Terry Smith Straight Talking

The UK's total unfunded pension obligations = 321% of GDP

The new supplementary table published by ONS in Levy (2012)10 includes the following headline figures for Government pension obligations as at end December 2010:

· Social security pension schemes (i.e. unfunded state pension scheme obligations): £3.843 trillion, being 263 per cent of gross domestic product (GDP) (£3.497 trillion at end of December 2009)

· Centrally – administered unfunded pension schemes for public sector employees (i.e. unfunded public service pension scheme obligations): £852 billion, being 58 per cent of GDP (£915 billion at end of December 2009)

·  Funded DB pension schemes for which government is responsible: £313 billion, being 21 per cent of GDP (£332 billion at end of December 2009).

In summary, the estimates in the new supplementary table indicate a total Government pension obligation, at the end of December 2010, of £5.01 trillion, or 342 per cent of GDP, of which around £4.7 trillion relates to unfunded obligations.

Or visually:

Source: ONS

Today Programme - France and America

I appeared on the Today Programme (fast forward to 1hr 18m 14s) this morning. The main topic was France. It is amazing how France is viewed as being alongside Germany in terms of economic standing, dispensing advice and judgement to the peripheral countries in the Eurozone crisis when in fact it has far more in common with those countries than is does with Germany. In particular:

• France’s public debt was 79% of GDP at the end of 2011 and is expected to rise to 84% this year and 86% next year

• The French public sector accounts for 56% of GDP - 10 points higher than Germany - and tax revenues are 51%

• France has run a current account deficit for 10 years which now stands to be almost €100 bn by the end of the year, and its export performance is worsening: its share of Eurozone exports has fallen from 17% a year ago to just 13%. It now exports less than Holland which has 16 million people compared with 63 million in France

• Unemployment in Franc e is over 10% despite it being almost impossible to make anyone redundant, compared with under 7% in Germany

• France is uncompetitive: its average hourly wage rate is €34 compared with €30 in Germany and €20 in Spain. Surveys of competitiveness continually show that France is in a poor position: the World Economic Forum shows France in 21st position versus Germany in 6th place; and the Institute of Management Development has France in 29th place behind - in Europe - Austria, Belgium, Denmark, Finland, Germany, Ireland, Luxembourg,  the Netherland, Norway, Sweden, and the UK. In other words it is closer to the peripheral countries in this respect than the core of the Eurozone

• President Francois Hollande’s actions so far are precisely the opposite of that sage advice about what to do if you find yourself in a hole: he has raised taxes to 75% on earnings over €1m at a  time when London is already the sixth largest city for French population, and reversed an earlier planned increase in the retirement age from 60 to 62. His Labour Minister has said ‘The main idea is to make redundancies so costly it’s not worth it.’ That will really help the cause of structural economic reform and labour mobility in a  country where firing people is already a near impossibility

• France already lost its triple A status on its debts in January so we cannot say we weren’t warned but this seems to have been forgotten

• Even the IMF which is run by a French woman has warned that the French economy needs ‘a comprehensive programme of structural reforms’ and deeper spending cuts rather than tax increases

Sooner or later the market is going to figure out that France is in a mess and getting worse with dire consequences. French pride makes it unthinkable that it will leave the Euro but staying in will cripple it given the lethal combination of an inability to devalue its currency or to achieve competitiveness through deflation of wage rates.

I was also asked on Today whether we should worry about the US ‘fiscal cliff’. The answer is Yes and No: the so-called fiscal cliff, or the forced increase in taxes and cuts in spending which will occur next year if the President and the Republican controlled House of Representatives cannot reach agreement is in some respects a red herring . As usual in this crisis, if you take the news coverage and commentary at face value, you might believe that if they can reach agreement then all the attendant problems will be solved. Sadly that is not so. The US will have to raise taxes and cut public spending whether they can reach agreement or not. It is going to go over a fiscal cliff anyway.

“IMF warns France urgent need for reform” – Le chien qui ne parle pas!

Guest post by Martin Bralsford:

This article (£) in the Financial Times of 6^th November 2012 was unusual in two respects:

-The IMF Annual Report on France was critical of the management of their economy

-It did not mention the views of the Managing Director of the IMF, Christine Lagarde.

It is so unusual these days not to read of Madame Lagarde’s views on all the Euro economies in which the IMF has taken such a recent interest. Her fingerprints are all over every IMF statement and her picture in every photo-call. Yet, along with that of Germany, the French economy is one of the pillars of those EU countries which share the Euro as a common currency.  One wonders whether the IMF’s MD has been taken over by international political and diplomacy considerations rather than the organisation’s original brief, to focus on international monetary cooperation and balance of payments problems.

