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The End of the Fake Recovery

This is going to be a relatively long post. But I think it’s important. I have been meaning to update my thinking about what I heralded in early 2009 as the “Fake Recovery” as the economy in the US began to turn. My view is that without policy support this recovery is now on its last legs.

Here, I want to review how we got here in the context of the banking system and what that means about the banking crisis right now.

Engineering Recovery

In early April 2009, I remarked:

financial services companies shedding troubled assets, not marking other assets to market and having an enormous margin spread due to ridiculously low interest rates. To me, this is a huge buy signal.

-Wells profit forecast is a clear bullish sign

The end of mark-to-market accounting in the spring of 2009 was a huge filup for banks that meant a technical recovery could begin. At the time I said that

It should be patently obvious that a downturn which began in December 2007 would be fatal to many politicians if allowed to continue well into 2010. This is why recovery of some sort must take place before that time – irrespective of whether it is sustainable.

The idea was to engineer a Fake Recovery based on the following elements:

  • Moderate fiscal stimulus
  • Quasi-fiscal role for the Fed
  • Quasi-fiscal role for the FDIC
  • End of mark-to-market as we knew it
  • Interest rate reductions
  • Bank margin increases

Concentrating on the role that accounting played in this recovery and what the broader implications were down the line, I wrote at the time:

You should have noticed that most of the assets written down in the past two years have been marked-to-market. Securities traded in the open market are marked to market. Loans held to maturity are not. This is one reason that large international institutions which participate in the securitisation markets have taken the lion’s share of writedowns, despite the low percentage that marked-to-market assets represent on bank balance sheets. But, this should end because of new guidelines in marked-to-market accounting. However, the new guidelines do have two major implications. First,there are still many distressed loans on the books of U.S. banks that if marked to market would reveal devastating losses. Second, there will also now be many distressed securities on bank balance sheets that if marked-to-market would reveal yet more losses. In essence, the new guidelines are helpful only to the degree that it prevents assets being marked down due to temporary impairment. If much of the impairment is real, as I believe it is, we are storing up problems for later.

[…]

You should be under no illusion that the coming rebound is permanent. Much of it is not. What we are seeing is the makings of a cyclical recovery that might begin as early as Q4 2009 or Q1 2010. How long or robust that recovery is remains to be seen. Moreover, it is still questionable whether we will get any meaningful recovery at all in spite of the ‘green shoots’ because the banking system in the United States is severely undercapitalised and more asset writedowns are coming due. This is a fake recovery underneath which many problems remain.

Nevertheless, banks are going to earn a lot of money and that is bullish for their shares – at least in the medium-term. Yes, the stock market is overbought right now. However, if banks put together some decent earnings reports over the next few quarters, their shares will rise.

Furthermore, if the banks can earn enough, this cyclical recovery will have legs as banks will then have enough capital to resume lending and that is supportive of the broader market as well. It is still too early to tell how this will play out over the longer-term. For now, I am much more positive on financials, and somewhat positive on the broader market as well.

TARP exit was a mistake

The exact opposite is now true. The cyclical recovery’s legs are tired and almost all of the policies that led to recovery are exhausted. Fiscal stimulus is dead, the Fed has wound down most of its liquidity programs, the PPIP was a bust, and permanent zero is going to erode bank margins. Only the mark-to-market accounting dodge and the Fed’s interest rate policy remain – and the zero rate interest policy is just not effective in inducing lending. This has exposed the banks to the nagging doubts that resulted from the mistake of allowing them to exit the TARP program without greater capital.

As I wrote at the time in late 2009:

Just re-capping here, Citigroup, Bank of America, and Wells Fargo were the last three big banks allowed to leave the TARP program.  They were allowed to do so because Treasury says TARP was a success and the banks are well-capitalized institutions. Meanwhile, the FDIC will not allow new accounting rules to come into affect that would make the banks look less well-capitalized.

If you sensed subterfuge here, you and I would be on the same page.

-On releasing Citi from TARP and banking by accounting subterfuge

Citigroup was the sickest patient; it nearly failed. But Citi has escaped more scrutiny than the other two this go round largely because as I suspected in late 2009 it was forced by the government to sell assets. It is Bank of America which has had the greatest problems with capital during the panic now. But Citigroup and Wells Fargo are also in the spotlight. BofA and Wells have been downgraded by Moody’s.

