Posts Tagged ‘gdp’

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It is kind of assumed that savings are good, debt is bad. If that is so, then there has been good news from the EU and bad news from the UK. In the EU savings ratios are rising, according to recent data, while in the UK they are falling. So that is EU good, UK bad. It is just that the real story is quite different, because there is something missing, and that missing ingredient is called investment.

Across the global economy savings equal investment. They have to; it is a matter of definition. GDP equals consumption plus exports, minus imports, government spending and investment. But across the global economy exports must equal imports. Drill down and look at government spending and actually it is one of two things: consumption or investment. So GDP really equals consumption plus investment.

But what are savings? By definition they are income that is earned but not spent on consumption. So by definition, savings equal investment.

But supposing we all decide we want to save more, and we all park more of our earnings in our savings account. Supposing there is no corresponding rise in investment. If this were to happen, given the equation that GDP equals consumption and investment, then either as we save more, other people borrow more, or the money we save is lost forever.

To put it another way, across the economy there is no point in saving unless this is matched by investment.

Now take the EU. According to data yesterday (30 July) in the EU27, the household saving rate was 11.0 per cent, compared with 10.7 per cent in the previous quarter. In contrast the household investment rate was 7.9 per cent in the first quarter of 2013, compared with 8.1 per cent in the fourth quarter of 2012.

Now take the euro area. In the first quarter of 2013, the household saving rate was 13.1 per cent, compared with 12.4 per cent in the fourth quarter of 2012. The household investment rate was 8.4 per cent, compared with 8.7 per cent in the previous quarter.

In short, savings ratios are rising, but investment ratios are not. This is not merely a negative development, it borders on being disastrous.

In contrast, the household savings ratio in the UK was 4.2 per cent in Q1 2013, the weakest since Q1 2009 when it was 3.4 per cent. The UK savings ratio is too low, but what really matters is not savings, it is investment.

In the UK investment remains way too low, but here is some rare good news. 2013 looks to be on course for seeing the highest levels of investment in the UK since before the crisis of 2008.

© Investment & Business News 2013

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Permanent! Do recessions and economic depressions cause permanent damage to the economy, or do we see a catch-up period in the years that follow? In some ways it is like asking whether going on holiday damages your total level of productivity. Do you work extra hard in the days before going away and then when you return, so that within a few weeks, as far as backlog of work is concerned, it is as if you never went away? Do holidays cause permanent damage to output?

The answer to that question is quite important because it may determine whether the UK will boom later this decade. One thing we can say is this. The Great Depression in the US during the 1930s was very nasty, but within a decade or so of it ending, US GDP was much greater than it would have been had growth followed the pre-depression trajectory.

Recessions caused by financial crises tend to be different. They tend to be more severe and it can take longer for recovery to occur. Various economists have had a go at calculating the permanent loss of GDP that occurs after a recession caused by a financial crisis. Estimates vary, but, according to Capital Economics, they are all – or nearly all – within the 2 to 10 per cent mark. That is to say once the dust has settled and things have returned to normal, total GDP is between 2 and 10 per cent less than what it would have been had the financial crisis never occurred.

Of course the causal link may be the other way round. It may be that GDP in the years leading up to a financial crisis is illusionary. It is not so much that such a crisis causes permanent loss; rather it is that total output was not real, not really real, and largely constructed from the economic equivalent of smoke and mirrors.
Right now

UK GDP is around 15 per cent short of what it would have been had things carried on, or as most forecasters had predicted before 2008. By the end of next year, the gap between actuality and what one might loosely call potential is likely to be around 16.5 per cent.

So let’s say that permanent damage caused to the economy lies somewhere halfway between the 2 and 10 per cent figures, and is 6 per cent. That means the UK will eventually claw back no less than 10.5 per cent of GDP lost during the downturn. Let’s say this happens between 2015 and 2020 – not an unreasonable assumption – and that underlying growth is 2.5 per cent. During this half a decade annual growth should average around 4 per cent a year. And funnily enough, this is precisely what Capital Economics expects to happen.

In the build-up to the financial crisis Capital Economics was definitely one of the more bearish of commentators, and made its name for forecasting something of a crash in UK house prices. Indeed, when it comes to forecasts of UK house prices it remains distinctly bearish. Yet, earlier this week it forecast what one can only really call a boom for the UK economy within two or three years.

