Soaring petrol - Government response

So the PM is to respond to soaring petrol by meeting industry leaders. I can imagine that this will rapidly turn into a dialogue of the deaf. The industry will claim that they only make a few pence per litre profit from pump fuel. The government will claim that the tax cannot be removed as it will unwind the budget. There is degrees of truth in both of these positions. The meeting will therefore be purely and simply for show. It is not about doing anything, simply being seen to try. It is bogus.

In truth the PM and the Chancellor have little room for manoeuvre on this score as they have nothing in the tank to rely on as the bad times roll. The problem for the rest of us is that vehicle fuel is rocketing on the back of the high oil price. The politically uncomfortable truth is that we are going to have to get used to higher prices. In the short term the government should seriously consider deferring the next fuel duty rise to stave off the worst impacts of the current price acceleration. It could also pledge to look at the extraordinary double taxation of petrol whereby it is hit by excise and VAT. Finally though there is going to be no avoiding the urgent need for next generation domestic fuel for cars. The government needs to come up with some means of encouraging the development of fuels for our cars that are not based on oil. For too long all our fuel eggs have been in one basket, we are all now paying the price. Of course we will continue to do so in the short to medium term, but the government must now signal serious intent to diversify our energy supply both in terms of electricity production but also in terms of the fuels to power our transport.

“I have done it before and I can do it again”

This was Gordon talking about himself and steering the economy through a rocky patch. Is it just me or does it smack as just a touch arrogant? Brown coasted on the back of Conservative reforms for much of his Chancellorship and on the back of a debt bubble on the rest, he has piled taxes up by stealth to buck the reverse half of the Laffer curve and now the debt bubble is bursting. A little humility might behove Mr Brown, if he shows no humility then he may be given a humiliation.

Did the Chancellor mislead the house?

Just looking at the statement that Alistair Darling gave to the house of Commons today in which he announced that the threshold for higher tax would be reduced and said “I am therefore reducing the threshold at which an individual starts to pay tax at the higher rate by £600.” However when one looks at the HMRC press release it states something different and says “To reduce the higher rate threshold as announced by the Chancellor, the basic rate limit will be reduced by £1,200 from £36,000 to £34,800.”  The press release then states that higher rate taxpayers will not lose out. Now my maths might be slightly dodgy here but the tax free threshold goes up by £600 so as the basic rate is 20% that is a saving of £120 in tax. However if the 40% threshold is lowered by £1200 pounds then that means that an extra £1200 is charged at 40% tax equating to £480 less the £120 benefit of the tax free threshold so higher rate taxpayers will be worse off to the tune of £360 pounds it seems, or about 99p a day worse off. Please someone correct me if I am wrong.

Somewhere along the line someone was being misleading. Also when did we become customers of HMRC? Can we withdraw our custom?

Update:- Just looked at the tax bands for 2007/08 and the 40% rate kicked in at 34,600, as a result of the budget that was indexed up to 36,000. From the press release today the level has been bought down again to 34,800 all but cancelling the indexation in the budget. This is major fiscal drag and will trap new people in higher rate tax.

Update 2:- Having looked again at a simple tax calculator it appears that the £1200 difference does mean that higher rate tax payers get no benefit from the increased personal allowance, however the point stands that Darling said that the Higher rate threshold was being reduced by £600 not £1200.

Taxes are high - so what?

In the House of Commons today there was a revealing exchange, well more of an aside really. David Cameron was making a point that the UK tax burden is quite high historically, Ed Balls, then said from a sedantary position “so what?”.  It is drawing the ire of commentators from across the spectrum and quite rightly so. Ed Balls dismissive comment about taxation that is hitting the wrong people at the wrong time tells you everything about the attitude of late term Labour. They have lost their sense of affinity with hard pressed taxpayers. I cannot imagine that Tony Blair would have said “so what?” to a point about high levels of tax. The Blair approach would have been to link tax with investment and to accuse Cameron of wanting to cut investment. Balls attitude used the words “so what” but what he actually meant was “stuff you”. It is Labour’s approach from the start.

Complain that taxes are too high  -  so what, stuff you.

 Waiting for decent healthcare   -   so what, stuff you.

 Want a referendum that we promised  -  so what, stuff you.

This attitude is typical of a government that is out of touch and in the twighlight of it’s years. In anything up to 2 years time the Labour government will go to the polls and try to convince people “We deserve another four years, please give us your vote”. I suspect the resounding response from the public will be “so what, stuff you.”

