Archive for the ‘Politics’ Category

The rich get richer and the poor get poorer. It sucks, but that is the way of the world. At least that is what most of us assume, but data from the ONS out this week suggests this may be wrong.

Since the start of the economic downturn in 2007/8 the richest 20 per cent of households have seen disposable income fall by 6.8 per cent, the poorest 20 per cent have seen income rise by 6.9 per cent.

It is important that we point out what we mean by disposable income at this point – it’s after taxes and benefits. The ONS has included VAT in the equation, by the way.

In 2011/12 the richest 20 per cent – before taxes and benefits – enjoyed income of £78,300, which is 14 times greater than the poorest fifth, which had an average income of £5,400. That is a ratio of 14 to one.

But take into account taxes and benefits and things look different – very different. The top 20 per cent saw disposable income fall to £57,300, while the bottom 20 per cent saw it rise to £15,800. The ratio changes to just four to one.

So what a bunch of socialists the government of the last few years has been. Except they haven’t really.

For one thing, the data does not tell the full story. It does not tell us about average income in the top 1 per cent quartile.

Besides if you drill down, things look different. If you look over a much longer time period, say from 1977, a quite different picture emerges. Since 1977, disposable income for the bottom 20 per cent has risen by 1.93 per cent, and by 2.49 per cent for the top 20 per cent.

There is in any case a more noticeable gap between the top 20 per cent and the rest of the population.

Average disposable income for the second poorest 20 per cent was £21,373 in the last financial year, or 1.35 times more than the first 20 per cent. Average disposable income for the middle 20 per cent was £27,526, or 1.29 times the average for the second poorest. Average disposable income for the second richest 20 per cent was £34,437, or 1.25 times the average for the middle 20 per cent. And average disposable income for the richest 20 per cent was 1.66 times the second richest.

But then again, so what? Don’t the rules of numbers mean that the average of the top 20 per cent will always be much higher than everyone else for the simple reason there is no upper limit to the top 20 per cent. The lowest disposable income can be is zero, the highest is… well, it’s infinite. Instead let’s look at how things have changed.

Equivalised disposable income, by the way, means: “The total income of a household, after tax and other deductions, that is available for spending or saving, divided by the number of household members converted into equalised adults; household members are equalised or made equivalent by weighting each according to their age, using the so-called modified OECD equivalence scale.” See: Glossary: Equivalised disposable income

And by the way just one more point. The proportion of people in the bottom 20 per cent who are retired has fallen over this time period. . This is because retired households have seen incomes growing at a faster rate than those of non-retired households.

© Investment & Business News 2013

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This may come as a shock. But apparently there used to be a system in the UK where if you wanted to send a message to someone, you wrote it down on a piece of paper, put the paper in a flat paper bag known as an envelope, stuck an adhesive picture of the queen in the top right corner of this ‘envelope’, and put it complete with this likeness of the Queen in a big red box.

Some people put other things in the red box, but they were not thought of positively by society. And then, something miraculous occurred; this envelope appeared on the door mat of the person for which the message inside was intended a day or two later.

It seems like a primitive custom, but that, according to a research recently made available on Facebook and emailed to journalists, is how things used to be.

And now, a company that operates in this state of the art way of delivering messages is set to be privatised. The Unions say that the Royal Mail is the type of company, offering such an essential service as it does, that should be under state ownership.

The Unions are right. How could we possibly manage without the Royal Mail if it wasn’t for email, Facebook, Twitter, Skype, LinkedIn, oh and DHL and TNT and, well… the list goes on a fair bit.

Delivering messages by the British postal service was once a lynchpin of the British economy, and indeed of the British Empire. Where would Victorian Britain have been without it?

But, and this may come as a shock to some, Queen Victoria is no longer on the throne and these days we have this thing called the Internet. Funnily enough, in this Internet age the Royal Mail has found a new function – namely to be the means by which shoppers and eBay users can have the products that they buy online delivered.

