Saturday, 28 March 2009

What's Wrong With Deflation?

We kept getting told that deflation is the greatest threat facing the economy. In my Moneyweek column this week, I'm suggesting we shouldn't be so sure about that. Here's a taster....

Like a last-minute twist in a movie, March turned out not to be the first month of deflation after all. Despite widespread predictions of the first fall in prices for half a century, the Retail Price Index was stuck at precisely zero percent.
All the experts ready to warn us about how deflation was the greatest threat since the black death had to put their lectures on hold. The wise-sounding reminders about Japan’s ‘lost decade’ had to be wrapped up for another month. But they won’t go away. As more and more money is printed, we’ll carry on being told that the threat of stuff getting cheaper is the real danger the global economy faces.
It’s nonsense. The truth is, there is nothing to fear about deflation. Indeed, it has been central bankers’ paranoid and irrational fear of falling prices that has helped to land us in this mess in the first place. To start clawing our way out of the economic crisis the world needs to start learning to accept there is nothing wrong with prices dropping occasionally.
Deflation is fairly simple phenomenon. It means prices going down a bit year on year, rather than going up. Our Victorian ancestors would have found nothing very odd about that. In the 19th century, according to statistics published by the House of Commons library, prices went up some years, then down in others. In 1854, for example, prices rose by 15%, then came down by 8.4% in 1858. The net result was that in 1914, prices were roughly the same as they had been a century earlier. By contrast, prices have risen every year since 1945, making an aggregate rise of 22 times.
Most people might think stable or falling prices sounds quite good. A whole army of economists, however, keep telling us how terrible it is. On close examination, however, it turns out that most the arguments against it are remarkably threadbare.
We keep getting told that it will hurt the economy because it will force people to postpone decisions. Why buy that sofa today if it will be cheaper in six months time? Demand will collapse, and people will be thrown out of jobs.
The trouble is, it’s not really true. If it was, we wouldn’t have a computer or electronics industry. Both are subject to savage price deflation, and yet are among the most innovative and fastest-growing businesses in the world. The reality is that people adjust. They know they can buy a better and cheaper PC in six in six months time. Against that, they really want one right now. Quite quickly a balance is struck.
True, deflation is bad for people who’ve borrowed lots of money. The debt stays the same whilst their income may go down. That will hurt. Against that, however, they could always try working a bit harder, and paying back their debts honestly, rather than letting inflation do the job for them.
Then there is the upside of deflation, about which we hear remarkably little. Whilst it is bad for borrowers, it is good for savers, who find themselves getting magically richer year on year rather than poorer. It may well have a positive impact on consumption as well, despite what we kept being told. After all, if you reckon that falling prices will be make you slightly richer next year, why not spend a bit more now?
In truth, deflation, like any other economic event, is fairly neutral. It has winners and losers. Its gets a bad press largely because the losers are a lot more powerful than the winners.
Deflation is bad news for the chief executives of big companies. So long as there is some inflation out there, they can push prices steadily upwards, and keep profits growing without doing very much. They can even slip through some stealth pay cuts for the workers by increasing their wages at slightly less than the inflation rate. With deflation, none of that is possible.
It is even worse news for the City. One of the main ways the financial industry makes money is through inflation. Without it, the private equity firms would be completely finished. So would most of the hedge funds (who rely just as much on debt). Inflation usually means savers – the customers, that is – get clobbered, whilst borrowers – the city institutions – get rich.
And, of course, it is great for the government. It gets stealth tax rises (by leaving thresholds where they are). And it sees its vast debts quickly wiped out. Deflation would hammer the Chancellor of the Exchequer before anyone.
The people who it benefits – mostly small savers and ordinary consumers – are far less powerful.
That doesn’t mean they should be ignored, however.
Indeed, fighting deflation is one of the ways we got into this mess.
The past decade should, looking back, have been a period of gradually falling prices. Globalisation, and particularly the integration of India and China into the developed economy, put a lot of downward pressure on costs. So did technological change: computers have made lots of things cheaper to produce. In the U.K.’s case, the strong pound was another factor – with everything we import getting cheaper, prices on the high street should have been falling.
Overall, prices by 2007 should have been 5% or so less than in 1997.
But central banks fought that. In thrall to a paranoid fear of deflation, they kept printing more and more money to stave it off. They succeeded, as we know. The price, however, was a massive asset price bubble. Now that it has burst, the world has been plunged into recession.
It would have been far better to accept a short period of deflation, ignoring the industrialists and financiers who warned it would lead to catastrophe. And you know what? It still would be.

