The Monetary Situation

Anthony J. Evans Associate Professor of Economics, ESCP Europe

Director, Kaleidic Economics

www.kaleidic.org

October 14th 2014

Contents

•  Some background data –  Money and financial markets 03 –  Output and the labour market 22 –  Costs and prices 38 –  International economy 51

•  Threats to global growth –  EU 61 –  China 65

2

Money and financial markets

3

No major changes on broad money growth or lending

4 Notes: YoY growth rates NSA Source: Bankstats Table A2.2.2 and A2.3 (for M3), Bank of England, September 2014

-8

-6

-4

-2

0

2

4

6

M4 M4 excluding intermediate OFCs M4 lending M4 lending excluding intermediate OFCs M3

M4 growth continues to be driven by private non-financial corporations and household sector

5

-20

-15

-10

-5

0

5

10

15

Other Private Household Other SA Private SA Household SA

YoY growth rates Bankstats Table A4.1, Bank of England, September 2014

M4 lending to households has grown consistently, with high consumer credit growth compensating for contractions in unincorporated business and non profits

6

-8

-6

-4

-2

0

2

4

6

8

household credit Unincorporated

YoY growth rates NSA Bankstats Table A4.1, Bank of England September 2014

0.6%

2.5%

Consumer credit increasingly driven by “other” (i.e. non credit card) sources

7

-6

-4

-2

0

2

4

6

8

10

card

other

YoY growth rates NSA Bankstats Table A4.1, Bank of England September 2014

Credit conditions look stable

•  Demand for secured lending for house purchases fell in 2014 Q3 but is expected to pick up in Q4

•  Availability of secured credit to households fell in the three months leading up to September 2014. However this follows eight consecutive quarters of expansion and is expected to increase over the next three months

•  Demand for lending now expected to be driven by M&A, capital investment, and commercial real estate

8 Bank of England Credit Conditions Survey 2014 Q3, October 7th 2014

Narrower measures show robust growth

9 YoY growth rates Bankstats Table A1.1.1 and A6.1 (for Divisia, NSA), Bank of England, September 2014; and Kaleidic Economics for MA

0

2

4

6

8

10

12

14

16

2012 Oct

Nov Dec 2013 Jan

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2014 Jan

Feb Mar Apr May Jun Jul Aug Sep

Private non-financial Divisia MA Household Divisia Notes and coin

A note on MA

10

-15%

-10%

-5%

0%

5%

10%

15% Ja

n-01

M

ay-0

1 S

ep-0

1 Ja

n-02

M

ay-0

2 S

ep-0

2 Ja

n-03

M

ay-0

3 S

ep-0

3 Ja

n-04

M

ay-0

4 S

ep-0

4 Ja

n-05

M

ay-0

5 S

ep-0

5 Ja

n-06

M

ay-0

6 S

ep-0

6 Ja

n-07

M

ay-0

7 S

ep-0

7 Ja

n-08

M

ay-0

8 S

ep-0

8 Ja

n-09

M

ay-0

9 S

ep-0

9 Ja

n-10

M

ay-1

0 S

ep-1

0 Ja

n-11

M

ay-1

1 S

ep-1

1 Ja

n-12

M

ay-1

2 S

ep-1

2 Ja

n-13

M

ay-1

3 S

ep-1

3 Ja

n-14

M

ay-1

4

MA is defined as Currency + Demand Deposits This shows MA excluding MFI deposits, see http://www.kaleidic.org/news/2014/7/2/first-glance-at-m4ex.html)

