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.
Showing posts with label money week. Show all posts
Showing posts with label money week. Show all posts
Monday, 18 July 2011
Saturday, 2 July 2011
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.
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.
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.
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.
Monday, 25 April 2011
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.
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.
Sunday, 17 April 2011
The Vickers Whitewash....
In this week's Money Week column, I've been looking at the Vickers Report, and how it let the banks off the hook. Here's a taster....
This year, the UK had a Goldilocks moment to get to grips with its over-mighty finance industry. Two years ago, the banks were still too weak. You can’t put a patient in for major heart surgery when they are still recovering from a car crash. In the immediate wake of the credit crunch, the banks could not have survived radical restructuring. And in another two years, the banks will all be making big profits again, paying lots of corporation tax, and paying big donations to political parties. The memory of the credit crunch will have faded, and the political will to break then up will have evaporated.
But right now, the banks are strong enough to take some punishment. And the desire to make sure the events of 2008 are never repeated is still there. As Goldilocks would put it, it is neither too hot nor too cold – but just right.
Despite that, Sir John Vickers and his colleagues on the Independent Banking Commission blew it. Last Monday’s report on the future of the British financial services industry was the dampest possible squib. Its response was so feeble, and so irrelevant, that it now looks the British banks have in effect escaped from the worst series of collapses in a century or more without any meaningful reform to the way they operate.
No one can be in much doubt that Britain’s banking industry is in need of a major structural overhaul. Put simply, this country’s banks have become too big, and too risky, for the size of the economy that ultimately underpins them.
The point was well illustrated in a research note published by UBS last month. Barclays now has a balance sheet worth 100% of GDP. For a comparison, JP Morgan has a balance sheet worth 24% of US GDP. In effect, Britain is host to three very large banks – Barclays, HSBC and Royal Bank of Scotland – each of which has the potential to quite literally bankrupt the country.
We have already seen how Iceland and Ireland were ruined by the recklessness of their financiers. The same could easily happen to this country. It is a threat, and one the Commission had a duty to take seriously.
And yet, probably under the influence of lobbying from the banking industry, it has largely ignored it. The report singles out Lloyds for its main attention – when, in fact, it is the bank that poses the least threat to the stability of the financial system.
Lloyds will be forced to sell off more branches, over and above the 600 the EU is already making it get rid of. It is certainly true that Gordon Brown’s decision to bounced Lloyds into merging with HBOS was one of the former Prime Minister’s many catastrophic mistakes. It ruined a fairly sound bank, and dramatically reduced the competition in the mortgage and savings market. If reducing its size creates some space for new players in the financial services industry that will certainly be a good thing.
Yet, it is crazy to imagine that will make the financial system more stable. There is simply no evidence to suggest that too little competition between the banks is what led up to the credit crunch. Indeed, through 2006 and 2007 there were arguably too many lenders crowding into the British market. They were throwing around self-cert buy-to-let mortgages like confetti. More competition in a market is always a good thing. It creates more choice, and better service, with better prices. But anyone who thinks it is going to make the system safer is simply kidding themselves.
If the Commission was too harsh on Lloyds, it was too soft on RBS, Barclays and HSBC. It proposes stricter capital requirements, and dividing lines between the retail and investment banking units, so that the investment bank can safely be allowed to go bust, whilst the retail arm will be protected.
The trouble is, neither is going to fix the real issues.
The banks didn’t go bust because they had too little capital. A bigger buffer against financial shocks will help, but a reckless bonus system, too many complex products, and mindless expansion into markets they didn’t understand were the underlying causes of the crisis. Would RBS have survived with a couple of percent more capital? Almost certainly not. Neither would any of the other banks.
Nor is ‘ring-fencing’ the banks retails arms going to make a great deal of difference. It is very hard to believe that any kind of structure can be created that will make it certain that a collapse of the investment banking arm won’t bring down the retail bank as well. Bankers are very good at shifting money around a balance sheet. If there is a way of making the retail unit subsidise the rest of the bank, someone will find it and exploit it. For the system to work, you have to believe that the regulators are smarter and more knowledgeable than the people working in the banks – and the chances of that are just about zero.
Vickers had a one-off chance to do something really radical. He should have proposed a complete split between retail and investment banking. The retail banks would be safe, fairly dull institutions, and they could be fully protected by the government from failure. . The investment banks could take all the risks they liked, in much the same way that the hedge funds do, and if they went bust it wouldn’t matter very much to anyone apart from their staff.
Barclays might opt to move to New York. HSBC might decide to go back to Hong Kong, or to Shanghai. But so what? It matters much less than most people suppose whether a bank is domiciled in this country. The Commission had a duty to think seriously about whether it was responsible to host massive banks in the UK. It failed completely. The moment to protect the country from another massive banking collapse has passed – it won’t come again.
This year, the UK had a Goldilocks moment to get to grips with its over-mighty finance industry. Two years ago, the banks were still too weak. You can’t put a patient in for major heart surgery when they are still recovering from a car crash. In the immediate wake of the credit crunch, the banks could not have survived radical restructuring. And in another two years, the banks will all be making big profits again, paying lots of corporation tax, and paying big donations to political parties. The memory of the credit crunch will have faded, and the political will to break then up will have evaporated.
But right now, the banks are strong enough to take some punishment. And the desire to make sure the events of 2008 are never repeated is still there. As Goldilocks would put it, it is neither too hot nor too cold – but just right.
Despite that, Sir John Vickers and his colleagues on the Independent Banking Commission blew it. Last Monday’s report on the future of the British financial services industry was the dampest possible squib. Its response was so feeble, and so irrelevant, that it now looks the British banks have in effect escaped from the worst series of collapses in a century or more without any meaningful reform to the way they operate.
No one can be in much doubt that Britain’s banking industry is in need of a major structural overhaul. Put simply, this country’s banks have become too big, and too risky, for the size of the economy that ultimately underpins them.
The point was well illustrated in a research note published by UBS last month. Barclays now has a balance sheet worth 100% of GDP. For a comparison, JP Morgan has a balance sheet worth 24% of US GDP. In effect, Britain is host to three very large banks – Barclays, HSBC and Royal Bank of Scotland – each of which has the potential to quite literally bankrupt the country.
We have already seen how Iceland and Ireland were ruined by the recklessness of their financiers. The same could easily happen to this country. It is a threat, and one the Commission had a duty to take seriously.
And yet, probably under the influence of lobbying from the banking industry, it has largely ignored it. The report singles out Lloyds for its main attention – when, in fact, it is the bank that poses the least threat to the stability of the financial system.
Lloyds will be forced to sell off more branches, over and above the 600 the EU is already making it get rid of. It is certainly true that Gordon Brown’s decision to bounced Lloyds into merging with HBOS was one of the former Prime Minister’s many catastrophic mistakes. It ruined a fairly sound bank, and dramatically reduced the competition in the mortgage and savings market. If reducing its size creates some space for new players in the financial services industry that will certainly be a good thing.
Yet, it is crazy to imagine that will make the financial system more stable. There is simply no evidence to suggest that too little competition between the banks is what led up to the credit crunch. Indeed, through 2006 and 2007 there were arguably too many lenders crowding into the British market. They were throwing around self-cert buy-to-let mortgages like confetti. More competition in a market is always a good thing. It creates more choice, and better service, with better prices. But anyone who thinks it is going to make the system safer is simply kidding themselves.
If the Commission was too harsh on Lloyds, it was too soft on RBS, Barclays and HSBC. It proposes stricter capital requirements, and dividing lines between the retail and investment banking units, so that the investment bank can safely be allowed to go bust, whilst the retail arm will be protected.
The trouble is, neither is going to fix the real issues.
The banks didn’t go bust because they had too little capital. A bigger buffer against financial shocks will help, but a reckless bonus system, too many complex products, and mindless expansion into markets they didn’t understand were the underlying causes of the crisis. Would RBS have survived with a couple of percent more capital? Almost certainly not. Neither would any of the other banks.
