VOTERS may be warming to Gordon Brown's re-election chances but the markets are not. News that the latest opinion polls show just a 2 percentage point lead for the opposition Conservative party caused sterling to fall 2.5% against the dollar this morning. That result would leave the governing Labour party with the most seats, and Mr Brown (probably) still in office*.

The opinion polls were not the only factor. A plunge at 11.30 GMT followed news of the Prudential's planned purchase of AIG's Asian operations, a plan that will involve raising some $25 billion of cash. There is talk that the Pru was hedging its foreign exchange exposure by selling sterling today.

Nevertheless, with about nine-and-a-half weeks till the election, there is considerable scope for uncertainty about the British government's fiscal outlook. Both parties are committed to reducing the deficit in the medium term but differ about the need for speed. It is not quite clear which approach the markets would prefer; George Magnus of UBS has warned for example that too rapid belt-tightening would send the economy back into recession and might tempt the government down the inflation route. Equally, however, investors might be cynical that any plan to cut the deficit in the medium term is simply "gruel tomorrow, but never gruel today".

Britain's fiscal position is better than that of Greece, not least bcause the average maturity of its debt is almost 14 years. But it would be unwise for Britons to be too superior. Any plan to try to slash the deficit would face strikes, along the lines that Greece has faced. France and Germany might be willing to bail out Greece, in a pinch, but not Britain, which is too big and not in the euro-zone. 

It was only two weeks ago that I suggested Britain might be the next target of the speculators. That day may have come already. And once the markets start to worry about a country, it is hard to make them stop without taking some actions. This could be the "spring of discontent."

* The one good consequence of such a result would be that British smugness over its electoral system would have to be addressed. There was a lot of hubris over the Florida hanging chads and the fact that George Bush was elected President with a minority of the votes. But the British system requires the Conservatives to have a 10 percentage point margin to get a majority of seats. This is because the Tories pile up votes in England but barely win any seats in Wales and Scotland.

THE BBC ran an excellent programme last night, The Day the Immigrants Left, which contained an interesting social experiment and should be compulsory viewing for all readers of the Daily Mail (a British tabloid version of Fox News). It tried to deal with the standard complaint that immigrants "take all our jobs"; one that is completely contradicted by the other complaint that they come to Britain to live off benefits.

So the programme got three employers in Wisbech (a Fenland town close to where I grew up) to take on British unemployed workers instead of the eastern Europeans on whom they normally relied. One genial owner of an Indian restaurant offered four jobs for waiters and trainee cooks; three of the four failed to turn up on the first day. The other lad was baffled by "all these Indian names" for food although Indian meals are nowadays as British as roast beef; he lasted for about two hours, including one walk-out.  At a potato factory, another lad rang up on the first day to say he'd been out late and was now too ill to come in.

To be fair, some of the workers eventually knuckled down and one of the jobs on offer, picking asparagus, was back-breaking (or at least back-straining) work. But what was striking was not just the poor attendance work but the attitude; when told off for doing their job in the wrong way, the workers reacted with anger and threatened to walk out. Some basic sense of discipline was missing, perhaps because it had not been imposed at home or school.

How does one deal with the problem of unemployment if some people are unwilling to actually do a 9-5 job? (Of course, lots of people are out of work and desperate to find it; the problem is dealing with the cohort who like work better in theory than in practice.) I doubt this is a purely British problem. Back in the days when I was a regular visitor to Mississippi, I asked my then uncle why he employed Mexican workers to help with the cotton harvest. He explained that when he relied exclusively on local labour, several staff failed to turn up, creating the risk that the cotton would be left to rot in the fields.    

CHINA is well known for its many technological innovations through history, but not for its financial ones. But reading Glyn Davies's History of Money: From Ancient Times to the Present Day, I was struck by the fact that the emperor Hien Tsung, who ruled from 806-821 CE, developed paper money to overcome a copper shortage. Marco Polo describes how the Grand Khan of the Mongols also used paper money, remarking that

All his majesty's armies are paid with this currency, which is to them of the same value as if it were gold or silver.

It did not last. By 1448 CE, Ming notes nominally worth 1,000 in cash actually trading for three. That was one of the last references to paper money trading at all. The Chinese switched to silver, a conviction that lasted into the 20th century.

Meanwhile, in the west, the early printing machines developed by Gutenberg were also adapted for monetary purposes. As Davies remarks

It is a further irony of monetary history that not long after China finally abandoned its paper currency, European banks began increasingly to issue paper money notes about which they had first learned from the writings of travellers like Marco Polo.

