Public finances

A little tricky to follow, but the core idea is easy enough. Austerity is only for some - politics trumps economics (again)!

https://notayesmanseconomics.wordpress.com/2015/10/21/the-uk-public-finances-are-taking-the-pain-of-the-triple-lock-for-the-basic-state-pension/

A quote worth remembering:

Sound economics is not always good politics. In a democracy, it is politicians and people, not policymakers and officials, who make the decisions. Major policy decisions cannot be reduced to an economic calculation; countries are not like businesses, seeking to make optimal financial decisions. Politics trumps economics.

Two other ways of "valuing" an economy, Y12 & Y13

 

Measures of economic welfare

During the late 1960s, many economists began to question the over-reliance of governments and agencies on narrow, exclusively GDP-based, measures of economic welfare. It was at this time that the adverse environmental effects of uncontrolled economic growth began to be considered, prompting the search for a wider measure of welfare, not exclusively based on raw GDP figures.

 

Nordhaus and Tobin

In 1972, Yale economists William Nordhaus and James Tobin introduced their Measure of Economic Welfare (MEW)* as an alternative to crude GDP. MEW took national output as a starting point, but adjusted it to include an assessment of the value of leisure time and the amount of unpaid work in an economy, hence increasing the welfare value of GDP. They also included the value of the environment damage caused by industrial production and consumption, which reduced the welfare value of GDP. MEW can be seen as the forerunner of later attempts to create a sophisticated index of sustainable development.

*Nordhaus, WD and Tobin, J (1972) Is Growth Obsolete? Economic Growth, National Bureau of Economic Research, no 96, New York.

The Index of Sustainable Economic Welfare

The Index of Sustainable Economic Welfare (ISEW), develops MEW by adjusting GDP further by taking into account a wider range of harmful effects of economic growth, and by excluding the value of public expenditure on defence.

A look at the UK's latest data by Mark Carney

Actually the commentary is by one of my favourite bloggers, pulling apart the numbers and Mark Carney's comments. He isn't the best writer, but a) he went to the LSE, and b) he identifies the key problems. His blog is   notayesmanseconomics, and I recommend you take a look at it from time to time:




Posted on October 9, 2015  
  

Today is a day with plenty of UK economic news and it has started positively with the BDO Retail Sales tracker being publicly released.

consumer spending rebounded in September with sales recording a year-on-year uplift of 2.8% – the best figures for the month of September since 2012,

In terms of a break down then we are told that the drivers of this growth were as follows.

Lifestyle saw an impressive rise of +5.4%, largely caused by an uplift in spending of giftware and stationery items

Although one area of this may fade in England but not Scotland, Wales or Northern Ireland.

Some retailers indicated the Rugby World Cup had helped to boost sales.

Some caution is required as the numbers for last month on this series were dire but it does seem to provide an impression of the direction of travel if not the size of the move. So we have an upwards hint for the official retail sales numbers.


Mark Carney
He has been speaking overnight at the International Monetary Fun meeting in Lima. Presumably embarrassed by the continual failure of his Forward Guidance on Bank Rate he decided to indulge in yet more Open Mouth Operations. From Reuters.

“The exact timing of the Fed move is not decisive for the timing of the move by the Bank of England,” Carney said in a seminar at the annual meeting of the International Monetary Fund.

He went so far as to point out this.

Carney made the point that in the five rate cycles since Britain adopted inflation targeting, the Bank of England moved before the Fed in two of them.

That is a bit like when a football commentator tells you about results been clubs from 20 years ago when some of the players had not even been born! Of course Mark Carney has the problem of his promises back in June 2014 which were plainly designed to make investors think an interest-rate rise was on its way. This compares starkly with yesterday’s vote of 8-1 against with him being one of those against. Still he thought he would recycle his lines one more time.

“Anybody who states with certainty the timing, is not right, because there are tactical considerations around the timing.”

