The History of the Greek Crisis

I've done a piece of History Today about the Greek debt crisis. You can read it here.

Invest in Stable Democracies....

In my MarketWatch column this week, I've been arguing you should invest in stable democracies - there are more of them all the time. You can read it here.

The IMF Isn't Worth Any More Money

On RealClearMarkets this week I've argued that the IMF shouldn't be given any more money. You can read the piece here.

Sterling Will Fall Again....

I've made my debut as a Huffington Post blogger this week with a post on sterling. You can read it here....

France Will Be the Next Eurozone Victim

In my Money Week column this week, I argue that France may be the next country to fall to the euro crisis. Here is a taster.


The euro debt crisis increasingly resembles a teen horror movie. As soon as you think it is all over, the monster springs back to life. There is an unlimited number of sequels. And it usually ends up with a bloodbath.
This week it was the turn of Italy to be in the spotlight. The country’s bond yields started to spike upwards, a serious issue for a nation that has vast debts to pay the interest on. After flying under the radar for much of the crisis, the Italian debt market looks close to unravelling. Spain is coming under increasing scrutiny as well. It might well be next.
But in fact the markets are looking in the wrong place. True, there is plenty to worry about in both Italy and Spain. But the real testing ground for the euro is going to be their northern neighbour, France. It too is struggling to stay in the euro – and it, far more than Italy or Spain, has the potential to trigger a financial meltdown. France matters to the global financial markets far more than any of the other euro countries in trouble.
Monetary union was, of course, largely a French idea. The country’s industrial and financial establishment had long been unhappy with floating exchange rates. As one of the major exporters within the European Union, they could see that constantly shifting currencies made life very difficult for their companies. While Germany primarily exports to the rest of the world, France is a euro-zone manufacturing hub. A fixed currency system was very much in its interests. Indeed, one interpretation of the creation of the euro was that it was a deal between the French and the Germans: the Germans accepted merging their currency with France’s in exchange for French support for the re-unification of Germany after the fall of the Berlin Wall. It is ironic, therefore, that it isn’t working out the way France planned.
Could France seriously have a problem staying in the euro? After all, it is a big, successful economy. It is not a peripheral nation like Greece or Portugal, neither of which ever really industrialised, or a chronically financially chaotic country like Italy. Then again, Ireland was a successful, wealthy economy, and that didn’t stop the country going bust as a result of monetary union.
In reality, France is steadily losing competitiveness within the euro. That was confirmed last week with the latest trade data, which showed a widening deficit. The April trade gap rose to 7.42 billion euros. The UK, by contrast ran a deficit of £2.8 billion or 3.1 billion euros in April. The French deficit now amounts to 3% of GDP, and has been hitting fresh records month-by-month. France’s trade deficit with Germany, its main trading partner, is now one billion euros a month. “Within euroland, France is losing competitiveness to Germany, and it has no option for devaluation to help itself out,” noted Hi-Frequency Economics in an analysis of the figures. “A potential rift between France and Germany on trade would be a far more serious challenge to EMU’s political fabric than a disagreement over how to restructure loans to euroland’s second-smallest economy [Greece].”
Indeed so. There is no great mystery about what is happening. French wages have been rising at a faster rate than German wages, and their productivity is not as good. The country is steadily becoming a less attractive place to make things.
The important point is that persistent and rising trade deficits are clear evidence that France is struggling within the single currency in precisely the same way as the Greeks – it’s the same explosion, just with a much longer fuse. As it runs bigger and bigger deficits, the money will have to be re-cycled through the banking system. Eventually that will lead to a financial crisis.
It may happen sooner than anyone thinks. While a country such as Italy has a greater stock of out-standing debt, France is racking up new debts at a far faster rate. Last year it ran a deficit of 7% of GDP. French debt will total 90% of GDP this year and 95% in 2012 according to estimates by Capital Economics. That isn’t exactly running out of control – but it is getting very close.
There are other problems on the horizon. A Presidential election is due next year. That may turn into a competition for who can make the most extravagant promises. And the far-right National Front leader Marine Le Pen is pledged to bring back the franc. If she continues to do well in the polls, then pulling out of the euro will be on the agenda. That is not true of any other euro area country, not even Greece.
At any point, the bond markets may well take fright. They will start pricing in the possibility of France pulling out of the euro, or defaulting on some of its debt. Yields on French debt will start to spike upwards. And that will be the point at which the crisis turns scary.
While Greece, Portugal and Ireland don’t matter very much to the global capital markets, France does. In fact, it matters much more than Italy and Spain. It has $1.7 trillion of outstanding public debt, making it the fourth largest debtor in the world, according to data from the Bank for International Settlements. (The US, Japan and Italy are ahead of it). That debt is widely traded – 37% of French debt is held internationally, which is a lot more than Italy (24%), the US (19%) or Japan (1%), again on BIS figures. In truth, French bonds are held by institutions right around the world and have always been regarded as rock solid.
On current trends, that will have to change. France can no more survive in the euro-zone than Italy or Spain can. At some point, the bond markets are going to wake up to the problems in France. They are going to get very nervous about French debt, the same way they did about Greek and Portuguese and Spanish debt. They will start marking down the bonds, and factoring in potential default. But if that happens the losses to the financial system will be very nasty indeed. The euro was created in France. It may well be in France that it starts to finally unravel as well.

The British Monetary Union Isn't Working Either....

In my Money Week column this week, I've been looking at the the UK as a monetary union, like the euro....and concluding that doesn't work either. Here's a taster.


