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Archives for January 2009

The pressure for protectionism

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Stephanie Flanders | 14:41 UK time, Friday, 30 January 2009

"History is not destiny", Gordon Brown said in Davos this morning. His aides tell me he was referring to the need for governments to stop talking about the global crisis and start acting.

But this is a day when striking refinery workers have thrown his talk of "British jobs for British workers" back in his face.

He might just as well have been talking about the history of the 1930s - when countries turned to protectionism and the global capital market fell apart. The growing feeling in Davos is that it is history we may be about to repeat.

Gordon Brown in DavosI talked earlier this week about the rise of financial protectionism. Gordon Brown called it "financial mercantilism" in today's press conference and he stood against it.

He said that the banks' return to their home markets was already hitting capital flows to the developing world, and could lead to full-blown protectionism down the road.

He also grimly reminded his audience that "protectionism protects no-one and least of all the poor". And yet, his government's own approach to Britain's banks shows how hard it can be to resist.

We have a huge stake in keeping the global capital market going - global capital is something we need quite a lot of. But British banks have themselves been under pressure to focus scarce lending on borrowers here at home.

The pressure is not always explicit, but it's there - and as much in the City as on Wall Street.

At least one central banker I spoke to here in Davos politely suggested the prime minister might want to get his own mercantilist house in order before lecturing everyone else.

Uncharted territory

Stephanie Flanders | 17:16 UK time, Thursday, 29 January 2009

"Unconventional" monetary policy is only supposed to happen when official interest rates are at zero and plain old vanilla policies have nowhere to go. So why did the Bank of England confirm today that it was poised to buy up "high quality" corporate debt?

This is not "quantitative easing". Nor is it printing money. But, by the governor's own admission, it is highly unconventional (in fact, he says it's an "unconventional unconventional measure", but let's not go there). And it's despite the fact that official interest rates are still at 1.5%.

One answer is that this is all about confidence, and after playing catch up for so much of the credit crunch, the authorities need to do everything to show they're thinking ahead.

Another is that buying up corporate debt theoretically has a distinct objective - improving the credit environment by reducing the yields in those markets.

But there is a more general point: as the economist David Miles noted in this week's Green Budget from the IFS. The Bank may well hope to avoid taking the policy rate to zero - for the sake of the banks.

Their problem is that whenever official rates go down, they are under heavy pressure to cut lending rates in tandem, but many deposit rates are already very low and can go no lower. So margins shrink further, and the banks get squeezed even more than they are already.

The upshot: the Bank of England is likely to be doing a lot of unconventional things long before rates get to zero.

However, a senior economist I spoke to in Davos reminded me that we've heard this argument before - in fact, the Federal Reserve tried the same thing last year. It didn't work.

If the central bank is successful in increasing banks' cash reserves, overnight market rates can go down close to zero, even if official rates are still positive.

The Fed found the anomaly sufficiently uncomfortable that it fairly quickly brought the official rate down too. As it confirmed in yesterday's gloomy statement, it is going to stay there for a long time.

Economists I've spoken to here think the UK will end up in the same place. But it's possible they will be happy with overnight rates being out of step with Bank rate.

After all, the pressure on commercial lenders is to match "headline" interest rate changes. The mainstream press now pays more attention to the overnight markets than it used to, but it's hardly the stuff of headlines.

Whatever happens, it's uncharted territory for the UK's monetary policy and we are about to step into it.

Biggest game in town

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Stephanie Flanders | 13:00 UK time, Thursday, 29 January 2009

It started in the US. And that is where it must end.

For all the talk of the rising power of the East, the passage of today's $819bn stimulus package reminds us that some things haven't changed.

The very absence of US policymakers from Davos tells the story. None of them are here because they're too busy saving the world.

In 10 or 20 years' time, the world economy will probably have other engines it can turn to when American demand starts to falter. But right now, we are still all chained to the buying capacity of the US.

Chinese and Russians officials don't like America's presumption. Their complaints about the US are today festooned on the front page of the FT.

Having caused the crisis, the Chinese premier effectively suggested the Americans should show a bit more humility in deciding the best way out.

