Small Change (archive)


Taboo of nationalisation

  • Evan Davis
  • 17 Mar 08, 03:09 PM

Is it a good time to nationalise the banks?

The taboo of nationalising a bank – evident in the government’s reluctance to accept that option for Northern Rock – may have to be overcome in the next few years.

This is one lesson to draw from previous banking crises. The Swedish banking crisis for example, is generally regarded as well handled. And the solution there was to take ownership of the failing banks, to strip out the bad assets and to put them into separate well-funded asset management companies whose only job was to extract as much value from them as possible.

Once that had been done, new “cleaned up” banks could be re-established and operate again very quickly. It worked for them, although it was helped by buoyant economic conditions.

But it tells us that a successful resolution of a bank crisis can involve governments or central banks owning more of their banking systems than they would probably like.

The relevance of this argument today is that the banking crisis we are now in is one in which the banks’ own capital has been eroded by losses they have incurred on their past decisions.

The banks' capital is best viewed as a relatively small rock, on which the rest of their activities sit. Before they can borrow and lend £12, they need £1 of their own capital to serve as a kind of safety cushion. That capital is one thing that makes it safer to lend your money to a bank, than it is for you to lend directly to the bank’s borrowers.

It is no wonder that bank capital is regulated. When borrowing and lending is profitable, it is tempting for banks to scale up their operations and to borrow and lend too much in relation to their capital, in effect reducing the effectiveness of the potential capital cushion.

The problem for all of us is that when bank capital is eroded, the banks’ lending has to be curtailed, with broad economic consequences. Whatever the central bank rate of interest, or whatever the credit-worthiness of potential borrowers, banks are constrained from lending and sometimes have to call in loans that have already been made.

We want banks to lend responsibly, but we don’t want them to curtail lending too far.

So the goal has to somehow be to get more capital into the banks.

That’s not about us putting deposits into banks, or central banks lending money to banks… it is about extra money finding its way into the banks, to rebuild the capital rock on which successful banking depends.

Who can invest new money in banking right now?

The most obvious candidates around the world are the sovereign wealth funds sitting on large amounts of spare cash.

But in the absence of clear information about how much the banks are worth, the funds may be reluctant to throw more money in.

(The experience of CITIC Securities may put other investors off. As China’s biggest brokerage firm, it promised last October to invest $1bn in Bear Stearns in return for 6% of the company, a price that looks high given the news that has occurred since.)

If wealthy foreigners are not going to inject capital into the banks, and if the crisis is as bad as some suggest, the best candidate to inject capital might instead be our own governments.

It’s not quite bailing the banks out, and it would not be aimed at rescuing the shareholders – the new money would go in, and in return the state would obviously have to take a stake in the banks future profits. The existing shareholders would lose some of their share.

These kinds of solutions are not infrequently adopted, but normally occur when the banks have run out of money. But does it have to be a 100% stake in a bank? And does it have to wait until the bank is in dire trouble?

Ultimately the solution to the problems of the banks is clear: the full scale of losses incurred in the bad lending of recent years has to be recognised; the failing assets written off without a fire sale of assets; and for the banks to be recapitalised and re-launched from a healthy base.

Taxpayers might object to their money being sent in to support banks, but it is probably money well spent if it supports the economy generally, and stops the rot quickly.

In fact, there is one final lesson to be drawn from history, from the Japanese banking crisis, which was less well-handled than Sweden’s.

As problems unfurled in the early 90s, the public objected to the idea of helping banks and only one trillion yen of support was mobilised. By the end of the decade, as the crisis worsened, more like 6o trillion had to be found.

These things can get very out of hand.


Chancing it

  • Evan Davis
  • 12 Mar 08, 03:25 PM

The slogan for the Budget - you mustn't grumble, it's not too bad.

Sure, the next year or two is not what we thought it'd be, but it's not all permanent damage to the economy we're facing.

In other words, while he is not dismissing the current problems as a mere blip, the chancellor is at least arguing that some of it is simply a temporary disturbance to normal service.

So, on the economy, the chancellor concedes that some growth in the next two years will be lost - and it won't come back later (which is in itself a major concession. His predecessor always assumed that any growth lost returned later).

But at least by 2010, the economy will be growing again at its normal rate. And there'll be no recession in the meantime.

The same pattern occurs on government borrowing. After several years of painfully slowly trying to bring it down, the chancellor is now actually predicting and allowing for more borrowing next year. Overall, the finances are £5-8bn a year worse than he'd expected last year.