Some of the products shipped over the Internet will be sent that way only on a temporary basis. Love Film is a great user at present, but for how much longer? Given the increasing ease by which we can watch films online whether there will be a need for DVDs delivered by post seems unclear.

The Unions don’t like it, and it may be harsh to say that they need to accept Queen Victoria isn’t the throne anymore, but their concerns are legitimate. But the government has come up with a way to appease workers; 10 per cent of the shares on offer will be given to staff. Unions may try to block the privatisation, but once it has happened they will surely be forced to step back.

The Royal Mail has too many competitors for the Unions to risk weakening it, and the job security of members.
But there are some questions.

Does Royal Mail have an unfair advantage? In much the same way BT used to have (perhaps still does) an unfair advantage in supplying cables to the home (which the competition authorities tried to counteract), the Royal Mail has a distribution monopoly. When was the last time you went to the Post Office to send a parcel and the clerk asked you if would be using the Royal Mail or DHL today?

And then there is timing.

Privatising state companies, such as the Royal Mail and indeed Lloyds Bank and RBS, may well be a good idea. Frankly, the government coffers could do with some extra money. But does that mean the ideal timing is now? It may, but right now the government can raise money easily and cheaply.

The plans to privatise the Royal Mail have nothing to do with whether this is a good time, and a lot to do with where we sit on the political calendar.

Finally, there is a question mark over the belief, commonly held, that governments are lousy at running companies and that the private sector is always best. Maybe the private sector is best, but perhaps not for the reasons generally given. Lots of private firms turn out to be badly run, even more badly run than state owned firms. It is just that such firms go bust. State firms tend to get more subsidies.

See it in terms of evolution.

This works by having lots of different ideas, and selecting only a very small proportion of them. You can’t second guess what evolution will throw up next. The private sector scores over the state sector because it has survivor bias built in. Good businesses evolve. The state sector tries to do things via a kind of intelligent design, and that is what doesn’t work.

© Investment & Business News 2013

Uk Population

Here’s a chart for the UK population as of now with a line for the official projections 10 years hence.

As a tool for prediction this chart can be quite powerful; pictures speak a lot louder than words.  The way to use the chart is to imagine the blue and red lines being pulled across the page as we all move inexorably towards God’s waiting room on the right.

We’ll be pulled past 2 marks on the way. The left block shows where young people (16 – 24) might find themselves becoming employed and paying taxes – remember that 20% don’t though so the ‘new workers’ line is copied and shifted lower.

The next mark, for the retiring age for men, shows an ever increasing rate of retirees, after a very steep previous 10 years there will be another 7 million arriving during our 10 year look into the future. You might notice an almost mirror image of the lowered ‘new workers’ line but the unemployed are living off the state too, so there is another 1 million to be added to the line on the right if we want to balance workers vs. state supported.

Unfortunately, because the leading edge of retirees points up and the leading edge of new workers points down, things just get worse. While this demonstrates the ex-growth nature of the economy it is reassuring to compare the huge block of substantially employed people and the much smaller wedge shaped block of the already retired.

So it looks a lot less gloomy right now but as our 10 year view unfolds it builds to uncomfortable levels all the way up to and past the baby boomer’s peak in 15 years.

Note how the red projection line slumps after the retirement age. I’d like to think that this is not an early death syndrome but rather an indication that retired people like to head off to countries with blue skies and sunshine. As we have seen, the retiree level is really lower than the new workers level and that’s a significant first; it just gets progressively worse after this as the retirees line builds even steeper and the workers line pulls across a dip. Incidentally there are dips because WW1 and WW2 were one breeding cycle apart (27 years) and the resulting post war pulses have yet to die down.

If you are about 50 now you are at the population peak age. Births subsequently declined for 13 consecutive years, and that was another first, signalling the end of centuries of perpetual population growth. Because accounting practices, pension arrangements, government finance, and much more, all worked because growth conveniently forgave all sorts of silly thinking, there were, and still are, bound to be some serious consequences.  The way the world works has changed forever.