It suggests the loss to the UK’s permanent output was limited by two key factors. Firstly, spending on R&D as a proportion of GDP has actually been higher since the recession began. Theoretically potential output continued to grow, even if actual output didn’t. It also suggested that because unemployment did not rise to the kind of levels seen in the past, there was less permanent damage. The rationale behind this is that people who have been unemployed for an extended period of time often lose hope, and become less productive in the future.

© Investment & Business News 2013

If UK consumers open their wallets and purses and start spending in any significant way soon something is wrong. But there are reasons to think that exporters and investment may lead the UK forward. This is where we enter a danger period. A recovery built on correcting imbalances will be a good thing. But recovery built on consumer debt, as rising house prices encourage them to go out and buy, would be most worrisome and may even give credence to the prophets of doom.

The truth is that growth in UK wages has been lagging behind inflation since the beginning of 2010. Savings have been much higher too. In the second quarter of 2008, the UK was entering recession, but at that point economic forecasters had not woken up to this, and many were still forecasting a mild slow down. During this quarter the UK savings ratio was just 0.2 per cent.

This was surely evidence we had entered a time of madness. But a year later, the savings ratio had risen to 8.6 per cent. That was a staggering rise. UK households, scared by the prospect of falling house prices, had hit a big red button with the legend danger emblazoned on it. They saved more, and soon after, their wages fell.

So what do you get when consumers spend a lower proportion of their wages, while wages relative to inflation fall? Answer: a very severe dip in spending. No wonder the recession was so severe.

But the solution to this problem is surely not to encourage households to save less and borrow more. It is to try to get wages to rise, and for business and the government to use the money that households are saving to fund investment. At the same time, UK company profits are surging, and corporate cash sitting in deposit accounts at UK banks has hit 25 per cent of GDP, which is a 25 year high.

The UK can go one of two ways. The money that is not being spent, and is instead sloshing around the banking system, could be used to fund mortgages and in turn create a housing boom. Writing in the ‘Telegraph’ recently, Jeremy Warner said: “UK housing was not the cause of the financial crisis; in fact, UK mortgage lending has remained a haven of calm and safety for the banks throughout the storm.” See: Unbalanced and unsustainable – this is the wrong kind of growth

Maybe he is right, but isn’t that the problem. For too long, whatever money that is available has been used to fund mortgages, even buy-to-let mortgages because they are seen as safe, instead of funding entrepreneurs and wider investment because this is seen as risky. Even many would-be entrepreneurs have been seduced by the allure of easy and low risk money from buy-to-let, and have left the path of wealth creation and joined the path of re-shuffling wealth, which is all that buy-to-let achieves.

If the UK goes down the path of creating a housing boom, the causality may be true entrepreneurism and a boom based on debt rather than productivity. Alternatively, if savings were used instead to fund investment, the result would be truly exciting.

Despite George Osborne’s efforts to administer the first of the alternatives – the cheap and easy way to growth, election victory and an unsustainable economy in which falling government debt is paid for by rising household debt – there are signs that the second approach is occurring anyway.

The UK’s export recovery has been held back by the rather unfortunate fact that the Eurozone, our largest trading partner, is in the midst of an economic depression. But since 2002 exports to China have risen sevenfold. According to a report published by the ONS a few days ago: “In the latest three months the value of exports was 17 per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the latest three months.”

Just as is the case in the US, there are also signs of manufacturing led recovery. UK car exports are beginning to outstrip imports. There is also anecdotal evidence of companies returning their manufacturing to the UK. As Capital Economics said: “The decline in offshoring has reflected a variety of factors. For a start, the trend towards more capital intensive production as technology improves means that the savings in labour costs that can be achieved by switching production to Asia have become a smaller component of total costs.

Western manufacturers are also increasingly specialising in high-tech sectors in which production cannot necessarily be replicated elsewhere. The strengthening of Asian currencies has also reduced the savings from offshoring. In addition, fast supply chains are increasingly valued, so that production can respond quickly to consumer tastes and inventory costs can be reduced. “

As for the UK, it said: “According to the manufacturers’ organisation EEF, the proportion of firms repatriating some output rose from 15 per cent in 2009 to 40 per cent last year.” It continued: “Low-value sectors such as textiles have been declining, while high-value markets such as pharmaceuticals and transport have been growing rapidly. The destination of UK manufacturing exports has also evolved. The share of goods exports going to the fast-growing BRIC economies increased from 5 per cent in 2007 to 8 per cent last year and has also persuaded some firms to produce domestically.”

