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As I write this, Britain sits second in the medal table, above China (a nation of over 1.35 billion people to our 0.06 billion), with 15 gold medals and at least one more guaranteed this evening. For those who may be too young to remember, this is a far cry from Atlanta 1996 where Team GB only managed to rustle up a single gold medal (bonus points for those who can guess who won it*).
Aside from totally disrupting my sleep pattern for the last 10 days, there is a notable economic parallel to be drawn from this transformation of our sporting prowess to our current economic climate. Following the 1996 Olympics an investigation was launched into what went wrong and how it could be fixed, with a rather obvious result: lack of investment – and thus the National Lottery Funding scheme was born.
The parallel to today is that currently most of Western Europe, Britain included, has found itself grinding to a halt in terms of GDP growth. This is not a new phenomenon on the Continent, but where most of 2015 saw UK politicians boasting of our world-leading growth, 2016 has seen them pointing fingers in various directions to explain why it has suddenly dropped to 0.4% quarter-on-quarter growth. Granted, part of this is attributable to referendum-linked uncertainty, but various other issues have been lying in the periphery and are only mentioned when linked to economic data. Few of these issues are as important as investment.
Underinvestment has been noted for the last number of years and is a key factor in why productivity and wage growth are less than desirable, and why GDP is not growing as fast as it potentially could be. Since Brexit, the need to improve investment has been noted by those who potentially have it within their control to make it happen, starting with Mark Carney who decided to expand QE measures a fortnight ago, not only for Gilts but also £10 billion allocated for corporate bonds. The idea being to force capital holders to hunt for yield by lending to more corporates who will be investing this to grow the economy.
As with so many things that come out of central banks, the theory and the reality differ widely. Yes, the problem has been correctly identified, and according to textbooks the solution will work. However, the Bank of England has forgotten that every economic hypothesis out there only works with a list of assumptions that would make the Chilcot Report look like a short story and so does not work in practice.
As was reported by media outlets last week, the first issue has already been encountered; the lack of appetite to sell the bonds applicable to the QE scheme. Many of these bonds are held by pension funds and their like which are looking for long-term cashflows. Even if they sold their current bonds at above market value, they would still need to find another instrument with similar maturity to invest in, but as of yet there is not a plethora of them in the market to acquire.
In order for QE to reach the real economy via investment as hoped, the bond issuer would also need to be corporate, preferably not at FTSE 250 size. This is where things really break down. There are three points that reduce the effectiveness of the QE programme:
1) Companies of this size are less likely to want to be issuing long-dated bonds which would restrict their debt flexibility in the future as they reach the next stage of development.
2) Corporate bonds would be a distinctly lower credit grading than the gilts they have just sold.
3) Most funds are required via regulation to maintain a minimum proportion of top rated assets on their books.
So, given Gilts are likely to be among the highest rating assets in the portfolio, they would need to de-risk elsewhere to bring the average back to where it was originally. A similar issue plague the main UK banks with regards to QE too. On the one hand they are being told by the Bank of England “here is a pile of fresh liquidity in exchange for some of your bond-holdings, please go out to market and lend to SME’s.” On the other, the financial regulators are looking over their shoulder requesting that they need to raise more capital and de-risk their balance sheet to reduce the systemic risk they pose. It is totally contradictory to request both things concurrently.
Moving back to the Olympic funding and lessons learned. First and foremost the horizon was long-term, funding wasn’t provided in order to achieve a huge medal haul in 2000, but to encourage a wider take-up of sports delivering success in the next generation. Secondly there was a targeted approach to specific sports rather than scatter-gun.
Translating this to our economy, the government, or another economic body, needs to target specific industries which are going to be economically significant for the world in the next half century and focus funding primarily in infrastructure to support these. Instead of pushing QE through the regular channels in the hope it produces the desired growth, create a specific fund, whose investors are bought out by the Bank of England, with a targeted investment strategy in the long-term.
This week has a handful of key data releases to note. Tuesday sees UK inflation figures, in which CPI is expected to be the same as last month’s 1.4% figure. Wednesday has the UK employment data and eyes will be looking closely at the three-month change in employment which wildly surprised markets last month with a figure of 176,000. This time it is anticipated to slip to 150,000 but this is still a very strong figure for this year’s May, June, July period given everything that went on. Wednesday night is when the Fed’s July meeting minutes are released, which could provide further insight into what their thoughts are on any further policy changes this year. Thursday has July’s retail sales data for the UK, which could be the next big indicator of how people’s spending habits may have changed following the referendum. Although it is expected that this will be dampened by the result, there is the offset of higher tourism both from UK families staying at home and more foreign visitors due to the exchange rate.
*The answer was, of course, Sirs Steve Redgrave and Matthew Pinsent.
All views expressed here are the author’s own and are based on information and data available at the time of writing.
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