economonkey

The Laffer Curve is a description of the theoretical optimum point of taxation rate on a population. It implies that there’s a ’sweet spot’ of taxation where the most income is generated for government coffers. Set the taxation rate too low and the government misses out on potential revenue. Set it too high and an increasing proportion of the population finds ways to avoid tax, moves abroad or simply works less because the extra effort isn’t worth the reduced extra reward.

What the Laffer Curve doesn’t explicitly take into account is the effect on a population of the perceived morality of public spending.

For example, while an argumentative person might perceive taxation to be nothing more than demanding money with menaces, and the government to be simply the mafia by another name, that person wouldn’t necessarily object to paying taxes if the money collected was spent efficiently on things that benefited the wider community and, either directly or indirectly, that person’s life.

Examples might be effective healthcare through a reduction in unnecessary layers of management, best business practices through the reduction of red tape, good education with the accent on questioning and rational thought, and, in my personal opinion, the distinct lack of a surveillance state.

Experience has shown that the public is remarkably resilient when it comes to believing that government taxation and spending is beneficial. In spite of numerous examples to the contrary, there has been an underlying perception that the government – of whatever colour – is overwhelmingly ‘good’ and that only ‘good’ people enter politics because they want to make a real difference. The few obvious black sheep over the years have failed to puncture this belief.

And perhaps it was valid in the past. But whether politics has changed or merely the perception of politics has changed, that belief has gone. Opinion polls (for what they are worth) now show significant minorities, and in some cases majorities, of the population having no faith in politicians or the political establishment. Criminal and civil actions are likely to be launched against sitting members of parliament. The mood is far from pretty.

So what has this to do with economics? Everything.

Economics is faith-based. The belief that we live in a capitalist system where hard work and ability are rewarded is what underpins all efforts at innovation and entrepreneurship. It has been blown away.

Bankers fail spectacularly and are rewarded with huge pensions, cosy sinecures and, when their bonuses are under threat, higher salaries to compensate. Politicians fail to prevent foreseeable economic disasters while governing through implied force rather than real consideration for their constituents, and not only reward themselves with ‘expenses’ and CGT-free house sales profits, but conspicuously fail to realise, almost to a man/woman, that what is at stake is not the money or ‘the rules’ but the basic belief that the ‘mother of all parliaments’ is a place of morality and integrity to which the entire country, perhaps the world, can look up.

What comes next might be the ‘me first’ time. What politicians sickeningly call ‘ordinary people’ and ‘hard working families’ look at what they see in the banks and the houses of parliament and think, “That’s where my money is going? Why am I giving so much of my work* to these thieves, wasters and incompetents who either give it away to their friends and family, spend it on their homes as ‘expenses’ or use it to bail out bankers who will then employ them as ‘consultants’ on huge salaries when they leave parliament?”

“What’s in it for me?”

Tax rates in the UK are projected to rise after the next election, whenever that may be, in order to start to pay back the frankly staggering levels of borrowing currently being racked up by Labour. But I wouldn’t be surprised to see the UK tax take, already well down on last year and below projected government figures, drop even further as those ‘ordinary people’ and ‘hard working families’ decide that they’ve had more than enough of giving their increasingly scarce money to thieves and spendthrifts.

* For most working people in the UK, your entire salary from January to May goes to the government in taxes.

(c) Alex Cruickshank 2009

The author is still paying his taxes and will continue to do so, but may soon be in a minority.

Could there have been a worse possible time for the MP expenses scandal to break? The recession is in full swing, and even if you’ve not lost your job or had your home repossessed yet, chances are you’re feeling a little anxious about the precarious state of the economy.

At a time like this you’d probably like to know that our elected representatives in government are capable of empathising with our concerns and perhaps even make some sort of gesture of solidarity by tightening up their expenditure. But what do we get instead? Reports of politicians on both sides of the house milking the expenses system for every penny they can get, profiteering from property deals and wriggling through every tax loophole in the book.

What makes it worse is the petulant insistence that they ‘didn’t break the rules’ as if that’s somehow supposed to make us all feel better about it all. Back when we voted the Blair government in, on the promise of a new day of fairness and integrity from our leaders, who would have imagined that same government, albeit with a new prime minister, would preside over such a grubby and sordid episode?

