Olen niin iloinen

For those of you who do not speak Finnish, a clue to the meaning of the words above might be found in the following questions.

What happens on 20th March 2018?

Answer – UN has declared it to be World Happiness Day

What do Norway and Burundi have in common?

Answer – they both dropped in the UN World Happiness Report. Burundi dropped to bottom place while Norway dropped out of the top slot to be replaced by Finland – hence the Finnish comment “I am so happy”.

The Report ranks 156 countries by their happiness levels, and, this year, it also looked at 117 countries by the happiness of their immigrants, with Finland coming top in both rankings.

The top and bottom 10 are recorded below. A sample in each country are asked to score their happiness on a scale of 10 (most happy) to 1 (least happy) with Finland scoring 7.6 and Burundi 2.9. In order to identify the reasoning behind the score, the report also looks at economic strength (measured in GDP per capita), social support, life expectancy, freedom of choice, generosity, and perceived corruption. The biggest loser was Venezuela, dropping 2.2 on the scale, which is little surprise considering the state of their economy. This year the study also looked at the happiness of migrants,

It is worth a warning note about the numbers – the difference between the top 6 countries is only 0.191 on the 1 – 10 scale.

The world’s happiest – and least happy – countries 2018 World Happiness Report
Happiest Least happy
1. Finland 147. Malawi
2. Norway 148. Haiti
3. Denmark 149. Liberia
4. Iceland 150. Syria
5. Switzerland 151. Rwanda
6. Netherlands 152. Yemen
7. Canada 153. Tanzania
8. New Zealand 154. South Sudan
9. Sweden 155. Central African Republic
10. Australia 156. Burundi


It is rare to see two successive blog posts on the same topic but it is also rare for an economic issue to receive the attention which President Trump’s proposed tariffs on steel and aluminium have attracted. Since the last post, Gary Cohn, his chief economic adviser, has resigned in protest at the decision, swaying the political balance in the White House from supporters of free trade towards protectionists, the EU has added to its list of potential targets for retaliation to include peanut butter, Bourbon, Florida orange juice and Harley Davidson motorcycles, and President Trump has continued to threaten retaliation against the retaliation, talking of tariffs against EU car exports. There have also been comments in the newspapers looking back to the 1930s and the protectionist measures imposed by the USA as a way of helping them escape the Great Depression, which served only to make the world situation worse.

The language of the debate (if that is what it can be called) continues to be confused. On the one hand President Trump argues that the tariffs are justified by WTO rules on the grounds of national security, a legitimate reason for imposing tariffs; the argument being that steel is an important product for the defence industries. However the main exporters of steel to the USA are the EU (the largest), Canada, Mexico and South Korea – hardly countries which are likely to go to war with the USA. China does not feature among the list of the major steel exporters to the USA. Furthermore some of the steel exported is highly specialised and not even manufactured in the USA.

While talking of national security as a justification, President Trump simultaneously continues to refer to the need to reduce the US balance of payments deficit, arguing that the deficit is “BAD” and the fault of foreign countries. Not only has the deficit occurred in part because foreign producers can produce more cheaply than US ones, it has also allowed the US to consume more than it produces and, subsequently, living standards have risen. Foreign trade is not a zero-sum game – both deficit and surplus countries benefit from greater trade.

So how has a country like the USA (and the UK) been able to run such a large and persistent deficit? This is because foreign governments, banks and individuals have been willing to hold dollars and US assets rather than change them back into their own currency. In the same way that a generous parent’s continual lending allows their children to spend more than they earn, the UK current account deficit might be partially financed by a financial account surplus caused by rich foreigners and businesses placing money earned from selling to the UK in UK banks or buying property in London, UK shares or government bonds. The same applies to the US, but is reinforced by the additional benefit the USA has which is that the dollar is so widely used for international trade and as a reserve currency.

Structural Unemployment in Australia


Structural unemployment has many causes; advances in technology can make some jobs redundant, offshoring production to low-cost producers means a lack of domestic demand for certain workers, and a permanent decline in demand can make some industries obsolete.

This article, courtesy of Ryan Z, is an illustration of the 2nd cause mentioned above. Australian’s, obviously, will still buy cars, but all will now be imported as domestic production ends. Car plant workers will find it difficult to find work because their skills are no longer in demand. They either move overseas to find work or retrain. The latter is far more likely but does come at a cost to the individual, through lost earnings, and the government, who are likely to partly fund re-training programmes. Building a flexible workforce can help reduce the level of structural unemployment, but this is far from easy.




Falling Share Prices – Causes and Effects

This week has seen major falls in share prices across the world with $6 trillion being wiped off world share values.  America’s Dow Jones index dropped 5.2%, Japan’s Nikkei index fell 8.1% and the UK’s FTSE index fell 4.7%, the lowest it has been for 15 months, while in Japan and America the falls broke records for the size of their drop since October 2008.

