With worries about Greek exit from the eurozone, with the unlikelihood of further quantitative easing in the USA and the UK, with interest rates likely to rise in the medium term, and with Chinese growth predicted to be more moderate, many market analysts are forecasting that stock markets are likely to fall in the near future. Indeed, markets are already down over the past few weeks. Since late April/early May, the FTSE is down 4.5%; the German DAX index is down 7.0%; the French CAC40 index is down 6.9%; and the US Dow Jones index is down 2.3%. But does this give us an indication of what is likely to happen over the coming months?
If stock markets were perfectly efficient, then all possible information about the future will already have been taken into account and will all be reflected in current share prices. It would be impossible to ‘get ahead of the game’.
It is only if market participants have imperfect information and if you have better information than other people that you can are likely to predict correctly what will happen. Even then, the markets might be buffeted by random and hence unpredictable shocks.
Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.
If Greece were definitely to exit the euro, if interest rates were definitely to rise in the near future, if it became generally believed that stock markets were overvalued, then stock markets would probably fall. But these things may not happen. After all, people have been predicting a rise in interest rates from their ultra-low levels for many months – and it hasn’t happened yet, and may not happen for some time to come – but it may!
If you want to buy shares, you might just as well buy them at random – or randomly sell any you already have. As Tetlock says, quoted in the Nasdaq article:
“Even the most astute observers will fail to outperform random prediction generators – the functional equivalent of dart-throwing chimps.”
And yet, people do believe that they can predict what is going to happen to stock markets – if not precisely, then at least roughly. Are they deluded, or can looking calmly at likely political and economic events put them one step ahead of other people who perhaps behave more reactively and emotionally?
Bond rout spells disaster for stock markets as global credit kraken awakens The Telegraph, John Ficenec (14/6/15)
Comment: Many imponderables for markets The Scotsman, Bill Jamieson (14/6/15)
How Ignoring Stock Market Forecasts Will make you a better investor Forbes, Ky Trang Ho (6/6/15)
The Predictions Racket Nasdaq, AdviceIQ, Jason Lina (21/5/15)
Questions
- Why may a return of rising interest rates lead to a ‘meltdown in equity prices’? Why might it not?
- Why have bond yields fallen dramatically since 2008?
- Why are bond yields rising again now and what significance might this have (or have had) for equity markets?
- Why may following the crowd often lead to buying high and selling low?
- Is there an asymmetry between buying and selling behaviour in stock markets?
- Will ignoring stock market forecasts make people better investors?
- “The stock market prices suggest that investors believe both the Federal Reserve and the Bank of England are bluffing about raising interest rates. That may be so, but it is an extremely risky game of chicken for investors to play.” Explain and discuss.
In the late 2000s, Zimbabwe experienced hyperinflation. As a post on this site in January 2009 said, two estimates of the inflation rate were made: one of 5 sextillion per cent (5 and 21 zeros); the other of 6.5 quindecillion novemdecillion per cent (65 and 107 zeros). In January 2009, in a last attempt to save the Zimbabwean currency, a new series of banknotes was issued, including a Z$100 trillion note.
Prices were typically being adjusted at least twice a day and people had to carry large bags of money around even to buy a couple of simple items. The currency was virtually worthless. As the Guardian article below states:
Hyperinflation in Zimbabwe left pensions, wages and investments worthless and spread poverty as everyday items became unaffordable. It also caused severe cash shortages, because the government could not afford to print bank notes to keep pace with inflation.
The solution was to allow other currencies, mainly the US dollar and the South African rand, to be used alongside the local currency. Although the Zimbabwean currency was still legal tender, it effectively went out of use. Prices stabilised and since then inflation has been in single figures.
But many people still have stocks of the virtually worthless old currency, either in cash or in savings accounts. The Zimbabwean government has now said that it will exchange Zimbabwean dollar notes for US dollars at the rate of US$1 = Z$250tn (250,000,000,000). People have until September to do so. Up to now, they have mainly been used to sell as souvenirs to tourists! For people with Zimbabwean dollars in their bank accounts, they will get a minimum of US$5. For amounts beyond Z$175,000tn they will get an additional US dollar for each Z$35,000tn.
Historical examples of hyperinflation
As case study 15.5 in Economics 9e’s MyEconLab points out, several countries experienced hyperinflation after the First World War. In Austria and Hungary prices were several thousand times their pre-war level. In Poland they were over 2 million times higher, and in the USSR several billion times higher.
