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Whither Keynes?

July 29, 2010 Much has been talked about the impact of Keynesianism to our current predicament and I am a great Keynes fan. I might go to say as far as to say that Keynes is an honorable man. I come not to condemn but to praise him. At the time, Keynes was one of the few who stood out against the herd. His famous quote, “I suppose that they are such very plain men that the advantages of not spending money seem obvious to them.” At times, it is not right to cut spending which undoubtedly causes (some) unemployment and shaves potential tax receipts. Of course the debate is fought hard on both sides. Current ‘Keynesians’ would say that cutting bloated government deficits would lead to billions being made homeless; anti-spenders take the view that it will make people ‘get on their bikes’, to be ambitious and find work (as they do where there is no welfare state). The correct answer of course lies somewhere in between.

All we know is that decades of benevolent government, politicians hungry for power and easy money has led to everybody benefiting from government deficits. If we wanted to buy a car, we could afford a BMW rather than the Ford. We could buy a Breitling not a Seiko; and if we really pushed hard we could mortgage up to a four bedroom flat/house not a three bedroomed one. That is the difference that governments spending four dollars for every three that they raise has done to all of us. The apportionment of the slices of the big spending cake has not been even but at least the cake has got bigger.

The noughties are revisiting the thirties; “At the present time,” Keynes continued, “all governments have large deficits. They are nature’s remedy for preventing business losses from being … so great as to bring production altogether to a standstill.” Sadly, our modern-day deficits have been caused by too much spending in the good times on non-productive activities and even more in the bad!

The last Conservative-Liberal coalition in the UK in 1931 came out with a cutting budget that was generally regarded well. Keynes thought that the budget was injudicious. He wittily commented, “every person in this country of super-asinine propensities, everyone who hates social progress and loves deflation, feels that his hour has come and triumphantly announces how, by refraining from every form of economic activity, we can all become prosperous again.” Oink!

I am all in favour of a sensible government pump-priming the economy but we all know what happens to an engine if there is too much petrol. It won’t start. Adding more petrol to the situation may even cause a fire. We are not in a comfortable position today. There is too much petrol – in this case, too much liquidity. Central Banks have created so much liquidity through quantitative easing (what the papers call QE, which in Keynes’ day was a cruise liner) that budget deficits are enormous. There is no more cash, no more borrowing, no more liquidity available to pump-prime the economy.

Keynes was right but in a different time under different circumstances. He was a man for our times. He grabbed the low hanging fruit – the tree is now bare and cuts are not just the right policy but inevitable. More spending will be inflationary and may even lead to eventual attacks on counties, not just in South America or the Southern Mediterranean, but on the UK and – it is possible – the US.

We do not have an economic crisis, we have a financial crisis. It is an earthquake on Wall Street – not on Main Street. Main Street is able to handle cuts – in 1930, it could not.

Now is the time to act to cut deficits. Cuts are not nice, they may not even be considered successful but they may save us from secular meltdown. There is no more cash left to follow Keynes. Somewhere out there is the new Keynes but he will have to do without; not with the patrician hand of a benevolent government to help and hold a sagging economy.

I’ve solved the deficit problem

July 15, 2010 Simple and Efficient Government is the key. I met a young man a few weeks ago who was doing his summer tour of Asia. His last job had been handing out winter fuel payments to pensioners in Cardiff, Wales. The same people can be accessed through their old age pensions – as the conditions are the same, and pensions must be paid – why not add the heating allowance to the pension?

Such is government. The former Prime Minister, Gordon Brown, was very keen on handouts rather than a hand up, perhaps some said to increase people’s dependency on government (himself). So a huge government bureaucracy was developed to manage this. Efficient government will lead to a smaller private sector. The tax system, legal system, the military can all be refined from the grass roots to provide the same services at a lower cost.

There are naturally huge vested interests against such a move, not the least in the private sector. A wildly complex tax system such as in the UK or especially the US provides jobs for a plethora of private sector advisers. If you develop simpler government, they might have to get a real job.

