Monday 27 June 2016

Reflections on the Revolution in Britain

“By the deep cultural instinct of a free people, this amazing, unprecedented restoration [of parliamentary accountability] was accepted without riots, or police, or revolution. It is the most momentous thing I have seen in nearly 40 years covering British politics, and the most moving.”
               - Charles Moore
“We must learn from brexit: Elderly xenophobes will lie to pollsters to hide their racist views, then vote for destructive policies anyway.”  
                 -  Anil Dash

Revolution? It’s a big word, but justified. If you doubt it, consider the global Establishment consensus deployed for shock and awe by Remain campaign: Metternich himself could only have dreamed of such a comprehensive conservative coalition.  And consider now the response of some of those whose fates are hostage to Remain: counter-Revolutionary plans which fully deserve to be recognized as deranged and in a narrow sense, contemptible. The instinct to cut out the middle-man and send in the tanks is barely repressed.

Although there are many many things which the counter-revolutionaries don’t understand, primarily because they no longer share a language with the rest of their fellow countrymen, they are right in one thing: Brexit is a decision which threatens the extraordinary privileges they enjoy and which have now proved intolerable to their fellow citizens. In that, the outraged hostility they are now directing to their fellow citizens is understandable.

I have been, and am, pro-Brexit on the grounds that, since all policymakers are flawed,  democratic accountability matters above all else. But that’s probably not why most people voted to leave. As we look through the dust and poke through rubble, it also seems to me that this revolution is best understood as a response - the first serious response, albeit delayed - to the collapse of the western financial system in 2009.  It represents a demand for a different type of economic settlement, and that in turn demands a different type of financial system.

Language matters. One of the most perceptive readings of the current political situation came from (of all people) a Houston-based poet Anis Shivani writing in (of all places) Salon.  He was writing about US politics, but his analysis certainly extends to the UK referendum:

“The neoliberal economy has become pure abstraction; as has the market, as has the state, there is no reality to any of these things the way we have classically understood them. Americans, like people everywhere rising up against neoliberal globalization (in Britain, for example, this takes the form of Brexit, or exit from the European Union), want a return of social relations, or embeddedness, to the economy.”

He asserts that “capitalism today is placeless, locationless, nameless, faceless”, and that the difference between Mitt Romney and Donald Trump is that “while Trump’s entire life has been orchestrated around building luxury and ostentatiousness, again things one can tangibly grasp and hold on to (the Trump steaks!), Romney is the personification of a placeless corporation, making his quarter billion dollars from consulting, i.e., representing economic abstraction at its purest, serving as a high priest of the transnational capitalist class.”

You don’t have to agree with Shivani’s ultimately conclusions (for which, read the article) to see that he’s on to something. Moreover, the logical consequence of fully buying-in to the abstracted politico-economic set-up is precisely the loss of the language in which to talk to that part of the electorate for which ‘social relations’ and ‘embeddedness’ are the very stuff of everyday life.

It plays out in the US: forget the policies - Trump is (scary) funny to listen to; Hillary is a grind. And it played out in the UK referendum Boris is (absurd) funny, Nigel Farage ‘likes a pint’ and the Remain campaign kept name-checking more experts you’ve never heard of say that at some unspecified time in the future Brexit might mean a loss of family income equivalent to £4,300.  Or alternatively, it might mean World War III or the collapse of Western Civilization.  OK, thanks, mine’s a pint.

The shape of that settlement isn’t yet clear, but elements of it are, and they are not usefully explained as being ‘right wing’ or ‘left wing’, or ‘socialist’ or even ‘capitalist’. If Britain gets it right - and is there a country anywhere in the world more capable of re-inventing itself? - 23rd June may yet come to be seen as ushering in a new chapter of economic development. And London’s financial markets are likely to be right at the centre of it. We do live in exciting times, even if right now the danger is more obvious than the opportunity.

Language matters. This loss of essential language has two major consequences: it made it impossible for Remain to talk to the electorate in a language they could relate to; and second - and now more importantly - it means that the wider Establishment does not yet have the vocabulary it needs to understand what has just happened.  Currently, it merely flails. This will change in time, but right now this generates a third consequence which might lead to bad investment strategies: its forecasts about likely future developments and trajectories are unlikely to score any better than chance. 

