A sea change from across the Atlantic?

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North America is leading the way once again, with the exceptional communicator and statesman Barack Obama safely installed in the hot seat for a second term.

Having led (i.e. caused!) the credit crunch, the US is making the most of its relative safe haven advantage and utilising the depth and diversity of its funding markets to great effect. This in turn has provided good real estate investors with more funding options through corporate bond issuances, plus loans from insurance companies as well as banks. DTZ boldly stated last autumn that, as a result, there was no funding gap in the US. In consequence, acquisitive US Private Equity funds such as Blackstone have begun mopping up bargains all over the world. Over the last year, domestic unemployment has decreased from 8.3% in January to 7.7%, homebuilder sentiment has risen to its highest level since 2006, and prices are up by about 17%.

Just as significantly, DTZ also said they expected the UK’s real estate funding gap to be all but eliminated by 2014, with equivalent funding lines to those active in the US recently tested and expected to expand significantly in the months ahead.

In the Eurozone, meanwhile, DTZ expect the funding gap to remain outstanding for some years. Even so, it looks promising that the crisis is taking a course “less bad” than most had expected  -much to the credit of (ex-Goldman Sachs) Mario Draghi, President of the European Central Bank and FT Person of the Year 2012. Draghi’s promise to “do whatever it takes” seems to be working.

As a result, the recovery of Greek Bonds has proven to be the hedge fund play of 2012. And if the Spanish government finally requested a Euro bailout, the country’s banks only required half the expected £100bn. The great exception of course is France, where policy makers seem to be doing their utmost to dismantle the economy (to the benefit of London). Economic disaster looks increasingly likely as wealth creators jump ship before they are pushed or even have their ships confiscated (as with Arcelor Mittal)!

Returning to the outlook for the UK, Mike Carney (notably also ex-Goldman Sachs) has been recruited as the new Governor of the Bank of England. He is widely considered to be one of the top two central bankers in the world, which is quite a coup for George Osbourne. Carney is generally expected to promote higher growth and employment, with interest rates staying lower for longer at the price of higher inflation.

This should be good news for investors like Inspired who concentrate on “real assets”, as values and incomes increase while debt as a proportion of value diminishes.

It is likely to encourage greater risk taking by investors who need to find higher returns in order to protect their capital, which will be at greater risk of erosion from inflation – currently standing at 2.7% and remaining stubbornly above the 2% target. Again, this represents good news for opportunistic investors like us: competition for assets may make it harder to buy cheaply, but there should still be plenty to go around as the US funds that bought loans in 2012 take action and make their margin by offloading in 2013. Additionally, our existing assets are all located in Inner London and should benefit from an increase in value, while capital should become easier and cheaper to raise.

I firmly believe that more risk taking (within reason) is a good thing generally: fear has a corrosive rippling effect through morale and into trust, investment and employment and has in itself become the greatest threat to our future wellbeing and prosperity. A more confident approach, as we’re beginning to see in the US, may just offer the perfect antidote.


Bad, but this year could have been a lot worse

This article from the Sunday Times summed up the year very well.  Some of my take-outs were:

  • Deflation averted – good news
  • Temporary inflation boost over Xmas & in the New Year – better than deflation
  • Global growth estimated at 3% in 2010 by the IMF
  • V-shaped recovery likely

By David Smith

We have all lived through a remarkable time. As we approach the end of 2009, we are also preparing to say goodbye to a year that will go down as the worst for the global economy and world trade since the second world war.

It has also been, by a margin, the worst year for the UK economy since the Depression. Even if the figures are eventually revised up, as I expect them to be, that record will not be affected. On the Treasury’s estimate of a 4.75% slump in gross domestic product this year, that is more than twice the decline recorded in the previous worst year, 1980.

For the global economy, the International Monetary Fund estimates that world GDP has fallen 1.1% this year. That does not sound much but is the first drop recorded on the IMF’s database, which stretches back to 1970. Before that we had the post-war “golden age” of the 1950s and 1960s.

Advanced economies have seen a GDP fall of 3.4% this year, the IMF says. World trade has slipped before, falling 2.7% in 1975 and 0.9% in 1983, but this year’s fall, 12%, takes us into new territory.

It may seem odd then to say that things could have been a lot worse. Part of my mission is to take the “dismal” out of the dismal science of economics.