Band of 8.7%-10.9% from Feb 2013-Oct

2014

Major currencies similar to pre crisis levels…

11

60

70

80

90

100

110

120

01-J

an-0

6 01

-Apr

-06

01-J

ul-0

6 01

-Oct

-06

01-J

an-0

7 01

-Apr

-07

01-J

ul-0

7 01

-Oct

-07

01-J

an-0

8 01

-Apr

-08

01-J

ul-0

8 01

-Oct

-08

01-J

an-0

9 01

-Apr

-09

01-J

ul-0

9 01

-Oct

-09

01-J

an-1

0 01

-Apr

-10

01-J

ul-1

0 01

-Oct

-10

01-J

an-1

1 01

-Apr

-11

01-J

ul-1

1 01

-Oct

-11

01-J

an-1

2 01

-Apr

-12

01-J

ul-1

2 01

-Oct

-12

01-J

an-1

3 01

-Apr

-13

01-J

ul-1

3 01

-Oct

-13

01-J

an-1

4 01

-Apr

-14

01-J

ul-1

4

AUD

EUR

USD

Monthly average effective exchange rate (1990 average = 100), Bank of England, September 2014 Series codes: XUMAADG, XUMAERG and XUMAUSG

60

70

80

90

100

110

120

01-S

ep-1

2

01-O

ct-1

2

01-N

ov-1

2

01-D

ec-1

2

01-J

an-1

3

01-F

eb-1

3

01-M

ar-1

3

01-A

pr-1

3

01-M

ay-1

3

01-J

un-1

3

01-J

ul-1

3

01-A

ug-1

3

01-S

ep-1

3

01-O

ct-1

3

01-N

ov-1

3

01-D

ec-1

3

01-J

an-1

4

01-F

eb-1

4

01-M

ar-1

4

01-A

pr-1

4

01-M

ay-1

4

01-J

un-1

4

01-J

ul-1

4

01-A

ug-1

4

01-S

ep-1

4

AUD

EUR

USD

… albeit Euro falling and Dollar rising more recently

12 Monthly average effective exchange rate (1990 average = 100), Bank of England, September 2014 Series codes: XUMAADG, XUMAERG and XUMAUSG

Effective exchange rate of sterling

13

60

70

80

90

100

110

120

130 01

-Jan

-80

01-N

ov-8

0 01

-Sep

-81

01-J

ul-8

2 01

-May

-83

01-M

ar-8

4 01

-Jan

-85

01-N

ov-8

5 01

-Sep

-86

01-J

ul-8

7 01

-May

-88

01-M

ar-8

9 01

-Jan

-90

01-N

ov-9

0 01

-Sep

-91

01-J

ul-9

2 01

-May

-93

01-M

ar-9

4 01

-Jan

-95

01-N

ov-9

5 01

-Sep

-96

01-J

ul-9

7 01

-May

-98

01-M

ar-9

9 01

-Jan

-00

01-N

ov-0

0 01

-Sep

-01

01-J

ul-0

2 01

-May

-03

01-M

ar-0

4 01

-Jan

-05

01-N

ov-0

5 01

-Sep

-06

01-J

ul-0

7 01

-May

-08

01-M

ar-0

9 01

-Jan

-10

01-N

ov-1

0 01

-Sep

-11

01-J

ul-1

2 01

-May

-13

01-M

ar-1

4

Monthly average effective exchange rate (Jan 2005 = 100), Bank of England, September 2014 Series code: XUMABK67

Sterling continues to strengthen since mid 2013

14

70

72

74

76

78

80

82

84

86

88

90

Monthly average effective exchange rate (Jan 2005 = 100), Bank of England, September 2014 Series code: XUMABK67

Production and manufacturing rising…

15 Seasonally adjusted Index of Production August 2014, ONS, October 7th 2014 (Fig. 1)

92

94

96

98

100

102

104

2012MAY 2012SEP 2013JAN 2013MAY 2013SEP 2014JAN 2014MAY

Index of Production Index of Manufacturing

… but - unlike services - still catching up ground on pre crisis levels

16

90

95

100

105

110

115 20

03 Q

1 Q

2 Q

3 Q

4 20

04 Q

1 Q

2 Q

3 Q

4 20

05 Q

1 Q

2 Q

3 Q

4 20

06 Q

1 Q

2 Q

3 Q

4 20

07 Q

1 Q

2 Q

3 Q

4 20

08 Q

1 Q

2 Q

3 Q

4 20

09 Q

1 Q

2 Q

3 Q

4 20

10 Q

1 Q

2 Q

3 Q

4 20

11 Q

1 Q

2 Q

3 Q

4 20

12 Q

1 Q

2 Q

3 Q

4 20

13 Q

1 Q

2 Q

3 Q

4 20

14 Q

1 Q

2

Index of Production Index of Manufacturing

Seasonally adjusted Index of Production August 2014, ONS, October 7th 2014 (Fig. 2)

