Not Learning the Lessons

As unemployment ticks higher again, I find myself thinking of the below quote:

Blame for unemployment lies more with finance than with industry. Mass unemployment is never the fault of the worker; often it is not the fault of the employers. All widespread trade depressions in modern times have financial causes; successive inflation and deflation, obstinate adherence to the gold standard, reckless speculation, and over investment in particular industries…

The view is now widely accepted outside the ranks of the Labour Party, by most economists, by many Government officials, by many businessmen, even by some bankers…

Finance must be the servant, and the intelligent servant, of the community and productive industry; not their stupid master.

The Labour Party, ‘Full Employment and Financial Policy’, 1944.

I worry that we’ve forgotten much of what we once knew. As Larry Elliot says today:

Even assuming the Bank of England gets it right, all that happens is that we return to a fundamentally flawed model. The return of property inflation, asset bubbles, private equity deals and the whole big swinging dick culture that pervaded Britain back then does not signify real economic recovery: it is evidence of a deluded and chronically sick nation determined to learn nothing and forget everything from the crisis.

Deluded because the over-reliance on debt-driven consumption, speculation and financial engineering was what got us into this mess in the first place. Chronically sick because each of the recessions of the last 30 years has ripped a bit more out of the UK’s industrial base and hence aggravated a problem ever-present since the second world war: we consume too much and produce too little.

Lloyds

I’m still here, although I’ve been rather busy with actual work for the past few days. So please accept my apologies for the lack of posting. I’m working on three long-ish posts but realistically they wouldn’t be finished before my upcoming two week holiday (during which posting will be light).

Today though, I want to talk about Lloyds. They’ve annoyed me. To be honest they’ve been annoying me since they billed me a fortune in overdraft charges when I was a student. I don’t like being ripped off. Now they’re trying to do it again. This time ripping me off as a taxpayer.

Lloyds Banking Group’s tentative plans to raise an estimated £15bn-£20bn ($25bn-$33bn) in a rights issue to reduce its reliance on the government face a wall of scepticism in Whitehall and among investors.

Lloyds last week floated the idea that the terms of its participation in the government’s asset protection scheme (APS) might be open to renegotiation after second-quarter results that were more upbeat than expected.

This all sounds a little technical, so let me explain. The APS was the scheme launched earlier this year whereby the government essentially guaranteed a load of useless assets on Lloyds (and other banks) balance sheets in return for a fee.

It was only because of the APS that Lloyds passed the FSA stress tests. The whole point of the APS was to prevent another round of capital raising by the banks.

Now, with the green shoots making the world look a little rosier, Lloyds have decided they don’t want to take part anymore.

Basically have free-rided on Treasury help in the dark days of the first quarter of this year, they now want to back out. This is unacceptable.

If they did proceed with a £15bn rights issue to raise capital, UKFI (the Treasury’s holding company) would face the choice of either seeing it’s 43% stake diluted down or putting in another £9bn to maintain the stake.

Officially, the bank declined to elaborate on a weekend statement that it was working with the Treasury on the fine print of the scheme and expected to conclude a deal that was “in the best interests of our shareholders”.

‘The best interests of shareholders’ indeed. Not necessarily their biggest shareholder.

We should be clear about this – RBS and Lloyds are only solvent because of taxpayer help. HSBC and Barclays (despite not having needed capital injections) have benifited massively from liquidity support schemes. These banks owe us.

And yet we are letting them ride roughshod over us on the issues of lending to small business, excessive charges, bonus and now they are trying to short change us. UKFI needs a new CEO urgently and they need someone to fight our case.

As John Ross commented on Reuters yesterday:

The UK government is rightly desperately attempting to increase bank lending in order to counter the economic downturn. As is also well known it is having little success in these efforts despite hundreds of billions of taxpayers money put into the UK banking system.

In China this problem does not exist. The state owned banks can be, and are, instructed to increase lending. The second part of China’s stimulus package, after the investment programmes, is therefore a rapid increase in bank lending — new loans in the first half of 2009 were $1.1 trillion and M2 to June rose by 28.5 percent providing an extremely strong counter-recessionary impulse.

Vince Cable, the Liberal Democrat’s Treasury spokesman, has rightly repeatedly pointed out the absurdity of the current situation with UK banking. All UK banks today exist only due to taxpayer subsidy — although Barclays and HSBC did not receive taxpayers equity, they would not be profitable operating without the taxpayer funded guarantee and economic stimulus schemes.

Yet despite UK banks existing only due to the taxpayer, Chancellor Alistair Darling is reduced to ineffectually pleading with them to increase lending. No such problem exists in China. A side effect is that China now has the most valuable banks in the world by market capitalisation –- but banks simultaneously doing the key job of expanding lending. In China, private and public interest are properly aligned within the banking system.

China’s growth: Pettis vs Ross

The China debate continues.

Moving to the pages of the FT.

Michael Pettis wrote an article for last week’s FT, predicting trouble ahead for China.

