Further evidence of parallel universes

News story: Anatole Kaletsky was named Financial Commentator of the Year 2010 by the Editorial Intelligence Comment Awards . (Who dat?)

In related developments:

JLS named best rock band ever by NME.

Richard Dawkins consecrated as Cardinal by the Pope.

Wayne Rooney lauded as Husband of the Year by Mumsnet.

The risks are next year's story, peeps

UK GDP data for the third quarter came in much stronger than the market consensus of 0.4%. The actual increase was 0.8%, after a 1.2% gain in Q2. (Kudos to RBS, whose forecasters called it exactly right). So far this year, the economy has been growing at an annual rate of over 3%, above its long term trend.

There's been a small amount of "yes, but" commentary from the media, mostly focusing on the fact that "it's all about construction, which is still recovering from the tough winter". It isn't, though: construction accounted for only one-rhird of the quarterly rise in GDP. Manufacturing and services also performed very respectably.

The more common reaction, however, has been to suggest that the data mean that the economy will avoid the feared "double dip" recession -- a view that's almost as ludicrous as the media's usual doom-and-gloom. Look, children, I'll spell it out for you one more time. Growth will remain positive through the end of the year -- in fact, Q4 could be surprisingly strong, as people try to make big-ticket purchases before VAT goes up in early January. The risk of a double-dip will be strongest in the first couple of quarters of 2011, as the VAT hike takes its toll and spending cuts really start to be felt (as opposed to just being talked about, as they are at the moment).

I'd be a bit surprised if we meet the technical definition of a recession -- two declining quarters in a row -- but early 2011 is when it could happen. All the rhetoric of recent months about an imminent double dip, with The Times at its forefront, has been based on very poor analysis indeed.

QE 2 far?

It looks as if any day now, Fed Chairman Ben "Helicopter" Bernanke will announce another round of quantitative easing for the United States. If third quarter GDP data for the UK, due out this week, show a significant slowdown (consensus is 0.4%, after 1.2% growth in Q2), the Bank of England may well follow suit. For both countries, it's a risky choice.

The initial resort to QE (or printing money, as we'd call it if we were talking about the Bank of Zimbabwe) made a lot of sense. Economies around the world were teetering on the brink of depression. There was a compelling need to ensure that the whole world didn't tip into the same kind of stagnation that has bedevilled Japan since the 1990s.

Both the US and UK economies have been growing for the past several quarters, so something seems to have worked. It's just not clear that the "something" that got things moving again was QE. It may have boosted confidence by providing reassurance that governments and central banks still had a few tricks up their sleeves to head off a depression. However, it has done very little to restore the flow of credit to the private sector, which was the supposed object of the exercise.

The combination of near-zero interest rates and QE seems to have gifted banks with history's biggest ever example of the much-loved "carry trade". Banks are taking in money almost free from their depositors and investing it in riskless government debt, a nice little earner. As a result, bond yields in both the US and UK are heading ever lower, despite record levels of issuance as both countries run up massive fiscal deficits.

You can't really blame the banks, who have been getting mixed messages from governments. They have been sternly warned to strengthen their balance sheets (which forces them to earn a secure and steady income, and hence leads them to tighten credit criteria) at the same time as they have been urged to maintain and enhance lending in support of the economic recovery (which, even in the best of times, means taking risks). Given the continuing overhang from the borrowing binges of the past decade and the prevailing uncertainty over the duration of the economic recovery, it's no surprise that balance sheet rebuilding has been a greater priority than lending growth.

There can be no guarantee that QE2, in either the US or the UK, can break this cycle. (People are using the old Keynesian term "liquidity trap" to describe the situation. That's not strictly accurate: what we have here is a sort of evil postmodern version, with both fiscal and monetary policies looking tapped-out). It seems only too likely that the main (if not the only) consequence of further printing of money will be to drive government bonds even further into overbought territory. Ben Bernanke watched Alan Greenspan inflate three asset bubbles, eventually producing the dire consequences we are all too familiar with. He may well be about to trigger a first bubble of his very own.