National Rock - Labour will pay a high price

Sunday 17th February 2008, will become a date to slap into the Calendars of all political anoraks. It is the date on which Gordon Brown’s economic credibility collapsed. That it has collapsed is perhaps less surprising than the speed with which it has collapsed. Anyone with a reasonable grasp of such things could see that Labour’s economic credentials were largely smoke, mirrors and Brownian bluster. The economy they created is mired in debt both public and private, the public sector has been grown to a size not seen since Callaghan was in Downing Street, and the tax code is now one of the most complex in the world. This is a dire record, but it was masked by Gordon Brown’s formidable spinning and a benign economic climate. The benign economic climate has now disappeared, in the middle of 2007 the economic community woke up to the alchemist efforts to repackage sub-prime debt as worthwhile economic instruments and the Global credit markets seized up. This led to the issues with Northern Rock whose business model relied heavily on a liquid credit market. When the market seized up Northern Rock was left high and dry.

The government has now after dithering, delaying, extending deadlines and in every other way trying to put off the inevitable point of decision decided to nationalise Northern Rock. This is a calamitous decision and was entirely avoidable at several points in the chain. Firstly to start with the decision to bail out the Rock was understandable at the time when there was a fear of contagion and a systemic problem developing in UK banking. It was therefore broadly correct that the government stepped in to guard against that scenario. However the fact is that the risk of that contagion and systemic banking issue receded rather quickly and it soon became clear that Northern Rock’s issues were largely unique. At that stage action should have been taken, in my view to wind the company up as it was by then clear that the Rock brand was damaged almost beyond repair and that the scale of the problem was such that it would be impossible to sell the Rock whole. The government pursued an alternative route and has ended up by getting itself into the position of seizing the company into public hands.

Public ownership is rightly a discredited philosophy, the lessons of the 1970’s and 1980’s showed that publicly owned enterprises rarely make a profit and are usually inefficient and costly to run. That the government has found themselves in this position is incredible, and it is wrong to state that they had only the options of nationalising the business or of the two commercial solutions; they had a third option to wind the company up. It is also disingenuous of the government to mouth the platitude of temporary public ownership when in all likelihood the Northern Rock bank will be government owned for years. This nationalisation is not temporary it is at best a medium term solution and could be a long term solution. Then there is the thorny issue surrounding how a State owned commercial bank can operate in a sector that is largely privately owned. Firstly if the Rock tries to be competitive then the other banks will rightly cry foul because the Rock can’t now fail as a business. If however it doesn’t compete then it cannot be a profitable business as customers will go elsewhere. Northern Rock is now doomed to exist as a twilight business neither succeeding nor being in a position to fail. The government however could find itself in a worse position if the EU decides that nationalisation breaches state aid rules.

The tragedy for the UK is that it now finds itself with a Prime Minister schooled in the 80’s with a 90’s outlook, applying 70’s solutions to 21st Century problems. Taking Northern Rock into public hands looks like only the beginning of the problems for the government, there will probably be a succession of lawsuits. The political damage will grind on and it will have to answer for every repossession that Northern Rock pursues; every redundancy and every time it refuses a mortgage or loan. What a dire position to find yourself in. The problem stems principally from the failure of the tripartite regulatory system that adopted a see no evil, hear no evil, speak no evil approach. The FSA who had oversight saw nothing, the Bank of England who had the power to intervene saw nothing, and the Treasury who were told that problems were mounting heard nothing. We now have the spectacle of a Government that has failed to regulate the banking sector adequately having to take an active part in that sector by running a retail bank. The damage to the UK’s reputation as a place to do business has suffered and will take a long time to recover.

The nationalisation of Northern Rock is a neat codicil for this first stage of the Brown premiership, it started so well with what looked like a new broom. Then came the autumn as voices tempted the PM with a snap election, but Gordon dithered and ultimately delayed that election. Then with tax changes the Chancellor announced them then dithered and delayed over reviewing them Now with Northern Rock the PM and Chancellor have dithered and delayed and dithered some more. Ultimately the delayed election will be seen as the point at which Labour realised they were vulnerable to election defeat, the nationalisation of Northern Rock is the point at which the defeat of Labour becomes a much more likely prospect. Politics will resume and the dust may settle somewhat but nothing will ever be the same again for Labour.

National Rock

The government look like they have accepted the inevitable and are going to Nationalise the Rock. This is an utter disaster for the government and represents a serious blow to their economic credibility. I don’t actually think that it is the fact of nationalisation that will crucify them but that it has taken them so long to get to the point of decision.

The Fed’s response to the crisis

So the US Federal reserve has come out fighting in the emerging crisis engulfing world stock markets in 2008. The decision to drop interest rates by 75 basis points outside of the normal cycle was a stunning move, and it resulted in a stock market bounce, a Bernanke bounce if you like. The markets were actually unsure about this swinging wildly from negative to positive all day and even after the interest rate move. Personally I am not sure how welcome this move is, I think the reasoning is classically correct but I think the analysis of the nature of the crisis is somewhat off and so the response is largely incorrect.