The initial reason for the fall was, paradoxically, good US economic data as their service sector boomed and wage levels grew at the fastest rate since the start of the decade. This good news meant that it is now more likely that US interest rates will rise sooner and by more than had previously been anticipated. Mark Carney reinforced this view when he expressed similar sentiments about the future of UK interest rates.

Although a rise in interest rates has been expected for some time as the world economy’s growth accelerated, the reminder that it might occur soon has come as an unpleasant shock. The scaling back of QE by central banks is expected to reduce the ability to borrow cheaply, some of which has financed recent purchases in shares. Financial investors expect that the forthcoming rise in interest rates will reduce company profits, therefore reducing the demand for shares. Simultaneously existing shareholders might be encouraged to sell quickly before prices fall further, thereby increasing the excess demand. In addition, the economic uncertainty was increased by the fall in the value of bitcoin by approximately 50% since the state of the year.

Economists are trying to decide whether we are currently experiencing a “correction” or  are entering a bear market, where prices fall by more than 20%. The “correction” proponents believe that shares are over-priced in terms of their price compared to their earnings – the price:earnings ratio – and therefore the fall was due. However there is concern that the behaviour of investors, whether in shares, currencies or commodities, sometimes leads to markets over-shooting since falls (increases) in price encourage selling (buying) which further reduces (increases) the price.

According to economic theory, the fall in share prices might lead to a negative wealth effect (the idea that consumption is determined by one’s wealth as well as one’s income). However, given that many shareholders are in the upper income brackets, their marginal propensity to consume will be low and therefore the effect will small. More significant might be the general impact on consumer and business confidence from the media reports about the falling share prices. As Keynes wrote in his General Theory,  “animal spirits” outweigh the  “weighted average of quantitative benefits multiplied by quantitative probabilities.”.


So how is the economy doing?

This week has seen the publication of considerable economic data and much of it is contradictory, making it hard to tell exactly how well the UK economy is (or is not) doing.

In the year to March 2017, household spending in real terms returned to levels not seen since before the financial crisis, reaching £554 per week. The UK budget deficit has fallen and was £2.6bn in December, compared with £5.1bn in December 2016, and almost half economists’ expectations. This was partly due to higher than expected tax revenues from income tax receipts because of higher employment, higher VAT receipts and a refund on contributions to the EU. The positive news on the budget deficit means that government borrowing is likely to be at its lowest level since the financial crisis. Before celebrating too much, be aware, firstly, that the higher VAT receipts were due to higher inflation as well as to the growth in consumption and, secondly,  the refund from the EU was because the UK share of the EU budget has been revised downwards as a result of slower growth in the UK than the rest of the EU.

Another boost for the UK economy  was news that the employment rate had risen to a record high of 75.3% or 32.2 million, confounding forecasters who had predicted that the employment boom was over, based on the fall in October 2017 which is now being treated as a temporary fluctuation. At the same time as the employment level rose, the unemployment rate remained at 4.3% or 1.4 million, a 42-year record low. Equally encouraging was the shift from part-time work to full-time work which occurred over the period.

Further positive news  was that the economy grew at 0.5% in the last three months of 2017, faster than expected, largely because of the resilient service sector which makes up about 80% of the economy. As a result, growth last year was 1.8%, significantly higher than the 0.5% prediction by some disappointed economists following the Brexit vote. However, it is worth noting that the UK has dropped from being a growth leader to a laggard among the G7 countries, its growth rate is now at its lowest rate for the last five years and, given more rapidly rising incomes among our main trading partners, a slowdown in UK growth is disappointing.

On the downside, wage growth continues to be slow, meaning that real incomes are falling, the number of people starting apprenticeships fell by a quarter in the three months between August and October compared to last year, and sterling rose to its highest level since the Brexit vote. While this is good for importing businesses and holiday makers, it is less good news for exporters who have enjoyed the benefits of a low pound. It has also hit the share prices of companies with significant dollar earnings which are now worth less when converted into sterling.

Finally a word of caution; some of the figures, such as consumption spending, relate to the previous financial year while others, such as the growth in GDP, are subject to significant revision over time. Most recently, the figures for UK productivity have been questioned because the ONS might have significantly over-estimated inflation in the telecommunications industry and therefore underestimated the increases in its output. As a former Governor of the Bank of England pointed out, “trying to control the economy is like steering a car by looking in the rear view mirror”.


The exchange rate and the economy.

The traditional view of a fall in the value of a developed country’s currency was that it would lead to an increase in the value of their exports and a fall in the value of their imports, hence improving the balance of payments and, via the resultant increase in aggregate demand, cause an increase in employment and growth.

However the above analysis needs considerable qualification. Although a fall in the value of a currency will almost always increase the VOLUME of exports and reduce the VOLUME of imports, whether the values change in the same way will depend on the elasticities of demand for exports and imports. For a developing country whose exports are commodities with an inelastic demand, a fall in the value of the currency might worsen its balance of payments. Over time the UK’s exports have moved up-market and therefore it can be argued that they have become less price sensitive since factors such as design and quality become more important.