What does the euro need to make it work better? The most common answer is that it needs to be turned into a fiscal union, with large-scale transfers from the richer regions to the poorer. It is the conventional wisdom of every editorial, and City pundit. Until it becomes a ‘transfer union’ it doesn’t stand a chance of succeeding.
A caveat or two is usually thrown in. The political obstacles are formidable. The Germans might never agree to their taxes being sent to bail-out Greece or Portugal. The treaties might need to be re-written, and that would require the agreement of all the European Union’s members. Still, if only those obstacles could be overcome, a fiscal union would smooth out most of the problems.
The trouble is, no one seems to have stepped back and questioned the fundamental assumption. The evidence suggests it may well be wrong. Europe has another monetary union between countries at very different stages of economic development. It is called the UK, and the currency is sterling. Reverse the polarities – the UK has a rich south, and a poor north, rather than a rich north and a struggling south – and the sterling area has many similarities to the euro area. It is made up of group of countries with very different levels of prosperity. And it has huge transfers between the richer regions and the poorer.
And the result? It doesn’t do any good at all. True, it holds the currency area together. But it only does so at the cost of creating regions that are ever more dependent on state aid. The truth is, a transfer union won’t save the euro even if it was politically feasible. Nothing will. The project is doomed.
That doesn’t stop people from trying, The most common critique of the single currency is that is an economic union without a political union. George Soros has argued for a year that without a single government the currency won’t survive. The President of the European Central Bank Jean-Claude Trichet has called for a European finance ministry.
The UK’s experience, however, suggests that even if it happened, it wouldn’t work. Britain used to be a fairly homogenous economy, with wealth relatively evenly spread out across its major industrial centres, much as it is in modern Germany. Not any more. Post-industrial Britain has a very, very prosperous capital, surrounded by equally wealthy suburbs. The Midlands and East are doing fine. The rest of the country has been falling behind at an increasingly rapid rate. The result is that there are huge disparities between output per head in the South and Wales, Scotland and Northern Ireland. It isn’t quite as dramatic as the gulf between Germany and Greece – but it isn’t that far off.
That gets fixed by fiscal transfers. The UK, which has of course a single government, and single finance ministry, shuttles large sums of money from the richer regions to the poorer. Oxford Economics, the consultancy firm, has calculated the amount the British government spends per person employed – per taxpayer, in other words - for the different parts of the country. In the prosperous South-East, the government spent £14,100 per working person. In Northern Ireland, it spent £21,200. Wales, Scotland and the North-East were all way above average. The East, East Midlands, and London were all below average – although London, which has pockets of real poverty amidst its wealth, not by as much as you might think. It also looked at expenditure relative to gross value added, that is the actual output of the region. Taking the average for the UK as 100, Northern Ireland scored 155 and the South-East just 84. In other words, a lot of the wealth from the South-East gets sent to the ‘periphery’.
The UK is, therefore, a monetary union with very significant transfers between its richer and poorer regions. The trouble for the euro’s would-be fiscal unifiers is that there is very little evidence that it fixes the problem. Northern Ireland for example has had a consistently lower growth rate than the UK as a whole – this year, it will grow by 1.1% compared with 1.7% for the UK according to estimates by Northern Bank. Much the same is true of Wales and the North-East. The regions with the biggest fiscal transfers have grown consistently more slowly than the rest of the UK, with the result that the ratio of state spending relative to their local economies has grown steadily over time. Between 1999 and 2010 state spending rose from 50% of the Welsh economy to 69%, according to calculations by the Centre for Economics and Business Research.
Fiscal transfers can hold a monetary union together. There is no sign of the sterling area breaking up, although the Scots might eventually decide to go their own way. But they won’t close the gap between the richer regions and their poorer neighbours. They are a permanent subsidy – and one that will probably grow over time.
If anything, the fiscal transfers probably make the problem worse. They crowd out private investment – after all, why would anyone in Northern Ireland set up a business when they are relatively few industries where it has much strength, and when they could just get on a plane to London, or else get a secure job in the public sector? It creates whole regions where the fiscal transfers are the only thing that keeps the economy afloat.
That just about works in the UK. It has been a unified state for several hundred years, and has close ties of language, culture and family between its regions – although it remains to be seen whether the Tory voters of the south-east will accept the deal forever. But it is very hard to see it working for the euro zone. Voters in Munich and Eindhoven already seem outraged by paying for the Greeks and Portuguese. When they get told that the transfers are permanent, and will rise steadily over time, they will surely refuse to pay. The scary truth is that even the one plausibly fix for the euro crisis doesn’t work.

How The Euro Will End....

How will the euro actually come apart. I've been exploring that in my Market Watch column this week. You can read it here.

Greece Isn't Lehman Brothers. It is Worse Than That...

In my Money Week column this week, I've been writing about why Greece is even worse for the markets than Lehman Brothers. Here's a taster....


If the Greeks had a euro for every City analyst and financial reporter who has solemnly warned that the country’s debt crisis risks being ‘another Lehman moment’ for the financial markets, their economy would probably be in far better shape than it is. It has become the most over-used cliché of the last few weeks – and like every tired cliché, simply shows that the people using it have stopped thinking clearly for themselves.
In truth, the Greek crisis is nothing like the Lehman collapse. It is far worse than that. Lehman was a short, sharp shock for the global markets, and although it caused massive damage to the global economy, it was over relatively quickly.
The sovereign debt crisis, by contrast, is going to be a long, drawn-out and messy affair, with no clean resolution. It will depress investment, economic output and equity market for years to come.
Over the course of the last week, the Greek crisis has prompted a global sell- off in every kind of asset – and rightly so. The government of the beleaguered Greek premier George Papandreou looks on its last legs. The Germans have been wrangling with the European Central Bank over the terms of a fresh bail-out. Protestors have been marching across Greece, fighting yet more austerity. There were certainly reasons to fear that Greece might be forced into a sudden default – and that would pose huge risks for the European banking system. Greek debt is hidden on balance sheets right across the financial system. No one really knows where the losses will come out.
Even so, it is nothing like Lehman Brothers. When the Wall Street investment bank collapsed in 2008, the US Treasury and the Federal Reserve had no real idea it would pose a systemic risk to the financial system. If they had, they wouldn’t have let it go down. They would have stepped in to rescue it instead. The crisis it provoked was largely unexpected.
That isn’t true of Greece. Germany’s Chancellor Angela Merkel and France’s President Nicolas Sarkozy are well aware of the threat a Greek collapse poses to the financial system. They aren’t going to let it happen until their experts have reassured them their banks can survive. After all, they aren’t stupid. They are not going to let their financial system blow up. If they have to find a few more tens of billions of euros to prop up their wayward southern neighbour for another year they will. It’s better than the alternative.
There isn’t going to be a sudden collapse. The risks are all flagged up, and everyone will work hard to avoid them.
The trouble is, Greece is just the tip of a much larger iceberg. The sovereign debt crisis is going to depress economies, deter investment, and keep a lid on assets prices for a long time yet.
Greece has been running massive budget deficits for years. So have most of the other peripheral countries, such as Portugal, Ireland, Spain and Ireland. France shows very little sign of getting its deficit under control. Neither does the US. The UK is making some progress, but lower than expected growth means we are unlikely to meet our targets. The sovereign debt crisis is not just a Greek issue. It is hitting most of the developed world.
That is going to impact the markets in three ways.
First, it is going to depress economic growth. There is only one real way to bring deficits under control, and that is to make deep and painful cuts in government spending. Nothing else works. But as governments everywhere scale back on their expenditure, growth is going to be hit. Over the medium-term, a smaller state allows the private sector to grow faster. It is a mistake to fall for the simplistic Keynesian mistake of thinking state borrowing and spending promotes growth. It doesn’t. Cuts allow the economy to grow faster – eventually. But it takes time for that to happen. And in the medium-term, the economy will be more sluggish than it otherwise would be.
Next, the debt crisis is going to deter investment. Who would want to build a new factory or sales office in any of the peripheral euro-zone countries right now? You have no idea what the economies will look like, or even what currencies they might be using in three or four years time. You are likely to face years of grinding austerity programmes as governments struggle to stay in the euro. And yet investment is the lifeblood of economic growth. If companies don’t invest, then economies are not going to be able to grow.
Finally, it is going to depress asset prices. For all the reasons outlined above, the debt crisis is going to slow global growth. That is bad for just about every class of asset, from equities, to bonds, to commodities (although probably not for gold, which is usually the one clear beneficiary of a monetary crisis). Clearly enough, that is going to depress the markets as well. But it is also means investors are going to be very cautious. The constant threat of defaults, the worries that it will lead to a fresh banking crisis, and the nervousness over which country is likely to be targeted next, will all make any kind of bull market very hard to sustain. And the lower asset prices are, the lower growth will be as well.
In many ways, we’d be better off with a Lehman moment. A quick, sharp crisis that ended with Greece defaulting on its debt, re-establishing its own currency, and one or two over-exposed banks being bailed out, would be better than a saga that drags on for years with no clear resolution. But it isn’t going to happen. The global economy suffered from the Lehman collapse – but was able to start recovering the following year. Unfortunately, this crisis will take far longer to resolve.

The Greek Default

In my MarketWatch column this week, I've been looking at what will happen to the markets if Greece defaults. You can read it here.

The Decline of the IPO....

In my Money Week column this week I've been looking at the decline of the IPO. Here's a taster...