Actually the main person who has been trying to hint at the timing has been him. After all the crying wolf efforts he finds that markets listen to him now with the Who on in the background.

Then I’ll get on my knees and pray
We don’t get fooled again
Don’t get fooled again
No, no!

Oh and for a man representing an institution which has been badly damaged itself by the Foreign Exchange and Li(e)bor scandals as well as its missed inflation targets this was really from an alternate universe.

FIFA “is a four-letter word,” Carney jokingly told a panel in Lima with IMF head Christine Lagarde and Brazilian Finance Minister Joaquim Levy.
“Ultimately it is about accountability to global citizens,” he said. “It’s a pretty mild criticism to say FIFA lost sight of that.”

It’s all about the trade
It was nice of the Office for National Statistics to set the background in today’s release.

In volume terms (chained volume measure) the UK has been running a consistent trade deficit (as a percentage of GDP) since quarter 1 (January to March) 1998.

However the Bank of England chose in its latest meeting Minutes to put a positive spin on all of this.

The revised estimates had shown a smaller current account deficit over the past year. In 2015 Q2, it was estimated to have been 3.6% of nominal GDP, after a peak of 6.3% in 2014 Q4. In the previous vintage of data, the deficit had peaked at 7.1% in 2014 Q3, and had improved only modestly since then.

Actually the numbers are still poor just less poor than they were so let us examine the reason for it.

Around 40 per cent of the improvement over the past six months was a consequence of an increase in the primary income balance………A narrowing in the trade deficit, to 0.7%, had accounted for a further half of the narrowing of the current account deficit since its peak last year.

Okay so the Bank of England welcomes an improvement so in the era of Forward Guidance what happens next?

In the 3-months to August 2015, the trade in goods deficit widened by £1.8 billion to £31.4 billion. Exports decreased by £1.5 billion to £72.4 billion and imports increased by £0.3 billion to £103.8 billion over the same period……
In the 3-months to August 2015, the UK’s deficit on trade in goods and services was estimated to have been £8.1 billion; widening by £1.3 billion when compared with the 3-months to May 2015.

Sadly the more recent position is in fact even worse than that as June had for once virtually no deficit at least by UK standards at £400 million but you get the idea that it was followed by July at £4.4 billion and August at £3.3 billion. So the last two months have been a return to a much worse trend. Should this continue then it will be a drag on UK GDP (Gross Domestic Product) as one of the reasons for the better number in the second quarter was the improved trade performance which looks as though it has faded away.


Imputed Rent
I feel a bit like Brian “class of one” Clough when I venture into this area as elsewhere it barely merits a mention but it has now popped up in the trade figures under “Withdrawal of income from quasi-corporations (cross border-property income)”. Hardly friendly is it? So sorry about that but the numbers published make even less sense than usual.

The impact increases gradually over time with an upward revision to exports of services of £0.5 billion and £3.5 billion in 2014, leading to a reduction in the trade in services surplus by approximately £3.0 billion.

I have pointed out to the ONS that this only makes sense if the £3.5 billion is an upwards revision to imports. There was a time when £3 billion was a lot of money but this is another downside to the UK property boom.


Construction Output
Let me analyse this in the style of the Bank of England Minutes. “On the one hand” it is going rather well. From Markit:

Construction firms enjoyed a strong finish to the third quarter of 2015, as a sustained rebound in new development projects continued to have an impact on the ground.

Meanwhile “On the other hand” it isn’t. From the UK ONS.

In August 2015, output in the construction industry was estimated to have decreased by 4.3% compared with July 2015 and decreased by 1.3% compared with August 2014. This was the first year-on-year fall since May 2013.

The former includes September but it was very positive for August too.
As it would have been the 75th birthday of John Lennon then let me use his words as a summary of how we are left.

