The Hollow Men of the EU

Here we go round the prickly pear
Prickly pear prickly pear
Here we go round the prickly pear
At five o'clock in the morning.

Between the idea
And the reality
Between the motion
And the act
Falls the Shadow


This section of T.S. Eliot's poem 'The Hollow Men' just popped into my head whilst thinking about the latest chapter in the Euro crisis, but other parts of the poem also seem oddly appropriate.  The prompt for thinking about the poem was the ongoing woes of Spain and the reporting about the Spanish budget, and the wider concerns about the Euro. Reuters gives a good overview of the budget:

Ministry budgets were slashed by 8.9 percent for next year and public sector wages frozen for a third year as Prime Minister Mariano Rajoy battles to trim one of the euro zone's biggest deficits.

"This is a crisis budget aimed at emerging from the crisis ... In this budget there is a larger adjustment of spending than revenue," Deputy Prime Minister Soraya Saenz de Santamaria told a news conference after a marathon six-hour cabinet meeting.

Beset by anti-austerity protests and threats of secession by the wealthy northwestern region of Catalonia, Rajoy is resisting market and diplomatic pressure to apply for a rescue, partly out of concern for national sovereignty but also because European Union paymaster Germany insists Spain doesn't need help.

The central government sees budget savings of 13 billion euros in 2013, with spending down 7.3 percent -- not including social security and interest payments -- and income rising 4 percent thanks to a 15 percent leap in value-added tax take.

The budget goes to parliament on Saturday and debates could last weeks. The country's 17 autonomous regions still must present budgets and find an additional 5 billion euros in adjustments to meet overall public deficit reduction goals.

Apparently, the budget was well received with the Euro gaining against the $US, and stock markets rising in response.  As I have mentioned in an earlier post, there was also an audit of the Spanish banks, with the following finding:

Spain's banks need €53.75 billion ($69.23 billion) in new capital, an independent audit showed, a figure below initial estimates that provides a benchmark for the cleanup cost of the ailing sector, the government and the Bank of Spain said Friday.

The number was lower than an €62 billion estimate Spain gave in June, providing some welcome news to the government of Primer Minister Mariano Rajoy which this week announced a series of spending cuts and tax increases in an effort to stabilize the economy amid protests and political challenges from the country's richest autonomous region.

In my last post on the Spanish crisis, I questioned whether the audit would genuinely reveal the true extent of the losses, and that more toxic debt would be revealed at a later date. I am still of that view and, as I stated before, I suspect that we will see further requests for bailouts in the future. In short, I suspect that the requests for bailout money will be given in 'bite-sized' chunks. The disclaimer of liability at the start of the report and the explanation that the report 'methodology and process' was agreed with the Spanish Government and Banco de Espana might be seen as indicative of the reliability of the report.

The devil is in the detail, of course, and a quick look through the report and raised concerns in my mind, such as the limited sample size used for the assesment due to time constraints (p.13), and crucially, the audit assumes that 2014 is the date of sale of real estate assets, but I found no real clarity on how the values were projected, and it makes heroic assumptions that the assets will sell at all. However, I have only briefly glanced through the report and may have missed details or misunderstood sections, and I am not an expert. In other words, I just looked at the report to get a 'flavour' of the approach.

The point is this; it is not the initial positive market reaction that matters, but the reaction once experts have dissected the detail and methodology. It is then that the quieter shifts in markets will take place, and at which time the real judgement on the report will be felt. In many cases, those assessments will not be make public, but will remain proprietary. An article in the FT, before the audit publication, captures the pressures for positive results from the audit:

This time, it has to work. This is the view of senior bankers in Madrid as Spain prepares to unveil on Friday the results of an audit of its financial sector. Many now consider it the Spanish government’s last chance to convince the world that it has the banking crisis under control.

[and]

The investors and analysts that Madrid is anxious to convince, however, are already questioning the integrity of the latest review, with some arguing it is likely to resemble a stage-managed announcement with few surprises.

Mr Guindos has said that the final amount of total capital required is likely to come in at about €60bn, which is close to a provisional estimate of between €51bn and €62bn made by Oliver Wyman and fellow consultant Roland Berger in June.

In what he labels “the Don Quixote approach to valuation”, Santiago López, an analyst at Exane BNP Paribas, has said it is not credible that the Ministry of Finance has already indicated no listed bank, aside from Bankia, will need new capital under the tests, even though they use aggressive economic assumptions.

[and]

“Spanish banks are not giants but windmills,” Mr López says. “The assumptions of the tests seem reasonable but the conclusion is not credible.”

We have seen plenty of similar bank reviews in the past, and the pursuit of confidence over clarity seems to be the real purpose in many cases, such at the EU bank 'stress tests' that found Dexia to need no additional capital just a few months before it ran into trouble. In summary, perhaps I am wrong about the audit but I do not believe that this is the end of this story. My own view is that it is now just a question of 'when' the next bad news will arrive as the hollow men continue to seek that the crisis resolves, Not with a bang but a whimper.

Added Just after Publication:

German Wages

I just thought I would add a quick note. I stumbled on an article in Slate which grumbles that the low unemployment of Germany is based upon wage stagnation, and could not resist mentioning it.

The real secret to Germany's job market success, though perhaps in some ways related to the labor market regulations, seems to be simpler—don't give the workers any raises:

Now you look at this and you can see why Germans aren't chomping at the bit to offer bailouts to their southern cousins. But by the same token, you can see why the rest of Europe isn't rushing to embrace this model. The pitch for more flexible labor markets is supposed to be that you'll earn higher wages if employers have more freedom to organize work relationships to maximize productivity. Less job security and lower pay is not a great slogan. It is, however, a huge exporting success story. Germany has completely reoriented its political economy around the needs of its export industries which is nice except that just like in all other rich countries the majority of Germans work in non-tradable services.

My central thesis proposes that the shock of oversupply of labour sits underneath the economic crisis. That Germany has followed the logic of this position to its conclusion might be seen as explaining why German workers are still employed. I suspect that, given a choice, many unemployed workers would be pleased to turn back the clock and follow a similar path if it was to keep them in employment. However, before we get carried away with the German success story, it should be remembered that the fallout from the wider crisis may yet pull Germany down. Nevertheless, it is interesting that the German model was the correct response; with the labour supply shock, German workers allowed their compensation to drift down such that their value remained aligned with changing circumstance. And that value still remains high, perhaps reflecting the quality of the German workforce overall.