A couple of examples of this failure of language might help illustrate the points. First, the Remain campaign was keen to persuade the electorate that British people were not ‘quitters’.  What I think they were trying to connect with was the British people’s notion of themselves that they tend to be very resistant to foreign pressure. ‘We shall never surrender’ etc. But since ‘we shall never surrender’ wasn’t available (for obvious reasons) the speechmakers substituted ‘quit’ and ‘quitters’.  But ‘quitting’ doesn’t have the meaning (use) that the speechwriters needed: Brits are proud of ‘quitting’ smoking, and they’re perfectly happy to tell you they’ve ‘quit’ a lousy job. ‘Quitting’ in these senses, is, in fact, the opposite of ‘giving up’: in fact, most of the time, for Brits ‘quitting’ is an act of virtuous though sometimes pig-headed self-assertion.  Whoever lit upon ‘quitting’ as a word is either a foreigner (an American, perhaps?) or someone who hasn’t talked with many fellow Brits over the last 20 years. 

Perhaps more seriously for current policy, and definitely for future forecasts, is the notion that leaving the EU appealed mainly to those who have been ‘left behind’ by globalization. The people being referred to here tend to be those living in Northern towns which have suffered through 45 years of de-industrialization.  But the key problem with the language used is that it quite wrongly implies that for everyone else the problem has gone away - after all, those people have been ‘left behind’.  But they haven’t: they are absolutely still here.  And in fact, that’s the most important point of all being made by the referendum. There is no sense at all in which the ‘left behind’ aren’t still right here, right now.   

What’s more, they are far more ‘embedded’ than you, dear reader, are likely to be, since you are all priests of some standing in globalized capitalism. 

The two sets of people likely to be least-embedded in their society are i) Londoners (because of the size of the place, the national and international churn of its population, and its central preoccupation precisely with the abstractions of globalization; and ii) young people, particularly students, because by definition they’ve not yet had time to become ‘embedded’ in their society. These are precisely the people who voted to Remain, and they are also the people now likely to be making forecasts about the future. 

The difference between London and the rest of the country which hosts it has long been globally anomalous. This is not so much an opinion as a measurable fact: one of the most robust relationships in economic geography it that there is Zipf distribution in the size of towns and cities within a given polity. London simply doesn’t fit this law: it is far bigger than the frequency of cities in the UK of smaller size would suggest.  In fact, London conforms to the Zipf law distribution of cities only if you include the rest of Europe in the sample: purely in these terms, London is revealed as the capital not of the UK, but of Europe. (Sorry, everyone, I’m not making this up, this is simply how the maths works). 

This divorce not only left London without a language with which to talk with, or even listen to, the rest of the people of the UK, but also seemingly contemptuously hostile towards them.  It was not a good starting point for a political campaign in which the vote of a non-Londoner was no less important the vote of a Londoner. 

History Matters.  I have no theory of history, but it does seem that sometimes the past can be a good interpretive guide. For instance, if the nations of the EU are split, you can be all-but certain that they divide precisely along the lines taken the Thirty Years War.  And in Britain, if you want to know fundamentally what sort of ‘political’ person you are faced with (or are yourself), you ask: ‘Which side would you have been on in the Civil War’. This breaks down between the Cavaliers (‘wrong but romantic’) which supported Charles I, and the Roundheads (‘right but repulsive’) who fought for Parliament (etc, long story). 

Right now, everyone in Britain knows the answer to this question, for themselves and for others too. The Cavaliers were all-too obviously for Remain, asserting essentially the divine right of trans-national legislators, and manned by the princes of the Establishment (in this case, the notable Labour princelings of Will Straw and Stephen Kinnock). An at the end, the found themselves, relying on an unsteady and unnatural alliance between the Scots and London aristocrats. Although Prince Rupert wasn’t actually called from the grave for one last hurrah, his descendents were in the saddle all the way through.  The Brexiteers meanwhile were, with uncanny precision, the Roundheads, asserting the primacy of parliament (long story), and even drawing strength from precisely those parts of England which brought forth Cromwell.  Before long, I expect they’ll propose union with the Netherlands and mess up Ireland. 

If you want to translate that into different views on political ‘legitimacy’, the Remainers asserted that political legitimacy was won by national and international creditation of particular ideas and policies; the Brexiteers asserted political legitimacy still rested with the people. 