Gilt yields falling slightly since the summer

17

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5 01

-Jan

-10

01-M

ar-1

0

01-M

ay-1

0

01-J

ul-1

0

01-S

ep-1

0

01-N

ov-1

0

01-J

an-1

1

01-M

ar-1

1

01-M

ay-1

1

01-J

ul-1

1

01-S

ep-1

1

01-N

ov-1

1

01-J

an-1

2

01-M

ar-1

2

01-M

ay-1

2

01-J

ul-1

2

01-S

ep-1

2

01-N

ov-1

2

01-J

an-1

3

01-M

ar-1

3

01-M

ay-1

3

01-J

ul-1

3

01-S

ep-1

3

01-N

ov-1

3

01-J

an-1

4

01-M

ar-1

4

01-M

ay-1

4

01-J

ul-1

4

01-S

ep-1

4

20 yr

10 yr

5 yr

Monthly average yield from British Government Securities, October 1st 2014, Bank of England

Standard variable rates have been steadily rising

18

0

1

2

3

4

5

6

Tracker 5 year fix SVR

Series IUMBV24, IUMBV42 and IUMTLMV from Bank of England. 5 year fix is 75% LTV. Lifetime tracker. Updated October 10th 2014.

Deposit rates are falling

19

0

0.5

1

1.5

2

2.5

3

3.5

4

2 yr bond Instant access (include bonuses) Instant access (excl bonuses)

Series IUMB6RH , IUMB6VJ and IUMB6VK from Bank of England. All NSA. Monthly interest rates (excl. central bank). Updated October 10th 2014.

FTSE 100 has fallen since September but similar levels to Spring 2007

20 Yahoo! Finance, October 10th 2014

FTSE all-share index shows continued growth

21 Yahoo! Finance, October 10th 2014

Output and the labour market

22

Good employment data relative to last year

23

Employment (aged 16 and over)

Unemployment (aged 16 and over) Inactivity (aged 16 to 64) Inactivity (aged 65+)

Changes 774 -468 -31 167

-600

-400

-200

0

200

400

600

800

1000

Thousands, seasonally adjusted UK Labour Market, ONS, September 2014

Unemployment continues to fall, reaching 6.2% (May-Jul 2014)

24 UK Labour Market, ONS, September 2014

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Jan-Mar 1997

May-Jul 1998

Sep-Nov 1999

Jan-Mar 2001

May-Jul 2002

Sep-Nov 2003

Jan-Mar 2005

May-Jul 2006

Sep-Nov 2007

Jan-Mar 2009

May-Jul 2010

Sep-Nov 2011

Jan-Mar 2013

May-Jul 2014

7% threshold for Forward Guidance was reached in Feb

2014

Continue to see low pay growth – only 0.7% higher than last year

25

-4

-2

0

2

4

6

8 Ja

n 07

M

ar 0

7 M

ay 0

7 Ju

l 07

Sep

07

Nov

07

Jan

08

Mar

08

May

08

Jul 0

8 S

ep 0

8 N

ov 0

8 Ja

n 09

M

ar 0

9 M

ay 0

9 Ju

l 09

Sep

09

Nov

09

Jan

10

Mar

10

May

10

Jul 1

0 S

ep 1

0 N

ov 1

0 Ja

n 11

M

ar 1

1 M

ay 1

1 Ju

l 11

Sep

11

Nov

11

Jan

12

Mar

12

May

12

Jul 1

2 S

ep 1

2 N

ov 1

2 Ja

n 13

M

ar 1

3 M

ay 1

3 Ju

l 13

Sep

13

Nov

13

Jan

14

Mar

14

May

14

Jul 1

4

Private sector Public sector

% change year on year, 3 month average UK Labour Market, September 2014, ONS, September 17th 2014

Some big revisions should reaffirm skepticism towards the National Accounts

•  The peak to trough fall of the economic downturn in 2008/2009 is now estimated to be 6.0%. Previously this was estimated to be 7.2%.