Secondly, the analysis assumes that firms can increase their production of exports to meet higher demand and this will depend on the state of the domestic economy, the availability of labour, raw materials and components. This is unlikely to be easy in the short term and economists talk of the “J Curve effect” whereby a devaluation initially leads to a worsening balance of payments as quantities of exports and imports do not change much, possibly because of long-term contracts or the difficulties in increasing output of export and import-substitutes and, only over time, will the balance of payments improve. While this might not apply to tourism, where people can switch their holiday destinations relatively quickly, high tech exports and imports of manufactured exports will be much slower to adjust. Firms need to take a view as to the permanence of any change in the exchange rate. In my last post, I wrote that the £:$ exchange rate fluctuated from $1.71 in July 2014, $1.32 after the Brexit vote, then to $1.21 in January, 2017, and was at $1.38 (20th January 2018) but at the time of writing (27th January 2018) it had risen to $1.42. Firms planning long-term contracts will need to take a view as to the likely long-term exchange rate and largely ignore short-term fluctuations.

We should also not forget the downside of a devaluation which is that imports become more expensive and therefore living standards fall. Not only does one’s foreign holiday cost more, but imported finished products and anything using imported components or raw materials becomes more expensive, with the increase in price depending upon how easily the supplier can pass on the increased cost to the buyer. As products become more complex and firms take advantage of globalisation, the supply chain becomes longer and there is a greater likelihood of imports being involved in some in the final product. Thus an increase in UK exports of goods is very likely to require an increase in imports needed to make our exports and some of the increased competitiveness will be lost by the higher cost of imported components and raw materials.

Recent examination of the exchange rate and UK trade in goods might suggest that the exchange rate  has a significant impact. In the last year the volume of UK goods exported rose almost 9% which would imply that the fall in sterling post Brexit has had a positive impact until one reflects that UK imports have increased by 7% during the same period, despite their increase in price. What this shows is that the exchange rate is simply one of many factors affecting the demand for imports and exports and we cannot ignore factors such as quality, income, interest rates or anything else which changes the desire to consume goods and services.


Sterling and the UK Economy

The pound has undergone something of a roller-coaster ride over the past three and a half years.  It was $1.71 in July 2014, fell from $1.49 to $1.32 after the Brexit vote and then again to $1.21 in January, 2017 and has recently risen to $1.38 (20th January 2018). However, it is worth noting that while, historically we usually measure sterling against the dollar, the fall against the euro has been greater.  In July 2015, £1 would buy 1.49 euros but by August 2017 the rate had fallen to £1 = 1.08 euros  and it is currently at £1 = 1.33 euros.

This post will consider the factors which might cause the value of a currency to fluctuate. (and the next will discuss the impact fluctuations might have on an economy). Over the last 100 years, the world has moved from a system where currencies were fixed to gold (the Gold Standard), to a time when the dollar was fixed to gold while currencies such as sterling were pegged, with limited flexibility, against the dollar (the Bretton Woods Agreement) to a system of flexible exchange rates where, today, in theory, the demand for and supply of the pound in the foreign exchange market determines its value.

In old economics textbooks, the adjustment process was simple.  The demand for a currency is determined by foreigners wanting to buy UK exports and needing to pay for them in sterling while the supply of sterling came from UK firms and consumers wanting to buy foreign goods and services, such as overseas holidays, and needing to swap pounds for foreign currency to pay for them. If the UK had a balance of payments deficit, the demand for sterling in the foreign exchange market would be less than the supply and so the value would depreciate against other countries, making UK exports cheaper and imports more expensive, restoring international equilibrium.

Today the situation is far more complex; not only do we have to consider the impact of a currency such as the euro which has replaced the individual currencies of the members of the eurozone, making it impossible for them to use depreciation to improve their balance of payments, it is now no longer the sale and purchase of exports and imports of goods and services which determines  the exchange rate, it is the trade in financial assets which is far more important as banks, businesses, governments and individuals buy and sell foreign shares and government securities and move money between countries to gain higher interest rates or profit from speculative movements in currencies. To put this into perspective, the World Trade Organisation estimated that in 2015, total international trade in goods and services amounted to $20 trillion while $5 trillion was traded on the foreign exchange market EACH Day.

Therefore factors which influence speculators’ views of the economy will have a major short-term impact on the value of the currency. Hence, immediately after Brexit, the general view was that leaving the EU would have detrimental effects on the economy (or at least on those dealing in financial assets and currencies) and this reduced the demand for sterling from overseas and increased its supply from UK holders seeking to purchase foreign financial assets. Similarly if the political situation changes and that affects views of the economy, then the value of the currency will change. Other things which will affect the value of the currency will be changes (or expected changes) in our rate of interest or the rate of interest in other major currencies, the economic performance of our economy or other major countries since if, for example, the US economy weakens, then relatively, the UK economy will be stronger and this will encourage a movement of money from the dollar to the pound.