Stress tests mandated TARP exit

Allowing the sickest patients to exit the TARP program was absolutely foreseeable because of the way the stress tests were sold. When the best-capitalised institutions left the TARP program in June 2009 I remarked that:

this repayment makes clear who really is in trouble and who is not.  Do you see Citigroup’s name anywhere?  How about Bank of America?  Wells Fargo anyone?  I anticipate every bank that is still receiving TARP funds will struggle to get off the government breast as soon as possible because we are likely to see a divergence in stock/preferred share performance between those who get off TARP and those who do not.

We were told the exact amounts that banks needed to meet the right capital levels in order to withstand economic weakness. And once they got to those levels, they had to be released. Eventually, all of the banks got out of TARP, Fifth Third and Wells Fargo being the last big banks. I should point out that Wells was the last and that tells you that Warren Buffett’s comments that Wells Fargo passed Buffet’s ‘own stress test’ were not very serious; he always talks his own book.

The Propaganda Machine

Let’s remember that we have been spun a completely different story here. I have remarked on this many times and I have a list of these kinds of stories in the Credit Writedowns reading list. The one called “Imagine the Bailouts Are Working“ is one of my favourites.

Writing ahead of elections last year about the pro-bailout narrative, I said this:

I don’t know what immediate purpose this kind of revisionism serves because it is not likely to be helpful in the mid-terms given how mad Americans are about the bailouts. Moreover, I do think it is too early to label TARP a success because, despite regulatory forbearance, another downturn would expose the banks to serious losses.

In the end, I am left with the sense that this is how history is made. It pays to fashion a history early. The simplification of all historical narratives means whitewashing events of the intricacies of competing contemporary accounts. Thus, if the US economy recovers, I expect historians will look back on TARP as an unmitigated success – largely due to simplified contemporary accounts…; Opportunity costs will become irrelevant. If we double dip on the other hand, this narrative will be for nought anyway.

-Despite the propaganda machine’s attempts to label TARP a success, it was not

European Stress Tests

Europe never had a TARP to play up. But they have had two sets of stress tests. I saw an article on the European Bank Run and stress tests in the Guardian today that reminded me of what I wrote about the value of stress tests when they were being conducted in Europe last year.

The Guardian asks “How did Europe’s bank stress tests give Dexia a clean bill of health?”:

It may seem like a lifetime away, but it is only in July that the European Banking Authority published the result of "stress tests" on 90 banks across 21 countries in the EU, covering around 65% of the banking industry.

Eight failed. Sixteen were border line with core tier one capital ratios – a key measure of financial strength – of between 5% and 6%.

So presumably, Dexia, the Franco-Belgian bank on which markets are currently fixated, was in one of the danger-zone categories?

Well no. Its statement issued on the day proclaimed "no need for Dexia to raise additional capital".

Why? Well under the "shocks" imposed by the EBA its core tier one capital ratio would fall to 10.4% by 2012 from 12.1%, its actual ratio at the end of 2010. An easy pass.

Yet, barely three months later, Dexia is regarded as being in deep trouble, unable to raise the cash it needs on the financial markets – largely because the market is concerned about its ability to withstand losses on its €3.4bn (£2.9bn) of exposure to Greece.

France and Belgium have been forced to make statements promising to stand behind it – which in turn is raising questions about Belgium’s ability to cope with the financial strain.

The tests have proved to be meaningless even quicker than they were in 2010 when Ireland’s banks were given a clean bill of health, only to be bailed out four months later. In July, 2011 the EBA had been reckoning that the capital shortfall of the banks that failed was just €2.5bn. Now the markets reckon that the hole is more like €300bn.

This is the problem. Stress tests don’t have a lot of value beyond the confidence building they are supposed to engender from the enhanced disclosure they give investors. That allows the banks to then go out and recapitalise. However, if everyone believes the banks really need €200 billion instead of €2.5 billion, the stress tests will end up looking like a sham.

This is what I had to say about the stress tests in June of last year as they were being conducted in Europe:

Undercapitalised Europe

The Eurozone banks are less well-capitalised than US banks. If you recall, last year I went through this exercise (see The top 25 European banks by assets) because of an article in the Telegraph which indicated that European banks were sitting on 16.3 trillion in toxic assets. I expect that many of the toxic assets that were on European bank balance sheets in February 2009 are still on their balance sheets at cost i.e. without having been written down. This is why I think the European banks are undercapitalized and why the stress tests are happening.

