What Would Happen To The Markets If Mobiles Did Give You Cancer?

In my Money Week column this week I've been looking at what it would mean for the markets if mobiles did give you cancer. Here's a taster....

There is no shortage of stuff out there to make investors feel nervous. The euro could get blown apart if a long hot summer of protest in Greece and Spain boils over into civil unrest. The Chinese economy might suddenly turn down, removing just about the only source of global growth. Inflation might suddenly rip out of control, provoking central banks to sharply raise interest rates.
But there is one risk that most people probably haven’t thought about at all.
What if mobiles really do give you can cancer?
Speculation of a link between cellular technology and brain diseases has been running for a decade or more. But last week the World Health Organisation said its latest studies suggested there was a possible link between talking on your mobile and cancer.
Leave aside the medical implications for a second – although there are serious enough. This is a huge issue for the markets as well. Just think about the hundreds of billions of investment now tied up in keeping everyone texting and talking on their phones all day. From the operators, to the equipment suppliers to the handset manufacturers, to the computer and software industries, many of the largest companies in the world could be devastated if a meaningful link was ever proved.
Mobile technology has the potential to be another tobacco – a huge and powerful industry that was just about destroyed by the unfortunate fact that it killed people.
Of course, there is still no proven link between mobiles and brain disease. The WHO is not claiming that there is. It’s International Agency for Research on Cancer gathered together 31 experts to meeting in Lyon last week to review the available evidence. It concluded that there was ‘a possible’ link between mobiles and a type of cancer called glioma. The WHO has five rankings of cancer risk, ranging from ‘carcinogenic’ to ‘probably not carcinogenic’. The ‘possible’ ranking is right in the middle of the range. So it is not saying it is definite. And it isn’t ruling it our either.
For anyone tracking the industry, that isn’t particularly helpful. Lots of studies have been done of potential links to cancer, and none of them have been very conclusive so far. Mobiles appear to have some health impact. Against that, there has been no big increase in the rates of brain cancer in the twenty years or so since mobiles became a ubiquitous part of everyday life. And it is difficult for anyone to assess the data accurately because brain caner is a relatively rare condition, so there are not very many people to study.
But just because cancer rates haven’t taken off yet, it doesn’t mean they won’t. People were smoking heavily for a long time before the damage that tobacco does to your health became apparent. Asbestos was widely used in building for decades until the risks with that material were discovered. Right now, all that anyone can say is that there is some form of risk, which the medical experts will need to keep an eye on.
What we do know for certain is that if a link were ever proved, or were simply to move up from possible to probable, then the economic implications would be huge.
This is a massive industry. According to the International Telecommunication Union, there are now 5.3 billion mobile subscriptions. That is 77% of the world’s population. More than a billion handsets are being sold every year. Vast quantities of capital have been poured into building those networks. The rise of smartphones means that even more is being spent each year, and people are doing more, and spending more money on their phones. Tablet computers will only send those figures even higher.
On just about every major bourse, the big mobile players are among the leading companies. Vodafone – with a market value of £83 billion – is a giant of the FTSE. France Telecom, which owns Orange, is one of the largest businesses on the CAC-40. The world’s largest mobile operator, China Mobile, is one of the world’s biggest companies. Nokia may be struggling to re-invent itself, but it is still the world’s major handset manufacturer, and worth $25 billion. Much of the South Korean stock market depends on the mobile divisions of Samsung and LG. New players such as Taiwan’s HTC have soaring share prices (indeed, it recently overtook Nokia in value). And, of course, Apple, which is now critically dependent on its iPhone, is now the third biggest company in the world.
It doesn’t even stop there. Microsoft and Google have invested fortunes in creating mobile software divisions. Chips and other components manufacturers help sustain the commodities boom. Many retailers depend on the sales of phones. So do the new generation of app writers.
In short, mobiles have fuelled much of the growth of the world economy in the past decade. A cancer link would be an economic catastrophe as well as a medical one.
There is not a great deal investors can do about it. But they should be monitoring the medical data, and keeping up with the latest developments. And they should be preparing an exit strategy. If a link is ever decisively proved you don’t want to be holding the shares or bonds of any of the main players in the industry. You might no want to be holding equities full stop – the knock-on effects for the rest of the markets would be severe.
Meanwhile, don’t give up on some fairly old-fashioned technologies. Fixed-line operators such as British Telecom could be set for one of the greatest bounce backs of all time – and with the shares yielding 4%, it might be worth tucking a few of those away. If we all decide to get rid of our mobiles and start calling one another on the landline again, they will soar in value.

The Decline of the IPO....

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


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

The Decline of Home Ownership

In my Money Week column this week, I've been looking at the decline of home ownership, and what it means. Here's a taster....



There aren’t many things that everyone in the country can agree on. We’re not likely to win the Euro 2012 championship with Fabio Capello still in charge of the team perhaps. Possibly that Pippa Middleton has a stunning, er, figure. And, of course, that owning your own house is what everyone aspires to – and the bigger the house, and the smaller the mortgage, the better.
Except that now even that last one might have to be scratched from the list. After nearly half a century during which the British increasingly owned their own homes, and when home ownership has been held up as the summit of social aspiration, fewer of us now own the place we live in every year.
Home ownership is now falling sharply in the UK, as it is in the US as well. That trend is well-established, and likely to accelerate over the coming decade. For the financial services industry that has huge implications it has barely even begun to take on board yet. The banking and savings industry is largely built around helping people to own their own home, and allowing them to borrow money against it once they do. If that is no longer a mainstream aspiration, it will have to re-organise itself completely.
The decline in home ownership is already well-established. The peak in owner-occupation was reached all the way back in 2003, when it hit 70.9% of English households. Since then, it has been going down at a steady rate of about 0.5% a year, which has bought it down to 67.5% for 2010, the latest date for which numbers are available. Owner occupation is now back to the same levels it was in 1991, so in effect there has been no growth for 20 years.
Don’t expect that to change soon – if anything the trend is likely to accelerate.
For starters, government subsidies have been steadily withdrawn. You used to get tax relief on mortgage interest payments, so that in effect the government paid part of your mortgage for you. That was steadily withdrawn, and finally abolished about ten years ago. These days, steadily rising council taxes and stamp duties mean that far from subsidising home ownership, the government now actively penalises it.
Next, houses are still very expensive. The long-term figures suggest the average house should be worth 3.5 times the average salary. They are still way above that. One reason why people aren’t buying homes any more is that they are too expensive – and until that starts to change, owner occupation rates aren’t going to rise.
Thirdly, and most importantly, the days of easy debt are well and truly over. The housing boom was largely fuelled by borrowed money, but that too is now much harder to come by. In the UK, the average deposit on a first home is £26,000, a big sum when there are student debts to pay, and real wages are falling. Pushing owner-occupation levels up to 70%-plus was only really possible when there were 125% self-cert mortgages available – in other words by lending money to people who couldn’t really afford it. The banks are not going to be doing that again for a long time – and that means that ownership will be restricted to a narrower range of people.
Take all those three factors together, and it is hardly surprising that owning your own house is less popular than it used to be. Where the numbers will settle exactly, we don’t know yet. But it is not going to be anything like the levels we were used to.
So what does that mean for financial services? There are three big points.
First, mortgage lending is not going to be the dominant force it once was. Mortgages have been a huge industry in the UK, employing tens of thousands of brokers, advisers and solicitors. It has been the major revenue source for the High Street banks and the building societies. But lower home ownership means fewer new mortgages. It’s already happening. Back in 2001, 41% of households had a mortgage. It is already down to 35%, and on current trends it is going to keep on falling. There will be less business for everyone in the industry. A lot of those jobs are going to disappear, and the profits with them
Second, lending is going to be a lot harder. Banks won’t be able to dish out money against people’s houses the way they used to. Fewer people will own their house, and those that do will probably be higher up the income scale, and so won’t need credit the way younger, cash-strapped people do. A lot of the personal lending industry is going to vanish. That which remains will have to find new and smarter ways of judging whether people are a good credit risk or not – because they won’t simply be able to take a charge over people’s houses and threaten to take them it if they don’t pay.
Lastly, and perhaps most importantly, renting will be a huge growth industry. Just because home ownerships is in decline it doesn’t mean people are going to start sleeping rough. They’ll still be living in apartments and houses, it is just that other people will own them, and they’ll be paying rent instead of mortgages. There are already more people in private rented property than local authority or social housing. The buy-to-let sector, which took such a knock during the credit crunch, is going to bounce back strongly. New private rental corporations, owning huge numbers of properties, are going to start emerging. The banks will need to start lending to them. And many of the brokers will need to turn themselves into letting agents instead.
There will be opportunities as well as threats, just as there are with any big social change. The traditional building societies will be hit hardest: their entire business was about helping ordinary people onto the property ladder. But the whole financial services industry is going to be knocked – unless it finds a way to re-invent itself fast.