But again, you mustn't grumble. The public finances improve with time, and there's only a modest new overall tax rise to help recoup some of the revenue lost during the slowdown.

Fair enough. But behind this scenario though, people might still find things to grumble about.

By 2010, on Mr Darling's forecasts, the economy is a little smaller than the Treasury had been expecting; prices are a little higher and while public spending will be the same, it won't go so far, in that world of higher prices.

And then above all, what if the next few years are far worse than the chancellor has allowed? With so much going on outside the UK, you really can't rule that out.

That may lead to full scale moaning.

The chancellor though, is chancing it - at least , until the next election.


Shrinking economy

  • Evan Davis
  • 12 Mar 08, 02:38 PM

I was wrong an hour ago, to say the Golden Rule measure of borrowing was looking better than it had been in 2012. Sorry, bit rushed.

Looking at the data, the chancellor is conceding that by 2011, the economy will be 0.5% smaller than he had thought. And he doesn't appear to be thinking that "lost growth" will magically re-appear later.

That is a real concession. It’s says the slowdown is not all a blip.

This all means the Treasury have "lost" revenue and has extra costs, amounting to a five to eight billion a year deterioration in the public finances for each of the next few years. Of that, about 1.9 billion is being raised in new tax rises

But fortunately for the chancellor, the finances would be even worse than they are, but for the fact that inflation is higher than it was meant to be when he last spoke to us. Higher prices bring tax revenues in.

Perhaps the clearest way to see this story, is to look at the changing Treasury view of the year 2010. Compared to the picture in the Pre-Budget Report, the economy is half a per cent smaller, prices are 0.75% higher and the finances are 6.5 billion worse than expected, but taxes go up 2 billion to recoup some of the money lost.

Public spending is the same as before, but with prices higher, that will make the public spending settlement tougher to deliver than it was going to be.


As expected

  • Evan Davis
  • 12 Mar 08, 01:00 PM

The Budget has the shape I expected… a downgrade of the near term, and a bounce back in the medium term. By 2012, the golden rule measure of borrowing actually looks better than it did back in October. I suspect that means it is a net tax raising budget, with the tax rises delayed.

We've already had one tax rise from 2010 - the return of a new fuel tax escalator, with the half pence per litre rise in tax each year, over inflation. The MPs barely seemed to notice it, but it is a tax rise that the next government will find itself dealing with.


Real change of direction

  • Evan Davis
  • 12 Mar 08, 12:56 PM

Alistair Darling adopted the technique beloved of his predecessor of rattling through the borrowing figures. But the news this year was good - it seems lower than it was expected to be. The bumper tax receipts that the government received in January seem to have helped.

But the more significant thing is that borrowing is expected to rise in the chancellor's new forecasts. That marks a real change of direction. In the past few years, Gordon Brown always budgeted for borrowing to fall. Of course, his forecasts were often wrong but he always budgeted for borrowing to come down.

Mr Darling does think that by 2012 borrowing will be right back to where he thought it would be.


Not so cautious

  • Evan Davis
  • 12 Mar 08, 12:40 PM

The economic forecast is more realistic than it was, having been downgraded this year and next. For 2008 1.75 to 2.25, for 2009 2.25 to 2.75 and for 2010, 2.5 to 3.0. The current consensus among outside forecasters is for growth of 1.7% this year, and 2.0% next.

The chancellor focuses on the bottom range of his forecasts and calls this "cautious", but in reality, the risks are mostly on the downside next year, and those risks could be quite significant. Mr Darling's forecasts appear reasonable, but not very cautious.


To spend or not to spend?

  • Evan Davis
  • 18 Jan 08, 02:30 PM

If you were a benevolent, omnipotent deity, governing the UK economy at the moment, what would you do?

Assuming that is, you can’t cheat, and help us all by creating a new set of oil fields or offering us free car insurance.

Would you drive consumers into the shops to spend more to boost the economy?

Probably not.

Consumers are saving well below their long run average. We probably need a consumer slowdown of some kind, and we need to wean our economy off the growth that depends on consumers constantly increasing their debt to income ratios.

But while a slowdown is desirable, an abrupt or dislocating halt to all spending is not.

It goes back to John Maynard Keynes and the so-called “paradox of thrift”. Saving is good, but if we all try to save too much simultaneously, we all end up in an economic quagmire as spending dries up, incomes contract and the economy shrinks.