The City, just like every other tight-knit profession, observes its own omerta: an unwritten code that whatever arguments may break out within the community, you don’t make them public. So when major institutions start falling out with each other in a very public way, it is time to take notice.
Last week, the fund manager BlackRock launched a biting attack on the way IPO’s were handled. The fees, they complained, were outrageous. The bankers were actively deterring new companies from coming to the market.
The point was a good one – and long overdue.
The number of new companies listing has been declining for years. But raising money for new companies is the fundamental purpose of a stock market - if it doesn't do that, it is really just a casino. What the IPO market needs is new banks that get it right - because the existing players have clearly forgotten what a stockmarket is actually for.
In a letter sent last week, Luke Chappell and James Macpherson, two of BlackRock’s most senior UK executives, laid into the banks arranging new listings with both barrels of a metaphorical shotgun. “It is in all of our interests for London to remain at the centre of a thriving capital market,” they wrote. “We are always keen to invest in companies that need equity to develop their businesses, particularly in opportunities that we are currently unable to access. However, recent developments in the IPO market have, at times, been frustrating.”
Specifically, they accused the banks of being too aggressive on price, demanding fees that were way to high, and not allowing fund managers enough time to get to know a business before they invest in it.
Given that BlackRock, with assets under management of more than £2 billion, is the single largest investor in the UK stock market, its complaints will have carried plenty of weight.
And the record of recent IPOs suggests they are onto something. Glencore, a mega-IPO that because of its size was always going to vault straight into the upper reaches of the FTSE-100 index, managed to get its IPO away, but the shares immediately sank below the issue price. Betfair, the online betting company that staged one of the biggest IPOs of last year, jumped to a premium on its first few days of trading, but is now well below its issue price. Other new issues have had to be pulled because the demand for the shares just wasn’t there.
That matters. When fund managers buy into an IPO they want to see the share price going up steadily for at least a couple of years. Everyone understands that the prospects for a company can change. But if the idea becomes fixed in investors minds that IPO prices are unreasonably hyped-up, and whoever gets suckered into buying into them is going to end up losing money, then it won’t be any great surprise if they increasingly steer clear of new issues.
The figures suggest that is already happening. The numbers of new companies joining the stock market is, as a percentage of the economy, declining all the time. According to the World Federation of Exchanges, the number of quoted companies has been roughly static – at around 45,000 businesses globally – since 2005. In the Americas, it is going down, whilst in Europe it is only going up fractionally (0.1% over five years). Since the world economy has been expanding at around 4% a year, apart from the recession of 2009, you would expect the number of quoted companies to be growing at 4% to 5% annually. But it’s not. Some high-profile names aren’t even bothering with the hassle of a quotation. Facebook, for example, chose to sell shares privately, rather than go to the bother of an IPO.
So, overall, the number of listed companies is going down, or standing still. And yet the number of trades has roughly doubled in this period. So investors are, in effect, trading less and less ever more frantically.
That is hardly a happy situation for the long-term health of a market.
First, new companies are the lifeblood of any bourse. Young companies are where the real growth is going to come from. If they can’t be bothered to join the stock market, or they find the process too expensive, then the main indices are just going to become a collection of older and older businesses. They won’t be able to grow as fast as the economy – and eventually investors will have to find some other way to buy into corporate growth.
Next, raising capital for companies is what a stock market exists for. It is why they were created in the first place – to allow new business to raise money on a scale they could never hope to get hold of whilst remaining private. If they don’t do that, then they really are, as their critics maintain, just casino tables without the bight lights and cocktails. Without any real purpose, nobody should be surprised if they get regulated out of existence.
The core problem is that the investment banks have forgotten how to build and maintain long-term relationships, both with the companies they bring to the market, and the investors that buy shares in them.
Two changes need to be made. First, the sponsoring bank should take a lot more time getting to know the businesses they are bringing to the market, understanding the medium-term prospects of each one, and figuring out how to price it accordingly. Ideally, the shares would deliver a steady 10-15% a year for at least three years after the IPO. Investors would then feel reasonably confident the IPO was worth supporting.
Perhaps the main investment banks don’t want to do that. They may have become so immersed in a short-term, quick profits culture that they no longer find it possible to build relationships over five years. If so, new players should emerge to take their place – because if they don’t, eventually equity markets are going to fade away.

To Be A Better Trader, Try Being Happier.

In my Money Week column this week, I'm looking at how you can become a better trader - just by being happier. Here's a taster.


What makes a successful trader or fund manager? An all-encompassing view of how the global economy is developing? An instinct for a bargain? A fleetness of foot, and the confidence to take bold positions? A willingness to ignore the herd, and buy the stuff everyone else is selling? Or the patience and perseverance of a tortoise?
They are all perfectly reasonable suggestions, and there are many great traders and investors who have made fortunes through one or other of qualities.
But actually the answer may be a lot simpler.
Just try being a bit happier.
According to research released this month by the French business school Insead, the happier people are, the better they are at predicting the future – and the more depressed they are, the worse they are.
The implication is clear, both for banks and fund managers. Just make sure your traders and stock-pickers are cheerful and positive, and their performance will improve. The trouble is, however, they are caught in a classic Catch-22. Everything about the way most people in the financial markets work is guaranteed to make them miserable – and therefore to make them worse at their jobs.
The Insead research provided a fascinating insight into what makes people good at predicting future events – and what makes them bad at it as well. It has long been noted that more cheerful people tend to have a more optimistic view of the future, whilst the more miserable, not very surprisingly, are usually more pessimistic. In the markets, the optimists are usually bulls, while the pessimists are bears.
The Insead study went a lot deeper than that. It took 1,100 people, and asked them to predict the results of games during the 2010 World Cup. They weren’t particularly being optimistic or pessimistic – they weren’t making predictions for their own nations - they were just forecasting what was likely to happen. As an incentive to try and get it right, there was a cash prize for getting it right.
Interestingly, the more depressed the people were, the less likely they were to make accurate predictions. Indeed, many of the most down in the dumps did worse than they would have done just by picking winners from a hat. And they were significantly more likely to make ridiculous predictions, such as forecasting that North Korea would win the whole tournament.
The Insead team is now taking the same methods, and applying then directly to the emotional states of stock and commodity traders. But the implications are already clear enough. If being happy or depressed has a bearing on your ability to forecast the outcome of events, then it follows that happier fund managers or traders will be better at their jobs than their more morose colleagues.
The snag is, how do you influence the happiness of your staff?
Well, in truth, it isn’t that hard.
We have a fairly good understanding of what makes people feel good about life, and what make them depressed. Most of the key points were summarised by the ‘Action for Happiness’ campaign launched earlier this month by Professor Richard Layard, the guru of happiness economics, among others.
Happiness, it turns out, comes down to a few fairly simple things. Do things for other people. Take care of your body. Notice the world around you. Keep learning new things. Be part of something bigger. Have goals to look forward to. They may sound fairly like being in favour of motherhood and apple pie, yet, despite sounding platitudinous, they are certainly likely to make people more balanced and positive, and significantly less likely to suffer bouts of depression.
Here’s the catch, however.
They are not the kind of values promoted within the average bank or fund management firm.
If anything, the financial markets do precisely the opposite of what is likely to make people happy.
They concentrate on paying out huge cash bonuses, usually tied to demanding performance criteria, even though there is very little evidence to suggest that beyond a certain minimum level having more money actually makes people any happier.
They promote a ruthless competition between staff, and between companies, constantly benchmarking their performance against their peers. In fund management, for example, you have failed if you haven’t managed to beat the guy doing the same job at the next fund, even though you may have made plenty of money for your investors. And yet that is only likely to make their staff feel anxious and insecure.
And they promote a relentless short-termism, continually shortening the time to come up with results, even though it is usually far better to concentrate on medium-term performance, and more satisfying for the staff as well.
In short, if they were deliberately setting out to make their traders and stock-pickers depressed, it is hard to see how they could be doing a better job.
But, of course, the more depressed their staff are, the worse they will be at their jobs. In fact, it is a classic Catch-22. To trade well, you have to be happy, but everything about the work is likely to make you depressed, so you’ll end up being a very bad trader – the kind of person who thinks North Korea will win the World Cup, or that oil will be trading back at $20 a barrel by the end of next year.
Is there a way out of that? Perhaps.
Maybe investors should stop looking at all those charts that banks and fund managers love to produce showing how they out-performed their peers over the last there months. And maybe they should stop listening to all those boastful adverts about how the pay of staff is linked to performance.
Instead, just ask if the traders and stock-pickers are cheerful, feeling good about themselves, and are well looked after. Who knows, over the medium-term it might even produce better results.