Nor is ‘ring-fencing’ the banks retails arms going to make a great deal of difference. It is very hard to believe that any kind of structure can be created that will make it certain that a collapse of the investment banking arm won’t bring down the retail bank as well. Bankers are very good at shifting money around a balance sheet. If there is a way of making the retail unit subsidise the rest of the bank, someone will find it and exploit it. For the system to work, you have to believe that the regulators are smarter and more knowledgeable than the people working in the banks – and the chances of that are just about zero.
Vickers had a one-off chance to do something really radical. He should have proposed a complete split between retail and investment banking. The retail banks would be safe, fairly dull institutions, and they could be fully protected by the government from failure. . The investment banks could take all the risks they liked, in much the same way that the hedge funds do, and if they went bust it wouldn’t matter very much to anyone apart from their staff.
Barclays might opt to move to New York. HSBC might decide to go back to Hong Kong, or to Shanghai. But so what? It matters much less than most people suppose whether a bank is domiciled in this country. The Commission had a duty to think seriously about whether it was responsible to host massive banks in the UK. It failed completely. The moment to protect the country from another massive banking collapse has passed – it won’t come again.
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.
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.
Saturday, 2 April 2011
How People Power Can Curb Bonuses
In my Money Week column this week, I'm looking at how people power may be able to curb bonuses. Here's a taster....
Banking bonuses are like cockroaches. Nobody much likes them. They can do a lot of damage. And short of an all-out nuclear war, they appear to be just about indestructible.
The financial collapse of 2008 didn’t do anything to curb the way the financial sector rewards itself. Nor have the attempts at greater regulation made much progress. Even higher taxes don’t work.
But how about people power?
In Holland, ING was forced to abandon a bonus scheme after a Twitter-led campaign against the bank that threaten to turn into a mass boycott. In France, last year, the former footballer Eric Cantona led a campaign for mass withdrawals from the banks. In this country, the UK Uncut campaign, has achieved a lot of impact with its protests against financial institutions.
In the end, banking pay, like just about anything, needs permission from society. Banks can’t operate unless millions of ordinary people are willing to put money into them, and use them to shift funds around. It may be that only direct action from ordinary people can finally bring the banking industry back under control.
There is little question that financial sector pay has got out of hand. The sector routinely pays its staff rewards that are far and above what other people earn, and which bear little realistic relation either to the success of the banks they work for, or to the contribution they make to the economy.
Just take a look at the latest revelations about pay at The Royal Bank of Scotland. Last month, the bank revealed that it paid out around £1 billion in bonuses. More than a hundred of its staff were paid more than £1 million. And this is despite the fact that RBS went spectacularly bust, is still majority-owned by the tax-payer, and is still losing money. It is far from alone. HSBC revealed that it paid 253 of its staff more than £1 million last year, 89 of them in London. Right across the board, bonuses have bounced straight back to 2007 and 2008 levels.
There is nothing wrong, of course, with people earning lots of money. If they are working hard and creating wealth they deserve it. But all the evidence suggests that the banking industry has become a cartel that operates against the public interest. The banks are too big, they take on too much risk, they require too much in the way of hidden subsidies from the taxpayer, and they pay themselves too generously. According to research by Harry Huizinga, an economics professor at the University of Tilburg in the Netherlands, twelve banks have liabilities of more than $1 trillion, and thirty banks have a ratio of liabilities to GDP in excess of 0.5, meaning in effect that if they go bust they may well bring down the country with them. Furthermore, the same banks pay consistently lower returns to shareholders than banks that are smaller, and less systematically important. In short, the mega banks aren’t very useful to anyone, except for their lavishly paid staff. We’d be better off without them.
But how do we bring them under control? There have been plenty of regulatory initiatives but none of them seem to get anywhere. Governments don’t appear very effective – they are too easily brow-beaten by the argument that the banks are vital for the economy.
But maybe people power can make a difference.
In Holland, ING last week agreed to scrap a bonus scheme that would have paid its chief executive Jan Hommen 1.25 million euros. ING was bailed-out by the Dutch government in 2008, and although it has since re-paid five billion euros of the money it received, there is still another five billion euros to pay back. The sober-minded Dutch objected to the sight of bankers who still owed the government billions paying themselves vast rewards. A Twitter-led campaign mobilised public opinion against the bank. People were threatening mass withdrawals from their accounts, creating the potential for a run on the bank. Although by last week only a few hundred people had taken their money out, it was enough to rattle ING. By the end of last week, it had decided to withdraw its bonus scheme, replacing it with something far more modest.
The footballer Eric Cantona tried something similar in France. At the end of last year, he launched the ‘Bankrun 2010’ campaign. The campaign threatened a mass withdrawal of money from the banks. Tens of thousands of people signed up for the Facebook campaign, in France, Britain, the US and elsewhere. The French banking unions warned of an economic catastrophe if it happened. In the end, the event was a bit of a damp squib. Some accounts were closed. But no banks went out of business. And probably those accounts that were closed were opened up somewhere else a few days later.
Still, there are signs that things are stirring.
There is no question that ordinary people feel deeply uneasy about the way that the financial sector rewards itself. They don’t buy into the argument that the banks are engaged in a fierce war for talent that means they have to pay everyone huge salaries. And they suspect, almost certainly correctly, that the way the banks reward themselves makes the system more risky, not less – and that they may have to end up paying for it.
Most of all, they feel powerless to do very much about it. But that, of course, isn’t really true. A bank such as RBS depends on its millions of retail depositors. Without them, it would be sunk. A pure investment bank depends less on ordinary customers, but there are not many of those left – and, in truth, the retail banks are the original source of the money the investment bankers play with.
The Cantona campaign didn’t work. But the ING protest was far more successful. And if the idea of depositors mobilising against banks take off, it could pose the most potent threat yet to the system. After all, for any bank there is nothing scarier than a run. Regulation won’t curb bonuses. It is unlikely that politicians or central bankers will manage to either. But people power might just do the trick.
Banking bonuses are like cockroaches. Nobody much likes them. They can do a lot of damage. And short of an all-out nuclear war, they appear to be just about indestructible.
The financial collapse of 2008 didn’t do anything to curb the way the financial sector rewards itself. Nor have the attempts at greater regulation made much progress. Even higher taxes don’t work.
But how about people power?
In Holland, ING was forced to abandon a bonus scheme after a Twitter-led campaign against the bank that threaten to turn into a mass boycott. In France, last year, the former footballer Eric Cantona led a campaign for mass withdrawals from the banks. In this country, the UK Uncut campaign, has achieved a lot of impact with its protests against financial institutions.
In the end, banking pay, like just about anything, needs permission from society. Banks can’t operate unless millions of ordinary people are willing to put money into them, and use them to shift funds around. It may be that only direct action from ordinary people can finally bring the banking industry back under control.
There is little question that financial sector pay has got out of hand. The sector routinely pays its staff rewards that are far and above what other people earn, and which bear little realistic relation either to the success of the banks they work for, or to the contribution they make to the economy.
Just take a look at the latest revelations about pay at The Royal Bank of Scotland. Last month, the bank revealed that it paid out around £1 billion in bonuses. More than a hundred of its staff were paid more than £1 million. And this is despite the fact that RBS went spectacularly bust, is still majority-owned by the tax-payer, and is still losing money. It is far from alone. HSBC revealed that it paid 253 of its staff more than £1 million last year, 89 of them in London. Right across the board, bonuses have bounced straight back to 2007 and 2008 levels.
There is nothing wrong, of course, with people earning lots of money. If they are working hard and creating wealth they deserve it. But all the evidence suggests that the banking industry has become a cartel that operates against the public interest. The banks are too big, they take on too much risk, they require too much in the way of hidden subsidies from the taxpayer, and they pay themselves too generously. According to research by Harry Huizinga, an economics professor at the University of Tilburg in the Netherlands, twelve banks have liabilities of more than $1 trillion, and thirty banks have a ratio of liabilities to GDP in excess of 0.5, meaning in effect that if they go bust they may well bring down the country with them. Furthermore, the same banks pay consistently lower returns to shareholders than banks that are smaller, and less systematically important. In short, the mega banks aren’t very useful to anyone, except for their lavishly paid staff. We’d be better off without them.