While Chinese consumption was growing at an impressive 9 per cent a year over the past few years, Chinese gross domestic product growth substantially outpaced it, clocking in at 10 per cent to 13 per cent annually. China was able to do this in large part because as it poured resources and cheap financing into manufacturing, and in so doing produced many more goods than Chinese households and businesses were able to consume, the balance was exported abroad, where much of it was absorbed by US consumers.

But everything has changed. Willingly or unwillingly, US debt levels will decline over the next several years. As a result American consumption will grow substantially slower than the US economy, and so the trade deficit will decline. For the rest of the world, even ignoring the possibility of a decline in global investment, a contraction in the US trade deficit will bring with it a period in which economic growth will be less than consumption growth.

This matters, especially for China. If the Chinese economy was the biggest beneficiary of excess US consumption growth, it is likely also to be the biggest victim of a rising US savings rate. For now, China has been able to avoid the brunt of this reversal. Although Chinese exports have dropped, imports have declined even faster, so that China’s GDP continues to grow faster than its consumption, and China’s savings level, which is the inverse of consumption, continues to rise. But this has come at the expense of an unsustainable squeeze on China’s export competitors.

Eventually, and maybe this is already happening, the decline in the US trade deficit must result in a decline in China’s ability to export the difference between its growth in production and consumption. When this happens, China’s economy will grow more slowly than Chinese consumption, just as the opposite is happening in the US.

…

 

For now an extraordinary but inefficient expansion in new bank lending has powered the Chinese economy into growth rates that many thought unlikely even six months ago. But rapidly rising bank lending, especially if misallocated to nearly the same extent as in previous loan surges, cannot be a long-term solution for slowing Chinese growth.

Over the next five years or more Chinese economic growth is going to be constrained by growth in Chinese consumption. The massive but unsustainable investment in infrastructure and new production facilities that characterises the Chinese fiscal stimulus package will not be able to change this fact. From its dizzying heights during the past two decades, the world needs to prepare itself for a decade during which, if all goes well, China grows at a still respectable but much lower rate of 5-7 per cent. If the current fiscal stimulus package retards China’s adjustment process, as many analysts argue that it does, growth rates may be much lower.

John Ross has responded with  a letter in today’s edition:

Sir, Michael Pettis (“Get ready for lower Chinese growth”, July 31) unfortunately arrives at a wrong prognosis on China, predicting a slowdown of its growth to at best 5 to 7 per cent a year and quite possibly lower, because his article is wrong factually and contains errors in economics.

Prof Pettis writes that “although Chinese exports have dropped, imports have declined even faster”. This is the reverse of the actual trend. China’s imports have fallen less rapidly than its exports. Since the peak month of August 2008 China’s exports have fallen by 28 per cent but its imports have declined by only 18 per cent. China’s trade surplus reached its peak in January 2009, with a monthly surplus of $42.1bn, and since then its surplus has fallen steadily and rapidly – the surplus for June was $8.25bn.

This decline is despite trade price shifts which have tended to exaggerate China’s surplus. Research published by Goldman Sachs estimates that in real terms, if an adjustment is made for changes in export and import prices, China’s surplus has shrunk to one-third of its level 12 months ago.

Prof Pettis writes that “the decline in the US trade deficit must result in a decline in China’s ability to export the difference between its growth in production and consumption. When this happens, China’s economy will grow more slowly than Chinese consumption … rather than act as the lower constraint for GDP growth, as it has for the past two decades, growth in Chinese consumption will become the upper constraint.”

This is erroneous economics, as it confuses China’s domestic demand with its domestic consumption. Investment is equally a source of domestic demand and therefore increased growth of both investment and consumption is capable of allowing China’s economy to grow more rapidly than its rate of growth of consumption – as indeed it is doing at present.

Therefore there is no reason to accept Prof Pettis’s conclusions of a sustained growth slowdown for China. A high level of investment by China permits it to maintain rapid growth of the type seen in the last 30 years.

This debate is crucial. China is being touted by many as the engine of the world’s economy. If Pettis is correct, then we may have a problem. Ross is challenging him on both factual and theoretical grounds.

The debate is clouded by another story in today’s FT questioning the accuracy of Chinese economic figures.

China’s gross domestic product figures are among the world’s most closely watched since they can move markets or boost hopes of an imminent recovery.

But the latest set of first-half numbers provided by provincial-level authorities are far higher than the central government’s national figure, raising fresh questions about the accuracy of statistics in the world’s most populous nation.

GDP totalled Rmb15,376bn ($2,251bn) in the first half, according to data released individually by China’s 31 provinces and municipalities, 10 per cent higher than the official first-half GDP figure of Rmb13,986bn published by the National Bureau of Statistics.

All but seven of the regions reported GDP growth rates above the bureau’s first-half figure of 7.1 per cent. At the start of the year, Beijing set 8 per cent as China’s growth target for the year.

With the rest of the world looking to China as a beacon of expansion, the discrepancy is a reminder that statistics there are often unreliable and manipulated regularly by officials for personal and political purposes.