Igor Yurgens, a senior advisor to the Russian president, took a sharper tack. He said President Obama's stimulus package was "selfish" and philosophically akin to protectionism.

Bill ClintonBill Clinton is the closest thing Davos has to a senior US official this year and he responded pretty directly at a packed session this morning.

"The Chinese PM is right. It all started in the US." But, he said, the only way out was through a US stimulus, and that depended on other countries buying US debt - primarily countries like China that are "export-dependent, cash-rich but hurting."

The world needs the Chinese to stimulate their domestic economy to help fill the gap left by collapsing US demand. But I doubt that any Russian or Chinese policymakers seriously want the Americans to sit on their hands.

At the heart of the spats with the US is a more basic frustration that the dollar's status as the world's reserve currency means that, yet again, America is getting a free pass.

Governments all over the world are plunging into deficit to get themselves out of this mess. And the more profligate they were in the past, the more they are paying the price in the form of a falling currency. Witness what's happened to the pound.

But not the US. Because it is the world's reserve currency it can flood the world with US debt, and the dollar barely falters. It has even risen a little today.

It's not fair. And it may change. But for the moment, America and its currency are the biggest game in town.

After the fog...?

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Stephanie Flanders | 20:26 UK time, Wednesday, 28 January 2009

There used to be something symbolic about Davos - all those movers and shakers going to the mountains to talk about capitalism being on top. This year the more apt feature is the fog. No one knows where the world is going. But they're fairly sure it's in the opposite direction to the one before.

It's not just that economies have gone into reverse - spectacularly so in the case of the UK, if you share the pessimism of the IMF. There's also a more general sense - that the market capitalism they've promoted so long here at Davos is now seriously in retreat.

Even here, the call is for more regulation and more government to save the global market system from itself. But when the fog finally lifts, some here fear there won't be much of a global market system left. At least when it comes to international capital.

Speaker after speaker in the meeting halls talked today of preventing a costly retreat into protectionism. But where the financial system is concerned, we're already there. Nearly all governments are pressuring their banks to direct scarce lending to their home markets, with costly consequences for countries like the UK that depend on foreign loans. When things get tough, we've learned that even the most 'global' of commercial banks will skulk home to raid the coffers of national governments.

Persuading developing countries to open their economies to global capital flows has always been a hard sell - especially after the emerging market crises of the late 1990s. Now even some senior policy makers in the UK and US are wondering whether a global capital market can work.

In a few years time, Davos Man may make a comeback. But if it's globalisation he's talking about I suspect it will be globalisation minus finance.

The IFS spells out the bad news

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Stephanie Flanders | 11:33 UK time, Wednesday, 28 January 2009

Anyone who wants to get to the bottom of the mess in the UK's public finances needs to read the latest Green Budget from the Institute for Fiscal Studies, out today.

This annual publication is usually for fiscal aficionados (try saying that quickly). But this year it has something for everyone - none of it good.

For the government, there's devastating clarity on the scale of the problem and how far Labour has come from the bright promises of 1997.

For the Conservatives, there's a warning that the economic options for an incoming Cameron administration would be even narrower than they think.

And for us lowly citizens, there's a road map to the future that makes for bleak reading indeed.

Typically we look to the IFS's Green Budget to find out how wrong it thinks the Treasury's budget forecasts are likely to be. There's some of that here too. The IFS economists reckon that borrowing will be more than £6bn higher this year and next than the Chancellor forecast in his November Pre-Budget Report.

Overall, they think the government is being around £20bn too optimistic in its forecasts for borrowing between now and 2013. That's not nothing. But, as the IFS admits, it's well within the margin of error for forecasts like these.

The average forecasting error for borrowing one year in advance is around £15bn; for forecasting three years ahead it is £30bn. The Green Budget's own forecasts for borrowing in 2007-8 were actually further off than the government's (oddly enough, both were too pessimistic).

More interesting than these short-term forecasts is a chastening bit of historical perspective.

Graph showing deficit under Tories and Labour

As this chart shows, the deficit under Labour has followed almost exactly the same path as it did under the Tories. Only this time, the final act is looking even worse.

