Should BOE commence exit strategies of the economic stimulus to manage the mounting budget deficit?

Guardian : http://www.guardian.co.uk/commentisfree/2009/nov/20/public-finances-deficit-government-borrowing presented an article entitled Public finances: Broke but not bust yet. The article portrayed the state of despair of public finance and for the past 2 years, the only predictable outcome is uncertainty. The article presses for tough fiscal choices to address decline in tax receipts, retrenchment, and rising welfare bill that firms deem they can no longer afford. I note that cheaper interest rates, access to QE “print money” are artificially creating economic activity which is unlikely to last. While I disagree with the Tory’s rhetoric of the doom state of the economy, I also believe that Labor is offering confusing strategy of continuously pumping more money into the economy. Should BOE hold the debt through to maturity, which would effectively cancel; or it could move to sell rapidly, potentially flooding the market with gilts in a way that could undermine the government's ability to raise extra funds. These views in my opinion can cause panic in the financial markets if the desire to rebalance the books takes priority.

Telegraph : http://www.telegraph.co.uk/news/newstopics/politics/6608660/Government-deficit-now-increasing-at-3bn-a-week.html notes that the Government deficit now increasing at £3bn a week in an article dated 20/11/2009. Simultaneously, Gordon Brown pledged to halve Britain's record budget deficit within four years. I find it rather contradictory when the news from Reuter confirmed on the same date that the Government is due to borrow even more this year than it forecast in the Budget. How is the desire to overcome the deficit likely to materialise in 4 years when Britain continue to borrow. Office of National Statistics(ONS) also affirmed a record £11.4billion in October 2009, questioned the wisdom of the government’s action. Referring to OECD criticism that the Fiscal Responsibility Bill from the Queen’s Speech, I believe that the Labour “soft” economic stance are weak and inadequate to solve Britain’s fiscal problems, demonstrating a lack of understanding of the need to take immediate and effective steps to balance the budget.

BBC : The Government is due to unveil its latest pre-Budget report on December 9, with Mr. Darling expected to pledge how the Fiscal Responsibility Bill will reduce budget deficit. The article also noted an interview with Gordon Brown indicating that Mr. Darling will have to announce further tax rises if the deficit is to be contained. I find it rather inconsistent in terms of the government at one hand trying to spend its way out of recession, while on the other hand, taxing the people thus, and curbing spending. Also, the desire to implement spending cuts on public spending in near terms, and in conjunction with that QE to expand money supply. George Osborne, the shadow chancellor politicized the Britain's debt issue by blaming Gordon Brown for damaging public finances noting the latter has lost the economic argument about the debt crisis. I do believe that Tory’s assertion is biased and unfounded because there has been some positives as well. However, I have not heard of any clear and coherent strategy to manage the budget deficit by both Labor and Conservatives. However, the mild good news offered by BOE that Britain should be out of recession by end of the year do support Gordon’s position. However, with elections around the corner, I would be surprised if Labor would actually do anything that suggested introducing fiscal disciplines to beat the deficit budgets such as tax rises, spending cuts, or cut on social benefits such as child tax credit.

Telegraph reported on “OECD urges governments to sort out finances as recession recedes” http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6608234/OECD-warns-Britain-risks-debt-spiral.html : Acting chief economist of OECD, Jørgen Elmeskov, was vocal in advising the UK government to do more than halving deficit to prevent debt spiral. I think his assertion is founded in that the government intervention has actually been more than necessary; no other country has injected such a sum into the economy. However, it is not desirable to “over kill” the economic stimulus by drastic fiscal measures which could push the fragile UK economy into financial doldrums. Instead, I believe that BOE should start gradually and progressively unwinding the stimulus to ease the risk of high inflation in the near terms. Furthermore, from my diverse reading, many confirm that the failure to act from now will lead not just to inflation, but also debt increases, market confidence dampening, interest rates pushed upwards drastically, and this could leads to even higher deficits. This can aggravate the situation and thus, I believe that OECD’s advice is not a pessimistic statement but one that is grounded on reality if the economic and budget imbalances are left unchecked.

I conclude by reviewing an article in The Economist(http://www.economist.com/world/britain/ displayStory.cfm?story_id=14924465&source=hptextfeature)  that described the key elements of the Queen’s speech by Labor on the UK economy touching on empowering FSA, curbs on bank bonuses, with very little discussion about the economic direction. It seemed as if the speech was more to do with winning public votes with empty promises rather than assertive strategies on economic policies and direction to manage the economic problems and budget deficit. I find it rather amateurish as to what the Labor is aiming to accomplish. Also, while the BOE remains split about the desirability of further QE, signaling the need to focus on some form of exit strategies, the overall “blank cheque book” mentality or printing money strategies are likely to lead to unending economic vows and budget deficits for her citizens for a long time.

