Deficits with inky blots and rotten parchment bonds sustained - of Balance of Payments and Public Sector Finances. 

Earlier this month is his speech at the Mansion House, Mark Carney, Governor of the Bank of England, referenced the Sterling Crisis of 1931 and imbalances within the economy.

“We need balance. One has only to look back to 1931 when Britain’s economic prospects were strained by a large budget deficit and a deteriorating balance of payments. In the ensuing crisis, the government of the day resigned, sterling was forced off the gold standard" [and the Governor of the day went back to Canada.]

In 2014, despite significant internal and external deficits, neither the resignation of the  government, nor the repatriation of the Governor of the Bank of England appears imminent. It is however, worth revisiting 1931 and recalling the worlds of Sir Warren Fisher, permanent secretary to the Treasury.

In September of that year, Sir Warren Fisher, warned Cabinet, of the Balance of Payments Crisis and the National Budget problem - "Deficits with inky blots and rotten parchment bonds sustained". He could easily have been talking of the present day, QE and debt monetisation.

Trade Deficit ...
Fisher 1931: The seriousness of the financial difficulties which are engaging public attention is perhaps not fully realised. The root cause of the "run on Sterling" on the part of the foreign depositor is the fact of our living beyond our means as evidenced by our ordering from abroad more goods than we could pay for and therefore our owing to other countries more in dollars and francs than they owe to us in sterling.”

Public Sector Finances …
Fisher 1931: Closely associated with this fact in the foreign mind is the question of our national Budget. After the war a certain number of countries continued to have difficulties in balancing their budgets and instead of pulling in their belts, resorted to the expedient of meeting deficits by printing innumerable bank or currency notes. Whenever this was done, the national currency lost much or all of its value i.e. purchasing power, and with the corresponding rise in prices, hardship, even hunger, was widespread.

Consequently, when any of these countries subsequently desired financial assistance from other countries before the citizens of the latter could be induced to lend, they insisted on the borrowing country balancing its budget. And no one was more emphatic than ourselves in preaching this doctrine.

National Budget …
Fisher 1931: A national Budget has thus come to be regarded as a touchstone of a country's financial stability second only in importance to its international balance of trade; and if, as the case at present with us, we are "down" on our balance of trade with other countries, foreigners to whom we owe money automatically turn a microscope on to our Budget. And if the Budget is not really balanced, but is merely dressed up to look as though it were, the distrust abroad of our soundness would be intensified. Any expectation that we might continue on a "rake's progress" would complete the destruction of international confidence and thus result in the final collapse of our greatest asset, i.e. our credit.

Living beyond our means …
Fisher 1931: The remedy is to reverse the process which has been responsible for the trouble, and this means that instead of living at a level which has entailed ordering abroad more goods than we can pay for, we must relate our orders to our capacity to pay. And unless we can produce and sell abroad more goods (including "services") than we have been doing, we shall be forced to cut down our orders abroad, and our and our standard of living must be reduced accordingly.

Consequences ...
If not the epitaph of us English of to-day will be written by historians to come in Shakespeare' words (Richard II , Act 2, Scene l ) ­
"England, bound in with the triumphant sea,
Whose rocky shore beats back the envious siege of watery Neptune,
Is now bound in with shame, with inky blots and rotten parchment bonds.
That England, that was won’t to conquer others, hath made a shameful conquest of itself".

Lessons from History
And so history is revisited. With inky blots and rotten bonds sustained. The latest data on the Public Sector Finances is hardly reassuring and the trade deficit will continue to present a problem for an economy growing faster than major trading partners.

Note "By the Secretary, The attached memorandum by Sir Warren Fisher is circulated to the Cabinet by instructions from the Prime Minister. (Signed) M. P. A. HANKEY Secretary, Cabinet, Whitehall Gardens, SW1. September 14th, 1931. Footnote : Up to this time the pound sterling, has for international purposes been valued and accepted as the equivalent of a gold pound or of 4.00 dollars or 124 Francs.

The Financial and Economic Position of the United Kingdom 1931. Memo to Cabinet from Sir Warren Fisher, Permanent Secretary to the Treasury September 1931. Deficits with Inky Blots and Rotten Parchment Bonds sustained.

This article was originally published John Ashcroft.co.uk in July 2009. References : Fun with the National Archives : Cabinet Papers

Good news in the car market but the higher level of sales will drive the trade deficit higher - no rebalancing on the road ahead. Download the file here.

The new 14 plates have been great for the car market. Registrations in March were 465,000, up by 18% on March last year.

UK car registration increased by 15% in the first three months of 2014. We forecast total sales of almost 2.5 million this year, returning to levels of sales, last seen in 2004 and 2005.

