Thursday, March 19, 2009

When will the recession end?

The old-fashioned answer is "When the market clears". That is, when gluts are eliminated, balance sheets repaired, debts repaid and pent-up demand builds to the point where it can't be postponed and people spend again and the economy rebounds.

The biggest threat to markets not clearing is the banks' balance sheets. As the BoE noted in it's Feb09 inflation report:

"UK banks need to restructure their balance sheets,reducing their overdependence on wholesale financing and realigning the scale of their loans relative to their deposit base.That in turn will require adjustment to private sector balance sheets — in part by the non-bank financial sector, but alsothrough higher saving and lower spending by households and companies"

But of course to do this, the banks need money to repay their wholesale loans. The best way to do this is have the household sector repay some of their debt, which in turn allows the bank to use the money received to repay some of their wholesale debt. But whenever someone suggests this (I've been writing posts urging people to repay their debt since early Feb), the Paradox of Thrift is invoked. When Bush urged Americans to "go shopping" in the 2001 recession, he was invoking the Paradox of Thrift. Greenspan urging Americans to invest in housing and abandon the traditional American 30-year fixed year rate mortgages in favour of variable-rate mortgages, so they saw a rise in disposable income (temporary as long as interest rates remained low), was also acting on the Paradox of Thrift and trying to keep consumption going.

It's perfectly true that if everybody stops spending (households, businesses and government), the economy spirals down in a vicious cycle. However, lets get a few things clear. This is not the 1930's. In the UK at least, we now have a full-blown welfare state, and government spending automatically increases in a downturn on things like unemployment benefit, housing benefit, mortgage help and so on (the so-called automatic stabalisers), which support a degree of consumption in the economy. And governments can always expand spending beyond that on public works (the Olympics-related spending being an example).

As long as government stands ready to take up the slack, there isn't any danger of a spiral down. But recovery depends on the private sector clearing - without the private sector clearing you get a stalemate and stagnation.

The best way to illustrate this is the Japanese example. Japanese businesses took on a tremendous amount of debt in the 1980's. Their debt to equity ratio was 4 (they were financing about 20% of assets with equity and 80% with debt). In US companies in the 80's the ratio was 1.02 (equity was financing 49.5% of assets). When Japan went into recession in the early 1990's, after some hesitation the Japanese government embarked on a Keynesian expansion. As Stephen King points out, they managed pretty well to avoid a collapse 1930's style: "growth was very low but not entirely absent; unemployment rose, but not too far; and per capita incomes were maintained at a high level by international standards.". It was a success, as they prevented the spiral down.

But they still lost a decade in stagnation and barely-there growth, and in the meantime the government debt kept climbing (Japan's debt as a % of GDP is forecast to be 217% in 2009). People focus on the stupendous Japanese government debt and shudder and claim that thus we shouldn't go down that path. But their government debt rose so much only because it took so long for the private sector to clear. If they had cleared in about five years instead of a decade, they wouldn't have the public sector debt they have now.

The problem was not in the government action (they did what they had to do), but in the private sector which took forever to repay debt and thus "clear". Worse, in a deflationary situation, debt becomes harder and harder to repay as incomes and corporate revenues fall, so the longer you leave it, the worse it gets.

The conclusion must therefore be that we should encourage our private sector to clear as fast as possible, while letting the government take the strain. Those whose disposable income has increased thanks to interest rates being cut should do their bit for their country (and themselves) and repay debt as fast as possible, including overpaying their mortgages if they are allowed by their mortgage terms. We'll have a few bad quarters, but at some point a tipping point will occur. The banks will clear their wholesale loans and start to think about profits again (which they can't make unless they lend again). When households repay their debts they will find disposable income jumps as their monthly debt commitments disappear, and they will spend some of the money freed up. Pent-up demand will build (purchases of things like cars can only remain at current depressed levels if existing cars last about 27 years, which they are not designed to do). Obviously it will help a lot if those who have no debt carry on spending as normal and are not panicked into drawing in their horns.

