Monday, November 24, 2008

Some initial thoughts about the budget

My main impression was that this was a budget to shore up business. Let's deal immediately with the temporary cut in VAT from 17.5% to 15%, which will cost circa £12bn. Tories are saying "this won't make any difference". They sincerely believe that releasing £12bn into the economy will have no effect and this reflects their lack of understanding of how business works (possibly because their leadership comes from the aristocracy rather than the commercial community).

Here's why it will make a difference. In the current tough retail climate, retailers are slashing prices - for example the M&S 20% discount sale. When retailers slash prices, they are in effect slashing their margins. But there is a limit as to how low they can slash. If the price the consumer is demanding is below the break-even price for the retailer, the retailer has only a few options. They can try to cut costs such as heads of staff - which will increase unemployment, and which has the effect of scaring other consumers, fearful for their own jobs, into spending less. They can try to cut the price below break-even to grab market share and force their weaker competitors to try to match them and take losses in the hopes of forcing them out of business (job losses again), which then opens up room to raise prices again. Or they can try to hold prices at break-even and hope that their competitors who are discounting cannot sustain the discounts for long, and either go bust (job losses) or raise prices to above break-even again.

Therefore doing nothing leads to job losses. VAT represents a cost to business. So the 2.5% cut means that they should be able to maintain small margins even while discounting, and hence forstall the need to cut costs through letting employees go. That's why the retail industry has welcomed todays move. The main point about this is to help businesses maintain trading and thus safeguard employment.

The Tory opposition to the £12bn cut is also incoherant - if we had raised VAT by £12bn they would have made no end of fuss. But if it makes no difference one way it should make no difference the other way!

The govt has also deferred the small business corporation tax increase, and let struggling businesses spread the amount they owe the Inland Revenue, which should make a huge difference to cashflow. As any small business knows, the Inland Revenue is the scariest of creditors and it is usually not being able to pay the Revenue that precipitates firms going into bankruptcy. The additional help to small business will be worth £7bn.

What about boosts to the consumer, I hear you ask. This will come from monetary policy. The 1.5% cut in the base rate has been passed on by most lenders (apart from HSBC), and will hit people on the standard variable rate or trackers in Dec. It's worth about £100 a month. The BoE will undoubtedly cut rates again in Dec, and going forward.

So you see a two-pronged attack - putting money into pockets via monetary policy and shoring business up (and hence employment) via fiscal policy.

With regard to the tax rise for those earning over £150k - the cover for doing this comes from the election of President Obama. I wrote the following on 5th November:

Obama has stated that he thinks a person on an income of $250k is rich (this is about £158k). He intends to raise the top federal tax rates to to 36% and 39.6% (from the current 33% and 35%). Remember that Americans pay state income tax in addition to federal income tax. The American state that mirrors Britain's economy most is New York State. There, the state income tax if your income range is between $100,001 and $500,000, is 7.375%. If your income range is $500,001 and over, your tax rate is 7.7%. People living in New York City pay city income tax too of between 2.9% and 3.6%.

That means that the top marginal rate of tax for high earners in New York City (London's great rival) will go up from the current 46.3% to 50.9% under Obama. Compare that to the 41% levied in the UK.

The tax rise comes into effect in 2011, when Obama will have implemented his tax rise. This means that those in the City inclined to complain won't find it viable to up roots and go to New York. They are still better off in London. The 0.5% increase in N.I. will mainly affect those who earn over £20k (due to moving of the thresholds).

The other point to make is that the tax rises will come after the general election, so the country has a chance to vote on it.

Regarding borrowing - the point needs to be made that doing nothing and letting a deep sustained recession take place will kill tax revenue, and force government borrowing up even further. Only the economically illiterate do not understand this. As for public spending, the next round will have an increase of just 1.2%, which is very tight. In order for the Tories to do better than that they will need to actually close schools and hospitals.