Wednesday, 25 March 2009

Another Step to Meltdown

The UK economy is taking a step closer to meltdown every day. The gilts auction failed today. It seems no one wants to buy British government debt yet. And we haven't even started issuing the stuff yet. Hang onto your hats.

The Business School Scam

On Bloomberg today I've been writing about Business Schools and the role they played in creating the credit crunch. It is probably harsh to blame them completely. But, as one person who e-mailed me pointed out, their fees and exclusivity created the bubble in which much of the business world has lived for the past decade. I mean, it does seem extraordinary that Andy Hornby, formerly CEO of HBOS, could have an MBA from Harvard and not realise there was something wrong with the way the bank was being run.

Tuesday, 24 March 2009

The UK Takes A Step Closer to Meltdown

Although the chances of it are not more than 10% or 15%, there is a meltdonwn scenario for the UK. It is that inflation rises sharply, the currency collapses and the Bank of England has to hike interest rates sharply to control inflation. Then the economy would be in real trouble. It came a step closer today with the news that inflation roese despite the recession. Could it happen. Probably not. But it is a scary prospect, and even it doesn't, 1970s stag-flation is the best the UK can look forward to right now.

Bankers & Bonuses

I was on France 24 last night discussing banks and bonues. You can watch it here. Although I tend to agree with the view that the arguments over bonuses are a distraction from fixing the economy, it's also true that public upport for banking rescues won't be sustainable whilst these huge bonuses are being paid. So something does have to be done about it.

Saturday, 21 March 2009

Should Tax Havens Be Banned

In the run-up to the G20, there is lots of debate about tax havens. Everyone from Gordon Brown to Barack Obama is trying to ban them. There is a typcially thoughful piece by John Kay in the FT, and by my Bloomberg colleage Celestine Bohlen. My own view is that they are being picked on unfairly and made a scapehoat, a point I've been elaborating on in Moneyweek. Here's a taster....