The first thing to say is that the worst of the downturn happened quite a long time ago. The period between October 2008 and April 2009 was when global growth, world trade and the UK economy “fell off a cliff”. Economies then stabilised and started on a modest path of recovery. That is true of the world economy and, notwithstanding the official GDP figures, of Britain.

The improved economic tone, and the rise in markets, has happened as we have come out of that sickening dive. Anything could have happened to the banking system, from nationalisation of every bank to the cash machines running out. Instead, as the Bank of England’s financial stability report pointed out on Friday, the banks are a long way from being back to normal but an even worse crisis was averted, for which credit is due to the authorities.

In March, the world was looking at “mark-to-market” financial losses of £24.3 trillion. The recovery in markets has cut that to £6.3 trillion. House prices, expected to fall by up to 25% at the start of the year, will end with a modest rise. Sterling rose over the course of 2009 too.

There is other good news. Last week saw a flurry of concern about inflation, as headline consumer price inflation rose from 1.5% to 1.9% and retail price inflation turned positive (by 0.3%). There will be further rises over the next two to three months, before inflation comes down again.

Why is that good news? The dangers of prolonged deflation were exaggerated but the risk was there and has been averted. Had this crisis been followed by a prolonged period of deflation, comparisons with the 1930s might indeed have been justified. As it is, I would much rather have Britain’s problems than those of Japan.

Best of all is the job market. Employers and employees have shown huge flexibility to get through this recession. Wage freezes, cuts and shorter working weeks mean employment has fallen by only a third of what it was reasonable to expect.

The government deserves a little credit for its labour-market policies, including job and training guarantees. Aggressively expansionary monetary policy and modestly expansionary fiscal policy have helped.

Last week brought news of the first drop in the claimant unemployment count since February last year. The wider Labour Force Survey measure held below 2.5m for the fourth month running, against high-profile predictions of something like armageddon in the job market.

One of the worst labour-market forecasters, interestingly, has been Danny Blanchflower, formerly of the Bank of England’s monetary policy committee, who was appointed to the MPC for his labourmarket expertise.

In January he predicted that unemployment would rise to 3m, or worse, over the following 12 months. In May, even when it was clear from the data that the claimant count was rising much more slowly than expected and that the wider jobless measure could be expected to follow suit, he predicted monthly unemployment rises of 100,000 for the rest of the year. Even as lower numbers came through, he insisted it was the lull before the storm.

It may still be, though it would be an odd recovery that saw job losses accelerate. Unemployment probably has further to rise and will be slow to fall. The Treasury expects the jobless total in 2014 to be some 50% above its pre-recession level.

Only if there is a “double-dip” in the economy, however, would you expect a big unemployment surge. The job-market numbers suggest the economy has been recovering for some months. The risk of that recovery running into a roadblock will be one of the key issues for next year.

There will be more to be said on this but let me just leave you with a couple of quick observations. We are clearly not yet out of the woods. The Bank, in its report, noted renewed worries about the vulnerability of the financial system to sovereign risk, because of Dubai and Greece. Many high-deficit countries, including the UK, have yet to announce the “credible fiscal consolidation plans” the Bank thinks necessary.

The banking system has to wean itself off emergency financial support and needs to get on with it. The Old Lady has taken the banks to her bosom but wants them to stand on their own two feet.

Banks should be doing more to help themselves. By reducing pay bills by 10% and cutting dividend payments by a third, they could rebuild capital by £70 billion over five years. They face big challenges, of big losses on commercial property and rolling over funding in the markets, though the Bank sees these as bumps in the road rather than roadblocks.

The debate about whether banks are lending enough to businesses — or whether the demand for loans has just shrunk — will continue. The return to normal interest rates (which the Bank thinks is 5%) will pose problems, though it will not happen over the next 12 months.

Having said all this, it is very difficult for Britain not to have a recovery if the world economy is growing. The UK is an open economy and 3% global growth next year, which is what the IMF expects, will lift Britain. Most recoveries are V-shaped and the strong likelihood is that this one will be, though there are any number of alternative shapes, including W, square root and saxophone, to debate.

But as we look forward to those debates and say farewell to a fascinating year, probably never to be repeated, we can breathe a sigh of relief that it was not even worse.