Help me, get my feet back on the ground
Won’t you please, please help me, help me, help me, ooh

Comment
Things are not going so well for Mark Carney’s Flying Circus are they? Somehow or the other he feels the need to keep the illusion going that he and his colleagues will raise Bank Rate. Today’s official numbers have headed in the opposite direction with us having 2 months of poor current account numbers and the official construction numbers falling. Of course there was a time that we would raise interest-rates in response to poor trade figures (and indeed a house price/rent boom) but such thoughts have long since been erased and redacted from the  minds of modern central bankers.


Also my theme of official data being unreliable has had a good day. No sooner had the Bank of England become a cheerleader for the UK trade figures the numbers got worse again! The song lasted a lot longer! The downwards revision to services by £3 billion for 2014 makes you think to say the least especially as it comes via Imputed Rent which usually boosts GDP.


I am glad that I wrote to the Professor Sir Charlie Bean UK Economic Statistics Review about our services trade numbers.
As to the official construction series well I think I will stick to counting cranes in Nine Elms.

Y12 Measuring National Income notes

Measuring National Income

What is National Income?

National income measures the monetary value of the flow of output of goods and services produced in an economy over a period of time.

Measuring the level and rate of growth of national income (Y) is important for seeing:

• The rate of economic growth
• Changes to average living standards
• Changes to the distribution of income between groups within the population

Gross Domestic Product

• Gross domestic product (GDP) is the total value of output in an economy
• GDP includes the output of foreign owned businesses that are located in a nation following foreign direct investment. For example, the output produced at the Nissan car plant on Tyne and Wear contributes to the UK’s GDP

There are three ways of calculating GDP - all of which should sum to the same amount:

National Output = National Expenditure (Aggregate Demand) = National Income

(i) The Expenditure Method - aggregate demand (AD)

The full equation for GDP using this approach is GDP = C + I + G + (X-M) where
C: Household spending
I: Capital Investment spending
G: Government spending
X: Exports of Goods and Services
M: Imports of Goods and Services

The Income Method – adding together factor incomes

GDP is the sum of the incomes earned through the production of goods and services. This is:

Income from people in jobs and in self-employment
+
Profits of private sector businesses
+
Rent income from the ownership of land
=
Gross Domestic product (by factor incomes)

Only those incomes that are come from the production of goods and services are included in the calculation of GDP by the income approach. We exclude:

• Transfer payments e.g. the state pension; income support for families on low incomes; the Jobseekers’ Allowance for the unemployed and other welfare assistance such housing benefit
• Private transfers of money from one individual to another
• Income not registered with the tax authorities Every year, billions of pounds worth of activity is not declared to the tax authorities. This is known as the shadow economy.
• Published figures for GDP by factor incomes will be inaccurate because much activity is not officially recorded – including subsistence farming and barter transactions

Value Added and Contributions to a nation’s GDP

• There are three main wealth-generating sectors of the economy – manufacturing and construction, primary (including oil & gas, farming, forestry & fishing) and a wide range of service-sector industries.
• This measure of GDP adds together the value of output produced by each of the productive sectors in the economy using the concept of value added. .

Value added is the increase in the value of goods or services as a result of the production process

Value added = value of production - value of intermediate goods  

Say you buy a pizza from Dominos at a price of £9.99. This is the retail price and will count as consumption. The pizza has many ingredients at different stages of the supply chain – for example tomato growers, dough, mushroom farmers and also the value created by Dominos as they put the pizza together and deliver to the consumer.

Some products have a low value-added, for example cheap t-shirts that you might find in a supermarket for little more than £5. These are low cost, high volume, low-priced products.

Other goods and services are such that lots of value can be added as we move from sourcing the raw materials through to the final product. Examples include designer jewellery, perfumes, meals in expensive restaurants and sports cars. And also the increasingly lucrative computer games industry.

GDP by output – the distribution of GDP from different industries

The UK is an economy where the majority of GDP comes from the service industries such as banking and finance, tourism, retailing, education and health. In 2008 less than half of one per cent of our GDP came from agriculture. Manufacturing accounted for less than 15 per cent of GDP and construction a further 6 per cent. In contrast, the service industries now contribute nearly three quarters of national income.

