Smoot-Hawley and the Italian job

One consolation for the observer of the current slide into recession has been the fact that for the most part, governments have been conscious of the need to avoid the mistakes that aggravated and prolonged the Great Depression of the 1930s. Action to combat the slowdown has been prompt and massive, and there has been a welcome willingness to suspend fiscal "prudence" for as long as it takes to end the slump.

There are, however, worrying signs that trade protection is rearing its ugly head again. As usual, the US is in the forefront. President Obama's fiscal stimulus programme includes "Buy America" provisions so explicit that a number of large corporations, including Boeing, firms have been lobbying for their removal, out of fear that other countries may retaliate against US exports. With the Democrats in control of the White House and both Houses of Congress, it's likely that the "Buy America" provisions will stay. It's all scarily reminiscent of the Smoot-Hawley Tariff Act of 1930, a protectionist measure widely blamed for turning the stock market collapse of 1929 into the depression that began in 1931.

Even before the Obama stimulus is passed into law, there are plenty of signs of protectionist sentiment around the world. Despite earlier agreements, there has been no resumption of the suspended talks on a new world trade agreement. In France, the Sarkozy Government has made its assistance to the auto industry conditional on a "Buy French" policy. Judging from the scale of the "Black Thursday" protests in France this week, other segments of the economy will be looking for similar help in the months ahead.

The protests at the Lindsey refinery in Lincolnshire over the hiring of Italian workers can be seen as part of the same process. Gordon Brown, hobnobbing with the rest of the headless chickens at Davos, has already indicated that he will talk to industry about how jobs can be secured for British workers. That's just another form of protectionism, though it has to be said that sympathy for the the Italian (and Portuguese) workers at Lindsey might have been eroded just a titch when two of them were photographed making rude gestures at the British protesters.

The excellent Chris Dillow asks in his blog why workers are up in arms about the Italians, yet have not taken to the streets to protest against bankers, who have caused far greater job losses. His view is basically that it's a question of salience. People can make a more obvious connection between the Italians and job losses than they can between bankers and job losses. That seems fair enough, and as we are only now beginning to see mass redundancies as a result of the recession, there are sure to be many more such protests to come.

If resisting protectionism is to be the next test for politicians, how are they likely to perform? It's hard to be optimistic. Over 1,000 economists signed a petition against the Smoot-Hawley Act, but it still got passed. Even with history's damning verdict on the effects of Smoot-Hawley, similar steps are being considered by Congress right now, and it remains to be seen whether the objections of large US exporters will carry any weight. Other governments are facing similar pressures from their voters. Rescuing the financial system may yet turn out to have been the easy part.

Bull watch

Media coverage of the recession is becoming more and more unhinged.....

* I'm sure you've noticed that ONS has confirmed that the UK is now in a recession, with GDP falling in both Q3 and Q4 of 2008. But did you also notice that retail sales rose in December -- up 1.6% in volume terms from December 2007 levels. That's on top of an equally "unexpected" 1.5% gain in November. There are caveats about the data (the VAT cut for one), but these numbers do rather give the lie to all the doom-mongering from the BRC, CBI and others. I guess these guys are just jealous of those sectors of the economy that really are in recession, like manufacturers and homebuilders. No doubt they'll come out with some statement casting doubt on the ONS data, and saying that anyway, things will be worse in January. However, given that John Lewis just reported a 4% sales rise in its latest week of trading, that might need to be taken with a pinch of salt as well.

* Early in the week the BBC's Robert Peston poured scorn on anyone who said that the resumption of short selling might have contributed to the sharp falls in bank stock prices. He "understood" that there had been very little short selling. Today one hedge fund, Landsdowne, announced it had made £12 million in four days from shorting Barclays plc. Peston stands corrected, right? No, no.... he says in his BBC blog that it's ridiculous to think that Landsdowne's tiny short position could have caused the carnage. I don't suppose it occurs to him that Landsdowne might not have been the only hedgie looking for a piece of the action. The world and his dog knew that the hedge funds had been gearing up to whack the banks as soon as the lifting of the short sale ban was announced. It probably also wouldn't occur to Peston that regular investors, watching the hedgies getting tooled up, might have seen fit to lighten up their holdings of bank stocks as a precaution against getting mullered.

