Terry Smith Straight Talking

Krugman undone?

Since I was asked by some readers to comment on the Newsnight debate between Paul Krugman, Jon Moulton and Andrea Leadsom MP, I thought you might be interested in this debate in which, Pedro Schwartz, a Spanish economics professor, took on Paul Krugman, and in my view wiped the floor with him.

http://www.youtube.com/watch?v=EX55BH97quk&feature=player_embedded#! (35:20)

Two statements by Professor Schwartz stand out to me:  "Keynesians got us into this mess and now we have to sacrifice our principles so that they can get us out of this mess".

He also praises Krugman’s work but is serious with his criticism "Often Nobel prize winners are tempted to pontificate on matters that are outside the specialty in which they have excelled," noting "the mantle of authority whereby whatever they say - whether sensible or not - is accepted with resignation from some and enthusiasm by others."

His comments about the degree to which we are following the Japanese “cure” and the obsession of the Keynesian’s with short term fixes to demand growth at the expense of structural reform are also noteworthy.

Libor: If you put a fox in charge of a hen coop don’t be surprised by the outcome

I wrote an article for today’s Guardian about the causes of the Libor scandal: Traders are the ruin of retail banking

Amongst the many comments posted on it were several which said it was wrong to blame the investment banking/trader/"casino" operations for these ills as retail banks like Northern Rock had also failed. Please note that I did not say that combining investment banking and retail banking was the sole reason that banks failed, but whenever they are combined; a) the traders end up in control; b) they always seem to suborn the banks retail operations and sell the customers toxic products and/or manipulate markets against them; and c) once they are combined you have to save both because they are linked like Siamese twins.

I also gave several interviews to BBC radio this morning:

BBC Radio 4 Today Programme
BBC 5Live (click to 2hrs 5mins 50sec)
BBC World Service (click to 17mins 50sec)

I made three main points:

1. With regard to Marcus Agius' resignation I gave the example of a submarine which sank when it was being refuelled because someone left a porthole open. The captain was court-martialled even though he was absent on leave. The point was that he was responsible for the culture of the crew that had led to the sloppy procedure. Of course it does not mean that the officer who was in charge of the refuelling shouldn't go too.

2. Retail and investment banking need to be split. This is now becoming a more popular stance, but I first said it publicly in the Daily Telegraph back in 2008 (Strong medicine needed to cure ills of cheap money).

3. It is no good blaming the culture of traders, you just need to keep them away from retail banking and the ability to fix or manipulate rates or benchmarks. Blaming traders for being greedy and manipulative in these circumstances i.e. where you put temptation in their way is like putting a fox in charge of a hen coop and then expressing surprise about the outcome.

The Times - Cut taxes, cut spending. That's the only way

Today, The Times published my views on how the UK can extract itself from the economic bind in which it currently finds itself with zero growth. I outline the key messages that George Osborne and Vince Cable need to take on-board. In short we need to stop the notion of pretend austerity and make noticeable reductions in public spending whilst stimulating the economy through a programme of tax cuts.

Here is my comment in full:
 
Cut spending and taxes. That should be the message that George Osborne and Vince Cable hear today from the business people attending The Times CEO Summit. You cannot borrow and spend your way out of a debt crisis.
 
So-called Keynesian solutions will not work in these circumstances - the bond markets limit your scope for spending, as the eurozone has discovered. Just because the UK has so far retained its triple-A status and low borrowing costs does not mean that we are immune from this. The market takes a benign view of the UK because we are outside the train wreck going on in the eurozone and because of government rhetoric about cutting spending. But there are almost no cuts: public spending in 2011-12 was £681 billion against £689 billion in 2009-10, Labour's last year in power. Our debt is rising significantly at more than £100 billion a year. As a percentage of GDP we are more indebted than Spain.
 
The only solution is to cut the size of the public sector, which is 50 per cent bigger now in real terms than a decade ago. What did we not have from the Government ten years ago that we cannot live without now? Nothing. Get it back to where it was then.
 
Having made the markets supportive as a result of that policy of spending cuts, the economy can be stimulated by cutting taxes. Money is spent more effectively by those who earn it than it is by governments.
 
Nothing can be sacred in these cuts, and that includes the health service. Two reforms are required: first, the proportion of non-clinical staff to clinical staff needs to be cut to less than 1:2; and, second, the NHS should be restricted to covering, for example, just oncology, pregnancy and genuine A&E - all of which might be difficult to insure privately or inhumane to refuse to supply. Everything else will have to be purchased privately.
 
Pensions cannot be ignored. The first social security system was implemented by Bismarck and he set the retirement age about six months short of the average life expectancy. This was not a coincidence.
Pensions are merely claims by those no longer in work on those still working. We cannot support an ever-growing non-working proportion of the population as people live longer.
 
