By Michael Baxter 14 Jul 2010 [0 Comments | 1,717 views]
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Credit rating agencies are in the news today. Standard and Poor’s wants to have its cake and eat it. At least, its latest comments on the UK do smack of someone who, having eaten a gorgeous gateau, with fresh cream oozing from all over, complains that their plate doesn’t look so nice now that it is covered in cake debris.
Then Portugal found itself on the receiving end of Moody’s poisoned analysis. You could say the credit rating agencies have been hopeless, waiting for the moment that countries try to implement measures to pay back debt, before slamming them for their indebtedness. But then you could say it’s a long journey to the moon. Both statements are pretty much stating the bl***ing obvious.
It is just that it has taken China to spell the problem out, with a credit rating agency of its very own. And the agency ain’t much impressed with its Western counterparts.
Talking of not being impressed, there was just a hint earlier in the year that Bill Gross, he who heads the giant asset manager PIMCO, had his doubts about the UK. Mr Gross was very subtle in voicing his opinion of course. This is what he said: “The UK is sitting on a bed of nitro-glycerine.” Investment and Business News can exclusively reveal that our analysis of Mr Gross’s comments earlier in the year clearly demonstrates that the investment guru had some qualms about the UK. You see, wonderful things are journalists. When someone says something really ambiguous, we can clear things up. Anyway, Mr Gross has been at it again. But this time his thumbs have done an about turn, and are pointing upwards.
Meanwhile, Andrew Sentance is getting worried. He is the man who voted to up interest rates at the last Bank of England rate setting meeting. Inflation fell again in June, but by less than expected. The inflation hawks are revealing themselves now in growing numbers. Squawking and swooping, the hawks with all those warnings earlier in the year about inflation were right all along. Interest rates are on their way up, quantitative easing has been proven to be the work of the devil after all. Except, they aren’t really and it wasn’t. We are going through a dangerous phase, and now those people who totally failed to call the economic crisis want to impose policies that would make things a hundred times worse.
But finally, hope arrives at the party, all dressed up to the nines – or is that nine billion tiny little ‘nine-ers’. Intel has just posted its best results in a very long time. You would have to wind the clock back all the way to … well, actually, you would have to keep winding, for Intel’s results were its best ever.
You see, it’s the three Is: innovation, innovation and innovation; that’s how we can get out of trouble, and it is something that credit rating agencies, bond investors and the inflation hawks, just don’t get.
Credit rating agencies eat cake, but why can’t they have it, too?
The UK has kept its triple-A credit rating, as measured by Standard and Poor’s. Phew. But the agency is worried. There is a 33 per cent chance the rating may be downgraded, or so it says. “The negative outlook reflects the potential of a downgrade if the government does not implement its challenging fiscal consolidation programme on the scale planned,” said Trevor Cullinan from the agency. Or at least that’s how the Guardian quoted him. He added: “A slackening of that, in our view, could put the UK’s net general government burden on a trajectory that would be incompatible with a triple-A rating.”
‘Hello, is there anybody out there?’ Haven’t you heard of the austerity budget? George Osborne has just announced a budget that was much, much tougher than anyone had predicted in the build up to the election of just eight weeks ago, and now Standard and Poor’s, which kept quiet for so long when things were going all wrong, starts making warnings. It seems that during the boom they were comfortably numb, and now they have built a wall blocking themselves off from reality.
Mind you, the OBR doesn’t help. Alan Budd, its boss, is the economic world’s answer to Fabio Capello. His reputation was without equal. But then when it comes to the crunch, things don’t look so good. No one seems to believe the OBR’s predictions for growth. You can’t blame Budd. Economic forecasting is guessing, disguised to seem like science. A good technique they may want to try is called the ‘blindfold and pin’ technique. It can be a whole lot more accurate than the predictions of the professionals.
Still, at least Bill Gross seems to be more cheery about the UK. Apparently, thanks to George Osborne, PIMCO is more optimistic about investing in Britain. See this Guardian piece for more: PIMCO turns bullish about UK gilts in light of budget cuts and euro debt woes
Meanwhile, Portugal has seen its Moody’s rating downgraded from AA2 to A1. It’s quite confusing, all these As. Most of us were delighted to get an A-anything for an essay when we were at school. Even a B-minus was quite good. Presumably the awarding of B-plus would have been greeted with pleasure, too. And a BB-plus, one assumes, would have been even better. This is strange, because BB-plus is what Standard and Poor’s gives Greece. And yet a growing body of opinion says Greece will default. The grades are a part of the problem. Why not have an honest system and give Greece a D-minus? We all know what that means.
Maybe it is not so much cake that the credit rating agencies have been eating, but rather they have been taking something else entirely. The Guardian quoted one anonymous hedge fund manager as saying: “Credit rating agencies are always two steps behind the market… The time when a credit rating could determine whether people would buy your bonds is over: now politicians know they must do their homework to sell their bonds. Money is now expensive, and you need to pick where it works best.”
There is a good summary of the latest credit rating agency scores on this website: Credit Writedowns
It is no wonder that China’s top credit rating agency Dagong Global Credit Rating Co. has come up with a quite different conclusion. It reckons that when giving a country a credit rating, it should take into account things like the size of its debts. And would you believe it, according to its way of doing things, neither the US nor the UK have top notch ratings. China, Germany, and Canada all boast higher ratings.
Then again, the Chinese agency may have got it wrong, too. The fact is, Germany and China are reliant on these indebted countries to charge their growth. If the US and UK do go bust, which China seems to think is not an impossibility, the crash in global demand which will follow will create an even bigger problem for Germany and China, which are, after all, totally reliant on the rest of the world buying its products.