The workings of pension schemes are of particular interest. With perpetual growth there was always a bigger pool of funds to pay out the liabilities so nobody needed to be particularly efficient. That is no longer the case and you can be sure there will be a raft of pension scheme failures.

With such a huge pension liability arriving over the next 15 years the pension funds have to prepare by switching out of equities and into bonds and then progressively the bonds are then sold as net payouts increase. Logically we might expect weak equities and strong bonds eventually followed by weak bonds.  When the bond sell-off stage arrives one wonders how the Government finances will work – who will they sell bonds to then?

An ex growth world has some implications for equities. Shareholders have got used to accepting lower yields in exchange for corporate growth. As soon as the growth stops then a proper yield will be required. As an example a company yielding 2% and going ex-growth might have to yield 4% to remain attractive. So that means the share price would have to halve!  How likely is this scenario?

Well take a supermarket for example. As a footfall company, whose profits are directly linked to the traffic through the door, the impact of an ex-growth population will be severe. Actually the population is not quite ex-growth, it is just slowing down, but even so companies in this category are subject to massive falls as soon as their growth is seen to end. Just to be safe, sell all your growth stocks?

You can see why there was a property boom over recent decades as the only way the available housing stock grew was via owners dying or new houses being built. Looking back it seems so obvious that fewer old people (from a previously smaller population) supplying demand from a much bigger block of house seekers would result in big price rises.

The chart is giving a strong indication of a repeat performance. Note how there is a bulge moving into the first time buyers age groups and then compare that to the lower height of the chart where old people might shuffle off. Demand will clearly outstrip supply for a while and looking forward 10 years this is increased by immigration as can be seen by the way the bulge actually grows as it moves across. The low end of the housing market looks like a good bet and you can expect a rally in the house builders too.

All this is good for the economy with an added twist. The baby boomers already have a house and yet they are about to inherit their parents houses which can easily be sold on at today’s fairly substantial prices; an added boost to the economy for several years to come.

This last point reinforces the idea that retiring couples with windfall cash will head for the sun. That’s bullish for overseas holiday homes so get in while they are depressed.

Any negatives? Well the way the dotted red line sits above the blue line has implications for NHS services over the next 10 years. It doesn’t look much but in percentage terms there is a significant increase with a detrimental age bias to account for too. An already stretched service has a crisis looming.

The big bulge in the new adults group will all be driving cars for the first time; good for the motor industry but bad for traffic jams.

Conclusions:  No great dramas for the next 10 years but this is the lull before the storm. After 15 years the peak of the baby boomers will be at retirement age and from then on it is hard to see how the books stack up unless the, already brimming, country is filled with more foreigners.

The houses to buyers ratio is likely to top out, leading to a sustained bear market in house prices. The stock market will slump horribly as it goes absolutely ex-growth and the pension funds go into net draw down.  The Government will find it hard to fund the state pension burden and increased demands on public services. Borrowing to bridge the gap will be hard as traditional lenders, in the net draw-down scenario, have no need to buy bonds. Interest rates may well climb as a result and then the National debt financing costs spiral up. Pay more, borrow more, pay higher; sounds familiar.

A UK Government default before 2028?  Not so hard to imagine is it?

Data – The Office for National Statistics

Opinion – Patrick O’Connormist

Here are two technical terms, before we get underway: fiscal multiplier and blinkered. A fiscal multiplier simply describes the relationship between government spending and GDP. Blinkered, which was a theory developed by Professor Obvious from the school of common sense, may apply George Osborne.

Here is some simple maths. Let’s say that for every pound the government spends on welfare and department spending, the economy grows by 60p. Let’s say that for every pound spent on infrastructure, the economy expands by one pound. Professor Obvious might suggest the following: spend less on welfare and departmental spending, and use the money saved to boost spending on infrastructure.

If you want to take a view from the ‘School of the Not Quite so Bleeding Obvious’ (SNQBO), then things change. What is true now may not be true tomorrow, next week or in, say, ten years’ time.