Germany in the 1920s
But even these staggering rates of inflation seem insignificant beside those of Germany. Following the chaos of the war, the German government resorted to printing money, not only to meet its domestic spending requirements in rebuilding a war-ravaged economy, but also to finance the crippling war reparations imposed on it by the allies in the Treaty of Versailles.
From mid 1921 the rate of monetary increase soared and inflation soared with it. By autumn 1923 the annual rate of inflation had reached a mind-boggling 7,000,000,000,000 per cent! As price increases accelerated, people became reluctant to accept money: before they knew it, the money would be worthless. People thus rushed to spend their money as quickly as possible. But this in turn further drove up prices. (The note shown above is in old billions, where a billion was a million million. So the note was for 50,000,000,000,000 marks.)
For many Germans the effect was devastating. People’s life savings were wiped out. Others whose wages were not quickly adjusted found their real incomes plummeting. Many were thrown out of work as businesses, especially those with money assets, went bankrupt. Poverty and destitution were widespread.
By the end of 1923 the German currency was literally worthless. In 1924, therefore, it was replaced by a new currency – one whose supply was kept tightly controlled by the government.
Serbia and Montenegro 1993–5
After the break-up of Yugoslavia in 1992, the economy of the remaining part of Yugoslavia (Serbia and Montenegro) collapsed. The government relied more and more on printing money to finance public expenditure. Prices soared.
The government attempted to control the inflation by imposing price controls. But these simply made production unprofitable and output fell further. The economy nosedived. Unemployment exceeded 30 per cent.
In October 1993, the government created a new currency, the new dinar, worth one million old dinars. In other words, six zeros were knocked off the currency. But this did not solve the problem. Between October 1993 and January 1994, prices rose by 5 quadrillion per cent (5 and fifteen zeros). Normal life could not function. Shops ran out of produce; savings were wiped out; barter replaced normal market activity.
At the beginning of January 1994 a ‘new new dinar’ was introduced, worth 1 billion new dinars. On 24 January this was replaced by a ‘novi dinar’ pegged 1 to 1 against the Deutsche Mark. This was worth approximately 13 million new new dinars. The novi dinar remained pegged to the Deutsche Mark and inflation was quickly eliminated.
Articles
Zimbabweans get chance to swap ‘quadrillions’ for a few US dollars The Guardian (13/6/15)
175 Quadrillion Zimbabwean Dollars Are Now Worth $5 Bloomberg, Godfrey Marawanyika and Paul Wallace (11/6/15)
Zimbabwe is paying people $5 for 175 quadrillion Zimbabwe dollars Washington Post, Matt O’Brien (12/6/15)
Zimbabwe dollars phased out BBC News Africa (12/6/15)
Zimbabwe ditches its all but worthless currency Financial Times (12/6/15)
Zeroing in Thomson Reuters, Breaking News, Edward Hadas (12/6/15)
Old articles
Could inflation fell Mugabe? BBC News (28/7/08)
ZIMBABWE: Inflation at 6.5 quindecillion novemdecillion percent IRIN (21/1/09)
The Worst Episode of Hyperinflation in History: Yugoslavia 1993-94 Roger Sherman Society, Thayer Watkins (31/7/08)
Questions
- Why have several governments in the past been prepared to allow hyperinflation to develop?
- Itemise the types of cost imposed on people by hyperinflation.
- Does anyone gain from hyperinflation?
- What are the solutions to hyperinflation?
- What difficulties are there in eliminating hyperinflation? What costs are imposed on people in the process?
- Why might the causes of hyperinflation be described as always political?
HSBC is a familiar feature of many high streets in the UK and this is hardly surprising, given that it is the largest bank in Europe. But could this be about to change? With uncertainty surrounding the UK’s in-out vote on the EU, the future of the banking levy and HSBC’s desire to reduce the size of its operations, the UK high street might start to look quite different.
In the UK, 26,000 staff are employed in its retail banking sector, with 48,000 workers across the whole of its UK banking operations. HSBC has plans to downsize its business globally, with expected job losses in the UK of 8000 workers and a total of 25,000 jobs across the world. This would reduce its workforce by around 10%. This could have big implications for the UK economy. Although many of the job losses would not be enforced, given that HSBC does have a relatively high staff turnover, it is likely to mean some forced redundancies. With job creation being one of the big drivers of the UK economy in the last couple of years, this could put a dampner on the UK’s economic progress.