Globalization. The Chinese spokesman followed that country’s oracular tradition when he told the UK papers: ‘A brick has been prised out of the mansion of globalization.’ 

I think this is right: the British decision to pull out of the EU may just represent the first decisive step in re-casting the terms upon which globalization takes place. Britain has an extraordinary and possibly even protean ability to re-invent itself quite fundamentally every few decades, and this looks and feels like the start of another re-invention. If we are all lucky, we may look back on the 23rd June vote as the first step the West took to re-invent its economy in a way which acknowledged and finessed the collapse of its financial system in 2009. If so, we are seeing nothing less than a revolution. 

To explain why, and possibly how, let’s ask a fundamental question: why do we put up with the inequalities generated by capitalism in the first place? Well, first, from a personal point of view the market provides a wonderful and, to me, natural, outlet for my creative (and destructive) energies. And, hurrah, it rewards me for it at the same time.  From a systemic point of view, however, we tolerate the inequalities of capitalism because there’s overwhelming evidence that it delivers the goods in terms of improved and enlarged qualities of life. 

This has never been more abundantly true than during the last 25 years, where (very broadly) the introduction of capitalism has lifted probably upwards of a billion people in China alone from a condition of enslaved and immiserated poverty to one of material decency. This is the great economic and moral good achieved by this round of globalisation - let no-one doubt that. We have witnessed, and participated in, the greatest improvement of the human condition any generation has ever experienced. 

But notice that there’s an implicit trade being made here, in which an increase in inequality is granted as the acceptable price of improved living standards for all. Now let’s think again about how that trade has been working out recently, in Britain.  

What is “Left Behind”?  To do so, one needs again to have some knowledge of what it means to be ‘left behind.’ I honestly doubt that most people in London have any idea (or possibly, interest) in what it means. I do, because I’ve been in flight from it all my life.  Here comes the personal history: I come from Huddersfield, the 11th largest town in Britain, with a population of roughly 164k. When I was being brought up (the 1970s), the town’s key industry, textiles, was dying, week by week, month by month - I’d count the chimneys on the way to school, and the count fell and fell. Nevertheless, the textile industry bequeathed a social and infrastructural legacy which is visible to this day: on the one hand the Huddersfield Choral Society got to sing in a splendid high-Victorian copy of Amsterdam’s Concertgebouw; on the other hand, the town invented rugby league, and spawned the Luddites. Nowhere, I dare say, was more ‘embedded’ - and even today, although saying you’re from Huddersfield has vertiginously negative social cachet, at least you are without doubt ‘from somewhere’. 

Now, consider this: whilst Londoners admire the new extension to the Tate Modern, and ponder the possibilities of a ‘garden bridge’ over the Thames, Huddersfield has been told there’s not enough money to keep open an Accident and Emergency Unit in its hospital. Reader, if you go on a field trip to Huddersfield to discover what being ‘left behind’ means, don’t collapse in shock, because there will be no A&E to keep you alive if you do. In truth, this shrinks health provision back not just to Victorian conditions, but to pre-Victorian conditions. Tell me, then, that the deal between greater inequality and ‘delivering the goods’ is working for places like Huddersfield. 

Obviously, it’s easier not to know, and not to care because, as I say, in the grand scheme of things, globalization has delivered munificently on its promise.  But the grand scheme of things is, as Anis Shivani says, now absolutely abstract. What language would you use to explain its virtues to the ‘left behind’ of Huddersfield? Tricky, I’d say. 

The unwillingness to listen has evidently hardened among many of Britain’s Establishment into a most extraordinary inability to hear even the plainest message.  You hear intelligent, well-educated and presumably well-meaning TV reporters front up to a ‘left-behind’, who patiently explains that he/she can’t get a doctor’s appointment, a school place, a house, a job with a permanent contract, and the TV reporter duly turns to camera and says something along the lines of ‘And it’s this fear of immigration that’s been driving the Brexit vote’.  And from there it’s but a hop skip and jump to Anil Dash’s insult: “Elderly xenophobes will lie to pollsters to hide their racist views, then vote for destructive policies anyway.”

EU bureaucrats have this excuse: they genuinely do speak a different language. But what excuse does the British TV reporter have? 