It won't be like that

As media types solemnly scrutinise every detail of today's UK spending review, the main thing to remember is this: one way or another, the future will not unfold the way George Osborne is predicting. If opponents of the cuts are correct, the impact on the economy will be so severe that the government will have no choice but to slow the austerity programme, or else risk tipping the economy back into a recession that will make its fiscal targets unachievable anyway. If, on the other hand, the economy responds well to the dose of austerity, spending will start to creep up again as the government ponders the approach of the general election due in 2014.

A few months ago there were suggestions everywhere that the coalition would take its cue from the fiscal austerity programme supposedly implemented with great success in Canada in the 1990s. We even saw superannuated Canadian politicians pitching up in London to brag about what a good job they had done. As I have written here many times, there are almost no lessons for the UK to take from Canada's experience. Although the Canadian federal government indeed announced a series of spending cuts around the mid-1990s, well before the end of that decade all categories of public spending were rising again. How come? Well, rapid economic growth, largely triggered by a recovery in the US economy, boosted revenues so strongly that the spending cuts became unnecessary. Whether the Canadian government would have been able to push the cuts through if they had truly been needed is unknowable.

The UK is most unlikely to benefit from a surge in growth among its major trading partners, so the Canadian experience will not be repeated here. Where Osborne could have learnt from Canada is in setting achievable short-term goals (no more than two years at a time) and building credibility by ensuring that those goals are always met. Osborne has ignored that completely, spreading the pain over a four year period and back-loading changes that could surely have been implemented more quickly if the fiscal need was really as severe as the Government keeps claiming. The earlier announcement of changes in child tax credits to become effective only in 2013is a typical example of this, and there are many others buried in today's spending review.

For now, the incompetent but all-important ratings agencies and the dreaded bond vigilantes may profess themselves satisfied with the existence of a four-year programme. However, when unforeseeable events push the new fiscal plans of course, as they inevitably will one way or the other, it will be interesting to see how the government seeks to maintain its credibility.

Indefensible

Is it still an aircraft carrier if it doesn't carry aircraft? The British government evidently thinks so, because it's pressing ahead with plans to build two new carriers (at a total cost of £5-6 billion) even though, when they come into service (2016-2019) there won't be any aircraft available to fly from them, unless you count helicopters. What's more, the first one will be mothballed or sold as soon as the second one comes into service. And if a military man I heard on the radio this morning is right, the new carriers will never be able to handle fully-laden aircraft anyway, as they will be only two-thirds the size of US carriers.

Before either ship is ready, the Navy's existing carrier, HMS Ark Royal, will be decommissioned as a cost-cutting measure. Ark Royal does carry aircraft, the venerable Sea Harrier jump jets, and they're being retired too. So for five years or so, the navy of Nelson and Hood, Rodney and Collingwood will have no aircraft carriers. Then it will have one, but with no aircraft.

Welcome to the Looking Glass world of British defence, now being revealed in the Strategic Defence Spending Review. The story with the carriers is shaping up as the biggest scandal, in that it's clear that the government would dearly love to cancel them but is saddled with contracts that make it cheaper to proceed, even though the finished product will not be "fit for purpose". But there's plenty more where that came from. Example: the planned army training centre at St Athan in Wales is to be cancelled. It was going to cost £14 billion (!), under a "private finance initiative" scheme that has been under regular attack from Private Eye over the past couple of years. My usual questions over PFI schemes apply here in spades: what reason is there to think that there are people in the private sector who can carry out the task of army training better than the Army's own trainers can? If there are such people out there, who are they working for at the moment?

And let's not leave the RAF out of it. RAF Kinloss, on the Moray Firth, is to close as a result of the cancellation of the Nimrod reconnaissance aircraft. Bad news for the area, to be sure. Nearby, RAF Lossiemouth will apparently have to "compete" with a base in Norfolk to be the home of most of the RAF's Tornado fighter squadrons. There are currently four squadrons of Tornados at Lossiemouth, which is hundreds of miles from the UK's main population centres. Now of course, planes regularly have to be scrambled to intercept Russian aircraft cruising along the edges of UK airspace. Has it occurred to the RAF brass that if the Tornados weren't there, the Russians wouldn't bother with their reconnaissance flights? The whole thing is at best a wildly expensive training exercise for the two sides, at worst a total charade.

