Examination of Witnesses (Questions 1-19)
PROFESSOR ANTON
MUSCATELLI, PROFESSOR
DANNY QUAH,
MR JOHN
BUTLER AND
MR MICHAEL
SAUNDERS
6 JUNE 2006
Q1 Chairman: Good morning and welcome
to the Committee's hearing on the Inflation Report. Not all of
you need to answer every question. Whatever you think is your
strength, you can answer. Could you introduce yourselves for the
shorthand writer?
Professor Muscatelli: Anton Muscatelli,
University of Glasgow.
Professor Quah: Danny Quah, London
School of Economics.
Mr Butler: John Butler, HSBC.
Mr Saunders: Michael Saunders
of Citigroup.
Q2 Chairman: John and Michael, do
you think that markets have interpreted the Inflation Report as
a clear signal that rates will be moving higher in the coming
months?
Mr Butler: To some degree the
markets are already there with the news you had already seen,
but the clear message from the Inflation Report, with the constant
interest rates and inflation under that scenario overshooting
the target in two or three year horizon, was a signal that rates
were more likely to rise than fall over that forecast period.
Mr Saunders: I think that is fair.
Markets had got there already and the MPC basically endorsed the
market projections that rates were going to rise. Of course, if
you look at the pricing of rates which was used as the base case
in the Inflation Report, by the time the thing actually came out
markets were priced in a further 28 basic point hike compared
to what the MPC built in. Always part of the confusion over the
Inflation Report when it comes out on the day, is that the market
part of the rates which they use is not the same as the market
part of the rates as of that date. When the MPC was endorsing
the market view, they were endorsing a slightly more dovish market
view than what was actually priced in at that point.
Professor Quah: I think both the
Inflation Report and market response have been consistent one
with the other. The Inflation Report does pay mind to how markets
are interpreted through movements in financial markets and asset
prices and how markets are interpreting and forecasting their
own policy actions, and from what I can tell the wordings used
by different members of the MPC are well in line with that. This
is also consistent with actions that central banks around the
world internationally have taken recently such as the Central
Bank in China, and also the news this morning about developments
in the United States and possibly in the Eurozone area as well.
All of these are pointing in the same direction, that there will
likely be a slight increase in rates over the coming months.
Q3 Chairman: What do you see as the
biggest risks, both on the up and down-side? Anton, you mentioned
in your paper about the issue of spare capacity and energy prices.
Professor Muscatelli: It is a
difficult situation to assess. You will probably recall that in
my November memo I started to talk about the issue of slow investment
feeding through to a slower rate of potential output growth. The
difficulty is, of course, a lot of these things might be masked
by other cyclical influences on productivity so they are not showing
through very clearly. We are seeing productivity pick up, which
is probably an unwinding of the labour hoarding situation, but
we are not seeing the extent to which that lack of spare capacity
might actually be influencing inflation. I am slightly concerned,
and I can see where David Walton was coming from in terms of where
we might be towards the end of this year. There are possibly signs
that the spare capacity is not quite there and we might need to
look for an increase in interest rates, but I would not see that
coming through until later this year or possibly early 2007.
Q4 Chairman: Michael and John, as
City economists what would you say were the drivers behind the
recent volatility in stock markets?
Mr Butler: I think a lack of clarity
and greater uncertainty in the market.
Q5 Chairman: When you say a lack
of clarity, is that more to do with the Fed?
Mr Butler: Globally, but led by
the US, there is a lack of clarity about the challenges facing
policy makers. Up until now it has been fairly straight forward.
