Archive | November, 2012

Forecast for Pound Sterling in 2013

A look at the future prospects for the Pound in the coming months of 2013.


Sterling index

The Sterling index measures the value of the Pound Sterling against a basket of trade weighted currencies.

  • In  Dec 2011 the index was 80.4
  • By Oct 2011, the exchange rate index has increased to 83.6

This modest appreciation in the Pound has occurred despite:

  • Double dip recession in UK
  • UK Inflation remaining above target
  • Growing current account deficit
  • Quantitative easing increasing money supply.
  • One of largest budget deficits in OECD

Therefore the appreciation in the Pound is not so much a reflection of the strength of the UK economy – but a reflection of market nervousness about other currencies. In particulary, given the Euro crisis and difficulties of Eurozone economies, the Pound offers a greater semblance of normality and confidence.

However, given the weak state of the UK economy, it is likely that the fortunes of the Pound could deteriorate in 2013 – especially against the dollar and currencies other than the Euro.

In particular, the growing UK current account deficit (now over 5% of GDP) suggests underlying lack of balance between imports and exports.


The UK has one of the largest current account deficits in the OECD. There are other reasons to explain the current account deficit, but the widening of the deficit to over 5% of GDP, suggests the Pound is becoming more uncompetitive against its main rivals. In a floating exchange rate, this is likely to lead to some depreciation in the future.

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Investment in UK – Business and Public Sector


Total UK Business investment, slow recovery from 2009. (seasonally adjusted, Current Prices)

business investment growth

Source: ONS Q3 2012

An unconvincing recovery in business investment.

But still, business investment increased by £1.3 billion (4.5 per cent) when compared with the third quarter of 2011.

The outlook for business investment remains muted:

  • Despite low interest rates, banks are maintaining strict lending criteria and rationing finance. Many small and medium sized firms still state finance is difficult to come by.
  • Prospects for economic recovery are poor. The Bank of England’s latest inflation report painted a gloomy picture of an economy struggling to post positive economic growth.
  • With more austerity to come, business and consumer confidence is low.
  • Some reduction in producer price inflation has increased the profitability of business investment. However, commodity prices are volatile and there is no guarantee this low input inflation will continued.
  • Euro-zone debt crisis and EU recession also weigh heavily on UK investment decisions.

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Why Can Japanese Government borrow at Low Interest Rates?

Readers Question: After the insightful post on ‘Italian Economic Decline’, I was particularly captured by the % debt to GDP line graph of the different developed countries. The one thing that really caught my eye was Japan’s huge % debt to GDP and yet their government bond yields are consistently declining. Aren’t the markets worried that Japan may default on their debt someday or is the fact that they have a lender of last resort (no fear of liquidity problems) unlike Italy and their 0% interest rates shielding them from augmenting yields?

Source: Hoshi and Ito (2012).

It is true that Japanese public sector debt is over 229% of GDP, yet bond yields in Japan remain low. It seems the markets have no current concerns over Japanese repayment. Spain might feel aggrieved that they face rapidly rising bond yields – even though their public sector debt (70% of GDP in 2011) is considerably lower.

  • Japan debt 229.1% of GDP on a gross basis, and 127.8% of GDP on a net basis

Why Can Japan Government Debt be So High at Low Interest rates?

  1. High levels of savings in Japan. Japan’s saving ratio has fallen in recent years (partly due to ageing population) but although it may sound a paradox, there are still high levels of domestic saving. Upto now, this large pool of savings have been used to buy Japanese government debt. (Japan Saving ratio) Continue Reading →

Germany’s Current Account Surplus

A few years ago, global trade imbalances were dominated by China and the US. At its peak, China’s current account surplus reached over 10% of GDP. By contrast, the US current account deficit reached over 6% of GDP. The classic image was of China manufacturing goods, selling them to the US  consumer.

Then with this export revenue, China bought US Treasuries to keep the Chinese Yuan permanently undervalued. Many in the US criticised China for this ‘currency manipulation‘ – In fact, Mitt Romney, the 2012 Republican Presidential candidate, promised to label China a currency manipulator from day one. However, Romney was really a couple of years behind reality.