One more example: the Army will pull 20,000 troops out of Germany by mid-decade to save money. Good news, one supposes, except what have they been doing there for the last twenty years anyway? Are we worried about German revanchism or Russian (it would be more appropriate to say Soviet!) aggression -- or are we just fulfilling some NATO obligation that's way past its time?

In a way you have to feel sorry for the coalition government as it tries to sort through this fantastically expensive mess. It's an extreme case of "producer capture": politicians are caught between the pleadings of the armed forces themselves, always fighting the last war, and the graspings of the defence industry, always keen to provide fancy kit for the next one. The net result is that, largely as a result of past incompetence, the defence sector faces spending cuts of only about 8%, while if news reports are to be believed, tomorrow the social housing budget in England will be cut by almost 50%. It's indefensible.

Mullering the Maestro

The US investigative journalist Bob Woodward has written or co-written sixteen books of "instant history", going all the way back to the Watergate expose of the mid-1970s. If he could have one of those books back, I'm guessing it might be "Maestro", his hagiography of the former Fed Chairman Alan Greenspan. The halo Woodward slapped on Greenspan's head a mere decade ago has slipped so far in the last few years that the poor man must now be using it as a truss.

Surprisingly, in the welter of books about the financial crisis, there hadn't been one that attempted to pin the blame squarely on Greenspan. But one recently turned up on the shelves of the good old Hertfordshire county library: "Panderer to Power", by Frederick J. Sheehan, a Boston-based financial consultant. Published by McGraw Hill (though in many respects it feels more like a vanity publication), it's an extraordinary piece of work.

Let's get the bad parts out of the way first. Sheehan is, to put it as politely as possible, no prose stylist. He makes words up ("trancate"), misuses others ("Greenspan spoke in vagaries") and exhibits a jarringly baroque turn of phrase ("the most famous civil servant since Caligula's horse"). More seriously, he doesn't always understand what he's writing about. For example, his description of the workings of the simplest of financial derivatives, a plain-vanilla interest rate swap, is just plain wrong, and as a result he has an exaggerated view of bank counterparty risk.

You gotta say this for the guy, though: he really, REALLY disrespects Alan Greenspan. So much so, in fact, that it threatens to get in the way of the story. Take the first chapter of the book, innocuously titled "Introduction to Part 1: Prelude to Power". A few paragraphs about Greenspan's formative years, right? No way! Sheehan can't restrain himself from hurling the big bombs right from the outset. As early as page 2 we learn that "from the time Greenspan was named Federal Reserve Chairman until he left office, the nation's debt rose from $10.8 trillion to $41.0 trillion". On page 3: "(Greenspan) may not even have understood what (Ayn) Rand was talking about". and on page 6, "His record as an economic forecaster was unimpressive".

The insults and accusations go on for a further 370 pages, with a degree of repetition that can be a seriously wearing. Still, it can't be denied that Sheehan has done a lot of research, which shows up in the form of multitudes of footnotes on almost every page. He has read Fed minutes, FOMC transcripts, speeches by Greenspan and others, Congressional papers and media reports. Longstanding Greenspanophobes such as Jim Grant and Bloomberg's Caroline Baum have clearly influenced Sheehan's thinking, but the anger seems to be all his own.

The case Sheehan seeks to build is that Greenspan was never much of an economist but was always a superb self-promoter. His supposed mentor, Ayn Rand, reportedly asked a mutual acquaintance, "do you think Alan might basically be a social climber?". Sheehan cites evidence that Greenspan's doctorate from NYU was granted in unusual circumstances (he never wrote a dissertation, and the papers he submitted instead have never been published) and argues that his Wall Street consultancy (Townsend Greenspan) had an undistinguished history. This might seem like little more than mudslinging, but for the fact that the target is a man who became the most powerful figure in the global economy.

Sheehan's analysis of Greenspan's record as Fed chairman homes in on something that puzzled many people at the time. Greenspan hardly ever spoke about inflation or the money supply, two of the Fed's key raisons d'etre. In many of his key speeches, those things hardly figured at all. Instead, he was obsessed with technological progress, productivity and share prices. Over time he managed to convince himself, and more importantly almost everyone else, that low US inflation was not the result of cheap imports from China and elsewhere (which was almost certainly the case), but of rapidly rising productivity within the US itself.