The IMF was formed in December 1945, becoming operational in March 1947, with France being the first country to borrow from it. Until 1971, it monitored the fixed exchange rate regime based upon the US Dollar’s peg to gold.  Since then it has been a leader in international monetary policy, focussing particularly on arrangements between currency blocs. So why is it so interested in what goes on within one currency bloc – the Euro? Taken as a whole, the economies within the Euro have no aggregate balance of payments problems with other major economies and the Euro is not weak. The financial imbalances are intra-Euro.

Perhaps the leadership if the IMF gives us a clue – the role of Managing Director is a very powerful one within the organisation.  Here is the roll call:

Christine Lagarde	July 2011 to-date	French
Dominique Strauss Kahn	Nov 2007-May 2011	French
Rodrigo de Rato	June 2004-Oct 2007	Spanish
Horst Kohler	May 2000-Mar 2004	German
Michael Camdessus	Jan 1987-Feb 2000	French
Jacques de Larosiere	June 1978-Jan 1987	French
H Johannes Witteveen	Sep 1973-June 1978	Dutch
Pierre-Paul Schweitzer	Sep 1963-Aug 1973	French
Per Jacobsson	Nov 1956-May 1963	Swedish
Ivar Rooth	Aug 1951-Oct 1956	Swedish
Camille Gutt	May 1946-May 1951	Belgian

Noticed anything? All from Europe and all from what are now Eurozone countries, except for 1951-63, (14 out of 66 years); French nationals have been MD for 38 out of 66 years. If one was looking for diversity here in geographic terms, it is a poor show.

Maybe European members should let go of their stranglehold on this appointment, after all, the management of their domestic monetary affairs leaves much to be desired.  And maybe the job holder should be a monetary economic specialist rather than primarily a politician – with a fascination for the murky art of diplomacy and one eye on the possibility of returning to a leading political role back in their home country.

If I was on the interviewing panel for Christine Lagarde’s successor, I would ask them for a succinct summary of Thirlwall’s Law and its implications for world monetary conditions in the foreseeable future. And allow answers in a language other than French.

Model answer freely translated into English: “Thirlwall’s law (named after Anthony Thirlwall) states that if long run balance of payments equilibrium on current account is a requirement, and the real exchange rate stays relatively constant, then the long run growth of a country can be approximated by the ratio of the growth of exports to the income elasticity of demand for imports (Thirlwall, 1979).”

 Perhaps the IMF needs reform and not just France!

 

 

 

 

 

 

Martin Bralsford

 

Ed Balls pants on fire

Ed Balls, the Shadow Chancellor, managed to put another nail into the coffin of his economic credibility when appearing in interviews with Andrew Neil and Adam Boulton to discuss the IMF finding that there was a structural deficit in 2007. The IMF finds not only that this deficit existed before the financial crisis which Balls has continuously blamed for Labour’s deficit spending-but that it was not of £37 billion as previously thought but £73 billion or 5.2% of GDP. Balls seeks to claim that whilst he now accepts that there was a structural deficit, the key point is that he could not have known that at that time. That is highly debatable but what is not debatable is that a) he was still denying it existed on the Andrew Marr show in January 2011:“I don’t think we had a structural deficit at all in that period [before the recession]”-not in 2007 but four years later; and b) he is now lying in these interviews with Andrew Neil and Adam Boulton when he denies he said that to Andrew Marr. Liars need good memories. The man is not to be trusted.

 

The Great Depression - Fact v Fiction

As some of my readers may have seen, I recently wrote an article for the Independent in which I discussed the lessons learned from the Great Depression and the Wall Street Crash. In the piece I argued that whilst history often paints the US’ recovery as a picture of Keynesian success, the truth is that many of the measures implemented, including Roosevelt’s much lauded New Deal failed to stimulate the economy. In tackling the current economic crisis, we have to learn from history if we are not to repeat its mistakes, but we will learn nothing if the experiences of history are heavily edited to suit political agendas and prejudices. Too often I hear the so-called Keynsians and others of the “borrow and spend” persuasion saying that all the lack of economic recovery despite the massive stimulus of deficit spending, zero interest rates and QE demonstrates is that we need to do more of the same.  There is of course another possibility , as the economic history of the Great Depression suggests.
 
The full article is included below.

The Great Depression - Fact v Fiction
 
The philosopher George Santayana said, "Those who do not remember the past are condemned to repeat it."
 