Well, at least that is one thing cleared up. You might have imagined the credit crunch, and the sharp slowdown in the global economy, had something to do with the bursting of a credit bubble, lenders that ran out of control, and regulators and central bankers who turned out to be asleep at the wheel.
But no. It turns out it is all the fault of a few tiny state-lets such as Monaco, Liechtenstein and Andorra.
In the run up to the G20 summit to be held in Britain next month, prime ministers, chancellors and presidents have been launching blistering attack on the tax havens. “All jurisdictions must come within the rules,” the British Prime Minister Gordon Brown announced last week at a press conference in London with the German Chancellor Angela Merkel. “Standards that are being applied in some jurisdictions are too low. This is the beginning of the end of tax havens, and that is good news for everyone.”
The new U.S. President Barack Obama has set his sights just as squarely on the same target. He has promised to raise an additional $210 in taxes from American citizens and companies by cracking down the way money is pushed through offshore centres.
And there is plenty of evidence that the principalities and state-lets under attack are starting to buckle under the pressure. In the past month, Switzerland, Liechtenstein, Andorra and Monaco have all promised to change their banking laws. Territories such as Jersey and the Bahamas may not be far behind. Banking secrecy in the offshore industry is about to be consigned to history.
But hold on. There are two problems here. First, there is absolutely no evidence to suggest that the tax havens had any role in creating the financial crisis. And, in making them the scapegoat, we risk throwing away freedoms that we should all guard far more carefully.
Let’s start with the contention that offshore centres played a role in the credit crunch. So far, no one has been able to come up with a single shred of evidence to suggest why that might be so.
True, many of the sub-prime mortgages, off-balance sheet vehicles and derivatives contracts that played a role in the crisis may have been nominally offshore. But that is largely incidental. There is hardly a single complex deal struck anywhere in the world that doesn’t involve an offshore centre somewhere in the chain. It doesn’t follow that the use of tax havens created the crisis.
After all, the problems in the British banking industry were caused by lenders such as Northern Rock, Bradford & Bingley and HBOS completely abandoning prudent lending rules. It was buy-to-let mortgages in Leeds, and self-cert loans in Swansea, that caused the trouble – not debts run up by bankers in Jersey or brass-plate companies in the Cayman Islands. The problem was not that banks hid what they were doing. It was the regulators didn’t ask the right questions.
In reality, the politicians are playing two tricks with their attacks on the havens, both of them completely disreputable. They are creating a smokescreen designed to distract attention from the failures of the regulatory systems they created. And they are desperately looking for ways to shore up tax revenues that are starting to crumble as the recession bites.
There has been a long-running campaign to clamp down on tax havens. The Germans have led the way, with a series of bullying attacks on Liechtenstein, a favourite of wealthy Germans. Now Britain and the U.S., which are becoming high-tax countries as well, are joining the attacks.
And yet, the charges commonly levelled at the haven are entirely bogus.
For all the allegations about harbouring money launders and undermining global tax systems, we should remember that the havens in question, whilst they might not be full-blown nations, are sovereign entities. They are entitled to as much respect as any other small country.
So Germany, for example, has a perfect right to set whatever laws it likes for people living in Germany. If it wants to ban its citizens from holding accounts -- or setting up trusts and foundations -- in other countries, it can do so (and deal with the flight of people and capital that would certainly result). But it isn’t entitled to harass other countries into changing their laws – and neither is Britain or the U.S. If people want to put their money into a low-cost, low-tax country, that surely is their business.
There is no substance to the ludicrous charge, regularly peddled by campaigners against tax havens, that this is somehow ‘unfair’ tax competition. All competition is unfair. It is unfair that the Germans make terrific cars, causing all kinds of problems for everyone else’s auto industry. It is ‘unfair’ that the Italians make great suits, or the French terrific wine. Perhaps they should be stopped from doing that to make it easier for other countries. Absurd? Then why should Liechtenstein or Jersey be forced to close their financial-services industry?
Nor is there any evidence that they are used by money launders or terrorists any more than any other financial centre. Serious terrorists use everyday banks because they attract less attention. Third-world dictators will always find somewhere to park the odd billion.
In truth, the growth of the offshore industry has been driven by higher, more complex taxes in Europe and increasingly in the U.S. as well. Since becoming Chancellor more than a decade ago, Brown has turned one of the simplest tax systems in Europe into one of the most complicated. Obama is set on the same path in the U.S. Instead of picking on very small countries, Brown, Merkel and Obama would be better off using the G20 summit to start fixing their own.

Thursday, 19 March 2009

More Reviews for Death Force

Death Force has been pikcing up some more great reviews, which is very encouraging. In Australia, the Canberra Times described it as ‘blistering’ and ‘full to the brim with authentic military detail'. Over at the bookbag site, which is doing a great job of broadening out book reviewing, there is a great piece by Sue Magee. "From the gun fight on the road through to the reason for their being in Afghanistan the action never lets up for a moment. Lynn knows how to keep the pace going and there were occasions when I found I was holding my breath. Throw in all the boy's toys of weaponry that you could wish for and an almost impenetrable target and you have the stuff of which the big name movies are made." You can read the rest of it here.