So now the battle for the next election is set. People in 2010 will be voting to either increase tax on those over £150k to 45%, or to vote Tory and keep the top rate as it is, to increase the inheritance tax threshold to £2 million from the current circa £600k, and to pay for it by physically closing hospitals.

Monday, November 17, 2008

The Australian Dollar

As you can see from the chart, the Australian Dollar has also lost a third of it's value against the US dollar since August (and dropped precipitously against the yen too). This despite the Aussies running budget surpluses. The Australians were due to have a budget surplus of 1.8% of GDP in this tax year, it will be less than that as they are increasing spending to offset the downturn - but they will be in a fiscally sounder position than both the Americans and Japanese.

So why are they having a downturn and why is their currency falling? Hint: it's nothing at all to do with Gordon Brown! There is a global recession going on that is effecting every country on earth. As for currency movements, hot money tends to overwhelm movements due to trade or government borrowing. (If you doubt this, ponder on the fact that the pound's value against the dollar is exactly what it was in 2002, when the Labour government was running the biggest budget surpluses since the 1940's).

Since 2002, hedge funds and other traders have borrowed in dollars and yen (which had very low interest rates) and invested in Europe, Australia, New Zealand, and the emerging economies (Brazil, South Africa etc). These loans are being called in, money is also being withdrawn from hedge funds by investors, so they are selling assets abroad (causing falls in the world markets), and then repatriating the money to pay off their loans - which is why the dollar and yen are rising.

Now, every world finance minister and their opposition counterparts know this, apart from George Osborne, who is under the impression that the forex markets can actually be controlled by governments!

No one can control the forex market, it's too big, there is too much money in it and too many players. Those who direct fiscal and monetary policy with an aim to target a certain exchange rate are doomed to failure, as Nigel Lawson and John Major proved so expensively.

If exchange rate movements make you queasy, you can always take refuge within a fixed rate system like the euro. But if you want a floating currency, you need to accept that it will move all over the place, you need to accept that you will have no control over it and you need to have enough nerve to not intervene or panic about it.

The trouble is Tories hate Europe, so don't want the euro. But they are also the biggest panic merchants out there! We saw that with Lawson and John Major, and now with Osborne. But panic and intervention combined with a floating currency system is the worst of all worlds. Intervening in currency markets doesn't work. Crafting fiscal and monetary policy with the aim to target the exchange rate instead of domestic consumption, destabalises economies.

The Tories have clearly learnt nothing from the disasters of Lawson shadowing the D-mark and John Major's ERM experiment. But we should be grateful to Osborne for letting us see now, before the general election, how clueless he is.

Saturday, November 15, 2008

Osborne upset that floating exchange rate, er, floats!

George Osborne has today accused the government of causing a "sterling collapse, a run on the pound". No doubt he is trying to evoke memories of 1970's "sterling crises" (Osborne is rather obsessed with the 1970's - when Labour nationalised Northern Rock in February, Osborne's response was to say "We will not back nationalisation. We will not help Gordon Brown take this country back to the 1970s.")

However, you can only have a sterling crisis if you are within a fixed exchange rate system such as Bretton Woods, or the ERM, or if you have borrowed in a currency not your own, which means that movements in the exchange rate affect the government's ability to service existing debt (eg Hungary has a lot of euro-denominated debt, and the collapse of the forint has meant that existing coupons are suddenly more expensive as they have to pay these in euros). None of this applies to Britain at the moment - we are not in a fixed exchange rate mechanism, and our government only borrows in sterling.