Another addition Just After Publication:

 I nearly forgot, but there have been several people who have used the Paypal donate button, including some fairly large sums. I just thought I would express my appreciation. In particular, although traffic has remained relatively high (it dropped off during the period when I stopped posting but is climbing again), there is less commentary than before. As such, it is good to know that the blog is appreciated. Thanks!

China: What Next?

There is something that we need to remember about China; it is a powder keg. Like a powder keg, it is perfectly safe provided that there is no spark. The communist government of China undoubtedly realise the nature of the society over which they govern. When China opened with the reforms of Deng Xiao Ping, the government firmly turned its back on the world that was built by Mao Zedong, removing the imperial system that gave communism the legitimacy of the mandate of heaven. Mao was an emperor in new clothes, but rejection of the new imperial system represented by Maoist 'communism' left a gaping hole in Chinese society. It was a hole filled with the pursuit of economic growth. Never mind ideology, just enjoy a growing economy, and all the benefits that it will bring.

It is both a shallow and deep form of legitimacy. It is deep, because who would want to return to the poverty of the empire of Mao. It is shallow because it rests the stability and legitimacy of the ruling party only on growth in the economy. It gets worse; the Chinese government has raised expectations of endless growth to the point where it is a minimum expectation. This is combined with nationalism and resentment. Read a Chinese school history textbook in the original Chinese, and you can see how a metaphorical chip on the shoulder has developed. China is growing to become a major superpower, and with a desire to overturn the shame of recent history. What happens if China stops growing?

We may now be at that turning point. I emphasise may. There are worrying signs that are developing, and the prospect of a hard landing needs to be considered. A review of current news about China tells the story. Yukon Huang, writing in the FT 'gets it'.  The dispute over the Senkaku/Diaoyu islands are tinged with economics, and the economics are tinged with politics. However, the politics versus the economics may become ascendent; if the economy nose-dives, the risk is that nationalism will be seen as a route to re-establish the legitimacy of the government. There is a lot at stake when considering the Chinese economy, including the stability of Asia Pacific, and the intertwined question of the stability of China itself. In short, the stakes are high if China should have a serious hard landing. Perhaps not as high as this discussion might suggest, but certainly high.

From this context, I will review the questions surrounding the Chinese economy. We could look at the lows being plumbed by the Chinese stock market, but this particular casino is not to be trusted as an indicator of the real state of the Chinese economy. If the stock markets of the West have ceased to reflect economic fundamentals, the Chinese stock market has never really been anything but a stereotype of the Chinese love for high stakes gambling. Official outlets, such as the China Daily trumpet positive news, but are not trustworthy, being driven by political considerations. However, even official sources are reporting some worries about the Chinese economy.

BEIJING - Since the latest data reignited concerns about excessive production capacity in some raw materials industries in China, experts have urged those industries to step up restructuring and add more value to their products.

Data released this week by the National Development and Reform Commission, the country's top economic planner, showed that many raw materials industries have seen slowing growth and falling profits from a year earlier.

Total cement production in the first eight months grew by 5.9 percent, 12.5 percentage points slower than the same period last year, while the growth rate of crude steel output slowed 8.3 percentage points to 2.3 percent during the same period, according to the NDRC.

Profits of the country's building materials industry dropped 9.6 percent in the first seven months this year, with cement producers' profits plunging 53.1 percent.

The steel industry saw profits tumble 48.3 percent year-on-year, the NDRC said.
Zhu Hongren, chief engineer of the Ministry of Industry and Information Technology, said Tuesday in an exclusive interview with Xinhua that many materials industries in China are currently confronting serious problems, including overcapacity, dropping sales and sliding profits.

The problem is simple. China has state owned enterprises that have favoured status, and the Chinese government has been pouring capital at cheap rates into these industries. When the process started, the only direction could be positive; industry had been flattened by the destructive policies of Mao. As time moved forwards, the state juggernaut could hardly put a foot wrong, but in recent years - they have overtaken themselves; they are overinvesting in capacity for which there is no real market. A bust is on the way, albeit a bust that is backstopped by the government, and/or state banks that are likewise backstopped by the government. I have been discussing the malinvestment in real estate since 2008 (see post here) so will not continue on that theme in this post, except to say that some of the excess capacity will become even more 'excess' if there is a significant real estate bust. After all, miles of apartment blocks, office blocks, and shopping malls need a lot of industrial capacity to be built.

The possibility of an internal bust in China is intimately entwined with the wider global economy. The chinese economy was built upon a mercantilist export model. It has served China well in that it has seen what might be regarded as an economic miracle take place. It has seen the largest reduction in poverty in history, and a backward economy developed into a modern and sophisticated economy in the space of a heartbeat. I have said it before, and will say it again; the Chinese government played a blinder of a game. Stunning is the correct expression. They have almost managed to pull off an economic coup. However, as with so much in the Chinese economy, what started as an easy win game, as they have progressed, the game has become more complex. As the world economy faces increasing headwinds, this impacts upon the potential of Chinese exports. Furthermore, it is not clear that China is as competitive in some industries as during the period of huge growth.

Just one example of the increasing complexity is that there are reports of manufacturers wanting to return to the US due to diminishing cost advantages of manufacturing in China. In isolation, these reports offer a convincing case in some exemplar industries, but some perspective is needed. Whilst direct costs of manufacture need to be considered, location choices also bump up against other advantages of manufacture in China; the 'ecosystem' of manufacturers that present advantages above flat cost advantage i.e. large numbers of specialists, who develop particular areas of expertise (my own experience in China saw the development of an area that specialised in lighting, though this is not one of the areas that might perhaps attract foreign manufacturers). Although flat cost comparisons may favour onshoring, the ecosystems present another factor that will undoubtedly be considered in the decisions to return 'home'.There will be some impact from onshoring for cost, but this is only one factor that might influence the China policy of companies.

Perhaps a more compelling driver for manufacture in China is concern about the nature of China and stability. For several years now, there has been a policy in many manufacturing companies of China +1. The principle is to have an alternative manufacturing base in addition to China as an insurance policy. That principle may be extended and become more widespread. The recent reaction of Japanese companies to the tensions with China will only serve to create concerns:

Nissan, Japan's top automaker in China, said it would halt production at a joint venture in China starting on Thursday, three days earlier than planned, and extending through next week's national holiday period.

A Toyota executive in Beijing, who spoke on condition of anonymity, said it was "likely" the automaker would cut output in China in the coming weeks. A Toyota spokeswoman said the company had no immediate comment.

