So the solution to a dysfunctional housing market is to make it more dysfucntional?

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It seems that the housing sector has been captured by people whose grasp of economics and understanding of markets is diminishingly small. The Labour Party - under the direction of that old Stalinist, Jack Dromey, has had an enquiry. And the solution is:

A cross party inquiry led by a Labour peer is today calling for £5 billion of quantitative easing cash to be used to build homes across England, and for a £3 billion increase in funding for social housing.

Other ‘emergency measures’ demanded in the Housing Voice report include making the housing minister a cabinet position, and deferring the merging of housing benefit payments into universal credit.

In the medium and longer term the group wants to see the affordable housing budget raised to £4.75 billion a year, and for a national commission on affordable housing to be set up to report before the 2015 general election.

These people are serious about this you know. They really do want to print £8 billion and give it to housing developers. To build social housing - that's subsidised housing to you and me. Because there's a housing crisis don't you know?

Well yes there is a housing crisis but not the one you're thinking of. The crisis is that the social housing 'sector' isn't able to develop as much as it used to develop because the government isn't bunging in enough subsidy. This enquiry and its 'solutions' seems to be good old-fashioned grant-farming. Give us lots of subsidy and we'll build lots of houses in places where people don't want to live. Meaning that we won't have to answer the big question of how we get more houses in the places where people do want to live and where there's work for those people that mean they can afford those houses.

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What aid might teach us about quantitative easing

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In times past we used to think that one effect of international aid was to act as an economic stimulus. And, in orthodox economics, this rather makes sense – we get an increase in cash within the local economy thereby stimulating demand.

The main role of foreign aid in stimulating economic growth is to supplement domestic sources of finance such as savings, thus increasing the amount of investment and capital stock. As Morrissey (2001) points out, there are a number of mechanisms through which aid can contribute to economic growth, including (a) aid increases investment, in physical and human capital; (b) aid increases the capacity to import capital goods or technology; (c) aid does not have indirect effects that reduce investment or savings rates; and aid is associated with technology transfer that increases the productivity of capital and promotes endogenous technical change.

However, the research into the effects of aid on growth are mixed – there is no consistent evidence that international aid stimulates economic growth. For example:

(1) The effect of direct foreign investment and aid has been to increase economic inequality within countries. (2) Flows of direct foreign investment and aid have had a short-term effect of increasing the relative rate of economic growth of countries. (3) Stocks of direct foreign investment and aid have had the cumulative, long-term effect of decreasing the relative rate of economic growth of countries. (4) This relationship has been conditional on the level of development of countries. The stocks of foreign investment and aid have had negative effects in both richer and poorer developing countries, but the effect is much stronger within the richer than the poorer ones. (5) These relationships hold independently of geographical area.

There remains a debate about the effect of aid but it is very clear that the simple fact of stimulus – the mere presence of the aid money – is not sufficient to promote growth. Some argue that the policy environment is important (and here there is a debate as to whether macro considerations such as trade openness and fiscal policies are more or less important than micro considerations such as protection for property rights and labour market flexibility). But whatever the details, the fact remains that simply chucking in a load of new cash -  in return for absolutely nothing – won’t do the stimulus job.

Which begs a question – there’s ample evidence of ‘Dutch Disease’ resulting from aid transfers. In simple terms, aid creates inflation making it more expensive to export and therefore harder for the recipient country to grow.

It seems to me that any policy designed to promote inflation in an economy – for example quantitative easing – runs the risk of having the same effect as international aid. Namely a significant risk of inflation and its associated brake on real growth. If we pretend – by the use of legerdemain and jargon - that quantitative easing isn’t inflationary, then we are kidding ourselves that billions in new money can be created and poured into the economy without that money having any effect.

The latest bout of quantitative easing is akin to giving the economy – worn down by years of self-abuse – a large espresso and hoping that will do the job of waking it up. For a short while it will feel OK and then the underlying hangover will kick back in – maybe worse than before.

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...or you could just cut taxes? A comment on 'green quantitative easing'.

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A kind soul (well my sister actually) sent me a copy of Richard Murphy and Colin Hines masterpiece entitled “Green Quantitative Easing”. I am troubled by it since it makes very little sense.

First let me be clear that I’m not an economist – anymore than Richard and Colin are economists – and shan’t be talking about what is or isn’t quantitative easing. Or indeed whether or not such easing actually does any good. In general terms, I take the view that printing extra money without it actually being derived from the creation of value in the real world is inflationary. And I do not believe that the UK economy was ever really at risk of deflation.