It does, however, feel as though the equations described above are roughly right at the moment.

Yesterday the IMF said: “The United Kingdom could boost growth by bringing forward measures already included in its fiscal plan, such as spending on infrastructure and job skills.”

Capital Economics reckons that if the government was to spend £10 billion in this way, it could cancel out the GDP dampening effect of its planned £6 billion cut on welfare and department spending for 2013.

The other benefit of investment into infrastructure, and indeed job skills, is that it can lead to improved productivity, precisely the area where the UK is so weak.

Furthermore, by taking money scheduled for expenditure at a later date, Mr Osborne could implement the IMF recommendations without worsening the UK’s public debt in the long run.

So why not do it?

One reason might be, and excuse the introduction of another technical term, the slippery slope. Osborne may fear that short term one-off initiatives have a habit of becoming entrenched. That is to say that theory might suggest we just need to take the money from planned future expenditure, but when we get to that future date, the government may find that it is still under pressure to spend that money.

The other reason is that Mr Osborne, to use the jargon, is blinkered.

© Investment & Business News 2013

Last year I did a list of each country’s national debt divided by population to see what the next generation might either pay interest on or pay back.

Examples in $1000 per head:

UK 26.5

Ireland 35

Germany 28

France 31

Spain 17.5

Italy 38

Japan 83

USA 29

Canada 37

Norway 39

Australia 11.5

So what you might say? As a percentage of GDP it’s not so much … well that’s got naff all to do with it too unless there is a current a/c surplus … if you cut someone’s hair it adds to GDP but it hardly pays the £26,500 you owe on top of the £10,000 on your credit card.

Obviously, in the UK, with the old folks about to fund the out of work young folks as well as the civil servants, NHS etc (biggest GDP earners presumably and therefore the biggest ‘so what’ in this whole sad tale) this black hole is here to stay for a long time.

To get away from the obvious side of the story let’s have a look at the other side of the loans – the £26,500 each and every one of us had borrowed on their behalf… someone is the lender and so they will either ask for it back one day or extend the loan forever and the borrowers (you) will pay the interest. As the banks already went bust then presumably the debt is met by bond issuance from each government … “wow government – must be safe” bonds of course.

So who owns the bonds? i.e who is hoping to get paid back?  As it’s not countries per se nor banks so much, it must be the pension funds and the pension funds have your money in trust for when you retire. So the money they are going to give to you one day is indirectly the money you already owe ? And in order to realise that money, the pension funds have to redeem the bonds so the government has to find the money to give the pension providers to give to you….. enough of that … the real truth is that the government bought votes by indirectly spending your pension fund over the past few decades. The government borrowed from the very people it was robbing at the time. Many pension plans will have to go pear-shaped… whose will be first?  Do you doubt this? In that case just tell me who is going to produce your £26,500?

Any thoughts out there?

Patrick O’Connormist is this week’s guest contributor to The Money Spy blog

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Nobel Laureate Joseph Stiglitz reckons that US student loans are the next big western economic crisis in the making – the next sub-prime. In the UK, the numbers are not quite so scary, but we do seem to be adopting many of the worst elements of the US economy.

Meanwhile, we keep hearing about kids going to university, and coming back with degrees that are not much use to man nor beast – but they do have lots of debt.

In his book ‘Anti Fragile’, Nassim Taleb (author of ‘The Black Swan’) questioned the link between education and economic success. Taiwan had lower literacy rates than the Philippines before it embarked on its period of growth. South Korea had lower literacy levels than Argentina before its growth era, and before Argentina’s collapse.
When we look at a country’s wealth and compare it with education, we see a connection. Richer countries tend to spend more on education. But which way is the causation? Does education lead to wealth or wealth lead to education?

Taleb reckons that apprentice-type education models are more closely correlated with economic success.

Here is the snag. Higher and further education may not cause GDP to rise, but for individuals there is a link between education and wealth. Countries that offer free advanced education to all tend to see a more evenly spread distribution of income.