The whole point about floating exchange rates is that they float, shock horror! This means, Georgie-boy, that they go up, down, and occasionally sideways, and it doesn't always mean much due to hot money overwhelming fundamentals. See the chart at the top (click to enlarge it). Sterling collapsed in 1985, but this did not mean that the economy was in trouble - indeed the economy was far stronger in 1985 than it was in 1981. Similarly, the economy was stronger in 1993 than it was in 1990, the economy was stronger in the lead up to 2001 bust than after it. The exchange rate reflects more speculation and hot flows of money than anything else (though relative performance between economies plays some part too). At the moment, there is massive deleveraging going on in the markets. Money borrowed in dollars and invested elsewhere is returning back to the USA so that loans can be repaid (and this is also happening to the yen, hence that currency's sudden strengthening to the dismay of the Japanese - BTW Japan's sovereign debt is over 150% of GDP, so much for Osborne's theory that high sovereign debt weakens currencies!)

Does a weaker currency help or hurt the UK? It should help. The reason we have had a negative trade balance in recent years (i.e. imports are greater than exports) is because sterling has been so strong for so long. The currency level dictates the trade balance, rather than the trade balance being independent of currency as some ignorant Tories are suggesting. It's is cheaper to buy foreign goods and services than to buy local when you have a strong currency, and very difficult to export in these conditions. This should start to reverse.

We are already seeing people taking their holidays in the UK rather than going abroad - in the stats, this counts as a reduction in imports of tourism services. It's no longer worth people making a Christmas shopping trip to New York as they did last year - it's now cheaper to shop at home, to the relief of the retailers. I imagine supermarket buyers are already seeking to stop sourcing goods in the dollar and euro zones and looking to buy locally. We'll see fewer blueberries and cranberries and more blackberies and raspberries on the shelves.

Businesses like Airbus price their planes in dollars, but their costs are in euros and sterling (the cost of staff is always the biggest expenditure in modern manufacturing businesses). They were suffering under the strong pound and euro, but will now experience a competitive advantage over Boeing. Businesses that export IT services such as Sage will also benefit - they price their products to Europeans in euros and to Americans in dollars. Most international contracts are priced in dollars (especially to the Far East). The dollar is still the currency that the world does business in, and the Americans in recent years have been trying to borrow growth from the rest of the world with a weak currency. We have respite from this at the moment. How long it will last is anyone's guess - it will take a little longer to deleverage and longer than that to see how economies perform relative to each other. But British exporters of goods and services should make hay while they can.

Oh - there was some suggestion in the Times that Osborne was "talking down the pound", which made me chuckle. He has such a poor understanding of economies and such a poor standing in the world, I doubt very much that he has the ability to move anything. Vince Cable pointed out how odd it was that the Tories were complaining about the floating currency being flexible. Tories do have a tendency to worry about exchange rate flexibility - the last time they were in power they tried to shadow the D-mark, then when they got into economic difficulties, their solution was to remove flexibility completely and join the ERM! And now here we have Osborne thinking that the job of the govt is to maintain a certain exchange rate. Labour however knows that you should simply leave the exchange rate to do it's thing, and not interfere or worry about it (it's impossible to control the forex markets anyway and there are more important priorities for the government to concentrate on).

Saturday, November 08, 2008

The Interest Rate Cut

Apparently the banks were pretty miffed to be hauled up to see Alistair Darling and asked why they were not passing on the BoE's interest rate cut. The banks wanted to widen their margins some more (most didn't pass on the full 0.75% cut that took place earlier this year, and some didn't pass on the full 0.5% cut in October and they still wanted to widen their margins further by not fully passing on November's 1.5% cut). They've been whining about their profits - but bank net interest margins are more than holding up according to this article from the Times.

Of course it's not the British government's job to ensure the banks make profits. Merely to ensure that they don't collapse. After all, no one forced RBS to blow £49bn buying ABN Amro, no one forced Barclays to load up with worthless US sub-prime paper, no-one forced HSBC to buy the US sub-prime lender Household. The banks seem to think they are the most important part of the British economy and that it's the job of other well-run businesses like Tesco, Sainsburys and others to take a hit in profits because the banks have run their own businesses badly.