ShoppersSo the question that arises out of today’s retail sales figures is whether the slowdown is now going too far for our own good? Today’s figures were far worse for the shops than expected; worse indeed than the survey from the British Retail Consortium earlier in the month implied.

It is true that in the last three months spending rose by 0.4% and so there are no grounds for panic. (In fact, that 0.4 per quarter amounts to about 1.5% a year, which looks about ideal if you want a gentle slowdown).

The problem is that the decline in the three monthly growth rate has been very rapid, and it could turn negative or seriously negative fairly quickly.

And we need to be aware of the discounting that occurred. For example, buried deep in the data that we got today is the astonishing fact that in household goods stores, prices in December 2007 were more than 8% below their level in 2006. There hasn’t been any deflation like that in recent memory.

So if I were a deity looking after the economy, I would not be programming British shoppers to do their patriotic duty and spend money but I would be ensuring they spent something.

If the power of the consumer to rescue the economy is limited, what else could the almighty do for us? What other options are there for protecting the economy against the risk of a deep slowdown?

He or she could encourage the chancellor to loosen fiscal policy i.e. spend and borrow more and possibly cut taxes? That’s what the Americans are talking about today.

That is an idea for an economic rescue. It’s pure Keynes in fact, another of whose massive contributions to economics was to point out the power of fiscal policy when other policy tools are failing.

But in Britain today, you would probably say that the slowdown is not yet bad enough to merit any special action plan. And there is the small matter of the Chancellor’s Golden Rule. The rule might be breached if the government deliberately went out to spend and borrow more.

In fact, the British government is not that dissimilar to British consumers in having overstretched itself in recent years. With a deficit of about 3% of GDP this year (a year in which the economy has grown strongly despite all the financial market problems) the room to loosen fiscal policy is not really there.

So what else is there that could be done to help the economy? Probably the answer in the UK is for our deity to push down sterling.

That should have the effect of promoting exports, inhibiting imports, and thus reducing the country’s manifestly unsustainable trade deficit. At the same time, it would cushion the country from an excessive slowdown, by allowing households to save more while foreigners take up the slack and buy our goods instead of us.

If a weaker sterling is what the almighty would prescribe for the UK, it is of course what the invisible hand is already delivering to us too. The pound has had a strong year against the US dollar, but don’t be fooled by that. Against the euro, it has tumbled, and carries on tumbling.

And that means what an economically-literate deity would be striving for in the UK this year is re-balancing away from consumer spending, towards trade and exports, with the minimum possible slowdown in the process.

Unfortunately, the process of a significant economic re-balancing is never smooth.

And this one is no exception. Exports will struggle to offset the decline in consumer spending; exports may not take off at all if our customers in the rest of the world face financial troubles of their own. And we still have the problem that there may be a some inflation embedded into the economy – in which case we won’t be able to let sterling fall too far for fear that it will raise import prices in doing so.

So I’m afraid that this will be a difficult year even if it goes well. There’s little point in hoping that government or consumer spending can change that.

Even if we put ourselves in the lap of the gods, we won’t avoid some kind of slowdown in 2008.


How interest rates work

  • Evan Davis
  • 11 Jan 08, 10:14 AM

This is an article dedicated to Kevin Hawkins.

He is the director general of the British Retail Consortium, and probably the most effective trade association representative I have encountered.

He is a wonderful communicator, who avoids the kind of studied, cautious, mealy-mouthed jargon of many public figures. He’s always feisty and never apologises for representing the interest of his members. He’s earned his OBE, and when he stands down from the BRC soon, they (and I) will miss him.

I’ve heard him talk about supermarkets, minimum wages and chickens.

But in the field of macro-economics, there is one message that Kevin Hawkins delivers regularly and repeatedly: that it’s time for the Bank of England to cut interest rates.

He appears to do it month after month. For the BRC, it’s almost always time to cut interest rates.

Shoppers on Oxford Street, LondonWe’ve been through a decade of incredibly robust consumer spending, and yet I can never remember him asking for a rate rise to tame the excesses of the consumer.

In making the case that rates need to fall, Kevin is perfectly representing the desires of his members and I make no criticism of him.

But how relevant is that call in 2008? How successful will those interest rate cuts be at helping the shops?

A little diatribe on the economics of interest rates is useful here…

Interest rate cuts have an effect in stimulating an economy by directly or indirectly making someone, somewhere, spend more than they otherwise would.

That extra spending increases demand and ensures that we all carry on with work to do, without us having to slash our prices or our wrists.

