Put that thing away, Ben!

Before he became Fed Chairman, Ben Bernanke was recognised as an academic expert on the Great Depression. He famously noted that the modern-day Fed would always be able to prevent such a thing from ever happening again, because it could, if need be, drop money from a helicopter to stimulate demand. He thus acquired the sobriquet "Helicopter Ben", though in the rarefied world of the dealing rooms, it was common to hear a more technical expression: "Bernanke's chopper".

Ben may have been as surprised as anyone when the 2007-08 financial crisis gave him the opportunity to put these theoretical musings to the test, in the form of the $2 trillion quantitative easing (QE) programme. This week the Fed announced it would try to give the sluggish US economy a further boost through a second round of asset purchases, referred to as QE2, though this time the scale will be a lot smaller: about $600 billion between now and mid-2011, or about $75 billion a month.

The Fed's decision had been widely anticipated and had polarised opinion, among politicians and pundits as well as economists, even before it was announced. Bernanke took the unusual step of securing the front page of The Washington Post for an article explaining his rationale.

This may not have been the best idea, though Bernanke is certainly on solid ground when he describes the uninspiring state of the US economy:

"....we could hardly be satisfied. The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills".

However, he is far from convincing when he tries to make the case that more QE is the answer; and this claim, made just a day after the Fed made its announcement, is surely a huge mistake:

"This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action".

Yeah, well, that's what used to happen with the old "Greenspan put", Ben, and look how well that turned out. Also according to Ben,

"Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion".

Can anyone any longer seriously believe that the reason the US economy isn't growing is that there isn't enough money swilling around? There was no shortage of money in 2007, but that didn't prevent the financial crisis. Thanks to the first round of QE, there's a whole lot more money now, but it doesn't seem to be producing much traction, mainly because banks are still much too uncertain about asset values to step up lending to any meaningful degree. (The same, by the way, can be said of the UK, the other major economy to resort to QE since the financial crisis).

It's becoming clearer by the day that the main reason the first round of QE "worked" (the US economy has been growing again for more than a year) was not so much that it led to healthier financial markets as that it boosted confidence. In 2008 markets were pleading for something to be done, and QE was the right move; but with so many experts and market participants sceptical about what can be achieved this time, it's unlikely that QE2 will generate a lasting surge in confidence.

In the meantime, observers outside the US are becoming increasingly critical. In Toronto, the Globe and Mail bluntly observed last week that QE is "just another name for devaluation". Central banks in emerging economies are warning that the first round of QE has already produced a bubble in their markets (care to explain how that helped the US economy, Ben?) and are angry that the Fed is pressing ahead with more of the same.

Today Bank of England Governor Mervyn King announced that he will be keeping his own chopper sheathed for the time being. It may not be long before we are all wishing that Ben Bernanke had kept his under wraps too.

The float and the bubble

Way back when, US companies had a neat trick to boost profits, known as "playing the float". Here's an example. If you were a Maine resident waiting for a settlement from your insurance company, you would receive a cheque drawn on a bank account in Hawaii or the Pacific Northwest. Even after you'd presented the cheque to your local bank, you wouldn't actually see the money in your account until the cheque had wended its way all the way back across the continent (by train) to be cleared. If you lived in LA, your cheque would be drawn on somewhere like Manchester, New Hampshire.

The jet age, and now the internet age, have put the crimp on such shenanigans, though I believe that relatively remote spots like the Dakotas still see a disproportionate amount of clearing activity. After all, even an extra day's use of the funds is worth something to a large company.

I can report that the game of "playing the float" is also alive and well in the UK. I'm one of several hundred thousand domestic gas customers entitled to a refund from our former gas supplier -- no names, but its initials are npower. (For those lucky enough to be unfamiliar with the story, npower overcharged its customers for gas back in 2007 and was careless enough to get caught out). About a month ago, I got a letter from the company advising me that my refund would be £28 or so. I had to return the letter with certain added details so that they could verify that I really was entitled to the refund, which is fair enough.

So then they credit my account, the same one they enthusiastically debited each month back in 2007, with the refund, right? Wrong! OK, so they send me a cheque, then? Wrong! This week I received a letter with a couple of barcodes on it. I had to present this to my local Post Office, together with two pieces of ID, in order to receive the refund in cash.

So this morning that's what I did, spending a pleasant 25 minutes lining up behind people sending Christmas parcels and such before getting up to the counter. There the hapless clerk had to type the 18 digits of my driving licence number into her terminal, verify my other piece of ID, scan the barcodes, stamp the letter from npower and count me out my cash.

The clerk said she thought the reason npower was using this astoundingly primitive method of providing the refunds was that some of the older customers might not have bank accounts. That might be true, but I'd bet that even more of them live in places where the local Post Office has closed. And in any case, non-possession of a bank account never seemed to stop npower from getting its scruffy mitts on the money in the first place.

It's all blatantly a float play. How many people will walk into a Post Office clutching their npower letter, see the pre-Christmas queues and walk right back out, then forget to try again until its too late? (You have six months, according to the letter). How many will be unable to get to a Post Office at all because their local branch has closed? It all serves as a reminder of why I switched from npower in the first place.

Not that I'm spoiled for decent choices in the UK's "competitive" domestic gas market. One of the suppliers has just announced a 9.4% increase in its gas prices, and the rest are certain to follow very soon. This comes against the background of a global gas supply "bubble", which is expected to last anything from three years (according to Qatar, the world's largest LNG exporter) to a decade (according to respected independent analysts). In the very short term the UK is awash with gas because LNG cargoes destined for France were diverted here because of the recent strikes.

The company raising its prices, Scottish and Southern, claims to have lost £58 million supplying domestic customers in the past year, yet mysteriously it managed to eke out a profit of £1.25 billion in its overall business, virtually all of which is gas-related. I smell another refund in the offing -- maybe I should get in the queue at the Post Office right away.

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.