Is the sustainability of the UK Economic Recovery, a myth or a reality?

The announcement on the 11/11/2009 by governor of the Bank of England, Melvyn King noting that the UK economy is “only just started” recovering may have offered some comfort to the financial markets and investing communities.

 

BBC : http://news.bbc.co.uk/1/hi/business/8353931.stm In this article , BOE believe that a full recovery is anticipated by late 2011. The present inflation at 1.1%, on the back of GDP that unexpected drop by 0.2% in the quarter to September 2009. This was a far optimistic picture than those disclosed on the 23/10/2009 when GDP drop was announced. In all objectivity, when reports of such and expressions of opinion are raised, there is always a contradiction over the state of the economy. BOE and MPC continue to take a vague stance on the effectiveness of the monetary and fiscal strategies by stating things such as “open minded” about QE, further public spending at one level and desirable cuts at the next and then question the level of government debt problems the next. No doubt, the UK economic recession is unprecedented, the lack of clear messages and lead to loss of confidence by the financial community. I note a response by a former MPC member, Professor Blanchflower who raised doubts about the strength of the economy which is driven by government stimulus packages, and then look at information about the “real economy” with firms still not hiring evidenced by jobless rates, and a vast majority of established firms still posting losses apart from “budget” and “low cost, no frills” companies. The rate of business closures is still quite alarming.

The Economist :  http://www.economist.com/theworldin/displaystory.cfm?story_id=14742208. Britain's economic outlook: Still overcast, but brightening dated 12/11/2009. This article describes the sum of positives: Stronger labour market, lower Unemployment at 7.8% (compared to 10% predicted earlier), production index growing by 1.6% in September 2009 as compared to August 2009 and various surveys by purchasing managers showing growth and British Retail Consortium reporting buoyant sales. I believe that this information although bearing facts from statistics and reports, the question of sustainability remains to be seen. Why? Because a number of analysts including Melvyn King argued that there is still a downward pressure. In addition, the massive budget deficit warning by Fitch, a credit-rating agency, suggest that Britain was most at risk of losing its prized triple-A status as a sovereign borrower.  http://www.economist.com/theworldin/displaystory.cfm?story_id=14742208. These mixed messages demonstrate that the state of the economy is fragile and it is not possible to confirm recovery.

This is Money: The economy: From delusion to desolation dated 18 October 2009 presented an interesting article on how the economy is likely to increase the cost of living of her citizens over the next ten years. Of gem claimed that household energy bills could soar by up to 60% and cost of fuel to rise from 8.6% to 12% next year. The Institute for Fiscal Studies noted that the wrecked public finances, will cost each family £930 a year in taxes between now and 2018, the average household direct tax bill will rise by 8.6%.  A rather pessimistic article, which may hold some truth since both Labour and the Conservative party are proposing high income taxes. Is this the right move? With more businesses moving their UK headquarters to lower tax countries, and Britain risks seeing more people leaving the country, as evidenced from UK Border Control, the strategy of economic recovery may lead to less tax revenue for the government.

BBC : http://news.bbc.co.uk/1/hi/business/8199970.stm I chose this article as it compared Britain and the Euro zone to appreciate the sustainability of UK economic policies. The article noted France and Germany recovery as compared to UK and provided a good commentary about why it would take longer for Britain to recover. With the UK government spending £1.5 trillion, £200 billion on QE, no other country in the Euro zone have invested so significantly. I believe that the pessimism grounded by the article is valid. Why? The UK, unlike Germany and France, is (1)very dependent on the financial sector, (2)consumers are more in debt and (3)the huge credits available meant that unlike Germany and France who saw the return of domestic demand spurring their economy,  but UK consumers are unlikely to spend their way out of the recession due to enormous debts. On a positive note, the recovery of the UK financial sector to pre-crisis levels are likely to help recovery although the underlying weakness in the real economy may make it unsustainable.

 

To sum up, I chose the article http://www.kleinwortbenson.com/content/269/investors-signal-renewed-hope-in-india to assess market perception of the recent announcement by BOE. Stock investors undecided on market recovery with only 34% believed that the rally signalled market confidence with another 39% not prepared to make confidence predictions offers a good market analysis of the state of the UK Economy. All the articles included in the analysis points out to a very early indication of recovery, a myth to be able to confirm the predictions of a recovery with all the underlying economic issues. The reality of things is that in spite of the size of government spending, there is no evidence of a sustained economic recovery.

