The Great Debate UK

from Anooja Debnath:

When it comes to recessions, 40 is the new 50

If it were about age, 40-somethings would cringe. But it seems a dead certainty that 40 now means 50 -- or even higher -- when it comes to predicting the chances of a recession taking place.

Going by past Reuters polls of economists, every time the probability hits 40 percent, the recession's already started or is perilously close to doing so.

After the brief recovery period from the Great Recession, Reuters once again started surveying economists several months ago on the chances of developed economies stumbling back into the muck.

As the data get nastier and euro zone politicians wrangle over the sovereign debt mess, the probability goes higher. Just not high enough or fast enough.

The probability that Britain slides back into recession hit 40 percent in the Reuters poll this week, up from one in three last month.

The last time that happened was in July 2008, a few months before U.S. investment bank Lehman Brothers collapsed. The British economy contracted by 2 percent that quarter, its second contraction of 2008. And we all know what happened next. If 40 is the new 50, we're in it.

"It is a very big thing to say we are going into recession ... it is one of those things people are cautious sticking their necks out about," said Alan Clarke, who said there’s a 75 percent chance of that happening.

What could the Q1 GDP figures mean for my business?

By Jamie Jemmeson

-Jamie Jemmeson is a Trader at Global Reach Partners, the foreign exchange company. The opinions expressed are his own.-

The alarm bells have been ringing in the UK since the surprise contraction in Q4 GDP 2010.  The Bank of England (BoE) remains in limbo between the ECB, who recently hiked despite their problems with sovereign debt and the US, where quantitative easing remains in force until at least June. The release of the preliminary Q1 GDP on the 27 April could be instrumental in determining not just how the currency and financial markets perform, but in directing measures the BoE and coalition government may have to take. Since the surprise contraction in GDP, the BoE has been forced to sit on its hands and watch inflation continue to increase while reiterating its belief that this is just a temporary phase. There is a real dilemma in the UK that has split the market; will the UK face the daunting reality of a double dip recession?

Data that has recently been released has done little to reassure the markets; the British Retail Consortium reported that retail sales for the month of March tumbled at their fastest pace in 6 years as spending cuts, tax rises and high unemployment took their toll on consumer confidence. As a result, Sterling is very vulnerable to the outcome of the UK GDP figure later this month. This means businesses that import and export are exposed to a great deal of risk when protecting their budgeted rates in foreign exchange for the year.

If the UK does enter a double dip recession on the 27 April, the value of Sterling is likely to fall. Consumer confidence is already near record lows and will plummet further if we see the inevitable media frenzy that would accompany the news of a double dip. The result could be a decline in retail sales and higher unemployment, two factors that will not be greeted with open arms by UK businesses. The BoE’s task of tackling inflation will become a steeper uphill slog as the justification of an interest rate hike would become difficult. Various rating agencies have already warned that weaker growth could jeopardise the UK’s prized triple AAA rating, a downgrade can only have negative effects. Finally, let’s not rule out the possibility of further quantitative easing down track that would naturally weaken the Pound.  All of this uncertainty would weaken Sterling, and hurt businesses that import goods and raw materials as a result. However, companies that are manufacturing goods for the export market may embrace the weakness in the currency as the demand for British made goods become more appealing.

If the UK dodges the silver bullet and avoids the double dip recession, hope and confidence may start to be restored. The net effect should result in a stronger currency and strengthen the coalition government’s position. The main price driver this year has been interest rate expectations. A return to growth would give the BoE more scope to start tackling the mounting inflationary pressures by increasing interest rates. In this benign scenario it is more than likely that the nation’s AAA credit rating will be preserved thereby enticing business and foreign direct investment while allowing the Coalition Government to continue to plough on with their austerity plans to improve the nation’s finances.

The net effect will be positive for Sterling. The rising pound would assist in tackling some of the imported inflation. For those who are importing this would be a timely boost and a noticeable help in pushing prices lower. Conversely businesses that are manufacturing goods for export would see their products become less competitive in price terms.

Should a country always stand behind its banks?