Sheehan argues that this rise in productivity was almost entirely an illusion created by "hedonic" adjustments to GDP statistics. Simply put, a $1000 computer bought in 1990 could do much more than a $1000 computer bought in 1980, so the statisticians would make a "hedonic" adjustment to GDP data to reflect the quality improvement. This is not invalid in itself, but it's not hard to accept Sheehan's case that basing monetary policy on such adjustments is an extraordinary stretch.

Sheehan's reading of FOMC transcripts also shows that there was rather more scepticism within the committee than most observers (OK, me) would recall. Greenspan seems to have turned up at each FOMC meeting with the post-meeting press release already written. His usual response to any hint of dissent was to call for a coffee break, leading Sheehan to label him "Mr Coffee".

Sheehan doesn't just dislike Greenspan. He doesn't like his successor Ben Bernanke very much either; or Larry Summers and Robert Rubin; or stock analysts, or economists. While he is unclear as to what remedies he would propose -- he wants to abolish the Fed, but suggests no alternative -- he is very obviously a man for small government. You don't have to agree with that viewpoint to agree that this intemperate and in some ways deeply flawed book has performed a valuable service.

There are surely much better books about the Greenspan years to come, but Sheehan has done a lot of the spadework. And it will be hard for anyone to top some of his insights, for example: "most Americans who listened to Greenspan took him at his word -- even though they did not know what he was saying". Won't get fooled again? Not if Sheehan can help it.

Overdue pension change

There's so much stuff coming out of Whitehall these days that you almost wonder what they can possibly be saving up for next week's spending review. Today the government announced a series of reforms in personal pension rules which will, when they come into effect in April next year, save the Treasury an estimated £4 billion per year, or more than 20% of the annual cost of pension tax relief.

There's a lot to the reforms, but the most eye-catching and welcome change is a drastic reduction in the maximum annual pension contribution for which an individual can claim tax relief. Currently an eye-watering £255,000, this limit will be cut to £50,000. About time, too. The provision of tax incentives to encourage individuals to provide for their later years is all well and good, but allowing them tax relief on the accumulation of huge pension pots is nonsensical. The tax relief should allow the accumulation of a fund big enough to provide a "living pension"; beyond that, it makes no sense at all for ordinary taxpayers to be subsidising the better-off in building huge pension funds. If people want to save more, that's fine, but there's no reason for the taxpayer to subsidise it.

A related change will see the lifetime maximum for pension contributions lowered to £1.5 million from the current £1.8 billion, starting in 2012. This may be where things get interesting in the spending review next week. These limits apply to private sector pensions, but there is no similar limit in the public sector. Many senior public servants -- step forward, Bank of England Governor Mervyn King among many others -- have notional pension funds fare larger than these limits. Dollars to doughnuts, today's change will be used by the government to justify the imposition of a limit on public sector pensions as well.

University funding challenge

The UK seems incapable of coming up with a system of funding for universities that can command a wide range of support. (I should say England and Wales rather than the UK, as you don't hear many complaints about Scotland's abolition of tuition fees, at least from the students).

When I went to university over four decades ago, tuition fees and a portion of living expenses were paid by one's local authority. In one respect this made no sense at all: once I'd graduated, the London Borough of Waltham Forest was going to be among the last places I'd choose to live, so it wasn't much of a deal for the local ratepayers. But at least that system achieved one of the key goals everyone claims to be seeking: it allowed a kid from a working class background to go to one of the world's best universities, without taking on a crippling debt burden.

The latest attempt to sort out the system is a report by Lord Browne, the former head of BP. His plan calls for allowing universities to charge students what the traffic will bear, though fees above a certain level will have to be shared with the government. So Oxbridge degrees will cost more than those at some newly-minted ex-polytechnic. This is probably the only way to allow the Oxbridges, Imperials and others to compete with the immensely wealthy Ivy League schools in the US.