Manufacturing and service industries are not separate! For example the health of a car exporting business will have a direct bearing on demand, output, profits and jobs in many service businesses such as transportation, design, marketing and vehicle retailing. Equally service businesses such as online banking require plenty of physical inputs such as machinery and infrastructure to be successful.

The main service sector industries in the UK are:

• Hotels and restaurants, and a range of services provided by local government
• Transport, logistics, storage and communication
• Business services and finance, motor trade, wholesale trades and retail trade
• Land transport and air transport, post and telecommunications
• Real estate activities, computer and related activities, Education, Health and social work
• Sewage and refuse disposal
• Recreational, cultural and sporting activities 

The Share of National Output (GDP) for the UK Economy

Notice in the chart above how there are long-term shifts in the value added from the three main sectors – the pattern of GDP depends on many factors including the stage of a country’s development and the extent to which a nation has built up industries of competitive advantage in the world economy.

Gross National Income (GNI)

• Gross National Income (GNI) measures the final value of incomes flowing to UK owned factors of production whether they are located in the UK or overseas.
• Gross Domestic Income is concerned only with the incomes generated within the geographical boundaries of the country. Fr example the value of the output produced by Toyota in the UK counts towards our GDP but some of the profits made by overseas companies with production plants here in the UK are sent back to their country of origin – adding to their GNP.

GNI = GDP + Net property income from abroad (NPIA)

• NPIA is the net balance of interest, profits and dividends (IPD) coming into the UK from our assets owned overseas matched against the flow of profits and other income from foreign owned assets located within the UK.
• There has been an increasing flow of direct investment (FDI) into and out of the UK. Many foreign firms have set up production plants here whilst UK firms have become multinational organisations.

Nominal and Real - Measuring Real National Income

• When we want to measure growth in the economy we have to adjust for the effects of inflation
• Real GDP measures the volume of output. An increase in real output means that AD has risen faster than the rate of inflation and therefore the economy is experiencing positive growth. Consider this example

The money value of a country’s GDP is calculated to be $4,000m in 2007

In 2008, the money value of GDP expands to $4,500m but during the year, inflation is 3% causing the general index of prices to rise from a 2007 base year value of 100 to 103 in 2008.

The real value of GDP in 2008 is calculated thus:

Real GDP = money value of GDP in 2008 x 100 / general price index in 2008

= £4,500 x 100/103 = $4,369 (measured at constant 2007 prices)

Note here that the real GDP data is expressed at constant prices which mean that we have made an inflation adjustment. Look for this in the data response questions in the exam.

Total and Per Capita – Measuring Income per capita

How much does each person earn on average? We use per capita measures to give us a guide to this. Income per capita is a way of measuring the standard of living for the inhabitants of a country.

Gross National Income per capita = Gross National Income / Total Population

Our next chart shows two pieces of economic data

• The level of UK gross national income (GNI) which has been expressed in real terms (i.e. it is inflation adjusted) and is measured in pounds sterling
• The annual rate of change of real gross national income measured in percentage terms

The chart shows that real incomes per head of the population have risen over the years, i.e. average living standards have improved but that the rate of improvement is not uniform each year. We see that economic growth in the UK fluctuates from year to year, i.e. there is an economic cycle with periodic recessions (where the value of real national income declines.)

Real Gross National Income for the UK Economy –
During the recession (2008 to 2009) GDP per head decreased by 5.5 per cent

Remittances and Gross National Income

Remittances are transfers of money across national boundaries by migrant workers. Despite a dip because of the global recession, remittance flows have grown in the world economy over the longer-term as the scale of migration between countries has grown. For many developing countries, money coming in from remittances is an importance source of income.