London's Great Economic Escape....

In my Money Week column last week, I looked at how London escaped the recession, and what lessons we should learn from that. Here's a taster.

The classic 1960s war film ‘The Great Escape’ was based on the break-out of a group of Allied prisoners from a camp in the town of Zagen, in what was then Germany but is now Poland. But if you wanted to re-make it, with a financial rather than military escape, you’d probably set it in London.
At the height of the credit crunch, everyone was forecasting that London’s economy was doomed. The City, and the ancillary industries that fed off it, would come crashing down to earth. The rich would flee, and the bankers would soon be applying for jobs at MacDonald’s.
It hasn’t happened. The financial services sector has recovered sharply. London has emerged from the recession in better shape than the rest of Britain. Employment is stronger, growth is better, and house prices have bounced back. If anything the gulf between London and rest of the UK has grown wider.
There are important lessons in that. If the rest of the British economy was anything like as strong as London and the South-East, the whole country would be roaring ahead. Instead of talking about re-balancing the UK economy, we should be learning the lessons of London’s success, and trying to get the rest of the country to perform as well as it does.
The figures make it quite clear that, of all the regions in the UK, London and the South-East, have emerged best from the downturn. A CBI report released on Monday showed that financial services firms expanded strongly in the latest quarter. The big banks such as HSBC and Barclays are making huge profits again, and the City is doing well. A study by the London School of Economics, led by Henry Overman, the director of its Spatial Economics Research Centre, concluded that London had comes back stronger from the recession than any other region, and it suffered less in the downturn as well.
For example, London’s income per capita fell by 2.5% between 2008 and 2009, while it fell by 2.9% in England as a whole – and of course London was already a lot richer before the recession began. There were fewer job losses as well. The UK saw peak-to-trough falls in employment of 3.9%, whereas London saw only a 2.6% fall. And house prices bounced back quicker than anywhere else in the country. Indeed, Savills reports that prime London properties grew in value by 5% this year, whilst prices were still stagnant or falling in the rest of the country.
True, London benefited a little from government policy. The Olympics is a massive building project. The bail-out of the banks primarily helped the London economy rather than anywhere else. Against that, the massive run up in government spending did nothing for London. The South-East has far lower government spending as a percentage of the economy than other regions: in Wales for example, state spending accounts for more than 70% of the economy, whereas in the South-East it is around half that, at an estimated 36%. And of course London is harder hit by the tax rises than other parts of Britain – the new 50% rate will hit a lot of Londoners but not many people elsewhere.
In fact, the evidence of the recession is that London and the South-East have a hyper-resilient, hugely competitive economy. What we need to do is try and make the rest of Britain more like London.
There are four important lessons from the capital’s success.
First, and most obviously, London is plugged into the global economy far more than any other part of the UK economy. What happens to the rest of Britain or indeed Europe doesn’t matter that much. London’s bankers, lawyers, consultants and accountants are servicing the BRIC economies more than anything else. Russian and Far Eastern companies are flocking to raise capital on London’s markets, and that means paying lots of expensive fees. London had connected itself into booming markets – not locked itself into declining ones.
Next, London has specialised in professional services, and made itself a world-leader in selling those to the rest of the world. There is a lot of talk about reviving specialist manufacturing or creating other new industries for the UK. But the truth is, we don’t have many sectors where we can compete with Germany on quality, nor where we can compete with Eastern Europe on manufacturing costs. Maybe the best policy would be to recognize where our strengths lie – and get the rest of the country to try and do more of the things that London does so well.
Thirdly, London has a highly-skilled and hyper-flexible labour market. According to the Labour Force Survey, for England as a whole, professional and service occupations were hit less badly by the recession than administrative, trade and basic occupations. That was good for London, since professional occupations account for a larger proportion of its labour force – nearly 50%, compared with under 40% in the Midlands and the North. There was more flexibility on wages as well, partly because bonuses (which go down as well as up) are a bigger part of pay. That helped London’s workers keep their jobs through the downturn.
Finally, the state accounts for a far lower share of the London and South-East economy than it does for the rest of the country. Working for the government may be relatively secure during a recession, and that provides some protection for the regions. But the state sector also has low productivity, low growth, and it doesn’t export anything. It consumes rather than generates wealth – and it is only in London and South-East that it is small enough to allow the rest of the economy to flourish.
Forget everything you read a couple of years ago about how this would be a middle-class recession that hit London harder than anywhere else. It just hasn’t happened. Instead, London is pulling further ahead – and as the government spending cuts start to bite, that will become more and more obvious. But there is nothing that special about London. It is part of the same country as Manchester and Cardiff and Birmingham. If those regions could learn where the capital was doing so well, the UK would be doing a lot better than it is.

Why Investors Should Prefer Democracies...

In my Money Week column this week, I've been looking at why investors should prefer democracies to autocracies. Here's a taster....