The great breadth of analysis since August has been that we are in a credit and liquidity crisis and that the answer is therefore to artificially bring down the price of credit by hosing markets with short term liquidity in market intervention and slashing headline interest rates to keep the machine lubricated with credit hungry consumers. I think the analysis is misplaced, the credit crisis is symptom not cause, the cause is a risk crisis and I shall attempt to explain why in detail further on. If therefore it is a risk crisis then liquidity measures may soften the edges but won’t attack the problem, indeed as I will go into I am not even sure there is a package of measures that would be workable or even sufficient. I think it may be that we just have to suffer.

Over the past decade or so, the markets and the world economy has sought to decouple the risk from the return. In effect the main players in global economics have sought the economic equivalent of the philosophers stone, a means of getting high returns with limited risk turning market lead into profit gold. This led to the structured debt which is at the root of the sub-prime aspect of the crisis, however the problem is deeper even than that. The sub-prime disaster was another aspect of the downgrading of risk as a consideration as the credit-worthiness of mortgagees was often ignored in order to furnish them with a debt and the mortgagor with an income stream and profits. This toxic debt was then parcelled up and kicked around until instruments based on them were available that bore no relation to the true risk. In this country, credit has been extended to the level that consumer debt is now higher than annual GDP.

The initial credit crunch in August was the start of a process of reassessing risk, the banks were aware that there was large amounts of CDO’s and other structured debt that was now of unknown value hence the risk was unknown and therefore too great, banks stopped lending as the risk factor was fully understood. The banks are slowly taking the hit, with billions of dollars of write downs as the risk is recalculated and the values are staggering. However the threat to the economy which in my opinion is driving the down pressure on stocks is related to consumer credit and the reassessment of risk here. UK mortgage rates are increasing, credit is being refused in more instances, and so there is a tightening, this will impact on the economy.

The economy in the UK has largely been a complete mirage for certainly the latter part of the last 10 years. Several factors have distorted it, the absence of proper risk calculation, a huge increase in public spending, and the growth of China. The first I have detailed above, the effect of which is that a large part of economic growth has been fuelled in an entirely unsustainable fashion. The growth in central government expenditure put money in which naturally fuelled growth, most of this has been borrowed and so is unsustainable, but it added to the growth. In both these instances the money is now palpably running out, and the availability of further credit has run out to, probably even for the government. This means that growth levels will drop. My last distorter is China, this is because China has been flooding the west with cheap imports I think that the return half of the bargain has been twofold, first we exported cash to the Chinese current reserve. China now has so much reserves that it could fund the UK governments spending for the next 2 years in cash. I think the other export has been a subtle export or suppression of inflation. Just think Oil prices didn’t just suddenly jump to $100, they have been climbing for years and yet no inflation, gas prices likewise, unit costs of electric, still no inflation.

I think this led to a dreadful miscalculation on the part of the Central banks in the West, they had low inflation so interest rates came down, inflation stayed low so interest rates stayed low. I think that this was a mistake I think that when inflation did start to rear its ugly head and interest rates were raised steeply to put a lid on it, I think this blew open the risk crisis that had been developing for a decade. The risky mortgagees in the American sub-prime market couldn’t handle the rate rises, so defaulted and the dominoes started to fall. I think we are still in the domino rally, as monoline insurers begin to absorb the full horror of their exposure. The Central bank responses is now to cut interest rates to cheapen credit to tempt consumers to consume. I don’t think that it is going to work one iota, they are signalling that cheap credit is back in fashion, I think those at the sharp end are deciding that credit might be cheap but it is no longer available.

I think consumers are waking up to this and are seeing a squeeze on their spending, firstly house prices are dropping so the capital base from which they secured their credit is diminishing, even if that were not the case, lenders are setting the risk bar higher so credit is no longer being extended. Thirdly the result of this is that the consumer is gripped by a sense of nervousness about the state of play and so is voluntarily retrenching. I think the problem is not going to be solved by cheapening credit unless the banks and lenders decide to throw caution to the wind and abandon sensible calculation of risk to return. What does this mean for the economy as a whole, well growth will either be non-existent or very limited as consumers rein in their spending and credit is no longer freely given. Will it be a recession or a slow down, my guess would be that we will tip into recession, as the economy back pedals slightly to a size that can support the new risk reality.

The truth is that whilst interest rate cuts will soften the edges of the downturn it won’t be a solution, it is not a medicine for the revaluation of risk. There probably isn’t a fiscal remedy, the only option is to suffer and learn the lesson for next time.

