Disclaimer. After nearly 40 years managing money for some of the largest life offices and investment managers in the world, I think I have something to offer. These days I'm retired, and I can't by law give you advice. While I do make mistakes, I try hard to do my analysis thoroughly, and to make sure my data are correct (old habits die hard!) Also, don't ask me why I called it "Volewica". It's too late, now.

BTW, clicking on most charts will produce the original-sized, i.e., bigger version.

Tuesday, October 30, 2012

Lessons from history

I've talked before about the follies of trying to balance the budget during recessions. Here's a new and compelling example from an intriguing and instructive piece from Martin Wolf.

The UK emerged from the first world war with public debt of 140 per cent of gross domestic product and prices more than double the prewar level. The government resolved both to return to the gold standard at the prewar parity, which it did in 1925, and to pay off the public debt, to preserve creditworthiness. Here was a country fit for the Tea Party.

To achieve its objectives, the UK implemented tight fiscal and monetary policies. The primary fiscal surplus (before interest payments) was kept near 7 per cent of GDP throughout the 1920s. This was, in turn, accomplished by the “Geddes Axe”, after a commission chaired by Sir Eric Geddes. This recommended slashing government spending in precisely the way today’s believers in “expansionary austerity” recommend. Meanwhile, the Bank of England raised interest rates to 7 per cent in 1920. The aim of this was to support the return to the prewar parity. Coupled with the consequent deflation, the result was extraordinarily high real interest rates. This, then, was how the self-righteous fools in the British establishment greeted the hapless survivors of the hellish war.

So how did this commitment to fiscal famine and monetary necrophilia work? Badly. In 1938, real output was hardly above the level of 1918, with growth averaging 0.5 per cent a year. This was not just because of the Depression. Real output in 1928 was also lower than in 1918. Exports were persistently weak and unemployment persistently elevated. High unemployment was the mechanism for driving nominal and real wages down. But wages are never just another price. The aim was to break organised labour. These policies resulted in the general strike of 1926. They spread a bitterness that lasted decades after the second world war.

Quite apart from their huge economic and social costs, these policies failed in their own terms. The country went off gold, for good, in 1931. Worse, public debt did not fall. By 1930, debt had reached 170 per cent of GDP. By 1933, it had reached 190 per cent of GDP. (These numbers put the panic over today’s far lower ratios in perspective.) In fact, the UK did not return to its pre-first world war debt ratios until 1990. Why was the UK unsuccessful in lowering the ratio of debt to GDP? Briefly, growth was too low and interest rates too high. As a result, even a huge primary fiscal surplus could not constrain the debt ratio. 

The consequences of this folly were devastating. As a result of economic weakness, Britain lost its place in the world order, going from being the greatest superpower to a has-been.  It was left with an enduring class hatred, which embittered politics and slowed economic growth for two generations.  And how much of the appeasement of the 30s came from the absence of money to pay for rearmament?

There are obvious lessons here not just for the Tea Party numpties but also the the austerity ghouls in Europe.  The West risks negligible growth for two decades while the rest of the world powers ahead, pointlessly  since the austerity is unlikely to cut government debt.  The parallels with the US are frightening   Read the whole piece, it's really worth it.

Monday, October 22, 2012

Pundit extraordinaire

Martin Wolf, of the FT.

MARTIN Wolf has not got every call right in the global financial crisis, but it's hard to think of a significant one he's got wrong. In an uncertain world, he is now probably the most trusted commentator on the global economy.

When Europe's leaders decided their top priority should be to cut deficits, he warned this would condemn the European Union to a long recession, making deficits bigger, not smaller. Each time leaders declared they had found the solution to its problems, he shredded their PR bluff with relentless logic.

If governments, banks and companies all pursued contractionary policies at once, he asked, where would the growth come from?

Unless someone bought more goods and services, there could be no growth. Unless someone borrowed, there was no benefit in saving. The common euro currency meant countries could not devalue as a short cut to raising competitiveness. And while one country in trouble could adopt austerity as the way out, a continent could not.

Wolf's critique was resisted by the Bundesbank, the European Central Bank, the British government and the bureaucrats in Brussels. But time proved him right. Years that should have been used to get Europe out of trouble instead have dug it deeper into it.

Read more here.

Goldman's to face lawsuit

WALL Street titan Goldman Sachs will have to defend claims that it deliberately sold toxic subprime mortgages to an Australian hedge fund in 2007 as the US housing market began to unravel.

The New York Supreme Court has denied Goldman Sachs' bid to dismiss the $1.07 billion class action,

Read more here.

I dunno whether Goldman Sachs called clients "muppets", and sold paper to clients while shorting it in house, as other Wall Street banks did.  That's a matter for the court to decide.  If they did, they will deserve exemplary damages.  The Augean stables must be cleaned.

Friday, October 19, 2012

US rebound, part the second

My coinciding index, designed to track the current state of the economy, has rebounded in September after a few months of sogginess.  And that's before QE3.  The US economy is OK.

Friday, October 12, 2012

Do you want to come up to my room, bouncy bouncy?

Earlier this year I talked about "payback" -- about how unseasonably warm conditions in the US in the first few months of the year brought forward spending and investment, which had to be "paid for" with slower growth in the second and third quarters.  Growth duly slowed, but then the question became whether the slowdown was the prelude to yet another dip.

It seems now that growth has re accelerated in the US:

  • The ISM data showed a rebound in September;
  • The unemployment rate declined sharply.  And no, that wasn't because Obama was manipulating the figures;
  • Payrolls re-accelerated, and even more significant, the two previous months' data were revised up;
  • Housing data continue to strengthen (starts, prices, sales) and the 30 year mortgage rate continues to slide.
  • Now (yesterday's release), initial unemployment insurance claims have fallen sharply and unexpectedly.  Could be dodgy seasonal adjustment (it's notoriously difficult to seasonally adjust weekly data); it could be just random wobbles.  We'll see next week.  There'll be a rebound, surely.  The key will be how much.

[chart courtesy Econoday]

Thursday, October 4, 2012

ISM rebound

The ISM (Institute for Supply Management)  indices have been uncommonly reliable indicators of the US cycle, picking up the smaller fluctuations as well as the bigger waves.  They both ticked up last month.   My feeling is that US growth has started to accelerate again.  Not to boom levels, that's for sure, but better than the very sluggish conditions of the last couple of months.  I don't usually believe one month's data, but QE3 (the Fed's plan to buy mortgage bonds) is a a positive factor.  Talking of which .... have you seen how the 30-year mortgage rate is falling?  And house prices rising? I'll talk about them in my next post.

The fiscal cliff lurketh yet, like the bad fairy at the christening.

(click on the image to see a bigger chart)

Tuesday, October 2, 2012

Welcome back to the Eurozone Crisis

A telling piece from the FT.

(You have to sign up to read the story, but that's no big deal.  It's still free!)