How to Make Money from Bank Bonuses.....

In my Money Week column this week, I've been looking at how you can make money from other people's bank bonuses. Here's a taster.

Warren Buffett once famously remarked that the airline industry, whilst making it far easier for people to get around the world, had burned just about all the capital investors had ever put into it. “As of 1992, in fact—though the picture would have improved since then—the money that had been made since the dawn of aviation by all of this country's airline companies was zero. Absolutely zero,” he wrote in one of his letters to his shareholders in the 1990s.
Buffett probably doesn’t feel quite the same way about investment banking – he did, after all, help out Goldman Sachs when it was short of cash during the credit crunch and made a lot of money on the deal. But his observation about airlines is just as true of the traders and dealmakers of London, New York and Zurich. The industry has made a fortune for the people working in it. The executives and traders have walked away with fortunes. But, as a general rule, the outside shareholders have been stuffed.
Now, however, that might be about to change. Under political pressure, banks such as Barclays Capital and Credit Suisse are abandoning big cash bonuses in favour of paying their staff in deferred shares, or in bonds linked to the share prices. Whether that makes the banks any safer remains to be seen. But it should be a great opportunity for investors. The one thing we know bankers are really good at is manipulating the price of financial assets. All you need to do is invest in the same piece of paper that bankers bonuses are being paid in, and you can be sure it will soar in price.
Barclays has been making the most noise about changing its bonus scheme. Chief executive Bob Diamond is said to be about to unveil a scheme that would pay his most senior staff in convertible bonds, known as cocos, rather than just giving them wheelbarrows full of cash. The bonds would be freely traded, but would automatically convert into equity if the bank’s capital ratios fell below a required level. The idea is a simple one. If the bank gets into trouble, and runs out of equity the way many banks did during the credit crunch, all those bonuses would be converted into shares.
Credit Suisse has also been forcing its bankers to have more of a stake in the bank. The bank has started paying a far higher proportion of its bonuses in shares, and staff will have to keep them locked up for four years before they can sell them. Other banks are reported to be considering similar schemes, paying bonuses either in shares or else in convertible bonds.
It’s not hard to see the sense in the idea. Whether big bonuses played the part in the financial crisis of 2008 that is popularly supposed is open to question. It’s possible that lax monetary policy and global trade imbalances played just as big a role. What is certainly true is that bonuses have made investment banking a rotten industry for outside investors. The banks may at times make obscene amounts of money for doing very little – but, rather like football clubs, it was the players who walked away with all the cash rather than the shareholders.
The long-term performance of most of the big banks has been terrible. UBS shares are no higher now than they were back in 1993. Morgan Stanley shares are no higher than they were in 1998. The star of the industry Goldman Sachs has been a money machine for its staff, but not nearly so lucrative for its owners. The shares are still down on the 2006 price, and the yield is less than 1%. As a general rule, the people who actually own the businesses have missed out on all the money the industry makes.
No great surprise about that. There was no real need to share the spoils with the shareholders. For much of the last decade, investment banks didn’t need to raise much fresh capital.
The new bonus schemes will change all that. One useful rule in economics is that if you provide people with a big incentive to hit a target, they will do so regardless of whether it makes much sense. A classic example was in Soviet Russia. The Kremlin leadership decided too many people were dying in Moscow’s hospitals. The doctors were told to cut deaths by 50%. So they chucked all the old people out into the streets. Naturally, they quickly died of cold, but deaths in hospitals fell by the required amount. The target was met.
Banks aren’t going to chuck out old people – apart from anything else, they don’t employ any. But they will, just like those Moscow doctors, do whatever they need to do to meet their target. The one thing that we know for sure bankers are very good at is manipulating the price of financial assets. If actually getting their hands on their bonus requires that the share price or its convertible bonds hit at a certain price in two, three, or four years times, then you can be certain that the entire energies of the bank will be dedicated to making sure it happens.
Whether that will actually make the bank stronger or more stable in the medium-term is open to question. The long-term performance of Barclays doesn’t really depend on its capital ratios. The Credit Suisse share prices may or may not be a good indicator of its underlying performance. But none of that will matter. If it is what needs to be done, it will be done.
It is a great opportunity for investors. Just wait until the bonus scheme is unveiled. When it is, look at what piece of paper needs to soar in price for the bankers to collect their bonus. Then fill your boots. The bank may well go bust a few years later – but you can be sure that your investment will pay off handsomely before that happens.

Ed Balls Will Be A Disaster

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

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

Predictions for 2011...

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

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

Why Ireland Should Follow Iceland

In my Money Week column this week, I've been looking at why Ireland should follow Iceland. Here's a taster...

A year ago, there was a joke in the City that went like this. “What’s the difference between Ireland and Iceland.? One letter and about six months.” But right now, you could turn that around, and make the punch line. “One letter, and a realistic economic policy.”
The Irish crisis goes from bad to worse. Despite making the deepest cuts to public spending imaginable, there is little sign of a durable economic recovery. Last week, the government raised the cost of the banking bail-out to 50 billion euros. Its deficit will amount to an eye-popping 32% of GDP this year.
In fact, the country should consider the Icelandic option instead. Go bust. Apologise to the rest of the world, but point out you can’t possibly pay all the debts your bankers ran up.
That is precisely what Iceland did. And despite the warnings of disaster, it is now looking in remarkably good shape. It is possible that the Irish, and indeed the rest of the world, have got it all wrong. You don’t have to bail out the bankers after all.
Two years ago, when the credit crunch hit, governments around the world bought into the idea that they had to rescue their banking system, no matter what the ultimate cost to the taxpayer. Lehman Brothers in the US was allowed to go under, but after that no significant bank was allowed to fail. In Britain, we rescued out Royal Bank of Scotland and Lloyds-HBOS. In France, BNP was helped out. Ireland was the most dramatic example. Its government was forced to bail out Anglo-Irish bank, Irish Nationwide, and others. On a worst-case scenario – and worst cases have a depressing way of coming true – the total bill for the rescues will come to 50 billion euros. The country has been close to bankrupted by the recklessness and irresponsibility of a small group of financiers. In other countries, the cost hasn’t been quite so horrendous, but taxpayers were still saddled with bills running into billions that will take a generation or more to pay off.
Only one country took an alternative route – Iceland. It is such a small place, and its bankers had run up such enormous liabilities, that it simply wasn’t feasible to keep all the Icelandic banks afloat. The country was bust.
The banks have successfully sold the argument that a country has to rescue its financial institutions when they run into trouble otherwise the whole nation will be ruined. The economy will collapse. The global markets will slam the door in your face. If the banks go down, so the argument goes, pretty soon we’ll all be living in caves again, scraping flints together to start a fire.
In fact, however, it turns out that a banking collapse isn’t so bad after all. In fact, Iceland is looking in remarkably good shape.
With some help from the IMF, the country is starting to recover. The economy will shrink by 1.9% this year but is forecast to grow by 3% in 2011. Interest rates are coming down again – the Icelandic central bank in September took interest rates down to 6.25%. Inflation is falling, and the Icelandic krona is rising again – it is up 17% against the euro this year. Capital controls, introduced during the emergency, are expected to start being lifted soon.
Despite all the warning of catastrophe, the country has survived and is putting itself back together again.
That isn’t to say it hasn’t suffered. Real incomes have fallen by about 20% since the financial collapse. Jobs have been lost on a huge scale, and savings wiped out. Ordinary people are angry enough about what happened to put the Prime Minister Geir Haarde, who presided overt the reckless expansion of the financial system, on trial for negligence.
But Iceland still functions. People still eat. The country has survived. By next year, it should start growing again. Modestly, no doubt, at first, but with a sharply devalued currency, and with credit starting to flow again, it should be able to pick itself up. It may be a surprisingly short time before it is allowed back into the global capital markets – after all, Russia defaulted on its debts amidst its financial crisis of 1998, but less than a decade later you could hardly move in Moscow for investment bankers looking for business. The financial markets don’t hold grudges. If you have money, they will do business with you.
So what lessons should we learn from the country’s experience?
Almost every government in the world has accepted the idea that they have to bail-out their banks if they run into trouble. But Iceland suggests it isn’t really true.
In fact, governments could simply protect domestic deposits. After that, they could just say they were very sorry, but there wasn’t enough money left to pay back all the debts the bankers had run up.
It would be better morally. Reckless, irresponsibly behaviour would not be rewarded. Bankers would have to think a lot harder about what risks they were taking, and what their consequences might be. And depositors would have to be a lot more careful about where they put their money, rather than just lazily assuming the government would pick up the tab for any losses.
And it would be better financially as well. Bad debts would get written off immediately, rather than remaining a millstone around the neck of the country for years to come.
Ireland is the most exposed country right now. The debts run up by its banks may well turn out to be quite literally unaffordable. But other countries should keep the Icelandic experience in mind next time a big bank gets into trouble.
It would be better just to let the banks collapse. So long as you protect domestic depositors, and keep the payment system working, it needn’t be the end of the world. Indeed, it may be well be quicker route to recovery the struggling for years to meet all the obligations run up by a handful of bankers.