Of course, nowadays, the Chinese are very adapt at making money. I had another chat with Richard Duncan today, whose new book The Corruption of Capitalism has just been published. His argument is that a)the Chinese run, in good years, a quarter of a trillion dollar trade surplus with the US b)Chinese exporters sell those dollars to the central bank which inflate reserves and that the effect is both to inflate the Chinese money supply and to fund the US trade deficit on the cheap. Other central banks have followed similar policies. As a result, global foreign exchange reserves, which first hit $1 trillion in the early 1990s, are now almost $7 trillion. This credit bubble has inflated asset prices and will lead to a bust.

However long this system lasts, one suspects it will fall far short of the 600 years achieved by the last Chinese paper money experiment. 

ACCORDING to the Spaniards and other troubled countries, the "Anglo-Saxon media" are part of a plot to do down the euro-zone. See my colleague Charlemagne's post here. But never fear, Europe. The Anglo-Saxon media love nothing better than a bit of self-flagellation. Larry Elliott, the economics editor of the Guardian, our leading left-wing newspaper, has written a book on Britain's economy called Fantasy Island. Over at the right-wing Telegraph, Ambrose Evans-Pritchard, who makes your humble blogger sound like Dr Pangloss, is already gearing up for the crisis.  

When we published a combined debt ranking two weeks ago, the UK was third on the list of countries at risk. It has the great benefit of having borrowed very long term; its average debt maturity is almost 14 years, so it is harder to engineer a funding crisis.  Nevertheless, it has a bigger debt-to-GDP ratio and annual deficit than when it was forced to go to the IMF in 1976 (although a much better inflation record than it did back then).

In a research note dated yesterday, Citigroup writes that the UK

is an economy that looks to be experiencing rising inflation, which may put pressure on the cost of financing. The ability to raise debt is also at risk. With quantitative easing ending, the UK Treasury is without an important marginal buyer of its debt. Also Michael Saunders, our UK economist, believes the probability of a hung parliament after the coming election is 40-50%. So there may not be the stable political base required to undertake unpopular policy decisions like cutting spending or raising taxes.

Even though the total debt/GDP ratio of Britain is well below Greece's, there are lots of off-balance sheet exposures (private finance, public sector pensions) that may make the real ratio a lot higher. And the key ingredient of a debt crisis is not the data, but a loss of confidence.

That blow to sentiment may have come from today's data on public sector borrowing. January is supposed to be a bumper month for tax revenues; it is when personal income taxes are paid by the self-employed and much corporate tax is paid.  The market forecast a £2.6 billion surplus; it got a £4.3 billion deficit, the first for January since monthly data started to be recorded in 1993. In cash terms, the shortfall was £8.2 billion. That indicates that the UK economy is still very weak.

The 10-year gilt yield has only risen seven basis points on the news but that still leaves Britain paying more to borrow than Italy, or those victims of international speculators, Spain.

In short, the Anglo-Saxons (at least on this side of the Atlantic) may be next in the firing line, as indeed they were in 1931, 1967, 1976 and 1992 to name a few crises. Of course, we will have our own objects for xenophobia when the worst happens. We used to blame the Swiss...

TWENTY six years ago, when I was a tyro reporter, the big economic data of the week was the US money supply figures. Nowadays no-one seems to pay them any attention. But money matters, especially when the economy is recovering from a financial crisis.

The ever-assiduous David Rosenberg of Gluskin Sheff has some interesting data in his latest note. US bank lending fell by $30 billion in the past week, and has declined $100 billion this year so far, or 16% at an annualised rate. Total bank lending has fallen $740 billion from the peak. If you break the data down, credit card balances are off 28%, real estate loans have declined 13.5% and commercial and industrial loans 19.3% (all annualised figures).

This shows up in the broad money data. Growth in M2 is 1.9% year-on-year, the lowest since 1996. Capital Economics calculates a figure for M3, which the Fed has stopped publishing; it has shrunk 3% year-on-year and 5.6% if you annualise the latest quarterly data.