What’s changed? “Globalization has been chugging along pretty well now for decades, and you yourself say that the northern industrial decline set in decades ago. So what’s changed now? Why has the previously tolerable suddenly become intolerable. What’s changed?” 

The answer is that over the last few years, two factors have combined to dramatically recast the economic foundations upon which which consent for globalization rested: 
i) The EU imposed effectively uncontrolled immigration policies at the same time as its Euro policies were beggaring much of southern Europe; and 
ii) The western financial system collapsed.  

Separately, both these would probably have been tolerable: when combined, they become very sharply toxic. 

To understand why, let’s consider first what’s happening to the meat-packing business which is the biggest single employer in my market town. It’s doing ok, but a friend who’s been working there for years tells me it no longer offers any permanent jobs at all - instead, it relays through teams of East Europeans on short-term temporary contracts.  The obvious point to make is that, of course, access to an basically infinite and therefore infinitely flexible low-skilled labour force must have a negative impact on anyone competing for low-skilled jobs. What’s more, we can be pretty certain that the negative impact can be only partly relieved by legislation. 

The less obvious point is that for a business - for my meat-packing factory - it sharply changes the terms of labour/capital substitution. If the meat-packing factory encounters unexpectedly strong demand, it will simply import more East Europeans to cope with demand.  It is easier to do, less risky, and leaves a lighter balance-sheet footprint, than to invest in new machinery. 

In short the company gains nothing by investing to raise labour productivity, and loses nothing by not investing.  But if labour productivity is not raised, ultimately real wages will not/ cannot rise either. 


As the chart shows, between 2009 and late-2014, there was effectively no growth at all in capital per worker in the UK economy, reversing the steady 3-4% growth experienced previously.  The jolt upwards seen in 2015 reflected only the slowdown in hiring, and since capital investment has since slowed sharply (it rose only 1.6% yoy in nominal terms in 1Q16), we shall probably see the flatline return. 

What is the alternative? Next door to the meat-packing factory a different factory makes meat pies: the manageress told me the other day, she spends her time shouting “ship-ka, ship-ka” (“szybko” - it’s Polish for ‘quickly’).  No doubt her enthusiasm works wonders, but even so, on an economy-wide basis, real output per worker, once adjusted for capital per worker, is declining. 


The loosening of the labour markets is one part of the equation; the other is the inability/unwillingness of the banking system to finance investment.  Loans to the non-financial corporate sector have been falling continuously since late 2008, with net repayments since then of £133.8bn.  Nor is this simply a reflection of banks’ overall asset base contraction: loans to non-financial private corporations as a proportion of the balance sheet has also shrunk by approximately a quarter during the same period. 


Remember that the key question remains: “why do we put up with the inequalities generated by capitalism in the first place?” and the answer is that it delivers the goods.  It is this combination of infinitely flexible labour markets and a financial system which is not, and quite possibly cannot, allocate savings towards corporate investment which not only is no longer delivering the goods for a majority of people right now, and, just as importantly, is unlikely to deliver the goods in the future, because its problems are systemic. In such a set-up, the inequalities generated by capitalism are no longer tolerable. That is the verdict of the referendum. 

What Happens Now 1: Economics, Corporate Behaviour and Finance
If this is what underpins the verdict, then one only has to run the film backwards to see where it ends. First take away the assumption of an infinitely expandable/infinitely flexible workforce. If growth is no longer underpinned simply by adding labour, then growth will either a) stop or slow or b) have to be generated by productivity improvements.  Once you’d exhausted the improvements brought about by shouting ‘ship-ka, ship-ka’, that means investment in capital equipment, training and, possibly, infrastructure. 

In turn, this means that the UK financial system will have to rediscover a way of financing capital investment. The experience of the whole western banking industry strongly suggests that it doesn’t currently know how to do this; the experience of Japan suggests that once you’ve lost that skill, you don’t get it back. (Financial systems can fail in two ways: it can lose money by allocating savings to the wrong assets; or conversely, it can fail by being unwilling/unable to allocate those savings into any risk assets at all.  Before 2009 western banks failed the first way; after, they are failing the second way).

In addition, however, we cannot expect companies to suddenly discover an appetite for expanding their balance sheets by investing in fixed assets. In a non-inflationary or deflationary world, everyone understand that asset-turns are king.  

