26 May 2012

IMF Prescribing UK More the Same: a Prelude of Things Going Very Ugly Indeed?

Despite that UK has still (as of 25 May 2012) maintained its triple-A credit rating by the three major rating agencies (although with the warnings for downgrading by Moody’s and Fitch), the country’s economy is far from being healthy. Guess what “cure” IMF is suggesting in its recently published 2012 Article IV Consultation Concluding Statement of the Mission? More the same; it says: Further monetary easing is required.” This “lack of fantasy” by the IMF is providing a clear illustration of how the so-called advanced economies really work.

Some illustrations and “hard facts” about British economy

Although data can be manipulated (just remember Greece), it is still the best that we have at hand. So let’s look at it first.

Figure 1 presents the UK’s general government balance, as well as the gross and net government debts as a percentage of GDP over the period of 2006-2013 (forecasts are those of the IMF in its 2012 Fiscal Monitor report). As you can see, since the beginning of the last financial crisis in late 2006 / beginning of 2007, government debt has increased immensely. The deficit of general government is still expected to be large over the coming years, and this even in case of the assumed low interest rates for an AAA-rated sovereign. Among others, these numbers have urged Moody’s and Fitch to consider downgrading of UK’s rating (which has been unreasonably high for quite some time). They have also caused the UK to be highlighted in the European Commission’s Alert Mechanism Report as one of the countries that could possibly pose a threat to the stability of the European Union.

Figure 2 illustrates the size and development of the by definition explosive UK’s banking sector (that, among others, is very vulnerable to the crisis in eurozone as well as the general mood of “Mr. Market”). Ok, there has been some moderation since the time when this chart was first published, but even now after being several years in the crisis, banks’ assets are well above four times the UK’s GDP – that is a lot more when compared to the majority of the other “advanced” economies. As a side note: what an explosion since the “financial liberation” in 1970s when money became debt!

In Figure 3, you can see the expansion of Bank of England’s balance sheet starting from 2007. Note that since that it has already increased from 5.6% of GDP to 20.5% of GDP, i.e. more than 3.5 times.

Figure 4 shows that interest rates are at historic low starting from the 17th century. As can be seen, right now, these are at 0.5% only.

For the maneuvers of the Bank of England and the HM Treasury see for example my earlier article: Bank of England’s and HM Treasury’s Maneuvers to Accommodate Financial Crisis. This article is quite revealing about the visible and hidden schemes of money printing.

It may sound ironical, but the fact is also that all this quantitative easing so far has not helped much if anything at all except maybe preventing an immediate collapse; citing one of the concluding statements of the IMF’s April 2012 mission: “But the economy has been flat.” We might add that the private sector is over indebted, savings have been far too low and consumption unsustainably high (private sector debt as % of GDP is more than 200%).

Furthermore, as the Bank of England’s wake-up call illustrates, the standing of UK’s banking sector is far from being good: in fact, it is (still) very obscure rather than anything else. The only “solace” for policy makers may be that banking sector in Europe looks even worse (of course, because of the interconnectedness of financial systems, this is a bad news for UK too).

IMF’s suggestions

The key risks highlighted in earlier IMF reports have started to materialise. Most importantly, there is still no common political agreement for dealing with the situation in the eurozone; as Nouriel Roubini has called it: a “slow motion train wreck.” (Source: CNBS, 8 May 2012) So, most probably our elected leaders are / would be panicking if caring.

Give this background, here are the “drugs” that IMF is “prescribing” / suggesting to UK (after some flattering about the “progress” that has (supposedly) been made so far, of course):

1) policies to bolster demand (reasoning: the need to close output gap), incl. explore the options to further boost demand through credit easing measures that utilize government’s balance sheet, such as purchasing private-sector bonds and providing longer-term bank funding facilities against a broad range of collateral (reasoning: government borrowing costs have fallen to record lows, so the government can do it);
Comment: nonsense that largely results from the artificially generated demand for the government securities.

2) further monetary stimulus (reasoning: anaemic nominal wage growth and broadly stable inflation suggesting weak inflationary pressures) that can be provided via further quantitative easing (QE) and possibly cutting the policy rate (reasoning: essentially flat yield curve out to 3-year maturities);
Comment: we can see the problem; the freshly “printed” money is not reaching the real economy.

3) financial sector policies that focus on strengthening bank balance sheets by building capital rather than reducing assets – force banks to raise external capital as early as feasible, limit payouts of bonuses and dividends, take into account the availability of liquidity insurance from the Bank of England;
Comment: a suggestion for the prospective shareholders to buy crap.

4) slower pace of structural fiscal consolidation in FY12/13 is appropriate (reasoning: the weak outlook);
Comment: rating downgrade to be expected?

5) as there is still room, improve the quality of fiscal adjustment to support growth: make consolidation more “growth friendly” through cuts in spending on items with low multipliers (such as public employee wages) to fund higher spending on items with high multipliers (such as infrastructure);
Comment: one of the few suggestions that I could possibly agree.

6) fiscal easing and further use of the government’s balance sheet if the recovery fails to take off such as: reconsidering planned fiscal adjustments and writing a multi-year plan that focuses on further reducing the UK’s large structural fiscal deficit when the economy is stronger, temporary tax cuts and greater infrastructure spending;
Comment: government finances are highly uncertain; do not believe any multi-year plan being presented.

7) continued structural reforms, more specifically expanding the agenda for tax reforms by the “revenue-neutral reform of the corporate income tax to introduce an allowance for new corporate equity aimed at reducing the tax code’s bias in favor of debt over equity finance”;
Comment: the point is a bit difficult to see...

8) continue efforts to further “bolster the stability of the financial system”, more specifically: address the issue of “too big to fail” and complete the draft legislation to implement the proposals of the Independent Commission on Banking “as soon as feasible to provide clarity on what will be in the ringfence”, give additional powers to the banking supervisors (e.g. the ability to limit loan-to-value and loan-to-income ratios for restraining property bubbles, and greater authority over financial holding companies).
Comment: This further confirms that the banking sector is not a part of the private sector...

Comment for the IMF’s suggestions

In short, the IMF is suggesting more the same, i.e. the “drugs” that haven’t been working this far: quantitative easing (read: printing money), higher government spending, more and easier credit to the private sector, injecting capital into the banking sector but so that banks would still stay private in the maximum extent feasible (read: do everything to increase the profits of the banks, and not to allow these profits to be taken out as dividends, bonuses or whatever).

These suggestions are being given no matter the already very high levels of public and private debts that rightfully raise concerns in the markets, the unsustainably high level of consumption (read: wasting of natural resources), the opaque and possibly also deceptive financing schemes that have been implemented already...

A bit provocative question indeed, but: why should the tax payers (directly or indirectly) pay for this kind of nonsense suggestions?


In the debate about the monetary easing (led by the IMF, practiced by the UK for example, and supported by the many other indebted countries) vs austerity (led by Germany), both sides are right in the sense that the way proposed by the other side would not work. However, neither of them is proposing anything that could be considered as a real solution to the current (miserable) state of affairs.

If the policy makers are continuing like that, I’d not be too surprised if things go very ugly indeed, and this not only in terms of a simple stock market crash... As a peace-loving person and (at least at the time of writing this article) independent mind, I’d strongly advice thinking “out of the box”: we need a feasible alternative to the above mentioned two approaches of quantitative easing and austerity.

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