Production is forecast to increase to 1.6 million units following the increase to 1.5 million last year. A further increase to 1.7 million units, then 1.8 million units is expected by 2016. Good news? Of course.

But the majority of production is exported. Export sales may hit 1.3 million units in 2014, rising to 1.5 million by 2016.

As a result, imports will have to increase to 2.2 million units in 2014, rising to 2.4 million units by 2016. The trade deficit (unit sales) will increase to 0.8 million units, to the levels least seen pre recession.

The surge in car sales is a welcome demonstration of UK demand. As Mike Hawes, SMMT Chief Executive explains. “Given the past six years of subdued economic performance across the UK, there is still a substantial margin of pent-up demand that is contributing to a strong new and used car market.”

The pent up demand is to be unleashed. Remember we have over 31 million cars on the road in the UK of which over one third are over nine years old. Easy finance deals and advanced technologies make new cars cheaper to buy and to run. There has never been a better time to buy a new car. Let’s hope they don’t all rush at once.  That would create a traffic jam at the docks.

That’s another reason why we say the trade figures will continue to disappoint, and threaten the recovery, especially if the collapse in investment income continues. Download the short report here.

Economics news – import drive and the march of the makers ...

Import Drive ...
“Sales of European cars drive trade gap wider” is the headline in the Times today as Britons “flocked” to buy cars built on the continent. The trade figures released this week, reveal the September deficit (trade in goods) increased to £9.8 billion from £9.6 billion last month. The trade deficit with the EU reached a record £6.0 billion as imports increased by £0.4 billion to £18.6 billion. “Half of the increase is attributed to cars”, according to the ONS, hence the slightly unbalanced headline from the Times. In reality, Britons have been flocking to the showrooms since the start of the year. Car sales are up by 10% this year.

The deficit was offset as usual by a trade in services surplus of £6.5 billion. This is a familiar pattern which should come as no surprise to readers of The Saturday Economist. The trade deficit will deteriorate further especially if the UK continues to grow at a faster rate than major trading partners in the EU and USA.

We are forecasting an overall trade deficit this year of £110 billion offset by a service sector surplus of almost £80 billion. The residual overall deficit easily financed. The September figures are confirmation of the trends within our well established trade model. Depreciation damages UK trade in goods performance. Imports do not react significantly to price changes. There will be no rebalancing of the economy.

March of the makers picks up pace ...
Did the march of the makers pick up the pace in September? Not really. According to the latest figures from the ONS. Manufacturing output increased in the month by just 0.8%. Output for the quarter was flat as signaled in the Markit/CIPS PMI® survey data last week. Nevertheless we still expect manufacturing growth of almost 2.5% in the final quarter of the year. Last year was such a dismal quarter, even the stumbling marchers will make progress. Watch out for the headlines heralding the rebalancing over the next few months and tie me to a chair.

Other survey news ...
The service sector continues to drive growth in the economy according to the  Markit/CIPS UK Services PMI® for October. The headline Business Activity Index reached a level of 62.5 in October. “The UK service sector maintained its recent run of strong growth during October, with activity expanding at the fastest pace since May 1997 as levels of incoming new business rose at a survey record rate”. The construction rally also continues according to the Markit/CIPS UK Construction PMI®  index. The sharp rebound in UK construction output continued in October. The lead index posted 59.4, up from 58.9 in September, above the 50.0 no-change threshold for the sixth consecutive month.

So what does this all mean?
The economy is recovering and growing at a much faster rate into the final quarter. The pick up in manufacturing output will add to the growth in services and construction. Higher growth, more jobs, lower borrowing, inflation falling, investment will pick up in the second half of next year, it’s all looking pretty good for the Chancellor. Just the trade figures will continue to disappoint. We now think base rates are now more likely to rise by around 50 basis points in 2015. Higher growth will result in unemployment hitting the 7% hurdle rate in the third quarter of 2015, several months after the election.

What happened to sterling?
The Euro rate cut weakened the hybrid and Sterling strengthened as a result. The pound closed at £1.6018 from £1.5912. Against the Euro, Sterling closed at €1.1982 from €1.1814. The dollar moved up against the yen closing at ¥99.1from ¥98.7 and closing at 1.3368 from 1.3484 against the Euro.

Oil Price Brent Crude closed at $105.12 from $105.91. The average price in November last year was almost $110. We expect Brent Crude to average $110 in the month, with no material inflationary impact.

Markets, pushed higher - The Dow closed at 15,762 up from 15,616. The FTSE closed at 6,708 from 6,721. The rally continues with a stronger Santa rally in prospect over the next five weeks.

UK Ten year gilt yields closed at 2.77 from 2.66 US Treasury yields closed at 2.75 from 2.62. Yields will test the 3% level over the coming months.