A lack of lending is not just a US phenomenon either. Below is the extract from the latest Bank of England survey:

 

The total flow of net lending to UK businesses

weakened in December. In 2009 Q4 the stock of lending to companies fell across all the main sectors of the economy for the third consecutive quarter, though the stock of lending to commercial real estate companies was broadly unchanged on a year earlier. Syndicated lending remained weak, though lenders reported further signs of renewed activity from foreign lenders. More generally, some major lenders reported downwards pressure on loan pricing for better quality companies, partly reflecting increased competition. Contacts of the Bank’s Agents noted an easing in loan availability, albeit varying by borrower size and sector, and that demand for new corporate borrowing remained weak.mortgage lending slowed in December, though the three-month annualised rate of lending growth remained unchanged. Gross lending and mortgage approvals for house purchase fell in January, according to data from the major UK lenders. Lenders attributed part of the rise in gross mortgage lending towards the end of 2009, and its subsequent fall in January, to some homebuyers seeking to complete house purchases before the removal of stamp duty relief at the start of the year. consumer credit was slightly positive in December, though the twelve-month growth rate of the stock of lending remained negative and at a series low. Net consumer credit flows were reported by the major UK lenders to have weakened in January, partly reflecting adverse weather conditions. However, underlying demand for consumer credit was reported to remain subdued and the availability of credit tight. While effective interest rates on consumer credit fell in December, spreads over Bank Rate and Libor remained significantly wider than in late 2008.

All this is remarkably reminiscent of Japan, as detailed in Richard Koo's excellent book The Holy Grail of Macro-Economics, about which I blogged last week. The problem may not just be that banks are not willing to lend, it is that consumers and businesses are unwilling to borrow; they have too much debt already. The government is the only borrower left but that creates its own problems, as has been widely discussed (Japan's nominal GDP was lower in the third quarter of 2009 than it was in 1992; research shows that growth falls by about 0.12-0.13% a year for every percentage point rise in government spending as a proportion of GDP).

Of course, I said yesterday that we need a new economic model that is not based on debt accumulation. We don't have that model yet, but we are facing the aftermath of a debt binge. Can the economy recover if money supply is shrinking, or is the kind of deflationary stagnation suffered by Japan inevitable?

UPDATE: I confess that the reference to the "new economic model" is wishy-washy and needs a lot more space. The only answer is greater productivity, which could come from technology or some new energy source but this is a bit of a deus ex machina. My rather gloomy rant of yesterday was based on the research (the Reinart/Rogoff book, the McKinsey report on deleveraging) which shows that these debt binges are followed by sluggish growth. I would agree that speculation is an inherent part of capitalism (see Minsky's work) which is why it is so important to control credit growth, something that central banks have not done over the last 20 years. Alas, that's not much help now we are in this mess.

ONE factor that I did not have space to cover in this week's column on housing is the difficulty of generating mortgage finance. But Moody's has just published a report, indicating that the British market may struggle without government support. A key problem is the funding difficulties of building societies (the equivalent of savings & loans) which have historically been a big part of the mortgage market; they suffered a net deposit outflow of £8 billion last year. Two government schemes are being wound down; while this process will take years, it may still induce caution among lenders.

Anecdotal evidence also suggests that all the reports of a housing rebound are finally generating prospective sellers, who are being persuaded by estate agents that their houses can demand premium prices. But with taxes rising, an election due and first time buyers scarce, these sellers may well be disappointed. See the view of one estate agent in my corner of west London. 

THE title of this blog was inspired, directly and indirectly, by my trip to Athens. While there, I met Yannis Tsournaras, one of the 364 economists who signed an open letter criticising Britain's 1981 Budget.

That budget was drafted early on in Mrs Thatcher's first term, a period in office marked by high unemployment and the monetarist experiment, and one that was rescued by General Galitieri of Argentina and his invasion of the Falklands Islands, which transformed her popularity. The budget raised taxes and cut spending in the middle of a recession, violating all Keynesian principles. The 364 economists, who also included Mervyn King (now governor of the Bank of England) and Willem Buiter, now Citigroup's chief economist, denounced the plan as having "no basis in economic theory".

The then chancellor was Sir Geoffrey Howe, a man often underestimated (he later played a key role in bringing down Thatcher). His idea was that bringing down the deficit would allow bond yields and interest rates to fall, and help revive the economy. As it happened, Sir Geoffrey was right and the 364 economists were wrong. Rates fell and the British economy rebounded; strict controls on public spending were in place for years.

So my initial thought for this post was to wonder whether any government (Britian's Conservatives?) would have the courage to repeat Sir Geoffrey's experiment and to wonder whether that might not be the right thing.