Enough really is enough. You can argue about the two wars of this government, the erosion of civil liberties, whether or not they could have done anything to prevent the economic meltdown, and their abject failure to deliver any of the things we really wanted from a Labour government, but this final insult is one too many.

We trusted them with our future, but they’ve completely failed to deliver anything that could ever justify that trust. It’s just a shame that we’ll have to wait another year to remove them from power.

By now everybody except the most wildly deluded of optimists must see that the UK economy is in absolutely terrible condition. Two cornerstones of the country’s economic identity, the property market and financial services industry, have been given a kicking that they may take years to recover from. Interest rates are at an all time low, punishing savers harshly, yet credit remains elusive and nobody is terribly keen on putting money back into a schizophrenic stock market just yet.

Businesses are dropping like flies and personal insolvencies are at record highs. Billions of pounds of bailout money has failed to solve the problem and a government which once proudly boasted of its economic credentials has now seized up in panic, completely incapable of dealing with the situation. The problem with the economy is that economics is a complex science which is sometimes counterintuitive and doesn’t always produce quick fixes – politicians who can only think as far as tomorrow’s headlines are not the best people to be left in charge of the nation’s long term economic well being.

So where does that leave us? We’re a nation that’s grown accustomed to individual wealth and national economic power, are we really facing the end of all that? Is Britain on the verge of returning to the bleak days of the seventies, when the country was little more than the rusting husk of a collapsed empire?

It’s hard to say how things will play out in the financial services sector, which accounts for around 9% of the country’s GDP. There are a number of unanswered questions:

• What kind of rules will the government impose on the UK’s financial services industry following public anger over the recklessness which led to the recent economic collapse?
• How will the British banking industry adapt to the post-credit crunch world? The business models of the past twenty years led to catastrophic failure, so how will the banks rebuild themselves into profitable, sustainable businesses?
• Is it actually possible for the UK financial services sector to rebuild itself, or is it irreparably damaged?

This is, of course, a simplistic way of examining the problem – the real issues surrounding any recovery of the sector are numerous and complex, which is why you can take most predictions with a pinch of salt. The fact that you’ll struggle to find any two ‘experts’ who agree on what the future holds for Britain’s ‘financial services powerhouse’ should be a good clue that nobody can really say with any degree of accuracy at this point. Forget what the politicians and the bankers tell you – we’re in the realm of chaos theory right now.

Ultimately, however, we’re confident about the broader economy, even if the financial services sector goes down, it’s likely that other sectors will pick up the slack eventually. The country has a reasonably well educated, motivated and resourceful workforce, enterprise is strongly encouraged here – it may well take a couple of years to recover, but it seems reasonable to assume that sooner or later it will be business as usual for British companies that aren’t directly involved in financial services.

History has shown the stock market to be very resilient, bouncing back from all sorts of catastrophes within a year or so – which isn’t very surprising, given that it is entirely composed of organisations whose sole reason for existence is to generate profits and deliver shareholder value. Companies falter and fail, but they’re always replaced by leaner, hungrier, faster businesses – the stock market plods merrily onwards, regardless.

As for the housing market, all bets are off. The market was propelled to ridiculous heights over the past decade purely on the back of a speculative bubble fuelled by cheap, readily available credit – those days are gone and they aren’t coming back. You can talk until the cows come home about supply and demand, shortage of quality homes, over-crowding and all the rest of it, but ultimately the money has to come from somewhere, and the banks aren’t likely to start handing out easy money any time soon.

Recent reports have suggested another average 8% drop in house prices over the next two years, before prices start to pick up again. Like all housing market predictions, this one seems to have been plucked out of thin air by an organisation with a vested interest in painting a rosy picture. We think it’s wildly optimistic. The market will only ever support prices that people can afford to pay, and that is primarily governed by the amount of money banks are willing to lend. With that in mind, it’s hard to see anything other than an ongoing bloodbath for property prices and a significant chunk of the population stuck in negative equity for a long time.

The newest member of the Bank of England’s Monetary Policy Committee, which meets once a month to decide what to do with interest rates, claims that the worst may be over for Britain’s economic recession. Confusingly, however, he says that his comments should not be taken as a prediction and gives little evidence to back up his claim.

