Sunday, August 21, 2005
Bank is split as the outlook gets stormy
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Readers with long memories may recall Goodhart’s law, devised by former Bank of England chief adviser and monetary policy committee (MPC) member Charles Goodhart. This Murphy’s law of economics states that any indicator you target soon becomes unreliable.

It applied to the Thatcher government’s attempts to find a reliable measure of the money supply in the 1980s. It applies now to the consumer prices index (CPI), the inflation measure the Bank was switched to by Gordon Brown after the Treasury’s last assessment of Britain’s readiness for the euro two years ago.

Inflation on the CPI measure “jumped” to 2.3% last month, above the 2% target. The old target measure, the retail prices index excluding mortgage-interest payments, also showed a rise, to 2.4%, but this was below its previous target of 2.5%.

One of the key differences between the two is that the CPI excludes house prices. When the change was made, Brown was criticised for choosing a measure that left out an inflationary part of the economy. Now the inflation rise on the new measure reflects mainly the unfettered impact of higher oil prices. The lesson? Don’t tinker with the target.

Britain’s inflation rate of 2.3% is now running above that in euroland (2.2%) for the first time in a very long time. Britain is still growing faster than the euro area, but only just — gross domestic product here rose by 0.4% in the second quarter compared with 0.3% in euroland. Italy grew by a surprising 0.7%.

We should put the rise in UK inflation in perspective. The consumer prices index is above target but it rose by only 0.1% last month. In contrast, consumer prices in Zimbabwe rose by 47% in July alone. In the mid-1970s, when Britain really did have an inflation problem, prices rose by 4.2% in a single month, May 1975.

All that is by way of a preamble. The big story of the past two weeks has been the bonfire of interest-rate-cut hopes. I cannot remember a time when hopes of lower rates have been battered so comprehensively.

First there was the Bank’s inflation report, which implied that the markets were mad to be pricing in further rate cuts, and that the inflation target would only just be met with a 4.5% rate.

Then we had those inflation figures. Despite an apparent rise in “core” inflation, this is essentially an oil story. As discussed last week, inflation will drop as the oil price falls. So-called second-round effects are not coming through; wage settlements, if anything, are drifting lower. But the news was not good.

Not only that, but retail sales volume fell by just 0.3% last month, suggesting that the British Retail Consortium (BRC) — with its tales of high-street Armageddon — has been crying wolf.

I hold no brief for the BRC but that’s unfair. The retailing picture is indeed very weak, particularly for non-food sales, where most discretionary spending is concentrated. Retail-sales volume in the latest three months was up by only 1.3% on a year earlier, the weakest since February 1999. Household-goods stores’ sales volume dropped 0.9%, their poorest performance since December 1992. The value of all non-food sales last month was down by 1.8% on a year earlier.

Tie the retailers’ experience to the latest job statistics, which show the sixth successive rise in unemployment claims, and the economic slowdown looks genuine, not a figment of statisticians’ imagination.

Most significant of all, last week we had the minutes of the MPC’s meeting earlier this month, its 100th, which showed that it celebrated in unusual style. Not only was the vote close, just 5-4 for a cut, but Mervyn King voted against — the first time a governor has been outvoted on a rate change. He was joined by his two deputies, Rachel Lomax and Sir Andrew Large, along with Paul Tucker, the Bank’s executive director responsible for markets. Charles Bean, its chief economist, was the sole member of the Bank establishment who joined the four external members in voting for a cut.

This looks odd. How can the head of an organisation, and his deputies, be outvoted on the Bank’s core task of setting interest rates? Eddie (now Lord) George never allowed it to happen; Alan Greenspan would not countenance it. How can King and his colleagues defend the strategy of the majority if they disagree with it? Should the rest of us regard this month’s cut in base rate as not genuine and likely to be reversed at the earliest opportunity? The Bank’s view is that this month’s vote shows how the system was meant to work. All MPC members are equal and the governor, like any other, can be outvoted.

Except, of course, they are not all equal. King devised the Bank’s inflation report and presents it to the world at a press conference, as he has done for the past 12 years. This month’s report, as noted, was unusually hawkish in tone. Would it have been presented differently by one of the five who voted for lower rates? I suspect so. The Bank establishment may have been in the minority but its view came across louder and clearer than the majority.

Am I arguing that King should have bitten his lip and voted for a cut in rates even if he thought it was wrong? To some in the City his “no change” vote, coupled with the subsequent inflation numbers, make him something of a hero.

