How is the UK doing?

In the run-up to a big boxing or tennis match, the media is fond of making comparisons between the two competitors, comparing key measures such as height, weight and reach. As we approach Brexit on 31st October or later,  it is worth doing the same exercise for the UK and world economies to see what state the UK is in.

Optimists, looking at data published in August, highlight the increase in average earnings of 3.6% in the year to June, the highest increase since June 2008, the rise in employment to 32.8 million (largely due to increased females working), giving the joint highest participation rate ever.

However pessimists focus on the fall in GDP of 0.2% from April to June, the sharpest fall in high street sales since December, 2008 (although these are survey figures, so might not be representative) combined with a fall in internet shopping, the increase in inflation to 2.1%, the small increase in unemployment to 3.9%, the lower than expected government budget surplus and the balance of payments current account deficit amounting to 5.6% of GDP. They also worry about the quality of some of the new jobs being created, possibly on zero hours contracts, and ask whether the rise in employment is because firms are reluctant to commit themselves to expensive investment projects because of low confidence in the economic outlook.

The current state of the world economy is also a concern for the UK. Germany suffered a fall in GDP in the last quarter and is expected to move into recession (two consecutive quarters of negative growth), the trade war between the US and China is dragging on and growth in the latter is slowing, and the International Monetary Fund has cut its forecast for world growth to 3.2%, the lowest for ten years. The world economic situation has been a key factor in last month’s fall in UK manufacturing output – the fastest rate of fall for seven years. However, worryingly, another explanation provided was that some foreign firms are cutting the UK out of their global supply chains in anticipation of Brexit (but bear in mind that manufacturing is now only 10% of UK GDP).

However what was a feature in the news last month was the technical concept of an inverted yield curve. The yield on a financial asset, such as a government bond, is the rate of return based on its purchase price and, normally, it is higher for long term assets than short term ones. If the government borrows money for three months, the rate of interest would normally be lower than if it borrowed for ten years. This is because lenders are rewarded for committing their money for a longer, and therefore riskier, period. When this is reversed, i.e. governments can borrow at a lower rate of interest for ten years than one or two, it signals that the markets expect that the future will be poor and the government will cut short-term interest rates in the future, therefore savers will wish to lock into the current long-term rates of interest. An inverted yield curve also shows that savers wish to lock into safe assets, such as US, German and UK government bonds, and are prepared to pay a higher price for them. The higher price reduces the yield from the bonds. An additional concern is that current interest rates are already at very low levels so the scope for reducing them is limited so, despite concerns about high government borrowing, fiscal policy might be the only weapon left.

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An Economic Update

Rising employment                   Falling unemployment       Low inflation                Rising pay

Forecast inflation increases    Falling productivity              Forecast job losses

Falling confidence                      Increasing balance of trade deficit    Rising household debt

Over the last two weeks there has been much economic data published, together with forecasts of what might be in store for the economy over the next few years. While some of what has been announced for the future is easy to assess, such as Honda’s announcement of the closure of its Swindon factory in 2022, some of the data is contradictory, so it is not easy to see exactly how we are doing. Furthermore, the picture is clouded by difficulty in distinguishing between temporary features due to Brexit uncertainty, such as businesses delaying investment decisions with the Head of Make UK, a body representing engineering companies, talking of a no deal as being “catastrophic”. There are also factors such as increasing household debt which might have a significant long-term impact on the economy.

On the optimistic side, the latest labour market figures are positive. Employment has risen in the last three months of 2018 and, compared to a year earlier, has increased by almost half a million, with most of the increase being accounted for by an increase in female employment. Unemployment remains at 4.0%, or 1.36 million people, the lowest rate for approximately 40 years; the employment rate (the percentage of 16 – 64 year olds in work) was at 75.8%, another record, and therefore the activity rate – those who cannot or do not wish to work such as students or those medically unable to work – has fallen to a record low. In addition, the number of vacancies has risen to 870,000, the highest ever recorded, with the increases being mainly in the service sector such as retailing.