Suzuki, meanwhile, said it had stopped one of two shifts that it normally runs in China.
Production slowdowns are a normal feature of the auto industry in mature markets like the United States, where they are used to keep inventories from ballooning and avoid pressure for automakers to offer deep discounts that erode profitability.

But the steps by the Japanese automakers to cut output in China are an anomaly in a market that has driven the industry's global growth over the past decade and where most automakers had been adding capacity until China's economic slowdown in recent months caused production to outpace sales.

The anti-Japanese sentiment in China at present is undoubtedly causing reconsideration of investment into the Chinese market. For the wiser Western companies, ccurrent tensions with Japan may be seen as a signal for caution; 'there but for the grace of God go I'. China is starting to look a little dangerous, and many companies will undoubtedly be considering the potential benefits of China in relation to the very real risks that result from a nationalist environment that might see sentiment and profits determined by political considerations. Combine this with worries about intellectual property theft, and all of the other vagaries of doing business in China, the shifing cost advantages, and China may start to look positively unattractive.

In summary, the hard times are now starting to impinge on China. Their confidence is perhaps their greatest enemy. In the early days of opening the Chinese market, they could hardly do any wrong. A willing and compliant labour market, open for business attitudes, and there was a state that could only win when it picked 'winners'. These advantages are diminishing in the overall picture. In addition, there was some wonderful playing of the 'great game' by China, which saw countries clawing at the doors of China, competing with each other for a piece of the 'action' and giving China the position the belle of the ball (to mix mataphors). It was a great recipe. However, it is no longer the belle of the bal. Doubts about the politics are surely starting to impact on the economics, and the economics are in any case no longer so attractive.

Up to this point, the economics has driven the growing Chinese confidence, and the confidence of the politics may now be negatively influencing the economics - and at a time when both global and national factors are working against the economics. There can be no better expression of the problems of Chinese over-confidence than recent reports of propsals for a 'bond attack' on Japan:

It’s not often that the words “bond” and “attack” are part of the same headline, but that’s exactly what appeared in the Sept. 19 edition of the Daily Telegraph.

The story, titled “Beijing hints at bond attack on Japan,” is a telling look at China’s economic policy — and it’s one that carries some important implications for the United States.

The gist of the story is that China has indirectly, with official deniability built in (a common Chinese tactic), threatened to attack the Japanese economy through the bond market by using quasi-official sources. It is an exemplar of the growing over-confidence of China, and an over-confidence that is self-defeating for their own economic position. Quite frankly, it is scary. China is throwing its weight around, and it is being noticed. They are overplaying what is a a powerful hand, but not as powerful as some in China might imagine. Whilst there are many politicians still courting China, there are going to be many who seek the opposite path. China's overplaying of its hand is going to strengthen the latter, and that could be very bad news for the Chinese economy.

There is plenty more that could be said about the situation in China, and China's economy in relation to the world economy, such at their proclivity for industrial (state sponsored?) espionage. There is much more that could be said about the state of Chinese investment (or malinvestment). There is much more that could be said to emphasise the questions of the sustainability of the Chinese economic miracle. However, this is an overview, and I have limited the review to a very broad overview.

Although I have lived and conducted business in China, and read extensively on Chinese history, both recent and modern, and speak (and used to be able to read) Chinese, I do not profess to be all-knowing about the Chinese situation. Having lived in China, I view China with affection and fear. I would like to see a bright future for China, but the politics in China threatens the miracle of the last few decades. The politics cause the fear, and the endeavour and determination of the Chinese people to create a better life creates the affection and also an admiration. Regardless of my personal views, warning signals are starting to flash, and I would not, if it were my money, risk my money by investing in China. I am somewhat conservative, but not risk averse.

Chinese workers are restive. Whilst a few reports do not make a trend, it is necessary to remember that Chinese workers have been raising their expectations, and that the expectations may be dashed in the even of a downturn.The growing wealth and expectations might not match up in the event of a serious downturn. We should also remember that nearly 50% of Chinese exports originate with foreign multinationals. China still needs those companies, and they may be thinking of alternatives to China.

On balance, I think that China may be entering a period when there is a real risk that the powder keg may be lit. It is both a worrying and scary conclusion. As China goes through another opaque process of power transfer, I can only hope that the new regime recognises that the current paths of policy are taking China towards a world of high risk.





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Spain , Banks and Real Estate - Again....

After two quick posts in succession, this will be a very quick post. Just before my long pause in posting, in June I posted on the subject that Spain would be in a worse state than was being claimed. This is what I said:

My own belief is that the prospects of such a bailout are remote, and that the scale of the problems in Spain have not yet been fully acknowledged. In particular, there are concerns about the true scale of losses for Spain's banks. As the Economist reports, construction and real estate loans grew from 10% of GDP in 1992 to 43% in 2009. The same report highlights the degree and severity of the real estate bust in Spain, and the various (self-defeating) methods the Spanish banks are using to hide or delay the losses.

It perhaps comes as no surprise that there are rumours of delays of an audit of the Spanish banks, although the government denies any delays and is still promising to publish results at the end of July. Even when published, it is not clear how real estate assets might be valued in the context of the broadening problems and downwards spiral of the Spanish economy; the spiral will continue to impact upon real estate prices, and any assessment will only reflect, at best, a guess at the non-performing and underwater loans going forward. In other words, the losses in the Spanish banks are likely to be far greater than is currently accepted, and the Spanish economy likely has a long way to fall yet. When so much of an economy is dedicated to real estate, and real estate goes bust, the damage is going to be huge. As such, even if a large rescue fund were put together, however improbable that prospect remains, the scale of the rescue needed may be larger than is currently imagined.

Well, this is what has appeared in the news:

A bank-by-bank test of financial stability due on Friday is expected to conclude that Spain's lenders are dangerously over-burdened with toxic debts and need to be recapitalised, restructured or shut down. 

The stress test is expected to show a dramatic deterioration since the previous tests were carried out at the beginning of the summer which suggested a €60bn cash injection would be the worst-case scenario. 

Nomura Global Economics said in a note: "Our initial reaction to the publication of those estimates has been negative. The announced figures are well below the market expectations, which start at around €100bn, and, in our view, not only fall short of bolstering market confidence but may actually increase the risk of Spain losing market access."

Last week, the Bank of Spain said bad debts at Spanish lenders had risen to record levels, with almost one in 10 loans in arrears. It is the highest bad-loan ratio since central bank records began in 1962.