China still has a current account surplus, but it has fallen from 10% of GDP to 2.6% of GDP in 2012. China’s currency is no longer chronically undervalued, and the Yuan has appreciated 40% in real terms against the Dollar since 2005. Although China’s economy is still reliant on exports and investment, it has begun a process of rebalancing the economy. It is not the same source of global imbalances that it was five years ago,

The biggest global imbalances, in absolute terms, now come from Germany, who have seen their current account surplus to continue to increase. In Q3 2012, their current account surplus widened to $58 211 million (equivalent to an annualised surplus of  $ 232,844 million – (7.0% of GDP) OECD)

Current Account Deficits


The largest current account surplus is in Switzerland (13.1% of GDP) though this reflects the unique challenges Switzerland faces as a safe haven resort (investors trying to save money in a safe currency are pushing up the Swiss Franc causing an appreciation.)

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Cost of Benefit Fraud v Tax Evasion in UK

Benefit fraud and tax avoidance are currently emotive topics. What is the extent of benefit fraud and tax fraud in the UK?

Benefit Fraud

  • For 2011/12 (preliminary), it is estimated that  2.0 per cent of total benefit expenditure  was overpaid due to fraud and error.
  • In 2010/11 – benefit fraud was estimated at £3.4bn – 2.2% of total benefit expenditure (£154bn)
  •  (Dept for Work and Pensions)
  • It is also estimated that 0.9%, or £1.3bn, of total benefit expenditure was underpaid due to error.

More specifically

  • 4.4%, or £350m, of Income Support expenditure has been overpaid;
  • 6.5%, or £290m, of Jobseeker’s Allowance expenditure has been overpaid;
  • 6.0%, or £500m, of Pension Credit expenditure has been overpaid;
  • 2.4%, or £130m, of Incapacity Benefit expenditure has been overpaid;
  • 4.7%, or £1030m, of Housing Benefit expenditure has been overpaid.
  • (Dept for Work and Pensions)

Public Perception of Benefits

The public have an increasingly negative opinion to benefit claimants. A study suggested that 1 in 5 people believe a majority of claims are false, while 14% believe a majority of claims are fraudulent.  Benefits stigma

Benefits Unclaimed

“In 2010 an estimated £16 billion in benefits and tax credits were unclaimed. (charities claim £16bn a year unclaimed at Telegraph)

For example, the Dept for work and pension estimate:

Pension Credit: The number of pensioners that were estimated to be entitled but not claiming Pension Credit was between 1.21 million and 1.58 million. The total amount of Pension Credit unclaimed was between £1.94 billion and £2.80 billion.  (DWP) Continue Reading →

Italian Economic Decline

In the past 20 years, the Italian economy has stagnated compared to its main international competitors. Using different measures, such as labour productivity and relative GDP growth – Italy has fallen significantly behind. Despite low budget deficits (and primary surpluses) Italy is facing high bond yields and crippling interest payments. These high bond yields are in response to both the high levels of debt – but also the continued economic weakness.

Italian Productivity

italian productivity

Italian productivity relative to the UK. In the 1990s and 2000s, Italian output per workers has fallen behind it’s main competitors. It’s a similar story if we compare Italian productivity to France or Germany.

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The Economic Cost of High Bond Yields

Readers Question I’ve recently been looking up on the Eurozone financial crisis for random reasons and i don’t understand the statement in an FT article about what we must acknowledge in order to overcome the Eurozone problems. The statement goes ‘no country can be expected to generate huge primary surpluses for long periods for the benefit of foreign creditors’. Please can you help?!

Firstly, it is not an easy article – there is a lot of jargon! To quote:

“A fundamental shift of tack is required, towards an approach focused on avoiding systemic risk, restarting growth and restoring arithmetic credibility rather than simply staving off disaster”

To answer your question:

A primary budget surplus is the government budget balance excluding the cost of interest payments on government debt.