But, for what follows I am accepting Richard and Colin’s view that:

“The need to reflate the UK economy has not gone away...”

My problem is with their proposals – or rather the proposals they’ve borrowed from the New Economics Foundation’s “Green New Deal”:

1.  Direct government investment in infrastructure
2. A National Investment Bank
3. Local authority bonds for the “green economy”

Underneath these arguments sits NEF’s (and our authors) unquestioning belief in the effectiveness of the Keynesian multiplier – in this case as a means of raising tax revenues. Sadly, the authors don’t even seem to know what the Keynsian multiplier is:

The multiplier is a central concept in economics and especially regional studies where it is widely used to assess the long term impact on employment and output from different forms of investment. As such it represents a significant part of the Keynesian aggregate demand model of the economy and can be described as the impact of the marginal propensity to consume (mpc) on a given investment or expenditure where the higher the level of mpc the bigger the multiplier (Heertje & Robinson, 1979).

The problem is that our authors’ assumption – that creating jobs through infrastructure will resolve the government’s revenue problem is rather misplaced. For two reasons – 

1.  It is misleading to take the view that public spending decisions are optimal – we cannot assume that our spending isn’t at the expense of private investment simply because it has multiplier effects
2. Taxation – the thing at the heart of Murphy & Hines’ proposals – has an opportunity cost. If you take something in tax, even deferred taxation in the form of public borrowing, that comes at the expense of private activity and private spending

Even if we accept the multiplier effect as true, the model proposed here assumes that building infrastructure drives growth when there is little evidence that this is the case. And, worse, the proposals for a ‘national investment bank’ represent a return to that old socialist obsession with picking winners.

However, it is good that our authors provide a worked through (well sort of) example demonstrating just why this sort of spending doesn’t work – they propose repurchasing £56 billion in public finance initiative (PFI) debt with the “green quantitative easing”.

Now it may be a good idea to buy out this debt – although the contract holders might see it a little differently if Murphy & Hines’ figures are correct – but it won’t help the economy one iota. And – I find this quite remarkable – our authors are proposing to print over fifty billion in crisp fivers so as to hand it to the banks and financial institutions. Who do they think holds all that PFI debt?

There won’t be any multiplier effect from this “investment” (and if they really think they’ll get a deal at £56 billion Richard and Colin really are stupid) since no extra money will go into the real economy, no stimulus will have taken place. Those schools and hospitals will be employing the same number of people on the same wages as they were before the ‘green quantitative easing’ – it will be just like the QE our authors criticise, we won’t know where the money has gone or whether it has done anything to help the economy.

 

Our authors seem wholly wedded to the idea that only government can direct investment and stimulate growth. Perhaps if they hesitated in their obsession with setting ever higher taxes and borrowing ever larger sums to build this mythical “green economy” they might see a clearer, simpler alternative strategy. One that would provide an immediate boost to the economy, which would create jobs and would be popular.

That £56 billion could be used to cut taxes – either by raising thresholds further and taking less well off people out of tax or by a 10% cut in the basic rate of income tax. Rather than the great and good deciding how that vast mound of cash should be spent, ordinary people would decide on the basis of what they want. But then I suspect Richard and Colin would never countenance actually cutting taxes!

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"La, la, la. Not listening, not listening." The Bank of England and the inflation threat

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It is a while since I’ve commented on the extent to which our economic lords and masters are ignoring the damage that consistent above-trend inflation is doing. However I was prompted by the observation – from this source – that:

Most inflation is being caused by indirect taxation by the state

Now, while it is true that increases in VAT and in duty on fuel, fags and flying affect prices, this is not the full story. Over the past couple of years a range of excuses have been set out for our relatively high inflation rates – upward fluctuations in oil prices, poor grain harvests, bad weather and so on. Yet throughout all this – and even when rates of VAT were reduced temporarily – there was not let up in the rate of inflation exceeding both trend rate and the Bank of England’s forecast rate.

Back in February 2009, the Bank forecast that the inflation rate today would most probably be between 0% and 1%. They reckoned there was a 1-in-4 chance that prices would actually be falling (i.e. the Dreaded Deflation), and the chance of inflation being over 2% was put at well under 1-in-10.

Crank forward to February 2010 (just 9 months ago), and the Bank had nudged up their forecasts a bit - they now said inflation would most likely be between 0.5% and 1.5% by now. But they still thought there was a good chance of lower inflation, and still a 1-in-5 chance of deflation (despite the fact that the printing presses had been running in overdrive for a year).