Still Time To Break Up The Banks

In My Money Week column this week, I've been arguing there is still time to break up the banks. Here's a taster....


Nearly two years on from the collapse of Lehman Brothers, and there is still little sign of fundamental reform in the way the global banking industry works. In the US, President Obama has allowed the regulation of Wall Street to be watered down so much that it won’t make much difference. The Europeans have lost interest. And the banks have gone back to behaving pretty much exactly the same way they did before the crisis struck.
Despite that, the British should ignore the rest of the world. Even if no one else is prepared to attempt it, the UK should press on with splitting up its biggest banks. Britain is a relatively small economy. It simply can’t afford to shoulder the risk of another calamitous banking collapse – and should get on with doing something about it, even if no one else wants to.
In the immediate aftermath of the credit crunch there were plenty of calls for a radical break-up of the banks. We were constantly told that there would be no return to the wild risk-taking, the bonus culture, and the short-termism, that characterised the financial markets for much of the past decade.
But, two years on, there is plenty of evidence that everything has gone right back to the way it was. The banks are paying out big bonuses. They are trading in high-risk sovereign debt, even when it is obvious many of the countries whose paper they are buying are bust. They are expanding enthusiastically.
In the US, President Obama, last week ducked the challenge of serious change. The financial reform bill that emerged from Congress was watered down so much by the big banks and their lobbyists that it is not going to make any real difference to the way the industry works. Instead of prohibiting the big banks from trading derivative on their own account, and investing in hedge funds, it merely limited their ability to do so, and not very effectively either. The big Wall Street banks - Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley – have emerged two years after the credit crunch with an even tighter lock on the American capital markets.
Neither has the European Union done any better. It has proposed new legislation on the hedge funds and private equity funds, its two favourite targets. But since the hedge funds didn’t create the crisis, that is about as relevant as blaming our cricket team for the failure of our footballers to perform better at the World Cup. It simply misses the point. The Swiss central bank has talked about splitting up its two giant banking groups – UBS and Credit Suisse – but has so far failed to actually follow up its words with actions.
It would be easy for the UK to give up. If the rest of the world isn’t getting serious about financial reform, then it is hard for the one, smallish country to do it by itself. Easy, but wrong. In fact, the UK should press on with splitting up retail and investment banking.
The Chancellor George Osborne has already established a commission to study precisely that issue. We don’t yet know what it will conclude. But whatever the outcome, it is too risky for the UK to allow the City to carry on as before.
There is no reason to worry about the foreign banks. If JP Morgan, Deutsche Bank, or Credit Suisse want to have big offices in London that is fine. It doesn’t matter in the least to British taxpayers if they take wild and crazy risks. If they make money, they will have to pay taxes on the profits, either in corporation tax, or as income tax on the bonuses they pay to their staff. If they lose money, then it is American or German or Swiss taxpayers who will have to bail them out. For the British, that is a heads-we-win-tail-you-lose deal. There is nothing to complain about in that.
But the British banks are a different matter. As the Governor of the Bank of England Mervyn King put it in a speech: “If a bank is too big to fail then it is simply too big.”
True enough. The UK is a medium-sized economy, with an out-sized financial sector. RBS grew to be one of the biggest banks in the world, trading in every corner of the globe, but when it ran into trouble, it was the British government that had to pick up the bill.
It was affordable once – it won’t be affordable a second-time around.
Banks such as Barclays, mainly through its Barclays Capital division, and HSBC, are simply too big to be under-written by the British taxpayer.
The solution? Force them to split out their UK retail arms from their investment banking and global operations. When a bank fails, the risk to the UK economy comes from ordinary depositors losing their money. If an investment banking division, mainly trading derivatives on Wall Street or in Singapore, collapses, it doesn’t matter very much to the economy in Woking or Wigan.
Of course, the banks will fight it. The business model of collecting money from millions of ordinary depositors, then deploying all that capital in the world markets has worked very well. It has paid for a lot of bonuses. But the risks ultimately gets transferred to the taxpayer – and they are no longer sustainable.
The rest of the world may be ducking the challenge. It will be hard to be the only country demanding serious change. But the UK should stick to its guns. If the don’t like it, allow them to re-locate elsewhere. It would be better to allow one or two of the big UK banks to switch their headquarters to the US, or an offshore centre, than run the risk of another calamitous collapse.

Standing Up For British Business...

In my Money Week Column this week, I've been arguing that the British government needs to start learning how to stand up for British business. Here's a taster....