David Miles, a former senior economist at Morgan Stanley will replace David Blanchflower on the MPC in a month’s time.

In a press interview, Miles said “Economic history teaches us that a combination of tax cuts, running large fiscal deficits, substantial cuts in interest rates and more quantitative easing is likely, with a certain time lag, to have a substantial impact on demand in the economy and it may well be that the worst of the recession may well be behind us,” but followed these comments up with the warning that they were “not a confident prediction but a judgement about what may be the case”.

Anybody with a clue about what exactly that means is welcome to leave their explanation down in the comments box. Just what the economy needs, more cloudy vagaries and impenetrable observations from the people who are supposed to know what they’re doing.

Anybody with a tracker mortgage will no doubt be happy that the Bank of England has kept interest rates at their all time low of .5% today, but there’s no light at the end of the tunnel for anybody hoping to get a good return on their savings. The media is reporting that Alistair Darling has thrown cold water over Gordon Brown’s plans to help savers in the next budget.

There’s little hard detail on what exactly Brown was proposing, but it all seemed like fairly wishy-washy stuff such as increasing the amount of money you can hold in a Individual Savings Account (ISA) – which would largely be pointless because putting an extra £1,000 into an ISA that’s earning a paltry amount of interest will make absolutely no difference to most people’s savings.  We much prefer the Tory’s proposal of abolishing the basic rate of income tax on savings altogether – that would at least send a message that the government wants to encourage people to save, if nothing else.

But the Telegraph reports that Darling believes encouraging people to save at this stage will deter them from spending money, which he thinks will slow down an economic recovery. So, just as we’ve been saying all along, the government really doesn’t want people to put their money in savings and investments, they want us all to keep borrowing and spending, because that’s the only plan they ever had for the economy; to turn us into a nation of debt slaves. The very idea that people might want to live within their means and put aside money to build a secure financial future for themselves, instead of spending their lives owing money to the banks, seems to horrify the government.

Over recent months National Savings and Investments has enjoyed a massive spike in popularity with the British public. With interest rates at an all time low, the stock market floundering and high profile news reports of struggling banks and building societies on the brink of collapse, people suddenly want to put their savings and investments into a financial institution that has the security of being 100% backed up HM Treasury.

It may not be exciting, but at least your money is safe with National Savings and Investment – a reasonable, sensible sentiment. But is NS&I really the best place to put your money in the current climate? The truth is that the government will guarantee to protect up to £50,000 of your savings in almost any UK bank or building society if it goes bust, so the argument that NS&I provides the most security for your money doesn’t really hold up unless you happen to have more than £50k in cash savings, which the majority of people don’t.

It’s not as if National Savings and Investments offer a particularly attractive return on any of its products either. We took a look at the various savings and investments on offer to see what kind of return you could expect:

Premium Bonds – these were never a great bet to begin with, since you rely largely on chance to make a return, and now the chances of winning enough prizes on the Premium Bonds to beat other investments is lower than ever.

Direct ISA -the National Savings and Investments cash ISA offers just 1.3% interest on your money (and this is variable) which seems very stingy compared to the 3-4% you’ll find if you shop around at the high-street banks.

Fixed Term Bonds – both the NS&I growth and income bonds currently offer a maximum annual return of 2.6% over a 5 year period. But a quick look around offers available from high street banks (which are all covered by the government’s scheme to protect your savings) shows that you can find fixed five year growth and income bonds offering over 4% per annum.

There will always be people who prefer the absolute security of putting their money in a HM Treasury backed investment, and for those with over £50k to invest it might even be considered prudent to use National Savings and Investments. However, for the majority of people it’s hard to see what the benefit of putting their money with NS&I really is – most high street banks offer just as much security and far better returns on your money.

This is an article that I could have written a few months ago, when the Bank of England stated its intention to begin ‘queasing’. But it has become rather more relevant now that one of the pronouncements of the G20 summit is that the International Monetary Fund (IMF) will itself begin to ‘print’ additional SDRs (Special Drawing Rights, effectively the IMF’s own currency) which its contributor countries can draw down in the shape of dollars, euros, etc.