The ONS has also announced the January inflation figures which show prices are now rising at 1.8%, down from 2.1% in December. This is partly due to the energy price cap and falling fuel prices, but economists are predicting that the fall below the government’s 2% target will only be short-term as increasing oil prices and planned energy price rises feed through into the CPI.

Because of the tightening labour market, it is not surprising that wages are increasing with the latest data showing an annual increase of 3.4%. Comparing this figure with the latest inflation data shows that real incomes are now increasing by 1.6%, the fastest rate since summer, 2016. However, in real terms, average pay is still £10 per week lower than it was ten years ago and, despite rising real incomes, consumer confidence is falling, as measured by the Household Finance Index. This is a measure which tries to predict changing consumer behaviour. It is based on monthly responses from over 2,000 households, chosen to accurately reflect the country’s income, regional and age distribution. Among items examined are changes in household income, spending and savings, job security, household debt and borrowing, inflationary expectations, house prices and confidence in the government.

A key negative figure for the economy is the low GDP growth, which was only 0.2% in the last three months of 2018 and 1.4% for 2018, the lowest increase since 2009. While household and government consumption were positive, a poor balance of payments and falling investment reduced growth. The combination of high employment, low investment and low growth in GDP explain the poor productivity data for the UK with output per person falling 0.1% last year.

However, one positive figure is the latest data on government borrowing which, for January 2019, was a surplus of £14.9bn. While January is always a good month, because of self-assessed income taxes, capital gains tax, corporation tax and VAT falling due in January, the actual taxes received were higher than previously predicted, and government spending increased less than anticipated, meaning the actual budget surplus was almost 50% larger than the forecast surplus for the month of £10bn. The improved figures mean that government borrowing for 2018/19 is now likely to be £22bn rather than the previous forecast of £25.5bn, the lowest figure since 2001, and the National Debt, at £1.8 trillion is forecast to be 82.6% of GDP, compared to 85.6% last year. Most importantly, the deficit is likely to be only 1% of GDP giving the Chancellor scope to cut taxes and increase spending to boost the economy yet still remain within the 2% figure he suggested as a ceiling.

 

 

 

 

 

 

 

Venezuela

In the 1970s, Venezuela was a South American success story. It has the largest oil reserves in the world and wealthy Venezuelans flew to Europe on shopping sprees; indeed, Concorde, as well as flying businessmen and women between Europe and the USA, also flew to Venezuela. For twenty years, it had the highest growth rate and the least income inequality in South America and remained the richest country in South America until 2001.

Today, GDP is predicted to fall 26% by the end of 2019 and  inflation is 1.7 million per cent with the IMF estimating it will reach 10 million per cent by the end of 2019. Historically, this makes it comparable to the hyperinflation in Germany in the 1920s, Hungary after the Second World War and, more recently, Zimbabwe. (The worst example of hyperinflation is, currently, still Hungary in 1946, when, at inflation’s peak, prices doubled every 15 hours, compared to Zimbabwe where prices doubled every 24.7 hours.)

It is hard to imagine the effects of hyperinflation. Prices in shops are no longer displayed – customers find out when they come to pay. Everyday items are scarce, even if they could be afforded with farmers hoarding food because they can get more from selling their produce tomorrow rather than today. Hospitals have run out of medicines, with operations postponed because of a shortage of anaesthetics. Infant mortality rose 30% last year and in 2017, the average adult weight fell 24lb. Savings and pensions have become worthless and 10% of the population have left, including half the doctors. Crime has increased and the suicide rate has risen. Barter has returned to the economy and some people have taken to using  eggs as a substitute currency.