The rhetoric has been disgraceful. Over the last month, as oil spilled out into the Gulf of Mexico, President Barack Obama has been harassing and condemning BP as if the oil company had planned the spill from the start. The U.S.’s own role in creating the crisis – by completely refusing to control its own oil consumption, and by insisting that more of its energy is supplied from within its own territory – has been glossed over in a series of anti-foreigner tirades.
But the response hasn’t been much better. The Prime Minister David Cameron and the Foreign Secretary William Hague, have been about as firm as a lettuce caught in a thunderstorm.
In reality, the British government has completely forgotten how to stand up for British business. BP is the latest, and most glaring example, but it is far from the only one. Shell was treated disgracefully over its oil interests in Russia. Mining conglomerates such as RTZ are being picked on by the Australian government. Cadbury received precious little support when it was targeted for a hostile bid by Kraft. No one believes the UK has to embark on a French-style policy of economic nationalism. But it is worth recognizing that business and politics are increasingly intertwined. And the new coalition government should start re-learning the art of quietly helping this country’s companies.
BP hasn’t been called British Petroleum for years, but you wouldn’t know that from listening to Obama’s rhetoric over the past month. Of course, the spill in the Gulf of Mexico was a terrible accident, and the damage to the Gulf coastline a tragedy.
But it absurd to pin all the blame for this on BP, and it is deceitful to pretend that it is the fault of a foreign-owned company (particularly when BP happens to have as many American shareholders as it does British ones). In two respects, US policy is directly to blame. The Americans remain by far the largest oil consumers on the planet, both in total quantities and per capita – in case you were wondering, the US consumes 20 million barrels of oil a day, compared with the next biggest consumer, China, which manages to get by on 7.5 million barrels. On top of that, US policy in the last five years has been to source more of its oil from its own territory, rather than shipping the stuff in from countries that are a long way away, and which it doesn’t like very much.
If you want vast quantities of oil, and you want it from US territory, there is no point in complaining when the energy companies start drilling for the stuff in more and more environmentally sensitive areas. BP’s contractors shouldn’t have allowed the oil to spill. But it was the Americans who wanted them to drill there in the first place.
The British government, however, hasn’t been making those arguments. Nor, over the most of the last decade, has it been prepared to stand up for British companies.
The Anglo-Dutch oil giant Shell was largely driven out of its investments in the Russian energy industry by that country’s government, which was determine to re-claim control of the oil industry. Did the British government have anything to say about it? Not a word. The Australian government is proposing a punitive new tax on mining companies, which will hit hard British-based companies such as RTZ and Anglo-American. Has the UK protested about that? If so, not in public. When Cadbury was attempting to fend off the hostile bid from Kraft, the best the British government could manage was a few limp words from the them Industry minister Peter Mandelson. Why not call together the leading shareholders, and remind them that if this wasn’t a British company worth backing then it was hard to know what was? But it couldn’t even stop the state-owned Royal Bank of Scotland from lending money to Kraft. Crazy.
French-style national champions wouldn’t work in the UK. We don’t have the kind of industrial-financial elite that moves seamlessly between government and big business. But it is hard to imagine that France’s President, Nicolas Sarkozy, or the German Chancellor Angela Merkel would stand idly by and watch French or German companies get pushed around like that without having anything to say about it.
One problem, particularly with the last Labour government, was a cultural cringe. A generation of left-wing politicians felt uncomfortable with anything to do with big business. And they felt equally uncomfortable supporting anything with the word ‘British’ attached to it. Backing FTSE companies simply wasn’t the kind of thing they did.
Another issue was the divorce between big business and politics. Most of the political class are now full-time, career policy-makers. They move from university to research jobs, to Parliament, and then into government. Very few have had any experience of industry, or how tough it can be. They don’t know how industry works, or how government can help. That is as true of the Conservative Party as it is of Labour.
And yet, in reality, business is getting more and more political. Environmental pressures mean that in the developed markets, companies are likely to have to face more regulations, more legal fights, and more lobbying from campaign groups and governments. In the emerging markets, where just about all the growth will come from over the next decade, the boundaries between government and industry are wafer-thin. Sometimes they hardly exist at all.
British businesses deserve more help and support from the government. BP would be a good place to start. But regardless of what happens to the oil company over the next few weeks, the government should start re-learning the skill of getting behind British industry – because without strong, global companies, there is very little chance of the economy every recovering.

How To Break-Up The Euro....

In my Money Week column this week, I've been looking at how to break up the euro. Here's a taster....

There are two interesting questions to be asked about the euro right now. Does it have any chance of surviving in its current form? And, if not, how would you go about breaking up the single currency?
The euro can collapse in two ways. It can fall apart suddenly, overnight, in a chaotic scramble in which every country looks after itself. Or it can be split up in an orderly, organised way, in which the currency is slowly laid to rest, with the minimum possible disruption to the euro area’s economy. How? There are three ways. Germany could leave. You could create two euros, one for northern and one for southern Europe. Or, indeed, you could go back to the British proposal of the 1990s and have competing, parallel national currencies that would trade alongside the euro.
True, the euro might stagger on. It is too early to condemn the single currency to the lengthy list of failed monetary experiments. A sharp drop in the currency – and the markets are certainly doing their best at the moment to make sure that happens – might help the struggling, highly indebted members steady their economies for long enough to get their public finances back under control. The Germans might give up the habits of a generation and start spending rather than saving – and spend mostly on Greek and Spanish exports.
Who knows, miracles do happen – just not very often.
In reality, however, the experiment in joining Europe’s currencies together now looks doomed to failure. A system in which countries spend like crazy, run up massive public sector deficits, and then get someone else to pay the bill is plainly bonkers. The incentives are all wrong. Everyone has an interest in doing the crazy spending. No one has any incentive to do the bailing-out.
The euro could only work if you had strict limits on what governments could spend. The founders recognized that, and built it into the rules, but no one tried to enforce them. It is too late to fix that now. It is far better to recognize that, and think hard about breaking the currency up.
A chaotic, disorderly collapse wouldn’t help anyone. Greece could default, swiftly followed by Spain and Portugal. But terrible damage would be inflicted on the banks that were carrying their bonds on their books. The Germans could switch back to the deutschemark overnight – and the markets last month were briefly rocked by a conspiracy website that claimed to have pictures taken by a Deutsche Bank employee of the new German banknotes that had been secretly printed over a bank holiday weekend. But, either way, the markets would plunge. The impact on stock and bond prices would be finished, and could easily tip an already fragile global economy back into recession.
If the euro is finished, it would be far better to make sure it was quietly put to rest. So what are the options? Here are three to be thinking about.
First, Germany leaves. This option has been widely discussed in the markets ever since Morgan Stanley published a note on the possibility three months ago. It makes a lot of sense. One of the key problems with the euro is the overwhelming strength of the German economy compared with its neighbours. It is very hard for one of the weaker countries to leave to currency. All their debts are denominated in euros. If their currency collapsed, as it surely would, those debts would soar even higher. Capital would flee the country: in Greece, it already has. But Germany would have none of those problems. With its huge trade surplus and limited debts, it has one of the strongest balance sheets of any major country. Its new currency would soar in value. Investors would flock to it. Meanwhile, the euro-minus-Germany would sink sharply, as investors rightly worried who was going to pay all the bills. That would make it a lot easier for the highly-indebted countries to export their way out of trouble.
Second, create two euros, one for northern Europe, and one for southern. The key problem with the euro, as plenty of analysts have pointed out, is that it is not a natural currency area. The economies that make it up are too different. When the euro was launched, it was thought that sharing a currency would draw them together, but there has been very little sign of that happening. If anything, they have sailed even further apart. The solution? Create two euros. One would include Germany, France, the Benelux countries, Finland and Austria. The other would include Italy, Greece, Spain, Portugal, Cyprus and Malta. A few nations might be hard to place: Ireland, Slovenia and Slovakia don’t fit obviously into either camp. But they could be offered a choice. The southern currency would depreciate sharply against the northern, but otherwise all the advantages of having a currency that straddles several countries could be maintained. The two new currency areas, however, would be far more natural than the single old one.
Three, create parallel national currencies. When the euro was being debated in the 1990s, the British floated the idea of parallel currencies. You’d have the euro, and national currencies, and both would be accepted as legal tender in each of the member sates of the European Union. Companies and individuals could chose which currency they wanted to strike a deal in. Countries would get back most of the advantages of having their own currencies. They could devalue when they wanted to. But the euro would survive. Initially it would mainly be a currency for big business, the capital markets, and for tourists. But if the euro area economies did finally converge, the euro might gradually push out national currencies. The difference would be that it would happen naturally, when the market was ready, rather than being forced on economies that couldn’t cope.
None of the options, naturally enough, is painless. Each would involve sacrifices. But any of them would be preferable to letting the euro collapse amid chaos.

Apple Overtake Microsoft....

In my Money Week column this week, I've been looking at how Apple overtook Microsoft. Here's a taster....