Using data from the World Bank, for the world as a whole in 2010:

• Stock of immigrants: 215.8 million or 3.2 percent of population
• Females as percentage of immigrants: 48.4 percent
• Refugees: 16.3 million or 7.6 percent of the total immigrants

Top 10 remittance recipients in 2010 (billions): India ($55.0bn), China ($51.0bn), Mexico ($22.6bn), Philippines ($21.3bn), France ($15.9bn), Germany ($11.6bn), Bangladesh ($11.1bn), Belgium ($10.4bn), Spain ($10.2bn), Nigeria ($10.0bn)

Top 10 remittance recipients in 2009 (percentage of GDP): Tajikistan (35.1 percent), Tonga (27.7 percent), Lesotho (24.8 percent), Moldova (23.1 percent), Nepal (22.9 percent), Lebanon (22.4 percent), Samoa (22.3 percent), Honduras (19.3 percent), Guyana (17.3 percent), and El Salvador (15.7 percent)

 

Dear Mauldin Reader

China on the Edge, the new documentary from Mauldin Economics and Over My Shoulder is now available for you to watch—and it couldn’t be any timelier.
This fast-paced 25-minute video will take you behind the Bamboo Curtain for an insider’s perspective on what’s really going on in China.
Given its size and miraculous economic growth, what happens in China is of critical importance to every investor—doubly so given the recent sharp correction in Chinese markets.
The future of commodities, global equities, and bonds, and even the stability of world markets hang in the balance.
It all starts with Tiananmen Square…

Click here to watch China on the Edge.
 

Enjoy,

Y13 - More on the funding/credit possible problems issue:

This is a research note put out by my friendly investment bank; some will be way too financial for you, so don't try and understand it all. Skim read it, get the gist, and then try and focus on the numbers, and about two thirds of the way down, what happens if one of these firms fails:


Earlier today, in its latest attempt to restore confidence in its brand and business model after suffering a historic stock price collapse, Glencore - whose CDS recently blew out to a level implying a 50% probability of default - released a 4 page funding worksheet which was meant to serve as a simplied summary of its balance sheet funding obligations and lending arrangements to equity research analysts who have never opened a bond indenture, and which among other things provided a simplied and watered-down estimate of what could happen if and when the company is downgraded to junk.

 Meanwhile, in a furious race to shore up as much liquidity as possible, Glencore - which a month ago announced a dramatic deleveraging plan - and its peers have been quietly scrambling to raise billions in secured funding. Case in point none other than Glencore's biggest competitor and the largest independent oil trader in the world, Swiss-based, Dutch-owned Vitol Group, whose Swiss unit Vitol SA earlier today raised a record $8 billion in loans.

 It is not alone.

 As Bloomberg reports, another name profiled previously here, privately-held (but with publicly-traded debt) Trafigura "won improved terms on a $2.2 billion loan refinancing deal on Oct. 1 via a group of 28 banks. Swiss commodity traders Gunvor Group Ltd. and Mercuria Energy Group Ltd. are also marketing credit facilities totaling $2 billion."

 Louis Dreyfus Commodities, the world’s largest raw-cotton and rice trader, said in its interim report last month that it had six revolving credit facilities with staggered maturity dates totaling $3.3 billion. In June, it amended and extended its North American facilities totaling $1.6 billion and in July it refinanced a $400 million Asian lending facility with the company securing an option to request an increase of $100 million.

 Noble Agri, the agricultural commodity trader majority owned by China’s Cofco Corp., attracted four new lenders to its $1.58 billion one-year revolving credit facility, people familiar with the matter said this month.
In short - a race against time to pledge as much unencumbered collateral as possible for future funding needs, because as every CEO knows you raise capital when you can, not when you have to.


Yet this is odd, because even as the companies hold investor meetings and publicly comfort investors that they are adequatly funded and see no need for a liquidity-raising scramble, that's precisely what the world's commodity traders are doing.