The statutory retirement age for public sector workers and state pensions needs to be raised significantly - by more than ten years; most of the population's pension provision must be provided from their own savings. (These reforms are not impossible - the President of Brazil, a former Marxist, has just implemented something very similar.) Then the Government should establish a fund with investments that will insure all future state pension entitlements.
 
This should be part of a general move by the Government to accrual accounting; government accounts are at present produced on a basis that would attract criminal legal sanctions in the private sector. This will bring "on balance sheet" future benefits, healthcare and pension liabilities and, let's hope, would stop politicians making promises for which the bill only falls due long after they have left office.
 
You can tell this is the right way to go as the Government is moving in the opposite direction, having recently announced that it would transfer the Royal Mail fund, which has £28 billion of assets and £37.5 billion of liabilities, to the Exchequer. The assets will be used to reduce the figures for government debt and the liabilities will simply disappear from view.
 
Mr Osborne should make it clear that we will not contribute to any rescue of the eurozone, directly or indirectly. In particular, we will not increase our International Monetary Fund contribution unless this is explicitly and irrevocably excluded. We should renegotiate our relationship with the EU with a requirement that our contribution to the EU budget (currently £50 million a day) is reduced by at least 90 per cent. If necessary we should leave the EU to achieve this.
 
We should not be worried about leaving. The EU is the least competitive trading bloc in the world as it sinks into a morass of regulation and social spending. The EU will still need to trade with us: count the number of Audis, Citroëns, BMWs, Fiats, Mercedes, Peugeots, Porsches, Renaults, Skodas and VWs on our streets. Do you think they can afford to cut that off? The EU has a positive trade balance with the UK that it cannot afford to lose. Once we have renegotiated our position, we should hold a referendum on continued membership on those terms.
 
Overseas aid should be stopped immediately to any country that has GDP per capita higher than the UK; or a nuclear weapons programme; or more billionaires than the UK.
 
Cease all measures to support or "rescue" the housing market. The obsession with home ownership and house prices is part of the UK's problem, not the solution. We cannot become wealthier by selling each other more and more expensive houses. Houses cannot be exported. It is no coincidence that in the most successful economy in Europe, Germany, less than half of people own their home.
 
Stop subsidies for all alternative energy sources. Wind power does not work - full back-up capacity needs to be built to cope with cold and still conditions in winter. Solar power is not economic in the UK for obvious reasons.
 
To quote M&S: there is no Plan B.

 

Newsnight: Krugman v Moulton and Leadsom

I am in New York at present so I did not see the Newsnight confrontation between Paul Krugman, Jon Moulton and Andrea Leadsom MP. But a combination of my blog post on Krugman’s LSE lecture and the Newsnight piece created an unusually large number of comments on my blog so I thought I would post a response now that I have seen the programme on BBC iPlayer. You can view the interview here (starts 31mins in).

Alcuin asked me for my impressions of the debate. I thought that Moulton and Leadsom more than held their own. I hope that Jeremy Paxman’s remarks that you can’t disagree with a Nobel prize winning economist was, as it seemed, tongue-in-cheek. Jon is a very sensible financier. I have not come across Andrea Leadsom before but I agree with DarwenLad - she is one of the few MPs whom I have heard say anything sensible about the financial crisis and depression we are in. I know this - I would rather have the economy, government, and/or my money run by Jon Moulton than I would by Paul Krugman or any other economist.

I found Krugman condescending and dismissive, for example, when Moulton cited Antonio Afonso’s research showing that the size of the state is negatively correlated with economic growth, saying he could disprove it but it would require ‘some equations and charts’. Translation - “I need pictures in order for me to be able to explain this to mere mortals like you”. In my view if you are good, you can explain your arguments and a concept.

Krugman was almost a case study of accusing others of committing the sin he himself could be accused of being guilty of when he accused Moulton and Leadsom of wanting to cut the size of public spending for doctrinaire political reasons and using the crisis as an excuse to do so. Perhaps what has sensitised him to such concealed motivations is that he is a left wing economist who wants to pursue a big state and public spending for social engineering and who distrusts the private sector?

I was disappointed that Krugman was allowed to get away with the assertion that we have experienced two years of austerity already when there has been very little austerity in the sense of cuts in government spending, particularly in the UK, and none at all in places such as the United States.

To answer John Healy no one is engaging with me from government. I have made numerous offers to work with politicians from any party who want to try to fix this situation and my approaches have been universally ignored or rejected. This does not improve my view of the motivation and perspicacity of those in power.