Repayment of student loans will only start when a graduate achieves a certain income level: the initial proposal is £21,000 a year, which is just above the average wage. In an odd twist, however, higher-earning graduates will pay a higher rate of interest on their loans than the lower paid. This obviously opens up all kinds of perverse possibilities: someone who works hard to get a medical degree from a top school and then gets a job as a consultant will pay the full freight, while someone who goes to a less esteemed school and gets a degree in golf course management, then winds up on the dole, never pays back the loan.

Unfortunately, Business Secretary Vince Cable, whose portfolio includes universities, seems very taken with this idea -- so much so that he is talking of levying a fee against any graduate with the temerity to pay off their loan early, and even taking steps to prevent wealthy parents from avoiding the interest charges altogether by paying their offspring's fees in advance. Is it possible that Vince is not aware of the time value of money? People paying back their loans early, or getting a sub from mater and pater, are reducing the burden on the public purse, which is normally seen as a virtue these days. Then again, making the higher rate impossible to avoid would effectively move Lord Browne's proposed scheme back in the direction of a graduate tax, which may have been Vince's preferred route all along. Either way, it doesn't have much to do with fairness.

There's a surprise!

When you hire a plumber, there's one thing you know for sure. As soon as he's given your problem the once-over, he'll solemnly state that "the last bloke you had here made a right mess of this". And you know perfectly well that the next plumber to cross your threshold will say exactly the same about today's guy.

I see Sir Philip Green's report on waste in government spending in very much the same light. After a few weeks spent studying the workings of government, the retailing billionaire has concluded that there's scope for massive savings -- £700 million for telecommunications services alone.

I've no doubt Sir Philip is right about a lot of this stuff, but does anyone doubt that the next outside consultant called on by some future government to look at the same issue will conclude that Sir Philip didn't fix anything, and that waste remains at intolerable/shocking/unconscionable/your adjective here levels? Public servants don't go out of their way to waste money, but they lack strong incentives not to waste it inadvertently. Moreover, "good" procurement in government is rarely just a matter of getting the cheapest deal: there are often political issues to be weighed up: national preference, regional development, that sort of thing.

One of Sir Philip's particular recommendations points up very clearly the difference between the public and private sector ethos. Sir Philip thinks the government should start to demand 45-day financing terms from its suppliers, as his own businesses do. The government, bless its little heart, strives to pay all its suppliers within five days. This started out as a Gordon Brown initiative to help out small businesses when the economy slowed down, but now it's a general practice. Given the continuing scarcity of bank credit, how many companies supplying the government would struggle if Sir Philip's suggestion was put into practice?

Back in mid-August, when Sir Philip was appointed to look at government waste, I wrote that as a tax exile/avoider, he perhaps wasn't the best choice for the job. After all, the estimated scale of tax avoided in the UK greatly exceeds welfare fraud, yet which one is the government turning its guns on? Sir Philip told Robert Peston (see his blog on the BBC website) that if his companies were run like the government, they'd go broke. Well, if everyone ran their businesses and their tax affairs the way Sir Philip does, the government would go broke, however much it tried to curb spending. A point not lost on one of the commentators on Pesto's blog:

You forgot recommendation 12: transfer half the Government's assets into Samantha Cameron's name and get her to move to Monaco. I'm sure Sir Phillip could provide lots of advice on how to do that.

Keynes and the coalition

The Telegraph website has a video'd interview with John Maynard Keynes's latest (and possibly most sycophantic) biographer, Lord Skidelsky. His Lordship believes that Keynes would have been astounded and horrified at the economic illiteracy of the coalition government.

Very likely he would, but I'd venture to suggest that he would also have spoken out strongly against the Brown-inspired, drunken sailor spending of the period from 2000-2007, when the economy was growing strongly and was clearly in no need of fiscal stimulus. I don't recall hearing much from Skidelsky, or from any of the politicians and others who are now so happy to declare themselves to be reborn Keynesians, when that nonsense was going on.

It's a bit of a sad fate for Keynes that, for so many of the public (I exclude Lord Skidelsky from this), the only part of his massive written output that's ever remembered is his belief that governments should resort to fiscal stimulus at times of recession. If you need any insight into how well Keynes is understood, just read the barely literate comments posted by Telegraph readers in response to the Skidelsky interview. Herewith a sample or four:

Keynes was plainly a dolt, for only a dolt would have come with the plain stupid things that Keynes did; pay people to dig holes and fill them in again, my aunt fanny!yeah we need holes like we need another labour government. i.e. like an hole in the head.

and...