People have just extrapolated forward in terms of rates arising
in the US. The questions now are one about the growth of inflation
trade-off. There are some signs maybe inflation is picking up
globally but also in the US, but also some signs that the balance
sheet adjustment led by the big rise in house prices and the considerable
strength of the consumer poses down-side risk to growth. The question
is how do policy makers react. Do policy makers react to the inflation
pick-up or do they react to the prospect that growth could be
slowing? That uncertainly has unsettled the market, and the best
way to illustrate the lack of transparency out there is the fact
that you had a professional economist on the Bank of England Committee
looking at the same evidence and deciding to vote in three different
directions. That amount of uncertainty had not been there or priced
into equity markets and that risk led to quite a sharp correction
in equities. The bigger adjustment for the Bank of England was
the fact that it also meant people focusing on global imbalances,
the dollar falling, and sterling picking up sharply, particularly
compared what they had in the Inflation Report. In a sense, they
have already had policy tightening from the financial markets.
Q6 Chairman: Michael, you made the
point in your submission that you share the MPC's view that consumption
will recover only modestly, held back by high debts and modest
real income in growth. In terms of relating that to stock prices,
do you see that as a short-term correction or is it a longer term
bear market?
Mr Saunders: I put the slide in
equity prices, which is a global pattern not just a UK pattern,
as being an unsurprising consequence of the big global tightening
of monetary policy. If you look around the world, pretty well
every country's central bank is raising rates, or in the Bank
of Japan's case is tightening monetary policy without yet raising
interest rates. The scale of the global tightening cycle and its
breadth makes it one of the greatest of the last 15 years. In
those conditions it is not surprising that asset prices suffer.
Equities, commodity prices, a range of emerging markets, that
is what you usually see when there is a big global tightening
of monetary policy. If you talk in terms of a contraction of global
liquidity or a rise in the cost of risk, it boils down to the
same thing: tighter monetary policy usually means weaker asset
prices. The implication of that for the MPC is as John alluded
to. They thought at the May meeting that we need to tighten financial
conditions a little bit, not straight away but over the next year
through a rise in interest rates. Since then the pound is up 2%
cent to 3% and equities here are down 6%. Those swings, if they
are sustained, deliver more than the amount of restraint which
they judged would be needed. In other words, the market has done
their job for them without them having to do anything.
Mr Butler: Since the last inflation
move in asset price, it would be interesting to see what their
forecast would look like if they did a forecast today on those
asset price movements, because the asset price rises, equity markets
and the fall in sterling had been very instrumental in their optimistic
view about GDP growth going forward.
Professor Muscatelli: I take a
slightly different view. From the latest report, and even the
one before, it was clear they were not banking on very strong
consumption expenditure anyway, so I am not sure if it really
does impact on the monetary policy over the next two or three
months.
Professor Quah: It seems to me
there were two aspects to your question: one had to do with the
level of asset prices, and the other had to do with the volatility.
My colleagues have already spoken on the levels issue so let me
say a little about volatility. Your question has to do with why
it is that we might see heightened variability, heightened uncertainty,
in markets today. There are three large reasons: one is that people
are still trying to figure out the new Chairman of the Federal
Reserve. Ben Bernanke has done a superb job in communicating.
He has always been an outstanding communicator, but there was
a moment a few months ago when he made some off-the-record remarks
that were subsequently reported. When one reads newspaper reports,
things that he says, which seem to be very straight forward, are
differently interpreted by many well intentioned, knowledgeable,
financial journalists. People are still trying to figure him out.
The second large issue is Iran, which has the world's second largest
proven oil reserves and has taken a belligerent stance against
Israel and most of the West. That might resolve from developments
this last week as there seems to be greater reconciliation now,
but we shall see. The third, which seems to be moot now, as well
as US rhetoric on the dollar, the current account and China. All
three of these things are not permanent. My prediction would be
they will smooth out relatively quickly and we will see a return
to greater stability.
Q7 Mr Gauke: Why do you think long-term
real interest rates have risen, and do you think that is going
to continue?
Professor Muscatelli: We have
seen some of the unwinding of the speculative bubble that we were
talking about at our last session, so that is partly an explanation.
Partly it is also reflecting the tightening of monetary policy,
and partly it is reflecting at a global level this reversal of
the reduction in risk premium so a greater risk aversion. These
are the three effects, both in the UK and more globally.