So my guess is that the way forward for the financial services industry must be equipment leasing. Financial companies with unavoidably large balance sheets (ie, insurance companies) can be expected to develop equipment-leasing arms which:
i)  will allow companies to expand capital stock without expanding their balance sheets, 
ii) allow insurance companies a far larger return than is available on bonds; and 
iii) can be expected to attract extremely generous tax-treatment from a government eager to stimulate private investment. 

So, go to it, friends. 

What Happens Now 2: Game Theory and Diplomacy 
In the short term, however, there are good reasons to expect the leaving to take time. The fact that Britain has voted to leave the EU has all the force of a new fact which disrupts many of the forecasts and expectations which existed before that fact. One of the more important is that it strengthens the supposed hand Britain has to play in its negotiations to leave. The best way to appreciate this is through game-theory. 

In a predictably finite game, it always pays to defect, whilst in an infinitely extendible game, the defection strategy is merely one of mutual destruction.  Now that Britain has chosen to leave, the game itself has changed, from infinitely extendible to almost certainly finite.  So in those circumstances, it pays individual EU countries to ‘defect’, which effectively means accepting good bilateral trading terms with Britain, rather than try to impose poorer terms as a group.  For example, were Britain to offer free-trade terms to Germany’s auto manufacturers, would Germany’s government really rule this out in order to respond to the desire of, say, Belgian waffle-producers to play hard-ball?  

These calculations become even more advantageous to UK negotiators if there are, in any case, doubts about how long the EU will maintain its current membership. This is a different type of the same game: no country would want to be a member of the hold-out group imposing mutually damaging trade barriers if significant other currently EU economies had already defected. 

The most obvious way for the EU to avoid these game-theory negotiating pitfalls is to hurry the process as much as possible, in the hope that no-one notices that the game itself has fundamentally changed.  For Britain, of course, the opposite is true: the longer it takes to play the hand, the stronger that hand is likely to be.  There’s no surprise that the EU wants a quickie divorce; but unless the terms are good, any UK games-playing negotiator worth his salt will want to drag things out.  

And there’s a further element to the time-dimension: the longer the time taken, the more likely the unity underpinning the EU’s negotiating strategy will be undermined anyway by the eruption of other crises (Greece again?  Refugees? Budget problems? The demands of domestic politics in Italy, France, Spain, Germany etc). 

For all these reasons, although the EU institutions and some of its members may fervently desire a punitive settlement of scores with the UK ‘pour encourager les autres’, not only economic self-interest, but the logic of the changed game suggests they will ultimately be unwilling and probably unable to impose it. 

(As I write this, the news tells me that six of the founding EU countries have met in Germany and are ‘putting pressure on Britain’ to settle the terms of the divorce quickly. It’s difficult to determine who realizes the game has changed and who doesn’t, although certainly the reporter doesn’t.)  








Friday 3 June 2016

Time to Take China's Official PMIs Seriously

China’s PMIs, compiled monthly by the China Federation of Logistics and Purchasing, are among China’s most useful monthly indicators,  as they are not just timely, but also detailed and plausible both for their internal consistency and because they have a track record of getting major turns in trend right.  Looked at in detail, May’s Manufacturing PMI paint a coherent picture of China’s manufacturers beginning to gear up in response to an improvement in the external trading environment which is nowhere to be found, yet, in other official data. This otherwise hidden upturn shows up dimly but consistently across  export orders, imports, buying of inputs, inventory policies, work backlogs and pricing. 

PMIs are too a good an idea to be left to fulfil their potential. The idea of surveying managers who have to run their businesses responding to perceived short-term changes in the market environment is obviously attractive. If anyone feels the cross-currents of an economy, it must surely be them. They also hold out the promise of producing a speedier verdict on current and near-future market conditions than is possible for the fuller surveys demanded by the production of conventional industrial indicators (eg, industrial output, exports etc).

So when done properly, they are extremely valuable. The best examples come from the US, where the timely ISM manufacturing index and to a lesser extent the extremely timely various regional industrial surveys have earned the right to be trusted.