Tuesday, 17 March 2009

The Closure of Papers

At the start of the year, I wrote a column of prediction for 2009 for Bloomberg. One was that a major newspaper would make the switch to web-only publishing. So I was interested to see that the Seattle-Post Intelligencer is making precisely that switch. It won't be the last. It is hard to see many papers surviving in their current form. As a journalist, I can see the sadness in that. But the sooner journalism moves into the new age the better. There aren't enough profitable publishers at the moment - and profits won't return until the switch to the new technology is complete.

Saturday, 14 March 2009

Nationalised Banks

In Moneyweek, I've been writing about what a disaaster natioanlised bank will be. Here's a taster.

Another week, another bank get nationalised.
This time around it was the turn of Lloyds-HBOS to slip into public ownership as the government increased its stake in the merged banking group from 43% to as much as 75% in return for the state guaranteeing of £260 billion in high-risk assets.
It has plenty of company. The government already controls Royal Bank of Scotland, Northern Rock and the parts of Bradford & Bingley that it didn’t manage to sell on when that bank collapsed last year.
Nor does it necessarily stop there. Barclays has resisted allowing the government a stake but may not get through this crisis without state funds. Even HSBC is starting to look shaky: on Monday, in Hong Kong trading, its shares fell back to 1996 prices.
And yet there has been criminally little discussion about the wisdom of the course the British government had embarked upon. True, we may not like fat cat private sector bankers with their lavish bonuses and generous pension schemes, much any more, but just wait until we start getting used to their public sector successors. In truth, there were far better ways of rescuing the banking system than nationalisation – and we may be paying for the mistakes of this year for decades to come.
No one disputes that the banks needed to be rescued. As much as many of us would like to see bankers pay for their excesses with their jobs and their companies, the consequences for the economy would be catastrophic. Too many savers would lose their money. Small business loans would be called in. Confidence would plummet.
And yet, it is a big step to take banks into public ownership. Amid the chaos of collapsing markets, the consequences have not been thought through. But fast-forward a few years, and the chances are we will have learned to hate public sector bankers just as much as private sector one.
The historical record is instructive. In the early 1980s, France’s President Mitterand nationalised much of the French banking system, in one of the last gasps of old-school European socialism. By the end of the decade, banks such as Credit Lyonnais had run up huge losses. Among many terrible decisions, it ended up owning the MGM film studio.
In a few years, we may well see RBS bankers running around Hollywood, partying with actresses, and blowing millions on new films. There are three reasons why state-owned banks can be expected to run into big trouble.
First, without any shareholders there won’t be any pressure on banks to perform. Right now, we think that will mean they will tale fewer risks, and for the next couple of years that might be true. Over time, they will take even more. After all, they won’t be constrained by a lack of capital anymore, and they won’t have any irritating shareholders to answer to. Expanding rapidly is how you make yourself more important. So why not go as fast as you can?
Next, the banks will be subject to constant political interference. Without shareholders, there will be nothing to stop politicians meddling in their decisions. They won’t be foreclosing on dud loans, and certainly not if there is a factory or call centre at stake in a marginal constituency. They will be dishing out money to ‘national champions’. Worse, over time, we can expect to see a crony culture build up. Property developers and industrialists who want access to loans will need to get the bankers on board and that will mean getting the politicians on side as well. Expect to see a big increase in party donations, and generous non-executive jobs for even the most brain-dead backbenchers. It isn’t going to be very efficient. Nor will it do anything for the honesty of public life.
Lastly, there won’t be much in the way of innovation. With the bulk of our banking system state-controlled, there won’t be any or competition to spur new thinking. Right now, we have had a surfeit of financial innovation. But as we emerge blinking out of the recession, we’ll need finance to repair battered balance sheets, and to pay for mammoth government deficits. We’ll need more clever financing, not less.
In truth, it is a myth to think that state owned banks will allocate money any better than private sector ones. They will still blow it, only in a different way. Bankers like nothing better than spending other people’s money, and, courtesy of the taxpayer, they have just been offered a bottomless pit of the stuff. Don’t expect the results to be anything other than very ugly.
There was a better way. The government could have set up a series of so-called ‘bad banks’: one for each institution in trouble, or else one for each class of asset that had turned sour. The ‘bad banks’ would buy all the troubled loans at par, using money printed by the Bank of England if necessary. It would hold onto them until they recovered in value – as many mortgages will eventually, for example – or else until they had been deemed worthless.
The losses in the short-term would be horrendous, and would be shouldered by the government. But the taxpayer is taking on terrible losses anyway. Against that, the country would be left with a clean banking sector, with the toxic loans taken off its books, which could then start lending again, and competing with each other. The slate would have been wiped clean, and a fresh start could have been made. Doesn’t that sound better than a group of state-owned banks stumbling inevitably towards the next disaster?