Besides, in the era we are set to enter, in which we will see 3D printing, and nanotechnology, many people may have to re-train several times throughout their career. Maybe a good education provides an essential foundation in a world of very rapid change.

© Investment & Business News 2013

It used to be a magic formula. Never mind what is happening in the real world; in industry, in business. Never mind what is happening with wages and productivity. If house prices were rising, households felt as if they were better off, and went out and spent more as a result.

It happened in the UK. It happened in the US. Raghuram Rajan, a former chief economist at the IMF, argued in his book ‘Faultlines’ that rising house prices in the US made up for the growing gap in income distribution. So during a period in which median wages in the US hardly changed, house prices surged on the back of low interest rates, and plentiful supply of credit.

Government backed agencies Freddie Mac and Fannie Mae also helped to ensure that house prices only ever rose, and that consumers – most of whom had forgotten the very concept of savings because it no longer appeared necessary – enjoyed the perception of growing wealth as their home rose in value.

It ended in tears of course. These things do. Maybe it will end in tears again, this time with bond prices, as factors beyond the control of central banks force up inflation and in turn lead to higher real interest rates.

But in the UK, George Osborne came up with a cunning plan in his latest budget. It is called “help to buy” and is there to give first time buyers who can’t rustle up the necessary deposit a lift onto the housing ladder. He is also looking to help existing home owners move up the ladder, too.

It’s a bit like a UK version of Freddie Mac and Fannie Mae, and, of course, if our George can engineer house prices upwards, consumers will feel richer, spend more, and electoral success may belong to the Tories.

Alas, Andrew Brigden, a senior economist at economic consultancy Fathom, does not see it that way. He said: “Help to Buy is a reckless scheme that uses public money to incentivise the banks to lend precisely to those individuals who, absent the scheme, would not and should not be offered credit… Had we been asked to design a policy that would guarantee maximum damage to the UK’s long-term growth prospects and its fragile credit rating, this would be it.” And to that the ‘Daily Mail’ and ‘Daily Express’ exclaimed with delight: “Look!– House prices are set to soar,” they said.

And with that, George Osborne is now preparing to create economic recovery with two new discoveries. Apparently, two plus two equals five, and black is white.

© Investment & Business News 2013

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Ken Rogoff and Carman Reinhart – the two academics who wrote that rather controversial paper suggesting that when public debt to GDP rises over 90 per cent, growth falls sharply – have come out fighting. And you know what, their observations not only make a lot of sense, they are pretty much smack on in agreement with what has long been argued here.

Let’s be fair to Rogoff and Reinhart, they are not arch Austerians. It is just that their work is often quoted by arch Austerians. And when serious loopholes were found in it, the likes of Krugman practically danced on what some say was Rogoff and Reinhart’s grave. The Austerians responded by saying that the errors found in the Rogoff Reinhart model were trivial, and did not unduly affect the conclusion.

Sometimes, however, you need to stop listening to the interpreters and listen to the original instead.

Take as an example this extract from the Rogoff and Reinhart paper: The Aftermath of Financial Crises published in 2009.    “The main cause of debt explosions,” states the paper, “is usually not the widely cited costs of bailing out and recapitalizing the banking system. The collapse in tax revenues in the wake of deep and prolonged economic contractions is a critical factor in explaining the large budget deficits and increases in debt that follow the crisis.” In short, the paper states the case of the anti-Austerians; government debt does not cause GDP to slow, rather slowing GDP causes government debt to rise.

Rogoff himself has gone on record as saying that the conclusions of the paper he co-wrote are often exaggerated.

In today’s FT, Rogoff and Reinhart produced an article that says it, clearly in black and white.

“To be clear,” they said, “no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched.”

“Nevertheless,” they continue, “given current debt levels, enhanced stimulus should only be taken selectively and with due caution. A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.” See: Austerity is not the only answer to a debt problem 

Hear, hear to that. We need both. We need austerity and stimulus. This is no contradiction.