But how do we bring them under control? There have been plenty of regulatory initiatives but none of them seem to get anywhere. Governments don’t appear very effective – they are too easily brow-beaten by the argument that the banks are vital for the economy.
But maybe people power can make a difference.
In Holland, ING last week agreed to scrap a bonus scheme that would have paid its chief executive Jan Hommen 1.25 million euros. ING was bailed-out by the Dutch government in 2008, and although it has since re-paid five billion euros of the money it received, there is still another five billion euros to pay back. The sober-minded Dutch objected to the sight of bankers who still owed the government billions paying themselves vast rewards. A Twitter-led campaign mobilised public opinion against the bank. People were threatening mass withdrawals from their accounts, creating the potential for a run on the bank. Although by last week only a few hundred people had taken their money out, it was enough to rattle ING. By the end of last week, it had decided to withdraw its bonus scheme, replacing it with something far more modest.
The footballer Eric Cantona tried something similar in France. At the end of last year, he launched the ‘Bankrun 2010’ campaign. The campaign threatened a mass withdrawal of money from the banks. Tens of thousands of people signed up for the Facebook campaign, in France, Britain, the US and elsewhere. The French banking unions warned of an economic catastrophe if it happened. In the end, the event was a bit of a damp squib. Some accounts were closed. But no banks went out of business. And probably those accounts that were closed were opened up somewhere else a few days later.
Still, there are signs that things are stirring.
There is no question that ordinary people feel deeply uneasy about the way that the financial sector rewards itself. They don’t buy into the argument that the banks are engaged in a fierce war for talent that means they have to pay everyone huge salaries. And they suspect, almost certainly correctly, that the way the banks reward themselves makes the system more risky, not less – and that they may have to end up paying for it.
Most of all, they feel powerless to do very much about it. But that, of course, isn’t really true. A bank such as RBS depends on its millions of retail depositors. Without them, it would be sunk. A pure investment bank depends less on ordinary customers, but there are not many of those left – and, in truth, the retail banks are the original source of the money the investment bankers play with.
The Cantona campaign didn’t work. But the ING protest was far more successful. And if the idea of depositors mobilising against banks take off, it could pose the most potent threat yet to the system. After all, for any bank there is nothing scarier than a run. Regulation won’t curb bonuses. It is unlikely that politicians or central bankers will manage to either. But people power might just do the trick.
Tuesday, 8 March 2011
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.
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.
Monday, 28 February 2011
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.”
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.”
Sunday, 20 February 2011
The End Of Swis Banking
In my Money Week column this week I've been looking at the possible demise of Switzerland's formidable banking industry. Here's a taster.
There are a few things we think we know for sure about Switzerland. It makes nice chocolate and reliable watches. It’s sort of pricy, and a little on the dull side. And it has the most formidable banking industry in the world.
For a hundred years or more, Switzerland and banking have been just about synonymous. Countless thrillers feature a scene where a shady deal gets done at some discreet Zurich or Geneva office where the secrecy of the transaction can be considered absolute. If London has a serious rival within Europe as a banking and finance centre, it is Switzerland rather than Frankfurt or Paris.
But now the country’s finance sector is looking challenged in a way that it hasn’t been for a generation or more. The country’s two giant banks, Credit Suisse and UBS, are struggling to recover from the credit crunch. Smaller banks such as Julius Baer are fighting to maintain client confidentiality as data gets passed onto WikiLeaks. Those may just be blips. Every industry goes through ups and down. But they may also be signals of long-term decline.
In reality, the success of the Swiss finance sector was based on secrecy and access to lots of cheap capital. Both appear to be gone forever. And that may well mean that Switzerland’s competitive advantage is at an end.
Whilst most of the global banking industry is roaring back from the credit crunch in fine fettle, and paying itself bigger bonuses than ever, the big Swiss banks seem to be stuck in the doldrums.
Credit Suisse came through the credit crunch better than most investment banks. It didn’t need a rescue. But it doesn’t appear to have recovered much of its old panache as the global economy grows stronger. It results earlier this month disappointed the market. It cut its 2010 dividend 35% last week and lowered its target for return on equity in the next three to five years to around 15% from more than 18%. It seems to have accepted that it will be permanently less profitable.
UBS doesn’t look any happier. The bank only just scraped its way through the credit crunch. Its fourth-quarter pre-tax profit from investment banking slumped
75% t to 75 million Swiss francs. The bonus pool was cut by 10% to reflect disappointing figures. Its chief executive officer Oswald Gruebel admitted that the results were “clearly not yet satisfactory.”
Meanwhile Julius Baer, one of the oldest names in Swiss banking, has been hit by an embarrassing scandal. A disaffected former staffer has threatened to publish the names of thousands of its clients on WikiLeaks. The whistle-blower has been arrested for breaking Switzerland’s bank secrecy laws, and it remains to be seen whether the data is ever released. Even so, it is not the kind of thing that will make the well-heeled clients of Swiss banks feel very confident.
Of course, every industry goes through bad spell. The problem for the Swiss banking sector is that it faces two huge challenges that may make it less competitive on a permanent basis.
The first is that secrecy is dead.
The European Union has been chipping away at Switzerland’s tradition of confidential, numbered bank accounts for years. Neighbouring countries suspected they were losing billions in taxes on money salted away in Swiss accounts, and they were probably right. German businessmen used to drive over the border at weekends with the boot of their BMW full of deutschemarks to deposit in the country. The Swiss have been forced to end all of that.
Now the internet is finishing the job. In an era of hyper-transparency it is impossible for the Swiss banks to maintain the old traditions of client confidentiality. They may succeed in locking up the latest whistle-blower. But it is simply too easily for a disgruntled employee to post thousands of account details on a website like WikiLeaks. If the US government can’t stop sensitive military data being published on the web, a few Swiss banks can’t hope to.
The trouble is, secrecy is often what people were buying. The banks might blather on about how they offered excellent service, and in-depth, personalised investment advice. But usually what the customers wanted was to keep their money hidden from the taxman, their wives, or their business partners. Secrecy was the main reason people went to Switzerland, and if its banks can’t keep their accounts under wraps you might as well go somewhere else.
Secondly, the giant Swiss banks, like the British ones, have grown too big for their home country. The Swiss central bank knows that both UBS and Credit Suisse have assets worth many times the country’s GDP. If both banks ran into trouble the way that Royal Bank of Scotland did in this country, it would quite literally bankrupt the country. In response, they have introduced the toughest capital rules in the world. The Swiss banks will have to maintain capital ratios at double the levels agreed under the Basel rules. In effect, that means the money the banks use as their raw material will be twice as expensive as it will be for British, American or German banks. In a competitive market, that is a huge handicap.
Swiss banking was a great model. Lots of people deposited tons of money in the country. They didn’t much care about how much interest was paid on it, or what the investment advice was like because what they really minded about was discretion. The banks could use all that cash as essentially free capital, which would bulk up their balance sheets, and allow them to go out and finance deals around the world. It was a fantastic way to make a lot of money.
Now it seems the model is broken. The accounts aren’t secret, and the capital isn’t cheap. Unlikely though it seems, in twenty or thirty years we might not associate Switzerland with the banking industry anymore. Still, there’s always the chocolate and the watch industry.
There are a few things we think we know for sure about Switzerland. It makes nice chocolate and reliable watches. It’s sort of pricy, and a little on the dull side. And it has the most formidable banking industry in the world.
For a hundred years or more, Switzerland and banking have been just about synonymous. Countless thrillers feature a scene where a shady deal gets done at some discreet Zurich or Geneva office where the secrecy of the transaction can be considered absolute. If London has a serious rival within Europe as a banking and finance centre, it is Switzerland rather than Frankfurt or Paris.
But now the country’s finance sector is looking challenged in a way that it hasn’t been for a generation or more. The country’s two giant banks, Credit Suisse and UBS, are struggling to recover from the credit crunch. Smaller banks such as Julius Baer are fighting to maintain client confidentiality as data gets passed onto WikiLeaks. Those may just be blips. Every industry goes through ups and down. But they may also be signals of long-term decline.