Actually banks only employ 15% of the British workforce. The other 85% is employed elsewhere. The reason it was imperative for the recent rate cut to be passed on was that the benefit should hit households in December in time to pay for Christmas. We know that the banks don't wish to lend, and that households don't wish to borrow. The only answer in those circumstances is to make people's existing mortgage payments come down, so they have more disposable income available to spend for Christmas. Which in turn will keep retailers and others going and hopefully help them weather the crisis.

There are 1.7 million borrowers who are on trackers or the standard variable rate, and they will benefit from the rate cut being passed on. Another 1.5 million mortgagees were on fixed rates that expire this year. Most won't be able to remortgage - but going from a fixed of 3.75% to a variable rate of 5% isn't as bad as going to a variable of 6.5%. If people can keep up their payments, there will be less defaults. If those on variable rates have more to spend, there will be less pain for the non-banking sector, which also has debts to service. Which should help the banks, except they are too bloody short-sighted to see it.

I note that Barclays and HSBC are still holding out on passing on the rate cut. They are making a fetish of their "independence" from the government. They should be careful though. Customers are not stupid. They will walk to those banks that have the lower SVR, which should make those elusive "profits" much harder to come by for Barclays and HSBC.

Further musings on Glenrothes

The reaction from some Tories to the Labour win at Glenrothes on the message boards of the Guardian and elsewhere has been interesting. Many have rubbished the result saying in effect "How can holding onto a seat - previously considered rock-solid Labour - be considered a triumph?" You would never guess that Labour had been in power for eleven and a half years and was in it's third term, and that by-election wins in such circumstances were unprecedented.

They are acting as though Labour has only been in power for about 17 months, and that this is a major blow as the majority was a bit down from the general election! I could dismiss this as mere spin from them, but I can also sort of see where they are coming from. Because it doesn't feel like Labour has been in power for eleven and a half years, the Labour government feels newer than that.

I think a great part of it is down to the Brown government having a very different feel to the Blair government. Only four members of the old Blair government have survived - Brown, Darling, Straw and Mandelson, and of these, Darling previously didn't have a national presence at all, but now he's on our screens almost daily, which makes him a genuinely fresh personality that is dominating the government, and Brown too is a bigger presence than he used to be (under Blair, Brown only seemed to emerge twice a year at budget time). Indeed the travails of the government in the last year fits with the scenario of a new government taking over and struggling to cope with the transition, in the way that Clinton struggled in his first year (teething troubles that Bush suffered too and which Obama hopes to avoid). And the new bounce happened when they all got to grips with their jobs in time to handle the crisis. If they were newbies in 2007, they are not anymore. They got tested in the crucible and came through with flying colours. They are now experienced in crisis management.

An illustration of the change in flavour came today when Darling summoned the banks to scold them into passing on the interest rate cut to their customers. Such government activism was unthinkable in Blair's day. The Brown-Darling government feels more activist, more protective of the little person, more to the left of the Blair government. It's becoming clearer and clearer that the Brown-Darling administration is quite different to what went before.

What does this mean for British politics? Part of the reason John Major got elected in 1992 was because the public had their change of government in the form of him replacing Thatcher, and didn't want another one so soon. If the Brown-Darling government continues to offer a change in direction and continues to stay on top of events, the public might again conclude there is no need for another change in 2009/10, especially if the Tories resist going left with the zeitgeist and try instead to cling to the Reagan-Thatcher settlement. Just a thought.

Friday, November 07, 2008

Happy Days!

First Obama on Tuesday, then Brown on Thursday! And there I was trying not to get my hopes up for a Labour victory in Glenrothes of a mere 500!

I personally think it was Sarah Brown wot won it. Some SNP people dismissed her as "too English" to have an effect - and she is very middle England. But Gordon+Sarah represent Middle Scotland married to Middle England. Which is the antithesis of the SNP message. I think too that the people of Glenrothes liked the fact that the government was taking them so seriously that the Prime Minister and his wife came in person to woo them. (For those naysayers who said that Sarah shouldn't campaign - she's a paid-up member of the Labour party and is entitled to campaign as much as any other member.)