After ten years of Labour we are entering this recession with a larger underlying deficit and higher net debt than we had going into the early 1990s recession. Britain had the second highest structural budget deficit in the G7 in 2007. And the Treasury now expects debt and borrowing to reach levels higher than those seen in any year under the Conservatives.

But the opposition shouldn't feel too smug. There's plenty in the IFS report to give George Osborne pause for thought. The IFS rejects criticism of the November temporary VAT cut: "Those dismissing it as a failure ignore the likelihood that things would have been even worse without it."

The IFS also gives the lie to the notion that the explosion in borrowing can be blamed on the November stimulus package.


This wonderful chart shows the forecast for net public debt over the next few years - with, and without, the stimulus package. If you're finding it hard to spot the difference, that's the point.

At most the package accounts for only one-fifteenth of the rise in government debt by 2013-14. The looming hole in the public finances has very little to do with anything the Chancellor did to VAT.

The Conservatives have criticised the future tax rises announced in the PBR and insisted that tougher cuts in spending are the way forward. The IFS has now done them the service of showing them quite how tightly the government is squeezing spending already.

Thanks to the recession, spending will soar this year and next, but between 2010 and 2015 the budget is going to tighten by 2.6% of GDP. Of that, only 0.25% of GDP is accounted for by higher taxes.

Finally, the IFS brings the news that we taxpayers will be paying for the credit crunch for a generation. It reckons that debt will not fall back to the government's old ceiling of 40% of GDP until 2031.

The good news is that the Treasury isn't expecting that debt to cost us very much. If interest rates stay low, debt servicing as a share of GDP will be lower than in the mid-90s or early 80s. The bad news is that if interest rates go back up to more normal levels, debt will once again be on an ultimately explosive path.

On top of all that, there's a bleak assessment of the UK's potential growth rate over the next few years. But that's probably enough bad news for a single blog.

If you're looking for light relief, I recommend you take a look at the "four main goals for its management of the public finances" which Labour set itself in 1997, reprinted on page 10 of the IFS report. They're a hoot.

European borrowing: The ugly truth

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Stephanie Flanders | 11:39 UK time, Tuesday, 27 January 2009

Fitch, the ratings agency, has just brought out a special report on borrowing by European governments, and whether it's sustainable. The headline conclusion supports what I said yesterday: they think that the rise in debt levels is manageable for big countries like the UK. But the fine print is not very reassuring. .

Fitch projects that European governments will have to raise a grand total of nearly 2 trillion euros in 2009, or 17% of GDP. That's 45% higher than last year. Borrowing by the five largest borrowers - France, Germany, Italy, Spain and the UK - will be at a record level relative to GDP.

The figures are even worse for some of the smaller countries: Ireland needs to raise 47bn euros on the markets this year - a whopping 26% of GDP.

The sheer pace of the downturn in EU budgets is down to a combination of worsening economic news and governments' stimulus efforts. Fitch reckons that gloomier economic news since September will add, on average, another 1.5% of GDP to government deficits.

Some are now expecting further revisions to the UK's deficit numbers as a result of last week's dismal GDP figures for the last quarter of 2008. We won't find out the scale of the damage until the budget - although the Institute for Fiscal Studies will be giving its best guess in its Green Budget tomorrow.

For what it's worth, I don't expect the budget to show borrowing revisions for this year of much more than 0.5% of GDP - around £10bn. But that's only because the government forecasts were so recent, and already so gloomy.

Fitch thinks the UK's deficit will peak this year at 8.3% of GDP - second only to Ireland. But, interestingly, our funding needs for this year are actually lower than the other large economies because we have relatively little old debt coming up for repayment.

That's good news, for this year. But it could store up problems for next year, because few expect investors to remain quite so keen to buy up sovereign debt.

As I said yesterday, the Treasury is still borrowing very cheaply - the interest rate on 10-year debt is about one percentage point below where it was last summer. That's because investors everywhere are still seeking the safest investments around, and even high-grade companies are cutting debt, not looking for more.