For anyone investing in the Middle Eastern markets, the last few weeks have been a heck of a ride. The Dubai market, one of the more developed in the region, plunged all the way back to 2004 levels during the past month. The Saudi market was shakier than a palm tree in a hurricane. The Egyptian stock market closed as the country ousted its long-serving President Hosni Mubarak, and won’t re-open for another week.
Right across the world, investors have pulled back from emerging and frontier markets. The darlings of the global investment community until a few weeks ago, they are now about as popular as Colonel Qaddafi in Benghazi.
There is a lesson to be learned from that. It is far better to invest in democracies than autocracies. In the last few years, the markets have fallen for the idea that autocratic governments are more stable and more efficient. There may be some truth in that in the short-run. In the medium-term, however, a revolution will destroy your investment. In practical terms, that means avoiding China and much of the Middle East, staying suspicious of Russia, and focussing instead on India, Eastern Europe and South Africa as well.
Before the tidal wave of change swept across the Middle East investors could be forgiven for believing that the nature of the regime didn’t make much difference to the case for putting money into a country. True, the people in charge of a country might be a shady bunch of gangsters and thugs, but so long as oil was being pumped, minerals dug out of the ground, and new factories getting built, it didn’t matter very much.
Emerging and frontier markets have been booming for the last ten years, pretty much regardless of whether the government in question was stable or not. According to calculations by IJ Partners, the Pakistani market rose by 449% in the last decade, measured in dollar terms. The Egyptian market rose by 430% over the same period. That was a better performance than gold or oil, and way better than traditional stock markets. The FTSE-100 was only up by only 12% over the same period and the S&P 500 by just 2%. And yet Pakistan is widely regarded as a failed state. And the Egyptian government has just collapsed.
The premium that investors used to demand to invest in emerging markets all but disappeared over the 2000s. We all know the reasons for that. Growth has largely ground to a halt in the developed economies. It was only by taking on more and more debt that the illusion of prosperity was maintained. The frontier markets offered far better prospects. They were growing fast, they had healthy demographics, and usually high savings ratios and low deficits as well. They looked a far more attractive home for your money.
But investors forgot the one thing that in the past kept them out of emerging markets – political risk. After all the 400%-plus gains you might make in a market such as Egypt don’t count for much if the bourse then gets shut down, and a new revolutionary government seizes foreign assets. You can only invest where there are secure property rights – and that ultimately depends on a stable government.
That lesson is being re-learnt very quickly. Globally, investors poured $95 billion into emerging markets funds during 2010. In the first week of February alone, as the Middle East crisis broke, they pulled more than $7 billion of that back, the biggest withdrawal in more than three years. Where once investors were piling indiscriminately into new territories, now they are abandoning them just as rapidly.
Neither is the right response.
What investors need to do is discriminate between stable and unstable emerging markets – and remember that in the medium-term it is only democracies that offer security.
There is a temptation to look at an autocracy and think it is rock solid. After all, a leader such as Mubarak hung around in power for three decades. Dictators are usually pro-business and anti-union. There is none of the messy business of populist politicians demanding tax rises, or threatening to take control of foreign investments.
But it is an illusion. Under the surface, terrible tensions are always building up. When they break to the surface, there is violence and chaos. A very radical, anti-capitalist regime can easily emerge.
It is far better to focus on the democracies – and avoid the remaining autocracies. True, the democracies might appear messier. But so long as there is a commitment to free speech, fair elections, and property is protected, over the medium-term they are far more stable. It is very rare for a democracy to be thrown out by a revolution – and it is very rare for an autocracy not to be.
So, be wary of China. True, it has great growth prospects. But it is still ruled by an authoritarian Communist Party that shows little sign of relaxing its grip on power. There are tensions between regions that are growing at very different rates. The whole of the Middle East looks off-limits as well. States such as Saudi Arabia and Dubai will face their own revolutions in time, no matter how wealthy they might appear to be. And stay suspicious of Russia. It is slowing slipping from democracy back towards autocracy, and that will make it less stable in the medium-term.
Against that, India has been a remarkably successful democracy for a very long time, particularly considering its size and relative backwardness. Brazil is a reasonably free country and so are South Africa and Turkey. Nearly all of Eastern Europe, although its markets have not shone in the past couple of years, is far more democratic than anywhere in the Middle or Far East.
There will be bumps along the way, and elections that hit the markets. But over the medium-term, it is only countries that have already created functioning democracies that offer any chance of decent returns.

A Letter to Mervyn King....

In my Money Week column this week, I've drafted the letter that George Osborne should send to Mervyn King next time the Bank misses its inflation target. Here's a taster....

British economic life has acquired a new ritual. Every three months the Governor of the Bank of England writes a letter to the Chancellor of the Exchequer explaining why he has had missed the inflation target. And, on the same day, the Chancellor responds with an anodyne, sympathetic reply, accepting the Governor’s excuses without so much as a word of criticism.
We saw it played out this month. No doubt we’ll see it a couple more times before the year is out. The Bank has given up on hitting its 2% inflation target. With prices rises at 4% a year on the official figures, and significantly more on the kinds of things that people actually notice they are spending money on, there is little chance of getting back within range soon.
But, in any normal business, if you gave up on hitting the target your employer set for you, you’d expect a monstering. Next time around, George Osborne should rip up the rule-book. He should write Mervyn King a proper letter. Here’s what it should say.
“Dear Mervyn,
Thank you for your letter.
I am disappointed that inflation has yet again significantly exceeded the target set for the Bank of England by the government. I should remind you that meeting this target is a legal requirement. I accept that a target won’t be met every month. That is why some flexibility is allowed. But I am worried that you are not really trying.
I am frankly puzzled by some of the arguments put forward in your letter
I believe there must be something wrong with the forecasting model the Bank of England is using. In the letters sent both to me, and to my predecessor Mr. Darling, you have been consistently predicting that inflation will fall. For example, in your letter of May 17th last year, you argued that the rise in VAT and the drop in the value of sterling were the main reasons why you’d missed the target. “The effects on inflation can be expected to wane over time,” you stated. “As this happens, the MPC expects that inflation will fall back.”
It didn’t happen, did it? In fact, inflation has accelerated since then. If a model keeps producing the wrong forecasts, then it is time to get a new model. I would like you to ask the Bank’s economists to start working on that – and stop sending me wrong predictions.
As for your ‘explanations’, they sound more like excuses. Stop going on about the ‘output gap’. This is intellectual nonsense, and it is time you realised it. The idea that the Bank knows precisely what the ‘right’ level of output for the British economy is, and how much we are currently below it, is the kind of thing that even the Gosplan economists in Moscow in 1970 might have considered a little arrogant. In reality, we have no precise idea what the UK can produce, or how far below that we might be right now – and certainly not to within a couple of percentage points. This so-called ‘output gap’ doesn’t exist. It clearly isn’t bearing down on inflation in any meaningful way. So stop talking about it.
Next, stop blaming imported inflation. True, commodity prices are going up around that world – mainly because your friend Ben Bernanke over in Washington is running the Fed in the same incompetent way you are running the Bank. Of course global inflation impacts us here in Britain. But it is mediated through the exchange rate. If sterling was stronger, then the rising price of oil wouldn’t make any difference to the amount ordinary people have to pay at the pumps. Nor would the price of food or clothing be going up the way it is.
The Bank can certainly influence the exchange rate. Higher interest rates would strengthen sterling, and so change the inflation outlook. If you pledged that there would be no more QE, that too would help the pound. Both together would make sure we weren’t importing inflation anymore.
Finally, I would like you to read more widely. You used to be an academic economist (indeed you were one of the 364 economists who famously attacked another new Conservative Chancellor in 1981). You must be aware that there is plenty of economic theory to suggest that running negative real interests of 3.5% and printing money by the barrow load is a sure way to create inflation. Please re-acquaint yourself with the literature. In your next letter I’d like you to explain why the Bank’s policies of ultra-low interest rates and quantitative easing are not responsible for the inflation we are seeing now.
Most of all, I am worried by the air of defeatism that seems to have overcome you. Never believe that inflation is outside your control, or that it is an acceptable way of working our way out of our debts. In the inflationary 1970s, and early 1980s, when prices around the world were soaring ahead, and the price of oil more than quadrupled, one country never experienced any significant inflation. Germany. Even through the worst of the 1970s, the Bundesbank managed to keep the average German inflation rate at just 4.9% a year. In the 1980s, the average rate was just 2.1%. Please explain why the Bundesbank was able to achieve that in far more difficult global circumstance and the Bank of England can’t.
I am prepared to give you one more chance. But the Governor of the Bank of England can’t expect to be the only person in the country who is not judged by their results. Inflation makes life hard for ordinary people. Real wages are already falling. Families are struggling to make ends meet. The Bank is close to the point of losing credibility. Once that happens, there is a real risk of interest rates having to rise very sharply to bring prices under control again.
Your next letter should be your last. If you can’t find a way of getting the inflation rate back within the target, then I’m sure you will accept that it is time we found someone who can.
With best wishes,
George.”

Ed Balls Will Be A Disaster

In my Money Week column thios week, I've been writing about why Ed Balls will be a disaster as Shadow Chancellor. Here's a taster....