Ever since the financial crisis broke in 2008 some of the world’s major banks have their governments to thank for their survival. The fates of Royal Bank of Scotland or Citibank would have been much worse without large injections of capital from the UK and U.S. authorities. The UK government pumped more than £37 billion into its largest banks in the immediate aftermath of the Lehman Brothers crisis. Ireland took that a step further when it guaranteed all of its banks’ deposits and liabilities. This was affordable, the Irish government said at the time.

However, this policy failed spectacularly. Ireland’s bailout of its banking sector brought the country to the edge of bankruptcy and forced it to accept a 82 billion euro bailout loan from the IMF/ECB and the European Union. More than 30 billion euros of this loan is to re-capitalise the Irish banking sector and the rest is to shore up the state’s finances. The conditions of the loan mean that Ireland will have to implement harsh austerity measures for many years to come that will inevitably hurt growth.

So should governments always stand behind their banks? There are some success stories. Back in 2008, when the global financial sector teetered on the brink of collapse, it was necessary for the world’s major central banks and governments to offer unlimited support to their banks. The chief reason for this was to ensure that credit flowed through the economy to foster growth. In truth however, a mixture of stringent capital rules caused banks to shrink their balance sheets in the teeth of the recession, which didn’t help the overall economy but did boost their balance sheets. In the first six months of 2010 the UK’s four largest banks: Lloyds Banking Group, Royal Bank of Scotland, Barclays and HSBC (the latter two did not receive bailouts) made combined profits of £13.6 billion. This is a far cry from the £22.3 billion they lost in 2008.

The U.S. banking sector has also seen earnings recover sharply. The Federal Deposit Insurance Corporation (FDIC) announced that the earnings for U.S. banks rose by $14.5 billio in the third quarter of 2010. Now that the banking sector is back on its feet again one can hope that credit conditions will also become more supportive of economic growth. And strong earnings also increase the chances that taxpayers will profit from the capital injections at some point.

So why did things go so wrong for the Irish? There are two reasons. Firstly, the government’s guarantee to cover banks liabilities was too hasty. It didn’t inject capital, instead it promised to write an unlimited number of blank cheques. Secondly, there was a mis-match between the size of the banks’ liabilities and the size of the state. Ireland’s economy was 210 billion euros in 2008, the cost to bailout Anglo Irish Bank alone is at least 30 billion euros, and by some estimates it could be 50 billion. This makes the $40 billion plu capital injection (which then turned into equity) into Citibank look like small change for a $14 trillion economy like the U.S.

The trick is for governments not to bite off more than they can chew, and make sure they have conducted a rigorous analysis of a bank’ liabilities before underwriting its future losses. If you don’t do this then the punishment can be harsh, as Ireland has found out.

On paper Ireland’s banks guarantee doesn’t look like such a good idea, but a bank is also part of a country’s social fabric. Its citizens trust the banks to look after their deposits and expect 24-hour access to their money to fund their living costs – paying for a mortgages, school fees, clothing and food. If customers can’t access their money this hits confidence in the central plank of capitalism – the banks. The US has the FDIC to protect deposits of up to $250,000; Ireland didn’t have an equivalent institution so in October 2008 it had to offer a government guarantee for deposits. This was the right thing to do; however, it should have stopped there. A government should protect the hard-earned savings of its citizens, but it is learning how expensive it can be to essentially take on the risk for banks’ bondholders as well.

What is the extent of Ireland’s crisis?

- Kathleen Brooks is research director at forex.com. The opinions expressed are her own. -

The euro’s resilience in the third quarter has been astonishing. Since reaching a low against the dollar in June, the single currency has appreciated by an impressive 14 percent. This has coincided with the Irish financial crisis reaching boiling point, culminating in the announcement on Thursday by the Irish authorities of the final bill for winding down Anglo Irish Bank.

The euro didn’t flinch, even though the sums are enormous. The Irish government estimates that it will cost 29.3 billion euros to rescue Anglo. And it doesn’t stop there. Allied Irish Bank requires more capital as does building society Irish Nationwide, which may bring the total bill for rescuing the financial sector to 50 billion euros, pushing the debt-to-GDP ratio up to 32 percent. The Irish government doesn’t even anticipate making a return on any of this money. Ireland has so far funded itself on the open market and has not had to follow Greece to the European Financial Stability Facility (EFSF). But the final bill will fall on the Irish taxpayer.