There’s always a dilemma about whether cutting rates threatens inflation - that’s the essence of the decision the MPC has to make each month.

But there is an interesting secondary question to ask of interest rate cuts when they occur. Which spending is it that they are expected to encourage? How will lower rates work their magic on the economy?

In principle, there are only three main components of spending that much matter to monetary policy: consumer spending, business investment and exports and trade.

Taking the three in turn, we consumers are encouraged to spend by lower rates in a number of ways:

- they change our incentive to borrow and save,
- they change the income available for spending for some of us and
- they affect the price of our houses, thus affecting our perception of how much spending we can afford.

When rates are not driving consumption, they affect business investment in a number of ways too. Lower rates tend to cut the cost of capital, which companies use to pay for investment.

As far as trade is concerned, lower rates work through sterling. They mean people are less inclined to park money in Britain; they buy fewer pounds (after all, they earn less interest on them) so sterling falls, and that promotes exports (as well as discouraging imports).

The Bank of England, when making a decision on rates, doesn’t have to care much about which of these mechanisms transmits lower rates into economic action; all have the effect of stimulating the economy at the cost of potentially raising inflation.

People working at a factory in ChinaNow in the recent past, consumer spending has been the active ingredient in the economy – the years of easy money have encouraged consumers to borrow and buy. And we needed consumers to do that in order to soak up the huge supply of manufactured goods coming into the global market from China.

Those days were good for consumers, and for the shops.

But many people - including some of the retailers themselves - appear to work on the casual assumption that if consumer spending is now drying up, all that is needed is for rates to go down to a level at which it takes off again.

That may have been right in 2001. It may not be right for 2007.

The reason is that saving in the UK is still relatively low. At 3% of household disposable income, we are saving at half the long term rate.

Do we expect or want interest rates to drive saving even lower? After all, we have many problems in the UK, but a reluctance for consumers to shop is not one of them.

Fortunately, consumers will decide for themselves whether they want to spend or whether they want to stop. And consumers will look beyond interest rates.

If house prices fall for example, we might all feel we overdid it last year, and choose to be more cautious now.

That means even if interest rates fall this year, they may not do much to stimulate the economy by promoting consumer spending. They might prevent an abrupt and disruptive halt to consumer spending, but I wouldn’t necessarily think of it as likely (or even desirable) that they do much more than that.

To summarise - if the game is up for consumer-led growth, there may not much the Bank of England can do about it.

So does that mean the economy is doomed? Possibly. Lower rates might promote business investment, but in truth, businesses are not normally much inclined to invest if there are not going to be customers for their products.

Burt there is one remaining thing rate cuts can achieve: they can lower the pound and help exporters sell more. The Americans have pulled off this trick to some extent (although there is a long way to go). The British may follow.

That would be good for the economy (if it is not too inflationary); it would keep us in work, while at the same time allowing us to sort out our personal finances.

Shoppers outside Marks and SpencerThe only problem is that improving our trading position would do almost nothing to help Marks and Spencer, other retailers or estate agents.

Indeed, a lower pound can hurt British retailers, who often source from overseas and find their imported goods more expensive. It squeezes their margins.

Kevin Hawkins is probably right to call for rate cuts - the economy probably needs them and will probably get them.

He may be disappointed to find they do little to help his members.


On devaluation

  • Evan Davis
  • 19 Nov 07, 11:39 AM

This week marks 40 years since the 1967 devaluation of the pound. (You may have seen some of the archive coverage on BBC Parliament over the past couple of days.)

How appropriate that we are marking this anniversary now, one of the most famous episodes in British economic history.

Of course, there are lots of other notable episodes in history - the 1931 devaluation, the 1949 devaluation and the 1992 devaluation all come to mind.

But 1967 has a special place. It was the one that saw Harold Wilson famously draw the distinction between the falling value of the pound abroad, and the stable value of the pound at home - the pound in your pocket.

He was sort of right in that distinction incidentally, but not quite right. Devaluations only work when they make people feel a little poorer. Because whatever they do, they have to stop us spending quite so much on foreign goods by making them more expensive.

Now this is a good time to reflect on devaluations because next year we might see our currency fall quite sharply again.

To see the similarities between the sixties and now, we have to understand what a devaluation does.

Back then, we worried a lot about the trade deficit, and devaluations were seen as a way of improving our trading position. The falling pound raises import prices and cuts export prices.

