Opinion

Anatole Kaletsky

The budget deal and Washington’s new politics of compromise

Anatole Kaletsky
Dec 12, 2013 15:16 UTC

The muted market reaction to this week’s budget deal in Washington may initially seem like a disappointment. After all, uncertainty over government spending, debt and taxes has consistently emerged in business sentiment surveys as the biggest single factor holding back corporate investment and damaging financial confidence. Why then did Wall Street celebrate this breakthrough with its biggest daily fall in two months?

The standard explanation is that the budget deal will accelerate the tapering of monetary policy by the Federal Reserve Board, and that is probably a valid expectation. The main reason for the seemingly perverse response, however, is simply that this budget deal was predictable to the point of inevitability, even if most Washington pundits committed to the standard narrative of U.S. political dysfunction and gridlock did not see it coming until this week. Viewed from outside the Beltway, the inevitability of eventual bipartisan cooperation on the budget has been obvious since the 2012 election, which essentially settled all the important U.S. fiscal debates.

Having argued this position all year and having suggested back in October that a deal by this week was very likely, I could hardly be surprised that the markets greeted this event with a yawn. Short-term players on Wall Street have simply followed the time-honored formula of “buy on the rumor, sell on the news.” Business leaders and long-term investors, by contrast, are likely to be relieved and even enthused by this agreement, but their responses will have to be assessed over weeks, months and even years, not just a few days.

There are, however, several important lessons that can be drawn already from the U.S. budget agreement, several with implications for politics and economic policy in other countries. Here, briefly, are five:

1. Political analysts, lobbyists and media pundits whose professional reputations or business models depend on emphasizing or dramatizing political battles often present a misleading picture of economic policies. They naturally tend to exaggerate confrontations and underestimate the possibilities of compromise, even in situations where the interests of all the main political players point towards cooperation, rather than conflict. This principle is as true of monetary policy as of fiscal policy and it applies around the world. For example, European political analysts often exaggerate the confrontations between Germany and other countries or the risks to the euro posed by the German constitutional court or the Bundesbank.

British economic governance encounters turbulence

Anatole Kaletsky
Dec 5, 2013 16:52 UTC

Students of British history will recall the story of Thomas a’Becket, the 12th century prelate who was handpicked by Henry II to become Archbishop of Canterbury because of his loyalty to the Crown. Within months of his appointment, a’Becket turned against the King in the numerous conflicts between church and state. As a result, a’Becket was murdered at the altar of Canterbury Cathedral in 1170, after four of Henry’s henchmen heard their royal master mutter in irritation: “Will no one rid me of this turbulent priest?” Archbishops do not have much political clout these days, but comparable spiritual importance now attaches to central bankers. And a central banker who suddenly seems reminiscent of Thomas a’Becket is Mark Carney, the recently appointed governor of the Bank of England.

When George Osborne, the British chancellor of the Exchequer (finance minister), delivered his Autumn Statement on Britain’s economic and fiscal prospects this week, he intended it as a “soft launch” for the Tory-Liberal government’s campaign for re-election in May 2015. The big set-piece speech offered Osborne an ideal opportunity to boast about the British economy’s sudden improvement this year and to announce some populist measures, such as a “voluntary” price-control regime for energy utilities, that were carefully designed to wrong-foot the Labour opposition. Osborne’s speech marked the start of a long political campaign designed to create a Pavlovian association in voters’ minds between government policies, rising house prices and the economic recovery. If this campaign is successful it will virtually guarantee election victory for the Tory-Liberal coalition — and it could even make an outright majority for the Tories conceivable in 2015.

Last week, however, the plan for a mutually-reinforcing cycle of rising house prices, strengthening consumer confidence, accelerating economic activity and improving Tory fortunes suddenly came under threat from the most unexpected quarter. Mark Carney was hand-picked this year by Osborne and was imported all the way from Canada because he seemed to offer less resistance than any plausible British candidate to the Tory plan for a pre-election economic recovery powered by rising property prices and re-leveraging by homeowners.

