Monday, 28 October 2013

Generational Differences - Rise of the Socialists

Young people have a different view on the world than older generations who have made the most from capitalism

Youth is the one thing that most people would want – a chance to live it all over again – but it is not an easy time to be young at the moment.  Young people are facing the toughest job market in decades after having gone through an education system which has been neglected for years with more money being spent on pensions instead.  So it may not be surprising that youngsters are not as keen on capitalism as older generations.  And this is not just part of a rebellious phase but rather a response to an economic system which is geared to benefit long-time members to the detriment of new-comers. 

To start with, let’s look at the job market.  Unemployment rates remain stubbornly high in most countries with developed economies but the proportion of young people without jobs is typically substantially higher.  For example, more than half of younger workers in Spain and Greece are unable to find work.  Joblessness not only has temporary effects such as a loss of income but studies have shown that youngsters who enter the market when the economy is sluggish often earn less over their lifetimes.  The current situation for young people goes beyond this to talk of a “lost generation” who may become disillusioned with the job market and remain disengaged even when employment prospects improve.

This situation is made worse by a system fronted by labour unions geared to protecting the jobs of existing workers who come from an older generation.  This trend has been most damaging in Europe where the efforts of unions have resulted in a two-tier labour market.  Older workers have secured themselves stable jobs due to rules resulting in high redundancy costs whereas younger workers are typically employed on short-term contracts which are first to be terminated when job cuts are needed.  The rise of globalization also means that new-comers to the workforce are competing for jobs with workers in China and India as well as people in their hometown. 

This increased competition for jobs along with automation of work using computers and other new technologies has taken away many of the administration jobs that were the mainstay of work for the older generation.  Better paying jobs are increasingly limited to jobs requiring higher levels of education but this too is an area where young people have been short-changed.  Education is faced with spending cuts and students are being asked to bear a substantial portion of the costs as countries deal with high levels of debt as well as demands from older workers for lower taxes.  The irony of this situation is that spending on pensions and medical bills for the elderly is on the rise at the same time as education is suffering from cutbacks – societies are spending money on the old rather than investing in a new generation.

The housing market provides further evidence of the different fortunes of the older and younger generations.  Trying to get onto the property ladder is only getting tougher for first-time buyers whereas existing owners of property are benefitting from higher prices.  House prices have been surging in some places despite the economic doom and gloom as governments in many countries have even been bringing in measures to push up prices for real estate as a means to revive economic growth (which is why a rebound in UK house prices is not all good news).

With lower pay in less stable jobs (or unemployment) awaiting many youngsters, they are likely to be the first generation in a long time that will end up worse off than their parents.  The older generation must take part of the blame with many elements of the economy set up for their benefit – a seemingly obvious outcome in a world defined through competition where everyone from companies to political parties are battling it out.  The spoils from winning in this competitive environment are on the wane in wealthier countries as global economic rebalancing shifts more wealth to China and other countries on the rise (which is part of A New Inconvenient Truth).

Youngsters have experienced the harsher side of a market economy and it is no surprise that they see the current system as not working in their favour.  Surveys show a growing distrust of capitalism and increasing support for social spending among young people.  The disillusionment of young people has also extended to politics so it is later generations which vote and give direction to the policies of government.  But it seems obvious that changes beckon as the younger generation with their different experiences and views on the world take over the levers of power.  Marketing experts have been quick to jump on changes in habits of different age groups such as Generation X or Y.  Politics may see similar changes coming with the rise of a new generation – it will be interesting to see what world they will build for themselves.

Tuesday, 15 October 2013

Debt Ceiling: Once more unto the breach

Politics in the United States is starting to cause more problems than it solves as compromise still seems far off.

Politicians are not usually seen in the best light.  Even in that context, the partial shutdown of the federal government in the United States is exasperating, so much so that Your Neighbourhood Economist was not even going to bother to comment.  The situation leading to the shutdown brings to mind kids in a playground fighting over a toy with everyone losing out after all of the toys are put away.  However, behind all the antics and posturing, there are bigger themes at play which is even more depressing.

October is marked with a number of dates which gradually ramp up the economic stakes.  The month began with the US government having failed to pass legislation for its spending budget for the 2014 fiscal year which starts on 1st October.  While the bulk of spending by the government, such as benefits for the elderly or unemployed, is not affected, a significant portion of money doled out by the government must first be ratified by Congress before being spent.  As a result, not passing the budget resulted in a partial shutdown of the federal government with around 800,000 out of 2.8 million public employees being sent home without pay.  The parts of government affected include bodies such as the Environmental Protection Agency and the Food and Drug Administration, meaning that many procedures such as permits for certain business activities will not be processed.  NASA will also mostly shutdown as will many of the tourist sites overseen by Federal government employees.