There other reasons to be optimistic. Demographics are looking favourable. Population growth in the UK in this decade is likely to be at its fastest rate since the first decade of the 20th century. The shortage of homes to population is a problem, but there are signs this may be fixed as the government tries to reform planning laws. A house price bubble will do little for the UK in the long term, but a house building boom is different thing altogether, and this may happen.

North Sea oil output is on the rise again, and the shale gas revolution may or may not be a mixed blessing, but it should at least help to promote growth. And don’t forget that in a growing global economy the UK has certain innate advantages: its time zone being one. The UK working day overlaps with working days in both California and East Asia. The fact that English is spoken rather widely in the UK is another advantage. Add to that political stability and a strong legal system.

Yet, for all that optimism, something broken remains. The UK is not well disposed to encouraging risky investment. That may not sound like such a bad thing, but remember that risk is the key to innovation and growth in the long run.

The government can do more to help and it could start by using money created by the Bank of England via QE to directly fund investment into infrastructure and in entrepreneurs.

© Investment & Business News 2013

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During the height of the euro crisis, politicians in Europe, and indeed central bankers, blamed the markets and credit ratings agencies. Yesterday an official at the Fed followed that tactic too.

Richard Fisher, president of the Dallas Federal Reserve, told the ‘FT’: “I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they go after it.”

He also took the opportunity of being interviewed by the ‘FT’ to remind us all about George Soros – the man who shorted sterling in 1992, beat the Bank of England and hastened the UK’s departure from the ERM. He likened today’s feral hogs to Mr Soros, but is that right?

Being a messenger is never a good place to be, not if you bring bad news anyway. When Eurozone politicians blamed credit ratings agencies, and what they called bond vigilantes for the woes in Europe, they were surely deluding themselves. They had fooled themselves into thinking the crisis was less serious than it was, and they thought they could talk until the cows came home. The markets went some way towards correcting their complacency.

By hastening the UK’s departure from the ERM, George Soros probably did the UK a favour.

But what about this time?

Markets are selling because there are fears that interest rates are set to rise. The Fed has said as much, and even in China there are signs of monetary tightening.

But don’t forget that the news out of the US has been good of late. To remind you of two of the highlights: US banks’ profits were at an all-time high in Q1, and US households have cut debt substantially since 2007.

As things stand, the Dow remains substantially up on its start of year position as does the Nikkei 225 in Japan. And that makes sense.

Markets probably overdid their exuberance in May, but both the US and Japan are in a better place now than they were at the beginning of the year.

As far as equities are concerned, in addition to fears about the Fed tightening monetary policy, some are nervous about the possibility that US profits to GDP are set to fall. But in the long run, profits to GDP falling and wages to GDP rising is surely good thing.
Even higher interest rates are a good thing, if higher rates are symptomatic of the economy returning to normal.

But higher interest rates will be bad news for those with high debts, and for that reason the UK and – more so – the Eurozone may lose out.

The FTSE 100 has not performed as well as US markets this year. Unlike the Dow, it never did pass its all-time high. And unlike the Dow, the FTSE 100 has now fallen to within a whisker of its start of year price. That is probably about right.

But at least the UK has its own central bank, free to print money and buy bonds via quantitative easing.

The countries of the indebted Eurozone do not have such a luxury, which is why Europe may yet be the biggest loser.

Image: Pig In Pen by Kim Newberg

© Investment & Business News 2013

In 2004, the US Federal reserve upped interest rates. Three years later crisis rocked South East Asia. Some fear a repeat of this, but Matthew Dobbs, fund manager of Asia ex Japan equities at Schroders, is cynical about such cynicism when it comes to the so-called ASEAN countries, and especially when it comes to Thailand.

He said: “Whereas 1997 was a currency crisis, caused by an unsustainable accumulation of US-denominated debt, the country’s foreign-denominated debt, as well as those of its neighbours, is at a far more stable level.