So how did it get to this state? At the end of the 1990s, it elected Hugo Chavez, a socialist president, who embarked on a programme of public spending involving free healthcare, improved education and subsidised housing, all of which were financed by the country’s vast oil revenues. His government took over the steel, agriculture and mining industries and installed new managers who lacked the experience and skills of their predecessors. As a result, real GDP has fallen by 46% since the start of 2014. The state-owned oil industry was used as a source of finance and starved of investment by the government. However, the fall in oil prices reduced government revenues, with the government having to replace lost revenues by printing more money. This created the classic conditions for hyperinflation. In economic terms, we can explain this by looking at the Fisher equation MV = PQ (money supply x the velocity of circulation equals the average price level x the quantity of goods and services produced). M is rising rapidly as the government prints more and V, which is how fast money is being used, is also rising rapidly since people are trying to spend it as fast as possible. Therefore the left hand side of Fisher’s equation is rising rapidly. On the right hand side, which, by definition, must equal the left hand side, the quantity of goods produced is falling because of poor economic management, therefore the price level increases – a classic case of inflation “caused by too much money chasing too few goods”.

 

How are we really doing?

This post looks at the current state of the economy.  Although the data may seem to be a few months out of date, it is the latest available and indicates a difficulty for economic bodies such as the Bank of England who try to control the economy. Their task is made even more difficult because, for example, not only are the Labour Force Survey figures out of date, they also do not respond quickly to changes in the economy since employers often wait a few months before hiring or firing workers to see if changes they experience are permanent or temporary.

GDP growth slowed at the end of 2018 from 0.4% to 0.3% in the three months to the end of October. This was largely due to a 0.8% fall in the manufacturing sector, particularly the manufacture of vehicles and pharmaceuticals. Our productivity continues to disappoint having been almost flat for 10 years, and about 20% below what it would be if it had grown at the trend rate for the last ten years. Investment has fallen for the last nine months, unlike our G7 partners who have experienced double digit growth.

However, the labour market continued to do well between August and October with the number of people in work increasing to 32.48 million, 396,000 more than a year earlier. The employment rate (the proportion of people aged from 16 to 64 years in work) was 75.7%, higher than a year earlier (75.1%) and the joint-highest estimate since comparable estimates began in 1971 while the unemployment rate (unemployed people as a proportion of all employed and unemployed people) was 4.1% or 1.38 million people. As a result, the proportion of people inactive was approximately 21%, again the joint lowest since 1971.

Inflation, measured by the CPI, dropped to 2.1% in December, the lowest since January 2017 when it was 1.8%, caused by falling air fares and oil prices (causing falling petrol and diesel prices among other things). Employee average weekly earnings increased by 3.3% over the year, giving a real increase of 1.2%, a welcome change from recent years when the rate of inflation has exceeded the increase in earnings. However, over the year, poverty increased, with 14 million people (22% of the population) in relative poverty (defined as 60% of the median income after housing costs). This includes more than 4 million children, with more than half of the children in single parent families in poverty. Food bank use has increased by 13% in the last year.

The balance of payments current account deficit increased to £26.5 billion between July to September, 2018, which equated to 5% of GDP, the largest deficit recorded for two years in both value and percentage of GDP terms. Contributing to this was an increase in the deficit on trade in goods and services, as the service sector surplus fell, and an increase in the primary income deficit caused by an increased net outflow of profits from FDI in the UK. (Primary income is the net flow of profits, interest and dividends from investments in other countries and net remittance flows from migrant workers). The majority of the deficit was financed by foreigners purchasing UK shares and UK investors selling part of their overseas portfolios.

Finally – an apology to younger readers. The latest government figures have shown that the share of UK wealth held by those over 65 has grown to 36% of the total, averaging £1.1 million.  The proportion of over 65s who are millionaires increased from 7% in 2006 to 20% in 2016. This wealth is in the form of property, their pension funds, holdings of shares and other savings. The biggest losers were those in the 35 – 44 age group whose share has dropped from 15% to 10% (although the value of their wealth rose from £180,000 to £190,000. This is a major change over the last 20 years when 21% of pensioners were in poverty.

UK household debt reaches peak

www.bbc.co.uk/news/business-46780279

Article of the week – Harjot M.