In alarmist early 2009 posts like Switzerland threatened with bankruptcy, German banks loaded with 816 billion in toxic paper or The European problem, the genesis of my alarm was the interconnectedness and undercapitalisation of the European banking system. I first wrote about this before Lehman and the panic of 2008 (see my June 2008 post European banks: still undercapitalised). So, it’s not as if the undercapitalisation meme appeared on the scene due to the panic and drop in asset values. And these are the same issues today, two years later. We are talking solvency – not liquidity – in Europe as we are in the US.

Stress Tests

As for stress tests, I think they are of dubious value. However, in a November post I presented both sides of the argument on the US Treasury’s handling of the credit crisis – with the stress test and liquidity/solvency issues front and centre:

Note the following about the US tests:

Of course the stress tests were a sham. They were a confidence trick to raise more capital and buy time for the banks to earn yet more still. The point was to allow the banks to ease into their losses. And that’s exactly what’s been happening for the past year.

-The fake stress tests and the coming wave of second mortgage writedowns

So, if the European stress tests are equally ‘successful,’ the European bank liquidity crisis will fade and we will see banks raising much needed debt and equity capital in the market instead of having the government inject capital.

The view of the stress tests I presented in March is still operative:

If I had to summarize these thoughts I would say the stress tests were a mock exercise to instil confidence in the capital markets. This was important first and foremost because it would induce private investors to pay for bank recapitalization instead of taxpayers. But it was also important for the economy as a whole as the sick banking sector was dragging the whole economy down. The key, however, is that the tests were a mock exercise. Despite the additional capital, banks are still hiding hundreds of billions of dollars in losses in level three, hold to maturity, and off balance sheet asset pools. If asset prices fall and/or the economy weakens, all of this subterfuge would be for nought.

-Geithner: jusqu’ici tout va bien

The same issues are at play in Europe. If recovery continues, I fully expect the biggest and best capitalized to escape trouble and be home free. This is important as many of them are too big to bail. However, if recovery fades and asset prices fall again, we are in big trouble across the board. And you should expect bankruptcies and bailouts all around – just a warning.

Expect more failures and bailouts

The recent Dexia rescue tells us that this view is now being validated by markets. What’s more is that it’s not just the Euro banks, although they are the ones most imperilled and under capitalised; the American banks are on the line too because of the interconnectedness of our financial system.

Robert Reich wrote yesterday:

The Street has lent only about $7 billion to Greece, as of the end of last year, according to the Bank for International Settlements. That’s no big deal.

But a default by Greece or any other of Europe’s debt-burdened nations could easily pummel German and French banks, which have lent Greece (and the other wobbly European countries) far more.

That’s where Wall Street comes in. Big Wall Street banks have lent German and French banks a bundle.

The Street’s total exposure to the euro zone totals about $2.7 trillion. Its exposure to to France and Germany accounts for nearly half the total.

And it’s not just Wall Street’s loans to German and French banks that are worrisome. Wall Street has also insured or bet on all sorts of derivatives emanating from Europe – on energy, currency, interest rates, and foreign exchange swaps. If a German or French bank goes down, the ripple effects are incalculable.

Get it? Follow the money: If Greece goes down, investors start fleeing Ireland, Spain, Italy, and Portugal as well. All of this sends big French and German banks reeling. If one of these banks collapses, or show signs of major strain, Wall Street is in big trouble. Possibly even bigger trouble than it was in after Lehman Brothers went down.

This is what Felix Zulauf meant when he said we should expect more market turmoil than in 2008.

Let’s bring this full circle back to the root of the Fake Recovery, accounting. I think Barry Ritholtz made some good comments on this score. He called it Banking’s Self Inflicted Wounds and wrote:

Morgan Stanley in a free fall. Goldman Sachs at multi-year lows. Citigroup looking Ugly. Bank of America off 50% from recent highs.

You may be wondering what is going on with the major firms in the financial sector. While each of these firms have different problems — vampire squids to Countrywide acquisitions — they all have something in common: Their balance sheets are opaque.