But on the way back from Athens, I read The Holy Grail of Macroeconomics: Lessons From Japan's Great Recession by Richard Koo.  This very convincing book argues that Japanese economic policy over the last 20 years has been maligned. He says that the problem was a balance sheet recession in which, thanks to the popping of the asset bubble, the Japanese corporate sector's liabilities were much bigger than its assets. As a result, monetary policy did not work. The problem was not a lack of lending power, but a lack of willing borrowers. Japanese companies were repaying debt at zero interest rates, contrary to all economic theory. (Koo's thesis is well backed up by data.)

In the absence of private sector spending, Koo argues that the Japanese government had to step into the breach. Its huge deficits propped up the economy and saved the country from the kind of falls in GDP suffered by the US in the 1930s (another example of a balance sheet recession, in Koo's view). The mistakes made by Japanese policymakers occurred when they tried to tighten policy, as in 1997, when a rise in the consumption tax pushed the economy back into recession. That lengthened the crisis and resulted in a much bigger debt-to-GDP ratio than might otherwise have occurred.    

This lunchtime, I went to see a talk by Richard Duncan, whose book The Dollar Crisis has been mentioned here before. Mr Duncan has a new book out, Corruption of Capitalism, in which he argues that paper money and government deficits have brought the economy low. But he too seems to accept the Koo arguments and ends by proposing a $3 trillion stimulus plan in which the government invest in solar power, biotech etc to revive the economy. Regardless of whether this plan would have any chance of practical success, and not be just a boondoggle for well-connected corporates, it has zero hopes of political approval. 

So is 1981 or 1997 the right parallel? Sorely tempted as I am by the 1981 example, I have to admit there are crucial differences. Back then, inflation and bond yields were in double digits and there was plenty of scope for interest costs to fall. Now rates seem more likely to rise than fall.

But the 1997 parallel is also depressing, if the result is that we are faced with a long period of rising government involvement in the economy and the inevitable misallocation of resources (bridges to nowhere) that will follow.  

And that brings us back to Greece. The deficit-cutting measures that will be forced on that nation (by the markets or the EU) will be an interesting test. If the economy is liberated and rebounds, then 1981 will have won the day. But if the Greek economy slumps, then Mr Koo, and the 1997 camp, will be right. 

STUCK here for longer than expected, I decided to visit the Acropolis this morning. It was, alas, closed for the strike evoking the obvious metaphor that the Greek economy is in ruins.

Mind you the Bloomberg headline that Athens is "paralysed" by strikes is a gross exaggeration. The Syntagma square, focus of the demonstration, was empty by lunchtime (it is wet and windy here so why turn out?); the cafes and shops were all open and the trams were running. Police had taped off a few streets but motorcyclists just ducked and carried on regardless. One investor described the strike as "kabuki theatre"; the unions have to call it but they are heavily linked to the governing party (Pasok) and will go along with the changes.

Perhaps the more accurate metaphor is that the taxis will strike from 5am tomorrow because, believe it or not, they are expected to provide receipts. Tax evasion is so rife here that the provision of a receipt is an onerous imposition. One person told me that when his child was born last year, he had to pay the doctor 2500 euros; his receipt was for just 1500. A planned government reform is that anyone wanting to claim the 12,000 euro tax allowance will need to produce that amount of receipts; a clever way of getting the tax system in order.

Another area of reform is of the benefits received by civil servants that can be up to half the salary. This even includes a "wood allowance" dating back to the days of wood-fired heating. The biggest potential for pension reform is not raising the pension age but enforcing the existing one; most public sector workers have retired by 59. 

All this suggests there is plenty of fat to cut and the main parties are united behind the idea or reform. There is a lot more that can be done; trucking, for example, is a government-licenced cartel. There are the same number of lorries on the road as in 1990, even though GDP has doubled. It costs the same to transport something from italy to Athens as it does from Thebes, 50 miles away.

The action, of course, is not really in Athens but in Brussels and Frankfurt where the other governments are deciding how to help Greece out. It is all strangely reminiscent of the bank bailouts; the hope is that a display of confidence can see off the speculators but, after Lehman, the notion of allowing a bankruptcy to enforce "moral hazard" is perceived to be too big of a risk.

And so the bailout bill gets passed up the chain. As someone remarked, it is a bit like the Roman phrase Quis custodet ipsos custodes (who guards the guards?); who bails out the bailouters?