•  2012 GDP was 6.2pc larger than we previously thought* •  In Q2 2014, GDP was estimated to have been 2.7% higher

than the pre-economic downturn peak of Q1 2008, having first exceeded this peak in Q3 2013.

•  Largely due to reclassifications of Research and Development spending and inclusion of sex and drug industries

26 Quarterly National Accounts, Q2, 2014 (published September 30th 2014) * Allister Heath, http://www.telegraph.co.uk/finance/economics/11073744/Everything-we-thought-we-knew-about-the-economy-was-wrong.html

GDP growth looks strong

27

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

97

98

99

100

101

102

103

104

105

106

2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2 2013 Q3 2013 Q4 2014 Q1 2014 Q2

QoQ growth 2011=100

Chained volume measure Quarterly National Accounts, Q2, 2014 (published September 30th 2014)

Revised up by 1% since Second

estimate

Driven by service growth but all expanding since 2013 Q1

28

80

85

90

95

100

105

110

Services

Manufacturing

Construction

Production

Chained volume measure Quarterly National Accounts, Q2, 2014 (published September 30th 2014)

Increasingly driven by investment rather than household consumer spending

29

0

2

4

6

8

10

12

2012 Q1 2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2 2013 Q3 2013 Q4 2014 Q1 2014 Q2

National household final consumption expenditure Gross fixed capital formation Gross domestic product at market prices

Chained volume measure, quarter on same quarter of previous year growth Quarterly National Accounts, Q2, 2014 (published September 30th 2014

Business investment has risen above 10% annual growth

30

-20

-15

-10

-5

0

5

10

15

2008 Q1

2008 Q2

2008 Q3

2008 Q4

2009 Q1

2009 Q2

2009 Q3

2009 Q4

2010 Q1

2010 Q2

2010 Q3

2010 Q4

2011 Q1

2011 Q2

2011 Q3

2011 Q4

2012 Q1

2012 Q2

2012 Q3

2012 Q4

2013 Q1

2013 Q2

2013 Q3

2013 Q4

2014 Q1

2014 Q2

Quarter on same quarter of previous year growth Quarterly National Accounts, Q2, 2014 (published September 30th 2014 (Table F)

Real disposable income rose last quarter

31

-1.1

0.6

-0.3 -0.2

1

-1.2

-2.1

0.9

0.4

-1.2

-0.1

3.1

0.1

-1.1

-1.8

2.2

0.4

-0.8 -0.6

2.2

-3

-2

-1

0

1

2

3

4

2009 Q3

2009 Q4

2010 Q1

2010 Q2

2010 Q3

2010 Q4

2011 Q1

2011 Q2

2011 Q3

2011 Q4

2012 Q1

2012 Q2

2012 Q3

2012 Q4

2013 Q1

2013 Q2

2013 Q3

2013 Q4

2014 Q1

2014 Q2

Chained volume measure, quarter-on-quarter growth Quarterly National Accounts, Q2, 2014 (published September 30th 2014).

Consensus forecast for 2014 is 3.1% growth (and 2.6% in 2015)

32 Source: Forecasts for the UK Economy, HM Treasury, No. 329, September 2014

Composite leading indicators suggest this won’t be permanent

33

97.5

98

98.5

99

99.5

100

100.5

101

101.5

United Kingdom United States Euro area (18 countries) China (People s Republic of)

Source: OECD

Strong rates of expansion were persistent in US and UK according to Markit’s PMI survey, albeit falling

34 See http://www.bbc.co.uk/news/business-29503366 and http://www.markit.com/Commentary/PrintCommentary/09102014-Economics-Markit-economic-overview