PS: We may be getting close to wrapping up 2009 but the excitement is not yet over. Next week will be my annual forecasting league table, which will make some people’s Christmases and ruin a few others. This year’s competition, as much a part of the seasonal ritual as mulled wine or carols from King’s, has an added twist. Readers were invited to submit their own forecasts and some will have done well in comparison with the professionals. There will be prizes.

We are in an online age but the forecasting league table is best viewed on good old-fashioned newsprint. So make sure to get a copy of the paper, even if it means trudging through shoulder-high snowdrifts. Until then, I offer you my best wishes for Christmas. (David Smith, The Sunday Times) http://business.timesonline.co.uk/tol/business/columnists/article6962721.ece

Home Economics: Can taxes control house prices?

By David Smith

With some people arguing that we have not yet got through the bust, thoughts are already turning to how to stop the next house-price boom.  Adam Posen, a member of the Bank of England’s monetary policy committee, argued last week that interest rates alone would not be enough to stop prices from getting out of hand in the future.

One way to do so, he suggested, would be to vary housing taxes according to the economy’s position in the cycle.  So, when prices are rising too strongly, stamp duty should rise to deter buyers.  Other taxes could also be used to cool over-exuberance.  When the market slows and prices fall, such levies could be cut.  We have, of course, seen a stamp-duty holiday on properties below £175,000 during this recession.

Could such a variable tax work?  There is a month of data to go, and anything could happen, but it seems clear that on the Nationwide Building Society’s measure, house prices will end the year higher than they started.  Prices rose by 0.5% last month, up 8.3% on their February low and 2.7% on a year earlier.  Because prices fell sharply in December last year, even a flat figure this month would ensure that prices end 2009 more than 5% higher.

This was not in the script.  At the end of 2008, house prices were falling at such a pace that few saw them stabilising, let alone recovering.  The average prediction was for a 10% drop in prices during 2009, and several leading forecasters predicted a 20% fall.

This year’s experience shows how hard it could be to set a variable tax.  Triggering an increase in duty each time, say, house-price inflation went above 10% would be fraught with difficulty, although we should not reject the suggestion out of hand.

Posen’s proposal was not the only tax idea doing the rounds last week.  The Liberal Democrats modified their “mansion tax”, which would now apply only to homes worth more than £2m.  Taxes, as we all know, will be going up in the next parliament, whoever wins the next election.  And that in itself may be enough to cool any boom.

More than one in three tenants expect their rent to rise in the next year, according to a consumer-confidence survey conducted by Rightmove.  The website also found that, of the 35,000 people questioned, almost two in three were renting only because they could not afford to buy. (David Smith, The Sunday Times).

Mind the housing gap

By David Smith

The Queen’s speech, published last Wednesday, sets out the areas the government considers important in the year ahead.  Britain’s impending serious housing shortage, one must conclude, is not a priority.

True, this was a speech designed to extract maximum political advantage for the government in the months left before the election.  And true, not all changes require legislation.  But the need to build many more homes in Britain, and thus improve affordability, which was once such a priority for Gordon Brown, has slipped off the agenda.

When he was chancellor, this was a big issue.  Britain needed 240,000 new homes annually to meet demand and hold down house-price inflation.  Though the housing market has changed since that target was set, the underlying picture has not.  The UK has 61.4m people, and official projections are for this to rise to 63.5m by 2013, 67.8m by 2023 and 71.6m by 2033.

How far are we running behind the target?  The National House-Building Council reports that it received applications to build just under 25,000 new homes in the three months from August to October: 27% up on the same period last year, but still barely more than a third of the target.  While the builders are increasing their output, it is from a very low base.  Government initiatives, meanwhile, most of them launched in a blaze of glory, have either been forgotten or scaled back to the point of irrelevance.  Remember the £60,000 home?  How about eco-towns?

The slump in new housing supply has, of course, helped to prop up prices, thought not as much as the “sellers’ strike” by existing homeowners.  But it is storing up serious problems for the future.

Stuart Law, chief executive of Assetz a property investment company, says: “The current undersupply of property is likely to worsen, as house builders struggle to deliver any substantial increase in new properties in 2010.  Developers are only going to be building about 100,000 units next year, whereas at the peak this was around 180,000 units a year.”  The market will stay thin, which will support prices, but it is a long way from normal.  Judging from the Queen’s speech, the government has run out of ideas about what to do about it.