This is no accident. Indeed, it was by design that execs in the banking sector, and their outside accountants, hatched a scheme in 2008 to hide their balance sheets from public view. The bankers had been lobbying the Financial Accounting Standards Board to change the rules that governed “Fair Value Measurements” also known as FAS157 (September 2006).

[…]

The bottom line is this: Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell.

That’s it exactly. And it’s this doubt that is creating panic. With the stimulative measures that supported recovery over, the end of the fake recovery is at hand. You need to get rid of any sense that banks are undercapitalised. Until the banks take substantially more credit writedowns and recapitalise, this crisis will continue and get worse.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

26 Comments

  1. Namazu says:

    It seems to me the trouble with TARP is just a microcosm for the trouble with the broader economy. Unless enough credit is written down, only ‘highly optimistic’ assumptions about the income statement can repair the balance sheet–in non-helicopter dollars, at least. Paul Krugman dealt his main argument a fatal blow by assuming a V-shaped recovery on the order of 7-8% initial GDP growth, although perhaps I missed the retraction. Even our modest fake recovery came after a long period of fake growth. Until the neo-Keynesians convince us they can estimate a sustainable (non-accelerating debt) rate of growth, they’re blowing helicopter dust up our orifices.

  2. Blissex says:

    Even our modest fake recovery came after a long period of fake growth.

    about 25-30 years of fake growth…

    I have an even stronger impression that the USA economy (and those of most of the first-world) have never recovered from the 1980s recession. If you overlap the debt and GDP graphs for the past few decades applying some kind of deflator (like PPI), that is in sort of real terms, it is pretty obvious that there has been little real GDP growth since 1980, and arguably whatever little growth has happened has been entirely driven by higher consumption by the highest earning 10%, thanks to capital gains and income gains powered by that debt increase.

    Until the neo-Keynesians convince us they can estimate a sustainable (non-accelerating debt) rate of growth,

    You should be asking the Republicans and conservatives about that. They have been in control of economic policy since 1980 almost continuously, and if one looks at the top graph in:

    http://www.creditwritedowns.com/2011/09/total-private-market-debts-decline-should-be-a-glaring-warning-sign.html

    The two accelerations in debt creation happened a bit after 1980 (Reagan Involution) and 1995 (Contract on America). The only slow down in the debt bubble was when Democrats were in control, even if probably it was luck (despite Rubinomics). The two trend changes in debt creation also are largely reflected in stock market margin ratios, stock indices and P/E ratios, and later the same (margin ratios, indices and P/E) for real estate.

    It looks as if soon after 1980 and even more so soon after 1995 the unofficial industrial policy of the USA was to redistribute a lot of income to some “key” constituencies via massive low-tax or tax-free capital gains generated by a debt bubble.

    More than a neo-keynesian experiment, a neo-liberal one (which is not keynesian in either case, as neo-keynesians policies are as far from keynesian policies as neo-liberal ones).

    • Namazu says:

      25-30 sounds about right to me, and I’ll go you one further insofar as I think the PPI understates inflation. Whether this makes Reagan a Keynesian, neo-Keynesian, or paleo-Keynesian is a quibble: my ability to influence Republicans or conservatives is as limited as yours on this subject. But two wrongs make two wrongs, and I don’t see the arithmetic that gets us out of this without eventual monetization or nasty inflation down the road. The monetization wouldn’t phase some of your MMT-oriented guest bloggers, and perhaps they’re right to be sanguine. But that’s a very different argument from saying that non-monetized deficit spending will get us from A to B. The quiet bi-partisan agreement to think about jiggering the Social Security COLAs again provides a strong hint of what policy-makers consider the path of least resistance. The other problem the neo-Keynesians have is that their macro view that we need to “throw money at the problem” (I think Brad DeLong used this exact phrase in a Bloomberg interview) means the money has to be thrown through the political pork grinder and (with great luck) end up producing wealth instead of just more fake GDP.

      • fresno dan says:

        good points. And I always say, the problem isn’t what the Dems and Republs disagree about, its what they agree about…of course, our media can only cover the wrestling match.