* A number of commentators have pointed out that UK exports were weak in November "despite the collapse of Sterling to multi-year lows". Two explanations for this suggest themselves. One is that there is always a delay between a currency depreciation and improvement in a country's balance of payments -- something about a J-curve effect if memory serves. The other is that a large part of Sterling's fall has taken place in December and January, which makes it highly unlikely that it could have had any impact on trade data for November.

* David Cameron says that confidence is the key to economic recovery. Can this be the same David Cameron whose party has bitch-slapped anyone who has dared to express any hope for the future of the economy, and who is today warning that the IMF might have to get involved?

Wow. Bull watch may have to become a regular feature. I don't think I'll run out of material any time soon.

Evan Davis founders on Black Scholes

Last week the BBC's economics correspondent, Evan Davis, began a three-part look at the crisis in the financial markets, called "The City uncovered". The first episode dealt with the banking sector, and by focusing on the related but very different experiences of Northern Rock and Lehman Brothers, did a very creditable job of explaining the whole mess. There was the usual amount of pointless gallivanting about (Davis popped up in Venice, New York, London, Newcastle etc) but that seems to be par for the course these days, and the visuals never detracted from the analysis.

Last night's episode was called "Tricks with risk". It was trailed as being mainly about hedge funds, but turned out to be mostly about insurance, specifically AIG. Not that you'd have guessed it from the first five minutes of the show, which featured Davis in his motorbike leathers taking an advanced riding course. The lesson? That there are ways to get more comfortable with risk taking, apparently. Motorbike lessons, complex hedging strategies, same difference.

Davis and his trusty iron steed showed up at regular intervals throughout the show, without adding anything to our understanding. There was another leitmotif as well. To illustrate the point that much of the math used in finance is similar to that used in rocket science, the Black-Scholes option pricing model regularly appeared out of an aircraft contrail.

This kind of gimmickry is usually evidence that the presenter doesn't have much to say, or even worse doesn't entirely understand what he's saying. I'm not sure which was the case here, but either way this show was much weaker than the first one. At no point did Davis explain to his lay audience why "derivatives" are so called. Almost all of the explanation of derivatives was focused on options, but when it came time to explain what went wrong at AIG, it turned out that the problem had been with credit default swaps -- yet there had been no mention of swaps of any kind until that point.

It wasn't a dead loss by any means. The hedge fund guys, when they did appear, were true to type -- smooth and venal. There was a young "derivatives consultant" who made a couple of excellent points. We were introduced to Nicholas Taleb, whose "black swans" theory is now the accepted explanation for why the financial excesses of the past decade went so disastrously wrong. And we got to see Davis in some more nice places -- Boston, Chicago, even Galway, where he interviewed Nick Leeson. Still, it could have been so much better, and as it's unlikely that the BBC will ante up for another series on the topic, it's a real shame that it wasn't.

Just a coincidence

I'm sure it's no more than a coincidence that the two trading sessions following the lifting of the UK's ban on short selling of financial shares have seen carnage in bank shares. Barclays plc, one of the banks that declined to accept government help back in October, is now valued at barely 150% of its expected 2008 earnings. Even the announcement today of phase 2 of the government's bank rescue plan (a phase which is, in truth, more like a rescue plan for borrowers, as Robert Peston points out) has done nothing to restore sentiment.

The removal of the short-selling ban was demanded by the hedge fund industry, with the enthusiastic support of most of the financial press. And what good has it achieved? The government's losses on its investments in the banks have been magnified, which can only serve to increase taxpayer anger at the whole rescue plan. Those banks that have tried to avoid taking the government's money -- HSBC and Standard Chartered, as well as Barclays -- will now find it much more expensive to raise capital in the markets, and may even be forced to swallow their pride and accept government money. (If media reports are to be believed, Barclays is the most likely to have to do this).

We don't need the hedge funds to tell us that banks are having a difficult time. It's nothing short of insanity that the FSA has unleashed the short sellers again at a time when confidence is so fragile.

Princess Di and Chauncey Gardiner

Remember how things were when Princess Diana died? Public mourning was compulsory. The Queen came under fire for not being grief-stricken anough and had to be coached on emoting by Tony Blair. The whole mawkish episode has been described as the end of the traditional British stiff upper lip.