Professor Quah: The puzzle I have
follows very quickly on your question. We spent a lot of time
a few months ago, not just we but in general, trying to explain
why globally long-term real interest rates have been low and we
came out with very good convincing reasons. Now what we have to
do is look back and try and unwind those reasons to figure out
why the reverse has started to occur. I would say there is a greater
recognition of global economic growth and the general tightening
everywhere.
Mr Butler: The puzzle was why
were they so low in the past. What you are having now is a normalisation
of long-term interest rates. There is a greater uncertainty about
inflation going forward. By historical standards, 5% long-term
interest rates in the US is still incredibly low, and in terms
of going forward it has the scope to rise further.
Mr Saunders: I would put it in
the context of global savings and investment balances. We know
ex post savings and investment must balance as a sort of
accounting identity. You can get an ex ante imbalance between
desired levels of savings and investment, and real interest rates
move to achieve the balance ex post. The last five years
have been a period in which the global investment share of GDP
was unusually low, hence real interest rates pulled lower and
lower. For this year on the IMF numbers, the global investment
share in GDP, and I stress global, is the highest since the mid-1990s
and slightly above its long-term average. In other words, we have
climbed out of that period of low global investment which was
the main cause of low global real yields. You can add country
specific factors on top of that, pensions and so forth, but the
global conundrum, as Greenspan called it, and Bernanke referred
to the global glut of savings, really was a story of global shortfall
of investments which now is largely finished.
Q8 Mr Gauke: Can I ask about global
imbalances and to what you extent you see that as a major risk?
The recent Spring conferences involving the IMF, how significant
would that be? Do you think that stock market volatility has been
connected to these global imbalances?
Professor Quah: I think it is
a huge risk. The US is still running a 7% current account deficit.
Most of that is being financed by poorer countries in the world
as part of this global imbalance, as my colleagues have suggested,
saving more than they are investing and, therefore, putting their
resources into the West. Some of that shows up in the UK. Even
though the UK has a negative external debt position, it is getting
a net investment income to the tune of 2% of GDP. What is happening
is that many of these poorer countries are sending their funds
to the West. They are getting a fairly low rate of return. A higher
rate of return may be available elsewhere but no-one seems to
be searching for them at this point. The poor people in the world
are financing the consumption patterns of the rich. Should that
unwind, the US is a major source of aggregated market in the global
economy so contraction of the US economy has severe repercussions
for the rest of the world. The risks are quite high. A flattening
or a reverse term structure of interest rates is a rather good
thing if it is done smoothly and gradually.
Professor Muscatelli: I am very
concerned because the pattern is very different from the last
major dollar imbalance which we saw in the 1980s. First of all,
it was not quite as big as the 7% we have just now. Secondly,
that was rectified with a mixture of a falling dollar, which fell
by about 15% between the mid-1980s and the late 1980s, but also
with a correction of fiscal policy in the States, coupled with
a correction of fiscal monetary policy in Japan and Germany who
were the main surplus countries. The picture is a lot more complex
now. It does not just involve three or four G7 countries but involves
oil exporters, emerging economies and the US. It is much more
difficult to engineer a correction at a global level, plus, as
Danny said, it is fairly clear that there is still a continued
willingness on the part of these emerging economies to finance
the consumption of the US, and there is no evidence that the US
is going to correct its fiscal deficit, which for next year is
projected to be a structural deficit of 4.2% of GDP which is huge.
Hopefully the new US Treasury Secretary will make a difference,
but it is very concerning because the longer it goes on the bigger
the correction that it will require to unwind. I am very concerned
at the moment.
Mr Butler: Over the last six months
there are better signs that may have eased some people's concerns.