I’m not sure about that. The case for lower rates was based on the weakness of the economy in the first half of the year. It was a good case. What appears to have held the Bank establishment back is the worry that, if they acceded to a rate cut, it would be difficult to explain a subsequent increase if it proved necessary.

That goes against what the MPC was supposed to bring to monetary policy. When chancellors used to set rates they found U-turns hard because their political opponents would seize on them. The MPC has never had this problem, and nor should it. It should always be flexible, never rigid.

So what will happen to rates? It would take a brave man to predict another rate cut before the end of the year after recent events, though a weak economy could still bring that about. Looking into next year, it would be an odd interest-rate cycle that featured just one cut. The probability is of more.

PS Lest we get too worried about inflation, bear in mind the consumer prices index has risen only 13.6% since 1996, roughly 1.5% a year. Within that, however, there have been some huge increases. The biggest is home heating oil, up 95%, outstripping a 57% increase in petrol and motor oil.

But how do you justify an 81% increase in car insurance — 9% a year? This is an industry that promotes itself as competitive but appears anything but. One of my regular correspondents points out that this increase has occurred in the context of a 28% drop in car theft, a 39% fall in stealing from cars, a 5% drop in road deaths and a 33% decline in serious injuries. Perhaps we’ve been paying for the privilege of seeing Joanna Lumley and Michael Winner on our TV screens.

There have been other notable price increases. Hairdressing and personal-grooming establishments have raised their prices by 58% since 1996. For those of us still sporting a full head of hair and enjoying a weekly manicure, life has become more expensive.

Finally, the cost of education is up 62%. Some of that reflects university- tuition fees but most of it is private education. No wonder the A-level results were so good.

From The Sunday Times, August 21 2005


Even with Goodhart's and Murphey's law there is fractal order to the macro economy...

Valuation fractals represent a composite integration of primarily six elements in the complex economic system: cash and savings, debt, wages, assets, lending practices, and prevailing interest rates. Each of these six broad parameters has its own complex internal dynamics and summation characteristics. In a very mechanistic fashion, following simple near-quantum and near-quantum related Fibonacci numbers, valuation fractals 'grow' to buying saturation levels and thereafter 'decay' to lower selling saturation levels. The fundamental point is that the daily, weekly, monthly, and yearly valuation fractals represent the sum total integration of those six elements and their complex interactive relationships. Pour into the economic vat: cash for daily transactions, savings available for money to be borrowed at given interest rates using prevailing lending practices for both major purchases and minor credit card purchases, balanced by on-going wages and debt servicing obligations, balanced by relative valuation of assets and their relative state of consumption, mix it up on a daily, weekly, etc. basis - and - from the vat flows forth the daily, weekly, etc. summation fractals. While lower order time unit fractals such as minutes and hours represent trading valuation saturation points, intermediate fractals represent the larger picture of on going velocity of money growth percolating through the system. The higher order or 4-yearly, 17-18 yearly and 70 year fractals represent both business cycle and asset and debt saturation levels at the basic consumer level.

There are three sequential identified ideal growth fractals followed by a decay fractal. The near quantum number time units for the three cycles are x, 2-2.5x and 2x, respectively. A nonlinear devaluation typically characterizes the second growth fractal somewhere between the 2x and 2.5x time period. The third growth fractal which ideally is 2x in length can have an extension to 2.5x. This extension of the third growth fractal has characterized both the current US equity and heavily invested commodity areas, particularly oil and gold, for the entire 128 week duration of the March 2000 secondary growth period.

Just as the complex system is an integrative process, valuation fractals which exactly represent them are likewise composite nonlinear integrations. Fractals incorporate the terminal portion of the preceding decay fractal into the beginning of the follow-on growth fractal. An elegant pristine example of this rolling integration was the 40/100/100 day cycle exactly x/2.5x/2.5x that resulted in the March 2005 top for the DJIA. The first two fractals were 'declining' growth fractals with a very characteristic nonlinear break at the end of the second fractal in August 2004. That second fractal was likewise elegant in its evolution in that it was composed of a 29/72 day x/2.5x sub fractal sequence. The probability that these precise sequences are random numerical sequential events approaches zero and elevates fractal analysis, reciprocally, to a high probability real science descriptive of the complex macro economy.