Right now we seem to be seeing the Dianification of the UK economy. On Wednesday the junior Industry Minister, Baroness Vadera, led on by an interviewer, allowed as how she could see signs of "green shoots of recovery" in the economy, though she cautioned that it was too soon to tell if they would grow. I suppose it was a bit of a Chauncey Gardiner moment ("In the spring there will be growth"), but from the reaction she got from the opposition, you'd think she'd come out in support of Al-Qaeda. The Tories screamed that her comments showed that she, and by extension the Government, were out of touch and living on another planet.

Truth is, the lady may have a point. Her comments were apparently triggered by a successful bond issue by National Grid, which she sees as evidence that capital markets are unfreezing; but she could equally have pointed to the announcement of thousands of new jobs at several of the larger retailers and at the oiler manufacturer Worcester Bosch; or to plans to hasten the building of several new power stations. There's plenty of bad news all right, but as always in a recession, such good news as there is tends to get swamped.

Back in the dirty thirties, FDR tried to overcome this tendency by telling the American people "the only thing we have to fear is fear itself". The Tories seem determined to ignore this, just as they seem determined to ignore all of the other lessons that were learned during the Great Depression.

Sad to say, Baroness Vadera got only lukewarm support from her colleagues in government. Her boss, Lord Mandelson, was on TV by the end of the day, wearing his best shit-eating grin, to assure viewers that she wouldn't be saying anything like that again. If Chauncey Gardiner was around today spouting his wisdom, the politicians would probably put him in the stocks.

BBC in worthwhile reality show shock

One of my former colleagues in the City had a robust response for anyone who queried why people in the financial services sector made so much money. "It's because", he would say, "they have to work in our business".

Last evening the BBC showed the first episode of "Million Dollar Traders", a brief reality-type series that may enlighten a few people about what he meant by that. A hedge-fund manager, Lex van Dam, hired a group of eight complete novices, gave them a couple of weeks' training, and then set them to work in the equity markets, running a tiny (£1 million) fund that van Dam had set up. By coincidence, albeit a good one for the producers, the global markets slumped in the team's first week of trading.

Just in the first episode, we've seen some of the things that make working in the City so stressful. The early starts -- one of the participants was shown on the platform of his local station at 5:24 am, reading the FT. The relentless pressure -- one man's trade went wrong because he was still having breakfast at the time the markets opened. The unpredictability of the markets themselves -- one guy put on a carefully thought out trade with a hedge to prevent losses, only to see both sides of the deal lose him money. We haven't seen any of the more serious ructions that are common in dealing rooms yet -- screaming matches across the dealing floor, people barricading themselves in the bogs, fights, phones used to demolish computer screens -- but there are still two more episodes for that to happen.

And these folks are only playing for retail stakes -- no positions larger than £5000 at this stage -- and know they only have to do it for a few weeks. The stresses for those playing for real money, and with their careers on the line, are massively multiplied. So next time you see a bunch of traders piling into Stringfellow's, try to understand that they have a lot of stress to work off. And watch "Million Dollar Traders" -- it's a reality show that can actually teach you something.

Loose lips sink economies

I wish I had had a way of capturing the screen image that confronted me on Sky News this morning. While the reporter was yammering on about the dire state of the economy, there were three lines of text at the bottom of the screen. The first line simply said "RECESSION". On two lines below that was the sentence, "TESCO to add 10,000 jobs this year after rise in like-for-like Christmas sales". Wow, that's the kind of recession we want.

Still, at least Sky accepted that Tesco's sales were higher. Over at the Guardian, the same story began with the sentence "Britain's descent into full-blown recession was highlighted today as Tesco reported its weakest Christmas sales since the last slump". Or, to put it another way (and this time in line with the facts), Tesco's sales in December were its highest on record. True, the growth in same-store sales, at only 2.5%, was the slowest since the early 1990s. But Tesco pointed out that the impact of the VAT cut meant that underlying same-store sales were 3.5% higher; moreover, since these are same-store numbers, and given that Tesco is still opening stores all over the place, its total sales growth was higher even than that.