See this Telegraph piece for more: Chinese rating agency strips Western nations of AAA status
Break up the banks, says leading politician
Andrew Tyrie is no lightweight. He is none other than the new chairman of the Treasury Select Committee. And he is giving a good impersonation of John McFall, the previous chairman, but with a lot more teeth. (Not that we are casting aspersions on Mr McFall’s dentures.)
Anyway, this is what our new toothy chairman said yesterday about banks that are currently owned by the government: “I want to put the consumer first… and the only way that can happen is with the break-up of those banks.”
Is he right? Ahh … let’s think about that … ahh … yes.
You don’t need us to spell it out. We are getting an awful service from banks. If you have a question, you get put through to a call centre. Your local branch has virtually no decision making authority at all. During the boom, getting a loan to fund a jolly abroad, creating an exodus of money overseas, was easy; getting a loan to fund a business creating wealth was much, much harder.
Economic evolution works via failure. Bad businesses go bust, leaving a vacuum that may be filled by businesses that have better products. Banks that are too big to fail are a problem, because then economic evolution stops working.
It hurts to say this. It is, after all, so much more fun to point out when politicians are messing up, but Mr Tyrie has hit the nail right on the head.
Inflation dips, but not enough
Inflation fell from 3.7 per cent to 3.4 per cent in June. The retail price index dropped from 5.1 per cent to 5 per cent.
Stop right there. Re-read. Inflation, as measured by the retail price index, was 5 per cent in June. Deflation? – do me a favour.
No wonder Andrew Sentance is worried. He is the Bank of England Monetary Policy Committee (MPC) – the people who set interest rates – man who voted for a hike in rates last month. Upon the unveiling of yesterday’s inflation rate, he said: “If the recovery continues and headline inflation remains relatively high, there may be a further upward drift in pay growth in the private sector, offsetting some of the downward pressure from limited wage growth in the public sector… I favour a gradual rise in Bank Rate… to avoid destabilising confidence through a sudden lurch in policy.”
Mr S is worried about spare capacity. Excuse the pun, but he reckons the paragraph in the book on the UK economy that says ‘there lot’s of spare capacity’ may be over.
Or to put it another way, Mr Sentance has put a question mark on the Bank of England’s rosy view on inflation. Wage inflation is higher than one might expect, given where we stand in the cycle. Average wages rose 4.2 per cent in the year to April. Okay, that was lower than the retail price measure of inflation, meaning workers are becoming worse off in real terms. Even so, the wage increases are higher than common sense would have predicted.
Here is why we disagree with this viewpoint.
CPIX, that’s inflation with indirect taxes (VAT) stripped out, was 1.7 per cent. According to the British Retail Consortium, shop price inflation in the year to June dropped from 1.8 per cent in the previous month to 1.5 per cent. Even food inflation was lower, at 1.7 per cent. Producer prices fell in June. Input prices fell 0.2 per cent, output prices by 0.3 per cent. The Nationwide’s Consumer Confidence Index crashed to 63 in June, the lowest level since June last year. This suggests consumer demand will fall in the months ahead, again pushing down on prices.
But the big one is the money supply. M4 lending decreased by £15.1 billion (0.6%) in May. The twelve-month growth rate fell to 2.5% from 4.1% in April.
The untold story of 2010 is the change in global money supply, that is to say, the broad money supply. It is contracting fast. Such a development has deflation written all over it.
Corporate America provides hope
Where Investment and Business News differs from other publications is that we do have a belief in technology. New technology, be it faster chips or synthetic life, leads to new wealth; providing, and this is a big proviso, that demand rises with productive potential.
Globally, and over the last few years, demand has not been keeping pace with this potential. Or at least, it has only been keeping pace via increased borrowings from some, to make up for the higher savings from others.
But at least Intel has had a humdinger. In fact, Q2 saw the best quarter ever for the chip maker for both sales and profits. A year ago the company made a loss in this quarter, with $400 million flying out the door. This time around, net income has been $2.9 big ones, or billion, as big ones are also called. The company’s boss Paul Otellini said: “Strong demand from corporate customers for our most advanced microprocessors helped Intel achieve the best quarter in the company’s 42-year history. The PC and server segments are healthy and the demand for leading-edge technology will continue to increase for the foreseeable future.”
And that is where hope comes in. The US is like the economic equivalent of David Bowie and Madonna combined. It has this extraordinary ability to reinvent itself. Or at least corporate America does.
Its high indebtedness is the other side of a coin which says optimistic, and optimism fuels risk taking, which leads to wealth creation.
But even so, one snag still remains. Martin Wolf covered this well in the FT today. “As Corporate America has boomed, income distribution has got worse,” he said. Mr Wolf was himself quoting a new book by Professor Rajan called “Has Financial Development Made the World Riskier?” The FT piece quotes Prof Rajan as saying: “The political response to rising inequality . . . was to expand lending to households, especially low-income ones.” The financial sector’s “failings in the recent crisis include distorted incentives, hubris, envy, misplaced faith and herd behaviour. But the government helped make those risks look more attractive than they should have been and kept the market from exercising discipline.”
It is good news, really good news, that Intel is leading the way to record results. That’s one box ticked in the column that says road to recovery. But, somehow, another box has to be ticked, too; the one that says ensuring the fruits of globalisation and new technology are distributed in a way that promotes more growth. Martin Wolf and some others, and maybe this column falls into this bracket, have said what the problem is. But no one seems to have come up with an answer yet.