Keith Price I will let you know where I think the cuts should fall. I have already promised to post on this blog on that for an earlier Commenter on my Austerity v Growth piece and will do so.

Ken Charman - what a good idea. You are right. All ministers should be taught a litany which they should deliver at the start of any media interview which spells out the reality of this situation. I would add that any debate on austerity should be preceded by the simple statement “There hasn’t been any yet”.

Dropsopkcin: I don’t have a chart of tax v GDP but since tax is to fund the state I suggest you may get what you want from the study which Jon Moulton was referring to which I believe is by Antonio Afonso and Davide Furceri “Government, Composition, Volatility and Economic Growth” January 2008 available online here. Ironically it’s a European Central Bank research paper!

Paul Krugman

I am in New York at the moment but word reaches me from friends in the City who attended Paul Krugman’s talk at the LSE last night. I am told there was a very long queue ‘a bit like the one at the iPad launch [at] an Apple store’ but that his talk was ‘empty of details’ ‘woolly’ and that he offered ‘no evidence [to support] his theory. ‘He only repeats that we have to get out of depression now and spend our way out.’

Krugman is an ideologue not an empiricist.

He’s another believer in the magic money tree which will just enable us to spend our way out of this crisis. He shares that view with idiots like the Spanish authorities who thought that they could issue government bonds to Bankia in return for equity and Bankia could then deposit the bonds with the ECB for cash. You can see better conjuring tricks at a child’s birthday party.

There is also the small point that if you take the UK as an example, we have so far had GBP500bn of deficit spending, GBP325bn of Quantitative Easing, and interest rates have been at a 300 year low for over three years and the economy is still in recession. Krugman’s call to do more of this breaches Einstein’s axiom that to keep repeating the same action whilst expecting a different outcome is a definition of insanity.

The only way out is to cut state spending back to where it was 10 years ago-in the UK that’s a reduction of one third. What is it that the government didn’t provide 10 years ago that you can’t live without? Nothing. Then you can cut taxes and that will stimulate economic growth. Individuals and companies that earn the money are much more efficient at spending it than governments, so why not leave more of it with them? If you don’t believe that you are either a) mad and/or have no experience of real life; and/or b) are ignoring the statistic that between March 2000 and March 2010, individual and government debt increased by £3.11 for each £1 increase in GDP. Plus if you cut back the size of the state you can relieve business from the growth of regulatory interference.

The Euro is doomed

I was surprised to see the headline in Friday’s Financial Times “Seven days which shook Europe” looking back over the fall of the Dutch government, the election of Francois Hollande in France and the Greek elections. As I have been predicting for more than a year that Greece will leave the Euro and that this will produce a domino effect which will probably see Portugal, Spain and Italy follow suit, I am surprised that anyone could be surprised by these events. But then I suppose I don’t spend my life swallowing a diet of PR spin from the Eurozone “elite” and their acolytes.

As ever, people are looking in the wrong place for the source of trouble. All eyes have been on the bond market, whereas they should now be on bank deposits as most Greek bonds are now in official and/or local hands so the bond market is no longer playing a central role in the Greek tragedy/farce. There is an old saying that a currency can endure despite a lack of faith in it from foreign investors, but not when it is rejected by its own population (see Argentina in 2001 for details). Greece’s bank deposits have been fleeing its banking system as its citizens fear that they will wake up one day soon and discover that they are New Drachma deposits rather than Euros. When this happens, the €3 trillion of deposits in Italian and Spanish banks are going to try to do the same. This will represent a tsunami which no amount of Eurozone spin can prevent and which will require drastic action - like exchange controls.

Whilst we await these events, herewith a piece of research which tells you why the Euro was doomed from the outset:

 

Cameron's veto was consistent with history

There was a wonderful letter in the FT yesterday from a Mr Shenkman. He has clearly got a better grasp of history than those who have claimed that David Cameron’s veto of changes to the Lisbon Treaty and the UK’s alleged isolation as a result is in some way a reversal of British foreign policy towards the Continent.
 
I have a strong interest in history as I have a first class honours degree in the subject and in my view Mr Shenkman is right. For hundreds of years Britain’s successful policy with regard to the Continent has been to ally with the weaker powers to prevent a single power dominating the Continent. This which would have been to our detriment as an island off the coast of mainland Europe whose prosperity has depended upon trade with the wider world.
 
This policy was implemented during the Napoleonic Wars when the successful military intervention of Nelson and Wellington prevented the Continental System from being imposed upon Europe, and again in the twentieth century with two world wars fought against Germany.
 
There may no longer be a military dimension to the current problems in Europe (although I think we should hesitate before dismissing that possibility given the historic instability of south east Europe). There is, however, little doubt that the Eurozone has been used as an instrument for Germany to dominate the Continent through productive might and David Cameron’s veto is consistent with the aims of centuries of successful British policy on Europe which it would be foolish to abandon.