Tax receipts for 2010 are expected to be 31 billion euros, according to a forecast from the Department of Finance. That is less than the final cost of winding up Anglo. With growth weak and the possibility of another recession on the horizon, it wouldn’t take much for the markets to force Ireland to the EFSF like they did to Greece.

Is there a way out for Ireland?

Ireland does have one of the lowest tax takes in the European Union at less than 30 percent of GDP. It also has one of the lowest corporation tax rates in the world at 12.5 percent, compared with Germany where federal and national corporate taxes equate to company tax rates of more than 30 percent. So Ireland could boost tax take to help remedy its huge deficit, but at the expense of losing its reputation as a low-tax destination for global corporations.

What does it mean for the euro?

Monetary policy: QE2 or the Titanic?

“Those whom the gods would destroy, they first drive mad.” – the words of a wise Roman thinker (or was it a Greek central banker?). At any rate, the gods certainly seem to have no benevolent intentions with regard to this country, judging by the statements coming from the Bank of England, in particular the calls for another round of quantitative easing from one member of the Monetary Policy Committee and the cry of “Spend, spend, spend” from another.

The view emerging from the Bank and the Monetary Policy Committee is that the country is in the grip of a slow-growth recession, facing the threat of Japanese-style deflation and a double-dip recession, and that this grim situation requires near-zero interest rates, supported by QE2 if necessary, in order to restore consumption and lending (including mortgages) to pre-crisis levels.

As soon as anyone compares the UK and Japanese economies and finds similarities, I start to worry about their sanity. Leaving aside the massive differences in labour market flexibility, the key difference is that Japan got itself into a mess single-handedly in the late 1980’s, largely because of its unsustainably high levels of saving and investment. Indeed, for the last 20 years its massive stock of accumulated savings have largely insulated it from any sense of urgency. Its fiscal policy consists of running enormous Government budget deficits which are funded out of this stock of private sector assets, so that its expansionary fiscal policy simply serves to offset the excessive thrift of its overprudent households – hence, Japan’s ability to borrow well over twice its GDP without generating any sign of market nervousness about its ability to repay and with a buoyant Yen exchange rate.

Somehow, this does not sound to me like Britain’s current predicament. If we face years of stagnation, it is because of a debt overhang, the absolute opposite of Japan. Yet the Bank – no doubt in line with the majority of the UK economics profession – is convinced that Japanese-style demand weakness is our problem.

Take the deflation threat first. For all the worries, Britain’s inflation rate fails to follow the script. Not only does it repeatedly exceed the Bank of England’s own forecasts, but at over 3% it is still well above – not below – the inflation rates of every other major economy and double the Eurozone average rate. In particular, Germany’s inflation rate is only 1% and the USA’s is 2%.

What about unemployment? Again, it is far from obvious that the UK is in any way out of line with the rest of the industrialised world, given that our unemployment rate is still only 7.8% compared to 6.9% in Germany, 10% in France, and 9.5% in America (and 5.2% in Japan).

As far as household saving and consumption are concerned, the conclusion again depends on what yardstick you use. At 7.7% of disposable income, the UK saving rate is higher than it has been for a few years – it was barely 2% in 2008 – but this is still extremely low compared to well over 13% in the Eurozone and over 15% in France and Germany, not to mention 30%-plus in the Asian tigers. Only the USA has similarly low savings rates.

from The Great Debate:

Obama and the American dream in reverse

"It's like the American dream in reverse." That's how President Barack Obama, ten days after taking office last year, described the plight of Americans hit by the faltering economy. His catchy description fell short -- the dream has turned into a nightmare for tens of millions.

So much so that an opinion poll this week showed that 43 percent of those surveyed thought that "the American Dream" is a thing of the past. It "once held true" but no longer does. Only half the country believes the dream "still exists," according to the poll, commissioned by ABC News and Yahoo against a background of dismal statistics on growing poverty, inequality, unemployment, and Americans without health insurance.