Gold closed at $1,284 from $1,312. The bulls may have it may just have to wait for now.

That’s all for this week, don’t miss The Sunday Times and Croissants out tomorrow and watch out for news of our Friday Financials Feature with Monthly Markets updates coming soon.

John

Join the mailing list for The Saturday Economist or please forward to a colleague or friend. UK Economics news and analysis : no politics, no dogma, no polemics, just facts.

© 2013 The Saturday Economist. John Ashcroft and Company, Dimensions of Strategy.

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice. It's just for fun, what's not to like! Dr John Ashcroft is The Saturday Economist.

Economics news – Feeling good but not about lending ...

Latest government research shows, if people are in health, in work and in love, preferably living with someone (the loved one even better), the national well being scores soar. If you are educated, that's tough, - higher levels of education create greater levels of anxiety - ah yes - ignorance is bliss. And what of kids? Children of any age, have no impact on anxiety levels apparently. Hard to believe, so much for research bias! Is this really survey money well spent? It doesn’t make me happy thinking about it.

Great set back to national well being, in the Bank of England, lending stats this week. “Lending to business plummets” according to The Times mid week. Lending to business fell by £3 billion in April, to a level of £470 billion. Actually, it was more of a plop than a plummet, a fall of around 0.5%, as lending to small businesses fell by £700 million. Banks blamed a lack of demand amongst borrowers, business leaders were a little more circumspect. Does this mean FLS is failing?

The funding for lending scheme is an ambitious sales promotion tool in a moribund market. Credit supply does not a recovery make. Money supply M4 increased by 4.8% in April, no dramatic change but a continued demonstration that liquidity is not a problem within the economy, domestic demand is the real challenge.

Banks are using FLS each in their own special way, some to tighten spreads, some to ease arrangement fees, and some as a simple cash back model for capital investment. Buy a fork lift truck and get 10% cash back, that sort of thing. Try fitting that into the Bank of England, monetary transmission mechanism, it would make a PhD’s eyes pop.

As for eyes popping, is the answer to Britain’s economic problems another round of sterling depreciation? asks Sam Fleming in The Times today. Mike Amey, Managing director of Pimco, suggests the incoming governor of the Bank of England, may seek to weaken sterling against the dollar in an attempt to stimulate exports. Calling $1.37 as a reasonable target, Amey suggests another round of QE could effect the currency shift. Let’s hope not.

Even Charlie Bean the deputy governor of the Bank of England, is becoming sceptical about the depreciation solution. “The disappointing performance of net trade is another puzzling aspect of this downturn”, says the DG, speaking at the Official Monetary and Financial Institutions Forum in London this week. “there is a possibility the demand for, and supply of, exports have become less responsive to relative price signals, perhaps reflecting the nature of the goods and services in which we have a comparative advantage”.

Crikey Charlie, we stopped talking about comparative advantage once Ricardo had persuaded the good burghers of Lisbon to part with fortified wine in exchange for dodgy textiles from Lancashire. At least you didn’t mention the J curve. The Bank is beginning to get the message about which we have been writing for years.

Depreciation does little to improve net trade. Imports and export elasticities are demand dominant, with relative price, relatively inelastic, in the case of exports and almost inelastic with regard to imports, there is no substitution effect. The Old Lady is a slow learner. In the 80s the Bank models claimed interest rates had little impact on consumer spending, five years ago the model claimed low base rates would lead to a surge in investment. The Bank of England has a slow adaptive model, it may be DSGE but it is hardly dynamic and appears to be oblivious to shocks.

What happened to sterling?
Sterling rallied to 1.5198 from 1.5123 against the dollar but steadied against the euro at 1.1687 (1.1691). The Euro dollar closed at 1.2996 from 1.2932. On fundamentals the pound is fair value at 1.50 - 1.55 dollar but remains undervalued below 1.25 euro basis, the technicals are all for the present.

Oil Price Brent Crude closed at $100.39 from $102.64. The average price in May around $103 compared to $107 last year. June 2012 $95 is the number to beat! The best for inflation may be over.

Markets, it is pay the piper week. The Dow closed at 15,115 from 15,303. The FTSE closed at 6,583 from 6,654. Time to sell in May and go away we said mid May, we are off to Crete next week.

UK Ten year gilt yields increased to 2.03 from 1.91 - US gilt yields closed up 2.13 from 2.01. The great rotation has now begun. Markets are beginning to fret about QE cessation and exit. The financially repressed, obliged to buy gilts for now, will slow the return to market equilibrium in the medium term.

As for gold, closed at $1,387 from $1,392. The excitement is over for now, this is a hung chart.

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John

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice. It's just for fun, what's not to like! Dr John Ashcroft is The Saturday Economist.