  • Suppose the UK budget deficit is 11% of GDP.
  • But, interest payments on the government debt cost around £40bn or 3% of GDP.
  • Therefore, the primary budget deficit of the UK is 8%.
  • Suppose Italy’s budget deficit is 2% of GDP, but interest payments are 7% of GDP. In this case Italy actually has a large primary surplus of 5% (even though an actual budget deficit of 2% of GDP)

Source: OECD Economic Outlook June 2012

This graph showing changes in primary balances shows how countries in the Eurozone have pursued fiscal tightening (spending cuts and tax increases) to reduce their budget deficits. Excluding interest payments, many now have a primary budget surplus.

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GDP at PPP compared to GDP in $US

A look at how GDP per capita in $US gives different values when measured at purchasing power parity.


GDP at Purchasing Power parity (PPP) takes into account variations in living costs.

PPP is an attempt to work out how much currency will be needed to buy the same quantity of goods and services in different countries. If this can be done, it can show the underlying exchange rate between the two different countries and a more accurate reflection of actual living standards in countries.

Often exchange rates don’t actually reflect different living costs because some goods are not easily traded. For example, if you live in Norway, it is irrelevant if there is cheaper accommodation elsewhere in the world. What is important is how far your income goes in buying goods and services.

Norway v India

For example, GDP per capita in Norway is $98,102. However, in Norway the cost of living is much higher (higher VAT, higher wages, higher rents). Therefore, even if you have a salary of $98,102 – it doesn’t go as far as elsewhere in the world..

By comparison, in India, GDP per capita is $1,489 per year. However, in India, living costs are much lower and so that income goes much further. If we adjust for the relative cost of living in the different countries, the gap between India and Norway is much reduced.

  • Using GDP per Capita in $US, Norway’s national income is 65 times higher than India.
  • Using GDP per Capita adjusted for PPP, Norway’s national income is only 17 times higher than India.

So we get quite a different outlook.

GDP per capita in PPP is the most useful for comparing living standards. If your income increased £400 a month, but at the same time your rent increased by £400 – would you feel any better off? No.

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Costs and Benefits of Globalisation

Globalisation is a complex and controversial issue. This is a look at some of the main benefits and costs associated with the greater globalisation of the world economy.

Definition of Globalisation – the process of increased integration and co-operation of different national economies. It involves national economies becoming increasingly inter-related and integrated.

Globalisation has involved:

  • Greater free trade.
  • Greater movement of labour.
  • Increased capital flows.
  • Growth of Multi-national companies.
  • Increased integration of global trade cycle.
  • Increased communication and improved transport, effectively reducing barriers between countries.

Benefits of Globalisation

1. Free Trade Free trade is a way for countries to exchange goods and resources. This means countries can specialise in producing goods where they have a comparative advantage (this means they can produce goods at a lower opportunity cost). When countries specialise there will be several gains from trade:

  1. Lower prices for consumers
  2. Greater choice of goods
  3. Bigger export markets for domestic manufacturers
  4. Economies of scale through being able to specialise in certain goods
  5. Greater competition

See: Benefits of Free Trade


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GDP per Hours Worked v GDP per Capita

Readers Question: Which is more useful for determining living standards – GDP/capita and GDP/working hour

  • GDP per capita measures national income per population
  • GDP per working hour measures national income / total hours worked in economy.

source: US bureau of labour statistics

GDP per capita would probably be the first measure to look at. It is the most obvious reflection of national income per person.

GDP per hours worked is also useful for determining the productivity of an economy. Though it depends what determines the number of hours worked – For example, is a low number of hours (and high GDP per hours worked) due to unemployment or greater efficiency leaving more time for leisure?

GDP / working hour could be inflated if there is a rapid drop in employment and hours worked. For example if unemployment increased by 1 million because firms became much more strict in getting rid of surplus labour (causing structural unemployment) this would cause an increase in labour productivity and higher GDP per working hour. But, the rise in unemployment is a clear drop in living standards.

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