If you wanted a resolution, one of the resolutions would have
been stronger growth in the Eurozone, stronger growth in Japan,
stronger growth in China so that the US is not the one powering
all the growth around the world. That is happening, although it
is not 100% sure that they are domestically driven and can, therefore,
sustain global growth if the US starts to slow aggressively. I
share the concerns here. One of the major concerns of the UK economy
is the global imbalance. If that unwinds, it could unwind fairly
aggressively. One of the big implications could be that over the
last year the dollar has been supported by the fact the Fed has
been hiking interest rates. If you are getting close to a peak
in US interest rates, the focus would shift back onto the current
account deficit, the imbalances, and you could see a sharp and
disorderly fall in the dollar. If that happened, and sterling
strengthened aggressively, the net export boost to growth in the
UK would disappear and you are once again dependent on the consumer
to drive UK growth which is not desirable.
Mr Saunders: I basically agree
with that. The MPC should have that as a down-side risk going
forwards. We have had a small taste of that in the last month
or so: dollar weaker, sterling pushed higher just on the perceptions
that US rates may be near their peak. That is part of the way
in which we may get the tightening we need through external pressures.
Q9 Mr Fallon: You have just spoken
of the down-side risks, but in your paper you take issue with
David Walton on the up-side risk.
Mr Saunders: Walton's view, as
far as I can tell, is that there are up-side risks to growth coming
from investment in net trade. My base case is for growth to be
a little bit below the MPC, frankly not hugely different, but
the thing which I would disagree with is that the risks around
the MPC forecast are to the up-side. If you look back, net trade
has not made a significant positive contribution to growth in
the UK since the mid-1990s when the pound trade weight was about
20% lower. Export performance since then, once you strip out MTIC
fraud, has been poor. Although global growth is good at the moment,
as we were just discussing with these down-side risks going forward,
I do not see anything which says that export performance is improving
so dramatically and net trade suddenly goes from being neutral
or minus to a plus. Investment is always more uncertain, either
because you know the data is not great quality and can be quite
volatile, but it would have to be really strong, far stronger
than you see in any surveys at the moment, to produce a significant
boost to overall GDP growth just because it is a relatively small
part of GDP. There is nothing at the moment which indicates it
is going to be that strong.
Q10 Mr Fallon: You said the key aspect
of the May Inflation Report was that the CPI inflation was expected
to overshoot the 2% target throughout the forecast period in the
current number of rates. Do you think they will change that opinion?
Mr Butler: As I alluded to earlier,
it would be interesting if they re-did their forecasts on the
movement in equities and sterling. I think if you had updated
for the 2% or 3% move in trade weight to sterling, that is equivalent
to a 25 basis rate hike. My issue with the May Inflation Report
is that the level of GDP in their forecast is very similar to
what they had six months ago in November. The real difference
is the inflation trade-off. They have a far inferior trade-off.
They believe inflation is going to be higher for any level of
growth. One element of that is they seem to be of the view there
is very little spare capacity, which is David Walton's view, at
a time when actually the labour market structurally seems to be
improving. The labour market is probably loosening at the fastest
pace since the last recession because of structural immigration
issues. I do not see where the evidence is of the deteriorating
trade-off between growth and inflation. If anything, I think it
is improving.
Q11 Mr Fallon: Nonetheless, you say
there is a bias now towards tightening. Is that just because of
Nickell's disappearance from the Committee?
Mr Butler: It is more than just
personalities. It is a feeling on the Committee globally that
there is a different set of circumstances. The rising oil prices
may raise inflation expectations and central banks around the
world are on inflation alert rather than in the past six months
they were on growth alert.
Q12 Mr Love: I was interested in
what Mr Saunders said in terms of his view about business investment
going forward because Professor Muscatelli in his contribution
to us took a slightly more optimistic view. Tell me why you differ
from him?
Professor Muscatelli: I differ
from him probably in the sense that last year was such a bad year,
and despite what was happening to business earnings I think we
were all waiting for this to unwind and we can see the beginning
of it. It is always very difficult because business investment
figures are quite erratic and they are subject to considerable
revisions subsequently, but, on average, if anything, they are
revised upwards. We are beginning to see the situation unwind.
However, business investment by itself cannot pull the economy.
If you begin to see failing global trade and consumption still
mitigated, it would be difficult for investment to be the only
pulling force on the economy. That would eventually fizzle out
but I see it as being a bit of a catch-up from the low investment
we have seen over the last couple of years.