After initial promise, Japan’s new economy risks backsliding

Anatole Kaletsky
Nov 29, 2013 15:55 UTC

At a time when economic optimism is growing and stock markets are hitting new highs almost daily, it is worth asking what could go wrong for the global economy in the year or two ahead. The standard response, now that a war with Iran or a euro breakup is off the agenda, is that some kind of new financial bubble could be about to burst in the U.S. But a very different, and rather more plausible, threat is looming on the other side of the world.

Japan is the world’s third-biggest economy, with national output roughly equal to France, Italy, Spain, Portugal and Greece combined. This year, Japan has become, very unusually, a leader in terms of financial prosperity and economic growth. According to the latest IMF forecasts, Japan’s 2 percent growth rate in 2013 will be the fastest among the G7 countries, easily outpacing the next strongest economies, Canada and the U.S., each with 1.6 percent growth. Japan’s stock market has gained 70 percent since last December, far exceeding the 25 percent bull market on Wall Street, and Japan’s corporate profits are projected to increase by 17 percent, according to Consensus Economics, compared with the paltry gains of 3 to 4 percent in Germany and the U.S.

As someone very much caught up in the economic optimism inspired by the election of Shinzo Abe, I fear it is now time for a reality check. And observing the complacent inertia that seems suddenly to have paralysed Japan after July’s Upper House election, it seems worth recalling the famous maxim (usually attributed to Keynes) about unexpected events: “When the facts change, I change my mind.”

The end of the Fed’s taper tantrum

Anatole Kaletsky
Nov 21, 2013 15:03 UTC

Following Wednesday’s publication of the Federal Open Market Committee minutes, we now know that a reduction in U.S. monetary stimulus could be on the agenda for the next FOMC meeting on December 19. How much does this matter?

When the Fed unexpectedly decided not to “taper” in September, the markets were stunned and gyrated wildly, although investors had only themselves to blame for being wrong-footed in this way. Ben Bernanke had made crystal clear his reluctance to reduce monetary stimulus as long as the U.S. economy appeared to be weakening, which appeared to be the case throughout the summer. By December 19, the situation may well be very different, since the economy will probably be improving and the U.S. fiscal stalemate may well have been resolved. If such improvements happen, the Fed will have no compunctions about wrong-footing investors again, in the opposite direction, as this column suggested last month.

So what will be the impact on the world economy and financial markets if the Fed decided to taper as early as December? The answer is, not much. As long as the Fed stands by its commitment to keep interest rates near zero for the foreseeable future, tapering will have no major economic impact. Therefore its financial significance should also be marginal, except insofar as investor psychology overwhelms rational economic analysis.

Central bank stimulus is here to stay, but what if it fails?

Anatole Kaletsky
Nov 14, 2013 16:29 UTC

If anyone still doubted that central bankers all over the world will keep interest rates at rock-bottom levels, those doubts should have been dispelled this week. Janet Yellen’s statement on Thursday to the U.S. Senate that the Fed has “more work to do” to stimulate employment, and that “supporting the recovery today is the surest path to returning to a more normal approach to monetary policy,” capped a series of surprisingly clear commitments to easy money from central bankers this week. On Wednesday Joerg Asmussen, a member of the executive board of the European Central Bank, and Ewald Nowotny, the Austrian central bank governor — both of whom had previously been reported as voting against last week’s surprise ECB rate cut — said that they might in fact support further rate cuts and even negative interest rates, as well as the possibility of breaking the taboo against U.S.-style purchases of government bonds. And Mark Carney, the Governor of the Bank of England, reiterated more strongly than ever that any early increase in British interest rates was out of the question, despite the fact that the outlook for the British economy has turned out to be much better than the BoE had expected.

But what if these zero interest rate policies produce disappointing results in the year ahead, as they have in each of the past four years? What if the world economy fails to spring back to life or just plods along with sub-par growth, despite all this stimulus, as has happened in each of the past four years?