But there's another way of describing the effect of a devaluation, more relevant to our economy today. Falling currencies are the best way an economy can reorient itself from away consumption towards saving.

In fact, the trade deficit is often just an expression of too much spending and borrowing... and not enough saving.

Falling currencies, rising savings and increasing exports are often all part of one and the same thing.

A country that saves more probably has a falling currency. Why? Because if we all choose to save, we lend money to foreigners rather than borrowing it from foreigners, so we buy foreign currency to lend - the pound falls.

You can think of a falling currency as either helping the trade deficit, or increasing savings. They're often the same thing.

Now that's what our economy needed in the 1960s, and it's what it might need now.

Back then, we couldn't afford to keep spending, so we had to increase exports to keep the economy moving. Today, the same is true. We've borrowed and spent enough. If we ask who then can buy our output, it's foreigners. That'll probably take a lower pound now, as it did then.

Of course, the pain of successive devaluations means we have now decided not to join any fancy currency fixing schemes - we'll fix the pound against the price of eggs using an inflation target. Not against the price of Dollars or Deutschmarks.

But just because we don't have a fixed rate pound to devalue, doesn't mean the pound can't fall anymore.


Long-awaited solution?

  • Evan Davis
  • 19 Sep 07, 07:01 AM

The trouble started in the US, and the Federal Reserve's decision to cut interest rates had been awaited for weeks as one potential solution to it.

Indeed, there are worries the US might have become overly dependent on the Fed coming to the rescue at times of financial difficulty - if Superman is always there to save the day, then doesn't Lois Lane let herself get into trouble?

But at the moment, such concerns are not bothering Wall Street. They got what they wanted - the authorities to shift their recent preoccupation with inflation, and to ease the pain of those that have been suffering from their lending decisions. As it is, the US is adjusting to a slowdown - from growth rates of about three per cent, to those of about two per cent.

That adjustment is probably inevitable, as Americans move to more sustainable levels of borrowing and saving, and not even Superman can prevent that. But the goal is simply to prevent a slowdown turning into a recession, particularly given falling house prices.

However - in the UK, where similar issues arise, the heroic job of steering the economy through current stresses is being made far easier by falling inflation. If the Bank of England doesn't have to worry about that, it has more room to manoeuvre to deal with other problems, perhaps sometime following the US with lower interest rates.


My prediction - July

  • Evan Davis
  • 5 Jul 07, 10:00 AM

My prediction today is that interest rates will rise, but I am much less sure of that than everybody else appears to be.

My approximate probabilities are:

Quarter point rise - Two-thirds
No change - One-third

The reason you might expect a change is that the Bank's last inflation forecast implied at least one more is necessary. And if only one MPC member switches vote, we'll get that rise today. Moreover, the governor, Mervyn King, is in favour of a rise. He was opposed by three of his own internal bank colleagues last time, so one of them might move on to his side now, to avoid the (minor) embarrassment of him being out-voted twice in a row.

The reason you might not expect a rise is that little has changed since the last vote which was to delay acting; we are only now a month away from the next inflation report, when there is a new inflation forecast. The MPC prefers to move in those months.

But most significantly, it is still rather early to tell just how biting the previous four rate rises will be. The pain seems to have been delayed by the prevalence of fixed rate mortgages that have yet to expire. Once they do expire of course, the pain to the mortgage-holders is delivered in one hefty dose. We are only beginning to see that occur.

Until we know what the full effect of the other rises is on the economy, the bank has to be wary about over-doing it. Several MPC members think that delaying another rise for a month to see how the existing rises bed down is not particularly dangerous.

Incidentally, if the MPC does vote against the governor again, there will undoubtedly be a flurry of talk about his position being awkward and possibly untenable. Some commentators will say the MPC "lacks confidence" in Mervyn King's leadership..

I'm deeply sceptical.

Disagreements around the timing of quarter point changes in interest rates are of little real intellectual significance. Surely anyone who understands interest rates understands that.

It would be odd if a system built around individual voting - as ours is - rather than collective responsibility, accidentally morphed into one in which everyone had to agree with the governor (or that the governor had to agree with everyone else).

That's not to say there aren't real disagreements on the MPC over other things - such as the importance of money supply in determining inflation. But if our system can't cope with these stresses, MPC members would forever have to be thinking about the politics of how they vote as well as the economics, which would be unlikely to improve decision-making.


