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Deflation - Economics Weekly

Global Economics Weekly Brief


Judging by the first two weeks, 2015 is going to be a very interesting year globally. Last week alone brought `deflation` in the Euro zone, a big fall in US unemployment, more signs of a slowing UK housing market and oil prices falling further. What will happen next? Watch this space every week and we will share our insights on the global economy.

Deflate the bankers bonuses?

Bankers Bonuses Again
Bankers are used to choosing their battles. But this one has been picked for them. And, to compound problems, they have brought knives to a gunfight. As Nick Clegg, the UK deputy prime minister, recently said about the vitriol he had invoked with his u-turn on tuition fees: “You often cannot defeat emotion with reason.”

Here are three examples of similar mismatches in the bonus debate:

Ø “We need to pay big bonuses to remain competitive.”

Ø This is a popular defence made by bankers. It was the main line that Diamond peddled in front of the Treasury Select Committee. And this argument does have the force of logic behind it. You can complain about the amount that gets paid, the way it gets paid and the fact that it has been subsidised by implicit government guarantees of the banks. But it is pretty hard to argue with that fact that if Bank A pays less than Bank B, staff won’t so much walk out of the offices as run. But will they?

Ø But this logic presupposes that the general public differentiates between banks. All the evidence suggests that they neither know nor care about the difference between retail and investment banks (or even hedge funds), those that were bailed out and those that were not, or UK-headquartered firms and their foreign-based counterparts.

For the large majority of the population a bank is a bank is a bank. Their gripe is with bankers in general and that classification essentially extends to include anyone who has anything to do with money. The banks naturally see themselves and their rivals as separate entities but arguments about competitiveness are internal to the industry and largely irrelevant beyond it.

Bonuses also smell fishy. For one thing, they can be just plain enormous. And for another, the public is acutely conscious of the asymmetries in the remuneration policies of the banks, which, they feel, allowed bankers to cream off sports star compensation in the good times but suffer no recourse when they brought the global financial markets to the brink of ruin.

Bankers counter this by pointing to the changes that have already been made in remuneration policy with the introduction of deferment and claw backs. But changes to how bonuses are paid are not going to convince anyone until they can be shown to have worked and photos of bankers taking their Ferraris to the pawnbrokers appear in the press. Money makes money when you are gambling with information!

“Nearly 60% of the money paid in bonuses will go straight to the Treasury.” !

This is the biggy – the slam dunk, the knockout punch. Or so you might think. Of the £7bn bonus pool, it has been estimated that the Treasury will take £4bn. This is often combined with the fact that the City paid £53.4bn in tax last year – more than a tenth of total government tax receipts. Therefore, it is the UK government interests for the banks to pay bonuses, as governments gain, big time!

The natural instinct of bankers is to give away as little as possible; to play right up to the line and then see if they can bend around it a little; to leave no basis point on the table. They may well decide not to change lifelong habits. Perhaps they will keep their heads down, hope the furore blows over, and assume that the politicians are only pretending not to get what the banks are trying to say.

But if they honestly want to change the tide of public opinion (and they would do well to remember that governments rule at the public’s pleasure) they are going to have to seriously overcorrect. Think teams of investment bankers swapping pin-striped suits for orange boiler suits to collect litter from the roadside. Whether they have the collective appetite to do so remains to be seen.

When will governments bail out the Banks again or will they let them go-bust?

It's official. Deflation finally broke through European Central Bank's (ECB) defences in December 2014. Prices fell by 0.2%y/y led by energy, which fell by 6.3%y/y. With inflation slowing since 2012, falling prices have been a while coming. The long build up allowed ECB President Mario Draghi to position the political chess pieces to begin asset purchases (QE). But there is still reluctance for QE among some member states, despite the Euro zone's unemployment rate remaining stuck at 11.5% in November. More challenges to come in 2015 and if only these global governments listened and read material from successful/knowledgeable business people the world would be a better place! What is deflation? (link)...

Slowing. Global growth slowed in December according the Purchasing Managers Index surveys. The UK results suggest output increased by 0.5% in Q4. If true, that would be the slowest pace in a year, but no cause for concern. Similarly, US growth was decent in December. Euro zone growth slipped to its slowest pace in 18 months. Germany grew but France and Italy remain in recession. Nowhere is there the slightest sign of inflation. Why?