In June, Mariano Rajoy, the Spanish prime minister, negotiated a deal that secured lending from Brussels of up to €100bn to recapitalise the banks. Experts now think that it will not be enough. Amid soaring borrowing costs and a stricken economy, Spain has come under intense pressure to ask Brussels for a full sovereign bail-out.

My own view is that the latest calculation of the losses is still probably way off the mark of the real scale of the losses. This uptick is just that. I am very confident that, in few months time, the figures for toxic debt are going to be raised even higher, and the size of the potential bailout will grow again. I suspect that those doing the audits will be fully aware of this, and that any figures given are there to try to make the scale of the bailout that would be needed less dramatic, by implementing it in small increments. However, we shall see.

The US Election: Economic Policy - do not vote for Romney or Obama

I have already written one post today, and thought I would start some research for another post. The subject of the next post was; analysis of the economic policy of Obama and Romney. The plan was a detailed analysis, point by point. It was going to be a lot of hard work.....or so I thought.

I thought it would be hard work, right up to the moment I visited the official websites for each of the candidates. On arriving at each of the sites, I looked at the links and clicked on the links for 'Jobs and the Economy' (identical names for both sites). I fully expected to find some soundbites, and some general waffle on the section home pages. They are both, after all, politicians.

What I did not expect was that both of the official sites go no further than waffle and soundbite. They are instead filled with vague and unsubstantial content that fails to tell you what you should know; the actual detail of their economic policy. Whilst some might argue that I should trawl through speeches, the endless commentator analysis, I would say one thing; an official website for a candidate for the US presidency should absolutely include the detail of the policy that they plan to enact. It is their official website, and should have, in 'black and white', details of their policy.

If I was a US voter, my answer is simple. I would not vote for any candidate who fails to give an accountable and clear description of exactly what they plan to do on economic policy, and they should do so on their own official campaign website. Neither candidate passes this test.

If you doubt what I am saying, take a look here for Obama, and here for Romney.

Although I say vote for neither, their official websites are not equal. Whilst Obama's site is horrifically bereft of any substantial content, at least Romney makes some attempt to flesh out his economic policy.This pathetic discussion is typical of the Obama website:

Made in America

forward

President Obama has a plan to bring jobs back to the U.S. by eliminating tax breaks for companies that ship jobs overseas, and creating incentives for businesses to bring jobs back to America.

Perhaps pathetic is too kind. This is an insult to the intelligence. A further insult is that the links to the policy sections is titled 'get the facts'. It reminds me of Obama's first presidential campaign. Whilst so many people around me were lauding him, I kept asking the same questions; what will he actually do? From my perspective, it appeared that Obama was going to be elected without any real policy commitments and/or would be elected with policy commitments that shifted with the audience for his speeches. His official website follows this pattern. Sorry if it sounds partisan, but it it pathetic.

As for Romney, I have said he is somewhat better. By this, I mean better than pathetic. Not much so. Instead of barely a paragraph of soundbite, there is some 'half-substance'. On the home page, there are some links to policy areas, and some detail of the policy discussion in each area. I have copied 'Mitt's Plan' on trade below in full as an illustration:

Mitt Romney believes that free trade is essential to restoring robust economic growth and creating jobs. We need to open new markets beyond our borders for American goods and services on terms that work for America.

Opening New Markets

Every president beginning with Ronald Reagan has recognized the power of open markets and pursued them on behalf of the United States. George W. Bush successfully negotiated eleven FTAs, encompassing sixteen countries. He also had the vision to commence negotiations with a number of allies around the Pacific Rim to expand significantly the Trans-Pacific Partnership. All told, these agreements have enabled people across the world to come together and build a better future. Economists estimate that the agreements have led to the creation of 5.4 million new American jobs and support a total of nearly 18 million jobs. Looking beyond just our FTA partners, our total exports support nearly 10 million American jobs. These are not just jobs; they’re good jobs, paying significantly above average, and more than one-third are in manufacturing.

• Reinstate the president’s Trade Promotion Authority
• Complete negotiations for the Trans-Pacific Partnership
• Pursue new trade agreements with nations committed to free enterprise and open markets
• Create the Reagan Economic Zone

Confronting China

China presents a broad set of problems that cry out urgently for solutions. It is time to end the Obama administration’s acquiescence to the one-way arrangements the Chinese have come to enjoy. We need a fresh and fearless approach to that trade relationship. Our first priority must be to put on the table all unilateral actions within our power to ensure that the Chinese adhere to existing agreements. Anyone with business experience knows that you can succeed in a negotiation only if you are willing to walk away. If we want the Chinese to play by the rules, we must be willing to say “no more” to a relationship that too often benefits them and harms us.

• Increase CBP resources to prevent the illegal entry of goods into our market
• Increase USTR resources to pursue and support litigation against unfair trade practices
• Use unilateral and multilateral punitive measures to deter unfair Chinese practices
• Designate China a currency manipulator and impose countervailing duties
• Discontinue U.S. government procurement from China until China commits to GPA

Well, there is some kind of half-substance in this. In the original document, the bullet lists are in the the colour normally used for links; I mistakenly assumed they were actual links that would take me to more detail.....but 'no', above is as much policy detail as you get. Not far from useless. For example, for point three of the last section, what punitive measures, under what circumstances, and under what legal framework?  We have no idea, just a vague commitment to so something 'punitive'.

So, given a choice, who would I vote for; neither. With a gun to my head, I would prefer Romney, as at least I have some vague notion of his official economic policy. But I emphasise, 'with a gun to my head'. As such, if you do not have said gun against said head, do not vote. You do not know what you are getting, and have no official 'in 'black and white' position to hold these comedians accountable. This is not democracy, it is a popularity contest with the depth of American Idol. For US readers, think hard about your political system; it looks broken. Don't support it with your vote.

Note: I have seen discussions in the media of their economic policy. Yes, they make speeches, they chatter, they answer interview questions, but where is the 'black and white' detail. The 'this is what I will do' presented in clear terms, as an official position.

If I have missed the location of this detailed policy plan, let me know, and I will correct this page. However, why would they not put such detail on their official campaign sites?  Also, neither website declares itself as an 'officially' endorsed website, but they certainly appear to be the official sites, and I have therefore treated them as such.