    • Dave Holden says:

      Karl Deninger’s favourite graph at the moment

      http://market-ticker.org/akcs-www?get_gallerynr=2248

  3. The Europeans have a serious credibility problem due in no small part to their farcical stress-test exercise. Now some vague-and-subsequently-clarified statements from Olli Rehn on a coordinated recapitalization plan are giving the markets their fix of hopium. Here’s a view on what any eventual plan should include to be considered credible: bit.ly/pTCkgV

  4. Blissex says:

    But the “market ticker” chart is just the same as the one in a previous entry in this blog:

    http://www.creditwritedowns.com/2011/09/total-private-market-debts-decline-should-be-a-glaring-warning-sign.html

    but from a different angle.

    As mentioned in some late comments I made today to that entry, I have recently discovered another “smoking gun” chart, about prisoner numbers in the past few decades:

    http://timinglogic.blogspot.com/2011/09/economic-realities-created-by-pigmen.html

    There is a (very) sharp change upwards after 1980. The graphs of debt and prisoners have very much the same shape, and I think they are entirely related (same underlying cause).

    Even if in most “money” graphs there are actually two inflection points, just after 1980 and just after 1995.

    • Right, the policy has been to increase the potential for capital gains, control the playing field and mask the stagnation in median income by deregulating financial services, offshoring jobs, crushing unions, allowing consumers to increase their indebtedness, and by criminalising the underclass in the drug war. This has led to an asset-based economy wholly dependent on asset price gains to keep the middle class above water. When the asset prices collapse, the lack of savings, the debt overhang and the poor wage and employment prospects create a very negative situation.

      Anyone who sees this pattern has to know it is destined to fail. Yet, this has been the essence of American industrial policy – and it has worked for thirty years. Those who benefitted will get to keep their wealth. meanwhile the economy will suffer for a long time to come.

  5. Blissex says:

    «I think the PPI understates inflation»

    Perhaps, but I think that it is more useful than the various CPIs because the definitions of the latter have changed more over time, and the PPI seems more stable and comparable over the decades.

  6. Blissex says:

    The saddest part of the post-1980 industrial policy is that it has been very popular with voters, who have continued to re-elect the its advocates.

    Around 1980 either the majority of voters or the majority of swing voters turned authoritarian-rentier, with strong political demand for locking up or executing nasty-looking dark skinned minorities, for driving down wages with the destruction of unions and unlimited immigration and exploitation of oaf-looking brown skinned minorities, and the redistribution of purchasing power via a series of capital gains, from the unproductive, property-less lower classes to the propertied middle and upper classes. Plus switching the bias of family and criminal law from pro-male/husband to much more pro-female/wife.

    Except for the last bit about switching gender bias, I call the resulting picture the dream of a plantation economy, with a small number of plantation owners in their hilltop manors, a layer of affluent supervisors around them in handsome mini-manors or white picket fenced cottages, and a mass of of serfs (largely colored) in camps made to work the plantation for the benefits of the other two groups. The Dixiefication of America.

    As to the causes, the book “The Right Nation” suggests that this in part a reaction to the leftist excesses of the 60s/70s, in particular the constant strikes, the drug culture, the minority riots.

    I think that those contributed, but I think that it was also as Johnson said the signing of the Civil Rights Act losing the south to the Democrats for decades.

    But most importantly I think it was the irish/jewish/italian working classes traditionally represented by the Democrats (to this day many of the big names in that party have obvious ethnic roots) moving into the middle class and in particular into propertied status, with share portfolios and real estate, thanks to the high wages and benefits won by the unions. Their dream was if not to become plantation owners at least join the plantation supervisor layer.

    Grover Norquist described several aspects of the new politics in some of my favourite quotes:

    http://www.enterstageright.com/archive/articles/0903/0903norquistinterview.htm
    «The growth of the investor class–those 70 per cent of voters who own stock and are more opposed to taxes and regulations on business as a result — is strengthening the conservative movement. More gun owners, fewer labor union members, more homeschoolers, more property owners and a dwindling number of FDR-era Democrats all strengthen the conservative movement versus the Democrats.»

    http://www.prospect.org/web/page.ww?section=root&name=ViewWeb&articleId=11699
    «The 1930s rhetoric was bash business — only a handful of bankers thought that meant them. Now if you say we’re going to smash the big corporations, 60-plus percent of voters say “That’s my retirement you’re messing with. I don’t appreciate that”. And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher. And in 2002, voters said, “We’re sorry about the seals and everything but we really got to get the stock market up.»

  7. Stevie b. says:

    “” The bottom line is this: Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell.”