Almost alone among an anodyne generation of British politicians, Ed Balls has the ability to divide opinion. When the Labour Leader Ed Milliband appointed him as Shadow Chancellor last week plenty of people saw him as too addicted to back-stabbing and briefing to ever make an effective team player. But most praised his economic expertise, and concluded his combative approach would make life a lot harder for the Conservative-Liberal Democrat coalition.
In fact, that consensus is upside-down. Balls’s aggression, and his ability to make the life hard for his rivals, are his strengths. His weakness is his shaky grasp of economics. He’s got just about every major call on the economy wrong. And he has made himself the leading exponent of a crass version of Keynesianism that is going to end making him look absurd.
By constantly making the wrong predictions, and attacking the government for quite sensibly policies, Balls will ruin his party’s credibility. He will make the re-election of the coalition in 2015 far easier.
As it happens, Balls’s record provides plenty of ammunition for his opponents. He was the key economic adviser to Gordon Brown during his ten years as Chancellor. He boastfully claims authorship for many of his former boss’s policies, even though most of them later turned out to be catastrophic. It isn’t going to be hard to pin his past on him.
The new system of financial regulation put in place after 1997 led to the worst string of bank collapses for more than a century. The decision to run-up a vast budget deficit even while the economy was booming looks to have been a costly mistake. The housing market was allowed to run riot, mortgage lending spiralled out of control, and the trade deficit reach new heights. It wasn’t much of an economic record.
Balls points to the independence of the Bank of England and keeping Britain out of the euro as achievements. But, at the very least, these are questionable. The Bank has not done a great job of managing the UK economy. First it gave us the housing boom, now it is giving us rampant inflation. What’s so great about that? As for the euro, the Labour government could never have signed up to it without a referendum, which would have been decisively lost, so that was hardly a personal victory for Balls. It’s like claiming credit for stopping an invasion by Martians. Since it was never going to happen, it’s not much of a deal.
But electorates aren’t much interested in history.
Right now, and for the next five years, Balls is relentlessly pushing the line that the cuts are too fast, and will push the economy back into recession. Much of the media has fallen for this line as well. If you listen to the news, you’ll constantly hear that reducing the deficit may derail the recovery.
It is, however, complete nonsense.
The latest economic research suggests that, contrary to what we kept being told, deficit reduction leads to faster economic growth. And the governments that cut spending tended to be rewarded with re-election.
Take a look at the work of Harvard’s Alberto Alesina, for example. “The conventional wisdom about the political economy of fiscal adjustments goes more or less as follows,” he wrote in a paper for Ecofin last year. “Deficit reduction policies cause recessions which create political problems for incumbent governments. The latter therefore see fiscal adjustments as the kiss of death.” That’s very much how Balls sees it. The cuts will cause a recession, and a backlash against the coalition. “Fortunately the accumulated evidence paints a different picture,” continues Alesina. “First of all, not all fiscal adjustments cause recessions. Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run….Second and this is most likely a consequence of the first point, it is far from automatic that governments which have reduced deficits have been routinely not reappointed.”
Indeed so. In fact, cutting the deficit doesn’t lead to a recession. It more often leads to a period of rapid growth. That was true in this country in the early to mid-1990s, when big cuts in spending led to sustained recovery. It was true of Sweden and Canada in the 1990s as well. Alesina’s study looks at 107 examples of fiscal consolidation, defined as cutting the deficit by 1.5% of GDP or more, within OECD countries since 1980 and found that in nearly all cases it was followed by higher growth rather than lower.
There’s no great mystery about why that is. Of course, cutting spending takes demand out of one part of the economy. But it puts it back in somewhere else, either because the government taxes less or borrows less. There’s no reason why the overall level of demand in the economy should change.
Cutting the deficit, however, helps the economy in other ways. It improves confidence, as consumers and businesses worry less about future tax rises. Real interest rates may fall as the markets grow more confident about government finances, and that stimulates investment. The stock market usually rises, increasing demand as people’s wealth rises. And, of course, since a smaller state and lower taxes are usually good for the economy, anything that makes government smaller rather than larger will help promote growth. Indeed, another key finding of the research is that not only does deficit reduction help growth. The more spending cuts are used to cut debt rather than tax rises, the higher the rate of growth that follows it will be.
The evidence is clear. Cutting the deficit makes an economy grow faster not slower. That is true of just about every other country in the last thirty years. There is no reason why it shouldn’t be true of the UK over the next four years as well.
But Balls doesn’t get it. He insists the opposite is true. A Shadow Chancellor who spends five years issuing blood-curdling warnings about the economy, none of which come true, is not going to impress the electorate very much. He’s just going make himself and his party look stupid.

Why Japan and the US Are Still in the Game....

In my Moneyweek column this week, I've been looking at how demographics changes our perception of the big economic trends. Here's a taster....

Unless you happen to be a hedge-fund manager specialising in high-velocity yak hide futures, most investors operate on long time horizons. Whether the Nikkei or the Footsie will be up or down a bit by the time spring comes around, or whether the dollar will finish the year up or down against the euro, no one really has any idea.
The best you can do is figure out what the long-term trends are, and you’re your investment decisions accordingly.
Over a twenty or thirty year view, most of us probably think we have a pretty good idea of where the world economy is going. China will rise into a position of global dominance, closely followed by the other BRIC economies of India, Brazil and Russia. Japan will continue its long slide into irrelevance. Europe is just about finished, although the mighty German export machine will keep powering ahead. The United States is in irretrievable long-term decline, sunk by debts, deficits, and imperial over-reach.
And yet the latest demographic research suggests that script is just about completely wrong. In fact, Japan is doing much better than most people think. China isn’t doing nearly as well. German strength is deceptive. The US is far better placed than you’d imagine. And, in Europe, Britain and France will be the highest-growth economies.
In the long-run, economics is basically demographics, with a few supply and demand charts thrown into the mix. A country’s GDP is determined by the number of working people, multiplied by their output. Output per worker varies depending on productivity growth, fairly obviously. But the number of workers varies as well. Partly that depends on the participation rate – that is, the numbers of people who go out and get jobs. Welfare systems make a difference to that: they can easily deter low-paid workers from looking for jobs. So do social trends: the number of women working has made a big difference to employment rates in all the developed countries.
But the number of workers depends most crucially on birth rates. Once your population goes into decline, it is very hard for your overall economy to grow. And if the population is growing, it’s hard for the economy not to.
How does that change the big global economic trends? Like this.
Forget all that stuff about Japan’s lost decade. It’s nonsense, pushed by Keynesian economics to justify printing lots of money. As Daniel Gros, the director of the Centre for European Policy Studies, has pointed out, Japan ‘never lost a decade’. When you divide GDP by the number of working age people (defined as everyone between 20 and 60) Japan did better in the last decade than the US, and better than most European counties as well. That certainly seems to chime with the evidence we can see all around us. If Japan is doing so badly, how come the roads are full of Toyotas and our houses full of Nintendo Wii’s and Sony TVs? If Japanese demand is so weak, why is unemployment only 5%, half the rate in the US and the eurozone?
In fact, Japan did as well as a wealthy, mature economy could be expected to. It would probably have done better if the Bank of Japan had listened less to academic Keynesians, and printed less money. Even so, the message is clear. Japan remains one of the most innovative, successful capitalist economies in the world – it’s just not going to show up in the GDP numbers because its population is falling.
Next, re-think China’s rise to global dominance. True, the country is rapidly industrialising. It’s a big place, and it is going to be a big player in the global economy. But how big? Right now, China is in a demographic ‘sweet spot’. The one-child policy means there aren’t many children. And past population growth means there aren’t many old people either. So in this decade China has an exceptionally high percentage of its population of working age. That is terrific for growth right now, but bad for the long-term. By 2030, China will have a greater percentage of pensioners to look after than the US. That is going to act a big drag on economic growth. And there won’t be much anyone can do about it.
The US, by contrast, will be in much better shape. True, America had been running big budget and trade deficits, and its banking system is in a terrible mess. But those are all short-term problems. The over-60s currently account for just 18% of the US population. That will only rise to 25% by 2050. The US has one of the highest birth rates in the developed world (14 births per 1,000 people annually, compared with 12 in the UK, or 8 in Germany). And, of course, it remains open to immigrants, at least compared to other rich countries. There will still be lots of bright, hard-working Americans joining the labour force every year for the foreseeable future, and they won’t be paying a fortune in taxes to support an army of pensioners. It’s hard to see how that can be bad for growth.
Lastly, re-think what you know about Europe. Germany has catastrophic demographics, and the country is increasingly suspicious of immigrants. A kink in the birth rates means the working age population has been stable since 2005, and will stay that way until 2015. Then it falls of a cliff. You can’t keep an export machine going when there aren’t any workers. France and the UK, by contrast, are set to dominate Europe – they are the only two major countries with stable or growing populations.
What should investors make of that? Simple. Don’t be too pessimistic about Japan. It’s in much better shape than you’ve been told. The China story is over-sold. The US is in much better shape than most people have acknowledged. France and Britain look pretty good too. Turn all of that into portfolio consisting of index-tracking funds following the Nikkei and the S&P 500, with a side position in the FTSE-100, and France’s CAC-40. Then come back and check how your investments are doing in 2030 – and you’ll almost certainly find they have done pretty well.