What happened in Japan was that corporations hesitated to clear their debt and carried on like zombies, while some Japanese households who had no debt cut back on spending in a panic. If we do this the other way round (people with debt clear it at speed while people with no debt continue as normal), we should be out of this recession as rapidly as we got into it. Of course if this doesn't happen, this could drag on for years.

Tuesday, March 17, 2009

The Recession and Journalism

From tomorrow, the Seattle Post-Intelligencer becomes an internet only newspaper, as the Hearst Corporation tries to stem losses. According to the New York Times, they will go from news staff of 165 to 20 people who will provide commentary, with the news coming from feeds (presumably from Reuters or Associated Press). The problem was this: no one buys print anymore, and advertisers are loathe to spend high rates to advertise in newspapers. But internet advertising rates are so low that they can't support more than a staff of 20 (compared to print advertising supporting a staff of 165).

The Recession combined with the Internet is creating a bloodbath among American newspapers, (and can British and European newspapers be far behind?) The best article about the phenomenon is an essay written by someone called Clay Shirky - I urge people to read it in full.

He points out that the old newspaper model was built on a barrier to entry that doesn't exist in the internet world:

"If you want to know why newspapers are in such trouble, the most salient fact is this: Printing presses are terrifically expensive to set up and to run. This bit of economics, normal since Gutenberg, limits competition while creating positive returns to scale for the press owner, a happy pair of economic effects that feed on each other. In a notional town with two perfectly balanced newspapers, one paper would eventually generate some small advantage — a breaking story, a key interview — at which point both advertisers and readers would come to prefer it, however slightly. That paper would in turn find it easier to capture the next dollar of advertising, at lower expense, than the competition. This would increase its dominance, which would further deepen those preferences, repeat chorus. The end result is either geographic or demographic segmentation among papers, or one paper holding a monopoly on the local mainstream audience."

Because of this monopoly, newspapers could use their advertising revenue to subsidize all sorts of things such as war correspondents, whether or not the advertiser wanted their money spent that way or not. But with the internet, the advertiser can target their ads. Further, because there is no barrier to entry online and so many places to put advertising, the advertising rates that newspapers can command online are way lower than in print. After all, why advertise on a newspaper site such as the Guardian or the Times, where the readers might or might not be interested in your product, when you can target the ads like a laser by placing them on the Google search results, so that only people searching for your product niche see them. Google continues to do so well precisely because the ads on their search engine have a much higher convertability into sales than ads in almost any other medium, whether print, television or other internet pages.

But there is a side-effect to this - if the revenue supporting journalism dries up, stories won't get broken anymore, apart from by Reuters and Associated Press, who should do well by everyone buying their feeds. And as a result, pretty much all newspapers will start to feature exaactly the same news.

There is only one organisation that is immune from all this - The BBC. Alone, they can afford to send correspondents to Baghdad or Timbuktu. Alone they can afford to cover every part of the planet.

This is most certainly NOT the moment to curb the BBC whether by trying to cut their income by freezing the licence fee or by trying to force them to compete for the rapidly diminishing television advertising revenue (which is being hit by both the better targetting of advertising on Google and by the ability to tape shows and fast forward through the ads) - by doing so you would curb the one last source of free independent news (one of the pillars on which our democracy rests).

Journalism benefits society as a whole, and public service journalism has never been so vital when the private sector looks like it will curl up and die. Clay Shirky asks the question, So who covers all that news if some significant fraction of the currently employed newspaper people lose their jobs? and answers, "I don’t know. Nobody knows." One answer is that every country adopts the BBC model of a license fee funded public service journalism. It's either that or accept that most of the world's news will be coming from Britain via the Beeb (I can see the BBC selling news feeds to the world in much the way Associated Press does), which will have the side-effect of making our country the centre of the planet information wise.

Monday, March 02, 2009

January lending figures from the Bank of England

The monthly lending figures from the Bank of England were released today, and predictably the newspapers have reacted with screaming headlines saying that Mortgage lending plunges by 60% and lamenting how this would affect the economy.