But the partial government shutdown is just a precursor to something more threatening – the government running out of money to pay its bills.  While such an outcome may sound preposterous, it stems from the current budget deficit (with the government spending more than it receives) and the need to borrow to make up the shortfall.  The total amount of debt that the US government can take on is also something that requires approval from Congress.  With the government having racked up a string of budget deficits in the aftermath of the global financial crisis, the amount of borrowing has been steadily rising.  More debt is needed but the government has reached the debt ceiling which was raised in 2011 and is expected to run out of money by around 17th October.

The stakes are higher if no deal can be done with regard to the debt ceiling.  While the partial shutdown of government can be seen as a bit of a nuisance, a government cash shortage could have global ramifications if it means that the government misses an interest payment on its bonds and thereby triggers a default.  Given that US government bonds are akin to another form of currency in the financial system, a default has the potential to bring the global financial system to its knees. 

In spite of this, the financial markets, while on edge, have not panicked - negotiations regarding the raising of the debt ceiling are still on-going, and even if a deal cannot be brokered, the effects are still unclear.  There are other sources of income such as money from taxes so the government will be able to keep up with some outgoing payments.  But that in itself creates another dilemma – which, if any, payments to forgo.  Investors would hope that debt payment would take priority over, for example, the payment of pensions.  Despite the potential consequences to the international financial system, it would take a brave politician to cut off pensions for old people.

Considering what is at stake, the consensus view is that the politicians will sort themselves out before the government is forced into making such choices.  Your Neighbourhood Economist would like to assume that this will be the case.  But the two main political parties have been squabbling for number of years with the situation getting worse rather than showing any signs of improvement.  Over the past few years, there have been skirmishes over a previous increase of the debt ceiling in 2011 as well as the negotiations regarding the fiscal cliff less than 12 months ago (for more on this, see Winning the election was the easy part) and one of the key obstacles to compromise is growing in strength – that being the so-called Tea Party portion of the Republican Party.

The Tea Party is the radical anti-government element of the Republican Party which is not afraid to be aggressive in pushing for a reduction in the size of government among other policies.  Its members in Congress are targeting large concessions from Obama to raise the debt ceiling – a position which is further fortified by Obama having conceded little in previous showdowns.  Perhaps the biggest concern is that the anti-government fervour of the Tea Party will translate into a view that the debt ceiling is an effective way of slashing government spending irrespective of the costs involved.

The Tea Party has found growing support among Americans disillusioned with the role of the government.  It is part of the rise of populist movements that can also be seen in Europe which rail against mainstream policies, such as an opposition to immigration.  The multi-party political systems in Europe can include such movements as separate parties which often struggle to get the necessary level of support to make it into government.  The political system in the United States only has two political parties and the Tea Party essentially controls a large portion of the Republican Party.  With voting districts in the United States having been shaped over the years to produce safe seats for either the Republicans or the Democrats, Tea Party candidates in Republican seats are typically better at whipping up support enabling them to win out over more moderate candidates. 

The Republican Party as a whole has increasingly felt the need to pander to this radical fringe which has brought a heightened level of conflict to US politics, within the Republican Party itself as well as between the two major parties.  Its unique system of democracy has been a key element behind the successful rise of the United States to global dominance.  But with the country’s place at the top of the global pecking order no longer assured (as described in A New Inconvenient Truth), it would be ironic if its political system was central to its downfall.

Monday, 7 October 2013

Eurozone crisis: Still bubbling away

The debt crisis in Europe seems a long time ago but a political hiccup in Italy shows that its revival may not be that far off.

Around this time last year, weeks would go by without this blog commenting on anything but the Eurozone crisis.  The turning point came near the end of 2012 with a bit of imaginative policy making by the European Central Banks who said they were willing to do “whatever it takes” to save the euro.  By the start of 2013, the worst seemed to be over (Good and Bad in 2013), but many of the problems still had to be fixed.  This year has seen the economic problems in Europe simmering away in the background rather than being likely to erupt as in 2012.  However, the turmoil in Italy at the moment shows that it does not take much for things to heat up again.  Europe may not dominate the headlines as in the recent past but it is never too far from the front pages and here is a look into why.

Politics in Italy are tricky at the best of times but an election earlier this year left the country with a fragile coalition.  A fresh saga was triggered as the constant distraction that is Silvio Berlusconi looked to pull his support from the government after being convicted of tax fraud in August.  Yet it was Berlusconi who suffered from his latest attempt at meddling as he was forced into a dramatic U-turn which involved providing support to the government in order to avoid seeing his own party rebel against him.  After a jump in the interest rate on Italian government bonds, the weakening of Berlusconi cheered investors as he had held sway over Italian politics for a long time despite Italy having not benefited much from his time in power.