We need investment into infrastructure, energy, education, and (this is the one that ‘Investment and Business News’ has spoken up for more than anything else) into entrepreneurs.

But actually, move away from Rogoff and Reinhart and look instead at the National Institute of Economic and Social Research (NIESR), which under its director Jonathan Portes has looked very Keynesian in its attitude towards government debt and stimulus.

In NIESR’s latest paper on the growth prospects of the UK economy it recommended: “Investment in education, innovation and infrastructure is essential for future economic growth.” The paper stated: “With 10-year government bonds attracting yields of less than 2 per cent, the government can finance additional investment in much needed infrastructure at little cost. With an economy in such a depressed state the fiscal multipliers are likely to be far higher than in normal times.”

In short, the darling boy and girl of the Austerians, and NIESR, headed by one of the UK’s most articulate and apparently switched on Keynesians, are saying much the same thing.

Of course we need to see austerity, not just in Britain, but across much of Europe. In Greece, the public sector has been a drain on the economy for decades.

Of course we need stimulus, no stimulus at a time when households and companies are saving more will automatically mean less GDP.

So we need austerity in areas of the public sector that are bloated. We need stimulus in areas that will create not only more jobs in the short term, but also improved productivity in the long term.

What we don’t need are stimuli that just hand money to households and companies via tax cuts. Much of this money will be saved. There is no point in the government borrowing money to fund tax cuts that help the private sector to save more.

© Investment & Business News 2013

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Of course the headlines may be a little misleading. Union members may look at it and say: “We never went away.” But you know what it means. Time was when unions seemed to be holding the real power in the UK, and their control was too much. In the 1970s Ted Heath’s government went to the electorate and asked the simple question: ‘Who runs the country: the government or the unions?’ Since Heath lost the election one assumes the country chose the unions. There then followed a period in which the UK went into very sharp decline. Then Thatcher was elected, and while the unions were not exactly destroyed, it did seem as though they were disembowelled. And from that moment on unions were relegated to the back seat.

These days the old union ways seem to be so very, well…, so very post war years, so old fashioned, so completely inappropriate in today’s age. And maybe that is right. But ask yourself this question: Why is it that when the union power was at its height, the UK economy enjoyed its best ever 25 year period of growth?

It may be a coincidence, of course, correlation does not mean causation. If there are a lot of doctors in an area where there has been a disease outbreak, it does not mean the doctors caused the disease. Maybe the growth we enjoyed in the post war years led to the rise in unions. Maybe unions were a luxury during this era that the country could afford, and when it could no longer afford them, it elected Thatcher.

But here is a controversial idea for you. For a country to grow on the back of internal demand it needs wages to rise; it needs its workforce to feel confident. Under certain circumstances – note that the following statement does not apply all the time, just occasionally – the country’s best interests are served by ceding more power to the work force, and taking power from employers.

Take wages. With good reason, employers want the wage bill to be as low as possible. Some might reason that in order to attract the best staff a company needs to pay more, but the principle is right: the lower the cost, the better for companies. But apply that policy across the economy and the result can be disastrous. The economy needs wages to rise in order to enjoy sustainable rises in demand.

Take two pieces of news that have broken over the last few days. According to the ‘FT’, government ministers are considering freezing or even reducing the minimum wage. Their logic is simple: reduce the minimum wage, and employers will take on more staff. But think about that. If the minimum wage is cut, won’t that mean some workers will see their wage fall, and won’t that mean less demand? It surely depends on the circumstances of a particular moment, on the nature of the labour market, and on productivity. Economic theory says that a fall in the minimum wage will led to higher employment, but this does rather depend on what an economist calls the marginal productivity of labour, and how sharply the curve representing marginal productivity of labour is falling.

Right now, the UK’s main problem is not employment – in fact employment is at record levels – rather the UK’s main challenge is productivity. How will a cut in the minimum wage help that?

