19th August 2011 by Shaun Richards
After a few days of relative calm in the world’s financial markets we saw them return to panic mode yesterday and at one point the US Dow Jones had fallen by 500 points. We ended with the German Dax down 5.8% and the UK FTSE 100 down 4.5% and the US S&P500 down 4.4%. This morning these falls have continued and the UK FTSE 100 has fallen below 5000 again. As a child I used to watch the programme Stingray which often used the phrase “In the next thirty minutes anything can happen” and if yesterday was any guide they were preparing me for adulthood quite well!
One of the causes is the general fear that has pervaded markets in recent times and the feeling that events have slipped out of control. This is combined with a rising number of demonstrations that the world’s political leaders are trapped in a repeating loop of errors.For example the Merkel/Sarkozy agreement of earlier this week announced a Tobin tax on financial transactions. It did not seem to occur to them that rather than stabilise matters it would destabilise the share prices of many banks. Because of its large investment banking operation Barclays in probably the UK bank most exposed to this and having hit a high of 188 pence on Monday it is now at 147 pence some 22% lower compared with 6% for the wider market.
Whilst you are mulling over the incompetence of what I have argued many times is in effect a rescue for the banking sector which has driven their shares down such examples are not confined to the Euro zone. President Obama annouced this week that he has plans for extra spending to help unemployment to which he can add deficit cuts. Sadly these days nobody is willing to even consider that he might have truly discovered the economic equivalent of the holy grail! In reality we all know what to expect which is extra spending now to be paid for by deficit cuts later which will be conveniently on another President’s watch.
The real problem for politician’s right now is that continued exposure to their plans has meant that their inadequacies have been highlighted. It is much easier to look intelligent in a bull market as mistakes are hidden by it. Whereas now markets are much more likely to respond with the equivalent of the football terrace chant “You don’t know what you are doing.”
To this general unease we found some specific factors added to it.
US economic figures: more evidence of stagflation
Firstly we found that something familiar had returned after a sadly brief delay when the Bureau of Labor Statistics told us this.
In the week ending August 13, the advance figure for seasonally adjusted initial claims was 408,000, an increase of 9,000 from the previous week’s revised figure of 399,000. The 4-week moving average was 402,500, a decrease of 3,500 from the previous week’s revised average of 406,000.
So we are back above 400,000 again and after the usual upwards revision last week’s number nearly made it too. This is now the best part of five months we have been above this number or in one instance only 1000 below it. There was a little ray of light from the fall in the four -week average but the US unemployment situation is plainly still troubled.
Then we got a shock number from the Phileadelphia Fed survey of regional conditions. It is not a first line indicator as it is only regional but the effect of what is highlighted below resonated.
The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from a slightly positive reading of 3.2 in July to -30.7 in August. The index is now at its lowest level since March 2009.
I think that markets saw the drop in the index combined with the phrase lowest since March 2009 and simply panicked. However if we consider the situation logically what we see if we take both figures we see that there was yet more evidence of a US economic slowdown to add to what we have already seen. Indeed as a man who has argued that we are seeing stagflation we then got some more evidence establishing this but this time, and I will explain why I think this happened in a moment, this evidence was ignored.
US Consumer Price Inflation
The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in July on a seasonally adjusted basis….. Over the last 12 months, the all items index increased 3.6 percent before seasonal adjustment.
So consumer inflation is rising and if we look at producer prices for which we received new data earlier in the week we saw this.
On an unadjusted basis, prices for finished goods moved up 7.2 percent for the 12 months ended July 2011…………On a 12-month basis, the index for intermediate goods climbed 11.6 percent.
So there you have it about as clear a definition of stagflation as you are likely to ever get! In the market melee many are ignoring this and this is leading to the wrong conclusions being drawn I think. One of the features of any slowdown in the credit crunch seems to be that we immediately assume we are going to collapse and fall off the edge of a cliff and many seem unable to get past this particular “thought-bubble”. Many official bodies encouraged this with apocalyptic (and at the time incorrect views) claims of deflation fears to justify their use of extraordinary monetary measures and the fear this created may be one of the things which will undo all the money they have spent. I am no psychologist but I am aware it is a short journey from arrogance and hyperbole to panic.
There is also another factor which has come into play in recent times which goes as follows. You look at a rise in an inflation index and say that it is okay because a certain component went up. For example the US figures above had some discussing the rise in the price of coffee and tobacco respectively. Apparently they seem to think that inflation can rise without any price rising!
Evidence of this?
I wrote only yesterday about bond yields and how low they had become. Well this trend surged forwards yesterday such that the US ten-year or Treasury Note yield went briefly below 2%. I would like you to look again at the inflation numbers above again if you would be so kind and consider the yield again. For this yield to have value over the ten years inflation would have to absolutely collapse from its current levels. Whereas in reality we are looking at a probable dip in it but a collapse? We certainly do not know that.
The Swiss National Bank borrows from the US Federal Reserve
I am grateful to Mr.K for drawing my attention to this. It adds to the dollar borrowing under the aegis of the European Central Bank I discussed yesterday. However this indicates a deeper malaise to my mind. We know that certain Euro zone banks are feeling the strain as for example Italian banks doubled their borrowing from the ECB in July but Swiss ones? As we consider that we have spent 2011 with foreign exchange markets trying to force US dollars ( and Euros and Pounds) on the Swiss it seems even odder that a Swiss bank needed US $200 million. Surely the Swiss National Bank could have helped itself……
So my thought for the day is that like the UK the United States has economic figures that apart from a sort of mass delusion which has overtaken commentators would be generally acknowledged as stagflation. There are certainly events happening right now which sem likely to reduce inflationary pressure but certainly not enough to justify such matters as current bond yields and accordingly I think that we can give them bubble status. Of course another bubble is exactly what we do not need.
UK Public Finances show signs of an improvement
So far in this fiscal year we had until this months figures seen little sign of the UK governments “hairshirt” of austerity actually having any impact. Spending had been rising as fast as tax income. However fortunately July’s figures show a reduction in spending growth which is 3.2% for the fiscal year so far including July but only 1.8% in July itself. So some evidence of improvement there which led to these figures today.
public sector net borrowing was -£2.0 billion; this is £3.4 billion lower net borrowing than in July 2010, when net borrowing was £1.4 billion; public sector net debt at the end of July 2011 was £2266.3 billion (148.0 per cent of GDP). This compares to £2175.6 billion(149.1 per cent of GDP) as at the end of July 2010
So we see an improvement in our fiscal deficit and also in our net national debt which comes as something of a relief. Whilst we are not actually cutting public spending (as many media organisations persist in claiming) we have reduced its rate of growth.
For new readers you may be surprised to see me quotes figures with financial interventions. I have followed these because we have them! It is my contention that if you report the numbers without them you are misleading people, although it is convenient as you have to look a long way down the report to find them! Let me put this another way with Lloyds at 28 pence and RBS at 21 pence as I type this the UK ownership of these banks is looking more permanent than temporary right now. Where are all thsoe who only a few short months ago were telling us we would be able to sell them off at a profit this summer? Group-think again?