For all the drama of BP’s attempts to cap the oil spill in the Gulf, and of the chaos within the euro area, by far the most significant business story of the last few months was something else completely: Apple overtaking Microsoft as the world’s largest technology company.
It is a remarkable feat, and a testament to the determination of Apple’s guiding spirit Steve Jobs. But it is something else as well – a lesson in some of the fundamental principles that govern business and the markets. Apple’s unlikely resurrection is a reminder that, in a free market, all monopolies are transient: that consumers are far better at breaking up dominant companies than any regulator; and that arrogance and hubris will always undo even the mightiest of industrial empires.
A decade ago, anyone suggesting Apple stood any chance of overtaking Microsoft would have been dismissed as a drivelling lunatic. You might as well suggest that the Socialist Worker Party would take control of Tunbridge Wells council, that ITV would decide to replace Coronation Street with a series of Greek dramas to educate its viewers, or that Manchester City would overtake United as the town’s leading football club (ah, well, maybe that one isn’t so crazy). It would be dismissed as completely ridiculous.
Apple might have been one of the founders of the personal computer industry when it launched the first in its range of low-cost, easy-to-operate home PC’s in the mid-1970s. But as it completed its first quarter-century, it had been boxed into a dead-end by Bill Gates’s Microsoft. It’s closed, exclusive systems were stuck in a niche, bought only by graphic designers and a few techie nerds. The mass market, and the business market in particular, bought Windows. True, the clunky software may well have driven everyone bonkers, but it was the industry standard, and that was all that counted.
Indeed, so powerful had Microsoft become that by the turn of the last decade, anti-trust regulators were laying into the company, trying to force it to stop bundling its products together. It appeared to many people a monopolist, the Standard Oil of the digital age – a company so powerful that it could extract huge profits from helpless consumers for decades to come unless broken apart by government.
That, of course, misses the point about a free market. The consumer is always the king. And, usually, the customer, is a long way ahead of the regulators. As Microsoft reached the zenith of its power, the information and computing market was fast moving on. Apple recaptured the high ground with the launch of the brilliantly designed iPod music player in 2001, followed by the iPhone in 2007, and, this year, the iPad. It sensed that the next wave of computing was about small, mobile devices, not big desk-top PCs, and captured that market with verve and aggression. Microsoft had some success with its Xbox games console, but apart from that it was stuck with its little-loved operating system, and the office software it sold with them. Expanding out of that market proved impossible. Ever heard of its Zune music player? Nope, me neither. It currently has a barely noticeable 2% market share.
No great surprise, then, that Apple stock has been climbing, whilst Microsoft’s has been falling. Last week, Apple’s market value tipped past $222 billion, nudging ahead of Microsoft’s for the first time. Apple is now the biggest technology company in the world, and, remarkably enough, the second-biggest company in the US, behind Exxon Mobil.
There are three lessons investors should draw from that remarkable transformation.
First, all monopolies are transient. They are a product of a particular time: there is something about the market, or the technology, or the state of the competition, that allows one company to become dominant. But those circumstances are usually very brief. Within a few years, the market will have changed, and the competition will have transformed itself. In reality, so long as the market is open to new players, we should worry about monopolies a lot less than we often do. More often than not, they will have fallen from dominance in a few years anyway.
Second, the consumer is a far more powerful regulator than any government agency. A decade ago, the regulators were getting ready to break-up Microsoft because they feared its dominance of the technology market was stifling new players. They wanted to smash it to pieces, the way John D. Rockefeller’s Standard Oil had been in 1911. But, as it turned out, customers did a far better job of that. They stopped automatically using Microsoft’s web browsers, they showed total indifference to its music players, and its search engines remain a well-kept secret outside of Seattle. The technology market of 2010 is far more diverse. Microsoft didn’t need to be broken up to achieve that.
Finally, arrogance and hubris will humble even the most mighty industrial empires. A decade ago, Microsoft might have looked the safest investment in the world: a virtual monopolist in the world’s fastest-growing industry. It controlled just about every desktop in the world. But it became lazy. It didn’t take much notice of the internet to start with, and it never got the hang of social networking. It didn’t catch onto the significance of music players, and for a long-time appeared to think mobile phones were a completely separate industry from computing. The lesson? Avoid companies at the zenith of their powers. Once you dominant an industry, usually the only way is down.
Apple no doubt will go the same way. The control it maintains over its software may well prove its undoing. Google and Facebook will be chipping away at its products. So too will dozens of newly-formed competitors. Its reign may prove even shorter-lived than Microsoft’s. Even so, its resurrection is a useful reminder that all monopolies are fleeting. And that investors should bear in mind that no company ever has a lock on any market, no matter how strong it might appear at one particular moment.

What Osborne's Emergency Budget Should Say....

In my Money Week column, I've been looking at what George Osborne's emergency budget on June 22nd. Here's a taster....

It’s not hard to sketch out the scene on June 22nd, when the new Chancellor George Osborne delivers his emergency budget on behalf of the coalition government. He clears his throat, looks around the house, and announces. “Cripes! What a mess. We resign – and one of those Milliband’s can clear up the mess if they are so smart.”
Amusing, but unlikely. In reality, Osborne will have to deliver a set of measures that will define the new government. There are four priorities he should focus on: restoring honesty to the public finances: simplifying the tax system: making deep structural reforms to the way the UK economy operates: and kick-starting growth, even if that means taking some risks in the short-term.
It is a long time since a Conservative Chancellor delivered the first budget of a new Tory administration. The last one was Geoffrey Howe’s, delivered in June 1979, just after Margaret Thatcher was elected Prime Minister. Looking back, it was genuinely radical stuff. VAT was raised from 12.5% on luxuries , and 8% on most items, to a standard rate of 15%. The basic rate of income tax was cut from 33% to 30%, with a target of cutting it to 25%. And the top rate came down from 83% to 60%. Exchange controls were relaxed, and big cuts to public spending were announced. Later budgets by both Howe and his successor Nigel Lawson were probably just as radical. But the main thrust of the Thatcherite reconstruction of the British economy was all laid out in the first speech. It was a clear and decisive break with what had gone before.
Osborne should be no less bold. The UK can still escape from the perilous, near-bankrupt state that thirteen years of Gordon Brown have left it in, but it will require swift and decisive action. Here’s what he needs to do.
First, there needs to be complete honesty about the dire state of the public finances. The UK doesn’t just have one of the highest budget deficits in the world. It has hidden much of the waste and debt of the Brown years. What turned the markets against Greece was not just the scale of borrowing. It was the fact it had fiddled its figures for so long. A 10%-plus deficit might just prove sustainable, given how bad the debt figures are everywhere else. But if the bond markets get the sense they are being lied to, they will move in for the kill. The first task of the new Office for Budget Responsibility will be to root through all the quangos, the private finance initiatives, and the pension obligations, and come up with some meaningful analysis of what bills British taxpayers will have to meet over the next decade. Nothing other than brutal honesty will do.
Next, the tax system needs to be clinically simplified. Over the past thirteen years it has turned into a vast, Byzantine mess that does more to destroy wealth than either collect or re-distribute it. A few basic principles should be established. All taxes should be low, fair, and simple to collect. All taxes should be standardised, whether it is on income, or capital gains, or inheritances, to reduce the incentive to shift assets around. People and companies should be exempted from taxes instead of given allowances or benefits. It will be virtually impossible to reform the current tax system along those lines. Instead, repeal the entire thing, and create a new, simpler tax system from scratch.
Third, make structural reforms right away. Changes to the tax system can have a big impact on the way the economy works. But it will take time. Five years is a minimum, and quite possibly longer. A falling pound by itself isn’t going to revive British manufacturing. But creating tax-free zones for factories would work, particularly if you placed them in the regions that are going to be hardest hit by the cut in public spending (Wales, Scotland, Northern Ireland and the North-East). Encourage saving, with tax breaks if necessary, and make sure debt isn’t subsidised through the tax system. The UK needs to re-balance its economy from financial engineering towards industry, science, technology, media and manufacturing. A start has to be made on that in the first budget if any of the results are to be seen before the next election.
Finally, make a wager on growth. Howe’s budgets were deliberately deflationary. He had to beat inflation out of the system, as well as re-structuring the UK economy. Osborne doesn’t have that unenviable task. Inflation, though creeping worryingly higher, isn’t yet a big problem. Instead, this Tory-led coalition can borrow a trick from Ronald Reagan in the early 1980s. He pushed for radical, pro-enterprise tax cuts, even when he didn’t have the money to pay for them. The gamble was that growth would come through swiftly enough to keep the deficit under control. And he was proved right.
Osborne should try something similar. The UK can’t just cut its way out of this deficit – not without imposing huge pain on public services, for which there will be little political support. It can’t tax its way out either. Taxes are already at the upper limit of what can be raised: push them any higher, and you’ll just collect less revenue. Instead, it has to grow its way out of trouble. Big cuts in corporation tax – say to the 12.5% levied in Ireland – would be the best way to do that. Global companies would flock back to the UK. Follow that up with cuts to the top-rate of tax, and entrepreneurs would be re-motivated as well.
It would be a big risk, of course. But as Howe showed in 1979, this is no moment for caution. Osborne is only going to get one shot at a radical change of direction. And the one thing that is certain is that on its current path the UK economy faces years of austerity and decline – so there is little to be lost, and much gained, from trying to turn that around.