A further change we are likely to see will be the renaming of high street branches of HSBC, as new government rules are requiring HSBC to separate its investment and retail banking operations. Much of this stems from the aftermath of the financial crisis and governments trying to reign in the actions of the largest banks. Ring fencing has aimed to do this as a means of protecting the retail banking sector, should the investment banking part of the bank become problematic.
However, perhaps the biggest potential shock could be the possibility of HSBC leaving the UK and moving to a new base in Hong Kong. A list of 11 criteria has been released by HSBC, outlining the factors that will influence its decision on whether to stay or go.
The UK’s decision on Europe is likely to be a key determinant, but other key factors against remaining in the UK are ‘the tax system and government policy in support of [the] growth and development of [the] financial services sector’. HSBC pays a large banking levy, as it is based not just on UK operations, but on its whole balance sheet.
HSBC’s Chief Executive, Stuart Gulliver, has said that the discussion on the potential move to Hong Kong is based on the changing world.
“We recognise that the world has changed and we need to change with it. That is why we are outlining the following… strategic actions that will further transform our organisation… Asia [is] expected to show high growth and become the centre of global trade over the next decade… Our actions will allow us to capture expected future growth opportunities.”
Leaving the EU will have big effects on consumers and businesses, given that it is the UK’s largest market, trading partner and investor. Whether or not decisions of key businesses such as HSBC will have an impact on the referendum’s outcome will only be known as we get closer to the day of the vote (which is still some way off!). It will, however, be interesting to see if other companies raise similar issues in the coming year, as the referendum on the EU draws nearer. We should also look out for any potential change in the UK’s banking levy and what impact, if any, this has on HSBC’s decision to stay or go and on the future of any other banks.
Has HSBC already decided to leave the UK? The Telegraph, Ben Wright (10/6/15)
HSBC plans to cut 8,000 jobs in the UK in savings drive BBC News (9/6/15)
The Guaridan view on HSBC: a bank beyond shame The Guardian (10/6/15)
HSBC brand to vanish from UK high streets Financial Times, Emma Dunkley (9/6/15)
HSBC job cuts should come as little surprise Sky News, Ian King (9/6/15)
HSBC in charts: Where the bank plans to generate growth Financial Times, Jeremy Grant (9/6/15)
HSBC’s local rethink can’t shore up global act Wall Street Journal, Paul Davies (9/6/15)
Can George Osborne persuade HSBC to stay in the UK? BBC News, Kamal Ahmed (9/6/15)
Questions
- What is the UK’s banking levy and why does it affect a company like HSBC disproportionately?
- Look at the list of 11 criteria that HSBC have produced about staying in the UK or moving to Hong Kong. With each criterion, would you place it in favour of the UK or Hong Kong?
- Why is the banking sector ‘not a fan’ of the government policy of ring fencing?
- What impact would the loss of 8000 UK jobs have on the UK economy?
- Why does it matter to a bank such as HSBC if the UK is a member of the EU?
Insolvencies in England and Wales have fallen to their lowest level since 2005, official records show. The Insolvency Service indicates that bankruptcy, individual voluntary arrangements and debt relief orders have fallen, with the largest and worst form of bankruptcy falling by 22.5 per cent compared to the same period in 2014. There has also been a fall in corporate insolvencies back to pre-crisis levels.
The British economy is recovering and despite an increase in consumer borrowing of £1.2 billion from February to March, which is the biggest since the onset of the credit crunch, the number of people in financial difficulty and living beyond their means has fallen. However, there are also suggestions that the number could begin to creep up in the future and we are still seeing a divide between the north and south of England in terms of the number of insolvencies.
There are many factors that could explain such a decline in insolvencies. Perhaps it is the growth in wages, in part due the recovery of the economy, which has enabled more people to forgo borrowing or enabled them to repay any loan more comfortably. Lower inflation has helped to reduce the cost of living, thereby increasing the available income to repay any loans. Interest rates have also remained low, thus cutting the cost of borrowing and the repayments due.