The Pressure on Osborne

George Osborne is undoubtedly under pressure and from two directions; firstly there are those who will be demanding stimuli, and secondly those who will be noting and concerned about the failure to meet the borrowing targets that he set. For the former, I have discussed the flaws in the thinking at length, and will not repeat the arguments here. Instead, I will look at some key indicators for the state of the UK economy.


In reviewing an economy, I consider one of the key elements is the balance of trade. It is a good indication of whether an economy is self-sustaining for its overall standard of living or whether it needs credit to sustain the standard; in simple terms, whether the value of what is being purchased exceeds the value of what you are earning. As ever, the UK current account remains in the red (from the 2012 'Pink Book'), and the balance of trade can be seen below (from ONS):



The trend line is fairly clear. The UK is overall consuming a greater value of goods and services than it sells. If looking at the CBI Industrial Trends Survey, August saw a dire outlook for exports, whilst September saw a less dire outlook. The variability in the sentiment makes a firm position difficult to guage, but overall it is not encouraging. And there is good reason for this, with this from the Economist for the trade weighted exchange rate:

Sterling's is at a 13-month high. This partly reflects the Euro's weakness: the euro area accounts for 49.3% of Britain's trade-weighted exchange rate.

I will take a little aside from the main thrust of this blog, as I have been looking for charts to show absolute cumulative government net debt, and it is something that has become an increasingly frustrating process over time. There are plenty of charts that show debt as a percent of GDP, but no charts that show the same thing as 'money'. I have noticed that, over time, this simple statistic has become ever harder to find. I stumbled on this complaint from Steve Keen's blog, and have to agree:

The UK data source, the Office of National Statistics, is almost impenetrable by comparison—it’s the statistical system that Sir Humphrey Appleby would design. It gives the appearance of accessibility, yet either drowns you in so much data in response to any query that you give up, or which, when you get to what you think you want, returns rubbish.

For example, you’d think following the sequence “Economy—UK Sector Accounts—Financial Assets and Liabilities” would actually take you to something resembling the USA’s Flow of Funds, wouldn’t you?

Guess again. Figure 1 shows what it returns you: no data, no publications, but links to four methodology papers on Investment Trusts. “Well done, Bernard!“

I find it a concern that data that I could readily find when starting this blog becomes ever more difficult to find. Steve Keen's main focus is on global debt bubbles, and his comment reassures me that it is not that I am just not looking in the wrong places.  I have looked in a wide range of sources, but a chart (and/or usable/straightforward figures to make my own) that reports the figures I want is elusive, and becomes ever more elusive as time goes forwards. When starting this blog, the figures were easy to find. The Office for National Statistics was particularly useful. Perhaps it is incompetence, but it seems odd that simple statistics are now so hard to find. Unfortunately, even Steve Keen's site does not give the statistics or charts that I need. This is one of his charts:






As regular readers will know, I do not like the use of GDP, which includes activities of the consumption of debt, thereby making the figures of debt as a percentage of GDP useless. In particular, the more you borrow, the higher the GDP. I would normally expect that the Institute for Fiscal Studies would give transparent figures, but they are also obscure, notably with the figures for national debt suddenly stopping in 2003. However, they do give figures for debt on the basis of 'General government gross debt on a Maastricht basis', and this will have to do. I will confess that I am unsure of the details of how the 'Maastricht basis' is calculated, but have found some basic information here. Nevertheless, this appears to be the best and most reliable figures I can find, and I have converted the figures into the chart below:



The figures for 2012-23 are estimates, and the latest reports on the public finances presumably mean that the year will end higher than shown. The relentless upwards march from the period when the economic crisis became apparent is relentless. Despite so-called austerity, the debt pile is growing. Despite the massive government borrowing and spending, people are getting poorer overall:

The Annual Survey of Hours and Earnings from the Office for National Statistics (ONS) shows that the average gross salary for full-time employees was £26,200 in 2011, an increase of 1.4pc from 2010.

But in the face of CPI inflation rates above 5pc this represents a fall of over 3pc in real terms.

I have argued that the government has stepped in to fill the void in the growth of private debt growth, and this is apparent in the statistics:



From the same source as the chart, the pain that sits under the statistics is apparent, describing the the high levels of personal bankruptcy and debt rescheduling and property repossessions. And for the non-financial corporate sector:








It is not a complicated picture. The UK was booming on credit growth. When the credit growth in the private sector stopped, the government filled in the hole with state borrowing. In doing so, the government has continued the overall debt accumulation, where the UK consumes more than it can earn. But it is still not enough to maintain the standard of living of the average person in the UK. The country is getting poorer right now, and the accumulation of debt means it will be even poorer in the future.

What happens if the government were to really stop borrowing? To actually start to reduce the debt? Again, it is not a complicated picture. Even with the government borrowing, incomes are declining. What happens if that borrowing disappears from the economy? Sure, the UK government can keep borrowing for a little longer; it has been able to despite the underlying problems that are apparent in the UK economy. But for how long can this continue? When is the point when the UK is finally viewed as the bad bet that it actually is. This is a chart from Steve Keen:








How long? That is the question that nags. George Osborne may still have time to address the problems, but maybe not. There are some deep seated questions, and those are about what the real standard of living in the UK would be without debt accumulation. A key question is to ask what the government can really afford to do.

For example, can a system continue that sees large numbers of the UK population non-productive, sitting at home on benefits? How can the long term unemployed be put back into work in a tight labour market? Can the numbers of students going into higher education be sustained, when many graduates go into jobs that do not really require a graduate? Both of these are linked questions; a student at university is not 'unemployed' but might be unemployed if not continuing into higher education. Higher education reduces the numbers of unemployed, but does so at a cost. Is the cost and the education worthwhile; does it really add value to the UK economy overall. I give these thoughts as examples of the complexity of how to figure out what is affordable and trying to rectify the structural problems in the UK economy. The problems of how to transition to a lower cost economy are not easy. Nevertheless, a transition must take place at some stage.

The alternative is just not there. An economy can only sustain itself on debt growth for so long. In particular, there is no global recovery around the corner, a recovery that might (just might) help to lift all boats. The opposite appears to be the case, with red warning lights flashing across the world (see last post). Even were the current world economic situation not to get worse, the UK is already getting poorer and more indebted. I therefore make the same point I have now made for several years. The sooner the UK government really acts to address the problems, the better. The problems have not gone away, are not diminishing, but steadily growing. They may be difficult, the reforms may be complex, but carrying on as before becomes ever less tenable. Hard choices must be made, and they will not be easy and they will see a very tough period for many ordinary people. But that is, in any case, the future.