58.8 September (60.5 August)

Subdued exports due to weak Eurozone growth and strong sterling

35

-6

-4

-2

0

2

4

6

8

10

12

2010 Q1

2010 Q2

2010 Q3

2010 Q4

2011 Q1

2011 Q2

2011 Q3

2011 Q4

2012 Q1

2012 Q2

2012 Q3

2012 Q4

2013 Q1

2013 Q2

2013 Q3

2013 Q4

2014 Q1

2014 Q2

Exports Imports

Chained volume measure, quarter-on-quarter of previous year growth. Series codes KH2W and KGW7 Quarterly National Accounts, Q2, 2014 (published September 30th 2014 * http://www.thisismoney.co.uk/money/news/article-2787955/decline-exports-fall-construction-output-threaten-uk-growth.html

Trade deficit fell to £1.9bn in Aug (down from £3.1bn in Jul) Due to imports falling (mainly aircraft, fuels and chemicals)* by more than exports See UK Trade, August 2914, ONS, 10th October 2014

NGDP growth has returned to normal

36 Yoy growth rates (SA) where: NGDP=IHYO RGDP=IHYR GDP DEFLATOR=IHYU Quarterly National Accounts, Q2, 2014 (published September 30th 2014) 5.3% is the median NGDP growth rate from 1997-2007

-8

-6

-4

-2

0

2

4

6

8

10

P+Y Y P 4 6 5.3

What’s the optimal level target?

37 YBHA: GDP at market prices, £ million (SA) Quarterly National Accounts, Q2, 2014 (published September 30th 2014) 5.3% is the extrapolation from 2007 Q1

0

100 000

200 000

300 000

400 000

500 000

600 000

5.3

NGDP

4.0

Costs and prices

38

Oil prices continue their fall

39 * Wall Street Journal, see http://online.wsj.com/articles/oil-prices-fall-as-production-mounts-1412920881 ** Brad Plumer, see http://www.vox.com/2014/10/7/6934819/oil-prices-falling-russia-OPEC-shale-boom-gasoline-prices

Increased production by US (due to production improvements), Libya, Iraq (OPEC output highest since January 2013)

+ Reduced demand from China, Europe

= Prices have dropped 20% since June*

**

Input prices (i.e. raw materials) continue to fall

40

- 7.2% Aug - 7.5% Jul

-10

-5

0

5

10

15

20

Jan-

11

Feb-

11

Mar

-11

Apr

-11

May

-11

Jun-

11

Jul-1

1 A

ug-1

1 S

ep-1

1 O

ct-1

1 N

ov-1

1 D

ec-1

1 Ja

n-12

Fe

b-12

M

ar-1

2 A

pr-1

2 M

ay-1

2 Ju

n-12

Ju

l-12

Aug

-12

Sep

-12

Oct

-12

Nov

-12

Dec

-12

Jan-

13

Feb-

13

Mar

-13

Apr

-13

May

-13

Jun-

13

Jul-1

3 A

ug-1

3 S

ep-1

3 O

ct-1

3 N

ov-1

3 D

ec-1

3 Ja

n-14

Fe

b-14

M

ar-1

4 A

pr-1

4 M

ay-1

4 Ju

n-14

Ju

l-14

Aug

-14

Materials & fuels purchased Excluding food, beverages, tobacco & petroleum industries

12 month percentage growth, NSA Producer Price Inflation, August 2014, ONS, released September 16th 2014

Output prices (factor gate) for all manufactured goods remains negative

41

-1

0

1

2

3

4

5

6

- 0.3% Aug - 0.1% Jul

Driven by Petroleum products, which are down 7.1% compared to this time last year

12 month percentage growth, NSA Producer Price Inflation, August 2014, ONS, released September 16th 2014

CPI is 1.5%, RPI is muted

42 Consumer Price Inflation, ONS, August 2014

-3

-2

-1

0

1

2

3

4

5

6 Ja

n 20

06

Mar

M

ay

Jul

Sep

N

ov

Jan

2007

M

ar

May

Ju

l S

ep

Nov

Ja

n 20

08

Mar

M

ay

Jul

Sep

N

ov

Jan

2009

M

ar

May

Ju

l S

ep

Nov

Ja

n 20

10

Mar

M

ay

Jul

Sep

N

ov

Jan

2011

M

ar

May

Ju

l S

ep

Nov

Ja

n 20

12

Mar

M

ay

Jul

Sep

N

ov

Jan

2013

M

ar

May

Ju

l S

ep

Nov

Ja

n 20

14

Mar

M

ay

Jul

CPI RPI1 RPIJ 2.0

Update due Oct 14th!!!