But problems surface in Europe. There is certainly room for good PMIs in Europe, since official data tends to surface slower than in either the US or Asia, and in certain countries - the UK for example - the official statistics organizations currently seem incapable of generating stable series, even granted the extra time they take to produce them.  A commercial organization, Markit, has encamped on the space vacated by Europe’s official statisticians, and the beginning of every month litters Europe with a confetti of PMIs. To put it mildly, I am sceptical about their worth. I will confine myself to two observations. First, the minute sensitivities suggested by the results (the Eurozone manufacturing PMI, for example, has a standard deviation of only 0.6pts out of 100 during the last 12 months) is undermined by a lack of transparency about they are arrived at. Second, there is no significant statistical relationship between movements in the manufacturing PMI and movements in Eurozone industrial output.

The problems of Markit’s European PMIs tend also to cast a shadow over the credibility of the surveys it constructs in Asia. This is a shame, because in several countries, including India and Indonesia, credible manufacturing PMIs could be very useful.

Some Asian countries produce their own, and of these, there’s no doubt that China’s is potentially the most important. I believe China’s official manufacturing PMI is becoming a genuinely useful tool which provides timely, detailed and plausible information about the state of China’s economy.

The reason why I think China’s official manufacturing PMI should be taken seriously is that the headline figure is accompanied by 12 subindexes covering different aspects of the production phase, and that in the five cases where those subindexes can be checked against subsequently-released industrial data, they tend to tell similar stories. Moreover, those aspects which check out are central to our understanding of China’s industrial cycle: output, exports, imports, inventories and pricing.

First, we can compare the PMI subindex for output with year-on-year movements in industrial output. Since 2012, the changes in the PMI output subindex have generally moved in line with changes in the yoy changes in industrial output. Most recently, since the middle of 2015, the output PMI has signalled growth in output stabilizing at historically low levels. May’s subindex extends this trend, but signals no new deterioration.

The convergence between the export orders subindex of the PMI and actual US$ export growth is less clear, but captures well the deterioration in trading conditions endured since the middle of 2014. Currently, there is a recovery in the export orders PMI emerging that has yet to be seen in China’s raw trade data. 

Much the same can be said of the relationship between the imports PMI subindex and the imports reported in the trade data: there appears to be a general overlap of changes in trend, and currently there is a rise in imports recorded in the PMI subindex which is not yet coming through in the trade data.

When it comes to pricing, the relationship between the input prices PMI subindex and the monthly PPI yoy is much closer: both record the intensification of price deflation seen since the middle of 2014, and both are now signalling a recovery in price pressures since the end of 2015. 




Finally, we can compare the finished goods inventories PMI subindex with changes in inventories of finished goods contained as a line item in the monthly industrial profits data release. Again, the stories they tell mostly complement each other, although over the past few months, the PMI subindex has signalled a modest recovery in inventory-holdings which is not yet showing up in the industrial profits series.  

In none of these cases is the relationship between the PMI subindex and the reported data exact, but in each case it seems that the same trends and changes in trend are captured in both.  Because of that, we should be paying close attention to the official monthly PMIs: they seem genuinely to provide both an early lead on forthcoming data, and another source from which to triangulate other Chinese data.  Moreover, given the difficulties and uncertainties surrounding China’s official data, triangulating for internal consistency is always central to any interpretation of the data. 

In addition, the fact that these subindexes seem reasonably plausible lends credibility to other of the subindexes. This is particularly important because the employment PMI subindexes reported both in the Manufacturing PMI and the Non-Manufacturing PMIs provide practically the only timely and regular pointer to changes in China’s labour market that we have access to. The health of the labour markets is one of the top two economic priorities of China’s policymakers (the other is inflation). As the chart shows, currently these subindexes suggest the declines in the manufacturing sector during 2015 have been moderating since the beginning of the year, whilst employment in the services sector is largely unchanged. The net result suggests that the deterioration in China’s labour markets is moderating, though conditions are not yet improving. 


So what do these official PMIs tell us about the state of China’s economy? May’s Manufacturing PMI was unchanged at 50.1, suggesting nothing better than stagnation - although this is an improvement from the deterioration signalled between August 2015 and February 2016. The non-manufacturing PMI retreated 0.4pts to 53.1, suggesting expansion has slowed towards the lower end of a trend growth seen over the last year.  

The Manufacturing PMI subindexes, however, contain clear positive signals for both exports and imports, and slightly improved signals for both output and inventory policies. This slight improvement also shows up in quite strong upturn in trend for buying of inputs, and a noticeably slower erosion of work backlogs. In addition, there is a clear retreat in deflationary pressures reported since 2H2014.