 

Financial Times, Letters to the Editor
Long tradition of holding other powers in check
From Mr Gregory Shenkman.

Sir, Perhaps the history I studied at Cambridge was different to that absorbed some years later by Jonathan Powell at Oxford (“Cameron has betrayed 200 years of history”, December 12). Mr Powell suggests....

Read the full text at http://www.ft.com/cms/s/0/9f1ca328-1c4c-11e1-af09-00144feabdc0.html#axzz1gJnGZzdi

 

(Those of you without a subscription can access a limited number of articles each month via FT.com's free registration.)

Isolation Hysteria and the IMF

I am frankly amazed by the outpouring of hysteria from some politicians and the media on the subject of David Cameron’s use of the veto over changes to the Lisbon Treaty.

To listen to some in politics and the media bemoaning what they claim is the resulting ‘isolation’ of the UK you would think that the UK should accede to any request from the EU in order to avoid this fate. Why? The Euro, which these proposed changes were designed to support, has been a predictable disaster for almost all the countries involved other than Germany.

It is also worth bearing in mind that many of these commentators-such as Ken Clarke and Michael Heseltine- were vociferous supporters of us joining the Euro. Indeed, Michael Hesletine thinks we still should-an unusual case of trying to join a sinking ship. Had we done so, we too would now be bankrupt and quite possibly governed by an unelected official appointed by the EU, as Greece and Italy are. These commentators were wrong when they wanted us to join, so why should we listen to them now?

We should now move onto redefine and renegotiate our relationship with or within the EU, starting with the question “What do we get for the£50m per day we send to Brussels?”. If we do not get what we want, we should accept that the UK’s future, like its past, success will lie in being an open economy servicing and trading with nations with which it has historic connections in the Americas, Asia, Africa and Europe.

One aspect of the “deal” at last week’s EU summit puzzled me. It was seeing Christine Lagarde, the Managing Director of the IMF (a Frenchwoman-her predecessor being maybe not coincidentally a Frenchman) proudly announce that the EU countries (other than Britain’s) central banks were going to make loans to the IMF of €200 billion. This might seem counter intuitive-how can countries which are to put it mildly short of money make a loan to someone else? Of course the answer is that the funds would be loaned to the IMF for it to loan back to the Eurozone.

That is obviously a circular piece of none too subtle legerdemain, but the hope was that other countries would join them with additional funding. This hope was rather dashed when the Canadians immediately announced that they has no interest in subscribing funds to rescue the ‘rich continent’ of Europe. Sensible people the Canadians: they dragged themselves back from being a basket case in 1994 with spending cuts which restored a budget surplus and have not experienced a banking crisis. They also just announced withdrawal from the Kyoto protocol on climate change. Following the refusal of China to take part in such nonsense despite the myriad rumours, I can only assume that this latest leg to the circular Ponzi scheme that is now the Eurozone is a non starter.

The Brown Bottom

With the gold price hitting new nominal highs I thought it was a good moment to remind ourselves about the consequences of Gordon Brown’s sale of much of the UK’s gold reserves.

In 1999-2002 he sold 395 metric tons of gold at an average price of $275 an ounce. Today the price stands at $1749 an ounce. No wonder Brown’s sale on the gold price charts is known as The Brown Bottom. He also gave notice to the market that the sales would take place, thereby giving market participants every opportunity to drive the price down in advance.

Here are my calculations of the value which would have accrued if we still held the gold today:

	Sold then	Value now
	99 - 02	2011
Quantity sold tons	395	395
Average price $/oz	$275	$1,700
Sum realised US$m	$3,477	$21,492
Exchange rate avge.	$1.52	$1.63
Sum realised £m	£2,287	£13,185

The 2012 Olympics are estimated to cost some £9billion, so we could have paid for the Olympics with the amount of value he surrendered and had over £2billion in change left.

As of December 2010, estimated gold reserves were as follows:

US	8,133 tons
Germany	3,401 tons
Italy	2,452 tons
France	2,435 tons
UK	315 tons

The impact of the man’s stupidity is breathtaking.

 

The Today Programme, BBC Radio 4 Interview on 14 April

This morning I was interviewed on Radio 4’s Today Programme about share buybacks. Friend or foe to shareholders? Destroyer or creator of value?  You might think the answer is obvious, but think again.

Almost 20 years on from publishing my book, Accounting for Growth, I am exposing another loophole in the accountancy rules which is allowing companies to appear to have created value when they have not.  You can listen to the interview here at approximately 2:42 hours, and read my arguments in full here.