Predictions for 2011...

In my Money Week column I've been making some predictions for 2011. Here's a taster....

Predictions are ten a penny at this time of year. Just about every City economist and strategists has outlined their big themes of the coming twelve months. Tensions in the euro zone, rising inflation, a double dip recession and currency battles between China and the US have been exhaustively forecast.
But what makes a year interesting is not the trends that continue much as before, or the decisions that were relatively predictable. It is the stuff no one was expecting. Who would have guessed for example that BP would come close to being destroyed by an oil spill in the Gulf of Mexico during 2010, that Cadbury would be taken over or that both Greece and Ireland would go bust and put the euro in mortal danger?
So what might catch us out in 2011? Here are five surprises to watch out for?
One: The British economy comes storming back.
The UK is turning the corner faster than anyone could reasonably have expected. Growth keeps surprising everyone on the upside and unemployment hasn’t taken off in the way many feared. The coalition has proved remarkably durable, and has made a good start on getting the budget deficit under control – and, a few rioting students aside, the public have accepted austerity.
It may not last – but then again it might. In fact, there are encouraging signs of a recovery. The 30% devaluation of sterling in the wake of the credit crunch is reviving our withered manufacturing industry, and cutting into the massive trade deficit. The crisis in the euro zone has stopped the bond markets getting too worried about our own fiscal problems. Real wages are being cut – average earnings are rising by just 2.2% a year whilst inflation is running at 3.2% (and that’s the official figure – the real rate is far higher). That isn’t much fun for anyone, but there are few quicker ways to restore your competitiveness of your economy than cutting wages and devaluing your currency. It is too soon to be talking about an English Tiger, but there are signs the UK will do surprisingly well this year.
Two: Rupert Murdoch sells his British newspapers.
There is no evidence that the pay-wall for The Times and The Sunday Times has been the success that Murdoch must have been hoping for when he embarked on the experiment. News International claims 100,000 users, but it isn’t clear how many are paying full-price, or will stay with it. I haven’t met anyone who has subscribed, and I suspect you haven’t either.
Meanwhile the circulation of The Times continues to plummet. It is down to 466,000, down 17% on the year. The Sunday Times is stagnant whilst The Sun and The News of the World are also in decline. But the real problem for Murdoch is that he wants to take full control of BSkyB. It’s going to be hard for him to do that whilst he is also the country’s most powerful newspaper publisher. Too many competition issues are raised.
Is he really going to sacrifice the chance to get full control of a fantastic, growing business just so he can hang onto one that looks to be in irretrievable decline? It sounds unlikely. This is the year to get some money for the papers whilst they are still worth something.
Three: Jean-Claude Trichet’s term is extended at the European Central Bank.
The capable Frenchman is due to stand down in October from the world’s second most powerful central bank. The two leading candidates to succeed him are Mario Draghi, the governor of the Bank of Italy, and Axel Weber, the President of Germany’s Bundesbank.
Neither man is remotely suitable. Installing an Italian at the ECB’s Frankfurt headquarters would provoke riots in Hamburg and Munich. It might well be the decision that finally pushes Germany into quitting the euro – with Austria and the Netherlands close behind. But Weber wouldn’t be much better. He would be the hard money, austerity candidate, signalling years of German domination. Greece and Portugal might well decide there was no future for them in the euro.
What’s the EU to do? It could appoint and obscure central banker from Finland or Luxembourg. But that wouldn’t have much credibility. It would be far easier to extend Trichet’s term by two years until the euro is through the current crisis.
Four: The IPO market returns.
In 2011, there will be an upsurge in new listings. The private equity houses took over hundreds of companies at the height of the boom. With the credit markets unfreezing, and the equity markets doing well again, they will be looking to unload a lot of those businesses. They won’t be able to sell them to each other they way they used to, so they will have to list them instead. On top of that, governments will be looking to unload some of the banking shares they took control of during the credit crunch.
The net result will be an IPO bonanza. The investment banks will have so much stock to sell, they’ll need to tempt private investors into buying shares in new issues they way they used to. They’ll only be able to do that by offering them at a discount. Stagging – buying shares in IPOs and selling them within days – will be back.
Five: An African investment stampede.
On Christmas Eve, China invited South Africa to join the BRIC group of nations, making it the BRICS (Brazil, Russia, India, China and South Africa). That was an indication of how the continent is starting to join Asia and South America in rapidly modernising its economy. We tend to focus on the African disaster stories, but China in particular is pouring massive investment into the region’s wealthier countries, and growth is starting to pick-up. This will be the year when investors get bored with the other emerging markets and start looking to Africa instead.
Indeed, by the end of the year, South Africa, some of its neighbours and the UK may be among the best-performing economies – and that really will be a surprise.

The Era of Cheap Money is Ending

In my Money Week column I've been looking at how the era of cheap money is ending. Here's a taster.