“Thailand’s domestic economic engine is also being driven by policies aimed at growing consumer spending power and accommodating business growth – such as a near-40 per cent increase in the minimum wage that came into effect in April this year as well as a corporate tax rate cut in two phases, from 30 per cent to 20 per cent by the end of 2013. The ongoing urbanisation process in the country continues to spur growth as GDP came in at a salubrious 6.4 per cent in 2012 and is projected to grow at 5.3 per cent this year. Thailand’s latest private consumption growth figures witnessed a healthy increase of over 12 per cent year-on-year in the fourth quarter of 2012.

“Meanwhile, Thailand’s public debt-to-GDP ratio is a respectable 44 per cent, with most debt domestic and baht-denominated. It’s this fiscal room that has allowed the government to take on an ambitious multi-year infrastructure spending plan which seeks to invest up to THB2tn (US$68bn) over the next seven years. This push in spending will mainly go towards transport, with high-speed rail projects, an extension of Bangkok’s MRT and dual tracking of more than 2,000km of existing rail lines all forming part of the government’s vision.”

“On the whole, the region’s finances have seen a marked improvement over the past decade. Sturdier current account balances, along with robust FX reserves means governments have ample room to absorb any volatility the region may experience, while current account balances are significantly stronger than they were in the years before the crisis.

“Furthermore, there has been upside for countries and their credit ratings. Indonesia, which saw Moody’s and Fitch raise their credit rating for the country to investment-grade at the beginning of 2012, was joined by the Philippines as the fellow archipelago was also upgraded by both Fitch and S&P in the past two months to investment-grade status. In addition, Thailand has seen its currency perform the best among the 11 most active Asian currencies so far this year.”

© Investment & Business News 2013

Sometimes data is too good to ignore, and the latest Economics Review from the ONS contains such data. It shows that the star of the recession of 2008 was Canada. In Q1 of this year, Canadian GDP was no less than 5.1 per cent up on the pre-recession high.

US GDP was 3.2 per cent up, German GDP 1.3 per cent up, but French GDP is still 0.8 per cent below the pre-recession peak. In Japan GDP is now 1.3 per cent below peak, and for poor old Blighty, GDP is still 2.6 per cent below peak. Within the G7, Italy has suffered the worst performance, with GDP currently 8.6 per cent below peak.

Japan saw the steepest rate of decline during the recession, however, and at one point GDP was 9.2 per cent below peak before its recovery began.

So far, all is good for Canada. Just bear this mind, however. Levels of household debt in Canada seem high; they have risen since 2007, and are now even higher than in the UK and much higher than in the US. Meanwhile, Canadian house prices to both income and rent, relative to their historic average, seem excessive.

There are parallels between Canada today, and the US and the UK in 2007.

© Investment & Business News 2013

In 1994, the US Federal Reserve increased interest rates. The eventual effect of this was the Asian crisis of 1997, then the Russian crisis of 1998 and the collapse of LTCM.

History does not repeat itself, once said Mark Twain, but it does rhyme.

Did you hear that? It is the markets rhyming again.

This week the OECD said: “In East Asia…combined nonfinancial corporate and household debt has increased in several countries, reaching 130 per cent of GDP in China and Malaysia in 2012. For the East Asia region as a whole, private debt has increased by 19 percentage points of GDP since 2007, while in Latin America it has increased by 9 percentage points.

Household debt (only by deposit-taking corporations) in Thailand has risen 15 percentage points since 2007 and now stands at 63.4 per cent of GDP. Total household debt is estimated to be about 77 per cent of GDP in Thailand and almost 80 per cent of GDP in Malaysia.”

Countries across the emerging world where private debt is either around 100 per cent of GDP or even greater than this amount – and listed in order of size of debt to GDP – include: Thailand, Panama, St Lucia, Vietnam, Malaysia, South Africa and China.

Three countries stand out with excessive level of foreign debt. They are Papua New Guinea, Latvia and the Seychelles.

The World Bank said: “Public debt levels are high and proving difficult to manage in countries such as Cape Verde, Egypt, Eritrea, Jamaica, Jordan, Lebanon, Pakistan, and Sudan.”

But as markets panic, and emerging market debt becomes the thing they fear most, expect fundamentally strong economies to be punished too. The markets are like that. In times of either euphoria or panic they don’t tend to discriminate between sectors or regions.

That means opportunities may emerge. Watch out for the countries that make up the Pacific Alliance Trade Bloc, some countries within South East Asia, and the so-called TIMPs – Turkey, Indonesia, Mexico, and the Philippines – in particular.

© Investment & Business News 2013