The World Economy: The State of Play

First of all, I would like to apologise for the lack of posting for so long. I have several times sat down to start to post, but was somewhat at a loss as to where to start. I had a quite a long period in which all I had time for was a major project, and returning to posting has been difficult in the face of an ever more 'odd' world economic situation. Too much cries out for attention, and this is the problem; each of the many stories that are ripe for discussion do not make sense in isolation. As such, I will try to give a selective overview, and do so in the context of my underlying thesis of the causes of the world economic crisis.

[Note: as I have pressed forward in the post, I have limited references/links, and also digressed from my original purposes for the post. I hope that it still remains a coherent view.]

First of all, I will briefly outline my explanation of the crisis in the world economy. One of my discussions of the underlying cause can be found on Huliq, and I recommend reading this if you are new to the blog (there is a more detailed version somewhere, with more figures, but I forget where it is). The short version is that, with the entry of economies such as India into the world economy, there was a huge supply shock. The labour available to the world economy (by which I mean with capital and connected into the world economy) has approximately doubled. Even whilst this was taking place, the supply of many commodities failed to keep pace with the expansion of the labour force and, for other commodities that did expand in supply, the demands of building new infrastructure in places like China saw demand explode to a degree that commodity supplies still struggled to keep pace with demand.

The result of the labour supply shock, in conjunction with the problems of commodity supply, saw what I term hyper-competition. I dispute the idea that the 'financial crisis' was the cause of the economic crisis, but argue that it was instead a symptom of the supply shock (see the Huliq article for why). The economic crisis is resultant from hyper-competition, and the shift of limited resources towards the 'emerging' economies. From this underlying thesis, I have argued that the result will be that there will be a re-balancing of wealth around the world. Contra to the argument that the emerging economies would grow in wealth whilst the developed world continued to be wealthy, I have argued that the world economy would grow overall in wealth, but that the growth in wealth of the emerging economies would, due to redistribution of limited resource, come at a cost to the developed world. Whilst the emerging economies grew in wealth, the developed economies would generally see an erosion of wealth.

In the Huliq article, I link to my early posts on this thesis in 2008. Time has now passed, and we can start to see the outcome of the labour supply shock. An interesting example can be found in the many stories coming out of the US describing the shrinking of (and often described as the the 'death of') the American middle class.There are questions about what people might call the middle classes, but there is a clear picture in which median incomes and the quality of life of 'the middle' in the US is moving in the wrong direction. At the same time, stories abound about the 'rich getting richer', along with rafts of figures supporting this point. That this is taking place is unsurprising; if there is a massive increase in supply of one of the factors of production, then it should be expected that the price of the factor will go down. As labour prices have gone down, this in turn increases the potential for those with capital to make greater profits and those with capital reap the benefits of cheaper labour.

A similar story can be found in the UK, where incomes have been described as being 'squeezed' by the Governor of the Bank of England (sorry, no link) and reports of ongoing declines:

People in the UK saw their incomes squeezed in 2010-11, despite a modest recovery in the wider economy, according to a new report.

Data collated by the Institute for Fiscal Studies (IFS) has revealed that median household income fell by 3.1 per cent after accounting for inflation during this period, wiping out five years of minor growth within 12 months and setting income levels back to those seen in 2004-05.
This represented the largest single-year decline in income levels since 1981, with earnings falling across all parts of society.

According to the IFS, these figures can be attributed to rising inflation and the delayed effect of trends seen during 2008-10 at the height of the recession.

The situation in Europe is complicated by the Euro crisis, with the crisis an additional factor that is influencing the wealth of individual countries throughout the European Union. Nevertheless, the picture is one in which, for much of the EU, the economic situation can only be characterised as dire. The Euro crisis just complicates the picture. Perhaps the most interesting example in relation to my thesis are Australia and Sweden, which have largely been immune from the economic crisis that has been felt in the rest of the developed world.

Unlike Britain, it is sometimes said, Australia and Sweden are advanced economies that have managed to get their public policy agenda broadly right, and as a consequence now reap the rewards.

Both economies sailed through the credit crunch pretty much unscathed, unemployment is at or close to an all-time low, and unlike so many other ''rich'' nations, public debt is under control.

But while inspired policymaking has no doubt played its part, much more important is that both Australia and, to a lesser extent, Sweden are rich in natural resources. Sweden also has an abundance of relatively cheap hydroelectric power.

The blessings of nature, not the brilliance of policymakers, offer the better explanation as to why these countries have done so well.

Similar stories can be told for other commodity rich economies such as Brazil and Russia. The success of these commodity rich economies are exactly what might be expected in the era of hyper-competition. I have also argued that the world economy would be dominated by commodity supply and prices, saying that: 

In an earlier post, I presented an analogy. I described commodities as a moving brick wall to growth, with the world economy running behind this wall of constraint. As the economy runs forwards, it hits the wall and tumbles backwards. The world economy then gets back on its feet, and once again runs towards the wall only to eventually bounce back again. [sorry, I forget where I first wrote about this].

This has been the pattern that has emerged since the world economy fell into crisis. But, it may be that the situation may be about to change. The first element that needs to be considered is the energy revolution that has resulted from 'fracking', which has allowed an explosion in natural gas output. It is not a direct substitute for oil, with more limited uses, but it has changed the overall picture of energy supply. This is not to say that the constraints of oil supply  have been removed but they have been ameliorated. However, this is nothing compared with the potential for the Chinese economy to impact on the commodity situation:

Sharma is heard with respect when he gives an opinion on something concerning emerging economies. At the same time, the commodity supercycle standing for a very long-term surge in prices may or may not have run out of all its steam. Unarguably, bulk commodities and metals subject to stagnation in the two decades preceding 2000, subsequently started experiencing regular spikes in prices on the back of unprecedented demand growth in emerging markets.

If China stood out for its ravenous appetite for raw materials, a big market opened up for their suppliers, benefiting emerging economies, like Brazil and Russia. In the beginning of the cycle, demand for raw materials was ahead of supply and buyers in China and India (for coking coal) were constrained to pay ever rising premium prices. Raw material price spikes left huge surpluses with the mining groups leading them to invest heavily in capacity expansion to take care of the world hunger for minerals. This is bringing about a balance in demand and supply and as a result, a southward push to prices of raw materials and collaterally to metals.