The Demise of London's Bling Economy....

In my Money Week column this week, I've been writing about how the sale of Harrods marks the deminse of London's bling economy. Here's a taster....

Money Week: Mohamed Al-Fayed Is Selling Out of Bling London. So Should You.

Mohamed Al-Fayed always said he’d never sell Harrods. It was the prize in his portfolio, the one asset he’d take to the grave with him. That, however, was before Qatar Holdings came along and offered him £1.5 billion for one of the world’s most famous shops. There aren’t many people who wouldn’t change their mind when that kind of money was on the table - and al-Fayed is not among them.
The Egyptian-born grocer has never been a popular figure in his adopted country. His brash, money-drenched lifestyle endeared him to no one. Turning a traditional British department store into something about as classy as a Dubai gift shop didn’t do his reputation any good. Nor did encouraging conspiracy theorists to focus on the Royal Family after his son Dodi died alongside Princess Diana.
But he has always been a brilliant street trader – and he has a street traders’ inner sense for when to buy and sell. From 1985 to 2010 he brilliantly rode the emergence of London as the headquarters of the ‘Bling Economy’. He knew how to mint a fortune from that more than almost any other entrepreneur. But now he almost certainly senses that era is coming to a close. There are plenty of bling assets on the London market. If al-Fayed is selling out, then so should you.
Fayed’s colourful career has always been rich fodder for conspiracy theorists. The acquisition of Harrods involved a long and bitter battle with another flamboyant tycoon, Tiny Rowland. He was immersed in controversy over his application for a British passport, as well as Princess Diana’s death. He made enemies everywhere.
None of that stopped him making money. He paid just over £600 million for Harrods back in 1985, and had taken out huge dividends in the years he has owned it. He owns the Ritz in Paris, as well as Fulham football club. Overall, his fortune is estimated at more than £600 million.
Plenty has been written about how he wants to spend less time on the business. And a lot has been said about how sovereign wealth funds such as Qatar Holdings are snapping up trophy assets at fancy prices. And while there is no doubt truth in both those points, the reality is that a man as smart as Al-Fayed, and with as keen an eye for what was cheap and what was expensive, wouldn’t be getting out now unless he felt it was the top of the market.
His talent was to see how London was changing. When he bought Harrods in 1985, the London economy was still emerging slowly from the gloom and depression of the 1970s. There hadn’t been any Big Bang in the City. Barrow boys still sold fruit and veg, not credit swaps and derivatives. The word non-dom didn’t mean anything. There weren’t any Russian billionaires – anyone in Russia interested in making money was more likely to end up in Siberia than the King’s Road. Getting credit still meant knowing your bank manager, and convincing him you wouldn’t fritter away any money he lent you.
Over the next quarter century, that changed dramatically. The ‘Bling Economy’ emerged, and London was its epicentre. The deregulated financial markets were minting millionaire by the minute. London became the tax-friendly home of half the Russian oligarchs and Middle Eastern oil sheiks. Everybody was piling up easy credit on their cards, with no meaningful checks on whether they were allowing their debts to spiral out of control.
Harrods was precisely the place to spend all that easy money. It was showy, snobby, expensive and tacky. In short, it was ‘Bling Central’ - a place to spend the money you hadn’t really earned, and didn’t mind wasting.
But in the next decade all those trends are likely to go into reverse.
First, there isn’t going to be nearly so much easy money around. The City may have returned to paying itself big bonuses. But, to use the markets own phase, it’s a dead-cat bounce. Over time, heavier regulation is gradually going to chip away at the fantastic way the financial markets pay themselves. On top of that, credit is going to be tighter across the whole of the developed world. People won’t be bashing the plastic the way they were. That is going to impact most heavily on companies selling luxuries and indulgences – such as Harrods.
Next, the non-doms are not going to be around in the same kind of numbers. As the UK goes though a massive fiscal crunch, a lot of extra tax revenue will have to be raised from somewhere. Rich foreigners are always going to be an easy target. Expect them to face higher and higher levies – which will prompt many of them to base themselves somewhere else.
Finally, the centre of economic gravity is moving east. Most of the Europe – and the UK is no exception – faces a decade of retrenchment as it tries to make its economy competitive once again. The money is moving to different centres – Mumbai, Shanghai, Hong Kong and Singapore. London isn’t going to be the centre of anything very much – and there won’t be a lot of money to be made from servicing its rich.
Harrods is just one example of the ‘Bling Economy’, although an emblematic one. The London market is full of companies that depend on wealthy foreigners. Think of upmarket department store chains such as Debenhams, Selfridges and Liberty. There are plenty of luxury goods companies such as Burberry. And there are dozens of retailers that depended on the easy availability of credit. They are all going to find business a lot tougher in the next decade.
There will still be money to made in the UK. But it will be done in a far more down-to-earth way. It will be engineers and exporters who make the fortunes – not retailers courting celebrities and the super-rich. Al-Fayed was smart enough to see that he’d had a good innings, but that the game had changed, and that now was the time to depart. Investors should follow that lead.

The German Economy Is Back....

In my Money Week column this week, I've been explaining why the German economy is back in Europe'd driving seat. Here's a taster....

In a few weeks time, with the World Cup underway, we’ll no doubt get used to Gary Lineker and Alan Hansen reminding us to ‘never underestimate the Germans’. It’s their stock phrase, as a relatively talentless team uses reserves of power, discipline and organisation to secure itself at least a place in the semi-finals.
Just as ‘Never underestimate the Germans’ is a good rule in football, so it’s not a bad one in economics either. After two decades of under-performance, as it absorbed the horrendous problems of the old eastern Germany, the country seemed to have lost its way. Unemployment soared, growth nosedived, and its confidence evaporated.
Now there are signs that it’s re-claiming its traditional role as Europe’s dominant economy. It is the most creditworthy country in the world. It is one of the few that isn’t burdened with massive consumer or corporate debts. During the Greek crisis, it has taken an assertive role, the one nation that got to call the shots. Over the next few years, Europe will have to get used to the Germans being the dominant force again. That may be no bad thing. The German model of capitalism – engineering-based, export-led, debt-averse – is one that the rest of the world might start to find appealing again in the coming decade.
After the Wirtschaftswunder – or economic miracle – of the 1950s and 1960s, we’d got used to Germany being the economic powerhouse of Europe. The deutschemark was the continent’s strongest currency – so much so that in the 1980s, the British and the French both took to shadowing it, as the only way of bringing inflation under control.
The last two decades, however, saw a steady, relentless decline. The integration of Eastern Germany after the fall of the Berlin Wall in 1989 proved far tougher than anyone expected. The euro disguised the strength of its currency. Frankfurt lost out to London as Europe’s main financial centre. Indeed, the Germans were never really cut out for the financially-driven, debt-fuelled, casino capitalism of the last ten years. They don’t like to borrow money, aren’t interested in owning their own homes, and don’t even think much of stock markets.
Indeed, so far had Germany fallen that only a few years ago, even the British could imagine themselves outstripping the Germans. In 2004 for example, the chief economic adviser to Barclays published a report predicting that the British economy would be larger than the German by 2025 despite their larger population. There was nothing fanciful about it. If you projected the growth numbers forwards, that was how it worked out.
Except that lines on a graph are a poor way of predicting anything. This decade, the Germans will be back, and in a big way. True, the economy was hard hit by the credit crunch (the economy shrunk by 5% in 2009). The sudden dip in world trade hit its export economy as suddenly as any, and some of its regional banks lost a bundle during the credit crunch.
But it has bounced back quickly. The economy is forecast to grow by a respectable 1.5% this year. Its corporate giants are powering ahead. Total net income at German companies that have reported earnings so far this quarter have almost tripled, compared with a 54 percent profit increase for Western Europe as a whole, according to Bloomberg figures. Industrial production is accelerating., and unemployment is falling fast.
The rapid emergence of the BRIC economies of Brazil, Russia, India and China has left most of the developed world scratching their heads and wondering how to earn a living. The Germans just get on with selling them more stuff. Exports to China are now rising by 13% annually, and to Brazil and India by more than 30% a year. Indeed, Germany is still tied with China as the world’s largest exporter. But while China mostly exports cheap stuff, churned out by worker on miniscule wages, the Germans export luxury cars, complex chemicals, and expensive machine tools, made by people on good salaries.
Indeed, looking forward, German seems far better placed than almost any other developed country. It has an export-based, manufacturing economy that sells the stuff the emerging economies need. It didn’t have a housing bubble, and its consumers, while never great spenders, aren’t burdened down by debts. McKinsey has measured the combined growth of corporate, consumer, and government debt from 2000 to 2008. In Germany, it only grew by 7% over the whole eight years, compared with 157% in the UK, 150% in Spain, and 70% in the US.
That’s nice for the German, obviously enough. They won’t be running out of beer and sausages any time soon. But it also matters for the rest of the world in two ways.
First, the Germans are likely to become much more dominant within the global economy. The more money you have, the more power. Germany can take the lead role in sorting out the mess in Greece because it will be paying for it. Expect the same to be true of every financial crisis that comes around in the next few years.
Next, successful countries set a template. In the last decade, everyone wanted to copy the Anglo-Saxon model. It’s debt-fuelled, de-regulated, financially driven model of economic growth appeared to be delivering results. In the next few years, the German model will become far more fashionable.
The reassertion of German values may be no bad thing. Rhineland capitalism is, in many ways, the most attractive way of doing business. It values thrift, hard work, saving, and making things. It believes in sound money, and is suspicious of inflation. It doesn’t have much time for deficit spending, and doesn’t believe you can cure a debt crisis with more debt.
The Germans – as they usually do – take it to extremes. But an injection of Teutonic economic sternness is probably precisely what the rest of the world could do with right now.