With luck, these questions will not need answering because fiscal austerity has acted as a powerful headwind to economic recovery in the U.S., Europe and Britain and these budget consolidation efforts are now being relaxed. The new records on Wall Street and other stock markets suggest growing confidence among investors that monetary stimulus will finally deliver decent levels of growth next year — and this does indeed seem likely. But what if the optimism turns out to be wrong? What if the U.S. and Britain fail to grow by at least 3 percent next year, and what if Europe stays stuck with sub-1 percent growth and mass unemployment? In that case, the monetary and fiscal policy experiments since the Lehman crisis would have to be judged as failures — and that judgment would open the way to much more radical ideas than zero interest rates and QE. Such radical ideas would be of two opposing types.

This weekend, China will plot its economic future

Anatole Kaletsky
Nov 6, 2013 20:13 UTC

The ponderously named Third Plenary Session of the 18th Central Committee of the Chinese Communist Party, which takes place this weekend, is a more important event for the world economy and for global geopolitics than the budget battles, central bank meetings and elections that attract infinitely more attention in the media and financial markets.

The obvious reason for this meeting’s importance is that China is destined in the long run to become the world’s biggest economy and a political superpower. And the Third Plenum, traditionally held roughly 12 months after the appointment of a new Party leadership, has been used twice before as an occasion for the new leaders to spell out the main strategies they hoped to implement as they consolidated their power. At the Third Plenum in 1978, Deng Xiaoping launched the market reforms that unleashed the power of the profit motive in China, and it was at the corresponding event in 1993 that Jiang Zemin accelerated the process of dismantling state-owned enterprises and integrating China into the world economy that culminated with China’s accession to the World Trade Organization in 2001.

A second, more immediate, reason for the world to pay attention to this weekend’s meeting is that China has recently become not just the strongest engine of growth in the world economy, but also the biggest source of potential economic surprises, both good and bad.

Don’t expect the euro’s rally to last

Anatole Kaletsky
Oct 31, 2013 15:05 UTC

What is happening to the euro? Currencies are more important than stock market prices or bond yields for many businesses and investors, not to mention for globe-trotting families and humble tourists. Which makes it surprising that so little attention has recently been devoted to the strengthening of the euro, which hit its highest level since 2011 this Monday, having jumped by 5.5 percent since September and over 8 percent since early July. This remarkable ascent, which has also driven the euro to its highest level against the yen since the 2008-09 financial crisis, means that European exporters are losing competitiveness, Americans and Asians who live or travel in Europe are feeling like poor relations and many economists are starting to worry that Europe’s nascent economic recovery will be snuffed out.

Purely financial players, by contrast, seem to be more enthusiastic about the euro’s strength than they have been for years. Speculative futures bets in favor of further euro appreciation have reached their highest level since the summer of 2011 — and the only time they were higher than that in the past decade was in the period just before the Lehman shock. Significantly, both of these speculative crescendos were followed by sharp euro declines, since currency markets generally turn when bullish sentiment reaches extreme levels. But there is a deeper reason to expect the euro’s seemingly irresistible rise to reverse.

Currencies tend to move in trends for many years, and the fact is that the euro’s long-term trend against the dollar is still almost certainly downwards, despite the big gains of the past few months.

With hostage taking over, a Washington deal beckons

Anatole Kaletsky
Oct 24, 2013 15:37 UTC

Nobody should be surprised that Wall Street hit new records this week. After all, the U.S. has just witnessed the end of a sensational hostage crisis that was threatening national security and undermining economic confidence — and even more sensationally, this was the second such crisis in two months.

John Boehner was held hostage by Republican hardliners until last Thursday, when the U.S. Congress voted to continue pumping money into the U.S. government. The fiscal militants forced Boehner to endanger the U.S. economy with threats of a Treasury default. Boehner reluctantly paid this rhetorical ransom in order to preserve the appearance of party unity and therefore his own credibility as a political leader.