    That’s it exactly. And it’s this doubt that is creating panic.”

    What panic? The S&P/DJII are exactly where they were 2 months ago. Even the most financially unaware people on the planet are bearish and that’s why the markets are still where they were a couple of months ago – everyone’s made their bet and yet we are no lower than we were.

    Ed – as I’ve bored you with ad nauseam – the PTB will do everything to keep some sort of system going – e.g. including as you said devaluing consumer debt by any foul means & screw the thrifty in the process.

    The stock-market will actually be a hedge against the potential eventual inflationary outcome & I think we’re further down this road in the UK – stagnant wages, higher food bills for smaller packet-sizes & crucially inflation that’s becoming ingrained and the B of E couldn’t give a stuff – hell, it wants inflation, never mind its
    missed-target-idiotic-lying-letter-writing-garbage to the chancellor.

    http://www.blogger.com/profile/11427759744381570329

    • Stevie, now that the CBs are going QE, let’s see if we get a lift. They will do what they can to keep it going. It won’t be enough. Crisis will continue. I think the market will suffer in real terms and think hiding in high dividend, high quality stocks is the right way. So we’ll just have to see.

  8. Blissex says:

    «The stock-market will actually be a hedge against the potential eventual inflationary outcome»

    In past events this has not happened. But current politics may mean it will. But it would be nice to see an up-to-date chart of margin buying.

    «& I think we’re further down this road in the UK – stagnant wages,»

    Well, if GNP in real terms has shrunk, something has got to give, and either wages/profits shrink or the number of people employed has to shrink.

    Actually the goal in the UK like in the USA has long been to lower wages, to reduce the costs of the NHS and other large and small employers who provide goods and services to the middle and upper classes. What most propertied voters want is cheap polish plumber, cheap portoguese nurses, cheap spanish waiters, cheap latvian baristas.

    I have collected a couple of quotes from New Labour ministers that state this being government policy. You can imagine the Tories being a bit more keen on that. Indeed, I have just seen this in a nice article in The Times (2011-09-17):

    «The C2 women who voted Conservative last time did so because they, in low to middling-paid roles such as nurses, secretaries and carers, believed welfare had grown too generous, that benefits rewarded the do-nothings while they toiled. They hoped the Tories would crack down.
    Now, they are shocked to discover the Government regards them as part of the problem. They work in the “bloated public sector”, their meagre pensions are grotesquely lavish, their often tough vocational jobs are regarded as worthless and dispensable.
    »

    Which is quite funny because of the obvious meanness of those C2 women who got make-believe (if hard-working) jobs thanks to an extraordinary expansion in public spending funded by North Sea oil royalties. And the story is that since Blair resigned the UK has become a net oil importer, and the omens are pretty clear:

    http://mazamascience.com/OilExport/output_en/Exports_BP_2011_oil_mtoe_GB_MZM_NONE_auto__.png

    «higher food bills for smaller packet-sizes»

    Especially the «smaller packet» seems to be a signal of higher costs for long term.

    «& crucially inflation that’s becoming ingrained and the B of E couldn’t give a stuff – hell, it wants inflation,»

    Talking about “inflation” is meaningless, as there are as many inflations as there are prices.

    The “monetarist” definition is laughable and it is “a rise in all prices”, which is “always and only a monetary phenomenon”.

    Apart from that verbal voodoo, “inflation” is always and only a political phenomenon to achieve some kind of income redistribution.

    There are two types of “inflation” that are relevant, one is “wage push” inflation which is what is measured by the CPI, and the one that governments and central banks have been fighting very successful for decades, and the other is “cost push” inflation which is driven by the costs of materials and imports.
    There is also “asset price” inflation but every Serious Economist will deny that it can exist as any increase in asset prices is a well deserved reward for proprietors of assets for their sagacity (while any decrease in asset prices is a cruel punishment of the best and brightest and needs to be fixed already).

    The inflation you are talking about is “cost push” inflation, where the collapse of the pound sterling and commodity price bubbles are feeding through to the supply chain into the UK. This is just redistribution of income from UK consumers to foreign producers, and to UK banks financing the commodity bubble, which is an intentional goal of government policy to “rebuild bank balance sheets” by making them get giant profits.