In reality, the success of the Swiss finance sector was based on secrecy and access to lots of cheap capital. Both appear to be gone forever. And that may well mean that Switzerland’s competitive advantage is at an end.
Whilst most of the global banking industry is roaring back from the credit crunch in fine fettle, and paying itself bigger bonuses than ever, the big Swiss banks seem to be stuck in the doldrums.
Credit Suisse came through the credit crunch better than most investment banks. It didn’t need a rescue. But it doesn’t appear to have recovered much of its old panache as the global economy grows stronger. It results earlier this month disappointed the market. It cut its 2010 dividend 35% last week and lowered its target for return on equity in the next three to five years to around 15% from more than 18%. It seems to have accepted that it will be permanently less profitable.
UBS doesn’t look any happier. The bank only just scraped its way through the credit crunch. Its fourth-quarter pre-tax profit from investment banking slumped
75% t to 75 million Swiss francs. The bonus pool was cut by 10% to reflect disappointing figures. Its chief executive officer Oswald Gruebel admitted that the results were “clearly not yet satisfactory.”
Meanwhile Julius Baer, one of the oldest names in Swiss banking, has been hit by an embarrassing scandal. A disaffected former staffer has threatened to publish the names of thousands of its clients on WikiLeaks. The whistle-blower has been arrested for breaking Switzerland’s bank secrecy laws, and it remains to be seen whether the data is ever released. Even so, it is not the kind of thing that will make the well-heeled clients of Swiss banks feel very confident.
Of course, every industry goes through bad spell. The problem for the Swiss banking sector is that it faces two huge challenges that may make it less competitive on a permanent basis.
The first is that secrecy is dead.
The European Union has been chipping away at Switzerland’s tradition of confidential, numbered bank accounts for years. Neighbouring countries suspected they were losing billions in taxes on money salted away in Swiss accounts, and they were probably right. German businessmen used to drive over the border at weekends with the boot of their BMW full of deutschemarks to deposit in the country. The Swiss have been forced to end all of that.
Now the internet is finishing the job. In an era of hyper-transparency it is impossible for the Swiss banks to maintain the old traditions of client confidentiality. They may succeed in locking up the latest whistle-blower. But it is simply too easily for a disgruntled employee to post thousands of account details on a website like WikiLeaks. If the US government can’t stop sensitive military data being published on the web, a few Swiss banks can’t hope to.
The trouble is, secrecy is often what people were buying. The banks might blather on about how they offered excellent service, and in-depth, personalised investment advice. But usually what the customers wanted was to keep their money hidden from the taxman, their wives, or their business partners. Secrecy was the main reason people went to Switzerland, and if its banks can’t keep their accounts under wraps you might as well go somewhere else.
Secondly, the giant Swiss banks, like the British ones, have grown too big for their home country. The Swiss central bank knows that both UBS and Credit Suisse have assets worth many times the country’s GDP. If both banks ran into trouble the way that Royal Bank of Scotland did in this country, it would quite literally bankrupt the country. In response, they have introduced the toughest capital rules in the world. The Swiss banks will have to maintain capital ratios at double the levels agreed under the Basel rules. In effect, that means the money the banks use as their raw material will be twice as expensive as it will be for British, American or German banks. In a competitive market, that is a huge handicap.
Swiss banking was a great model. Lots of people deposited tons of money in the country. They didn’t much care about how much interest was paid on it, or what the investment advice was like because what they really minded about was discretion. The banks could use all that cash as essentially free capital, which would bulk up their balance sheets, and allow them to go out and finance deals around the world. It was a fantastic way to make a lot of money.
Now it seems the model is broken. The accounts aren’t secret, and the capital isn’t cheap. Unlikely though it seems, in twenty or thirty years we might not associate Switzerland with the banking industry anymore. Still, there’s always the chocolate and the watch industry.
Monday, 17 January 2011
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.
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.
Wednesday, 22 December 2010
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.
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.
Wednesday, 8 December 2010
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.
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.
Tuesday, 30 November 2010
Britain & The Euro Break-Up
In my Money Week column this week I've been exploring how Britain should handle the potential break-up of the euro. Here's a taster.
It would be easy for the UK to stay smugly on the sidelines as the euro collapses. After all, Britain had to struggle not to join the single currency when it was launched. And it had to put up with years of European politicians warning that the City, and the vast earnings it brings into London, would be finished as result of its government’s stubborn scepticism. You hardly need to be German to think the word schadenfreude might be an apporiate way of desribing many people’s response on this side of the English channel.
That would be temptimg, but wrong. Britain has a huge amount at stake in the euro’s crisis. We are contributing billions to the bail-out of the Irish. The Spanish banks, which could well be the next domino to fall, have a massive presence in this country. The euro-zone is our largest trading partner.
If the euro-zone does break-up – and it looks increasingly likely that it will – then the way that it does so, and the currency system that replaces it, will matter hugely to the UK economy over the next decade. Britain should be leading that debate, And it should be arguing for an orderly break-up, returning to national currencies, but with the euro preserved as a business and financial currency.
The troubles of the euro are getting too severe for even its most enthusiatic proponents to ignore. The Greeks going bust was one thing. The Greeks fiddled their way into the system, and made no attempt to play by the rules. They should never have been allowed in, and, once inside, should have been told to reform fast, or get out again.
But Ireland is something different. It was one of the most suscessful economies in the world before it joined the euro. It did everything that was expected of it, cutting wages, and public spending with a ferocity that no other country has matched. Yet it still ran out of money. With two out of 16 euro countries needing bailing out, it is hard to see how the single currency cannot be blamed. Nor is it going to stop here. Portugal will be next, then Spain, and probably Belgium as well. After that, it is merely a qustion of whether the bond markets take France or Italy down first.
For the UK, that matters hugely. We are on the hook for a large chunk of the Irish bail-out. This county will contribute around eight billion euros to the bail-out package for the Irish government. Royal Bank of Scotland and Lloyds, the two partially state-owned British banks, have billlions in exposure to the Irish economy. If Ireland goes down, it will cost the UK huge sums.
It doesn’t just end there. The Spanish banks – most notably Santander – have a massive presence in the UK. If the Spain is the next euro domino to fall, we may end up regretting allowing a bank from that country to end up owning such a large chunk of the British financial system. Likewise, if Portuguese, or Belgium, or French banks get caught up in the crisis, that will have terrible consequences for our own banks, and for the City more widely.
And, of course, the euro-zone is Britain’s main trading partner. It is no use thinking we can simply be a spectator at this drama. The UK needs to get involved in trying to shape the way it plays out.
Of course, as an outsider the UK may struggle to be listened to. Against that, our foresight in staying out may give us a voice. After all, the architects of the euro, who assured us the single currency would protect Europe from chaos in the markets, are looking fairly foolish right now. And, in addition, Britain is one of the largest economies in Europe. All of that gives us a role to play.
So what should the UK be arguing for?
The first and most important point is that the UK should be pushing for an orderly break-up of the euro. The subject is still taboo in Brussels and Frankfurt. That is crazy. There is a real risk the euro may collapse amid chaos and turmoil. If confidence in Spain goes, it might happen very suddenly, taking France and Italy with it. After all, the exchange rate mechanism, the precursor to the euro, fell apart over the space of a few days in 1992. The euro could do the same. It would be far better if there was a calm and measured debate now about how to unravel it. Sensible decisions are rarely made during a few hours of fevered debate with the global markets in freefall.
There is plenty of talk about creating a northern and southern euro – a neuro and sudo (or the medi, as one Morgan Stanley analysis called it). That would fix some of the problems. The peripheral countries could devalue as a bloc against the stronger economies of core Europe. The two currency zones would be more compatible than the one that exists at the moment.
But will there really be any appetite for another monetary experiment after the failure of the euro? Probably not. Nor is it clear that the two zones would work much better than the one we have right now. France has been losing competitiveness steadily against Germany. It might struggle to stay in the neuro. The sudo would be led by its largest economy, Italy. How much confidence would the markets have in a currency zone led by the Italians? Yup, you guessed right – not very much. Even the Italians probably wouldn’t want to join.