That won't be true forever (or let's hope not). In a year or so, government debt management offices might find themselves in a more competitive market.

The Fitch report raises another, related, worry. The uncertainty about the future means that investors at the moment like short-term government paper best - interest rates on short-term debt have fallen most of all.

If European governments all rush to save money by creating more short-term debt, that could raise problems down the road when conditions change, and they all find themselves simultaneously trying to roll over a lot of debt.

Robert Zoellick and Dominique Strauss-KahnThe heads of the World Bank and IMF yesterday criticized governments for not co-operating more in the face of the crunch. He was talking about bank bailouts and fiscal stimulus programmes. But the dry - increasingly central - area of debt management is another where countries might do well to follow their lead.

Update 1312: Several of you have asked whether we should put any store by a report by a major ratings agency. Wasn't it this kind of paragon that got us into this mess, by thinking you could turn risky sub-prime assets into triple-A?

You have a point. After the mistakes - if that's not too small a word - of the last few years, it will take time for the big ratings agencies to regain their credibility. If they ever do.

Trouble is, at the moment the ratings agencies have a pretty critical role in the global financial system. In fact, the new Basel II accord for bank capital standards makes them even bigger players. That may change. But whatever their past failures, regulators and governments have not yet come up with a better way.

That makes the views of the ratings agencies important - even if they might be wrong. That's especially true for governments. If the major ratings agencies don't think the UK is going to have trouble managing its public debt - and so far they don't - then the UK will keep its triple-A status. That, in turn, makes its easier for the government to borrow, and a serious debt problem that much less likely.

As we've learned, the fact that a ratings agency says something doesn't make it so. But in the imperfect financial system we all still live in, it sure does help.

Bust Britain?

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Stephanie Flanders | 16:29 UK time, Monday, 26 January 2009

Is Britain in danger of going bust? It's the question a lot of people have been asking as the pound lurches to new lows.

It makes for a lot of breathless comment. The leader of the opposition even raised the spectre of a return to the IMF. But there's a distinct lack of clarity on what it means and how, exactly, it might come about.

There seem to be two big concerns. One relates to the debts of the banking system; the other to the debts of the government.

A person holds an umbrella over the Bank of England in London. Tim Ireland/PA WireThe first worry is that the British banking system has a ton of foreign debts that it would find difficult to repay if sterling spiralled out of control. It's certainly true that the British banking system has a lot of foreign currency debt - the total foreign currency liabilities of UK-based banks were about £4.6 trillion in November of 2008 according to the latest Bank of England statistics, of which £3.3 trillion was owed to non-residents.

That's the figure that could rocket in value if sterling fell sharply. But a lot of that debt is owed by UK branches of foreign banks. Roughly £1.5 trillion of those liabilities are held by UK banks - £840bn of it owed to non-residents.

Most important, the banking system has plenty of foreign currency assets to counterbalance that mountain of debt - about £4.7 trillion-worth, on the last count, of which more than £1.5 trillion is held by UK banks.

When it comes to the debt owed to non-residents, UK banks actually have quite a significant safety margin: foreign currency assets of £1.1 trillion to put against liabilities of £840bn.

You may not think that the nationality of a bank matters very much any more. (Though it does matter to the authorities, and to the banks themselves. As the prime minister pointed out this morning, lenders from outside the UK have been responsible for much of the decline in lending to UK companies and households since the autumn. That's because they've been under pressure from their national authorities to keep up lending rates in their home markets.)

Either way, it's clear that UK banks - and the system as a whole - have foreign currency assets which match or exceed their liabilities.

Worriers point out that we don't know what those foreign assets are, or what they're worth in a shrinking global economy. They tend to be riskier than the borrowing on the liability side, and harder to sell in a hurry.

That is all true. But whatever the assets may now be worth, we can be fairly sure that their sterling value would go up in the event of a run on the pound.

The surprising bottom line is that British-owned banks should stand to gain from a lower pound, at least in simple balance sheet terms. Their net foreign currency liabilities would go down. Indeed, Ben Broadbent, an economist at Goldman Sachs, has put this forward as one justification for a "corrective" fall in the pound.