Q13 Mr Love: I will come on to the
international trade issues but let me press you a little bit and
ask others to comment because the surveys tend to be somewhat
contradictory. The CPI survey tends to be relatively pessimistic
and do not see an increase in investment, but the British Chamber
of Commerce takes an alternative view. What I would like you to
do is to tell us what evidence you have for this unwinding that
you think is occurring. I suspect your other three colleagues
do not see that unwinding occurring. Tell us why you think it
is likely to unwind. I think everybody has been waiting for it
but nobody is actually convinced yet it is happening.
Professor Muscatelli: The main
evidence I point to is the fact that we have low real interest
rates still in terms of long-term rates. We have had a number
of years in which earnings have been strong and investment has
been held back by a number of causes, including worries about
world inflation, worries about pensions, but eventually you would
expect some of that pent up investment to happen. People can only
hold back so much, especially in a time when the economy is still
growing. It is not growing as fast as it has done in some of the
earlier cycles but it is still growing. Simply because there is
an accelerator effect, you would eventually expect investment
to catch up.
Q14 Mr Love: There are issues about
uncertainty there but let me ask Mr Saunders, and perhaps others
would like to comment, Q1 of this year shows an increase in business
investment of 1.7%. Does that not show that we are beginning to
unwind the business investment, it is beginning to increase, or
do you think that is just a blip?
Mr Saunders: It may be a question
of degree. My forecast is business investment this year is a bit
stronger than last year. I am not sure that it is going to be
so strong that it is enough to produce above trend GDP growth,
that would need to be 10% plus which is really spectacular growth.
In terms of your ranking of the surveys, there is a third one.
The Bank of England does a monthly survey through its agents of
firms' investment intentions, and that is a little bit better
but really nothing much. You can put that between the CBI and
the Chamber of Commerce. The story on investment is that it has
been weak relative to profitability and relative to long-term
interest rates for about three years. Many of us thought that
it should pick up, because of those conditions it normally does,
but it has not done for a fairly long time. That is partly because
of the rise in company pension contributions and partly a global
story of investment going from high cost industrial countries
to low cost emerging markets and I do not think either of those
things have changed. It may not prevent it picking up a bit but
I would not look for the shortfall of investment to unwind totally.
Q15 Mr Love: My understanding is
that if you look at pensions, which is often used as the argument
for business investment not picking up, it does not take up anything
like the amount that is available through profitability and low
interest rates. I wonder if I can ask the other two to comment.
We have talked a lot in the early stage about uncertainty. Do
you think that is impacting negatively on firms' views about whether
they ought to increase investment by this mythical 10% that everyone
has been talking about?
Mr Butler: Over the last year
companies have just had other priorities. If you are cash rich
and you have money to spend, how do you do it? You are not just
investing. You mentioned the pension issue and said you do not
think it is that huge, but if you look at the annual contributions
companies have made to their pension schemes it has gone up by
£22 billion when business investments increased by £1
billion, so the numbers are substantial. Uncertainty is a huge
issue, and you did mention the surveys which do seem to be pointing
in different directions. Even on the British Chamber of Commerce
survey, it has improved, but it has improved back to where it
was in 2004 and 2004 was a bad year for investment. I think it
all becomes a bit circular. If you are of my view, that the global
uncertainty is still pretty large and domestic uncertainties are
big, then that paints a picture similar to what Michael said,
that you get an improvement in investment but it is about degree
and it is not enough to drive a recovery in the UK economy.
Professor Quah: I agree with my
colleague, Professor Muscatelli. We ought to expect to see an
upturn in business investment soon. The reason I say that is because
I am puzzled why business investment has been so low. We can tell
stories about uncertainty, the business environment, the prospects
for growth are unclear, but then I noticed last time when this
Committee met we had a similar discussion. We then turned the
story on its head. We said that the world has much less uncertainty
and that is why long-term interest rates are so low. We cannot
hold both stories in our head simultaneously: one of these has
to be the right one. It is a puzzle, and a puzzle not just in
this country but elsewhere in the world. The United States, for
instance, while we refer to it as 7% current account deficit so
that economy seems to be spending a lot, it is just the personal
sector and the government sector that is in deficit. The corporate
sector is awash with funds, the same way that the UK corporate
sector is. Some of this has to be released at some point and that
will show up in an up-turn in business investment.