The best solution would be to return to the national currencies. But it would be worth keeping the euro as a parallel currency – which is in fact what the British proposed when the euro was launched. The ECB could be jointly owned by the states of the EU, and the currency would be legal tender in every country. Over time, some of the smaller states might abandon their own currencies and just have the euro. But it would happen naturally, and from the ground up – not from the top down.
That would serve Britain’s interests best. But it isn’t going to happen unless we start arguing for it.
It would be easy for the UK to stay smugly on the sidelines as the euro collapses. After all, Britain had to struggle not to join the single currency when it was launched. And it had to put up with years of European politicians warning that the City, and the vast earnings it brings into London, would be finished as result of its government’s stubborn scepticism. You hardly need to be German to think the word schadenfreude might be an apporiate way of desribing many people’s response on this side of the English channel.
That would be temptimg, but wrong. Britain has a huge amount at stake in the euro’s crisis. We are contributing billions to the bail-out of the Irish. The Spanish banks, which could well be the next domino to fall, have a massive presence in this country. The euro-zone is our largest trading partner.
If the euro-zone does break-up – and it looks increasingly likely that it will – then the way that it does so, and the currency system that replaces it, will matter hugely to the UK economy over the next decade. Britain should be leading that debate, And it should be arguing for an orderly break-up, returning to national currencies, but with the euro preserved as a business and financial currency.
The troubles of the euro are getting too severe for even its most enthusiatic proponents to ignore. The Greeks going bust was one thing. The Greeks fiddled their way into the system, and made no attempt to play by the rules. They should never have been allowed in, and, once inside, should have been told to reform fast, or get out again.
But Ireland is something different. It was one of the most suscessful economies in the world before it joined the euro. It did everything that was expected of it, cutting wages, and public spending with a ferocity that no other country has matched. Yet it still ran out of money. With two out of 16 euro countries needing bailing out, it is hard to see how the single currency cannot be blamed. Nor is it going to stop here. Portugal will be next, then Spain, and probably Belgium as well. After that, it is merely a qustion of whether the bond markets take France or Italy down first.
For the UK, that matters hugely. We are on the hook for a large chunk of the Irish bail-out. This county will contribute around eight billion euros to the bail-out package for the Irish government. Royal Bank of Scotland and Lloyds, the two partially state-owned British banks, have billlions in exposure to the Irish economy. If Ireland goes down, it will cost the UK huge sums.
It doesn’t just end there. The Spanish banks – most notably Santander – have a massive presence in the UK. If the Spain is the next euro domino to fall, we may end up regretting allowing a bank from that country to end up owning such a large chunk of the British financial system. Likewise, if Portuguese, or Belgium, or French banks get caught up in the crisis, that will have terrible consequences for our own banks, and for the City more widely.
And, of course, the euro-zone is Britain’s main trading partner. It is no use thinking we can simply be a spectator at this drama. The UK needs to get involved in trying to shape the way it plays out.
Of course, as an outsider the UK may struggle to be listened to. Against that, our foresight in staying out may give us a voice. After all, the architects of the euro, who assured us the single currency would protect Europe from chaos in the markets, are looking fairly foolish right now. And, in addition, Britain is one of the largest economies in Europe. All of that gives us a role to play.
So what should the UK be arguing for?
The first and most important point is that the UK should be pushing for an orderly break-up of the euro. The subject is still taboo in Brussels and Frankfurt. That is crazy. There is a real risk the euro may collapse amid chaos and turmoil. If confidence in Spain goes, it might happen very suddenly, taking France and Italy with it. After all, the exchange rate mechanism, the precursor to the euro, fell apart over the space of a few days in 1992. The euro could do the same. It would be far better if there was a calm and measured debate now about how to unravel it. Sensible decisions are rarely made during a few hours of fevered debate with the global markets in freefall.
There is plenty of talk about creating a northern and southern euro – a neuro and sudo (or the medi, as one Morgan Stanley analysis called it). That would fix some of the problems. The peripheral countries could devalue as a bloc against the stronger economies of core Europe. The two currency zones would be more compatible than the one that exists at the moment.
But will there really be any appetite for another monetary experiment after the failure of the euro? Probably not. Nor is it clear that the two zones would work much better than the one we have right now. France has been losing competitiveness steadily against Germany. It might struggle to stay in the neuro. The sudo would be led by its largest economy, Italy. How much confidence would the markets have in a currency zone led by the Italians? Yup, you guessed right – not very much. Even the Italians probably wouldn’t want to join.
The best solution would be to return to the national currencies. But it would be worth keeping the euro as a parallel currency – which is in fact what the British proposed when the euro was launched. The ECB could be jointly owned by the states of the EU, and the currency would be legal tender in every country. Over time, some of the smaller states might abandon their own currencies and just have the euro. But it would happen naturally, and from the ground up – not from the top down.
That would serve Britain’s interests best. But it isn’t going to happen unless we start arguing for it.
Wednesday, 17 November 2010
The Tech Bubble....
In my Money Week column this week, I've been looking at the bubble in tech stocks. Here's a taster.
Right now, everyone in the markets is worrying about bubbles. It might be commodity prices, it might be bonds, it could be gold, or it could be the emerging markets. They are all up strongly in the past year. They all look as if they might have over-reached themselves.
But one distinguishing characteristic of a bubble is that no one really notices it. If everyone is complaining about the price of a particular type of asset, it is probably in perfectly good shape. It is the bubbles you haven’t seen that are likely to catch you out.
What are they? In a replay of 1998 and 1999, it might well be technology. Amazon is trading on a price earnings ratio of almost 70. Apple is now the third biggest company in the world. Google just keeps going up in price. And Facebook, if it ever comes to the market will be valued at billions.
And yet despite the explosive growth of the internet economy, all the old problems remain. Business models are flimsy, the barriers to entry are wafer-thin, and the technology moves so fast, it is hard for investors to make any money.
When the post-credit crunch bull market comes to a screeching halt, as it inevitably will at some point, it well be a technology crash that bring it down.
No one would deny that internet is now a huge business. That was underlined by a report by the Boston Consulting Group published last month. It found that in the UK alone, the online economy was now worth £100 billion a year, and accounted for 7.2% of GDP. If it was a separate economic sector, it would be bigger than construction, transport or the utilities.
Britain is not particularly advanced in its take-up of technology. What is true in this country will be true in every other advanced economy as well. This is a huge and growing chunk of the global economy.
It is absolutely right, therefore, that the companies that dominate the space should be sought after by investors. Anyone looking for long-term growth is going to want to own a slice of the leaders of the technology boom. Otherwise they risk getting left behind.
But hold on. Just because a company has good long-term growth prospects does not mean it is worth absolutely anything.
Take Amazon, for example. It was one of the pioneers of online retailing, and remains the best brand in that industry. I’d be surprised if there was a single reader of this magazine who wasn’t also an Amazon customer. Its latest figures were terrific: sales were ahead by 16% and profits were ahead by 39%. No doubt it will have a great Christmas. Even so, its share price has gone crazy. They have jumped from $25 a share in 2005 to $170 now. It is trading on multiple of 69 historic earnings, and 49 times the forecast earnings for next year.
Or take Apple. Sure, the iPhone is a big hit, and the iPad has been making a lot of noise. In the last five years it has got just about everything right, and there is probably no other business around that has so many devoted customers. Even so, there must be a limit to what it is worth. The shares are up by more than 50% this year alone. With a market cap of $290 billion, it is the second most valuable American business. It is the third most valuable company in the world, after Exxon Mobil and PetroChina. This, remember, is a company which, while it dominates the market for MP3 players, currently has just 4.1% of the mobile phone market, and slightly over 5% of the global market for personal computers. Those are hardly dominant market positions – but you would hardly guess that from its share price.
Much the same could be said of Google, or Facebook, or many smaller technology companies. They are good businesses, in a fast-growing sector of the economy. But they are also hitting crazy prices.