Gross mortgage lending last month was an estimated £13.5 billion, up 5% from September, but down 27% from £18.5 billion 12 months earlier, the Council of Mortgage Lenders says.  It reports that the number of loans to buy new homes has picked up significantly in recent months, but remortgaging has dropped to levels last seen a decade ago. (David Smith, The Sunday Times).

Why is America gloomy when the news is good?

Irwin Stelzer

It has been a long time since the economic data have been flashing positive signals, and an equally long time since consumers, businessmen and occupants of the White House have been so gloomy. It’s worth considering why this disjunction of fact and perception is dominating the economic news.

Let’s start with the data. America’s economy grew at a 3.5% annual rate in the third quarter (preliminary figures). The Federal Reserve Bank’s survey of business conditions reports “either stabilisation or modest improvements in many sectors … reports of gains in economic activity generally outnumber declines . . .” There follow the usual warnings that improvements are from low levels and that setbacks remain possible, but the news is better than it has been for some time.

Economists at Bank of America Merrill Lynch agree: “Recent data point to … modestly higher overall growth.” As do those at Goldman Sachs, who might be driven to excessive exuberance by the size of their bonuses: “We remain convinced that the worst of the recession is behind us. The global economy has steadied itself and the current recovery is sustainable. While there certainly are some threats to the recovery, we assign a low probability to any one of them derailing US growth.”

Even the gloomier bunch at Coutts, who believe the global recovery remains fragile, admit that “the financial climate has improved markedly”. As indeed it has: dollar-denominated corporate bonds worth more than $1 trillion have been sold this year, a record.

Retail sales are showing some strength and although sales of new homes fell last month, inventories of unsold homes are well below their peak and sales of existing homes are up, as are prices. And an increasing amount of corporate news is quite good: IBM is so confident that business is picking up that it is stepping up purchases of its own shares; Verizon Wireless, in which Vodafone has a 45% stake, reports the highest increase in its customer base since 2005; and — most important — Caterpillar, the world’s largest maker of construction equipment, is signalling a revival of the manufacturing and construction sectors by rehiring some of the 34,000 workers it laid off.

None of this seems to matter to the psyches of the businessmen with whom I speak, the consumers about whom I read, or the White House. Businessmen tend to look further ahead than most participants in the economy — consumers worry about paying the rent or the mortgage next month, and politicians worry about tomorrow’s opinion polls. Company executives know that the profits picture is improving but they worry that much of the improvement comes from cost cutting rather than increased demand.

They are fearful that a new banking crisis will emerge. They see an administration and a Congress that are spending America into such deep debt that the dollar will continue to decline, forcing the Fed to raise interest rates to prevent a collapse of the currency.

Some executives expect the price of gold to double or triple in the next five years, interest rates to climb from their current level of close to zero to perhaps 8%, and taxes to soar to bring the deficit under control. They also believe President Barack Obama has no use for a market economy, preferring instead to turn over the management of the country to a series of “czars” who set bankers’ compensation, run the domestic automobile industry, will take over the healthcare sector, and now issue some 85% of the nation’s mortgages.

Small-business owners are more concerned about the administration’s emerging $1 trillion healthcare plan, which will drive up their costs, and with the new taxes that are aimed squarely at the income groups into which owners of small firms generally fall. So they won’t expand or hire.

Which is why the White House is so unhappy. The only indicator that matters to the president is jobs, jobs, jobs, about which he quizzes his staff every day. That’s another way of saying votes, votes, votes. The latest polls show that the portion of Americans approving Obama’s handling of the economy has dropped from 58% to 50% in the past six months, approval of his handling of the deficit is down from 49% to 40% and that 67% believe it is “not possible” that his healthcare plan will not add to the deficit. Nevertheless, the president remains personally popular. He would like to keep it that way and is considering a programme that would give tax credits to employers who add to their workforces.

Consumers are the third unhappy group, completing the gloomy business-political-consumer troika. Consumer confidence fell in October for the second consecutive month, no surprise given the weakness of the job market, and the reasonable fear of the vast majority of Americans who are satisfied with their healthcare insurance that the Obama plan will reduce their benefits and raise their premiums.