 

Is bailing out RBS/Lloyds Bank justifiable on a public interest perspective

Is bailing out RBS/Lloyds Bank justifiable on a public interest perspective

The UK banking system was once reputed as delivering excellent corporate governance regime with proper supervision by both the FSA and BOE playing vital roles.

 

The Guardian: http://www.guardian.co.uk/business/2009/jan/19/bank-bailout-guide offered an explanation that revealed far reaching consequences for bank customers, employees, shareholders, taxpayers, the Government and the financial sector. The article noted the root of the crisis as the irresponsible bank culture of taking high risks, short term result-disproportionate bonus culture and lax control. On reflection, I can identify the various failures highlighted on the weaknesses in the way in which the FSA and BOE has been supervising the banking industry. I would have thought that the collapse of Bearings and Enron/Worldcom which raised a number of Internal Control and Corporate Governance issues in the 1990s would have highlighted these issues. Instead, we have the press over the last week revealing the 3^rd bail out of banks. It was claimed that the bail out was necessary in public interest to encourage lending to both homeowners and also, businesses. The rescue now would see the government owning 84 per cent owned by the state.

 

Telegraph : http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6496295/Bank-bail-out-every-family-shouldering-4350-tax-liability.html measured the impact of the “Bank bail-out: on every family which is anticipated to be  shouldering £4,350 tax liability from the £74 billion bail committed in total since last year. The Conservatives are right to point out the massive outlay by the government, but the real issue I believe is whether all this unimaginable sums is actually in the best interest of the public. Reviewing various press releases acknowledged mounting government debts, bail out leading to nationalisation of the banks leading to greater inefficiency and anti competition practices and a planned tax increase on the public to fund the significant risk exposure have all question the logic of the bail out in public perspective. The article, expresses Gordon Brown’s desire to recoup the full investment, Conservatives addressing their political agenda but very little concrete discussion have been made on the issue of public interest.

 

BBC : http://news.bbc.co.uk/1/hi/business/8347629.stm shared “Treasury seeks RBS lending proof” noted the claim by RBS that they have not been able to meet the £16 billion business lending targets due to poor demand for its loans. This claim seems preposterous considering that we are in a climate where most businesses are struggling. I reflected on a reading on the British Chambers of Commerce(BCC) article recently (http://www.britishchambers.org.uk/business-news/banks-lending-more-to-small-businesses-claims-bba.html) on the difficulty of SMEs and businesses as a whole to get much needed loans and confirms my thought on the matter. I believe that the government’s claim that bailed out banks, are doing more to help our businesses and economy is therefore unsubstantiated. The problem is aggravated by an article recently in The Independent : http://www.independent.co.uk/news/business/news/rbs-faces-another-year-of-losses-hester-admits-1816692.html noting, Stephen Hester, the CEO of RBS making no apology about the failure to achieve lending target noting that the banks were taking a more conservative position on lending by targeting only to those who can afford to payback. This might be a prudent stance especially when banks should be attempting to set suitable credit benchmarks but the impression given seemed to defy the government’s own directive of banks to support lending. It would appear to me that it would have been more appropriate at the hindsight, for the government to channel the funds directly through for instance, BusinessLink, rather than allowing banks to allocate resources at their discretion and promote self interest.

 

Moneyweek: http://www.moneyweek.com/news-and-charts/economics/an-extra-39bn-for-rbs-and-lloyds-but-will-it-work-46002.aspx confirms that the bail out package may not be effective since the penalty of state aid, is for the bank to break-up to encourage competition. The value of the stakes of the government is likely to see a further erosion of profitability. Why?  Firstly, the desire of the government and within the EC framework to encourage competition compels RBS to sell some of its more profitable businesses such as its insurance arm, retail operations which are key business, meaning loss of shareholder value and possibly longer period to recoup the investment. An article in Evening Standards (30/10/2009) noted a break-even point of 122p and 50.5p respectively for RBS and Lloyds to recoup paper losses of £6.6billion or 19% of bailout investment.  Although I believe that public interest is justified by increased competition, the fact that tax payers are in essence investors’ of the bank, it does not offer economic justification at all. 