We are in the sixth year of the financial crisis which started in 2007 and experiencing problems which are reminiscent of the Great Depression with faltering economic growth, high unemployment, deflation, and a badly damaged and still shaky banking system. It’s therefore unsurprising that commentators and policy makers would look to that period for lessons on what to do and what to avoid. However, what we need in order to learn from the Great Depression, is a firm grasp of what happened then.  Most commentary I hear or read is along the lines of: The Great Depression was triggered by the Wall Street Crash, itself the result of laissez faire capitalism. The Depression was deepened as a result of the failure of governments to adopt what would come to be called Keynesian techniques to stimulate demand and by adherence to the Gold Standard. It was only when Franklin D. Roosevelt took office and implemented the New Deal that America began to recover from the Depression as these Keynesian methods stimulated demand.
 
Sadly this version of events owes more to myth than reality. Firstly, the idea that laissez faire free market policies were the root cause of the Crash and subsequent Depression is far removed from reality. In fact Herbert Hoover who preceded Roosevelt as President until 1932 was criticised by FDR for ‘reckless and extravagant spending’ and ‘thinking we ought to control everything in Washington’, and he introduced the Smoot-Hawley Tariff in 1930 which stopped many imports. The dramatic contraction of the money supply by the Fed which began in 1929 and the rise in interest rates from 1928 helped to cause and then exacerbate the impact of the Crash. This was not simply a failure of capitalism or free markets. It had a lot of help from the government. The Hoover administration was interventionist, not laissez faire, and its interventions caused problems and made matters worse.
 
But surely all this changed after FDR said, ‘We have nothing to fear but fear itself’ (which was not original-it was a phrase borrowed from 19th century writer Henry Thoreau)?  Roosevelt announced spending of $10 billion when government revenues were $3 billion p.a., and government spending rose by 83% between 1933 and 1936 whilst Federal debt rose by 73%.
 
Simultaneously many measures were implemented which were a drag on economic activity. The Social Security Act which introduced a minimum wage kept many unskilled workers out of the labour market. The Agricultural Adjustment Act produced the destruction of crops and cattle. The National Recovery Administration or NRA created a massive bureaucracy which increased the cost of doing business significantly: shortening hours and raising wages. Night work was banned. 500 NRA codes were introduced governing production of articles ranging from lingerie to lightning rods. So-called “cut throat” pricing was banned - a tailor was sent to jail for pressing a suit for 35 cents instead of the NRA mandated 40 cents.  How these anti-competitive and bureaucratic measures were supposed to promote activity is a mystery. The net result was that industrial production dropped by 25% in the six months after the NRA came into effect.
 
Simultaneously, Roosevelt’s Civil Works Administration (CWA) engaged in employment of masses in some perfectly pointless activities such as researching the history of the safety pin and using balloons to frighten birds away from public buildings. When the CWA became the Works Progress Administration similar nonsense continued such as cataloguing ways of cooking spinach. In a foretaste of our times WPA workers were also used to collect Democratic Party campaign contributions. So was born the idea of a “client” class dependent on the state who would automatically vote for the party giving the handouts. The parallel with today’s loyal Labour following in the public sector, the North of England, Scotland and Wales is obvious.
 
Far from ending the Great Depression, such measures served to prolong it-preventing the workforce from seeking real jobs and diverting resources to politically motivated projects.
 
They were accompanied by a series of anti business and “soak the rich” tax provisions. The top marginal rate of income tax was raise first to 79% then to 90%, personal tax exemption was lowered to just $600 p.a., estate tax went up to 70% and gift tax to 52.5%. Corporate taxes were also raised with surtaxes for undistributed profits.
 
Unsurprisingly the economy slumped back into Depression in 1938 and the stock market halved again from 1937-38, which can hardly have been the result of laissez faire capitalism. FDR acolytes claim this was due to the Supreme Court outlawing the NRA and premature attempts to cut spending and balance the budget. But it is estimated that the reduction which resulted from this was only about 1% of GDP which was far too small to cause the problem-just as austerity cannot now be the cause of the UK’s problems because there hasn’t been any yet. Government spending has continued to rise inexorably since the coalition took office.
 
By the time war broke out in 1941, unemployment was still 17%. Hardly a triumph for two presidential terms of Keynesian policies.
 
So what did pull America out the Depression? The Second World War? America’s involvement in the War was unique. It did not join the War until two years after it started allowing America to benefit from the rearmament of the Allies as the ‘arsenal of democracy’ to quote FDR. Even when it entered the War, it suffered none of the destruction of assets and infrastructure which the other Allies did other than the attack on Pearl Harbour and so had all the benefits in terms of demand from rearmament and none of the disruption suffered by other combatants.
 
The War was then followed by the Truman administration which was far less anti-business than FDR’s had been. This combination of factors was the cause of recovery.
 