Government by its nature is accretive. A few regulations lead to more as it is discovered that there are exceptions or additions to the rule. Excessive standards apply; so that in order to limit the access of a handful of paedophiles to children, a nation’s children’s activities are hamstrung by a lack of helpers as the licencing process for the leaders of these activities becomes excessively onerous. So we end up with a nation of bored, fat children.

Eventually laws passed in the eighteenth century are added to those of the nineteenth, twentieth and twenty-first centuries providing a mix of barely enforceable statutes. Root and branch reform of particular government systems is now required before we all disappear in a mass of bureaucracy.

The UK Conservative government is talking about this – but on the margin. It takes a brave politician to develop simple, efficient government and the lack of bravery will mean that the taxpayer will continue to pay an inflated price for his community services.

The ‘Swoosh-shaped’ recovery

June 13, 2010 Just do it! It has been apparent for a while that a double dip recession is inevitable. The ‘V’ shaped recovery, the ‘U’ shaped recovery, even the ‘W’ shaped recoveryhave all been discussed at length and latterly ignored as the recovery appeared to be going nicely. However, the most likely medium-term economic profile is the ‘swoosh’ or tick-shaped recovery, as illustrated by that famous sports brand, Nike.

The Wall Street financial crisis of 2007-8 has been transferred comprehensively to Downing Street as governments digested the consequences of bailing out the ailing banking system in 2008. The movement of debt from Wall Street onto the public books (also known as ‘Downing Street’) has not made the problem go away – merely shuffled the deck.

Main Street, which had been doing reasonably well prior to 2008, wasimmediately affected by the credit crunch but reacted quickly to avert an economic catastrophe by shedding labour and trimming inventory. Thisfooled many that the worst was over and that we seemed to be on the right track for many to believe that the recession was behind us.

Far from it; we are in the early stages of a second leg down. This time it is Downing Street which is likely to impact Main Street, but now the effect will be more significant and lasting. Crisis in the financial sector may be bad but crisis in Downing Street is worse as government spending is now such a high proportion of most developed Western economies.

The Europeans have woken up to the critical nature of their deficits. We have seen the largest budget deficit cut in sixty years in Germany of €86 billion by 2014. In Spain, the cuts announced were €24 billion immediately and of course the near implosion of the Greek budget is testament to the severity of the action necessary now and to come. After slashing £6 billion off the UK budget less than two weeks after gaining power Prime Minister David Cameron promised ‘pain’ – in the form of much bigger cuts. Such language has not been heard as a demand to the people since Churchill defied Hitler.

Europe may be in crisis at present but fiscal confidence in the US too will surely be tested by the markets. When the Battle of the Euro has reached a stalemate; the Battle of the Dollar will surely begin.

Government spending is roughly half of the size of the economy in most European states; and indeed if fully accounted, it would probably be similar in the Americas.As Cameron says, “the size of the public sector has got way out of line with the private sector”. A slashing of 20% off all budgets in the style of Canada, who cut 12% of the public workforce in 1995 in a ‘bloodbath budget’, is on the cards. Canada cut quickly and very deeply but growth returned after about a year – and Prime Minister Jean Chretien remained in power until 2003. As unemployment increases and the government spending decreases, so the consumption of goods and services will decline. A fall in consumptionwill certainly lead to a fall in economic growth so the necessary cuts will inevitably be recessionary. There is no shame in this for the politicians proposing the cuts – it is the hard medicine required to get the economies back on course. We are in ‘reverse Keynesian’ territory. It is no longer possible to stimulate economies through government spending because there is no more capacity to borrow. Cuts, necessary and overdue, will destimulate any economy.

We are therefore in line for a couple of very weak quarters of economic growth, firstly in Europe, then in the US, and finally (but perhaps less fierce) the ripples will flow through even to China.

But it is not all doom and gloom. The base case today is for a double dip recession followed by a muddle through the Nike ‘swoosh’ recession and recovery path. This could include a dip of some magnitude (but not testing previous lows) followed by aslow but steady recovery; the process taking about two years.