My prediction - June

  • Evan Davis
  • 7 Jun 07, 09:09 AM

I think the Bank of England will probably not raise rates when it announces its decision today, preferring a little more time to wait and see how far its four previous rate rises affect us. With that in mind, here are my (subjective) probabilities, rounded up to the nearest 1%.

Probability of no change: 75%

Probability of a rise: 24%

Probability of a cut: 1%


On interest rates... II

  • Evan Davis
  • 10 May 07, 02:24 PM

I'm afraid I can't take any particular pride in having made the right call on interest rates yesterday.. as there was no-one making a different call.

Of course, when rates do change, the Bank gives us a short statement of its views - you can find it here.

The tradition among commentators is to deconstruct the Bank's words for inner meaning. I'm not sure that one needs to. There is a clear recognition that inflation remains a risk, even with it probably falling this year. That leaves open the possibility of further rises in interest rates. Rather than over-intepret the Bank's words though, I would say the argument I outlined yesterday remains valid.


Foot work

  • Evan Davis
  • 10 May 07, 11:01 AM

If you were interested in the decision to allow continued use of imperial measures alongside metric ones, you might be interested in a post I did last month about the subject.


Is the China effect over?

  • Evan Davis
  • 17 Apr 07, 01:28 PM

A few thoughts on inflation.

For the last few years, the biggest risk to the strong performance of UK economy has been inflation.

It has seemed fairly tame, and even-higher oil prices in recent years did push it worryingly high.

But the risk has long been that we would discover that underneath our strong economy, was brewing some hidden inflationary pressure.

If that emerged, it would imply that some of our recent economic success had been built on shaky foundations: it would mean that interest rates had perhaps been "too low", that the borrowing we have done on the back of low interest rates was less affordable than we thought, that the house prices we have paid on the back of easy borrowing are unsustainably high, and that any sense of consumer wealth deriving from higher house prices is a mere illusion.

Indeed, for quite a while, one has been able to imagine the benign conditions of the last few years unwinding if inflation materialised. And that's why economists have been watching it so closely. It is not just about the discomfort of higher prices.

Well, has this inflationary pressure now materialised, or is today's 3.1 per cent rate just a blip?

Certainly it could be a blip as inflation is volatile at the moment, largely as a result of energy price swings. We can soon expect the measured inflation rate to fall as last year's energy price rises drop out of the twelve month inflation rate. And it may fall further as this year's energy price rises push the rate down. And then we can expect it to rise again in a years time, when this year's falls also drop out of the twelve month rate.

So we have to see through that volatility and ask where inflation will settle. That should be well below three percent, but there is still room for concern.

cargo_203ap.jpgIt all comes down to the China effect. In recent years, our economy has been dependent on deflating imported goods prices. To some extent, we've been able to enjoy simultaneous fast domestic growth, strong consumer spending and low inflation, because the prices of manufactured goods have been falling each year.

If the flow of cheap imports dries up, either because the Chinese export prices rise or because our exchange rate falls, then we have to adjust the domestic economy to slower growth and restrained consumer spending.

Today's figures show some worrying signs that manufactured goods prices are picking up. Furniture, toys and games, clothes and textiles all get an honourable mention in the statistical press release, as exerting upward pressure on prices.

boxes203_ap.jpgOne theory is these are going up in price now, as we've reach the end of the gains to be derived from out-sourcing our factories. When there are no more factories to send abroad, there are no more cost-savings to be found in manufactured goods prices.

An alternative theory is that these price rises were merely a pre-Easter one-off, as shops raised prices in anticipation of cutting them again to boast of special offers over the holiday weekend. On that view, they'll unwind in the figure next month.

It's too early to be definitive on whether or not it's time to call an end to the era of ever-cheaper imports, but its certainly a factor to watch.

exchange203_pa.jpgThe other factor to watch is the exchange rate. It has been relatively high, and in recent days strengthening against the dollar. As most Chinese imports are priced in dollars, they are going to get cheaper not more expensive when converted into pounds. But unless the pound rises forever against the dollar - which is unlikely - the exchange rate provides just temporary shelter against import price rises. Don't learn to rely on it.

My own view is that the lesson from the last few months' news on inflation is that if we know we are relying on some potentially temporary factors in keeping our inflation rate down, we might want to be more cautious in economic policy.

Instead of running the economy at a fast speed with inflation pushing at the top end of the tolerable range, you would prefer to have a safety margin, so that if the worst price risks do materialise, there's less of an adjustment to be made.