We have to learn from history if we are not to repeat its mistakes, but we will learn nothing if the experiences of history are heavily edited to suit political agendas and prejudices. We need to be told the truth.

The hypocrisy of the BBC and the Guardian

Definition of HYPOCRISY: a feigning to be what one is not or to believe what one does not; especially : the false assumption of an appearance of virtue or religion

Today brings the revelation that MPs on the Public Accounts Committee have voiced concerns about so-called “off payroll” tax arrangements having discovered that 2,400 civil servants are paid not through normal payroll with PAYE tax deductions but via private companies which they own and which enables them to avoid National Insurance payments and to be taxed at the lower rates of Corporation Tax applicable to small companies rather than higher Income Tax rates.

http://www.bbc.co.uk/news/uk-19839836

You might have thought the BBC would struggle with reporting this as it was also revealed that there are 25,000 people at the BBC who have such “off payroll” contracts. Strangely the word “hypocrisy” did not appear in the BBC report.

Neither did it appear in a recent Guardian article about the Conservative Party Treasurer’s views that the UK should lower tax rates to allow the UK to compete with offshore tax havens like the Cayman Islands in which many hedge funds are incorporated.

The Guardian article managed to criticise the company of which I am CEO, Tullett Prebon plc, because it had previously had a Conservative MP on its board and operated in tax havens. Amongst the tax havens it listed that we have corporations in were Bermuda, the Channel Islands and Switzerland.

It was hard to see how the Guardian could legitimately have regarded this as newsworthy given that we had informed them that the companies in Bermuda and the Channel islands are all UK tax resident; and the Swiss company is our local broking business which operates in the local capital and money markets as an intermediary between local banks i.e. self-evidently none of these companies are being used to reduce the amount of tax Tullett Prebon pays.

But what was truly staggering is that the Guardian omitted to mention that Guardian Media Group has used Cayman Islands companies for tax management purposes and that it pays a lower rate of tax than Tullett Prebon.

The BBC, the Guardian and all those who drone on about “The pervasive culture of greed and tax avoidance in many areas of the private sector" need to be taught the rule about what you shouldn’t do if you live in a glass house.

Estonia v Krugman: It may work in practice, but it will never work in theory

Last Friday I attended a lunch at the Centre for Policy Studies with Jürgen Ligi, Minister of Finance for Estonia.

This was of particular interest to me as Estonia’s approach to cutting its budget deficit and coping with austerity had been cited by Jon Moulton on the Newsnight programme in which he was appearing with Paul Krugman, the Nobel prize winner and economist who writes for the New York Times.

Krugman was dismissive of the Estonian example both on and off the air. Krugman has criticised the Estonian model on the grounds that output has still not reached the level of the peak of the boom: “So, a terrible — Depression-level — slump, followed by a significant but still incomplete recovery. Better than no recovery at all, obviously — but this is what passes for economic triumph?”. As Estonian President Toomas Hendrik Ilves tweeted: “Let's write about something we know nothing about & be smug, overbearing & patronizing” And: “Guess a Nobel in trade means you can pontificate on fiscal matters & declare my country a "wasteland".”

The facts are that when the financial crisis broke, the IMF forecast that Estonia was on course for a budget deficit of more than 10% of GDP in 2009. But the austerity programme ensured that it never exceeded 3% of GDP and was back in surplus by 2010. Unemployment which peaked at 19% is now back to around the European average of 10% (compare and contrast Greece or Spain). Real GDP is still about 8% below its 2007 peak.

I thought that Jürgen Ligi made some interesting points at the lunch about the Estonian experience including:

1. Economic activity has not yet recovered to the level preceding the period of austerity, but that previous level of economic activity was illusory-fuelled by a period of excessive lending and borrowing to spend which reached its peak in 2004-07. This is a vital and often overlooked point.

This puts into sharp relief Ed Balls continual sniping about the poor performance of the UK economy. It is inevitable. The previous highs from which it is struggling to make any progress were illusory.

At a more micro level, there are a number of managers in financial services businesses in particular who may have to realise that aiming to restore profitability to the level before the financial crisis may be equally impossible for the foreseeable future.

2. Two thirds of the budgetary adjustment came from spending cuts, one third from tax increases.

3. The tax regime adopted was a simple one with flat rate income tax.

4. There were no exceptions to the necessary policy measures – whether taxes or spending cuts. VAT was raised from 18-20%, and imposed on food.

5. Everyone shared in the hardship, including politicians and civil servants. They didn’t just mouth platitudes about all being in it together. The Minister of Finance took a 27% pay cut.