Unlike Sharma, many others argue that rises and falls in commodity prices happen in waves lasting 20 years. If it is to be accepted that a supercycle has a life of 20 years, then there is no running away from the fact that halfway, the market is taking a hard look at slowdown in all emerging economies from where the bulls in the first place drew inspiration. The Chinese double digit growth rate is in the past and as the world’s second largest economy is aiming at a soft landing, it grew at 7.6 per cent in the second quarter of this year. China has now lowered its 2012 growth target to 7.5 per cent from the earlier eight per cent.

As for India, Moody’s says the combination of a sharp and broad-based slowdown, a poor monsoon and a government that has “badly lost its way” will restrict the country’s growth at 5.5 per cent this year and six per cent in 2013. Growth deceleration in the two BRIC (Brazil, Russia, India and China) nations will set off a chain reaction. Fall in China’s raw materials import growth rates in particular will be hurtful for resource-rich and export-dependent Brazil and Russia. Australia, a major supplier of a host of minerals to the world, is taking a hit because of a downturn in commodity prices. Retreat by bulls is also due to discouraging industrial output data from Euro zone countries. Their main concern is Europe’s manufacturing hub Germany, which after sustaining growth through the European debt crisis is now feeling the impact of the Euro zone storm. No wonder the German manufacturing PMI in July was at its lowest for more than three years. Bulls are further disheartened by the Bank of England warning the UK economy would grind to a complete standstill and the US Federal Reserve and European Central Bank refusing to introduce new stimulus packages.

For a long time, I argued that China was playing its cards superbly. They played the developed world players off against each other, stole intellectual property, and used their currency in support of mercantilism trading policy. From the ravages of Maoism, when China commenced opening up to the world economy, the massive investments in infrastructure were easy 'hits' for creating infrastructure with significant economic returns. However, even in my early posts, back in July 2008 I said the following:

The first point is that it is quite possible that China has a construction bubble. Whilst I was in China I noted that there were lots of apartment blocks being built, and that it was very popular for these to be purchased by investors. In many cases the investors were leaving the apartments empty (Chinese people like to buy property brand new, once it has been lived in the value falls), and they were holding on to the apartments in an expectation of increases in value. In addition to this there has been a boom in the construction of shopping malls, and I noted that they were already (back in January) starting to exceed demand. If the Chinese economy is pulled back due to world demand for exports dropping, it is likely that such investments will lead to a bust. It is also worth considering the state of the Chinese banks. If they are lending into construction in this way, will there be a repeat of the previous Chinese bad lending problems of a few years ago? What other bad lending is buried in their books?

Set against this is that the finances of the Chinese government are very healthy, as are the levels of savings in China. The real question with China is how much their continued growth is reliant on exports, and how much growth can be sustained within China. I will readily admit that I am not sure on this at all. I am not sure that anyone is. My best guess is that China will also hurt, and hurt badly, with a significant potential for civil unrest as a result.

The final paragraph; I was wrong, and China did pull through and in part because of the spending binge of the developed economy governments maintaining demand. However, it is now four years later, and the situation I described with housing and other real estate was indeed taking place, but no bust took place. Analysts have recognised what I saw on the ground all those years ago, and have similarly been predicting a bust in the last couple of years. That bust may, or may not be in motion now, but the curious question is why it was that the bust has been evaded so long. The answer is simple; the Chinese have nowhere else to put their money, except for the casino Chinese stock market, in state bank accounts with pitiful returns, or in places like Wenzhou in very dubious private corporate lending.

With regards to the finances of the Chinese government, they still remain relatively healthy, but only if you discount the provincial and local government. A combination of corruption and ineptitude has seen large investments being made in construction projects, in preferred state companies, and real estate. The result is massive investments in capital projects, including dubious infrastructure projects and real estate. As time has moved forwards, the easy investment 'hits' have diminished, and the result increasingly dubious investments. These investments are, in turn, linked into the state banking system, which will undoubtedly be sitting on low grade debt that will sour at some point in the future. In a previous post, I have detailed the cities being built with no people to live there, and this is just a very visible tip of a large iceberg.

The Chinese government sought to engineer a soft landing from the real estate boom, restricted credit, and the result may be a hard landing. I mentioned Wenzhou earlier, as it is the exemplar of how this tightening of credit led to a big bust in the private 'grey' credit markets; the limited access to credit in the state banks fed into a bust for many of the unregulated private lenders, often with horrendous results for small investors. However, in the face of dramatic drops in growth, the restraints on credit have been pulled, and a new round of large capital investments has been unleashed. The problem is that the re-loosening of the credit taps will see more malinvestment. It may (or may not) be too late to reverse a bust. The problems that are taking place in China are likely to be exacerbated by the problems of the EU economies weakening demand for goods, and the so-called 'fiscal cliff' in the US:

Congress is moving to quash the threat of a government shutdown, but the prospect of a one-two punch of tax increases and slashing, automatic spending cuts will still confront lawmakers when they return to Washington after Election Day.

The House on Thursday passed a six-month stopgap spending bill to keep federal agencies running past the end of the budget year, the elections and into the spring. It effectively scratched a major item off of Congress' to-do list heading into a potentially brutal postelection, lame duck session.

The bipartisan 329-91 House vote for the measure sent it to the Senate, which is expected to clear it next week for President Barack Obama's signature, capping a year of futility and gridlock on the budget despite a hard-fought spending and deficit-reduction deal last summer.

Nobody can predict at this stage how the 'fiscal cliff' will play out. If it does kick in, the US economy is likely to be hit hard, and this may explain the feds renewed bout of printing money; it is front-running the potential fallout from the fiscal cliff. In the meantime, the mess of the Euro continues to stagger forwards with compromise and delay, but with no real resolution. It is a crisis that simply refuses any resolution. It is almost becoming dull to watch the back and forth between crisis, and temporary bouts of market relief. As time goes forwards, it becomes ever more apparent that we are watching King Canute seeking to turn back the tide. We are just left with the hanging question of when and how the tide might finally overwhelm the desire that it be held back.

The problem is that, if China really does go into reverse, this will have knock on effects in the countries that have been sheltered from the economic crisis through the commodities super-cycle. The new bout of investment may just lift the Chinese economy enough to keep the economy from a bust, but it is far from certain in the face of wider economic headwinds.