The state of trade

  • Evan Davis
  • 12 Apr 07, 10:24 AM

While members of the World Trade Organisation spend much of their time arguing about potential reforms to the rules of global trade, (or trying to limit the impact of the rules they've already agreed), the secretariat of the organisation in Geneva gets on with the job of overseeing the trade that is already going on.

And the WTO publishes its annual overview of world trade this morning. (You should be able to find it on their website).

For trade boffins, there are a number of interesting things in it. I can't think of just one to highlight, so here are some bullet points to bring you up to date on the state of trade...

1. Trade continues to grow fast, notwithstanding the failures of trade negotiators to agree on new trade rules. World merchandise trade (i.e. trade in manufactured goods or commodities) grew by 15 per cent in 2006. Trade in commercial services grew by 11 per cent. (These figures take no account of inflation).

2. The WTO expects trade to have a rougher time in 2007 as the world economy is expected to grow less quickly than last year.

3. Trade involving the least-developed countries was strong in 2006, with the value of their exports up 30 per cent. This was driven by higher prices for oil and other commodities. But in addition, there was no evidence that China's surging exports of textiles have come at the expense of the poorest countries. For example, exports of textiles and clothing from least-developed countries to the EU grew by 30 per cent.

4. The world's biggest exporter is the US, followed by Germany and then China. Japan is fourth and Britain is fifth.

5. In terms of exports of goods alone (which account for four-fifths of global trade), Germany is the world leader, with the US second and China third.

6. China's exports of goods grew by 27 per cent last year. Indeed, in the second half of 2006 they overtook those of the US showing that as of now, China is probably the world's second largest goods exporter.

7. India's trade performance does not make it one of the big players. It is the world's tenth biggest exporter of services, but only ranks as the world's 28th biggest exporter of goods, with a one per cent share of global exports.

8. A third of Britain's exports are services, the highest proportion of the world's top 10 exporting nations.


Was it a con?

  • Evan Davis
  • 22 Mar 07, 11:43 AM

The political debate on the Budget has quickly settled on one issue: did the chancellor try to sell his Budget as a tax cut when in reality it is not?

Yesterday, I said that he had not hidden anything: the fact that it was neutral was mentioned in the Budget speech, and the big tax rise was also there for all to hear.

But if didn't hide anything, he didn't quite highlight things either.

A casual listener yesterday could have been forgiven for thinking that it was a tax-cutting Budget in the way the chancellor delivered it. That impression might have been reinforced by his claims this morning that it is a tax-cutting Budget. The sheer importance of the abolition of the 10p tax rise - which is more or less a straight swap for the lower basic rate - might have been given more prominence in a speech that was not designed to disguise the true effect of the Budget measures.

Overall, in 2009/10, when most of the measures take effect, the Budget takes £125 million away from us. That's not a tax-cutting Budget.

The personal tax package - NI, income tax and credits - is a giveaway. But it's more of a giveaway because of the tax credit rises, than because of the income tax changes.

We'll get chapter and verse on all of this from the IFS later today, when they give us their post-Budget analysis at lunchtime.

But the chancellor can at least reject the idea that the Budget tax rises were hidden away in the small print. He did mention them in his speech.

Of course, the charge that Mr Brown is trying to con us is resonant because the Treasury has been less than open and objective in its presentation of the Budget in other respects.

Just three petty examples that sound small but which appear deliberate:

1. Listening to the speech, you would be left with the impression that child benefit was rising significantly. It was mentioned twice. The chancellor said: "I have focused support on families by raising child benefits and child tax credits..." In fact, no extra cash is scored to child benefit at all, as the real increase in the benefit only bites in April 2010. Despite the fact the chancellor said it grows in "successive stages".

2. The Treasury documents furnished us with examples of families which gain from the changes. But they could not - even when pushed - furnish us with an example of any family at all who loses. Even though their own analysis shows there are some. This could not be said to be unspun clarity of exposition in describing the effects of what was being proposed.

3. In his speech itself, the chancellor chose to mention the cash borrowing figures from 2006/7 to 2011/12. For that 2006/7 year, he could tell us that he was borrowing less than he thought back in November. But when it came to the more important measure of borrowing, the current balance, he missed out 2006/07, and gave us the data from 2007/8. Is it a coincidence that on that measure of borrowing, the 2006/7 data has turned out worse than it he'd told us back in November?

Looking back on it today, I know I made some arithmetic mistakes in the rush to produce post-Budget analysis. But it would be much easier for those of us covering Budgets if we didn't have to spend so much uncovering them first.