6. Many people say that budgetary adjustment of the sort implemented in Estonia is impossible in a democracy because turkeys (the recipients of state aid) do not vote for Christmas (or Thanksgiving) as Mitt Romney has recently pointed out to his cost. So how did the Estonian government manage this feat? The Minister had an answer: The people of Estonia had experienced communism under Russian control and had no desire to go back to it. In contrast, the countries of southern Europe (and France) may have that ahead of them.

Euro Target2

My colleague at Tullett Prebon Dr Tim Morgan has written an article about the apparently arcane matter of the ECB's Target2 settlement system which enables debtors and creditors to settle cross border trade within the Eurozone. Most of you may not have heard of Target2 but it is a lot more significant than it seems.
 
The way this works is if a Spaniard imports something from a German, the money is deducted from the Spaniard's bank account and creates a debit to the ECB from Bank of Spain. The reverse happens in Germany. Simple enough, but here's the tricky bit. The sum of money has to be 'destroyed' in Spain and an equal sum 'created' in Germany. But this reduces Spanish money supply - a liquidity squeeze - which they can't afford to do. Failing to destroy the spent money is a bit like hanging on to money owed to others.

Historically, Target2 balances were very small, but they have grown rapidly as the attached charts show with huge debit balances for Greece (€108bn), Ireland (€96bn) Italy (€289bn) and Spain (€434bn) and a large creditor balance for Germany (c.€750bn) and Finland and the Netherlands. The scale involved is huge. €434bn means that it's more than a year since Spain actually 'paid' for any imports from other Eurozone countries! These balances are much bigger than the proposed Spanish bank bail-out for example and make it clear that some Eurozone countries have grave liquidity problems.
 
These numbers are not published by the ECB (no surprise there!), but are collated by German economists from individual central banks.
 
The source is the Institute for Empirical Economic Research at the University of Osnabruck. They believe that Europe is heading for a balance of payments crisis, which is why they collect the data (from national central banks) and publish it here.
 
The top man is Prof. Hans-Werner Sinn. His book 'The Target Trap', unfortunately only available in German so far as I know, is summarised as follows, which I think makes for interesting reading:

"The Target Trap

The euro project is in the throes of a major crisis. What began as a European peace project has led to dispute and discontent that can only be held in check by heavy borrowing from the savings accounts of citizens of the Eurozone’s core countries. Some euro countries that have lived beyond their means and accumulated high external debt since the introduction of the euro now find themselves on the verge of bankruptcy. Their central banks, in order to solve their economy's liquidity problems, are resorting to the printing press. With the European Central Bank's (ECB) approval, they are withdrawing savings from those countries with more solid economies using a virtual cash dispenser that they were allowed to set up upon joining the euro. The only way to prevent the crisis countries from continuing to do this is to supply them with ever more capital via official bail-out packages. And Germany is not the only country caught in this trap. If there is to be any future for the euro project, tougher budget constraints will have to be re-introduced, and the countries that cannot handle them must be given the opportunity to restore their competitiveness by temporarily exiting the euro."

 

Media bias

I believe that the BBC is now unfit for purpose as its political bias is now so blatant, and this is particularly worrying given that it is a state broadcaster funded a compulsory levy on TV owners. However, there are similar problems in the US media as this astonishing speech from Pat Caddell, a former Democratic analyst and pollster, at the Accuracy in Media conference “ObamaNation: A Day of Truth”

Pat Caddell: Media Have Become “Enemy of the American People”

Ed Balls

At least when I was criticising Nick Clegg’s pension proposals last week I couldn’t point to any hypocrisy on his part.

The same cannot be said of Ed Balls. His criticism of the government’s record on the economy coupled with his refusal to answer for the economic mis-management of the last Labour government earns that description.

I listened to his performance on the BBC’s Today programme in which Evan Davis made a sterling effort to hold him to account. There was much reference to the financial crisis as the cause of the soaring public debt and how this had affected many countries. The key question for Balls and any other member of that Labour government is: Why did you spend more than revenues during an economic boom for five years before the crisis (from 2002-07) and leave the country in the worst possible condition for dealing with it?

As for his proposals. I note that Labour would undertake a public spending review. He still can’t bring himself even to say the necessary words; that public spending would be cut. Leopards and spots spring to mind.

He says Labour would introduce a programme to build 100,000 houses using the proceeds of the 4G licence auction to fund the programme. At the same time he is talking about reintroducing the Stamp Duty holiday for property purchases under £250,000 that Alastair Darling introduced for two years in 2010. This is surely intended to encourage more people to buy houses. How will that make them more affordable? These two policies point in opposite directions, but then I would hardly accuse Mr Balls of economic competence.

Politicians of all persuasions need to learn one simple lesson on housing: in order to make it more affordable, prices have to come down.