Note my use of the word ‘print’ in the above paragraph. The days when first world countries used the printing press to increase the volume of money in circulation have long gone, assigned to eras such as Weimar Germany. Paper and ink are still heavily in use in Zimbabwe, of course, but for countries like the UK, where the notes and coins in circulation account for only about three percent of the total ‘money’ in the system, we’re really talking about digits on a computer screen.

Even so, while the phrase ‘quantitative easing’ sounds nice and strategic, in reality it has a similar effect to printing additional bank notes and throwing them out of the Bank of England’s window into the street.

To take a step back for a moment, let’s look at the main blunt instrument used by policy-makers to control the velocity of money and the rate of growth of an economy: interest rates. Set the base rate low, goes the received wisdom, and people will ‘invest’ their money rather than leaving it idle in a bank account earning nothing (or, depending on the level of true inflation, less than nothing). If the economy starts to run away from itself and bubbles form in a particular investment market, interest rates can be raised, increasing the appeal of saving and reducing the relative gains to be made by investing in speculative markets.

So much for the theory. This only works if interest rates are used properly, if they take into account all asset classes in which inflation is occurring and if the Bank of England or the government is seen as credible when it warns about the need for rates to rise. Quite obviously, in the past ten years that has not been the case, with the property asset class hitting bubble territory and being stoked ever larger by unrealistically low interest rates.

I’m not expressing my opinion here: it doesn’t matter what I think about property prices. It’s now widely accepted by economists and politicians (though perhaps not the property-ramping mainstream media) that interest rates were far too low for far too long, and that the resulting inequilibrium and subsequent bursting of the bubble led directly to the current financial crisis.

Aha. But at this point, as per the ‘Idiot’s Guide to Being a Central Banker’, all we have to do is slash interest rates, right? That’ll reduce the viability of savings and force people to invest in companies and other markets in order to get a better return on their money.

Well, potentially yes. But only if there’s anything out there worth investing in. The problem over the past year is that regardless of the probably negative true yield on cash savings, they are still losing value more slowly than pretty much anything else out there. Sure, Sterling has slumped, but houses priced in Sterling have slumped further and so has the stock market. I’ve no doubt that some investment classes have ‘bucked the trend’, but at the moment potential investors are feeling scared having had their fingers burned, and are quite happy to leave their money in the bank.

This is further compounded by the massive write-downs that lending institutions have suffered as a result of the value of their clients’ investments plummeting on the open market. Leverage works both ways, and banks’ balance sheets have been hit hard over the past 18 months. Since there are regulations in place to prevent banks overstretching themselves, this means that even if they’d like to lend more money to households and businesses, they can’t.

Why not change those regulations? Well, they were put in place to prevent dangerous levels of borrowing that could destabilise the financial system. Obviously they didn’t work, and even now a rule-change in the US is helping pummelled banks to mark their remaining assets to a model rather than directly to market (in other words, they can name their own price for the securities they hold) which may give them more leeway to lend. That to me looks prone to massive unintended consequences (and I’m being polite here), but then so does much of the policy action over the last few years.

Back to quantitative easing. If you can’t slash interest rates any lower, what you can do is give banks free money in order to replace their losses. And that’s what quantitative easing does. It generates ‘debt-free’ money that can be used to replenish banks’ coffers, allowing them to meet their statutory requirements and again increase their levels of lending.

What it also does, if left unchecked, is diminish the value of ‘the pound in your pocket’. While that’s not such a problem if the economy is truly shrinking (as long as the Bank immediately destroys the money once it’s no longer needed), the CPI measure of inflation in the UK is currently 3.2%, or 60% above target. The Bank of England is predicting inflation to drop, but printing money at a time when inflation is already so far above target has led more than a few observers to say, “Hang on a minute…”

Which is, arguably, also part of the point. If the Bank can convince savers that it is ‘inadvertently’ destroying the value of their savings still further, it might persuade them to take their money out and spend it rather than watch it all evaporate. There is more politics and psychology here than actual economics. It’s anybody’s guess what the endgame will be.

(c) Alex Cruickshank 2009

The author has his doubts about the likelihood of deflation in the UK.

Anybody deluded enough to hope for a property market recovery sometime this year will be sorely disappointed by the latest figures  from the Land Registry which show that actual selling prices of homes in the UK fell by 2% in February.