 

In conclusion, the banking crisis has given rise to loss of confidence of the UK public on the government’s handling of bail out. On one hand, bail out had prevented a major collapse of the British economy with far reaching implications on the entire banking system, but on the other hand, I believe that a lot of articles seem to show that the government is not able to hold accountable on the use of public funds and the role of the regulators (FSA/BOE) seems to be confused. 

Is Quantitative Easing(QE) the best strategy to deal with the much worst than expected GDP drop of 0.4% for the last quarter (June – September 2009)

Guardian: http://www.guardian.co.uk/business/2009/nov/01/bank-england-mpc-quantitative-easing In an article "Businesses urge bank to extend quantitative easing" noted British Chambers of Commerce supporting an immediate £25billion injection. Spending away £175 billion in the recent past and now a further £25 billion pushes the UK debt to £200 billion. This equates to the size of a few developing economies put together. It seems rather ambitious to continually carryout QE when economic indicators are adverse. In economics we appreciate that when recession hits a country, a string of economic stimulus are adopted. Why do we need to always resort to extreme measures such as QE to revitalise the economy. Of course, QE has had a positive impact on house prices, stock markets and business/consumer confidence but such drastic money supply injection will lead to massive government debts, that would translate to significant increase in future taxes and unsustainable debt levels which would take a long time to resolve.

BBC : http://news.bbc.co.uk/1/hi/business/8321970.stm Record recession for the UK economy described the frail state of the UK economy as compared to other countries. In spite of the massive QE that the BOE/MPC has implemented, the failure to see any positive progress in the UK economy as compared to the likes of Germany, France and even Japan, seriously questions the dependability of the technique. For one thing, as compared to other nations with EU, UK has taken on a more aggressive strategy, backed by mounting debts, while the other EU countries such as the 2 identified above, is managing their respective economy with a stronger foundation for the past, present and future. I note this with much concern as the "real" economy appears to be artificially propped up rather than self developing. To make matters worse, the rather optimistic view in the article by Alistair Darling indicating that the economy would recover by the end of 2009 does not seem to phantom the full extent of what lie ahead for the UK regardless of what the economic statistics may suggest.

Economist : http://www.economist.com/world/britain/displaystory.cfm?story_id=14770191 noted that the Bank of England is engineering an elusive recovery. The article noted a MPC member, Adam Posen describing how well QE has prevented deflation, improve credit and asset market which appears to be very much wanting. Reading major financial news recently, it can be observed that businesses are complaining about the scarcity of loans, especially SME, with banks extremely conservative with their lending, charging exorbitant interest rates (although the base rate is 0.5%), are very selective and focus on building their balance sheet from the "huge bad debts portfolio". Furthermore, another article "Loose Thinking" describes how Japan the pioneer of QE during 2001-2006 did not achieve much success in combating deflation or improve economy. What I believe is that the unconventional monetary strategy of QE seems to be linked to desperate attempts of MPC/BOE to do something to build confidence but lack any clear direction. Mr Masaaki Shirakawa, governor of Bank of Japan may appear to offer advise on how QE should be practiced, with Britain and US leading the race on QE but the real question is whether Japan is a good example to follow. Japan’s contextual economic structure is very distinctive from the West, with a culture of savings, reliance of businesses primarily on banks, time horizon for results, but also, whether Japan have in fact come out of economic stagnation.

FT: http://www.ft.com/cms/s/0/1a3a4456-c273-11de-be3a-00144feab49a.html?nclick_check=1 remarked what is believed to be the other factors that need to be considered to deliver economic recovery. I chose this article as it contained a remark that I have emphasised in this paper about the need to look at the holistic perspective. Mr Adam Posen exclaimed the need to restructure the small number of large banks to enable greater competition and wider available funds. I believe that we need a mathematical and holistic approach to manage the economy which involves setting the infrastructure right, before adopting economic stimulus. For instance, QE will not work if money supply increases and yet, banks are reluctant to loan to businesses. This means, access to funds remain futile and businesses, even those with good prospects are perceived risky, continue to be forced to shut down. What is required here is a wider source of financing for companies. Also, the focus on economic regeneration activities which I believe has not been emphasised in many readings.

In conclusion, I think IMF article UK Budget Imbalance in the Global Financial Stability Report noted an interesting caption which I feel best describes how UK’s QE strategy is being deployed. IMF notes that Britain is trying to do a Ryanair by pretending to reduce costs but simultaneously borrowing to meet its obligation. With no clear economic direction, worst funding gap in the world, reactive engagement of QE and MPC’s inability to understand and measure the effectiveness of QE, the economy is likely to be heading south, with far reaching economic consequences.