New alignment

  • Evan Davis
  • 21 Mar 07, 04:27 PM

One more thing about this budget... we shouldn't underestimate a significant point being reached: the alignment of the national insurance and income tax systems... under the old system, you didn't pay national insurance on income over about £35,000 a year. Then you started to pay top rate income tax on income over about £38,000. Now we know that the NI will stop where the higher rates starts.

It was a point that then shadow chancellor John Smith wanted to reach 15 years ago, going into the 1992 election. (People thought the idea lost Labour that election!)

In addition, we also lose the 10p band of income tax, so the tax system does look a bit simpler and more logical.

UPDATE 2100: One clued up reader points out that I'm wrong to say that Gordon Brown has done what John Smith proposed in 1992. Smith actually proposed scrapping the upper earnings limit on an employee's national insurance contributions, whereas Brown has just brought them into line with the top tax rate - a slightly different thing. I stand corrected.


Six Budget thoughts

  • Evan Davis
  • 21 Mar 07, 03:12 PM

1. There will be losers - even if we can't identify them easily, as it's a complicated package.

2. It is a watered down version of the Tory and Labour strategies for greenifying the tax system. By 2010, green taxes rise by £1.4bn, which is used to pay for other personal tax cuts. All three parties now have policies to take us in that direction.

3. It's a substantial budget. Many of the tax measures have been announced over a three-year period. There will be no need for the next chancellor to have a budget for a while!

4. It is the umpteenth budget in a row, in which the chancellor has had to confess that his public finance projections are worse than he thought they'd be! For yet another time, getting his key measure of borrowing - the current balance - into surplus has been postponed until next year. It always seems to be next year.

5. The spending side is tough, as expected. Gordon Brown will see spending grow at about 2% above inflation, instead of the 3.6% they've been used to in the last seven years. It'll feel like a cut.

6. The chancellor does now find himself reforming his own reforms of the tax system. The 10p income tax rate was his idea, he took credit for introducing it, and now takes credit for abolishing it and using the money to cut the basic rate of income tax.

Overall though, this was an ingenious and mega-package of measures, with huge political impact, that managed to use no new resources at all.


Who's paying for it?

  • Evan Davis
  • 21 Mar 07, 01:48 PM

This is a complicated package of national insurance and income tax changes - whopping changes in fact.

Gordon Brown has abolished the lower starting rate of income tax - 10p rate - that’ll raise him eight and a half billion pounds which he uses to cut the basic rate of income tax and this costs him nine and a half billion So, effectively he’s a billion adrift... This will have a huge political impact but it’s only cost him a billion pounds to cut the basic rate of income tax by two pence.

At the upper end, who's paying for it? Better off people, basically. He implements this alignment of the top rate of income tax with where you stop paying national insurance.


Odds on a rate rise

  • Evan Davis
  • 7 Feb 07, 07:53 PM

The close vote at the last meeting implies the MPC is not panicking, and as rates affect inflation a year or two years ahead there may be no need to rush to a second rise now.

However, there's a significant chance rates will go up again, as the data has been surprisingly strong in the last month.. rising pay settlements, strong retail figures, the economy still growing at an annual equivalent rate of over 3%... why would you wait?

Overall, I'd say there's a one-third chance rates will rise again this month.


Europe: A basket case?

  • Evan Davis
  • 1 Feb 07, 11:28 AM

I'm sure you don't expect me to answer this question. We are the BBC after all, and take a view on these things. But the OECD's annual report on the Euro area has landed on my desk with some reasonable views. So let me give you my three point executive summary of the full executive summary of the actual OECD report.

First, the Eurozone recovery seems to be underway. After slow growth for ages, and after predicting recovery for about six years, it does at last seem that growth is returning. This is a good thing, as the world needs someone to be doing some shopping so the fatigued American consumer can take a rest.

Second, the euro gets the blame for everything that goes wrong in Europe, which is misguided as in fact many of problems are longer term and structural rather than currency related. They'll take a lot more to cure than merely tinkering with monetary policy.

Third, fiscal policy is a bit ragged in the eurozone. Governments have not taken tough decisions to reduce borrowing and debt, and they had better start doing so because the changing demographics of the continent mean that things are set to get worse as pension and health systems become more expensive.

By the way, these points are not gospel, just because they come from the OECD. But the organisation is staffed by some very sensible and reasonable-minded economists.

The BBC is not responsible for the content of external internet sites