 Bloomberg's take was more optimistic: "The transactions show banks are still eager to loan money to commodity traders even after debt concerns caused by wild swings in Glencore’s stock and bond prices."
The new loans and refinancing signal banks are comfortable lending to commodity traders, whose business models allow them to profit from volatility and lower financing costs amid weaker prices for raw materials.
According to Bloomberg, Vitol’s record credit facilities from a group of 57 banks were increased by a third after the initial $6 billion sought by the trading house was oversubscribed by $2.7 billion, the Rotterdam-based company said in a statement. The facilities, refinancing a debt package signed 12 months ago, are the biggest in the firm’s 49-year history, a Vitol spokeswoman in London said.

 Then comes even more spin:

 The loan package, coming after Trafigura last week agreed to lower lending rates, suggests some analysts don’t understand the business of trading houses, which can benefit from lower commodity prices and the current contango market structure that allows them to profit by storing oil because forward prices are higher than current costs.

 Actually analysts (at least credit) understand the business of trading houses very well; what Bloomberg's reporters don't seems to understand, however, is the principle of muturally assured megaleverage destruction, or the implied threat for a company's secured lending syndicate that a borrower which already has billions of exposure to banks has all the leverage in demanding even more debt. After all, should Vitol fail, it would lead to a cascade of bank failures as all the banks that have lent money to the giant commodity trader are forced to charge off their exposure, in the process leading to serial defaults among undercapitalized financial institutions.

 It is these institutions whose credit officers underwrote the loans, that are the ones who "don't understand the business of trading houses" because based on the recent collapse in publicly traded securities, they never modelled what happens to cash flows in a world in which the price of oil, copper, zinc, aluminum or other commodities, suffer a 50%+ plunge in prices.

“Given the recent turbulence in the commodities space, we have been repeatedly asked by investors on the banks’ exposure to commodity traders,” analysts at Sanford C. Bernstein led by Chirantan Barua wrote in a note Monday.

 As they well should, and in order to avoid answering, the banks are perfectly happy to throw a little more good money after lots of bad money in order to avoid remarking their entire exposure to the sector to something resembling fair value.

 But the day of remarking is coming: as Bernstein calculates, commodity traders have raised at least $125 billion of debt, of which about $75 billion is loans. In other words, there is about $75 billion in secured debt, collateralized by either inventory and/or receivables collateral whose value has cratered in the past year, and as a result the LTV on the secured loans has soared. It is this that is prompting the panicked banks to be more eager to provide funds to the suddenly distressed energy-trading sector than even the borrowers themselves. And after all, if the banks do blow up, there is always the taxpayer-funded bailout as a last reserve.

 And here is a pop quiz to either analyst, or Bloomberg writers who don't "understand the the business of trading houses" - if you issue secured debt to shore up liquidity as a result of what is fundamentally a massively over-leveraged capital structure, does the pro forma debt increase or decrease. This is not a trick question.

 The good news for the Vitols of the world is that by pledging even more of their unencumbered assets to banks, they buy themselves a few more months, or quarters, of liquidity to pay down upcoming maturities and interest. Which is what Glencore did with its "doomsday" plan in early September... a plan which calmed the stock for all of two weeks before investors saw right through it for what it was: a desperate scramble to put lipstick on a declining-stage supercycle pig.

 In the meantime, the end result is this: companies that are even more levered to commodity prices in a world in which at last check commodity prices, a proxy for China's economy, are sliding. Which, incidentally, was our thesis in March of 2014 when we said that buying Glencore CDS is the best way to trade China's hard landing. This is precisely what happened.

 Which is why both the companies, and their lending banks, better pray that commodity prices pick upin the coming weeks and months, because for the Vitols, the Glencores, the Trafiguras, the Mercurias and so on, that is all that matters. Ironically, by levering up even more, they bought themselves some time now, but if and when the next leg down in the commodity supercycle takes place, the pain will only be that much greater.