Vince As Chancellor? Arghhhh...

In my Money Week column this week, I've been explaining why Vince Cable would be a calamity as Chancellor. Here's a taster....

There is little doubt who most ordinary people would like to see as Chancellor after the election. Not the granite-faced Alistair Darling, and certainly not Gordon Brown’s mini-me, Ed Balls. Not George Osborne either. The Liberal Democrat’s Vince Cable would waltz to the top of any popularity poll.
For most of the last few years, there was as much chance of that happening as of Gordon Brown admitting he’d bankrupted the country. The Liberal Democrats didn’t have so much as a sniff of power. Saint Vince, the Sage of Twickenham, could pontificate in an amiable, genial manner, and everyone could say how marvellous he was, without ever having to worry for a single second that the man might actually get his hands on the battered red box come Budget day.
And now? In the space of a week, all that has changed. In the wake of the first televised debate between the three part leaders, Liberal Democrat support has surged. On Monday, one poll even gave the party the largest share of the vote. A hung parliament looks a real possibility, with Cable as Chancellor the price of Lib Dem support.
It would be an easy concession for either of the other parties to make. He’s popular and looks competent. But what are Cable’s policies, and what’s his record. So far it has escaped any real scrutiny. But take a look at what the man actually says, and it is either confused or ridiculous. He flip-flopped during the financial crisis, supported Brown’s reckless Keynesian public spending splurge, and has offered a muddled and platitudinous manifesto for the election.
At precisely the moment when the UK will run the risk of a meltdown in confidence in the capital markets, Cable is the very last person you would want to see as Chancellor. If he gets the job, man the lifeboats.
It’s not hard to understand why he’s popular. He has a genial, friendly manner. He talks human, unlike many politicians, and certainly much more than his two main opponents. He has a knack of taking difficult concepts and explaining then in ordinary English. For a country used to Brown’s impersonation of a mid-level Soviet bureaucrat reciting tractor production statistics it makes a refreshing change. There is a lot of pain ahead for the British economy before the economy is put back on an even keel. Cable has the knack of putting a human face on that.
The trouble is, his reputation is absurdly over-inflated.
Cable makes much of the fact that he forecast the financial crisis. In reality, the evidence is fairly scant. True, he made a few speeches warning about rising house prices and debt levels. He suggested a couple of times that Brown hadn’t really abolished boom’n’bust.
But he didn’t really say anything that the Conservatives, or the Bank of England Governor, or indeed dozens of financial pundits weren’t saying. Nor did he warn of the two main threats to be the British economy: Brown’s absurd regulatory regime which handed banking supervision over to the FSA, and meant we had a worse banking collapse than any other major country: or the massive build up of public spending that had so undermined our competitiveness. Indeed, his party went into the last election advocating even higher spending.
In response to the financial crisis, Cable flip-flopped all over the place. His policy on the banking crisis changed from one interview to another. At one point he opposed the policy of quantitative easing, then he supported. He backed Brown’s massive Keynesian splurge, then, with an apparently straight face, started warning everyone about the dangers of the deficit. Through all of those positions, you’ll search in vain for anything approaching coherence or consistency. The closer you look, the more Cable appears to be just mouthing off into the nearest Radio 4 microphone.
Worse, his manifesto pitch is dismally weak. The UK is facing its most serious economic challenges for a generation, and yet Cable is unable to offer anything more than platitudes.
Cable claims he is he is being honest about cutting the deficit. Yet his main proposal is cancelling the Trident nuclear missile system, which isn’t going to save money in the short-term. The rest he tells us it will be done by ‘closing loopholes’ in the tax system. But the draconian, bullying tactics of the Inland Revenue have already started driving companies out of the UK. Another clampdown is only going to make that even worse?
His proposals for tax reform are even stranger. Cable wants to raise the tax threshold to £10,000. Fair enough. It is indeed shocking that the someone struggling to make end meet on earnings of less than five figures should have to pay income tax. But how’s it paid for? More clampdowns on loopholes. And taxing capital gains at the same rate as income tax. There is something to be said for levelling all taxes. But a capital gains tax at 50%? Presumably the intention is drive every last remaining entrepreneur out of the country.
Meanwhile, his ideas for re-booting the British economy verge on the comical. One idea: Regional stock exchanges “without the heavy regulatory requirements of a London listing”. But the reason the Manchester and Liverpool exchanges withered was because no one really wanted them – the telephone meant it was just as easy to do business in London. And if regulation is any lighter, won’t they just be a playground for spivs and fraudsters? Haven’t we just been through enough financial scandals without creating more?
Most of the rest of the manifesto is taken up with fiddly initiatives to promote green investment. It’s just not serious. Britain is the fifth largest economy in the world. Even if we do become a world leader wind farms and solar panels – and we have a long way to go to overtake the Germans – it’s not going to make much difference.
There is nothing about the need to lower corporation tax to attract foreign investors. Nothing about protecting all the foreign currency the City brings into the country – just populist banker bashing. Nor is there any explanation of how joining the euro – still a Lib Dem plan - will stop us turning into another Greece. But then Cable isn’t really a serious politician. And if he does make it to Number 11 in early May, the currency markets will conclude the country isn’t serious about tackling its economy either.

Why Britain Needs More Banks....

In my Money Week column this week I've been discussing why Britain needs more banks. Here's a taster....

