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Senior US Economic Advisor Suggests Markets Offer “Little” Help in Recovery Efforts

Occasionally, very occasionally, a senior figure within financial markets provides the correct answer to a difficult question. The question: Do financial markets contribute significantly to real economic growth? - has been addressed in this weekly report regularly for months.

The answer is, of course, that financial markets do not contribute significantly to real economic growth. In fact, the speculative sub-sector of financial markets offers close-to-zero economic benefits for the real economy. It’s just re-distribution of wealth from one party to another with the industry taking fees on the transaction for facilitating the transfer.

Reading it in this report is one thing. Receiving the same confirmation from the chairman of Barack Obama’s Economic Advisory Board is an altogether more powerful argument. The chairman, Paul Volcker, is no box ticking politicians’ patsy either. Volcker served as the chairman of the Federal Reserve from 1979 to 1987 (preceding Alan Greenspan) and therefore has near-unrivaled experience of finance and markets encompassing many decades.

As a sane voice in the financial asylum, Volcker is rare, but not unique. The Financial Services Authority chairman Lord Turner, appointed in 2008, is also following the route of painful honesty, rather than pandering to the city, and recently described banks as “socially useless”.

Whether or not such senior figures should have had the courage to speak out at the frothy peaks of a stock market bubble is another matter. No-one would have listened. Such a statement then, when so many were making paper money profits from the debt bubble, would have sounded like a Communist manifesto. Now, of course, the realization is spreading that the vast majority of the public are financially poorer, not richer, because of the banks. Self-serving greed has dominated much of the industry with a few institutions like Northern Rock, Lehman Brothers and Royal Bank of Scotland (NYSE:RBS) articulating such a degree of risk-control incompetence that each one will offer future students a text book example of how not to manage a bank.

UK Pre-Budget Report Dithers around Fiscal Challenges

Before progressing onto the rant-free zone of this week’s report, it’s worth noting that the above scenario has given the opposition in waiting, the Labor Party, the opportunity to avoid accepting fiscal responsibility in favor of issuing a vague, confusing and useless pre-Budget report. The PBR statement had few highlights and fewer still solutions to the UK’s fast deteriorating finances. However, in a futile and populist move, bank bonuses were beaten-up with a prepaid 50% tax burden on all payments over £25,000.

For example, a relatively lowly paid city worker, free from blame or association from the banking debacle, could be paid a fair salary of £45,000. The salary may be high by national standards but in Central London it’s no free lunch. If that employee is due a £26,000 year end bonus, it would receive a 50% tax burden within the bank’s combined bonus pool before payment. The remaining £13,000 would then suffer a higher rate income tax burden of a further 40% on the £13k. National Insurance is also due to increase by 0.5% from 2011. NI is already around 11% for the employee. So a £26k bonus at source would give the worker about £6,370 in its pocket. That’s a 75.5% direct tax rate. With the remaining £6,370 all the employee has to do is pay 17.5% VAT on most purchases, council tax, stamp duty, alcohol and tobacco taxes, fuel duties and an infinite number of other indirect taxes. If they are prudent enough to save any of the bonus leftovers, they can look forward to paying tax on their interest too.

Of course if you were that city worker the ‘after tax’ pay from your bonus (and your basic wage) is taxed eventually anyway. The money circulates in the economy, lands in someone else’s pay-packet and your small pot of after-tax money is then taxed in the hands of the next tax slave.

Other ‘news’ from the UK included confirmation that Kitty Ussher, elected as Member of Parliament for Burnley in 2005, claimed £16,723 for the kitchen renovation of her 2nd home in London, and thousands more on a sofa, chair and decorating costs elsewhere in the house. Ussher responded to criticism with distress, “most of the ceilings had Artex coverings”.

Poor Kitty. My heart bleeds.

Other Members of Parliament have also made strange efforts to bond with the recession-hit public. David Heathcoat-Amory claimed 11 sacks of manure for his expansive garden and £6,500 for his gardener. MP James Arbuthnot claimed £15,000 to cover costs including the painting of his summer house. Meanwhile, maintaining the garden theme, MP Mark Hendrick claimed more than £7,000 for the relaying of his lawn, garden reconstruction and for stone paving.

Previous claims from other Members of Parliament have included reimbursements relating to floating duck houses and pornographic films.

Federal Reserve Policy Remains Loose Despite Improving Unemployment Data

Monday’s Federal Reserve statement by Ben Bernanke must have been penned prior to the previous Friday’s unemployment announcement. The jobs news highlighted a firm bounce in the US economic recovery with the unemployment rate falling surprisingly from 10.2% to 10.0%.

The jobless news helped the dollar rally sharply against the other G7 currencies. However, the rally temporarily stalled as Bernanke repeated the “no inflationary dangers” sound-bite early this week ,confirming the Fed was committed to maintaining a loose monetary policy for some months yet.

Bernanke persisted with the loose stance, suggesting "We still have some way to go before we can be assured that the recovery will be self-sustaining” and "Also at issue is whether the recovery will create the large number of jobs that will be needed to materially bring down the unemployment rate."

The cautious ‘better safe than sorry’ approach can also be interpreted as ‘better to have inflation than a double-dip recession’ strategy. After all, if you owe $11 trillion wouldn’t inflation be a jolly handy tool to erode the real value of your enormous nominal debt?

Bernanke also took the opportunity to reassure markets he had a bucket load of ideas that would enable the Fed to withdraw stimulus effectively, when needed, but refrained from sharing any blue-sky ideas preferring to highlight the obvious - the cost of borrowing could increase.

Visionary Ben. You should work in finance.

US, UK Ratings Not Immediately Under Threat

Rating agencies issued a raft of statements over the week helping government bond and currency markets jump around in confusion and volatility.

The Moody’s mid-week statement helpfully informed investors, presumably those lost in the Montana wilderness for the past 18 months, that the US and UK economies had serious debt problems. The conclusion, that both governments’ debt levels were “resilient”, was a back-handed compliment initially greeted with apathy by speculators until one bright spark highlighted the fact that “resilient” was a poor cousin to “resistant”, the description given to German and French government debt.

The better understanding of Moody’s strangely worded rating system should have helped the euro to gain at the expense of dollar and sterling but other news prevented a euro rally. Two Euro-zone members, Spain and Greece, didn’t even get a “resilient”. Fitch and Standard & Poor’s, the two other main ratings agency, issued very downbeat guidance on Greece with Fitch describing Greek financial institutions as having “weak credibility”. Spain suffered a similar mauling.

Later in the week, Moody’s delivered more expert guidance, this time with a forward looking stance suggesting the UK couldn’t fall into a full-blown fiscal crisis before 2013. Moody’s suggested that if the UK government immediately introduced firm and prudent fiscal policies, the crisis could still be averted.

We may as well put the crisis in the 2013 diary now.

China Overtakes India in Gold Consumption

India, allegedly, has been the world’s largest consumer of gold for 2,000 years. Whether that un-provable claim is true or not, the Indian sub-continent has certainly been the most significant player in the precious metal market in recent memory, but that premier seat at the golden table now belongs to China.

Over the past year, gold demand in India has weakened due to economic and currency issues whilst Chinese demand has continued its relentless upward momentum. India is predicted to consume 422 tonnes during 2009 with China piping India at the post with 432 tonnes, up 8% on 2008.

China’s love for all things mined has helped gold reach a new all-time price high in 2009, though prices have eased recently as investors have taken profits and in response to the dollar's fight-back against depreciation. The US currency price trend has been negatively correlated to the price movements of gold during the economic recovery.

Source: U.S., U.K. Economies: From the Sublime to the Ridiculous