Keynes is dead. Unfortunately a considerable number of "Keynesians" don't seem to appreciate the fact. Various Universities have force fed them his past deliberations and like zombies they go around prosletising these second hand ideas as if they were a holy edict.

and...

Keynes and Keynesians are for economics what a witch doctor is for medicine. They approach Economics the same way a scientist approaches Physics or Chemistry.

None of the keynesians are known for running a business, but Academia is under their control. No wonder it's the case, it gives governments (which finance the Academia) the moral ground to steal more from the people (tax).

and...

Time and time again it has been shown that fiscal restraint results in economic growth. The mechanism isn't clear, but I'd suggest that fewer free lunches make people work harder.

The comment made by the Lord is completely in line with some socialist economic models but completly out of touch with the reality - which is, the more you give to people today, the less they produce, the les they have tomorrow. Very Labour indeed.

and my favourite...

haha another blow for the moronic telegraph economics desk, committed to trying their best to convince the readership that Keynes and our progressive leaders know best, but wait, look at all these wonderful comments!

THE SHEEP ARE WAKING UP!!!

We are not buying your propaganda Telegraph, your constant attempts to shove a pro Keynes bias is rejected ever more vehemently. Well done to all the posters below who have voiced their objections.

The Telegraph as a bastion of Keynesian economic thought! We must have flipped into one of Stephen Hawking's parallel universes.

Mr Osborne, meet Prof. Galbraith

Chancellor George "it's not his real name" Osborne has announced that the government will reduce the cost of welfare programmes, by replacing the current mish-mash of benefits with a single social credit and taking benefits away from higher-rate taxpayers. Going forward, no household is to make more from benefits than the average household makes from working; the idea being, of course, to encourage the benefits-dependent to join the workforce.

For the longer term, Osborne remains committed to reducing income taxes on the higher paid, in order to reduce disincentives to work that higher taxes supposedly create.

It's all very Reaganomics, and calls to mind the comment of the late John Kenneth Galbraith about the underlying fallacy of that mindset: that the poor don't work harder because they have too much money, and the rich don't work harder because they have too little. Maybe George doesn't think that's a fallacy.

By the way, if the need to reduce the deficit is so all-fired urgent, how come the withdrawal of benefits from the better-off won't start until 2013? You'd almost think these changes were ideologically driven, rather than being forced on the government by financial necessity. Surely not.

Yankee stay home!

Don't you love all the great things that happen when American money gets involved in global sports? To wit...

* the Ryder Cup has almost been washed out this weekend because the NBC television network, brandishing its chequebook (sorry, checkbook), insisted it should be played in October, instead of September as is usually the case. Sky Sports just ran a graphic showing that October is the wettest month of the year in South Wales, with 50% more precipitation than September. Maybe NBC thought it was the same place as New South Wales.

* the America's Cup has been landlocked for several years amid litigation. Now the holders, BMW Oracle (Larry Ellison, Prop.) have unveiled a new set of rules so outrageously rigged that a mooted UK challenge has already foundered. It may well be that no challenger is prepared to risk the $100 million it would take to get whupped by Larry, which would put an end to a sporting tradition stretching back well over a century.

* cricket narrowly dodged a bullet when the carpetbagger Allen Stanford's efforts to take over the game were stumped by his sudden incarceration on fraud charges.

* and here at home, two of the Premiership teams owned by US asset strippers (sorry, investors) -- Liverpool and Manchester United, are facing increasing financial pressure, with the situation at Anfield particularly ominous.

The amazing thing is that the major US team sports -- football, baseball and basketball -- are beacons of co-operative organisation in the land of red-blooded capitalism. Bad teams get first pick of young players, salary limits are enforced, there's even revenue sharing between teams in the major markets and those in smaller cities. It's a model the Premiership, in particular, would be wise to follow. Of course, it's much too restrictive for American entrepreneurs looking to get rich through sport. Which is why, with usually disastrous results, some of the more aggressive have taken their love of sport and their personal charm to foreign shores.