Now consider events a month earlier on the other side of Washington. Until September 18, when the Federal Reserve voted to continue pumping money into the U.S. bond market, Ben Bernanke was arguably held hostage by the Fed’s hardliners. The monetary militants forced Bernanke to endanger the U.S. economic recovery with threats of a premature end to quantitative easing. Bernanke reluctantly paid this rhetorical ransom in order to preserve the appearance of institutional unity and therefore his own credibility as an economic leader.

The positive side of the budget debacle

Anatole Kaletsky
Oct 17, 2013 15:07 UTC

The U.S. budget battle was always likely to end in a Republican defeat and a rout for Tea Party firebrands; but the outcome has turned out to be even more dramatic: an unconditional surrender, instead of the negotiated ceasefire suggested here two weeks ago. Trying to spot historic turning points in real time is always risky, but the scale of this debacle suggests that U.S. politics and economic policy really will be transformed in at least four important ways.

Firstly, the shift in the balance of power between Obama and the Republicans since last November, described here, has been spectacularly confirmed. It is too early to guess whether the GOP’s slumping popularity will give the Democrats a chance to regain control of the House of Representatives next November. The Democrats would be very likely to achieve this if they could hold on to their present lead of 5.5 percentage points in the Real Clear Politics average of Congressional vote polling, since this would represent a swing in favor of the Democrats of 4 percent, which should suffice to win the extra 17 seats they would need to win control.

Conventional wisdom in Washington contends that a Democratic win next year is almost impossible because of a historic tendency of presidential parties to lose votes in midterm elections, but this history has little statistical significance, and is counterbalanced by the voting figures from the three occasions since 1945 when parties that lost the popular vote kept control of the House. In all these cases the majority party in the House only lost the popular vote by tiny margins — in 1952, by 0.5 percent, in 1996 by 0.7 percent and in 2012 by 1.2 percent. So an election in which the Republicans lost the popular vote by 5.5 percent, as indicated by recent polling, but kept control would create a totally unprecedented situation. In any case, speculation about next year’s election is pointless since the polls are likely to shift abruptly — one way or the other and for reasons we cannot even imagine today. What is clear, however, is that the Republicans face deep unpopularity in the short-term and this will transform the outlook for economic policy in the next few months.

Learning budget lessons from Japan and Britain

Anatole Kaletsky
Oct 10, 2013 14:55 UTC

While the world is transfixed by the U.S. budget paralysis, fiscal policies have been moving in several other countries, most notably in Japan and Britain, with lessons for Washington and for other governments all over the world.

Let’s start with the bad news: Shinzo Abe’s decision to increase consumption taxes from 5 to 8 percent next April. This massive tax hike, to be followed by another increase in 2015, threatens to strangle Japan’s consumer-led growth from next year onwards, since Abe looks unlikely to offset this massive fiscal tightening with stimulative measures that would maintain consumers’ spending power. Even if Abe delivers on his vague promise to compensate with business tax reductions, these will only aggravate the over-investment and corporate cash hoarding that have long distorted the Japanese economy. Meanwhile, the government’s willingness to risk economic recovery in the cause of fiscal discipline implies that those of us who believed Abe was making an unconditional commitment to do whatever it takes to achieve economic recovery were simply wrong. Now that the forces of budgetary austerity have reasserted themselves, Japan’s probability of ending its decades of stagnation is much reduced.

Now for the good news: a change of attitude to debt and borrowing is transforming Britain from the second-weakest G7 economy (after Italy) into a world champion of growth. As recently as last April, the British government was attacked by the International Monetary Fund’s chief economist for “playing with fire” by trying too hard to reduce its budget deficits. This week the IMF World Economic Outlook praised Britain’s rapidly improving economy and upgraded 2013 growth projections by 0.5 percentage points, to 1.4 percent. That may not sound like much, but this improvement comes when almost every economy is being downgraded — and compared with last year’s miserable 0.2 percent growth rate, it feels almost like a boom.

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