I can't help feeling that the zeitgeist favours the centre-left. Now is our moment in history, 1997 was merely a holding point. The tide is with us, can we take it at the flood?

Thursday, November 06, 2008

More on the implications of the Obama victory

A rant first. Am a bit frustrated by the British coverage of the Obama win - they are going on about "defining moments" in American history, and then showing pictures of Kennedy, who was a very minor president indeed (he merely responded to events during his presidency, he didn't "make the weather" in the way FDR, Johnson or Reagan did). It's almost as though they think, Obama handsome, Kennedy handsome, they must be similar presidents!

They are also going full-on about the historic "black" win, with footage from civil rights etc (which of course they prepared earlier). But of course the reason Obama was elected had nothing at all to do with colour. Instead the contest, which had been close, tilted decisively to him when the meltdown happened in the financial markets. The really historic thing is that though Obama is half-black, the election was about policy, and people would honour the spirit of the moment better if they explored those policies.

American journalists however are focusing on policy. Joe Klien had this to say in Newsweek:

"Unlike Bill Clinton, whose purpose was to humanize Reaganism but not really challenge it, Obama offered a full-throated rebuttal to Clinton's notion that "the era of Big Government is over." He was a liberal, as charged. But the public was ready, after a 30-year conservative pendulum swing, for activist government."

Now, New Labour's strategy was modelled on Clinton's. The idea was that we couldn't dismantle the Thatcher settlement, but we could modify it. So higher rate taxes were not touched (apart from Brown raising N.I. above the upper earnings limit by 1% for the first time). And redistribution was done by stealth. It was only during this third parliament that Labour people actually started openly acknowledging the amount of redistribution taking place (through raising the minimum wage much faster than the growth in average earnings and through tax credits). Everyone kept quiet about it in the first eight years.

Obama however means to turn away from the Reagan-Thatcher settlement. He's a potential FDR if he wants to be. The financial meltdown has made Americans give him a fair hearing, and there is a fair amount of goodwill behind him. Ordinary people are irritated at the rich being bailed out while they struggle with basics and are scared to get sick. I've been saying for some time that the current crisis is very different from the early 90's one. Then government was blamed and the markets were heroes. This time the market is the villain and people are looking to government to protect them.

Obama's solution is to increase public spending, cut taxes for the poorest, and pay for it by raising taxes for the richest. It's something Labour would love to do, but the difficulty is the "raising taxes for the richest" bit. One big difference between the UK and the USA is that the Americans don't have any such thing as a person non-domiciled for tax. If you are a citizen, you pay tax, regardless of where you are living. There is no escape. They have double taxation agreements with most countries, but if you are paying less locally than you would in the USA, you pay the difference to the US treasury. So an American in Monaco will pay full federal tax to Uncle Sam. A Brit in Monaco pays nothing to the Inland Revenue (Monaco has zero income tax and Britain allows the concept of non-domiciles). So it's easier for Obama to collect his revenue than for Gordon Brown - unless we change the law to say that citizenship comes with the responsibility to pay tax.

The other interesting thing is that much of Obama's public spending may go on infrastructure. Many Americans look back to the era of Eisenhower with nostalgia for the full employment and job security. What is now forgotten is that Eisenhower had a top rate of tax of 90%, and he used the money to build the American Interstate system. In 1999, the building of the US Interstate system was voted the most important event of the 20th century that shaped US business, as it enabled goods to get to market, and thus powered the growth in the US economy. However, not much spending has taken place on US infrastructure since Reagan (with dire consequences in New Orleans). That might change. It's also something we should consider here, especially if the downturn means that government has to step in with projects to make up the shortfall in activity.

We are living through a once-in-a-generation shift to the left. I just hope on this side of the pond we have the nerve to seize our moment.

Wednesday, November 05, 2008

Wow it was a huge win!