This means that the rate of decline is actually accelerating, and the average price of a UK home now stands at a shade under £154,000. There were 42,000 completed sales in February, roughly half the number for the same period a year ago.

You can forget all those ridiculous feel-good stories about ‘increased buyer enquiries’ and ‘higher asking prices’ – the Land Registry figures show the actual number of sales, and the real value of those sales – these are really the only numbers that matter if you want to accurately assess the state of the British property market. And the accurate assessment of these figures is that the housing market is screwed.

With prices falling at this pace, only a fool would consider getting onto the property ladder (even if they could persuade any bank to give them a first time buyer mortgage) – who in their right mind would want to buy a house that will most likely be worth 10% less within six months?

It’s not just the housing market that’s collapsing at a record rate – the latest Gross Domestic Product figures show that the British economy shrunk by 1.6% in the final three months of 2008. Not only was this fall worse than the 1.5% widely expected by the men in suits, it also represents the biggest quarterly drop in GDP for 30 years in the UK.

The bigger than expected drop is being blamed on the collapsing construction industry. All this just goes to show the stupidity of building an economy which depends on constantly booming property prices. Quite apart from the human cost of ordinary people being unable to afford to put a roof over their family’s head, it means that when things inevitably go tits up it has a huge impact on the rest of the economy.

According to the British Bankers Association, the number of mortgages approved by major banks rose in February for the third consecutive month. Happy days are here again! Not quite, despite the rise, mortgages approvals are still close to historic lows and down over 30% on the same period for last year, so we’re not out of the woods yet.

Low interest rates and falling property prices may have tempted some cash-rich bargain hunters back into the market to buy houses at what they believe to be once-in-a-lifetime knock-down prices, but the bulk of the market is still frozen solid. Most importantly of all, first time buyer mortgages are still extremely hard to get hold of, and as everybody knows, the property market depends upon a steady supply of people buying their first homes in order for everybody else to be able to climb the ladder to bigger properties.

Even though the number of people taking out mortgages is edging upwards, the actual cash amount being let in mortgages is still plummeting. Just last week the Council of Mortgage Lenders said that mortgage lending in February was just under £10 billion, that’s 15% lower than in January and 60% lower than February last year. The CML claims that its members are finding it tough to lend to homebuyers because savers are putting their funds in safer places, such as National Savings and Investments.

Since the high street banks and building societies aren’t able to offer a reasonable rate of return, savers have nothing to lose by moving their money – which just goes to show that low interest rates are not necessarily going to help push property prices back up again.

Read my lips: The property market is dead.

Buying Premium Bonds from the government owned NS&I has long been viewed as the safe alternative to stock market investment for the British public; you get to keep all of your original capital, you stand a chance of making a million, and an even better chance of winning a smaller amount.

But if you’re one of the thousands of people eagerly awaiting the monthly Premium Bonds results from Ernie, you’ll be disappointed to learn that since interest rates have been cut to historic lows, NS&I has been forced to slash the prize fund, significantly reducing your chances of winning a big prize. The Premium Bond prize fund has been cut from almost £60 million down to £32 million. Up until now, NS&I have offered two £1 million Premium Bond prizes each month, in addition to numerous lower value payouts, but as of April there will only be a single £1 million prize per month.

The smallest possible prize has been lowered from £50 to £25. NS&I says the chances of winning a prize remain the same – for every £1 Premium Bond you hold, there is 36,000:1 probability of winning a prize each month.
They’ve never really been a particularly great investment (except for the lucky few who scoop the biggest payouts) and now there’s even less incentive to buy Premium Bonds. They may seem like something of a safe haven, given that your capital remains safe, but ultimately the opportunity for growth is left largely to chance. Even in today’s low interest environment you can still get up to 4%pa on a cash ISA, which isn’t great, but at least it’s guaranteed. On the whole, the majority of people who put their money in Premium Bonds will win less money than they would have earned in interest.

That said, any kind of investment is always a balance between risk and reward – and with Premium Bonds the risk you face is that of getting no return at all on your money, weighed against the very small potential reward of getting a significantly higher return than any other kind of investment. And that might seem attractive to a large number of people in the current climate.