Q16 Mr Love: If you take out the
fraud element, which has been much commented on in recent days,
our performance is pretty poor and unlikely to change. Do you
see any good news on the horizon? I take, in relation to that,
there has been a depreciation of the dollar recently. What impact
is that going to have on our trading performance?
Mr Saunders: If you compare our
trade performance, our export growth ex-fraud, with the growth
of imports and our main trading partners, our export market growth,
we have lagged persistently in recent years. That is what I mean
by export performance has been poor. The surveys on export growth
in the last few months have been better. Then, as we have discussed,
there is this risk going forward, and the reality of the last
few weeks, falling dollar rising pound, suddenly our export competitiveness
worsens again. It would need a very dramatic improvement on our
export performance to turn net trade into a plus for growth at
a time when domestic demand is picking up, yet that is what the
MPC seems to have as their base case. I would want to get them
to flesh out a bit more why they think our export performance
is about to improve so markedly.
Mr Butler: It has been one of
the biggest areas the MPC have made on their forecast. It is not
the first time they have expected a turn around in the net trade
performance for that not to materialise. We have lived under a
pretty good global environment for the last couple of years. If
you think that is not going to be as rosy going forward, and you
have the potential risk of the dollar falling quite sharply driving
sterling higher, then I would be much more pessimistic than the
Bank of England on that trade position.
Professor Quah: I too am pessimistic
on the trade position. The reason for that is most of the UK still
trades with Continental Europe, that is the largest chunk of our
trade, and Continental Europe is moribund. The most optimistic
people will say it might grow at 2% a year this coming year. For
most of the rest of the world, 2% a year growth at this stage
of the cycle is a statistical blip. Unless we re-orient, unless
something changes in our trade patterns and we re-orient towards
faster growing parts of the world, I cannot see we will have a
dramatic improvement in our trade balance.
Q17 Mr Love: Everyone recognises
that the exchange rate for the dollar must depreciate if we are
going to get rid of the imbalance over time, although we will
want to control that. A necessary consequence of that depreciation
is that either Europe, Japan, China comes in to offer the alternative
for international trade. Does anybody see any of that happening
in the short-term?
Professor Muscatelli: I think
it is very difficult to predict, as I said in my paper, how that
unwinding of the dollar might work. There is also the issue of
what might happen to sterling. Sterling may depreciate against
the dollar but there is no guarantee it will depreciate against
other major currencies. The position in that trade is quite complicated.
I am also not hugely optimistic because of these global risks
we have already discussed. The performance, as I said in the paper,
in 2005 Q4 is actually stronger than I expected it to be. After
a negative contribution of net trade to GDP growth in Q3, suddenly
you saw a positive contribution in Q4. It is not as rosy as the
MPC have painted but it is not as bad as some of us feared. That
lies behind the reason why I think holding rates is probably the
right policy because it is not quite as negative as some of us
feared.
Mr Butler: The Eurozone is the
big hope. You look at the Eurozone growth and people are becoming
more optimistic, but the Eurozone may grow in line with the UK
for the first time in 10 years. One of the most optimistic views
around is 2% growth. If there is one region where the UK has had
a deteriorating trade balance, a current account balance, it is
with the Eurozone, more so than with Asia and it goes way beyond
the relative to market issue. If sterling is overvalued against
a currency, then in my view it would be overvalued against the
euro.
Q18 Ms Keeble: There is one query
left on this section which is about the fact that the Inflation
Report shows that whilst we have a net inflow of investment income
we are an external net debtor. How do you account for that?