The lower bound case is represented by the logo of another popular, up and coming sports brand – Li-ning of China. That company has the memorable logo showing the tick the other way around. If Downing Street finds itself unable to cut, the consequences are severe with the global economy facing a recession that might be long hard and harsh.

There appears to be just enough political will to appreciate that the hard action must be taken now – whether politically expedient or not – in order to avoid sliding down the recessionary slope later on. The message to governments and policymakers around the world must be to quote the tag line: ‘Just do it!’ http://portshelter.com/wp-content/uploads/2010/06/170px-Nikec.svg_2.pnghttp://portshelter.com/wp-content/uploads/2010/06/Lining1.png Nike Li-ning

Debt, unrest and early solutions

May 25, 2010 This column is naturally bullish – however we have been bearish since mid-2009, around the time that the dead cat bounce that began in March 2009 reached about the 8,500 level on the Dow. Here we are at 10,000 level – a significant figure that needs to hold if we are not to see 8,500 again.

The news is not good as the debt has not gone away. The European governments got together to do their stuff – whether it was the right thing is irrelevant, it was the fact that something was done that is important. Much more concerted efforts on the economy will be needed in future months and policymakers used to meeting with each other at weekends will be critical when those times reappear.

So the spotlight on the European debt bad-boys has moved from Greece to Spain. The proverbial gnomes of Zurich strike again. But we can’t blame the gnomes – we can blame profligate governments for buying votes. Spain has major problems in its banking and property sectors – in a hot Mediterranean country there is little other industry. Spain however is a big country and is a much more serious prospect to deal with than Greece. Hard medicine will be applied soon. Investors should be long tear gas in Madrid.

In the UK we have experimental laboratory conditions with a new set of faces able to show us all what can be done. With great fanfare, the new government has announced £6.2 billion of spending cuts. Yet this is a drop in the ocean compared to a £150 billion annual deficit. Nevertheless inside two weeks in office it is a not unimpressive action.

The key factor however is that these cuts were bloodless. When asked about the impact on ‘jobs’ and ‘economic growth’ the response was that it was not going to affect either. Wrong answer. For real cuts to happen there must be a large impact on jobs and economic growth. That will sooner or later have to be admitted – economic slowdown is preferable to widescale bankruptcy.

One wise action was that the excellent plan by the last government to give each child a trust account for the future was correctly eliminated. As the Chief Secretary to the Treasury said and I paraphrase,’ there is no point adding a pound to the trust fund that is merely borrowed. The child will only have to pay the pound and more in the future’. The Child Trust plan was a great legacy from the previous Labour government who were saying ‘more debt but this time it is for your own good’!

At last we have younger people in power ( several former bankers!) who at least understand economics. The lack of financially-aware politicians most recently brought down the Russian Empire. Let us hope it does not bring down capitalism.

The point remains that jobs and economic growth are going to be under continued threat until budgets are balanced. This is not good for markets so we remain on a bearish-bias. The world is not (yet) in as difficult a situation as we were in October 2008, when we were all close to meltdown, but the 8,500 level is a real possibility and the pain may be more extended this time.

If we don’t see the lower level within the month we will see it within the year. Tighten the seat belts and buckle on the parachutes!

Naked Germany dresses up

May 19, 2010 Germany has banned naked shorting -it is always good to put the word ‘naked’ in any headline. A dream story for schoolboy-ish editors, but important nevertheless.

Naked shorting is the shorting of stock before you have located the cover for the position; before you have properly borrowed the shares to short. It is good money if you can get it in a falling market and is already regarded as being inappropriately risky behaviour among the elite.

To go short when you don’t have the stock is a complete punt. You are making a commitment to deliver an asset at a price when you don’t even own the asset. It is nearly as crazy as carry trading and buying an accumulators. These investors eat like a bird and poop like and elephant. Quite the wrong risk return profile for a sane investor.