Although Italy has avoided the unwelcome prospect of another round of elections, the problems that the country faces are greater than the immediate political woes (for some background, see Bigger than Berlusconi).  This year, the government budget deficit is expected to top 3%, which is the upper limit for EU countries, with government debt approaching 130% of GDP.  The coalition government lacks the political capital to push through the necessary reforms to get the economy moving ahead to help generate the tax revenues needed to reduce the shortfall in the government’s finances.

Italy is hampered by a problem which is typical for countries in Europe feeling the strain in the aftermath of the Eurozone crisis – voters weary of austerity measures with little to show for their perseverance.  Mainstream political parties who have been pushing government cuts have seen their support eroded by fringe parties which promise relief through policies which will have negative long term effects.  The democratic process has struggled to deal with the consequences of the economic slump and mounting debts following the global financial crisis.  Voters have been stuck with two unappetizing options – enduring the hardship of austerity with scant rewards or repelling against spending restrictions but becoming an outcast in the financial system.
The same themes can be seen being played out in Portugal and Greece among others.  Greece has witnessed the rise of the far-right extremist Golden Dawn party which has fed off the frustration of Greek voters.  Local elections in Portugal resulted in heavy losses for the ruling party who had pushed through austerity measures.  Despite all the hardship endured in these two countries, further bailouts are seen as necessary to deal with the stubbornly high levels of government debt.  The economic stagnation in Europe continues with countries like Greece still suffering with GDP down by 6.4% in 2013.  Portugal, Italy, and Spain among others also ended 2012 with lower GDP. 
While the European Central Bank has staved off the immediate threat of crisis, the flipside is that the pressure for reforms has eased.  As such, politicians can no longer blame the financial markets for their unpopular policies.  Leadership in Europe has also been lacking with the national elections in Germany drawing the attention of Angela Merkel away from Europe.  Coalition negotiations in Germany following the elections in September will leave Europe seemingly leaderless for a few more months.  The Eurozone crisis may have been put on the back burner but it could still boil over at any point if not watched.

Thursday, 3 October 2013

Inflation – Then and Now

Inflation is driven by different factors now that the West is no longer the only engine of growth in the global economy but why might that be important?

Life is always better as the top dog, whether it be on the playground or at work. The same holds true for the global economy where large and growing countries have others banging on their door to offer whatever they might need.  As a result, the global economy shapes itself around the countries at the top of the pecking order and these countries benefit as a result.  One seemingly innocuous way this plays out is through inflation.  Inflation in Europe and the United States has always moved in tune with their economies due to there being no other significant sources of demand.  But the switch to a global economy with other major players has resulted in international commodity prices being driven by what is going on in other countries as well.  This means that inflation is not what it used to be.  And, if inflation is different, must monetary policy change as well?

Inflation is the economic phenomenon of increases in prices, where prices will rise if demand increases at a faster rate than supply.  Due to globalization, many goods are now traded on international markets and growth in the global economy will push up demand (and the price) for any goods.  While demand can fluctuate dramatically in a short period of time, changes in supply typically take time.  Prices which rise due to expanding demand as an economy grows may remain high as increases in production require more time to catch up.  This is not so much of a problem when an economy is growing as consumers will have more money in their pockets and won’t be as bothered by higher prices.  Thus, it is easier to accommodate prices rising at a faster rate when the economy is prospering. 

In the past, the main source of demand for most products came from Western economies (Europe and the United States) along with Japan, with inflation moving in line with economic growth in these countries.  The level of synchronisation between these economies was also high so that growth spurts came at the same time and inflation was typically timed to when the economy was ready for it.  But this all depended on there being no other big economies which were out of sync with the West.

However, the economic rise of China and emerging markets put paid to this convenient form of inflation.  The number of factors which determined global commodity prices had increased and the economy in China was large enough to move to its own rhythms.  China’s entry into the global economy was initially a boost for Europe and the United States in some ways with low-cost manufacturing helping to bring down prices at the beginning of the century.  Yet, economic growth in China did not slow with the onset of the global financial crisis and prices for many global commodities kept climbing higher as a result.

High inflation is never good but it is even worse when an economy is struggling to climb out of recession.  Rising prices during slow economic growth further depress spending and put pressure on profits at companies when times are already tough.  Being an open economy with few of its own resources, the United Kingdom has had to suffer through both a stagnating economy and high inflation.  For example, real GDP in the UK edged up just 0.8% in 2011 while inflation reached as high as 5.2% in September.  Yet, the Bank of England did not change its monetary policy to quell inflation in 2011 as it was clear that the origin of the inflation was overseas. 

However, the situation may not always be so clear cut.  And it is not the first time that inflation has been out of whack with what is going on in the economy.  Interest rates were kept down in the lead up to the global financial crisis as inflation was weak due to cheap goods coming in from China.  The lower borrowing costs spurred on the lending binge which accentuated the crisis.  Inflation was picked out as a gauge which reflects the strength of an economy but it is questionable whether that is still the case. 