Interest rates are at a three-century low, and have been stuck at those levels for more than a year. Your bank deposit account pays so little interest you probably don’t even bother to look at the statements any more. The interest on your mortgage is so miniscule you might well wonder why the building society goes to the hassle of collecting it.
Rates are so pitiful that it may well appear bonkers to start speculating about the end of the era of cheap money. But a fascinating new study by the McKinsey Global Institute has looked at the trends at work in the global capital markets over the last three decades, and looked forward a decade or so as well. It concludes that we may well be close to a turning point.
The global savings rate is about to fall sharply, whilst investment will soar. A lot more people will be chasing a lot less money. If that happens, long-term interest rates will rise sharply.
For investors, that is explosive stuff. Bond prices will fall sharply. Equities may well suffer as well. The private equity and hedge fund industries will collapse. But the traditional bank deposit account will suddenly look quite attractive again.
What are the reasons for thinking the cheap money era is over?
The standard explanation for why money has grown so much cheaper over the last two decades has been that there has been a glut of savings, mainly from big economies such as China and Japan.
Whilst true, that hasn’t been the whole story. There has also been a steady decline in investment. Investment as a share of global GDP fell from a peak of 26% back in the early 1970s, to a recent low of just 20% of GDP in 2002. It has bounced around that relatively low figure for most of the last decade, according to McKinsey’s calculations.
Now it might be about to take off again. The world goes through occasional mega-investment booms. The industrial revolution, for example, or the post-war reconstruction of Europe and Japan. It may be on the brink of another one. New countries are industrialising fast, and creating new cities at the same time. Across Asia, Africa, Latin America and Eastern Europe, there is a soaring demand for new infrastructure. Roads, railways, water systems, homes and factories are all being built at a rapid pace. That requires vast quantities of capital. Indeed the rate of global investment was already starting to rise quite quickly. From 2002 onwards, it started to climb sharply, before being choked off by the global recession. As the economy recovers it will start growing again, probably back to the peaks seen in the early 1970s.
On the other side of the equation, global saving may well start to fall. China is probably not going to save as much in the next decade as it did in the past. Typically, as economies grow more mature, they save less and consume more. There is no reason for thinking that China will be any different. The same forces will be at work in other big emerging economies such as India and Brazil.
At the same time, populations are rapidly aging – not just in the developed world, but in places such as China as well. Typically, older people don’t save. Indeed, they live on the past savings.
In short, there will be a much higher demand for capital, and a lower supply of it. You don’t need to know much about economies to figure out that means prices will go up. How much? No one can say for certain. McKinsey estimates that 1.5% could be added to long-term interest rates. But it could be much more.
For investors, however, that is going to make a hug difference.
First, the bond markets will go into long-term retreat.
Although the equity markets get far more attention, the bond markets have been in a two-decade bull market – and you’d have been better off for most of that time invested in bonds than shares. With the cost of capital hitting record lows, fixed income investments just grew steadily more attractive. But rising long-term interest rates will reverse all of that. Bonds will enter a bear market.
Second, equities will be far more mixed. On the one hand, the cost of capital for companies will rise. Shares won’t benefit from investors switching out of low-yielding bonds. That 5% dividend that looked so attractive when a 10-year bond yielded 3% won’t look so great any more. Against that, costs such as pension funds will be easier to finance. Equities will be okay, but will hardly shine.
Thirdly, it will have a huge impact on the capital markets. The hedge fund and private equity industries have boomed as investors have looked for alternative strategies in a world where real interest rates kept falling. But with rates rising, plain old deposit accounts at the bank will look a lot more appealing. There’s not much point in paying a hedge fund manager 20% for some exotic, high-risk strategy when you could be making a perfectly decent return just by parking the cash in your local building society. The alternative investment industry faces wipe out.
Finally, it will impact the rest of the economy profoundly. The credit boom of the last two decades was fundamentally about money being very, very cheap. They were giving the stuff away – just about literally in the case of some credit card companies. Consumers and governments steadily ran up bigger and bigger debts, often without much of an idea how they would ever pay them back. Those days are over. Governments will have to balance their books, and so will consumers.
In a world in which capital is in short supply, people will have to go back to living within their means, and saving up for things that they want to buy or invest in. Now that really will be a big change.

On Motley Fool

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The Return of Stagflation

In my Money Week column this week, I've been looking at the return of 1970s-style staglation. Here's a taster....

Historical comparisons are vital for any serious investor, not because the past always repeats itself, but because it gives you a sense of what forces are at work, and how they are likely to shape events. The tricky bit, however, is deciding which historical parallel is the right one.
So where are we right now? Back in the 1930s, recovering fitfully after an almighty global crash? Standing on the brink of a long bull market such as the early 1980s?
In fact, we are probably somewhere around 1969 – coming out of a decade of relatively strong growth and prosperity, but heading into one that will prove a much harder slog. The ‘stagflation’ of the 1970s – a malignant combination of rapid and rising inflation, zero growth, and rising unemployment which wiped out the wealth of the middle classes – could well be what lies in store.
In the debate between whether we are looking at a decade of deflation or inflation, too much attention is paid to where we are right now. At the start of the 1970s, there wasn’t much sign that rising prices were going to be a problem any time soon. Nor was there much sign that mass unemployment lay ahead.
But, as a fascinating recent analysis by Morgan Stanley made clear, there were forces at work in the early late 196s and 1970s that were to pave the way for stagflation -- and which all have very clear parallels today.
There was an international monetary system, which meant that the expansionary policies of the Federal Reserve were exported around the world. In 1970, it was the Bretton Woods system that had been set up after World War Two. Today, it is quantitative easing. But the net result is much the same. The Fed is trying to inflate its own economy, for its own reasons, but much of the expansion of the monetary system ends up elsewhere.
There was a glut of dollars flooding onto the global economy. In the early 1970s, the US was printing money to finance the Vietnam War. Now it is to keep its banking system afloat, but again the net impact is very similar.
There is a twin-track global economy. In the early 1970s, the peripheral economies – in those days mainly Japan, and the emerging Asian economies such as Hong Kong, Taiwan and Korea – were growing very fast, while the main traditional economies were starting to stagnate. The same is true today, with the emerging markets racing ahead, whilst the established giants of the global economy have all slowed down sharply.
Finally, there were structural challenges to the old heavy-weight economies that meant they found it very hard to grow. In the early 1970s, they were faced with the loss of old basic manufacturing industries, and the creation of new service-based economies. In 1970, for example, 35% of British jobs were still in manufacturing, compared with only 13% now. It was impossible to grow very fast until that process was completed. Now, of course, it is debt de-leveraging: gradually restoring both personal and government balance sheets after the crazy borrowing spree of the last decade, which means that growth is likely to be very subdued for a long time to come.
The net result was rapid inflation and zero or minimal growth – the worst of all possible worlds.
Of course, there are differences as well. No historical comparison is ever perfect. There is none of the wage indexing that was common in the 1970s. When wages went up with inflation automatically, that ratcheted prices endlessly upwards. Today, wages are falling in the UK in real terms – they are rising at about 1% less than inflation – and in most of the developed world as well. The OPEC oil cartel is nothing like the force it was forty years ago – it isn’t going to be able to force up the oil price in the way it did in the 1970s.
Still, the parallels are clear enough. On balance, several years of stagflation looks the most likely outcome.
How should investors respond to that?
First, don’t worry about inflation just yet.
Although the main ingredients of stagflation were all in place by the beginning of 1970, inflation didn’t take off right away. It wasn’t until the oil crisis of 1973 that prices really started to run riot, and it was the second half of the decade that saw rampant inflation across much of the developed world. You need to reckon on the big upturn in prices around 2013 or 2014 – not this year or next. So for the time being you are fine remaining invested in assets such as bonds that don’t protect you from rising prices. They will carry on doing well for at least another two years.
Next, switch into real assets.
With zero growth, and rapidly rising prices you need to be out of cash. The outlook for property prices might look bleak on the surface, with squeezed incomes and little growth in lending, but for British investors there have been few better long-term hedges against inflation than houses and land. That was true of every other inflationary cycle and it will be of this one as well. Gold will do well. So will commodity prices. Even better, try and spot the next OPEC-style cartel that can take advantage of loose monetary policy to squeeze up prices to extraordinary levels – iron ore would be one possibility.
Finally, get ready for the clampdown.
Central banks remain remarkably relaxed about inflation – for now. They may well have decided that with so much debt on personal and national balance sheets, modest inflation is the best way of getting the economy back into shape. But stagflation is a nasty condition: minimal growth and rising prices squeeze living standards very quickly, creating real pain. Eventually, inflation will have to be squeezed out of the system. That will create a lot of losers.
At the end of the cycle, we should end up back in the early 1980s – and ready for another two decade bull market in equities. But that part of the story is still a long way off.