The trouble is, all the old problems with technology and internet companies remain.
For starters, there are still far too few barriers to entry. The days when a few bright Harvard students could start a website that would blow apart the industry, in the way that Mark Zuckerberg did when he started Facebook in 2004, may be over. Then again, they may not be. This is still an industry in its infancy. It is very easy for a few bright people to turn the web upside down with very little money to play with. That is great for them, and it is what makes high-tech so exciting. But is it very worrying for shareholders in the established companies. It is just too easy for a young entrepreneur to come along and blow you away.
Next, there are still relatively few sustainable business models. The online retailers make money, but often only by squeezing their suppliers to the bone. The internet is the most ruthless price comparison device ever invented, and one consequence of that is that margins will always be wafer thin. Businesses like Google may have a great advertising franchise right now – but there is no limit to ad space on the web in the way there is in the physical world. In truth, all online business models remain very flimsy.
Lastly, the technology moves so fast it is very hard for shareholders to make money. The founders and the venture capitalists who back them usually do pretty well. But by the time a company gets to the quoted market, its best days may already be behind it. It may never get to the stage of paying out steady dividends. Even Microsoft only paid its first dividend in 2003. Neither Google or Amazon have ever paid a dividend, nor are they planning to do so. By the time they do, they will probably look as far past their sell-by date as Microsoft does.
In reality, the tech rally looks overdone. It is bound to come shuddering down to earth again some time soon. And when it happens, it may well prove a trigger for a wider market correction.
Right now, everyone in the markets is worrying about bubbles. It might be commodity prices, it might be bonds, it could be gold, or it could be the emerging markets. They are all up strongly in the past year. They all look as if they might have over-reached themselves.
But one distinguishing characteristic of a bubble is that no one really notices it. If everyone is complaining about the price of a particular type of asset, it is probably in perfectly good shape. It is the bubbles you haven’t seen that are likely to catch you out.
What are they? In a replay of 1998 and 1999, it might well be technology. Amazon is trading on a price earnings ratio of almost 70. Apple is now the third biggest company in the world. Google just keeps going up in price. And Facebook, if it ever comes to the market will be valued at billions.
And yet despite the explosive growth of the internet economy, all the old problems remain. Business models are flimsy, the barriers to entry are wafer-thin, and the technology moves so fast, it is hard for investors to make any money.
When the post-credit crunch bull market comes to a screeching halt, as it inevitably will at some point, it well be a technology crash that bring it down.
No one would deny that internet is now a huge business. That was underlined by a report by the Boston Consulting Group published last month. It found that in the UK alone, the online economy was now worth £100 billion a year, and accounted for 7.2% of GDP. If it was a separate economic sector, it would be bigger than construction, transport or the utilities.
Britain is not particularly advanced in its take-up of technology. What is true in this country will be true in every other advanced economy as well. This is a huge and growing chunk of the global economy.
It is absolutely right, therefore, that the companies that dominate the space should be sought after by investors. Anyone looking for long-term growth is going to want to own a slice of the leaders of the technology boom. Otherwise they risk getting left behind.
But hold on. Just because a company has good long-term growth prospects does not mean it is worth absolutely anything.
Take Amazon, for example. It was one of the pioneers of online retailing, and remains the best brand in that industry. I’d be surprised if there was a single reader of this magazine who wasn’t also an Amazon customer. Its latest figures were terrific: sales were ahead by 16% and profits were ahead by 39%. No doubt it will have a great Christmas. Even so, its share price has gone crazy. They have jumped from $25 a share in 2005 to $170 now. It is trading on multiple of 69 historic earnings, and 49 times the forecast earnings for next year.
Or take Apple. Sure, the iPhone is a big hit, and the iPad has been making a lot of noise. In the last five years it has got just about everything right, and there is probably no other business around that has so many devoted customers. Even so, there must be a limit to what it is worth. The shares are up by more than 50% this year alone. With a market cap of $290 billion, it is the second most valuable American business. It is the third most valuable company in the world, after Exxon Mobil and PetroChina. This, remember, is a company which, while it dominates the market for MP3 players, currently has just 4.1% of the mobile phone market, and slightly over 5% of the global market for personal computers. Those are hardly dominant market positions – but you would hardly guess that from its share price.
Much the same could be said of Google, or Facebook, or many smaller technology companies. They are good businesses, in a fast-growing sector of the economy. But they are also hitting crazy prices.
The trouble is, all the old problems with technology and internet companies remain.
For starters, there are still far too few barriers to entry. The days when a few bright Harvard students could start a website that would blow apart the industry, in the way that Mark Zuckerberg did when he started Facebook in 2004, may be over. Then again, they may not be. This is still an industry in its infancy. It is very easy for a few bright people to turn the web upside down with very little money to play with. That is great for them, and it is what makes high-tech so exciting. But is it very worrying for shareholders in the established companies. It is just too easy for a young entrepreneur to come along and blow you away.
Next, there are still relatively few sustainable business models. The online retailers make money, but often only by squeezing their suppliers to the bone. The internet is the most ruthless price comparison device ever invented, and one consequence of that is that margins will always be wafer thin. Businesses like Google may have a great advertising franchise right now – but there is no limit to ad space on the web in the way there is in the physical world. In truth, all online business models remain very flimsy.
Lastly, the technology moves so fast it is very hard for shareholders to make money. The founders and the venture capitalists who back them usually do pretty well. But by the time a company gets to the quoted market, its best days may already be behind it. It may never get to the stage of paying out steady dividends. Even Microsoft only paid its first dividend in 2003. Neither Google or Amazon have ever paid a dividend, nor are they planning to do so. By the time they do, they will probably look as far past their sell-by date as Microsoft does.
In reality, the tech rally looks overdone. It is bound to come shuddering down to earth again some time soon. And when it happens, it may well prove a trigger for a wider market correction.
Monday, 1 November 2010
How To Fix The British Economy...
In my Money Week column this week, I've been looking at how to get the British economy growing again. Here's a taster....
After the cuts, the growth story. Addressing the Confederation of British Industry in Birmingham at the start of the week the Prime Minister David Cameron tried to sound a more optimistic note on the economy. It wasn’t just going to be about slashing benefits, closing down theatres and arts centres, and making everyone work until they are ninety-five. The economy would soon be expanding again.
That is surely right. The U.K. can’t simply cut its way out of a budget deficit of 11% of GDP, the highest in out peace-time history. It needs to start growing again, and at a faster rate than it did in the last decade.
Unless tax revenues rise, and jobs are created to replace those lost in the public sector, the books are never going to be balanced again. Rising unemployment and collapsing firms will mean that tax revenues keep on going down. Very quickly you get into a vicious circle of cutting spending, leading to lower tax receipts, which means even more cuts. Only growth is the way to break out of that.
But how? In fact, there are plenty of good places to start. Cut corporation tax to encourage investment: reform welfare aggressively to increase the labour force: deregulate those industries that are still too protected: and create tax-free zones in those areas of the country where the state has crowded out the private sector.
There is no reason why the economy shouldn’t expand at the same time as the budget deficit is bought under control. Despite the simplistic Keynesianism that seems to have gripped much of the media, it is perfectly possible for economies to expand at the same time that the government is reducing its spending. There are two reasons for that. The government doesn’t create any money itself, it merely takes it from other people, either by taxing them, or by borrowing it from them. So its spending decreases demand as much as it increases it. Next, as government gets smaller, there are more resources for the private sector to exploit. As a general rule, the smaller the state is, the faster an economy can grow,
Indeed, the last time the UK embarked on significant spending cuts – under John Major’s government in the early to mid-1990s – the UK grew at an impressive rate, and plenty of new jobs were created. Two million jobs were created under the Major government of 1992-1997, which more than made up for the 700,000 jobs that were cut out of the public sector. Under Mrs Thatcher’s Tory government of the 1980s, the experience was similar: after the peak of the recession or the early 1980s, 2.97 million new jobs were created by 1990, which more than made up for the two million lost in manufacturing. There is no reason to suppose the UK can’t repeat that experience in the coming decade.
But it isn’t going to happen by magic.
