By Michael Baxter 5 May 2010 [0 Comments | 3,866 views]
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Yesterday was a day of panic. Markets looked at the social unrest in Greece, at the plight of Spain and Portugal, and then at efforts to stage a rescue. They weren’t impressed. The Greek contagion is spreading. Yet bizarrely, while the UK media fret over the prospects of a hung parliament, the markets seem indifferent. The real news on the UK economy yesterday was actually very promising, maybe the most promising to date.
Markets
Yesterday was a day of selling. The FTSE 100, for example, was down 142 points; the Dow fell 225. Then again, when you consider the substantial rises seen this year, the falls were quite trivial. The Dow may have lost around 2 per cent of its value, but even so, it merely dropped back to the same level it was at around this time last month. The FTSE 100 has been having a slightly harder time of it, and it is down to the kind of levels last seen in March. Perhaps today’s movement will shine greater light on the level of market panic. At the time of writing, the Hang Seng is off 300 points; by the time you read this you will have a much better idea of how the stock markets are reacting.
Greek contagion, Greek default? Economic guillotine?
The real blow is for the yield on Spanish and Portuguese bond prices. The markets have turned their venom on the bottom left hand corner of Europe; it may not be entirely justified. In neither country is their debt anywhere near as high as in Greece.
But the markets have woken to the reality that the ‘one size fits all’ approach that is the euro is just not working. The social unrest in Greece is growing. And, frankly, you can understand the disquiet of the protestors. It was not them who fiddled the government’s books; it was not your ordinary Greek worker who underpaid tax. Maybe markets understand this, but they don’t award points for right and wrong, they just punish weakness. There is no justice, just the harsh evidence of maths.
It has been said here before that the only long-term solution for Greece may be the combination of a new, cheaper currency and debt default. A cheaper currency is needed to make the economy competitive. But default may be the inevitable consequence, as Greek debt is measured in euros, and if its new currency fell then its debt would rise to an impossible level. Ben May, at Capital Economics, said: “The economic pain that such belt tightening will bring suggests that it would be unwise to rule out a default further down the line.” He was understating the case.
The euro was down. At the time of writing it is at its cheapest level against the dollar since March last year. Against sterling it was at its cheapest level since last August.
Hangman’s economic noose may not matter
Ever since Nick Clegg’s strong performance in the first of the three TV debates between the three political party leaders, when the odds of a hung parliament rose sharply, sterling has been rising against the euro. Against the dollar it has barely flickered. In fact, the pound was cheaper against the dollar at the end of March, long before the Liberal Democrat rally.
Most commentators who have laid into the idea of a hung parliament were actually basing their criticism on their dislike of Liberal Democrat policies. They may or may not be right to dislike these policies, but that is not the point. One commentator even said a hung parliament would be a disaster because the Liberal Democrats don’t like nuclear power, and that the resulting policies will lead to even more expensive oil. You may agree or disagree with their nuclear power policy, but there is a difference between disliking Liberal Democrat policies and fearing a hung parliament. To say to people not to vote Liberal Democrat because this could result in a hung parliament, and as a result we may see Liberal Democrat policies, is not a valid argument.
The truth is that the yield on UK government bonds has barely flickered either. Or if it has changed, it has flickered down. On Friday the yield on three-month bonds was at its lowest level since December. Market commentators who want to see a Tory victory are saying a hung parliament would be a disaster, but this is patently not what the markets are saying.
Exports jump from electric chair, and taste freedom
Meanwhile, in Blighty but away from politics, yesterday saw the release of the latest CIPS/Markit report on manufacturing.
Of all the reports on the UK economy, this monthly survey has been providing the most promising evidence. Furthermore, history tells us this is one of the most reliable indicators there is. The CIPS/Markit Purchasing Managers Index (PMI), for example, had been falling quite sharply in early 2008 when economic forecasters were still saying the UK would avoid recession.
The April PMI index hit 58, the highest reading since September 1995. Any reading over 50 is meant to suggest growth in the sector, and the index has been above this level for seven months now.
The index tracking exports hit the highest level ever recorded. Bear in mind that the most recent Industrial Trends from the CBI had the index tracking exports rising to its highest level since the mid 1990s.
Despite the problems in the eurozone, UK exports are at last leading a recovery.
The snag is, there is so much slack in industry at the moment, that a rise in production will not necessarily lead to a rise in employment. Even so, the CIPS/Markit index tracking employment in the manufacturing sector rose to a three-year high as order book backlogs rose for the first time in the survey’s history.
The executioner is not finished
The dangers for the UK relate to Europe’s plight.
An article in The Sunday Times from a couple of days ago quoted analysts who reckon sterling is set to rise sharply against the euro. Richard Buxton at Schroders was quoted as saying 1.38 euros to the pound was fair value for sterling. Others have been talking about how ridiculously cheap sterling is.
This morning, Douglas McWilliams, Chief Executive at the Centre for Economics and Business Research, predicted a drop in bond yields. He said: “I see the 10 year down to 2.5 per cent within a year.” He added: “Any recovery will be based on the repricing of assets. Both shares and property prices could rise sharply on these policies – our models say by 40 per cent. This will generate new investment particularly in commercial property.”
And therein lies the problem. A UK recovery based on rising asset prices and a stronger pound will be a disaster. The UK needs more exports, it needs a cheap pound and it needs affordable house prices.
The real problem is that Germany is just not pulling its weight. It lectures the rest of the euro on German prudence, but the truth is, if every economy adopted the German economic model, the world would be in permanent recession. Germany has been freewheeling on Anglo-Saxon spending. The UK is spending less, and exporting more. German consumers now need to spend more.