    The BoE is trying to achieve a modest degree of slowing down “wage push” deflation, and since it has only got monetary levers it cannot do much but inflate asset price bubbles.

    Which are what the government desperately wants to please their propertied middle and upper class supporters. As Mr. Osborne declared recently:

    «Credit means investment. Investment means jobs.
    We’re making sure that British banks are strong enough, holding enough capital to cover loans in an emergency.
    We’ve expanded loan guarantees.
    We’ve struck a deal with the big high street lenders to increase lending to small businesses by 15 per cent this year.
    But all this may not be enough.
    Of course the Bank of England have their own independent judgement to make on quantitative easing.
    I’ve said many times before I will follow the procedures of my predecessor and give Treasury approval if they ask.
    But there is more the Government itself can do to get credit flowing and encourage investment.
    David Cameron and I have always said we would be fiscal conservatives and monetary activists.
    Everyone knows Britain’s small firms are struggling to get credit and banks are weak.
    So as part of my determination to get the economy moving I have set the Treasury to work on ways to inject money directly into parts of the economy that need it such as small businesses.
    It’s known as credit easing.
    It’s another form of monetary activism.»

    Of course just like in the USA there is no chance that extra credit in the UK will lead to more investment in productive jobs in the UK, which is a low-growth, high-cost country; any extra credit will go towards offshoring of jobs to high-growth, low-cost countries, and mostly towards asset price speculation, which is what the propertied middle and upper classes want.

    That’s why the goal of the government is to be «fiscal conservatives and monetary activists.»

    • David Lazarus says:

      Yes but the Tory backers while having the money are becoming rarer and rarer. The majority of UK households have not being going crazy with borrowing. It is just that their basics have taken more and more of their incomes. Elizabeth Warren has a report on American “overspending”.

      http://www.yale.edu/law/leo/052005/papers/Warren.pdf

      I would imagine that the UK are going through the same process just some way behind.

  9. Stevie b. says:

    Ed “now that the CBs are going QE”

    Exactly – no surprises there then and no surprises to come, whatever the apparent surprise! (…and not excluding negative interest rates…)

  10. Blissex says:

    «Everyone knows Britain’s small firms are struggling to get credit and banks are weak.»

    Virtually every commentator that I have seen remarked that small and large UK businesses are not even of asking for credit because they don’t dream that they have the business for it.

    Those who are really struggling to get credit is small time property speculators. At some point the government has realized that their electoral chances (70% of voters own real estate) depend on pushing up house prices again and again and again.

    BTW in the quote above «banks are weak» may be the understatement of the century. It is quite amazing for the Chancellor to be telling the world that UK banks (several of which he controls) are weak.

    • David Lazarus says:

      The reasons businesses are not asking for credit are that the banks have raised margins significantly. Loan rates are much higher even though cost if funds is practically zero they are unaffordable for businesses in the current economic climate.

  11. Stevie b. says:

    Blissex – reading between your lines, seems to me we’re at least sort-of on the same basic hymn-sheet.

    Fundamentally and in the fullness of time and any intervening trade-wars, we are moving inexorably towards a basic global levelling of wages. In western terms sooner or later this will be inflationary – despite or even because of current constraints to growth of a rocketing oil-price at the first sniff of any recovery. Anyone who thinks deflation is baked into this pie is IMO backing a legless horse.

  12. Some Guy says:

    [Insert dumbass moonbat rant blaming Ronald Reagan and those mean old Republicans for brainwashing the sheep here.]

    I’ve been holding off on getting a house in the DC area for two years because I don’t think the market here has even come close to hitting bottom. My wife thinks I’m nuts, but I haven’t seen the banks eat the full losses they took in DC. My crazy thinking is that the people who buy right now are in for a really nasty surprise by the middle of next year when the banks finally feel the pressure to short sell the crap out of all the non-paying mortgages they’re currently letting slide on their books. At some point, they have to account for the losses, right?

    • David Lazarus says:

      The DC area could be different in some respects that it will have a floor under prices because of its proximity to government. I do agree with you that DC prices are over valued but unless there is a reason for them to fall people will hold on demanding silly prices for a sale. If the economy downturns then it could change very quickly. Do not forget that until you have paid off that mortgage you are still only renting from the banks. Better the flexibility of renting for a while until markets are clearer. Plus many people have a vested interest in inflating property values, apart from banks.