You can expect to hear a lot of waffle from the government about boosting infrastructure spending, encouraging more lending to small business, promoting investment in green technologies, and cracking down on short-termism in the City. Most of it is nonsense. The Government has no idea which ‘green technologies’ will work in the future, and whether this country has any real competitive advantage in any of them. People have been fretting about the short-termism of the financial markets since Victorian times without ever finding a realistic way of doing anything about it. Nor does the government have any idea whether the banks should be lending more to small businesses, and if so, which ones.
In fact, the steps the government should take to get growth going again are far simpler. Here are four good places to start.
One, cut corporation tax. In Ireland, a 12.5% corporate tax rate made the country a magnet for investment from all around the world. It could do the same for the UK. Over the coming few years, dozens of ambitious new companies are going to be emerging out of the fast-growing economies of Brazil, China, India and Russia. Just as the Japanese did a generation ago, they will be looking for a base to expand into Europe. Britain should be the natural destination for them, as it was for the Japanese. But it won’t happen unless there is plenty of incentive for them to come here – and a low tax rates trumps just about everything else.
Two, reform welfare aggressively. The huge numbers of Polish immigrants who came to this country and found work in the last decade tells us the UK can easily create jobs for people that want them. There is no easier way of boosting growth than increasing the employment rate; GDP, remember, is just output per worker, multiplied by the numbers of workers. If you can move some of the roughly five million people now living in benefits into jobs, you not only save on their welfare cheques, you also boost the economy. That is what reforming welfare can achieve.
Three, deregulate protected parts of the economy. The Thatcher government of the 1980s freed up the economy to generate growth – mostly notably through privatisations.. This government should do the same. The most obvious candidate is land and building. It's virtually impossible to build anything, particularly in the South-East, which is one reason we have, for example, a relatively small tourist industry Make it easier to get permission for new buildings, and the jobs will follow.
Finally, create tax-free zones. Big parts of the UK - Wales, the North-East,
Northern Ireland - have reached Soviet levels of state dependency. The public
sector has crowded out any kind of private economy. Nothing can grow when the
state accounts for 60% or more of GDP. But just slashing state spending won't
work by itself. Instead, create virtually tax-free zones to encourage the
private sector to move into those areas as spending is cut.
Growth is not about picking winners, or choosing which sectors of the economy to promote. No one really has any idea, and least of all the government. But if it frees up space for entrepreneurs, the economy will respond – it has in the past, and it will do so again.
After the cuts, the growth story. Addressing the Confederation of British Industry in Birmingham at the start of the week the Prime Minister David Cameron tried to sound a more optimistic note on the economy. It wasn’t just going to be about slashing benefits, closing down theatres and arts centres, and making everyone work until they are ninety-five. The economy would soon be expanding again.
That is surely right. The U.K. can’t simply cut its way out of a budget deficit of 11% of GDP, the highest in out peace-time history. It needs to start growing again, and at a faster rate than it did in the last decade.
Unless tax revenues rise, and jobs are created to replace those lost in the public sector, the books are never going to be balanced again. Rising unemployment and collapsing firms will mean that tax revenues keep on going down. Very quickly you get into a vicious circle of cutting spending, leading to lower tax receipts, which means even more cuts. Only growth is the way to break out of that.
But how? In fact, there are plenty of good places to start. Cut corporation tax to encourage investment: reform welfare aggressively to increase the labour force: deregulate those industries that are still too protected: and create tax-free zones in those areas of the country where the state has crowded out the private sector.
There is no reason why the economy shouldn’t expand at the same time as the budget deficit is bought under control. Despite the simplistic Keynesianism that seems to have gripped much of the media, it is perfectly possible for economies to expand at the same time that the government is reducing its spending. There are two reasons for that. The government doesn’t create any money itself, it merely takes it from other people, either by taxing them, or by borrowing it from them. So its spending decreases demand as much as it increases it. Next, as government gets smaller, there are more resources for the private sector to exploit. As a general rule, the smaller the state is, the faster an economy can grow,
Indeed, the last time the UK embarked on significant spending cuts – under John Major’s government in the early to mid-1990s – the UK grew at an impressive rate, and plenty of new jobs were created. Two million jobs were created under the Major government of 1992-1997, which more than made up for the 700,000 jobs that were cut out of the public sector. Under Mrs Thatcher’s Tory government of the 1980s, the experience was similar: after the peak of the recession or the early 1980s, 2.97 million new jobs were created by 1990, which more than made up for the two million lost in manufacturing. There is no reason to suppose the UK can’t repeat that experience in the coming decade.
But it isn’t going to happen by magic.
You can expect to hear a lot of waffle from the government about boosting infrastructure spending, encouraging more lending to small business, promoting investment in green technologies, and cracking down on short-termism in the City. Most of it is nonsense. The Government has no idea which ‘green technologies’ will work in the future, and whether this country has any real competitive advantage in any of them. People have been fretting about the short-termism of the financial markets since Victorian times without ever finding a realistic way of doing anything about it. Nor does the government have any idea whether the banks should be lending more to small businesses, and if so, which ones.
In fact, the steps the government should take to get growth going again are far simpler. Here are four good places to start.
One, cut corporation tax. In Ireland, a 12.5% corporate tax rate made the country a magnet for investment from all around the world. It could do the same for the UK. Over the coming few years, dozens of ambitious new companies are going to be emerging out of the fast-growing economies of Brazil, China, India and Russia. Just as the Japanese did a generation ago, they will be looking for a base to expand into Europe. Britain should be the natural destination for them, as it was for the Japanese. But it won’t happen unless there is plenty of incentive for them to come here – and a low tax rates trumps just about everything else.
Two, reform welfare aggressively. The huge numbers of Polish immigrants who came to this country and found work in the last decade tells us the UK can easily create jobs for people that want them. There is no easier way of boosting growth than increasing the employment rate; GDP, remember, is just output per worker, multiplied by the numbers of workers. If you can move some of the roughly five million people now living in benefits into jobs, you not only save on their welfare cheques, you also boost the economy. That is what reforming welfare can achieve.
Three, deregulate protected parts of the economy. The Thatcher government of the 1980s freed up the economy to generate growth – mostly notably through privatisations.. This government should do the same. The most obvious candidate is land and building. It's virtually impossible to build anything, particularly in the South-East, which is one reason we have, for example, a relatively small tourist industry Make it easier to get permission for new buildings, and the jobs will follow.
Finally, create tax-free zones. Big parts of the UK - Wales, the North-East,
Northern Ireland - have reached Soviet levels of state dependency. The public
sector has crowded out any kind of private economy. Nothing can grow when the
state accounts for 60% or more of GDP. But just slashing state spending won't
work by itself. Instead, create virtually tax-free zones to encourage the
private sector to move into those areas as spending is cut.
Growth is not about picking winners, or choosing which sectors of the economy to promote. No one really has any idea, and least of all the government. But if it frees up space for entrepreneurs, the economy will respond – it has in the past, and it will do so again.
Monday, 27 September 2010
Lay Off Vodafone.
In my Money Week column this week, I've been looking at how the City is constantly attacking Vodafone. Here is a taster...
What’s the most successful British company of the last twenty years? Tesco would be a contender, but it is still a marginal force outside of Britain, and lags Wal-Mart and Carrefour in the global retail market. Royal Bank of Scotland would have been a possibility until Sir Fred Goodwin blew the whole bank up. GlaxoSmithKline has been treading water since its 1980s to early 1990s heyday.
In fact the answer is easy. Vodafone.
The telecoms conglomerate has 347 million subscribers, and runs the largest mobile network in the world, measured by revenues, even if it is slightly behind China Mobile in terms of its total customer base. It operates networks in 31 countries, and has partners in another 44. Not bad for a company which three decades ago was just a small unit of the long-since forgotten Racal.
And yet you would hardly guess that from the way the City treats the business. The share price is beaten up. The chief executive Vittorio Colao is under constant pressure to dispose of assets. There is an endless stream of stories about how he should be selling his businesses in the US, or France, or somewhere else. Demands are tabled for special dividends and share buy-backs.