Like it's 1999. The US economy rounded off the year with another impressive month of job growth. 252k jobs were added during December and 350k during November. It means the US economy added just shy of 3mn jobs in 2014, the best yearly total since 1999. Unemployment finished the year at 5.6%, the lowest since June 2008. But it's just as well petrol prices are falling because wages grew by just 1.7%y/y in December, lower growth than the same month a year ago. Yet more challenges for 2015 with the `passion to grow`!

Take That. "Patience" is the Fed's new watchword. At its December meeting it said it will be "patient" in beginning to raise interest rates, by which most Committee members mean waiting for at least a couple of meetings. At last week’s media conference, Janet Yellen confirmed that the definition of a "couple" is "two". But that doesn’t signal a rise in April. While the latest fall in unemployment will be welcome news, the FOMC is mindful of weak earnings growth and Euro zone troubles. Global challenges will affect the US growth!

The waiting game. The UK's Monetary Policy Committee doesn't describe itself as “patient”, but no-one is accusing it of rushing the decision. January's meeting brought no change to interest rates, meaning that base rate has been at 0.5% for 5 years and 10 months. But that continuity masks some divergence of opinion. Two of the MPC's members have been voting for a rate increase, we'll know in two weeks time whether either of them have changed their minds. Watch this space for news!

Highs and lows. Demand for borrowing on credit cards and personal loans grew by a record amount in Q4 according to the Bank of England. But lest we get too carried away with the recent past, lending growth has been picking up since the start of 2013. Meanwhile demand for mortgage borrowing fell by a near-record amount in the same period. With Halifax reporting a fifth consecutive slowdown in house price inflation (to 7.8%y/y), clearly the housing market is cooling and cooling fast. Government borrowings are the highest ever recorded at £1.4 trillion and domestic debt is recorded also at the highest by UK records! More challenges ahead!

Making and selling. UK manufacturing grew by 2.2%y/y in the three months to November. The three stand-out sectors? Rubber and plastics, food & beverages and computer, electronic and optical products. All three grew by more than 6%y/y. While UK exports barely grew in October and November, this was an improvement on the previous months of decline. With struggles in both the Euro zone and China, 2015 looks set to be another challenging year for trade. Global issues are the big challenges, plus, too few jobs for too many people! Many more people still coming to the UK for work which is causing friction with UK residents!

Bad old habits. China's slowdown appears to be making the government feel a little uncomfortable. Last week reports emerged that the government has a large infrastructure project pipeline equal to around £1trn. The figure is likely artificially inflated. Much of it includes projects that were set to go ahead anyway and much of the spending will take place over a number of years. It's a bold move aimed at supporting the economy. Structural reform deserves equally bold measures. China`s flame is flashing danger signs!

Down, down, deeper and down. Last month when we wrote about oil the price had fallen to $65 a barrel. The festive season failed to provide any respite and this week we are down below $50. The effects on inflation are now clear as the Euro zone broke into deflation, but there's more in the pipeline. It takes time for changes in wholesale markets like the global oil price to filter through to consumers. What's certain is that we haven't see the last of it. More challenges ahead globally!

Just a minute. Philip L. Graham said that news is the first rough draft of history. The release of the UK BoE minutes from the height of the financial crisis is a major step towards the finished book. They show the origins of the Bank regaining responsibility for financial as well as monetary stability, gathering greater information on banks and bolstering its analytical capability. Thus was the creation of the Prudential Regulatory Authority, the Financial Policy Committee and the Financial Conduct Authority. The banks need to answer more questions on how they nearly brought the world to its knees by pure greed!

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About the Author Colin Thompson

Colin is a former successful Managing Director of Transactional/Document Manufacturing Plants, Document Management/Workflow Solutions companies and other organisations, former Group Chairman of the Academy for Chief Executives, Non-Executive Director, Mentor - RFU Leadership Academy, Mentor - Coventry University, Mentor - The Chartered Institute of Personnel and Development, author/writer Business Advice Section for IPEX, Graphic Display World, NewsUSA, GraphicStart, many others globally, helping companies raise their `bottom-line` and `increase cash flow`. Plus, helping individuals to be successful in business and life in general. Author of several publications, research reports, guides, business and educational models on CD-ROM/Software/PDF and over 2000 articles and 35 books published on business and educational subjects worldwide. Plus, International Speaker/Visiting University Professor.

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