Driven by food and non-alcoholic beverages (down 0.08pp)

43

-0.10 -0.08 -0.06 -0.04 -0.02 0.00 0.02 0.04 0.06

Food and non-alcoholic beverages

Alcohol and tobacco

Clothing and footwear

Housing and household services

Furniture and household goods

Health

Transport

Communication

Recreation and culture

Education

Restaurants and hotels

Miscellaneous goods and services

Contributions to the change in the CPI 12-month rate Consumer Price Inflation, ONS, August 2014

•  “in Europe, inflation expectations remain well anchored

despite the current low inflation environment”**

Surveys suggest inflation expectations are well anchored

44

BofE/GfK Inflation Attitudes Survey*

August 2014 May 2014

M&G/ YouGov Inflation Expectations Survey**

September 2014 May 2014

Inflation over the coming year

2.8% 2.6%

2.2% 2.3%

12 months after that 2.8% 2.5%

5 years time 3.4% 2.9%

3.0% 3.0%

*Survey of 2016 people aged 16+ in 175 random areas weighted to match UK demographic profile. Conducted 7th – 15th August 2014 ** Survey of 2,090 people

Range of expert forecasts of CPI (Q4) in 2015 show no cause for alarm

45 Forecasts made in the last 3 months Source: Forecasts for the UK Economy, HM Treasury, No. 329, September 2014

1.7%

2.0%

3.3%

Lowest Median Highest

House price inflation is high but may have peaked

46

11.7% July (10.2% June)

ONS: Year on year growth rates Halifax: Measured over 3 months compared to same 3 months of previous year Nationwide: Year on year growth rates

9.6% Sep (10.2% July)

9.4% Sep (11.0% Aug)

Ratio of gross house prices to first time buyers earnings still above historic average

47 Source: Nationwide Median = 3.1%

0

1

2

3

4

5

6 19

83 Q

1 19

83 Q

4 19

84 Q

3 19

85 Q

2 19

86 Q

1 19

87 Q

4 19

87 Q

3 19

88 Q

2 19

89 Q

1 19

89 Q

4 19

90 Q

3 19

91 Q

2 19

92 Q

1 19

92 Q

4 19

93 Q

3 19

94 Q

2 19

95 Q

1 19

95 Q

4 19

96 Q

3 19

97 Q

2 19

98 Q

1 19

98 Q

4 19

99 Q

3 20

00 Q

2 20

01 Q

1 20

01 Q

4 20

02 Q

3 20

03 Q

2 20

04 Q

1 20

04 Q

4 20

05 Q

3 20

06 Q

2 20

07 Q

1 20

07 Q

4 20

08 Q

3 20

09 Q

2 20

10 Q

1 20

10 Q

4 20

11 Q

3 20

12 Q

2 20

13 Q

1 20

13 Q

4 20

14 Q

3

But not for all house buyers

48

3.00

3.50

4.00

4.50

5.00

5.50

6.00

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Price earnings ratio Halifax House Price Index, September 2014

House price growth driven by London but wide spread

49

12

5

10

5

7

19

12

0

5

10

15

20

25

UK Northern Ireland

North East Yorks & The Humber

West Midlands London South East

Selected regions, Source: Regulated Mortgage Agency See House Price Index, ONS, July 2014

Although house prices have only reach 2007 peak in nominal terms

50 Left: Nationwide House Price Index, September 2014 Right: Halifax House Price Index, September 2014 (Jan 1983)

40,000

45,000

50,000

55,000

60,000

65,000

70,000

75,000

80,000

85,000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Real average house price

International economy

51

The IMF anticipate a global recovery

3.4 3.3 3.3

3.8

2

2.5

3

3.5

4

2012 2013 2014 2015

52 Percent change in World Output World Economic Outlook, October 7th 2014

A pensive outlook for global growth

•  IMF forecast global growth of 3.3% in 2014 (down from a forecast of 3.7% made in April). They think it will reach 3.8% in 2015 (down from 3.9% in April).