Friday, 13 March 2009

Bankers Aand Their Bonuses

On Bloomberg this week, I have been writing about banking bonuses. What strikes me as interesting is how reluctant people are in that world to recognise that the world has changed. I suspect there is going to be a long slow period of adjustment where they realise that in the rest of the world you don't get a huge bonus just for doing your job and that when your company is bust you are lucky to get paid at all.

Wednesday, 11 March 2009

Death Force Review

There is a great review of Death Force on the Book Bag website.

Tuesday, 10 March 2009

Meeting Jeffrey Archer

I interviewed Jeffrey Archer last week for Bloomberg, and also talked to him a bit about my own book. Very kindly he's wished me well on his own blog. He recalls the publication of his own first book, and how they struggled to make sure the first 3,500 sold. I certainly know how that feels. I found Archer charming. There's an image of him as a hack writer, but that certainly doesn't survive a conversation with him - he cares passionately about his books, and that comes through when you read them.

Saturday, 7 March 2009

The Coming Private Equity Crisis

In Moneyweek this week, I've been writing about the looming crisis in Private Equity. Here's a taster of the piece, but do buy the magazine.

There must be relatively few thoughts that can console the former Royal Bank of Scotland boss Sir Fred Goodwin as he looks back over the tatters of his career. There won’t be many publishers asking for his memoirs, not many universities asking him to take up a chancellorship. Still, there is one. The backlash over his pension will look like nothing more than a mild disagreement between friends compared with the political and economic storm that is about to erupt over the private equity industry.
Fast forward a few months, and it already obvious to anyone who cares to take a look that the next, and potentially the most painful, stage of the credit crunch will be the collapse of a string of companies owned by the buy-out funds.
The signs are already there, just as they were in the banking industry six months ago. And yet, with extraordinary and reckless negligence, the City and the Government are keeping their heads buried resolutely in the sand, taking few steps to stave off the trouble ahead. In time, there will no doubt be a heavy price to pay for that carelessness.
This week, the warning lights of trouble ahead have been flashing bright red.
On Monday, Candover, one of the pioneers of the private equity industry, and among the smartest players within it, reported a truly terrible set of results. The firm cancelled its dividend, scrapped plans to invest in a fresh fund, and said it was looking at job cuts. Its shares have fallen from £22 as recently as last August to only just over £2 now. Elsewhere, the news is just as grim. KKR said this week the value of its publicly quoted funds dropped by a third in the latest quarter. 3i has watched its shares slump all the way from a peak of £11 to less than £2 now. Over in the U.S, shares in Blackstone, the world’s biggest quoted private equity group, have fallen back from $30 to less than $5 now.
No one should be in any doubt about why that is. The buyout business was partly about taking control of tired business run by timid and lazy management and freshening it up with a lot of smart new ideas. But, in truth, it was mostly about clever financial engineering. The funds loaded up company balance sheets with lots of debts, sliced and diced it a dozen different ways, then sold it on to hundreds of different institutions, all the while generating huge fees for the funds themselves and their bankers. If you think sub-prime mortgages are complicated, trying unpicking the average private equity deal.
Inevitably, there are going to be collapses. In a deep recession, the one thing a company needs, just like an individual, is a strong balance sheet. They need plenty of equity, adequate capitalisation, and the ability to ramp up borrowing to get through a couple of lean yeans. Very few of the businesses owned by the buy-out funds are in that kind of shape. True, some will be able to re-structure their balance sheets, swapping debt back into equity. But, in reality, that is a lot easier in theory than in practise. Bond holders won’t want to take the losses it will inevitably involve. Amidst the arguments and recriminations, companies will collapse into insolvency.