Before turning to the gloomy numbers, a brief detour to the meaning of the phrase "the American Dream," long a familiar part of the U.S. (and international) lexicon.  The survey defined it as "if you work hard, you get ahead." That's neat shorthand for the concept that the American social, economic and political system makes success possible for everyone.

More expansive definitions of the American Dream invariably feature home ownership, and there the dream went into reverse on a particularly large scale, with the subprime mortgage boom and subsequent housing bust. Last year alone, there were 2.8 million foreclosures -- 7,700 a day -- on homes whose owners could no longer afford their mortgages.

The statistic that best explains growing doubts over the achievability of the American Dream was released by the Census Bureau in mid-September. In 2009, the Bureau said, 3.8 million people joined the ranks of the poor by falling below the poverty line, defined by the government as an annual income of below $22,000 for a family of four.

In contrast, the net worth of the 400 richest Americans rose by a healthy eight percent in the year to August, according to a list by the business magazine Forbes published a week after the poverty figures. That perpetuated a rich-poor gap of proportions similar to the 1920s, before the Great Depression. For most of the past four decades, the annual incomes of the bottom 90 percent have changed relatively little while those of the top 1 percent have tripled.

In terms of equitable distribution of income and wealth, the U.S. is closer to Iran, Argentina or Mexico than to Canada or Germany. (That is according to the Gini index, a complex statistical measure of inequality named after Corrado Gini, the Italian economist who devised it in 1912.)

Double dip a done deal?

-Jane Foley is research director at Forex.com. The opinions expressed are her own.-

Earlier this week the S&P 500 was down 15 percent from its April 2010 high.   The ongoing debate on whether the U.S. economy is poised for a double dip recession can be linked with these falls.

At present there is insufficient evidence to conclude that the U.S. economy will fall back into recession, though there are signs that the recovery could be losing momentum.  A key question is whether the adjustment in asset prices seen since the end of April has been appropriate.

Proponents of double-dip imply that asset prices may have further to fall.  In contrast, die hard bulls suggest that equity valuations are looking cheap.  In the past few sessions, the bulls have been gaining the upper hand.

The reining in of government fiscal incentives and in many cases the implementation of austerity measures suggests that economic growth in most of the developed world will be constrained for the next few years.

The release a month ago of the much worse than expected May U.S. Labour report was followed by a bout of poor U.S. housing and confidence data  that had the effect of triggering a wide scale debate about the prospects for double dip recession in the U.S.

Friendly Cameron and King get mix right for now

By Ian Campbell

–  The author is a Reuters Breakingviews columnist. The opinions expressed are their own –

Just in government and David Cameron’s relationships are in question. Eyebrows have been raised about the prime minister’s friendship with an Old Lady, sometimes known as the Bank of England. The affection appears reciprocated by Mervyn King, the Bank’s governor. But to think the Old Lady’s independence is compromised is probably to take things too far. The bank’s current low interest rate policy looks more than just a political favour.

The overly friendly talk has arisen because both sides have made comments that might be deemed injudicious. King appeared in May, before the election, to give his backing to Conservative fiscal tightening plans. Cameron, meanwhile, has often mentioned how he thinks tight fiscal policy should allow interest rates to stay lower for longer. The new government has also fixed up the Old Lady with greater supervisory powers.

Could this chumminess lead to the wrong monetary policy? King’s critics might think so. Inflation is 3.4 percent, well above the 2 percent target. Andrew Sentance, one of the monetary policy committee (MPC) members, voted for a rate increase in this month’s meeting. Adam Posen, another MPC member, acknowledged “a direct difference with the governor” on one thing. He sees not just one-off inflationary factors but also a slight “unanchoring” of inflation expectations. And yet Posen also sees the UK poised between two very different outcomes — either recovery or “the renewal of a severe recession”. Similarly, David Miles, a third member of the MPC, believes that now is not the right time to raise rates even though inflation is “uncomfortably” high.

The great uncertainty means no conspiracy theories are required to explain the MPC’s position. There can be little doubt King approves of the coalition government’s plans for fiscal tightening. The VAT increase may make inflation worse. Not for nothing, perhaps, was it deferred to January. But the overall initial impact on growth of fiscal tightening is likely to be negative. If government departments do indeed slash budgets by a quarter, unemployment may rise a lot. Private sector wages are already depressed. Big cuts should bleed inflation painfully away.