The good old British Retail Consortium also weighed in today, saying that Christmas sales on the High Street were the worst in 14 years. Well, apparently they weren't for Tesco, which is by far the country's largest retailer. They weren't for Sainsbury's, Wm Morrison and Asda, either, all of whom are planning to join Tesco in adding jobs this year. Nor, staying in the grocery sector, for Waitrose, which had its best ever day of sales on December 23. Nor for Waitrose's parent company, John Lewis, nor for Amazon. (On January 9 the warehouse despatcher at our local John Lewis told me they had eight trucks and two vans out delivering for 15 hours that day). And certainly not for the local retailer whom I visited on January 5 to buy a television. The salesman told me that they had been painfully busy every day since Boxing Day, with queues outside the door on many occasions.

Interestingly, the media's "PANIC NOW!" message doesn't yet seem to be fazing the public. A Populus opinion poll in today's Times shows that while people are gloomy about the overall economic outlook, they're much less worried about their own situation. I can't think of any explanation for that gap, other than to suggest that opinions about the macro situation are largely formed by media comments, while personal expectations reflect what people see going on around them.

I'm not trying to deny that there are problems in the economy. But it would be more than helpful if the BRC and other such interest groups could keep a sense of perspective, and if the news media could find a few people who can actually read and report economic statistics accurately.

The purpose of Anatole Kaletsky

I think I've finally figured out why Anatole Kaletsky exists. He's there to fire out ideas of such surpassing stupidity that anything the government actually does will seem like the height of common sense by comparison.

Recall that the current crisis arose largely because of excessive credit creation, something which Kaletsky regularly applauded. (He was especially scathing about central banks such as the ECB, which never took his advice to pump up their economies by encouraging household equity withdrawal). When Northern Rock collapsed he declared it to be a storm in a teacup, and he continued denying the seriousness of the credit crisis until the spring of 2008. When Lehman was allowed to fail, he roundly blamed that decision for all the ills that befell the US economy, as if everyting had been fine until that point. This rather ignores the fact that the official verdict is now that the US recession began right at the start of last year. (What's the Latin for that kind of causation? Ante hoc ergo propter hoc?).

In the past few weeks he has been at the forefront of the band of idiots who are arguing that the measures governments have taken so far to address the crisis have failed, and that much more needs to be done. A couple of weeks ago he suggested that doubling bank reserve requirements would provide a cheap source of borrowing for the government, apparently not noticing that such a step would effectively neutralise any possible benefit from recapitalising the banks in the first place. Today he has slipped right over the edge of reason, arguing that bank deposits should be taxed to punish savers and encourage them to spend or to invest in more productive assets -- such as property!

It's certainly true that we don't need people with jobs to rein in their spending excessively right now, though it's hard to blame them when the media, including Kaletsky's own august organ, are replete with scare stories, many of which are exaggerated or just plain wrong. (Example: last Sunday's Times had a business section headline "One fifth of small firms to fail". The text of the story made it plain that the actual forecast was 5% of firms. One fifth, 5%, what's the diff?) However, after many years of debt-fuelled consumption it's a bit hard to argue that the UK's biggest problems is excessive saving. In fact, the lack of personal saving in the UK is one reason that many of the banks became reliant on wholesale funding, and look where that got them. In the absence of exchange controls, the main effect of a tax on bank deposits would be to drive savings abroad, exacerbating funding problems for the domestic banks. Kaletsky admits that "even Barack Obama" might consider his idea too radical. It's not radical, Anatole. It's just asinine.

Neither a borrower nor a saver be

Publication this week of the Bank of England's latest Credit Conditions Survey (you can find it on the Bank's website) has led a lot of commentators to declare the Government's bank rescue plan a failure. Not in the sense that it's failed to rescue the banks, but in the sense that bank lending is continuing to decline. Now there's talk of a further injection of taxpayers' funds being needed, if banks continue to turn a deaf ear to the Government's entreaties to resume lending. (It's worth mentioning -- since the Government certainly won't -- that for all the bluster about injecting £37 billion into the banks and "deserving" something in return, only RBS has so far received its share of the Government's cash).