When it happens, the anger is going to make the outrage over banking bonuses look mild. If a few derivatives traders lose their jobs, it doesn’t matter very much. Only the lap-dancing clubs of EC1 really suffer. But the private equity firms own huge companies, employing tens of thousands of people: Companies ranging from Iceland, to the AA, to Kwik Fit and Travelodge are all owned by the buyout funds.
Jobs will be lost, houses will be re-possessed, and pensions will be destroyed. On some estimates, as many as one in five private sector workers in the UK are ultimately employed by the buyout funds. The impact on ordinary people’s lives is going to be huge.
Neither the industry or the government will be able to escape the fall-out. The funds have been paying their partners a fortune during the boom years. If you think the board of Royal Bank of Scotland rewards itself generously, then you’ve never taken a look at a private equity firm. Sir Ronald Cohen of Apax has made an estimated £260 million from the industry. Guy Hands of Terra Firma has made an estimated £160 million. Damon Buffini, of Permira, is worth an estimated £150. Lower down, there are dozens of middle-ranking executives who have accumulated fortunes running into millions.
If, as seems likely, it becomes clear those fortunes were made by manipulating balance sheets, and leaving them in such poor shape that that thousands of people lost their jobs, there is going to be a lot of anger out there.
The Government won’t be able to escape the blame – and nor will it deserve to. Gordon Brown has long been the private equity industry’s best friend. Cohen bankrolled his leadership campaign. Buffini has been a key adviser. And whilst it is a myth that the private equity industry gets special tax breaks (it simply manipulates the existing rules better than most people) there is no question that as Chancellor Brown tolerated tax wheezes that allowed the industry to flourish.
He could have done a lot more to regulate its growth. As a result he can hardly complain if his government gets caught up in the backlash once companies start crashing down. If, as he claims, he was trying to ‘save’ the economy, he’d be trying to stave off the looming crisis now. Instead, either through ignorance or carelessness, it is being ignored – at least until the first major insolvency hits the headlines.

Thursday, 5 March 2009

The Private Equity Bust

The is taking me to task over a column I wrote for Bloomberg yesterday about private equity. They miss a few points, however. It doesn't matter if the firms themselves are not highly leveraged: the businesses they own certainly are. Next, they seem to think they are "the least of the economy's problems". But in the UK for example private equity controlled companies employ millions of people and the same is true in the US. If they start to go under, isn't that a problem?

Tuesday, 3 March 2009

Guy Hands and EMI

When I wrote about the decision of Guy Hands's private equity firm Terra Firma to buy EmI for Bloomberg, I got chewed up by his PR man at Financial Dynamics for suggesting it wasn't a fantastic deal. So it was interesting to see in the FT today that Terra Firma have written off half what they paid for the business. No doubt they will blame that on the credit crunch. But last time I checked, CD sales were actually rising. So maybe it was just a bad deal.

Monday, 2 March 2009

Why Fred Goodwin Hangs Onto His Pension.

I was on the James Max show on LBC on Sunday afternoon, and James very kindly gave a plug to 'Death Force', and also mentioned it on his blog. I was struck by how many calls we got on the Fred Goodwin story. There is a lot of anger out there about his pension. I wonder why he hangs onto it, rather than, say, donating it to charity. He must have a few million tucked away, so he isn't going to be short of cash. Why spend the rest of you life as a national hate figure? I suspect he hasn't come to terms yet with the fact that he was a failure at RBS, and handing the money back would, in effect, be conceding that.