What is one to make of all of this? Last quarter’s return to growth should be sustainable in the near and even the medium term. Inventory building, increased exports resulting from the declining dollar, stimulus money that is only starting to hit the economy, and other spending created by a Congress eyeing the November elections will combine to provide a boost. In the longer run, however, the pessimism of the business community seems justified: the White House and Congress are dominated by politicians with little understanding of what makes an economy grow sustainably, and a devotion to spend-and-tax that bodes ill for the future of the dollar as a reserve currency, and for future generations who will have to pay the bills Obama will leave in his wake.

However, what politicians have created, other politicians can put asunder. The problems that have so many so gloomy are reversible. As Lawrence of Arabia tried to persuade his fatalistic Arab allies, “Nothing is written”. (Irwin Stelzer, The Sunday Times) http://business.timesonline.co.uk/tol/business/columnists/article6898002.ece

Bank of England should release £30bn more in quantitative easing

David Smith: Economic Outlook

To QE or not to QE? It is the big question for the Bank of England’s monetary policy committee (MPC) this week, and it is a big question for the economy.
After those unexpectedly weak gross domestic product figures nine days ago, showing that officially the economy remains in recession, the onus is on the Bank to do more quantitative easing (QE) this week. Will it, and by how much?

The story so far is that the Bank has done £175 billion of quantitative easing: buying assets, mainly government bonds or gilts. The MPC, while not claiming it has solved everything, is upbeat about its effects.

David Miles, who joined in June, said recently: “I believe the evidence is that QE is having an impact and that it is relevant to economic conditions right across the country. And not just in financial markets in London, but in high streets and factories and homes throughout the UK.”

Kate Barker, another MPC member, said a few days ago that it had helped ease the recession in the housing market, thus supporting house prices.

I don’t suppose many people discuss quantitative easing before sitting down to watch EastEnders but if the Bank is right, they should. It is as important in its way as changes in interest rates and the guide on the Bank’s own website provides a simple explanation why.

The Bank, it says, “boosts the supply of money by purchasing assets like government and corporate bonds”, adding: “Instead of lowering Bank rate to increase the amount of money in the economy, the Bank supplies extra money directly. This does not involve printing more banknotes.

“Instead, the Bank pays for these assets by creating money electronically and crediting the accounts of the companies it bought the assets from. This extra money supports more spending in the economy.”

It goes on to say that this extra spending is necessary to get inflation back to its target — inflation is the Bank’s only target — but I suspect most people would rather see the economy boosted in a more straightforward way, such as getting unemployment down and preventing firms going bust.

The question is when the process should stop. Is £175 billion enough, or should the Bank go further? Let me first offer a guide to how the MPC would like us to think of its approach to policy, then offer my view.

There will come a time, though perhaps not for quite a while, when the Bank raises interest rates. At least some of the headlines that will accompany that announcement will be something like: “Worried Bank slams on the brakes”.

That is not, however, how the Bank would see it. Interest rates are very low, the lowest in the 315 years of the Bank’s existence. At 0.5%, Bank rate is a tenth of what I would regard as the modern-day norm, 5%.

So the way the Bank sees it is that as long as rates remain below 5%, then even if they are rising, monetary policy remains expansionary. So the right headline when, say, Bank rate goes up from 0.5% to 0.75%, would be: “Bank eases off the accelerator.”

The same applies, though in a slightly more complicated way, to quantitative easing. There are three ways any decision on interest rates can go: up, down or sideways.

There are also three ways this week’s decision on quantitative easing could go. The equivalent of a cut in rates would be announcing more easing, in other words more asset purchases.

Sticking with the existing £175 billion but not committing to any more would be like an interest rate “hold”.

An announcement that some of the gilts and other assets were to be sold back into the markets would be the equivalent of a rate hike, though it could still be argued that the policy would remain expansionary until they have all been sold back.

No such sell-off announcement will happen this week. The debate is about whether the Bank announces further easing or stops at what it has done so far.

It is of intense importance in the City, where the programme of asset purchases is seen to have helped lift markets (which the Bank acknowledges and welcomes). A halt would bring an immediate adverse reaction, most notably by pushing up the yields on gilts and corporate bonds.

It is also very important, if Miles and Barker are right, in high streets, factories, estate agents and homes up and down the country.

It matters too for the pound. The Bank’s aggressive easing programme has helped push sterling lower against other currencies though, as I shall try to explain, that might be a perverse reaction.