Thrilled to have been proved wrong about the US election being close. And also hugely relieved.

It really hit home that Obama had won when he started giving his speech, and I had the odd sensation of hearing phrases that we are familiar with in the Labour party these last twelve years - "rich and poor, gay, straight, disabled and not disabled" and "we cannot have a thriving Wall Street while Main Street suffers" (the kind of thing Cruddas says, only substitute City and High Street for Wall Street and Main Street) - coming out of an American President's mouth. One of us is in the White House!. How exciting is that?

Pleased too that he mentioned that the task of dismantling the Reagan-Thatcher settlement will take more than one term. The audience looked so desperately hopeful, at one point it was almost like a session in church with them answering him at set points. The expectations on him are almost too much for a mere mortal to bear. I really hope he pulls it off.

What does this mean for Britain? Well if Obama succeeds in tilting the USA leftwards, it makes it easier for the Labour govt. For instance if he raises taxes on the wealthiest, it will be easier to swat away those who claim that the British tax system is resulting in people fleeing the country. If he restores inheritance tax, it makes it easier for us to explain that the Tories are being just plain greedy to want the inheritance tax threshold raised to £2 million. If he goes ahead and puts in place policies to tackle global warming, it will be easier for us to bat away those in industry and in the Tory party who are complaining about the climate change levy. If he succeeds in producing a socialised healthcare system, we can finally say to the right-wing critics, see, even the USA has capitulated. Just as FDR's election in 1932 preceded a leftward tilt in Britain in the 1940's, Obama's win signals the end of the Reagan-Thatcher settlement and a move leftwards in the developed world.

This is a moment for the centre-left to feel very cheerful indeed.

P.S. Just checked the tax situation. Obama has stated that he thinks a person on an income of $250k is rich (this is about £158k). He intends to raise the top federal tax rates to to 36% and 39.6% (from the current 33% and 35%). Remember that Americans pay state income tax in addition to federal income tax. The American state that mirrors Britain's economy most is New York State. There, the state income tax if your income range is between $100,001 and $500,000, is 7.375%. If your income range is $500,001 and over, your tax rate is 7.7%. People living in New York City pay city income tax too of between 2.9% and 3.6%.

That means that the top marginal rate of tax for high earners in New York City (London's great rival) will go up from the current 46.3% to 50.9% under Obama. Compare that to the 41% levied in the UK. It gives cover for the Labour govt to raise N.I. by a mere 1% over the upper earnings limit (to take the marginal rate to 42%), should they wish. Especially as the Irish have introduced an income levy of 1% (and 2% for earnings over €100000) to take top rate to 43%. Alistair Darling has ruled out tax increases for now. But what has happened in the USA gives us room for manoeuvre if we need it.

Sunday, November 02, 2008

Good luck Obama

All of us on the centre-left are holding our breath hoping that nothing gets in the way of Obama winning the US Presidential election on Tuesday.

Perhaps it's because I'm Labour, but I believe the only moment of certainty in politics is the night the ballots get counted. The uncertainty starts again the very next morning. I am always astonished when people think something is "in the bag" - that's usually when things start to slip away from them (for the most recent example of this see this poll done by Conservative Home just before their party conference, where an astonishing 91% thought they were either heading for a large victory or a small victory - that was when the Tories were running a good 25 points ahead of Labour and before the meltdown of the markets).

American polls are more inaccurate than British ones - we saw this in the primaries. At least the regular primary ballots provided a reality check. We haven't had one for a while, and it's likely that media hype is disguising an unstated resistance to having Obama in the White House.

I hope I'm wrong, but if I was Obama I would get my people to fight fiercely to the very end to get out the vote. I think the result will be close and that every last vote will count. Obama has very good organisation on the ground, and if he wins it will be down to that rather than any radical shift in the zeitgeist (the shift will come after he wins and starts to govern, and has the power to "change the weather" in fundamental ways).