High levels of household debt pose a risk to the economy because any increase in interest rates could lead to a sudden collapse in consumption. Higher borrowing costs mean households have less discretionary income resulting in a fall in consumer spending. Aware of this risk, firms may consider cutting investment in the expectation of a fall in future demand. Consequently, aggregate demand decreases causing a fall in inflationary pressures, a decrease in economic growth and, potentially, an increase in demand-deficient unemployment.

Inflation in Venezuela

It is difficult to be precise about the rate of inflation in Venezuela since the government has significantly reduced its publication of economic data.  The Economist recently quoted a current rate of 46,000% per year, other estimates put it closer to 100,000% and the IMF estimates it will rise to 1 million per cent by the end of the year! The impact of such a rate mirrors what happened in Germany in the 1920s, Hungary in 1946 where inflation at one point reached 150,000% PER DAY, and Zimbabwe’s two episodes of hyperinflation in the last ten years. In Germany, workers were paid twice a day, and given breaks to buy things before prices went up even further, using wheelbarrows and suitcases to carry their money to the shops. Although the Venezuelan president, Nicolas Maduro, has blamed opposition activists, officials in Washington and criminal gangs for the hyperinflation, independent observers suggest it is caused largely by the government printing money to pay its budget deficit, currently running at 30% of GDP. Ironically in Venezuela today, almost everyone is a millionaire but 4/5 of the population live in poverty and their average weight is falling because they cannot afford enough food. There are reports of shoppers falling ill because the only meat they can afford is discounted because it is no longer fresh.

The effects of such high levels of inflation on the metro in Caracas (capital of Venezuela) epitomise the problems caused by hyperinflation. The metro, built in 1983, was once heralded as a sign of the efficiency and progress of the economy. It was highly efficient and ran on time. The price of a ticket was fixed at 4 bolivars by the government which now equates to only a tiny fraction of 1p but, even if they wanted to, travellers cannot pay the government has run out of the paper needed to print them so all the ticket machines are marked as being out of order and people travel for free. However the journey is unlikely to be trouble-free. Demand has risen since people cannot afford taxis or fuel for private cars and the system now transports 2.5m people a day, three and a half times the number it was designed for. Only half the trains are working. Despite there being 11,000 workers officially employed, there is a shortage of workers since pay is only around 50p per week.

In Venezuela at present, it is more profitable scavenging for food in rubbish dumps than working. Output is falling for the third successive year and, despite having rich reserves of oil, which should make Venezuela one of the richest South American economies, oil production, which accounts for 95%  of export earnings in the country and a quarter of gross domestic product, (total output of the country) fell by a half between January 2016 and January 2018. Venezuela has been unable to stop a six-year-long production decline, caused by inadequate investment, US sanctions and a lack of skilled workers who have left the country for a better standard of living elsewhere.

There was even a shortage of banknotes which are imported. Last year the banks were forced to limit cash withdrawals to the equivalent of one US dollar a day. Increasingly, transactions are made electronically but those trying to make even a medium-sized purchase via a debit card found that many screens in shops or on their phones were too small to handle the large number of zeros needed. One of most popular television programmes, a Venezuelan version of “Who wants to be a Millionaire”, was abandoned because of the fall in the value of the currency – were it being broadcast today, the top prize would be worth 13p!

To solve the problems caused by hyperinflation, the government has raised the minimum wage by 3,500%, and  President Maduro has announced plans to reduce the government’s budget deficit (the amount the government borrows) from 30% of GDP to zero by increasing VAT and the price of fuel, which is currently very heavily subsidised, therefore admitting implicitly that high government borrowing and the printing of money was a key cause of the hyperinflation. In addition, in August, the government devalued the currency from 250,000 to the US dollar to the black market rate of 6m to the dollar and then introduced a new bolivar, converting 100,000 old bolivars to 1 new bolivar. However the future does not look promising since the value of the new currency fell by 18 % on the black market in the first two weeks after devaluation.

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”.