What will it be? MPC-watchers say October’s meeting offered few clues, merely putting off the decision until this month, when the existing programme runs out.

The shadow MPC, which operates under the auspices of the Institute of Economic Affairs, has been keen on quantitative easing from the start and thinks it would be a mistake to stop now.

Tim Congdon, one of its members, did an impassioned presentation at a recent meeting, arguing that Britain stood out in its policy response.

The easing programme had lifted growth in the money supply at a time when it was heading down worryingly in both the euro area and America. On his analysis, the currency markets should be concerned about recovery in Europe and America, not Britain.

A more cautious note is struck by Chris Williamson, chief economist at Markit, which produces the monthly purchasing managers’ surveys. He is convinced on the basis of these surveys that the economy has been recovering for some months.

The danger, he suggests, is that the Bank pumps in more money at a time when the economy does not need it, risking that the inflation already present in asset prices extends to other parts of the economy.

He has a point, which is why I think the Bank, which also has its doubts about the official statistics, needs to proceed with caution. It is too soon to stop the asset purchases altogether, not least because of the adverse reaction in markets that would result.

It is fair to argue, however, that the economy needs less of a boost than it did. At its peak, the Bank was doing £25 billion of easing a month. In August it slowed the monthly rate to £17 billion-£18 billion. I would slow it further, to perhaps £10 billion, implying that the Bank should announce a further £30 billion of purchases this week. Let’s see what it does.

PS: Many have written books on the credit crunch — I’m just putting the finishing touches to one — but not many people have written two. So I take my hat off to Graham Turner, founder of GFC Economics, for his second; No Way to Run an Economy.

He has always advocated dramatic policy measures to lift Britain and other economies out of the crisis and criticised policymakers for their timidity. His latest book is no exception.

Some think Britain and America have been irresponsible in allowing their budget deficits to rise too much. He argues that they should have been bolder in their fiscal stimulus efforts and allowed deficits to rise much more.

The parallel he draws is with wartime. During the second world war, America’s budget deficit rose to 28.1% of gross domestic product, while Britain’s was just behind at 26.1%. Debt and deficits fell sharply in peacetime, when full employment was re-established.

By “socialising” the banking industry’s losses, he argues, governments have been unable to offer a proper Keynesian response to the crisis. As you might expect, he is not optimistic about the outlook. (David Smith, Economic Outlook, The Sunday Times) http://business.timesonline.co.uk/tol/business/columnists/article6898000.ece

Borrowers face the squeeze

David Smith: Home Economics

How big a threat to the housing market is the proposed clampdown on mortgage lending by the Financial Services Authority (FSA)?  And is there a bigger immediate problem?  Nobody thinks that irresponsible lending should be allowed to continue, and it would help if lenders know their customers better.  Thought we never really had 125% mortgages, even from Northern Rock, anything approximating to a 100%-plus mortgage should be discouraged.

Looking at the “table of shame” in last week’s FSA mortgage market review though, I am not sure how irresponsible lenders were.  It includes the striking statistic that 49.3% of mortgages handed out in 2007 (the market peak) were given without proof of income.  Yet not all of these were self-certified mortgages, wrongly disparaged as “liar loans”.

The other figures in the table suggest that the FSA may be overdoing the “irresponsibility” bit.  Fewer than a third of mortgages were interest-only, fewer than 14% were on a loan-to-value basis of more than 90%, and fewer than 4% were genuinely sub-prime – loans to people with impaired credit histories.

Regulators, by their nature, tend to lock the stable door when the horse has bolted.  To the extent that lenders were irresponsible, and I don’t dispute that some were, things will change.  The new guidelines will make it harder for some buyers to get mortgages, particularly the self-employed.  But nothing will change before the second half of 2010, so the deserving self-employed should make loan arrangements now.  In the long run they will be squeezed.

The new guidelines will take the edge off the housing market in the long term.  In the short term, there is another danger, identified by David Adams, head of residential at Chesterton Humberts estate agency, following Rightmove’s report that asking prices rose 2.8% in the past month.  “This is an agency-induced increase that is not sustainable,” he says.  “There is a huge stock shortage in much of the country, and agents desperate for instructions are giving unrealistic quotes to prospective sellers.”  He is right.  The best way to kill off the market is if prices rise too rapidly. (David Smith, The Sunday Times)