And now? Well, today's CPI inflation has actually turned out to be over 3%. And even the Bank's own November forecast acknowledges its back on a rising track.

So there you have it, the Bank of England – along with plenty of others - has hitched its wagon to the idea that we face deflation which requires us to have, what are in effect, negative interest rates. And today the Bank confirmed that rates won’t rise. And this is despite a big hike in commodity prices, continuing concerns about food prices and the VAT increase.

While all this is going on the Treasury is jumping up and down on the high street banks asking why they aren’t lending any money.

U.K. Chancellor of the Exchequer George Osborne said Tuesday that the government is in discussions with banks to ensure they make a material and verifiable increase in lending to businesses, especially smaller firms.

So let’s think about this George. The banks aren’t very keen on retail lending at the minute despite the Government having printed plenty of money (alright I know they haven’t actually printed any more notes then usual but shovelling money into the banks’ balance sheets* amounts to the same hill of beans). Now why do you think this is? Why aren’t the banks lending?

Spotted it! Banks aren’t lending because they’re losing money doing so – and, quite understandably, banks are not especially keen on making more losses. All that money (along with the make-believe money from the Government) is sitting snugly in the banks’ virtual vaults waiting for interest rates to rise. And the banks know rates have to rise because inflation can’t be allowed to continue at current levels for much longer.

If the Bank and the Government want to stimulate lending the best way to do that is to raise interest rates. Right now the banks are making plenty of money doing their everyday transaction management and ‘moving money around’ business and see no real point or incentive to encourage risky small business lending. Plus, of course, raising rates would reduce inflationary pressures.

Unless, of course, the Bank and the Treasury are really rather pleased about above trend inflation – what better way to reduce the deficit and control the debt! At the expense of savers, shareholders and those who didn’t behave like Viv Nicholson during the last decade.

*Technically QE isn’t ‘monetising Government debt’ as the Government isn’t buying its own debt. Third parties (banks and so forth) are buying the government’s debt. And the assets bought by the bank with QE are different and separate from this. Or put simply – we give the banks cash and they (and their clients) buy government stocks. This is of course wholly different from ‘Mugabenomics’.

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The coming economic winter - quantitiative easing, inflation and the crashes that are yet to come...

An economic winter is coming.

There are two business columnists in the Sunday Telegraph who I always read – and who seem often to be describing a different world. Such is, I know, the stuff of economics and finance. For every economist saying one thing we can find you one – or even 364 – who disagrees. Such is the case with Liam Halligan, Chief Economist at Prosperity Capital Management and Tom Stevenson, Investment Director at Fidelity Investment Managers (the two columnists).

So when they say the same thing we should take notice. Here’s Liam:

“That’s why QE (quantitative easing) will be blamed for so much more than “unfair” currency devaluations and for imposing a “soft default” on America’s creditors. This crazy money-printing is going to be seen as the primary cause of western inflation, food riots and a commodity price spike.”

All pretty polemical and typical of the Halligan style. Instead we can have Tom’s more measured, investment-advice:

“This is the so-called “Bernanke put”, whereby investors believe that if the worst comes to the worst the Fed’s helicopter will simply drop a load more newly printed dollar bills to bail them out.”

All told pretty high falutin’ stuff – not for the likes of us peasants toiling at the computer face. And, like the proverbial boiling frog (which on this occasion has nothing to do with Denholme), we’re not going to notice until it’s too late. We’re not going to see how our Governments – in a deliberate act – have set on a course of creating inflation so as to reduce the real deficit. It won’t hurt.

Or as our friend Liam puts it:

“So, in other words, QE has benefitted some pretty formidable interest groups – insolvent banks, public sector unions and cowardly politicians.”

The one group who emphatically do not benefit from QE is that group containing people without large debts, people living on fixed incomes, those reliant on savings, pensioners…in fact most of the population.

And what is worse is that QE isn’t working.

Far worse than that, the short-term, selfish decision to protect banks and the public sector now threatens to see a return to managed trade, to protectionism and to the misery of international stagnation – even depression.

“The US last week stoked the simmering tensions by unveiling plans for another $600bn (£370bn) of quantitative easing (QE) on top of the $1.7 trillion already in place. The dollar crashed in what is being seen as the latest round of competitive devaluations, as nations seek to debase their currencies to help domestic industry.”