Then take flexibility of labour. According to the 2011 Workplace Employment Relations Study published earlier this year, the proportion of workers on what is called zero hours contracts has risen from 11 per cent in 2004 to 23 per cent in 2011. That means more employers are taking on staff, but only making use of them from time to time.

Once again, we can see the benefits to employers, but step back and look at the macro economy and the picture looks different. When that many workers are on uncertain job contracts, how can they possibly justify spending more money than they absolutely need to spend?

A concept described here before is the paradox of flexibility and, related to that, the paradox of toil. The two theories suggest that under certain circumstances – namely with zero interest rates and a higher output gap – if we all start working harder, or the labour market becomes more flexible the result can be higher unemployment.

This is a bigger problem that it seems. New technology has changed the nature of the labour market. Power has drifted from workers, and the unions who once represented them, to employers.

In a world of increasing automation, and highly competitive global labour markets, the balance of power is likely to shift even further in favour of employers. Paradoxically, from a macro point of view, and very much from the point of view of the collective interests of employers, it may be well be that we need to find ways to re-redress that balance.

©2013 Investment and Business News.

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Did you know that Diego Maradona, most famous as for his prowess as a football player, was also a top economist?

Maybe we can go further than that and say he was an economist first, but used football merely to illustrate his theories.

Take the world cup match with England in 1986. First of all there was that goal; the one in which Maradona rose above the rest of the players on the pitch, his hand held aloft and deftly patted the ball into the net. That had the effect, as it were, of putting the fear of God up the England players.

Such was this fear that later in the match, Maradona was able to sort of dribble past five or so England players, and score one of the most memorable goals in the history of the World Cup. It is just that if you were to plot the trajectory of his run you will find that the Argentinean footballing legend actually ran pretty much in a straight line. The England players, in anticipation of Madonna’s magic, sort of fell away. If instead the English defence had not moved and stayed put, Maradona may not have got past his first marker.

It all boils down to expectations. If you are expected to act in a certain way,  others change their behaviour accordingly. The result is that by doing nothing, but creating the impression of doing something, you can affect behaviour.

So let’s apply the Maradona model to the markets. For the markets, expectation is crucial. So let’s say you are a central banker, and – for the sake of picking a name out of thin air – let’s say you are called Mario Draghi, and you are the President of the European Central Bank.

You want to see confidence return to the markets, you want investors to buy Italian and Spanish bonds, and you are worried about the strength of the euro. But you have a problem. Some of your colleagues within the ECB, some very powerful colleagues at that, are what you might call hawks. They don’t like quantitative easing, and like to see a strong currency. So what do you do?  Answer: absolutely nothing, other than talk. You say things such as: “I will do what it takes.”  And hope that simply saying you will do that is enough.

Somehow, the strategy appears to be working. Last week the ECB voted to do nothing again. There would be no change in monetary policy for another month, but the feeling that Mario is there, pulling strings, and orchestrating recovery was enough to get the markets buying bonds and selling euros.

And that is where Maradona comes into it. Back in 2005, Mervyn King came up with what he called ‘The Maradona theory of interest rates.’ He said that the markets are a little like those England players in the match with Argentina. He said: “Market interest rates react to what the central bank is expected to do.  In recent years the Bank of England and other central banks have experienced periods in which they have been able to influence the path of the economy without making large moves in official interest rates.  They headed in a straight line for their goals. How was that possible?  Because financial markets did not expect interest rates to remain constant.  They expected that rates would move either up or down.  Those expectations were sufficient – at times – to stabilise private spending while official interest rates in fact moved very little.”

What has that got to do with the here and now? Last week Jonathan Loynes at Capital Economics said: “The ECB president appears to have become the undisputed champion of the ’Maradona theory’ of monetary policy, in which market expectations of policy changes relieve the need for those changes to be implemented.”

So there you have it: Maradona economics.

But of course this begs the question: in today’s times do we need a new theory, perhaps a Lionel Messi theory of fiscal policy.

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here