Europe and the United States are already struggling to deal with the rise of new challengers (for more on this, refer to A New Inconvenient Truth) as well as the aftermath of the global financial crisis (see economy still stuck in a rut for more).  Shaping monetary policy around something which is influenced by external factors is not going to be helpful in steering clear of trouble.  And, inflation in itself is not enough of a negative for the economy to be managed for its own sake (go to time to rethink inflation?).  Monetary policy should instead look at other measures of economic health such as unemployment which is obviously something that needs to be lower (to a certain degree). 

A more relevant basis for monetary policy would help bring much-needed clarity with regard to the direction of monetary policy as we wait for the Federal Reserve to start the long process of ending its quantitative easing policy.  Central banks have a lot to answer for in terms of their role in the lead up to the global financial crisis and improving the way in which the economy is managed would go a long way toward making amends.

Tuesday, 1 October 2013

Quantitative Easing - Harder to End than to Start

The Federal Reserve changes tack on its change of tack in monetary policy which will make it less credible in the future.

It is still a month away from Halloween but something seems to be scared Ben Bernanke, the chairman of the Federal Reserve.  Bernanke was expected to announce that the Federal Reserve would be buying fewer bonds in September but surprised most pundits (including Your Neighbourhood Economist) by deciding not to make any changes with the status quo.  The unexpected bonus of a delay to the start of “tapering” helped push stocks in the United States to record highs but gains were limited by worries about the future direction of monetary policy.  By backing down from a change in policy, the Federal Reserve has made its job of finding an exit from quantitative easing more difficult while also making it trickier for investors to understand the big question that still remains – how far off is the beginning of the end for quantitative easing?

The Federal Reserve began to signal a change in direction in May and June using its own version of forward guidance where central banks outline future policy through using economic data as markers.  The current policy of the Federal Reserves has entailed buying US$85 billion in bonds each month with interest rates set at close to zero – its forward guidance in July put forward an end to bond buying by the time unemployment reached 7% with interest rates to rise once unemployment had fallen to 6.5%.  With unemployment expected to reach its first target by the middle of 2014, there was an anticipation that the Federal Reserve would move to reduce its bond purchases before the end of 2013, so as to ensure a more gradual decline in quantitative easing which would be less painful for the economy. 

Yet, investors drew their own conclusions from the forward guidance and took it as an excuse to sell bonds whose prices had climbed to record highs (for more, see Managing Expectations).  As lower bond prices translates to higher interest rates for bonds, the bond sell-off resulted in interest rates on benchmark US government bonds increasing from around 2% to close to 3%.  This ran contrary to the gradual adjustment which the Federal Reserve was attempting to facilitate to ensure that the nascent economic recovery would not be choked off by higher interest rates. 

The jumpy market reaction along with slower improvements in the US job market were enough to spook the Federal Reserve into keeping the quantitative easing going.  Only time will tell whether the cautious approach was the right call but Your Neighbourhood Economist fears that Ben Bernanke may have been too timid for his own good.  While there is always the possibility of gremlins lurking in the economy somewhere, the timing did seem as good as it will ever be for starting the drawn-out process of tightening monetary policy.

Unemployment in the United States has fallen to 7.3% in August compared to 7.9% in January (even though part of the fall is due to some people not bothering to look for work any more).  And, while the size of the market reaction was a tad overdone, investors always factor in events ahead of time – as such, the bond sell-off was just the normal response to an end to actions by the Federal Reserve which have propped up both the markets for bonds and stocks.  So, any further movements in the financial markets were likely to have been muted.  But as it happens, prices for bonds and stock perked up as investors looked forward to continued efforts by the central bank to prop up the markets.

With the Federal Reserve forgoing an opportunity to pare back its bond purchases in September, market participants are trying to figure out the possible timing for the inevitable change in policy.  The Federal Reserve meets again in October but will have few new bits of economic data to sooth its concerns over the strength of the economy.  The subsequent meeting of the Federal Reserve is in December with this seen by many as the next chance for action. 

The cautious approach by the Federal Reserve does have its costs.  It is a fad among central banks these days to signal in advance of changes to policy, but by choosing not to follow through with the expected change of policy in September, investors will be less likely to believe the Federal Reserve in future.  In the short-term, it is unclear what will be sufficient to trigger the beginning of the end of quantitative easing – weak economic data for the rest of 2013 may see the “to taper or not to taper” saga drag on for a while yet.  The resulting uncertainty and likely volatility in the financial markets may be even more harmful than the expected tightening of monetary policy. 

A central bank is only as good as its word and the Federal Reserve has cheapened its own words.  That is a scary prospect considering the current hands-on management of the economy by the Federal Reserve and how much it will have to do to talk its way out of this management role.