Interest Rate Decision day

Well it is decision day, will the BoE cut rates or leave them on hold? Stick or Twist? Anatole Kaletsky in the Times has an interesting analysis of the risks involved. I think the decision will be tight with probably one vote deciding the outcome. It is a tough one with issues in the wholesale credit market, inflationary pressure, and the first tentative signs of trouble ahead. I imagine that as with most things their isn’t an easy decision here and that there are good arguments for holding rates for a bit longer and equally good arguments for starting the downward movement.

In pure inflationary terms the decision would probably be to hold. In terms of the general health of the economy then the decision for a 25 basis point cut would be probably be made. Where do I stand? Well as a mortgage holder I would quite like a rate cut, I actually get the impression though that the Bank may hold. Although I would be delighted to be wrong.

Markets and Elections

Well I think we can safely say that the recent problems at NR have eliminated the potential for an election this October. I cannot think that any PM in their right mind would risk the charge of cutting and running, especially if it could be so easily made and not without some resonance. So I think that an election this year is all but impossible given recent events.

Are the market issues of recent weeks over? Well the government have given an unlimited largely unspecified guarantee to NR savers over any deposit currently held in NR. This appears to have quelled the issue for now. Over in the US Ben Bernanke has cut US loan rates by 50 basis points in order to stave off a recession, this led to a large rally in US stocks. I suspect there will be a general consensus that the worst has been avoided and everything will look rosy from here on in. Forgive my pessimism but I somehow just don’t buy it, I think that the economies of the world are looking ripe for a correction and nothing the governments or central banks can do will avoid it. They may stave it off but I still think it is coming. The economic cycle can not and has not been abolished, economies grow and then they stall and during that stall tend to consolidate the gains. The UK in particular needs a period of consolidation, as well as a long overdue lesson that you cannot buck the market. I don’t think that even after recent weeks that lesson is yet fully understood.

Economic situation

Yet again we are seeing turbulence in the markets, however we have also seen a steep drop in the inflation rate as well over the last month. I think that the two are not unrelated. Inflation is widely seen nowadays to be a factor of excess money in the system so less inflation less money, and vice versa. This is why when the Central Banks see inflation creeping into the system they put up interest rates which is the cost of money to limit the amount of money in the system and curb inflation. Well that’s the theory at least. The practice I am in no doubt is probably a heck of a lot more complicated. The markets over the last week hit a credit crunch, when the routes of borrowing began to close down rapidly. The central banks in order to preserve financial order, pumped credit into the system to keep liquidity and stave off a major problem. Investors took a bit of a pounding. Many probably needed the lesson that there is risk in financial investing as well as reward.

How is this related to the drop in inflation, well I am not saying that they necessarily are. I am not a trained economist. My reasoning is as follows, as I set out above inflation is linked to supplies of money, less money less inflation. The BOE has been raising interest rates to reduce the amount of money sloshing around in order to reduce inflation. This is supposed to be a gradual effect and gradually inflation drops and at the appropriate point the Bank cuts rates and the taps of money start to flow a little more. However I suspect that human nature is playing a large part in the current climate, for over a decade now we have been fed a line that today’s central bankers and finance ministers are so clever that the economic cycle has been tamed to the extent that large scale market corrections are history. I get the feeling that they are wrong about this. I think people are seeing the pain being inflicted necessarily by the BOE in terms of interest rate rises and are worried. I also think that the pain or interest rate threshold is lower than a decade ago and that we are at that threshold. I think the drop in inflation may indicate a rather rapid retrenchment in human spending behaviour. Obviously we need to see a couple of months figures before anyone can gauge what is happening. However if we are seeing a sudden change in behaviour and a rapidly departing sense of confidence in the markets then we could have a problem. If evidence mounts that consumers have stopped consuming then it could spell problems all around. The governments forecasts will be shot, the net cash requirement will soar. This will feed into the gloom and before we know it we will be in a recession.

Yes, I have mentioned the ‘R’ word. I do not think that a recession or economic retraction would necessarily be a disaster. It would inject a healthy dose of realism back into everyone and also it would highlight how well the modern financial set up can respond. Yes any recession will result in shakeout as businesses and individuals succumb to pure survival of the fittest. However, most recessions do not go on forever and eventually they turn into recovery. The biggest danger is if the system is not as good as it is made out to be and the wrong decisions are made. Then a small recession can be turned into a large slump. This is the lesson of the late 1920’s when bad decisions made a manageable situation into a crisis. There is no reason that a small general economic correction need be calamitous. It may be necessary, especially as we see a generation of younger consumers coming into the market who believe that there is no risk in economic life.