Of course, part of the reason for the markets' concern is that a lot of British banks' debts are effectively being taken over by the government. With all this new debt sloshing around, there is an easier way that Britain could get into trouble: the government could simply run out of buyers for its debt.

With borrowing on the scale the government now contemplates, nothing is impossible. But there's no sign of any buyers' strike happening yet - in fact, the government is still borrowing at historically low rates.

If demand for British debt did start to dry up, the interest rate the government had to pay could start to rise, and that would undermine the Bank of England's efforts to keep lending rates down. That, in turn, could trigger a further flight from the pound.

Any effort to defend the currency with higher interest rates could trigger another set of fears about the shape of the economy. You don't want to go very far along that road with the economy as weak as it is today.

But as I said, the government doesn't seem to be anywhere near that today. And the Bank of England is not about to start reversing its interest rate cuts to defend the pound.

Indeed, you can take some heart from the fact that senior French officials have been publicly fuming about the fall in sterling. They're not worried about Britain going bust. They're worried about British exporters doing rather too well out of a weak currency.

So, we won't be calling the IMF any time soon. And good thing too, because I suspect we'd be put on hold. These days the IMF doesn't have nearly enough money to help us out. It's also being run by a Frenchman.

Recession Greatest Hits

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Stephanie Flanders | 17:45 UK time, Friday, 23 January 2009

Every recession tells its own story - in the '90s, it all began with a housing bust; in the '70s, it was the rocketing price of oil. In the 1930s you had a global stock market crash and a lot of runs on banks.

This one has shades of all three - you could call it a Recession Greatest Hits. As in the past, the sheer pace of the decline has taken everyone by surprise. In fact, as this chart from Fathom Financial Consulting shows, the decline in the first six months is actually very similar to the average of past recessions.

Fathom Financial Consulting graph showing GDP difference from peak, per cent

Now that it's hit, there aren't many predicting a speedy end. Growth in the new year is about as optimistic as it gets. It could be two or three years before the economy gets back to where it was - and the 2012 economy could look rather different from the one we had before.

What will that post-recession economy look like? Chris Giles had a good stab at the answer in this morning's FT.

There'll be a smaller financial system, for sure. And lower house prices. Maybe even a return to selling stuff to the rest of the world.

Martin Weale, the director of the National Institute of Economic and Social Research, said today that he thought the fall in the exchange rate could pave the way for a British manufacturing "renaissance". Well, it could happen.

The 2012 economy should also be more frugal. We and the government will have to be more sensible with our cash. You can expect it to be a safer economy, less prone to excess. Just don't expect it to be quite as fun.

The writing on the wall

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Stephanie Flanders | 11:01 UK time, Friday, 23 January 2009

So it's official. The UK is in recession, and it's no mere technicality. It seems like old news. But from the standpoint of even a few months ago, it's a bolt from the blue.

As recently as last June, the City thought there was only a one in three chance of a "technical" recession - two consecutive quarters of negative growth. The odds on a full-blown recession, when growth falls year-on-year, were just one in five.

Today, we ticked both boxes with a single number: a preliminary estimate that the economy shrank by 1.5% in the final three months of 2008. The year-on-year decline was 1.8%.

quarterly GDP figures since 1990

Back in its November 2007 Inflation Report - not much more than a year ago - the Bank of England thought there was as much chance of that kind of decline in growth as there was of a rise of 4%.

At the time, I remember my illustrious predecessor Evan Davis and myself at the press conference launching the report both asking the Governor, Mervyn King, whether he really thought the chances were that slim. But I can't say that either of us thought it was the most likely outcome.

The astonishing thing is - nobody did. As HSBC's Chief Economist Stephen King pointed out recently, if you look at the consensus forecasts for 2009 at the start of last year, not one forecaster predicted the scale of the meltdown. Not one. And the average forecast was for growth of 2%, even though the credit crunch was already well under way.

Of course, economists weren't the only ones to miss the writing on the wall. Everyone did - bank chiefs, regulators, governments, and certainly voters. But there are particular reasons why economists were caught out.