But, another factor may simply be that lending is now more closely regulated. Prior to the financial crisis, huge amounts of money were being lent out, often to those who had no chance of making the repayments. More stringent affordability checks by lenders may have a large part to play in reducing the number of insolvencies. President of R3, the insolvency practitioner body, Phillip Sykes said:
“It may be too early to draw conclusions but demand could be falling as a result of low interest rates, low inflation and tighter regulation. This trend is worth watching.”
Mark Sands, from Baker Tilly added to this, noting that fewer people were now in financial difficulty.
“As well as this, we are seeing lower levels of personal debt and fewer people borrowing outside of their means due to more stringent affordability checks by creditors.”
Whatever the main reason behind the data, it is certainly a positive indicator, perhaps of economic recovery, or that at least some have learned the lessons of the financial crisis. The following articles consider this topic.
Personal insolvencies fall to 10-year low Financial Times, James Pickford (1/5/15)
Personal insolvencies at lowest level since 2005 BBC News (29/4/15)
Personal insolvencies drop to lowest level in a decade The Guardian, Press Association (29/4/15)
Corporate insolvencies at lowest level since 2007 The Telegraph, Elizabeth Anderson (30/4/15)
Interview: R3 President Phillip Sykes Accountancy Age, Richard Crump (1/5/15)
North-South gap widens in personal insolvencies Independent, Ben Chu (27/4/15)
Insolvency rates show ‘stark’ north-south divide Financial Times, James Pickford (27/4/15)
Questions
- What is meant by insolvency?
- There are many factors that might explain why the number of insolvencies has fallen. Explain the economic theory behind a lower inflation rate and why this might have contributed to fewer insolvencies.
- How might lower interest rates affect both the number of personal and corporate insolvencies?
- Why has there been a growth in the north-south divide in terms of the number of insolvencies?
- Do you think this data does suggest that lessons have been learned from the Credit Crunch?
The US economy has been performing relatively well, but as with the UK economy, growth in the first quarter of 2015 has slowed. In the US, it has slowed to 0.2%, which is below expectations and said to be due to ‘transitory factors’. In response, the Federal Reserve has kept interest rates at a record low, within the band 0.0% to 0.25%.
The USA appears relatively unconcerned about the slower growth it is experiencing and expects growth to recover in the next quarter. The Fed said:
“Growth in household spending declined; households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined.”
Nothing has been said as to when interest rates may rise and with this unexpected slowing of the economy, further delays are likely. An investment Manager from Aberdeen Asset Management said:
“The removal of the Fed’s time dependent forward guidance could be significant. It means that any meeting from now on could be the one when they announce that magic first rate rise.”
Low rates will provide optimal conditions for stimulating growth. A key instrument of monetary policy, interest rates affect many of the components of aggregate demand. 
Lower interest rates reduce the cost of borrowing, reduce the return on savings and hence encourage consumption. They can also reduce mortgage repayments and have a role in reducing the exchange rate. All of these factors are crucial for any economic stimulus.
Analysts are not expecting rates to rise in the June meeting and so attention has now turned to September as the likely time when interest rates will increase and finally reward savers. Any earlier increase in rates could spell trouble for economic growth and similar arguments can be made in the UK and across the eurozone. The following articles consider the US economy.
Federal Reserve keeps interest rates at record low BBC News, Kim Gittleson (29/4/15)
Shock stalling of US economy hits chances of early Fed rate rise The Guardian, Larry Elliott (29/4/15)
US Fed leave interest rates unchanged after poor GDP figures Independent, Andrew Dewson (30/4/15)
Fed could give clues on first interest rate hike USA Today, Paul Davidson (28/4/15)
Fed’s downgrade of economic outlook signals longer rate hike wait Reuters, Michael Flaherty and Howard Schneider (29/4/15)
Five things that stopped the Fed raising rates The Telegraph, Peter Spence (29/4/15)
Questions
- By outlining the key components of aggregate demand, explain the mechanisms by which interest rates will affect each component.
- How can inflation rates be affected by interest rates?
- Why could it be helpful for the Fed not to provide any forward guidance?
- What are the key factors behind the slowdown of growth in the USA? Do you agree that they are transitory factors?
- Who would be helped and harmed by a rate rise?
- Consider the main macroeconomic objectives and in each case, with respect to the current situation in the USA, explain whether economic theory would suggest that interest rates should (a) fall , (b) remain as they are, or (c) rise.
Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.