With this comes calls for limits on current account surplus (oh, to have one of those!) – limiting it by agreement – to 4% of GDP. Or at least calls from the US:

“Geithner last week sought to "reach a common understanding" with proposals that are likely be at the centre of discussions in Seoul. He raised the prospect of using current account targets as a way of reducing the imbalances, suggesting a 4pc of gross domestic product (GDP) benchmark. Under his plan, countries with persistent deficits would have to boost savings and those with lasting surpluses would have to cut export reliance.

Unsurprisingly, both China, with a 4.5pc surplus, and Germany, with a 5.1pc surplus, would have to take immediate action. In a damning riposte, Cui Tiankai, a Chinese deputy foreign minister, said the US plan harked back "to the days of planned economies".

It has become a strange world when the Chinese Deputy Foreign Minister is lecturing the US about the dangers of planned economies and managed trade.

At some point we have got to make the banks fess up – get them to lay out the extent of their liabilities on the table and let a few things die. So long as US and UK central banks protect their financial industry through QE – and it’s for the banks interests not ours, dear reader – we face the prospect of a new inflationary bubble in stocks, property, commodities or even tulips that will drive another economic crash.

An economic crash that will be accompanied by managed trade, protectionism, destabilising tax increases and untold suffering for poor people everywhere.

It may not be a good investment strategy not to fight the Fed. But it’s good politics – we should fight the Fed all the way to a world economy based on making, doing and trading things rather than on the fiction of central banker control. Those central bankers – urged on by the panjandrums of the public sector (who wish to protect their sinecures) – are favouring their friends at the expense of those who do that making, doing and trading. And this isn’t just bad economic policy, it’s just plain wrong.

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Up, up and away! More on the inflation threat.

In a meeting the other day I heard an officer make an observation - in the context of "the cuts" - that went a little like this:

"Oh the cuts won't be as bad as you think. Inflation and a wage freeze will deal with most of the deficit."

Now, dear reader, as you know I've been pointing out this aspect of the deficit reduction strategy for some while - especially the inflation bit. And today the inflation chickens are starting to lay their eggs:

Rising food costs could have the effect of pushing up the consumer prices index (CPI), the official measure of inflation, to 4 per cent – double the Bank of England's 2 per cent target

OK there's been a disatrous harvest in Russia this year and some other factors (doubtless all the fault of global warming or something) have affected prodution across Europe - mostly the bad winter. But the truth is that inflation remains stubbornly above the government's target figure and, for many people, the real inflation rate is far higher. This is especially true for those who spend less on consumer electronics and other high end manufactures - the poor in other words.

As Martin Vander Weyer observed a few weeks ago:

The painful truth is that the price of just about everything under the heading of middle-class discretionary spending — as well as many daily necessities — is rising at well in excess of the official Retail Price Index inflation figure of 5 per cent, not to mention Gordon Brown’s famously fudged Consumer Prices Index, which comes out lower (at 3.2 per cent) because it omits vital elements of housing costs.

All this means that we will - collectively - be poorer as earnings lag behind real inflation. And that is the real strategy - we are making everyone's savings smaller to reduce the debt the Government has run up. And in doing this we risk inflation rising too fast and doing enormous damage to our fragile economy. And some idiots are still saying we should print more money?

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Labour left an inflation time bomb - and it's going off some time soon

Back in February I wrote this:

The Government’s strategy is to use inflation to reduce the impact of massive debt and to protect Labour’s key public sector voters. That’s why they printed £180bn in so-called “quantitative easing”.Inflation is 3.5% now. Expect 4.5% - even 6% - over the next few months. And watch the value of your savings shrink! Transferred neatly into the reduction of the real value of government debt. Let it rip!

Now read this report on a Policy Exchange study:

That boom would quickly run out of control, as the £200bn of "money printing" by the Bank during the crisis would lead to "a huge expansion in the money supply, which will lead to inflation". He estimates that the Retail Prices Index (RPI), the inflation measure favoured in wage settlements and against which annual rises in train fares are priced, would rise "above 10pc". The Consumer Prices Index (CPI), the inflation measure that the Bank is responsible for keeping at around 2pc, will top 6pc, Mr Lilico reckons.

Or if you think Andrew Lilico is a loony right-winger, this:

CPI inflation has exceeded the Bank of England's 2pc target for 43 of the past 52 months. The CPI remained at 3.1pc in July – forcing the Bank to pen yet another letter of explanation. Since 2007, despite the screams of the self-serving deflationist crowd, eight such letters have been written. In the latest, released last week, Bank Governor Mervyn King invoked the spectre not of falling prices, but of 1970s-style price rises, warning of the dangers of "destructive high inflation".

I told you so!

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