THE tricky task of turning planned tax rises into actual revenues is illustrated by a couple of recent articles in the British press. In Sunday's Observer, Helena Smith writes that "Super-wealth investors move billions out of Greece", reporting that eight to ten billion euros may have been moved out of the country since November. One analyst is quoted that

People are moving funds either because they don't trust our banking system, want to avoid what they fear will be taxes on deposits or are simply anxious about the future of our economy

Greece has had a long problem with tax evasion, one of the reasons it is in such a fiscal mess. London, by contrast, has been seen as a haven for the wealthy; President Sarkozy of France came to the city to issue a plea for his compatriates to come home because of the number living in the British capital. But the tide may be turning. There will be a new 50% tax on high earners as of April (and a marginal rate of 60% for those earnings £100,000 a year). The Times reported last Tuesday that the government was significantly reducing its expected take from this tax. Mike Warburton of Grant Thornton said that high earners were

bumping up this year's pay, storing up pay in their firm to be drawn down at a later date, leaving the country or choosing to pay to charity rather than to the taxman

Of course, we should probably be pleased at the fourth of those options and the second may only result in postponing, rather than avoiding the tax bill.

The region that has probably suffered most from capital flight over the years is Latin America but then capital has had plenty of reason to flee. In Argentina, money is exiting again as the government has made a series of moves to address the fiscal crisis, including nationalising the pension funds.

Depending on your political point of view, this is either outrageous avoidance of their responsibilities by the rich or a sensible response to the rapacious demands of governments. It is still pretty hard to stop, short of resurrecting all the capital controls that were abandoned in the last 30 years.   

On that note, I am off to Greece for the next couple of days to test the mood in the country that is at the centre of the fiscal crisis. Will try to blog from there if time permits.

WHAT happens if one combines all three measures of risk - the debt trap (a bond yield higher than the growth rate), the debt-to-GDP ratio and the primary deficit/surplus?

The answers are below. The primary deficit figures are taken from the IMF's November survey, except for Switzerland which wasn't included. I have thrown in a figure from our consensus forecast, but it makes little difference since the Swiss are as safe as you would expect. The primary deficit is the excess of spending over revenues, before interest costs.  Nations in trouble need to run a primary surplus.

Greece looks rather good on this measure but remember this figure was calculated before that country's accounting revisions. But it was best to go with an authoritative source, albeit an out-of-date one.

Combine all three rankings* and Japan now looks very bad, subject to the caveats mentioned in previous posts about its debt being domestic. Imagine if its government had to pay the kind of bond yields that prevail in Britain or America, let alone Greece.

Note also how both Britain and the US have been drifting higher up the tables as we add factors. How dependent has Britain been on quantitative easing to keep its debt costs? Now that the Bank of England is not extending QE (for the time being), we may soon find out.  And note that the resource-rich countries of Australia, Canada and Norway are safely at the bottom.

It would be interesting to know whether hedge funds are getting into this trade. They are normally reluctant because shorting high-yielding debt to buy safe debt is a "negative carry" position; it costs money in the short-term. But at the moment, you get a better yield on Australian than Portuguese debt; that must be a tempting play for some funds. 

This week's column relates this problem of deficits and stimulus packages to the recent setback in equities.

* One point for being first, two for being second and so on. The lower the score, the worse your position. 

ANY complete analysis of national deficit problems must, of course, involve more issues than the growth rate/interest rate measure I used yesterday. The debt trap will close more tightly when a country has a higher debt-to-GDP ratio. So the first table shows the same countries as yesterday, ranked by the OECD's forecast for the debt/GDP ratio as of 2011. Going one year ahead captures at least part of one further factor, the size of the ongoing deficit.* In the case of Britain and America, these ratios are deteriorating rapidly.

The second table simply combines the rankings of today's table with yesterday's five year debt trap table. The higher you are in the table, the worse your position looks. Greece appears above Japan simply on alphabetical order, rather than on anti-hellenic bias. It is mildly amusing that the other tie is between the French "socialists" and the American "capitalists".  

The combined ranking moves both America and Britain into the middle of the distribution, rather than at the safe end. And clearly, if you want security in your government bonds, Scandinavia looks a good bet.

Japan, as one commenter on the last post rightly says, is in a rather different position because it largely owes the money to itself. This does not eliminate the problem altogether. In their excellent book This Time is Different, Reinhart and Rogoff find 70 cases of domestic default since 1800; even where countries do not default, they may resort to inflation. In Japan's case, the ageing population will be looking to run down its savings, rather than purchase additional bonds.

* I hope to produce another set of tables, with the primary deficits (before debt interest is paid), in due course. 

UPDATE: Negative debt/GDP numbers mean that government assets outweigh liabilities. The OECD numbers do not contain contingent liabilities, like public sector pension funds.