June.  

The second chart demonstrates that while the MPC has done a bad job inflation forecasting over the past few years, it still definitely has a point about inflation being temporary. If you measure inflation at constant taxes, then the inflation rate is only 2%, so assuming we don’t see another VAT hike in January 2012, we should see UK inflation fall sharply from the beginning of next year. 

That said, UK inflation at constant taxes has still gone from 1.4% yoy in August to 2.0% yoy now, so I wouldn’t relax entirely, but today’s headline inflation figure is nowhere near as bad as it looks. As Jim mentioned in a recent blog, hiking rates could be GDP suicide, and I’d be surprised if UK interest rates went up as much as the market’s expecting.

mike_riddell_100

Emerging market inflation – a big risk to global growth

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The reasons behind the ugly scenes in Tunisia are down to a combination of political and economic factors, but at least part of the discontent stems from rising food and energy prices.  Public unrest in Tunisia has spread to Jordan, where thousands were protesting against the government over the weekend, and demonstrations are also spreading to Egypt (10 year US$ bonds are down 4% today, and the 30 years US$ bonds down as much as 8%). 

The problem these countries face is that food and energy prices are a much bigger percentage of an emerging consumer’s shopping basket than for a developed consumer’s basket.  Food and energy therefore carry a much higher weight in domestic consumer price indices within emerging markets, which is something I discussed last year when going over some of the risks to the emerging market story (see here). 

As this chart demonstrates, there’s a reasonable correlation between a country’s wealth (as measured by GDP per capita) and the weighting of food and energy in the country’s CPI basket.  Poorer countries therefore tend to be those that are most vulnerable to rising commodity prices, so of the major emerging markets I’ve looked at, food and energy constitutes over 60% of the Philippines’ consumer basket, while South Korea, Taiwan and Israel’s inflation indices have a far lower exposure.  (Note that the latter countries should probably be considered ‘emerged’ rather than ‘emerging’ – Taiwan in fact had a higher GDP per capita than France and Japan last year).

While GDP per capita is a good indicator of the degree that a country’s inflation rate is vulnerable to rising food and energy prices, some emerging market countries would likely welcome higher prices if they’re producers of the stuff.  This chart from Nomura plots the weighting of the food and energy component in the CPI basket for a range of emerging market countries versus the degree to which the country is an importer or exporter of food and energy, where countries to the right are net importers and countries to the left net exporters.  The country that would most likely welcome higher commodity prices is unsurprisingly Russia, while the country that is most exposed is, again, the Philippines, which happens to be the world’s biggest rice importer.  
The global growth drivers India and China also flash up as being vulnerable to rising food and energy prices.  In India, the inflation rate was 8.4% year on year in December, driven by food prices climbing at 16.9% and today governor Duvvuri Subbarao warned about surging inflation, suggesting further interest rate hikes.  China’s official inflation rate is 5.1% year on year, and has only been higher in the last decade from mid 2007 to mid 2008.  I wouldn’t be surprised if China’s unofficial inflation rate was higher still, and the authorities have responded by tightening monetary policy and allowing a degree of currency appreciation, both of which should result in weaker Chinese growth. 

To an extent, higher food and energy prices are a result of expansionary economic policy in the US combined with a reluctance of emerging market countries (particularly China) to allow their currencies to appreciate versus the US dollar.  Would it not be ironic if the very policies that US authorities have pursued to return the US economy to growth then proceed to be the cause of global economic weakness?

jim_leaviss_100

Thoughts on the uselessness of economics, and some views on austerity

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Imagine if you had nine of the most skilled doctors in the country examining a patient, and you had such a range of views that one doctor demanded emergency surgery and an immediate series of organ transplants, and at the other end another doctor insisted that the patient is in such robust health that he must be discharged immediately and return his wheelchair and medicines on the way out.  You might not have much faith in the skill of those doctors.  Now I’m sure there are disagreements in the medical profession about the best course of treatment for illnesses, but when it comes to economics it’s the norm, rather than the exception.  In the UK’s Monetary Policy Committee you have Posen at one extreme, asking for more emergency QE, and at the other end Sentance, wanting rate hikes.  Isn’t it incredible that the science of economics (the dismal science) is so, well, useless? 

At the same time as we don’t know whether to print money or restrict it, we have no real understanding of whether fiscal stimulus in the face of weak demand is the priority, or whether it is more important to get public and private debt burdens down.  If you read Paul Krugman’s excellent blog you’d believe that another massive stimulus package is imperative.  Yet George Osborne and many on the right think that austerity is the answer to getting the western economies back to growth in the medium term.  Why don’t we know?  I think it’s important to acknowledge how limited the data set that economists have to work with actually is.  “Modern” capitalism is barely a couple of hundred years old, and a truly globalised free trade economy perhaps less than two decades old.  Our data set for QE pretty much only includes Weimar Germany, Japan and Zimbabwe; our understanding of the creation of massive currency unions is almost entirely theoretical; there’s only been one Great Depression – one data point on which to base our models and respond to our current predicament.  Let’s be frank and upfront – economics is about forecasting the behaviour of irrational crowds in situations we’ve rarely, or never seen before (yet many neo-classical economic models make rationality a key assumption!).  We’re bound to get it wrong.

So for what it’s worth – and given the grief I got for posting the Tea Party’s right wing views on Quantitative Easing earlier this year, here’s the left leaning False Economy website, which argues that government spending cuts are the wrong thing for the UK’s current predicament.  In particular this video by Professor Mark Blyth of Brown University is worth a watch – I hadn’t heard of the concept of the Fallacy of Composition before.  What might be right and appropriate for an individual economic agent might be terribly wrong for the collection of economic agents.  For example it might be right for the UK to try to reduce its debt, but to do so at the same time as every nation is doing so could be disastrous.

And whilst we are on the subject of the left wing – why on earth doesn’t the US have one?  It is staggering that the bottom 40% of workers in the US economy have not had a real wage increase since – wait for it – 1979.  Yet real US GDP is up by over 125% over that period, and the profits share of GDP is exceptionally high by historical standards.  The controlling power of the myth of the American Dream is amazing.

So that’s it for 2010.  My guess is that 2011 will see more of the same, with sovereign issues continuing to dominate the headlines (and Spain’s huge Q1/Q2 debt refinancing needs will be the next big test for the Eurozone).  We’ll post our thoughts on these and other issues of the day on this website (like – will the loss of output caused by the UK’s Royal Wedding send the economy back into recession?).  We might even make it our New Year’s Resolution to learn how to Twitter (tweet?).  Happy New Year.

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