I’m not well placed to judge the accuracy of this figures, so I asked John Ross for his opinion:

There are considerable difficulties in producing statistics for an economy as huge, decentralised and rapidly growing as China when it is still a developing country – compare India for example where the same problems exist.

But is should be noted that the main statistical changes to China’s GDP growth have been upwards. For example at the end of 2005 China had to carry out a major retrospective revision showing that real growth in 2004 was 10.1% instead of 9.5% and annual growth from 1979 to 2004 averaged 9.6% or 0.2% higher than originally estimated. Additionally, China also announced the 2004 census results, which resulted in an upward change to the GDP estimate by 16.8%.

The key problem lies in under reporting in the very decentralised service sector – 92.6% of GDP revision came from tertiary industry. A good survey of these  issues can be found at http://www.hktdc.com/info/mi/a/ef/en/1X007RVW/1/Economic-Forum/China-S-GDP-Revision-And-Its-Implications-To-Hong-Kong.htm

Given this problem in the statistics, it is entirely credible to have higher local growth figures being reported in China than national – because the regional figures are more in touch with the growth of the service sector.  Chinese national statistical services are improving fairly continuously and if this is the explanation they will catch up. Of course not every single statistical revision has been upwards, so this precise one has to be looked at, nevertheless the general result of statistical revisions has clearly been to raise China’s GDP growth upwards.

The Heritage Foundation stuff is not serious because they keeping going on about discrepancies in China’s statistics to try to say that its growth is exaggerated – and don’t point out that when the statistical inconsistencies are removed the result has actually been to revise growth upwards!

I am going to deal with some of these issues on my blog in the context of the discussion on China’s stimulus package  

John makes an important point. The first draft of GDP figures for any country are never that accurate, large revisions as data becomes available are the norm for any country. It may well be that the regional statistics are more accurate.

Northern Rock

So – the Northern Rock results are out.

The BBC reports:

Losses at nationalised bank Northern Rock have grown by 24% amid mounting losses on its mortgage loans. Losses at the bank totalled £724.2m in the first six months of 2009, compared with £585.4m in the first half of 2008. The Newcastle-based lender said that 3.92% of its mortgage loans were more than three months in arrears, well above the national average of 2.39%.

The plan now seems to be to split the bank into a ‘good bank’ for sale and ‘bad bank’ to run down the ‘legacy assets’.

Now possibly isn’t the best time to be offloading our stake…

Pesto says:

How far off would such a privatisation be? Well on the evidence of these figures, many in the City – except those angling for a sale fee – would argue that it would be better not to rush into disposal.

Taxpayers are currently nursing a pretty hefty loss on their ownership of the Rock – though this is not what the chancellor said would be their fate.

 The best way to recover that loss is probably to allow Gary Hoffman and his team the time to demonstrate – which is not impossible – that there is an attractive banking franchise hidden beneath those poor quality mortgages and personal loans. Which may take a good couple of years. Any earlier sale could well deprive taxpayers of full value.

I suspect he’s being optimistic. The longer we hold for, the better the value. 

I’ve just been reading the balance sheet. The key information is as follows.

On the asset side, loans outstanding of £67.1bn now down from £84bn a year ago.

On the liabilities side, deposits of £19.6bn now up from £14.6bn a year ago.

(the difference is the use of wholesale markets to fund lending).

So the loan-to deposit ratio has contracted to 342% from 575% a year ago. I wouldn’t be comfortable owning a bank with an LDR above 120%. I doubt many private sector buyers would be either.

So we need, if we’re looking for a sale, to concentrate on either growing deposits, cutting back the loan book or both. What we shouldn’t be doing is trying re-engineer a housing price boom. That won’t end well. Thankfully the bank’s battered state is already causing some pull-back here:

In February 2009, the Company announced that it intended, as part of its revised strategy, to lend up to £14 billion over the next two years, 2009 and 2010, including up to £5 billion in 2009. Reflecting its constrained capital position prior to completion of the legal and capital restructure and capital injection, Northern Rock’s new lending in 2009 is expected to be nearer to £4 billion than the previously envisaged £5 billion.

Ownership & Governance

Lord Myners is once again on interesting form, as Tom notes:

He suggests that Walker hasn’t gone far enough (!) and floats the idea that there could be differential voting rights for shareholders, with those in it for the long term having more influence. This latter argument will be controversial with some investors, who are very attached to the principle of ‘one share, one vote’. But the EU looked at this issue and found now evidence that one share one vote leads to better outcomes. And if such a reform did lead to a more long-term approach on the part of least some big investors, maybe it is a principle worth conceding.

I’m with Tom on this second reform. We need to find a way of incentivising longer term ownership. A tax credit for dividends from stocks held for, say, over one year is one solution. A rise in stamp duty on share transactions is another. Not only would this, hopefully, increase holding periods and shareholder engagement, it would also reduce trading levels and hence lower costs.