We may be used to Virgin planes, trains, health clubs, and the dozens of other ventures that the serial entrepreneur Richard Branson has launched over the years. But a Virgin Bank? Thanks to a £100 million investment by the American billionaire Wilbur Ross, we may end up as familiar with Virgin banks on the high street as we are with Barclays, Lloyds and HSBC.
It would be easy to portray that as a brave incursion into a toughly competitive market. No doubt that is the way Virgin formidable PR team will be spinning it if the new bank does get off the ground.
And yet, in truth, it is more interesting to look at it the other way around. What is striking is not that someone is finally attempting to launch a new bank, but that so few people have done so. Eighteen months after the credit crunch caused the near collapse of the British banking system, the old players are still firmly in control of the industry. And yet, these companies are widely disliked, distrusted, and they sell poorly designed products at rip-off prices. In any normal industry, they’d have been blown out of the water by dozens of entrepreneurs.
The fact they haven’t been suggests banking is still an over-protected oligopoly, with too many barriers too entry. Until that changes, we aren’t going to get a safer, better value financial system.
True, there is plenty of interest in launching new banks in the UK.
Virgin has already made tentative moves, buying one small bank to acquire a license. The money million from Wilbur Ross is earmarked for a bid for 318 Royal Bank of Scotland branches which are due to sold off: if successful, that will give it an immediate presence in the market.
Sandy Chen, a former Panmure Gordon analyst, had put together plans for a new bank called Walton & Co. Vernon Hill, another US entrepreneur, is launching a new venture called Metro Bank: it plans to open branches in South Kensington and London later this year, with plans for a network concentrated in the South-East of England. And, somewhat inevitably, Tesco is sniffing around the market, with plans to turn its existing financial services arm into a full-scale bank offering current accounts alongside the dog food and bananas.
They are, however, are fairly small-scale. Their impact on the mass market is likely to be limited. And yet, there can be few industries as wide open to new players as British banking. It isn’t hard to think of reasons why this should be a great time to launch a new bank.
For starters, the banks are widely disliked. They took crazy risks, went broke, got us all to bail them out, then went straight back to paying themselves vast bonuses. Even estate agents are more popular than bankers right now. Parking wardens could probably out-poll them. If people could punish the banks by switching their business elsewhere, then they surely would.
Next, their recklessness in the run up to the credit crunch has left many people wondering if their bank is really that safe. Two years ago, most people hardly gave a second thought to whether their money was safe with one of the High Street names. Now they are nervous of leaving big sums on deposit. They have blown most of the trust they once had. An airline that did that would expect to be in trouble: there is no reason why a bank should be any different.
Finally, the products were never that great anyway, but in the last two years they have got even worse. The banks have been busy repairing their battered balance sheets, and they have been doing so at the expense of the customer. Interest rates are at a record low of 0.5. But can you get a mortgage at that rate? Or a loan for your company. Forget it. In reality, they banks have been widening the spread between what they pay their depositors and what they charge for loans. It is a bad deal for both savers and borrowers.
In short, these are unpopular companies, that nobody trusts, offering a poor value stuff that often doesn’t do what it’s meant to – but it is still an essential product that everyone needs. If that isn’t an open goal for an entrepreneur, it is hard to know what is.
In a normal, properly functioning free market, you’d expect to see lots of new players getting into the business. In airlines, Ryanair blew up the old, established carrier. In autos, first the Japanese and now the Koreans took huge chunks of the market from the old European and American giants. Apple has just taken Nokia and Motorola apart in the mobile phone business. In most industries, old established players are constantly getting challenged by new entrants. Rubbish companies get replaced by better ones. That’s how capitalism works. So why not in banking?
Of course, there are some barriers to entry. It’s a lot of bother to change your bank account. There is a certain amount of inertia on the part of the consumer. It’s hard work to get people to feel safe putting money into a bank they have never heard of.
Even so, it is hard to escape the conclusion that this is still too difficult an industry to get into. The obstacle of acquiring a banking license, the burden of regulation, and the way that payment systems between the banks are organised, all mean it is hard for new players to get a toe-hold in the market. And it’s getting harder. Regulators are so nervous of a bank going under, they are making it tougher and tougher to break into the market.
In the wake of the credit crunch we heard a lot about how the system of financial regulation should be reformed. And yet, in reality, there are very few economic problems that can’t be fixed with a healthy blast of competition.
What the government and the regulators should be doing is making it as easy as possible for new players to get into the industry. Not just Virgin and Metro and Tesco: there should be dozen of new banks, all finding their own space in the marketplace. Only diversity and competition will make the system work better. And if there is one thing the regulators should be focussing on for the next ten years, it should be that.

How Risk Got Turned Upside Down...

In my Money Week column this week, I've been discussing how accepted ideas of financial risk are getting turned upside down. Here's a taster....

Every investor who has ever filled in one of those seemingly pointless ‘know your customer’ forms churned out by the bank or their stockbroker will be familiar with the way they have to tick a box describing their appetite for risk as high, low or medium.
We all think we know roughly what it means. Say you are low risk, and you’ll be offered some bank deposits, occasionally spiced up with a few gilts. But describe yourself as high-risk, and you’ll be offered a diet of Vietnamese software companies, Nigerian bonds, and Kazak yak hide futures.
That, however, is based on a spectrum of risk that is accepted right across the financial markets. At one end, there is a set of ‘safe’ investments: developed market equities, government debt, the dollar. At the other, there is all the flaky stuff: emerging markets, corporate bonds, commodities. How investors perceive and classify those different types of assets determines how money gets allocated around the world, and how much is charged for it. As a rough rule of thumb, the ‘safe’ assets get lots of money cheaply. The risky ones, much less, and have to pay more for it.
But what if that gets turned upside down? There is a good case to be made that everything the markets have traditionally thought about risk is about to become redundant. The flaky stuff has started to feel secure. The solid assets are looking a bit flimsy.
Let’s start with equities. Plenty of analysts have started to argue that the emerging markets are a lot safer right now than the traditional developed bourses. “While many Developed Markets are witnessing rapidly rising public debt, large fiscal deficits and slower growth, most top-tier Emerging Markets weathered the global crisis much better in terms of public-debt sustainability and the short to medium-term growth outlook,” argued Deutsche Bank in a research note this month.
Indeed so. The developing countries of Asia, Eastern Europe and Latin American look in far better shape than the old industrial giants of Europe and North America. Their economies are growing a lot faster. With the exception of Russia and parts of Eastern Europe, they have far better demographics. And they are in much better fiscal shape.
Of course, there are caveats. They have shallow and sometimes untrustworthy capital markets. They don’t have much in the way of experience. Nobody is sure if they trust the legal systems. Those are all reasons to be cautious. Still, it is looking increasingly odd to regard India as high-risk compared to Spain, or to view Vietnam as dodgier than Greece. On balance, there is a compelling argument that what’s risky has been turned upside down. Indeed, investors appear to have already recognised that, piling into the emerging markets far more enthusiastically than Europe or the US.
The same could soon happen to bonds. Government securities have always been regarded as safe, compared with corporate bonds. And the bigger and richer the country issuing them, the ‘safer’ they are rated.
But does that really make sense any more? Governments have run up massive debts, and show little sign of recognising the need to bring them back under control. Plenty of people are now reckoning in the prospect of default, either blatantly, or covertly through letting inflation rip. It’s certainly possible. Beyond about 100% of GDP it becomes virtually impossible for a government to pay off its debts either through growth or higher taxes, and plenty of governments are getting close to that. Some are way past it.
So who would you rather lend money to, BP or the British Government? One has tons of oil in the ground, and decades of experience of refining and distributing it. The other has a mass of liabilities, a spendthrift government, and a stagnant economy that is already taxed up to and beyond its ability to pay. In reality, corporate bonds may very soon look like a safer bet than government bonds.
How about currencies? The dollar has, for decades, been reckoned to be the most rock steady of safe assets, the ultimate haven. It was closely followed by the euro and the yen. And whilst those are all big currencies, backed by massive economies, it’s hard to believe they will be ‘safe’ over the next decade. The dollar and the yen suffer from massive fiscal deficits. With the growth of new economic powers, they will inevitably dwindle in importance. It is hard to see other currencies taking the place – not, at least, unless the Chinese decide to up the status of the yuan. But commodities could easily replace them. Gold would be the most obvious candidate. But oil could do the job just as well, or else a basket of industrial minerals.
The important point is that in every area of the markets, old ideas about risk are being turned upside down. That has two important implications.
The first is that is will change the price of everything. The riskier the investment, the higher the premium usually demanded to put money into it. So once your risk assessment changes, it follows the price of everything changes as well. Emerging markets will become more expensive than developed ones, corporate bonds pricier than government debt, and so on. As an investor, you don’t want to get caught on the wrong side of that shift.
Next, the flow of money changes as well. Traditionally, more money goes to the ‘safe’ assets, less to the ‘risky’ ones. So that is going to change as well. Everything we used to regard as risky will be drowning in cash. All the old ‘safe’ assets will be desperately short of it.
Once that trend gets established, it may well be unstoppable. And, by 2020, if you tick that box describing yourself as risk averse, you should expect your broker to offer you some Indonesian equities, some telecom bonds, and some oil futures – with, possibly, a few high-risk German government bonds or American equities thrown into the mix just to spice it up a bit.