•  Unchanged forecasts of UK growth of 3.2% in 2014 and 2.7% in 2015 •  Emerging market and developing economies projected to rise from 4.4% in

2014 to 5.0% in 2015 (down from 4.5% and 5.2% respectively) •  The IMF’s advocacy of public infrastructure to “help raise potential output

in the medium term” and “structural reforms to strengthen potential growth” is revealing… –  Generous view: depressed aggregate demand has now created a

reduction in potential GDP growth –  Alternative view: finally realising that a lot of pre 2008 growth was over

capacity, and negative supply shocks since then mean that we have a predominantly supply side problem

•  WTO forecast global trade of 3.1% in 2014 (down from previous forecast of 4.7%)*

53 World Economic Outlook, October 7th 2014 * “Oil and trouble”, The Economist, Oct 4th 2014

Equity markets rising

54 h/t J P Leschly Neergaard, Danske Bank

Volatility low

55 h/t J P Leschly Neergaard, Danske Bank

5

6

7

8

9

10

11

12

EU

UK

US

US, UK doing better than EU on unemployment

56 UK Labour Market, ONS, September 2014

UK manufacturing output above 2011 levels and rising

57

70

75

80

85

90

95

100

105

110

115

US

UK

Germany

France

2011=100. SA. Source: OECD. See Index of Production August 2014, ONS, October 7th 2014 (Fig. 3)

UK quarterly GDP growth rate is consistent and stronger than others

58

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014

Eurozone Japan United Kingdom United States of America

Chained volume measure, quarter-on-quarter growth Quarterly National Accounts, Q2, 2014 (published September 30th 2014)

Not out of the woods, but going in the right direction (at last)

59

80

85

90

95

100

105

110

US

UK

Japan

EU

Chained volume measure, quarter-on-quarter growth Quarterly National Accounts, Q2, 2014 (published September 30th 2014)

Threats to global growth

•  Possibility of triple dip recession in EU and/or deflation •  Chinese pondering their future •  Geopolitical tensions in Russia/Ukraine and Middle East •  Financial market excess (underpriced risk as a result of

search for yield) •  Ebola outbreak

60 Some of these were specified by the IMF in their World Economic Outlook, October 7th 2014 See also “Oil and trouble”, The Economist, Oct 4th 2014

The Eurozone is skirting with a triple-dip recession

61 ECB Statistical Data Warehouse, October 2014

German economy is a concern

•  European investment in manufacturing equipment down from €192bn in 2013 Q1 to €184bn in 2014 Q1* –  €66bn of which comes from German SMEs*

•  Total planned capital investment in Germany down 18% in 2014 Q1 compared to 2013 Q1*

•  Car sales down 0.4% in August 2014**

62 *European CapEx Barometer, GE Capital, Q1 2014 ** See http://uk.reuters.com/article/2014/09/17/uk-vehicleregistrations-europe-august-idUKKBN0HC0DA20140917

The ECB is to blame

•  ECB have been more effective at fending off imminent danger than creating a sound platform for economic growth

•  They have successfully bought time for governments to resolve public finance concerns and improve competitiveness –  But much of that debt problem is due to a collapse in

nominal incomes •  Significant supply side problems, and the political

constraints under which the ECB operate hinder their ability to act –  i.e. “setting monetary policy for countries that retain

fiscal sovereignty”* •  But ultimately the ECB is failing in their primary duty of

hitting their inflation target, and this is due to monetary timidity

63 * “The Exceptional Central Bank” The Economist, August 2nd 2014

•  Since “whatever it takes” (July 2012)* –  Monetary base is down 30% –  1 year real interest rate is 70bp higher