Mr Saunders: Arithmetically the
way you account for it is apparently our rate of return on direct
investment overseas is higher than the rate of return on direct
investments in the UK. Secondly, the pattern of our assets and
liabilities is such that we have more in direct investment on
the liabilities side, more in loans which have a lower rate of
return, than direct investment. We are lucky in that our assets
are more in high return assets and our liabilities are in low
return things. The US, by the way, seems to have the same position.
You have to be uncertain as to whether this is really happening
or whether it is just a statistical artefact from numbers which
are of uncertain quality. It may be that we have more external
assets and the income figures are correct, or it may be that that
pattern, relatively high returns on our assets compared to our
liabilities, will continue. I am not sure.
Mr Butler: I have looked at detailed
flows of investment income, and the UK has been a huge beneficiary
of the big rise in oil prices. UK oil companies registered in
the UK made huge amounts of profits abroad, and often those profits
are repatriated back to the UK. That has given us this big surge
in investment income and it is on the back of the big rise in
oil prices. That has implications in that it may be one of the
reasons that has kept sterling strong and out-priced other sectors
within the UK. Depending on your view about oil prices, you need
oil prices to carry on rising for that investment income flow
to carry on offsetting that deteriorating trade deficit.
Professor Muscatelli: My view
is that it is the first of these stories that Michael was outlining,
it is to do with portfolio composition and not to do with mismeasurement.
If you look at the box with the Inflation Report, it outlines
the various reasons. It is the first explanation to do with the
fact that we hold different assets from the composition of our
liabilities. The mismeasurement story is difficult to buy, partly
because this strong investment income only comes in the last couple
of years. Why should it suddenly transpire? It is much more likely
to be coincident with the fact that we have had low interest rates
with strong equity markets and strong returns from investment
during the last couple of years and therefore it is portfolio
composition.
Professor Quah: I do not disagree
with the strength of this first explanation. That is very much
the background of our discussion about global imbalances earlier
this morning. Global imbalance position is still one where many
poorer parts of the world continue to send their finance resources
over to the West and invest in lower return assets, whereas the
assets that are high paying, high return, are over the other side
of the world which they are sending money away from. All that
is very consistent, but I do not discount a second explanation
that the bank is certainly aware of, which is how we value our
debt and liabilities' position. Take an oil company that we have
invested a certain amount in oil resources. If the price of oil
increases, then the value of those overseas assets ought to rise
in a present discounted value accounting way. It is not clear
whether we have properly taken that into account, so our external
debt position might be more favourable than the book numbers suggest.
The investment income figures are accurate and telling rather
than the debt position.
Q19 Ms Keeble: Following on from
that, could you say something about what that means in terms of
the different type of investment? You said something about different
types of holding, but I was thinking about the change of our investments
over time, which used to be in manufacturing plants and now perhaps
is oil or different types of industry. Equally, investment in
the UK is different in type as well. The suggestion by the Bank
is it is mostly capital investment. What does that mean in terms
of, firstly, the susceptibility of that capital flight; secondly,
the instability of having large investments in oil or perhaps
in parts of the world which are not quite so stable; and, thirdly,
we have talked endlessly in the UK about the need to get Africans
to invest in Africa and not to export all their capital. Perhaps
it is not going to be the biggest export of capital there ever
was, but how do you join up the policy in what you saying in international
development and what you are saying on investment and business
interests?
Professor Quah: I am nodding because
we do need joined up thinking, but some of that joined up thinking,
as you appropriately put your finger on, takes us way beyond the
discussion of UK inflation and has to do with patterns of global
poverty, income distribution in the world, international development
and the efficacy of foreign aid. It is a huge problem and it ties
very much to our discussion of global imbalance. Why are the poor
people of the world, not just Africa, sending their resources
to us, earning lower rates of return, allowing us to enjoy positive
net investment income, while lots could be done in the rest of
the world. These are huge important questions but I do not feel
right pushing them too much because we are here to talk about
UK inflation.
Chairman: We are looking at that aspect
in the IMF report.
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