Delving into the figures shows a more interesting picture, however. It's net lending that had plunged (i.e. new lending less repayments and redemptions). Mortgages issued for purchases of houses were slightly higher in value compared to December. Remortgages are down - but that's because of a lot of people coming off their fixed-rate onto the standard variable rate are deciding to stay there instead of remortgaging for another fix (rational as the arrangement fees on new fixed rate mortgages have soared). As a result, gross lending is down by £875 million.

But net lending is down by £1104 million. Which suggests that in January households made a concerted effort to use the money released by falling interest rates to pay down their existing mortgages. This is actually a good thing. It puts households in a stronger position, and as explained in my previous post, repayments of capital help banks and building societies who wish to reduce their wholesale funding.

It's coping with the roll-over of wholesale debt that continues to pose a problem for the banks. According to UBS, HSBC has $97.3bn in securities maturing in 2009/10, Barclays has $69.8bn, and HBOS has $57.6bn in securities maturing in 2009/10. They can either try to refinance these over by issuing new securities - but every bank in the world will be trying this, and competing with governments also seeking to borrow from the markets at the same time. They can try for a rights issue to raise money from shareholders (as HSBC is doing). They can simply get more capital from governments through bailout schemes (but will make them even more "nationalised" than they are), or they can rely on households repaying debt at an accelerated rate.

The commercial sector is not repaying debt (most of the horror story of the HBoS losses concerns their commercial lending unit). Shareholders are reluctant to inject more money into banks - see the sell off of HSBC's shares today following the reports of the losses they made in the US and Asia and the announcement of their rights issue. Governments can inject more money, but there is a reluctance to nationalise, and the more money injected the closer outright nationalisation gets. That leaves households, the one sector that has had their disposable income increase, thanks to falling interest rates, falling oil and falling prices. As I said before, if I was in charge of these banks, I'd be writing to every mortgagee on a tracker or standard variable mortgage, pointing out the benefits of making extra capital repayments. The banks are not making much profit on these mortgages anyway, so they might as well encourage people to pay the money back.

Sunday, March 01, 2009

On part-privatisation of the Royal Mail/Post Office

Not sure why there is such a furore about this. It's exercising certain unionists but I'm detecting indifference from the general public. Most people don't actually get that much mail these days - we are all being incentivised to get our statements by email instead and given discounts off our bills to do so. Nobody sends cheques out any more, it's all done by automated bank transfer. No one sends personal letters anymore, all contact is made by phone, text and email.

The only mail that seems to be delivered is junk mail, and does it matter who delivers that?

And while people feel indifferent to the Royal Mail, they feel outright irritation with Post Offices. I remember having to go to the post office in my lunch hour to get my tax disc renewed. After queueing for ages, you finally got to the counter only to be told by a jobsworth, sorry I can't give you the disc, as your insurance starts tomorrow, you should have brought your old insurance papers with you as well. I'd protest in vain that they knew my old insurance was in place as the system had granted me a tax disc last year. To no avail. So I'd have to come back the next day and repeat the process. What a relief when the DVLA started doing tax disc renewal online!

One of the great achievements of the Labour government these last twelve years has been to automate government services and make them all available online. No need to venture into a hideous post office any more. I'm sure millions feel the same way I do - people have been voting with their feet, and that is why the numbers using post offices has dropped.

As to why the government is pressing ahead with this - to raise money of course. Doh! Because of the recession, tax revenue is down. And it's a bad idea to raise taxes in a downturn. And no self-respecting Labour person will countenance cuts to essential services like the NHS (which is well-loved, unlike the Post Office). So Royal Mail privatisation it is.

I also predict that the government will prefer to get the banks to buyout the government at the earliest opportunity, so the taxpayer gets their money back, rather than keep the bank shares and raise taxes. And I'm pretty sure that Northern Rock will get flogged off at the first opportunity too. If it's a choice between keeping public services and flogging off these albatrosses, the choice is clear.