It is crazy – and an illustration of the City’s short-termism at its most destructive. There are plenty of criticisms that can justifiably be made of Vodafone. And yet the mobile industry is still in its infancy. Its play for global dominance may yet pay off. It may be able to take full control of units it holds minority stakes in. The City should be supporting once of the UK’s few industrial leaders, not trying to tear it apart.
The last week has seen yet another round of pressure on Colao to dismantle the empire that his predecessor Sir Chris Gent so expensively put together at the turn of the last decade. The company’s $6.5 billion stake in China Mobile was sold off, amid pressure for divestments. The 45% that it owns in Verizon Wireless, the largest mobile network in the US, is constantly under review. So to is the 44% stake it owns in the French operator SFR, of which Vivendi owns the other half. The 25% stake in Poland’s biggest mobile operator Polkomtel could be on the block. One shareholder group to lobby for the break-up of the business has been active since 2007. The demand for deals to boost shareholder returns builds all the time.
Some of the criticism is fair. Amid the telecoms bubble of the late 1990s, the company spent almost £200 billion on acquisitions. The $175 billion it paid for Germany’s Mannesmann remains one of the largest hostile takeovers ever attempted in Western Europe. Of the largest fifty deals of all time, Vodafone was a party to three of them. Shareholders didn’t see much of a return for all that frantic, and expensive, activity. Spending £200 billion only produced a company worth £85 billion today: not a great return, even if much of the money was in shares rather than cash. The share price has perked up this year – its dividend is one of the most generous and safest on the London market – but at just over 160p is still a long way short of the 444p it reached in March 2000.
But so what? All that is ancient history. The fact remains that whilst it may have over-paid for its acquisitions, Vodafone is today an industrial giant. No other mobile company comes close to its reach and scale in the mobile market: China Mobile may have more customers, but it doesn’t have anything like the same global reach.
There is still a good chance that its ambitions may pay off one day. No one knows precisely how the mobile industry will develop. It is, in truth, still in its infancy. It may end up destroying fixed line networks. It may merge with the computing and social networking industries. It may develop into something completely different. Whether having a global presence, in the way that Vodafone does, will pay off remains to be seen. It’s a gamble. But it is hardly a foolish one. Being the biggest gives you muscle in a market. It doesn’t guarantee success – there are plenty of big companies that completely mess up – but it’s a good place to be starting from.
Many of its minority stakes are frustrating. It hasn’t received any dividend on its Verizon shares since 2005: the two companies appear locked in a stand-off that makes the War of the Roses seem amicable and straightforward by comparison. Vivendi shows no interest in selling Vodafone majority control of the French operation they share. In some countries, it has already abandoned its ambitions. In Japan, for example, it sold out in 2006 after years of making little headway in one of the world’s most competitive, and technologically advanced, telecoms business.
But is still crazy to pressurize the company to sell out of successful businesses in France, Poland, and most crucially the US. It may be a long struggle to get control of Verizon. But the prize is surely worth having. Likewise, it doesn’t make much sense to sell out of the Polish market, which must surely have some of the best growth prospects in Europe. It may not have complete control of that business. But who is to say it won’t be able to win it one day.
Mobile telecoms is one of the world’s most lucrative and innovative consumer industries. For the UK to have the global leader is a remarkable achievement. It is an indictment of the City that it only wants to rip that apart – and can’t seem to see any virtue in supporting the company. The German stock market doesn’t try and break-up its most successful business, and neither does the Swiss or the Japanese. The London market should be more worried about supporting the country’s few world-class companies – and should spend a lot less time thinking about where the next deal is coming from.
What’s the most successful British company of the last twenty years? Tesco would be a contender, but it is still a marginal force outside of Britain, and lags Wal-Mart and Carrefour in the global retail market. Royal Bank of Scotland would have been a possibility until Sir Fred Goodwin blew the whole bank up. GlaxoSmithKline has been treading water since its 1980s to early 1990s heyday.
In fact the answer is easy. Vodafone.
The telecoms conglomerate has 347 million subscribers, and runs the largest mobile network in the world, measured by revenues, even if it is slightly behind China Mobile in terms of its total customer base. It operates networks in 31 countries, and has partners in another 44. Not bad for a company which three decades ago was just a small unit of the long-since forgotten Racal.
And yet you would hardly guess that from the way the City treats the business. The share price is beaten up. The chief executive Vittorio Colao is under constant pressure to dispose of assets. There is an endless stream of stories about how he should be selling his businesses in the US, or France, or somewhere else. Demands are tabled for special dividends and share buy-backs.
It is crazy – and an illustration of the City’s short-termism at its most destructive. There are plenty of criticisms that can justifiably be made of Vodafone. And yet the mobile industry is still in its infancy. Its play for global dominance may yet pay off. It may be able to take full control of units it holds minority stakes in. The City should be supporting once of the UK’s few industrial leaders, not trying to tear it apart.
The last week has seen yet another round of pressure on Colao to dismantle the empire that his predecessor Sir Chris Gent so expensively put together at the turn of the last decade. The company’s $6.5 billion stake in China Mobile was sold off, amid pressure for divestments. The 45% that it owns in Verizon Wireless, the largest mobile network in the US, is constantly under review. So to is the 44% stake it owns in the French operator SFR, of which Vivendi owns the other half. The 25% stake in Poland’s biggest mobile operator Polkomtel could be on the block. One shareholder group to lobby for the break-up of the business has been active since 2007. The demand for deals to boost shareholder returns builds all the time.
Some of the criticism is fair. Amid the telecoms bubble of the late 1990s, the company spent almost £200 billion on acquisitions. The $175 billion it paid for Germany’s Mannesmann remains one of the largest hostile takeovers ever attempted in Western Europe. Of the largest fifty deals of all time, Vodafone was a party to three of them. Shareholders didn’t see much of a return for all that frantic, and expensive, activity. Spending £200 billion only produced a company worth £85 billion today: not a great return, even if much of the money was in shares rather than cash. The share price has perked up this year – its dividend is one of the most generous and safest on the London market – but at just over 160p is still a long way short of the 444p it reached in March 2000.
But so what? All that is ancient history. The fact remains that whilst it may have over-paid for its acquisitions, Vodafone is today an industrial giant. No other mobile company comes close to its reach and scale in the mobile market: China Mobile may have more customers, but it doesn’t have anything like the same global reach.
There is still a good chance that its ambitions may pay off one day. No one knows precisely how the mobile industry will develop. It is, in truth, still in its infancy. It may end up destroying fixed line networks. It may merge with the computing and social networking industries. It may develop into something completely different. Whether having a global presence, in the way that Vodafone does, will pay off remains to be seen. It’s a gamble. But it is hardly a foolish one. Being the biggest gives you muscle in a market. It doesn’t guarantee success – there are plenty of big companies that completely mess up – but it’s a good place to be starting from.
Many of its minority stakes are frustrating. It hasn’t received any dividend on its Verizon shares since 2005: the two companies appear locked in a stand-off that makes the War of the Roses seem amicable and straightforward by comparison. Vivendi shows no interest in selling Vodafone majority control of the French operation they share. In some countries, it has already abandoned its ambitions. In Japan, for example, it sold out in 2006 after years of making little headway in one of the world’s most competitive, and technologically advanced, telecoms business.
But is still crazy to pressurize the company to sell out of successful businesses in France, Poland, and most crucially the US. It may be a long struggle to get control of Verizon. But the prize is surely worth having. Likewise, it doesn’t make much sense to sell out of the Polish market, which must surely have some of the best growth prospects in Europe. It may not have complete control of that business. But who is to say it won’t be able to win it one day.
Mobile telecoms is one of the world’s most lucrative and innovative consumer industries. For the UK to have the global leader is a remarkable achievement. It is an indictment of the City that it only wants to rip that apart – and can’t seem to see any virtue in supporting the company. The German stock market doesn’t try and break-up its most successful business, and neither does the Swiss or the Japanese. The London market should be more worried about supporting the country’s few world-class companies – and should spend a lot less time thinking about where the next deal is coming from.
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