A big one is that most economists are nervous of sticking their necks out. As John Maynard Keynes once said: in the City, it's better to be conventionally wrong than unconventionally right.

Of course, you have your mavericks - or maybe just professional pessimists. (I interviewed one of the most prominent, Nouriel Roubini, this morning - see below.) But most are not employed by large banks or City firms. There may be several City analysts out there who thought we were heading for a fall, but as John Kay points out in a recent book, City mavericks can often lose their jobs, long before they are proved right.

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That's why economic forecasts tend to move together. Of course, once everyone expects a recession, it's safe to expect one too, as every City economist now does. But by then, the recession is already at hand.

I guess that part of the story is no surprise: if we - and policy makers - could all see recessions coming in advance, they would never happen at all.

Update 1403: A number of you have left comments saying that there were plenty of people who predicted this recession. Of course, you're right.

As I said, there were economists who forecast an end to the boom, and plenty more in industry and around the economy who said that it would all end in tears.

But I was making a specific observation about the professional economic forecasters in the City and in major institutions like the IMF, the European Commission and the OECD - and about their concrete predictions for 2009. It's all very well saying that the good times won't last forever; it's quite another to say that they will end next year.

Consensus Forecasts publishes a monthly digest of economic predictions by the top 36 major private and public sector forecasters. The digest for January 2008 shows only one, Economic Perspectives, forecasting a recession, and they only expected a decline of 1.3% in 2009.

Today, it all seems so obvious. How could we not have a full-blown recession after so many years of excess? You could ask that question of every financial regulator and every economic policy maker - not to mention every local estate agent.

But the simple fact is that even twelve months ago, nearly everyone paid to get these things right had it very wrong. Shocking, maybe. But true.

Welcome to Stephanomics

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Stephanie Flanders | 09:33 UK time, Friday, 23 January 2009

I'm an economist who always wanted to be a journalist. Or maybe a journalist who always wanted to be an economist. Either way, I've spent most of my life trying to bring economic ideas to a wider audience. And that's what I want to do in this blog.

Not so long ago, economics was a dry and dismal backwater. The "macro" issues had more or less gone away. We all lived in a Goldilocks world economy where the mix of growth and inflation was "just right". And the "micro" side of economics - all that stuff about incentives and why people do what they do - well, that was safely locked in the impenetrable prose of academic journals.

money and newspaper cuttings. debt, credit, recession, coinsNot any more. The fairytale economy of the nineties and noughties has turned out to be just that - a fairy tale. Old-fashioned macroeconomics is back, and the commentators are brushing up on the formal definition of a slump. Thanks to books like Freakonomics, The Undercover Economist, and others, the "micro" side of economics has come out of the woodwork as well.

So I don't think I'll be short of subject matter for this blog. There will be plenty of day-to-day observations on economic events - and plenty of economic events to write about. But I hope to also find time for some more considered entries along the way. And I've spent a fair bit of my career in the US, so don't expect me to focus only on the UK. You live in a global economy, and so does Stephanomics.

About Stephanie Flanders

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Stephanie Flanders | 09:13 UK time, Friday, 23 January 2009

I've been the BBC's economics editor since April 2008. Before that, I had been Newsnight's economics editor since October 2002.

flanders_226.jpgI've been a policy wonk as well as a journalist. From 1997 to 2001, I worked as a speechwriter and advisor to the US Treasury Secretary, Larry Summers, where I was involved in the management of the emerging market crises of the late '90s. (You could say they were a rehearsal for the crises of 2007-8.)

I've also worked as a reporter for the New York Times, and as principal editor of the UN's 2002 Human Development Report.

Before heading off to the US, I wrote leaders and economics columns for the FT, and worked as an economist at the Institute for Fiscal Studies and London Business School.

My father was Michael Flanders, of the 1950s and '60s musical comedy duo, Flanders and Swann; you can listen below to a programme I made about him for Radio 4's The Archive Hour in June 2007. But I don't plan to end any of my reports with a rendition of I'm A Gnu.

I live with my partner in west London, with our son Stanley and our daughter Claudia. She is a child of the credit crunch.

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