The subsequent growth fractals dating from August 2004 likewise have followed the same very precise fractal growth evolution with a 52/130 (x/2.5x) day first and second fractal growth sequence with the typical nonlinear drop between 2x and 2.5x of the second fractal. Anyone can verify this pattern using any of the major US or European indices. The third fractal US equity sequence has been a 12/30-31/28 day sequence, approaching the extended ideal form of x/2.5x/2.5x growth pattern. The major European indices ,e.g., the FTSE, DAX, and CAC have a slightly different mix of the six aforementioned underlying elements and have extended their growth - but are still confined within the 52/130/104 theoretical maximum and the theoretical Fibonacci maximum of 52/130/(1.62 X 52 = 84-85)
days. These recurrent numerically ideal patterns since August 2004 once again lend substantial credibility to the notion that the complex macroeconomy operates according to some relatively precise laws of fractal design.

What are the rate limiting factors that result in growth saturation points or asymptotes, decay selling saturation points or asymptotes, and the general nature of fractal patterning? Each of the six controlling parameters- assets, ongoing wages, lending practices, prevailing interest rates, debt load, and cash and savings - contribute to the saturation areas. Some are more important than others in determining cycle lengths and saturation points.

Assets have two important elements: relative valuations and saturation ownership. If the valuation becomes too high or too overly consumed, demand
will decease. The timing for this decrease is exactly represented by an asymptotic valuation saturation level or a single high valuation point followed by lower valuations. The valuation curves provide precise barometric information on demand relative to valuation level and relative to the consumption level. Some assets such as gas and oil must be purchased to maintain livelihood. As global consumption for the this finite resource increases, resulting price increases squeeze the null saving US consumer,
far too many living from paycheck to paycheck, to the financial breakpoint. Unnecessarily expensive US healthcare, 25 percent of the value of which goes to third party insurers and the non-value added bill collection system, can be considered yet another consumable asset, that, like 'uninsured equivalent' gasoline prices, is driving many to insolvency.

Ongoing wages and just as important the jobs that support those wages are perhaps the most important rate limiting factor in determining valuation saturation points. In the US jobs sphere, high paying manufacturing jobs with the exception of the housing industry have been significantly outsourced. As the housing bubble crests, overcapacity will become evident and high paying home construction jobs will contract. A considerable subset of jobs in America have questionable value-added real economic worth and will be lightened during consumer retrenchment. It is easy to image using the 1930's as a template of a positive feedback contracting system, where decreased ,e.g., construction jobs lead to decreased consumer spending leading to further job contraction leading to further spending contraction
and so forth.

Lending practices and prevailing interesting rates, the latter a Federal Reserve controlled parameter, work in synergy to foster money creation and asset inflation. Fractional reserve lending practices amplify the bank and money market savings used as a reserve base for lending. Extremely low interest rates, i.e., a Fed fund rate of 1 percent coupled with a lending practice of LIBOR type loans, no money down and interest only payments creates the interesting situation in which the interest cost of money is far below the real asset inflation rate. Not to borrow is to lose money that would be made with the expected inflation. Saving money under these interest rate and lending practice guidelines results in loss of purchasing power. Credit card interest rates reflect the needed higher interest rates to overcome the default rate. The last year of higher Fed Fund interest rates have resulted in both increased mortgage payments and decreased bank profitability secondary to the contracting spread of long term verses short term interest rates.

Ongoing debt load and the requirement to service that debt diminishes cash available for asset consumption and investment. Percentage wise the total debt load relative to wages and GDP has had very small incremental increases - a fact which has mistakenly reassured many linear thinking economists.
Debt load becomes a primary factor in the fractal decay process, where assets are liquated in an attempt to pay down debt. This results in a mechanistic deflationary process, lowering the value of nearly all non cash or non-cash equivalent assets.

Cash is the money that is represented by greenbacks in circulation and greenback equivalent readily convertible debt instruments such as treasuries, notes, bonds, bank deposits, and money market funds. In short cash represents the dollars in circulation and savings. The savings rate, which the Federal Reserve has bemoaned to be dangerously low and was reported to be zero in July, reflects the competition of the the various
Investment areas. With interest rates below the real(which includes housing) asset inflation rates, deposited money in saving instruments loses its purchasing power value its week that it is malinvested. Deposited money in saving instruments has been generally a bad investment in the last few years. During the decay fractal process, this scenario will be reversed with money from ongoing asset liquidation flowing into cash and cash equivalents, whose purchase power value will increase relation to asset devaluation.

These are the lumped six broad elements that are interacting with each other
to create the summation and integration valuation points, curves, saturation inflection asymptotes and fractals that respectively describe the real instantaneous state, the trending state, the saturation areas, and importantly the expected fractal nonlinearities of the complex macro economic system. Gary Lammert

Posted by: gary lammert at August 21, 2005 10:39 PM
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