The news that has caught the market’s attention today is the ECB’s first offer of 3-year money to Eurozone banks. The most interesting thing that has happened is that Spain has borrowed short-term for a much lower rate than in its last auction. Spanish 10-year yields are down to 5%. Is this an indicator of things to come for the other PIIGS, or something special to Spain? Certainly it suggests that credible austerity may stave off any crisis for the time being. Yields in the other PIIGS remain high for the time being (Italy 6.5%, Ireland 8.4%, Portugal 12.6%, Greece off the scale), but a general decline in yields would be an argument against my assessment that the latest European deal did nothing to address either the Eurozone’s immediate or its long-term problems.

I find investing in equities a frustratingly wooly business. First, the relationship between earnings and the share price is generally not stable. Second, future earnings are very hard to predict. I have gone some way towards addressing the first point by using a two-factor model for the share price, the factors being earnings and a credit spread. But I have so far not come up with any great insight on the second point. In general, equity analysts attempt to forecast earnings by immersing themselves in a world of stories about the companies they cover, and using those stories to establish a broad direction for earnings (they then construct models with spurious precision). But stories can be misleading, and companies are so complicated that one may construct a story out of facts that do not turn out to be the most salient to the future path of earnings, or out of known facts when unknown or unknowable facts turn out to be most salient. Some analysts have over time successfully forecasted future earnings growth using an objective methodology (for example, Gary West and James Inglis-Jones at Liontrust), and I am now turning my attention towards doing the same.

Bloomberg reports that the US is now working with European countries on the idea of some kind of restriction on Iranian oil exports. Oil revenues supply 50% of Iran’s budget, so a reduction in oil revenues to the regime would be significant, but restrictions on the physical export of oil would likely raise the price and could therefore benefit rather than hurt Iran (the nasty, selfish countries like Russia and China will likely continue to buy its oil). Bloomberg reports that the US has suggested to Japan that it impose a surcharge on Iranian oil imports, and quotes officials as saying that the objective of any action would be to reduce Iran’s oil revenues, not to achieve a complete embargo of its oil exports. This hints at an idea that might work: to the extent that Iran is a price-taker in the global oil market, any surcharge should fall on Iran and not on the purchasers of its oil. If the US and Europe are considering basing their wider policy on this idea, that would cohere with reports that Gulf diplomats have said that they would make good any shortfall caused by an interruption of Iranian exports to Europe (i.e. they would keep the oil supply to Europe the same and thus keep global prices steady, ensuring that Iran remained a price-taker). However, an obvious weakness in the scheme is that rising political tension could add a significant risk premium to the price of oil. If the Iranians understand this, then they will create as much tension as possible, in order to maximise the risk premium and thus offset the effect of any surcharges.

Bloomberg also has a story with the headline: “Bankers join billionaires to debunk ‘imbecile’ attack on top 1%.” A few thoughts on this subject:
  1. The rich people quoted in the story appear to believe that all their success is down to their own effort. That will be wrong in the great majority of cases. Luck is a significant factor in getting rich.
  2. People are not necessarily suggesting that the top 1% are wicked — I certainly would not — but merely that they should pay more tax. I have some sympathy with this view. It is a second-best answer to the extreme inequality of the income distribution in the US. I think a first-best answer would be to have an economic system in which more profit flowed to the providers of labour rather than to the owners of capital (hence I am less hostile to labour unions and labour regulation than I used to be), but that does not appear to be a realistic possibility at present.
  3. The behaviour of bankers since the financial crisis is quite a good argument not just for utility-style banking, but also for the nationalisation of retail banks. The major theoretical objection to this idea is that governments would interfere in banking, forcing banks into irresponsible lending; but the fact is that banks are already run by people who are hell-bent on irresponsible lending and other strategies with the potential for good short-term payoffs combined with large risks that are long-term in nature. Nationalised banks could be overseen by an independent committee of experts similar to the MPC and FPC, with the objectives of the committee set by Parliament. Sadly I think that there is a serious practical objection to this idea for the UK, which is that it would cause havoc in the City and thus cause job losses and a fall in tax revenue in the short term. Perhaps during a future banking crisis this objection will be less relevant and an enlightened government will be able to nationalise the lot of them.
What is happening in the UK government accounts? I thought I would have a quick look into this today. On a 12-month trailling basis, social security spending continues to rise but government consumption excluding social security and interest payments has actually begun to full. Total government expenditure looks like it has just begun flatlining. According to the OECD, government employment has fallen sharply in 2011, continuing a decline that began at the start of 2010.


Eurozone current account returned to deficit, d.e., in October.
Italian trade deficit narrowed in October. Is the adjustment of internal imbalances under way through the mechanism of recession? If so it is sooner than I expected. Perhaps the problem is not that Europe’s BoP imbalances will persist for a long time, but that they will only be eliminated under recession conditions and will re-emerge as soon as there is any growth, kicking off the whole cycle again.
UK Nationwide consumer confidence rose, b.e., but remains low.
German Ifo rose to 107.2, b.e.
Housing starts and building permits both rose to the top of their post-crisis ranges, b.e., Nov.
New Zealand current account deficit widened more than expected in Q3. Japanese trade balance moved further into deficit in Nov, disappointing expectations for a narrowing. Is this evidence of a slowdown in European or Chinese imports?
UK GfK consumer confidence declined, d.e.
Italian GDP 0.2% QOQ Q3 d.e.