•  Need to find a way to implement scalable QE tied to clearly communicated nominal objectives

64

0.3% Sep’14

ECB Statistical Data Warehouse, October 2014 * h/t J P Leschly Neergaard, Danske Bank

CPI is collapsing False start to M3 growth

Chinese tightening potentially damaging

•  China is currently attempting to stem credit growth, and rebalance away from commodity intensive investment in infrastructure

•  The problem is a combination of China’s increased economic importance and a potential economic slowdown

•  Plausible argument that a standard monetarist story explains what’s going on:

65 h/t Lars Christensen, Danske Bank http://marketmonetarist.com/2012/10/14/my-favourite-chinese-monetary-graph/

M + V = P + Y 16 – 2 ≈ 4 + 10

China’s monetary growth is undershooting their implicit target

66

0

100

200

300

400

500

600

700

800

900 20

00-0

1-01

20

00-0

5-01

20

00-0

9-01

20

01-0

1-01

20

01-0

5-01

20

01-0

9-01

20

02-0

1-01

20

02-0

5-01

20

02-0

9-01

20

03-0

1-01

20

03-0

5-01

20

03-0

9-01

20

04-0

1-01

20

04-0

5-01

20

04-0

9-01

20

05-0

1-01

20

05-0

5-01

20

05-0

9-01

20

06-0

1-01

20

06-0

5-01

20

06-0

9-01

20

07-0

1-01

20

07-0

5-01

20

07-0

9-01

20

08-0

1-01

20

08-0

5-01

20

08-0

9-01

20

09-0

1-01

20

09-0

5-01

20

09-0

9-01

20

10-0

1-01

20

10-0

5-01

20

10-0

9-01

20

11-0

1-01

20

11-0

5-01

20

11-0

9-01

20

12-0

1-01

20

12-0

5-01

20

12-0

9-01

20

13-0

1-01

20

13-0

5-01

20

13-0

9-01

20

14-0

1-01

20

14-0

5-01

M1

15%

16%

Recent reductions in growth forecasts support this view

67

2012 2013 2014 2015 2016

IMF World Economic Outlook, Oct 7th 2014

7.7 7.7 7.4 7.1

World Bank East Asia & Pacific Update, Oct 2014 (April 2014)

7.4 (7.6)

7.2 (7.5)

7.1 (7.5)

China GDP forecasts

An Austrian view is even more concerning

•  Problems relating to: –  Excessive nominal growth path –  Mis-allocated capital (i.e. credit fuelled housing

bubble) –  Validity of national statistics

•  Perhaps monetary tightening and lower growth prospects are inevitable

68

China’s role as a monetary superpower

•  Important channels through which a Chinese slow down could spread:* –  Exports – China is an important export market for many countries –  Commodity prices – China is a major source of demand for commodities –  Financial flow – China has large foreign currency reserves and is a major

source of global demand for emerging market bonds and equities •  Even if other countries aren’t pegged to CN¥, they can still “import” PBoC

monetary tightening •  Although it’s voluntary:

–  Brazil – Chinese tightening reduces Brazilian exports, this leads to higher domestic inflation (higher important prices) which Brazilian central bank responded to by raising interest rates (up 3.75% since April 2013)**

•  They’re responding to the negative supply shock rather than negative demand shock

–  Australia have been easing over the last few years (reduced rates to 2.5%) and unconcerned by inflation at 3% (July 2014). Happier to let AUD float

69 * http://marketmonetarist.com/2013/07/24/china-as-a-monetary-superpower-the-sino-monetary-transmission-mechanism/ ** http://marketmonetarist.com/2013/07/11/the-pbocs-monetary-supremacy-over-brazil-but-dont-blame-the-chinese/

Summary

•  Key question: Does the current situation require emergency monetary policy?

•  Relatively strong domestic demand conditions continue to provide an opportunity to begin normalization –  Should start to act when growth returns to normal, not

when it picks up sharply –  Serious macroeconomic disturbances can occur under a

stable/low inflation rate

70