There are some things which remain resolutely unchanged. The global 'too big to fail' banks still sit like time bombs within the global financial system, but post-crisis are even more 'too big to fail'. Although there have been vague and weak attempts to address some of the problems of these banks, central banks continue to support bust banks, and do whatever is needed to shore up the banking system. As I have discussed in previous posts, parts of the EU bailouts have been directed towards shoring up insolvent banks, and in return the insolvent banks have propped up insolvent governments. It is the same story I have discussed previously; banks are magic entities which are the foundations of economies. Somewhere along the way, the regulators and politicians lost sight of the purpose of banks as a support for the rest of the economy, and now the rest of the economy is a support for the banks.

Then there is the government borrowing. In the developed economies, the debts of governments just keep on growing. Whether financed through the printing presses, or financed through dubious credit lines of central banks, developed world governments just keep on borrowing and spending. The poster boy for the borrowing and spending approach is, in my view, the UK; they proclaim austerity whilst continuing to borrow and spend at astonishing levels. I am not going to discuss this subject in detail, as the blog is replete with discussions of individual economies, and general principles.

However, I will re-emphasise that this is a prolonging of the problems of the developed world. The shift in the world economy represented by the labour supply shock was hidden by huge expansion in credit. This allowed the diminishing levels of wealth in the developed world to be hidden for a while. Even though less wealth was being generated, lifestyles were maintained as if wealth generation was increasing. The 'financial crisis' was simply the 'bust' of this paradigm, and the developed world governments replaced the private credit growth with government credit growth. What the governments failed to recognise was that the private credit growth had restructured their economies to service credit growth, and that they are retaining that structure through the use of government borrowing. In the end, credit growth cannot be sustained forever, and any structure built upon ongoing credit growth must eventually collapse.

The point is this; the great labour supply shock has taken place. It is there in front of our eyes. It is not possible for the entire world economy to become richer if the rate of labour entry exceeds the increase in the rate of available commodities. It is a situation further complicated by the resource intensive growth in infrastructure needed to grow a developing economy, but it is a simple and logical formulation. If 10 people share access to 10 litres of oil, each can have a litre. If the number of people increases to 15, and the available oil only increases to 12 litres, it is not possible for each person to have a litre. What then happens is that those who want a litre of oil, as they had before, must compete intensively with the newcomers if they want to keep their oil. The newcomers, unsurprisingly, would also like to have a litre of oil. Welcome to hyper-competition.

It is a situation which is now being recognised. This from a conservative commentator in the Telegraph:

In his seminal study of business cycles, the Austro-Hungarian economist, Joseph Schumpeter, explained these long – or Kondratieff – cycles as the natural result of particularly high periods of technological innovation. This seems plausible, even though the latest phase of innovation is of course mainly about communications, little if any of which originated in China.

Modern communications has none the less reduced Western advantage in many commodity industries to virtually zero. The major beneficiary has so far been China, where dissemination of Western technology and globalisation of trade has driven a remarkable economic transformation.

Western economies have in a sense shot themselves in the foot. Their own innovation has made them relatively less competitive and therefore less well off than they used to be. One of the manifestations of this shift is that we have to pay a lot more for our commodities – be it food, oil or metals – than we used to. Speculation, Western money printing and ultra low interest rates have turbo-charged the bubble.

But even assuming that China avoids the much feared hard landing, there is good reason for believing the present super-cycle may already have peaked. The iron ore price has fallen nearly 40pc in the past year alone.

As in 2008-09, the fall may be a blip, but equally, it may a presage a much-needed shift in the composition of Chinese economic growth away from commodity intensive investment and capital accumulation to consumption. China’s investment and export orientated model is proving just as unsustainable as the West’s consumption driven approach to growth. China knows it must change if it is to keep growing. There’s no relief to be had from once buoyant Western export markets.

People are starting to get it. It was never a financial crisis for the developed world - it was a fundamental economic crisis - a shock that was buried in a credit make-believe. All the actions of policymakers and governments, including politicians and central banks in particular, has been a pretense that 12 divided by 15 can equal 1. The response has been to hide from the reality that the figures just do not add up.

We have seen the Chinese economic miracle, and to a lesser extent the other emerging economies, dominate the shape of the world economy. Rather than confront the challenge that was represented by this new challenge, the answer was to pretend that all could go on as before. Rather than adapt to the new and emerging reality, the answer was to preserve the structures of another time, even though they were increasingly impossible to maintain. In trying to preserve the existing economic structure, the policy response has been to create a new world in which governments are now in the driving seat of markets, are now taking an ever larger role in the economic activity of the world, and consuming ever greater proportions of the available resources. This action is supposed to 'save' the world economy.

But is is not. In the developed world, most people are getting poorer and poorer. Even as governments grow their debts ever larger and larger, people are still getting poorer. And those debts must one day be repaid. Then there is the money printing, and the market sugar rush that follows each bout of printing money. I reported on an analyst's view of this some time ago. His advice; invest when money is printed, and get out before the effects wear off. In other words, the markets are no longer about underlying economic drivers, but are responses to policy actions alone. It is hardly a basis for future economic growth. The same analyst gave five years of this paradigm before it all collapses horribly. And then there are the banks. Protected at all costs, wealth flows from the rest of the economy into the banks. Every bout of money printing helps them; they get access to capital for the carry trade. So far, they remain as the winners, albeit with some ups and downs. In the new paradigm, they are protected at the cost of everyone else. The economy now services the interest of the banks, not the banks servicing the interests of the economy.

For me, this is how I see the world economy. In some respects, it is a rambling discourse. However, there is a theme running through. Something changed, and there was a failure to respond. Something is changing now. The miracle of China is running its course, and there is a turning point. I am not predicting an immediate economic bust but rather that the corruption and ineptitude of the Chinese system is now starting to overwhelm the raw potential that was unleashed with the reforms of Deng Xiao Ping. This might have been an opportunity for a resurgence of the developed economies. However, when looking at the state of the developed economies resultant from the policies of the last few years, it is not clear that there is the foundation for a resurgence. That is the tragedy of the last few years. We are now at an inflection point, and the developed economies may be too weak to respond.

Note Added 16/09/12: The first comment has my thesis 'smashed' - I suggest for those who doubt the thesis, take a look at oil output over the last ten years, and consider this in the context of the growth of emerging economies. The idea that commodity prices are all controlled by speculation is a myth; it is possible to play markets for a while....but in the end the values are driven by demand for the actual product (with some obvious exceptions such as gold). I have no doubt that some will not accept this, whatever is suggested. 

Note Added 18 Sept, 2012: I have just published a comment below, but it nearly went in the delete pile. You will guess which one. Whilst robust comment is good, please refrain from personal attacks and insults.