There have been inherent contradictions in the bailout plan from the start. The Government stridently asserts that irresponsible lending caused the crisis, then promptly urges the banks to maintain their pre-crisis lending levels even though the economy is weakening and asset (collateral) values are slumping. And the banks are supposed to keep lending while at the same time rebuilding their balance sheets. (Or, as a leader in today's Times puts it "improve their loan to asset ratios" -- it's to be hoped that Alastair Darling takes advice from someone who knows left from right in balance sheet terms, rather than from leader writers).

What does the BoE's survey tell us about all this? It's true that the headline numbers for credit availability are grisly, with a threat of worse to come in the current quarter. However, it appears that demand for credit is also falling, both from the household sector and from businesses. Demand for loans for both M & A and capital spending has fallen. Credit availability for corporations was actually slightly better (or at least less worse) in Q4 than in Q3, except for commercial real estate. In the mortgage sector, loans for high loan-to-value borrowers are being restricted much more than for low loan-to-value customers. Default rates are rising, for both corporate and personal borrowers, and spreads are widening. If you ignored the clamour from the government and the media, you'd welcome the fact that bankers were acting like bankers again, after a decade of making like Santa Claus.

Interestingly, it's not just in the UK that banks are coming under pressure to lend more. There are similar calls in both the US and Germany -- and even in Canada, where the big five banks are well capitalised and have largely escaped the worst effects of the credit crisis (though you wouldn't guess that from looking at their share prices). A key reason we are facing such a major correction in global credit markets is that central banks, especially the Fed, were unwilling to allow even minor corrections over the past decade - the good old "Greenspan put". Governments have to allow the rebalancing and repricing of credit to take place, but there are worrying signs that they lack the patience to do so.

Meanwhile, the media are warning that a further cut in the Bank of England repo rate next week could result in interest rates on individual savings accounts falling close to zero. I always thought that one reason for Japan's "lost decade" was that that country's aging army of savers was impoverished by the BoJ's zero rate policy. Brits are not nearly as good at saving as the Japanese, but even so, there are more savers than borrowers in this country. The Government needs to keep their interests in mind as it tries to find a way to nurse the financial system back to health.

The Euro in your pocket?

Sterling's precipitous fall towards parity with the Euro has led to a bout of speculation in the media about the possibility that the UK might bid to join the single currency. However, a poll conducted for the BBC suggests that 71% of people in the UK still oppose such a step, and only 15% say that the pound's decline has made them more receptive to the euro.

I've had a bit of a love/hate relationship with the euro over the course of its 10-year life. Initially I favoured UK entry. I was baffled by the fact that UK politicians, having seen a never-ending series of sterling crises blight the UK economy for half a century, couldn't bring themselves to ditch the wretched pound while they had the chance. In the middle of this decade, though, I became more ambiguous about it, as the ECB's inflexibility seemed to saddle the eurozone with an uncompetitive exchange rate and needlessly high interest rates.

Now, with sterling in freefall, opponents of UK euro membership are gloating that the decision to stay out has been vindicated. They argue that the fall in sterling will improve UK competitiveness, and that the independence of the Bank of England allows it to be much more aggressive than the ECB in easing monetary policy. One or two people have even opined that if we were in the Eurozone right now, we'd be looking for a way out.

Yeah, but....if we'd been in the Eurozone all along, we probably wouldn't be in the mess we find ourselves in today. The steady, inflation-focussed approach of the ECB over the last decade now looks like sheer genius when contrasted with the manic, reactive tinkering espoused by the Fed and largely followed by the Bank of England. It's striking that the Eurozone economies that are in the most trouble today seem to be the ones (Spain, Ireland) that aped the Anglo-Saxon habit of leveraging up their housing stock. The larger Eurozone economies, the ones that the UK should want to be compared with, are suffering a slowdown, but for now seem to be coping, and are certainly far less panicky and anxious than the UK about their medium-term outlook.

There's no sign that the UK government is considering a move to join the euro. The fact that the minsiter designated to respond to the BBC poll was the relatively lowly Caroline Flint shows that the issue simply isn't on the radar screen. In any case, it's sheer fantasy to think that Germany and France would let the UK join the eurozone at anything like its current level. Still, a bit more respect for the achievements of the ECB in its first decade of existence might be in order.