Fiscal tightening is essential. And low interest rates themselves look essential — to avert the nastier of Posen’s outcomes. The UK is getting the policy mix it needs.

from UK News:

Budget for votes riskily delays UK debt pain

-- The author is a Reuters Breakingviews columnist. The opinions expressed are his own --

Alistair Darling promised no election "giveaways" and in one sense he delivered. The UK finance minister's budget is about not giving away the election. It might have been worse -- if Darling had acceded to his boss Gordon Brown's even more populist instincts. But there are vote-seeking swipes at high earners and banks, as well as a crowd-pleasing but misguided tax cut to first-time house-buyers. The UK's budget-balancing pain is being postponed and concealed. And that's risky.

The headline measure is a tax cut. First time buyers of properties costing up to 250,000 pounds won't have to pay anything to the government. Many voters will like that. They will like it, too, that people buying million pound properties foot the bill. A further bout of bank-bashing was part of the electioneering approach. Given the scandal of City rewards, few will blame Darling.

The economic impact, however, will be limited. The wobbly housing market may be helped slightly. But the UK economy needs to be buoyed by production and exports, not house price inflation.

Even so, Darling was able to present slightly better borrowing figures. VAT revenues have picked up strongly so far this year. Unemployment has not risen as much as feared. The budget projects a 167 billion pound deficit for this year, an 11 billion pound reduction on the previous forecast. And over the next several years a similar improvement is retained. But in 2010-11 the projected government deficit remains a colossal 163 billion pounds, 11 percent of GDP.

Thereafter, the deficit shrinks more rapidly as spending cuts start to take effect. But financial markets may not give much credit to these medium-term forecasts, because Darling has neglected to say where the cuts will fall -- presumably because he thinks it will be too distasteful for voters to see. What's more, he only reduces the red ink by projecting fairly rapid GDP growth of 3.25 percent next year and an average of 3.5 percent in 2012 and beyond. As the UK restructures, growth is unlikely to be high.

It is probably only a matter of time before financial markets signal, through interest rates, that their patience has run out. That moment could come soon if Greece or other troubled euro zone economies cause a new wave of risk aversion. But Labour's hope that the budget will get it through to the election will probably be fulfilled. Then it will be up to either an incoming Conservative government to tighten its belt or re-elected Labour to spell out where the spending axe will fall.

from Breakingviews:

Stock market rally celebrates bittersweet birthday

Birthdays are a good time to look back. The first anniversary of the global stock market rally -- the lows were hit on March 9, 2009 -- certainly brings back memories. It's easy to see why the MSCI World Index  is 71 percent higher now than then.

Then there was a steep recession, now there is GDP growth. Then it was realistic to worry about such horrors as rapid deflation, serial banking crises and a competitive protectionism. All of those menaces have now receded. And stock market investors can be cheered to see companies sufficiently in control of their short-term destiny for most of them to meet or beat analyst expectations of reported profits.

But this birthday celebration is no better than bittersweet. The stock market rally has spluttered somewhat. While the UK's commodity-heavy FTSE 100 index is hitting new highs, most others have made almost no progress for five months. That stalling reflects both an unexpectedly tepid economic recovery and serious worries about whether there will be much to celebrate on future birthdays of the 2009 stock market trough.

Too many of the wounds of the financial crisis remain unhealed. Central banks are still extraordinarily generous and unemployment rates remains unacceptably high. The world remains too leveraged for its own good. And while the financial system is no longer in crisis, its newfound ebullience is itself a cause for worry.

The new talk of inflation is a sign of how far from health markets are. Stock markets are ultimately good hedges against rising prices, but investors feel queasy when economists at serious institutions such as the International Monetary Fund, Morgan Stanley and Societe Generale see high inflation as either the most likely or the least bad way to erode excessive leverage.

Historically, a great 12 months in the stock market has usually been followed by a mediocre period -- an average 3 percent decline since 1940 in the United States, according to Deutsche Bank. Stock markets are still well below their peak levels, but there may not be much to celebrate this time next year.