It allows markets to be driven down dramatically as the selling frenzy takes place. Some will say that when you buy long it is a naked investment. However, markets falling ARE different from markets rising – when markets fall precipitously stop losses get hit, debt covenants get broken and the financial systems can come under stress very quickly as the whole process snowballs. Mere price falls themselves can deliver compound damage far beyond the fundamentals, especially in these days of global investment. A ban on naked selling means that at least speculative trend selling is mitigated.

This is not unlike the need for there to be an uptick after a big fall before people can start selling again. Any little circuit breaker or bump in the selling process allows investors to catch their breath and just think for a second.

Of course when the price goes up, short sellers get murdered. Having sold lower down and ten having to deliver stock higher up is painful, eye-wateringly so. The example of German car company, VW, whose share price benefited from a huge short squeeze during the credit crunch was a good example. There were so many people chasing just a few available shares that the price hit 912 at the end of October 2008 after being 270 on the first of October and it was around 290 at the end of November 2008.

Naked shorting is dangerous – for the market and for the shorters. There’s plenty of money to be made with covered shorts and plenty of workarounds that just make life a little harder for the shorters.

Markets do need circuit breakers – little hurdles; not to control prices or limit trading, but to prevent markets from doing harm to themselves. And by extension us all.

The German authorities are not doing this in a vacuum – they are planning for the big falls to come, perhaps in the next week. Falls that we have been predicting for a while.

European coalitions

May 10, 2010 The speed at which the European finance ministers have cobbled together their stabilisation package has been most impressive and is a very positive sign. If you don’t have the money, at least you need the will.

The support of errant sovereign states within the Euro was not part of the deal when Europe signed up to the strict rules on the Euro – but is now a reality. All those rules were broken because there was no discipline or accountability. Britain is breathing a sigh of relief that it is not in the Euro – especially at this time of their own political instability.

Concerted inter-government effort in Europe is actually made easier by the existing system and structure of the EU and the fact that the Europeans are used to coalition negotiation. Despite this, the key decisions are at the end of the day made by a just few people in Europe – those at the very top even if those individuals have an proportional representation mandate. A far greater democratic deficit than that seen by the first past the post system in the UK. What is clear is that this concerted effort is timely and critical to the financial stability of Europe and the Euro. And must succeed. When governments put their weight behind a stabilisation package like this one, failure is not an option. Expect the Euro and the markets to recover this week. This battle is won – but in the war against debt, it is only the end of the beginning.

Constitutional politics – or naked ambition?

May 9, 2010

9th May. E plus 3

Hung Parliament.

Only in Britain can the losers think, feel and sound as if they have won; and the winners feel that they have lost!

Gordon Brown the definite loser – of over 90 seats in parliament is still using the Prime Ministerial’s trappings of office; house, plane, finger on the nuclear button etc, and is perfectly entitled to do so as long as no other party emerges to form a government.

The Conservatives and the Liberal Democrats have spent much of the weekend behind closed doors talking about their respective positions and how they can form a government. The terms ‘amicable and constructive‘ is reminiscent of the famous words used during the Anglo-Chinese talks over Hong Kong where the term used was ‘useful and constructive‘. There will be no leaks until something workable can be presented.

I believe a deal will be done – the Liberals are too close to power – for the first time in nearly 100 years – to back out now, while the Conservatives are so close they can smell power. The Conservatives are looking for stability and unless they can win another 50 seats they will not have that.

The only thing that may defeat a coalition is the reaction of the party extremes. I sense Cameron has better party discipline, where relatively few extremists will pressure him not to do a deal. Clegg has the bigger problem. His supporters have never tasted power, don’t understand that you have to compromise to get it, and will continue to rock the boat to his disadvantage. The key element here will be how secure Clegg feels within his own party.

The whole reason for trying to get into power is to execute your manifesto and the Liberals manifesto remains ready for pulping unless they can do a deal with the Tories. The Conservatives will have to step towards proportional representation; the Liberals will have to accept a staged process to get there. The interesting thing is that we already have proportional representation. The voting came out 36% for the Tories, 29% for Labour and only 23% for the Liberals – exactly as the exit poll predicted. The parties also came first, second and third in the number of seats.

If we had PR, the number of seats would be about; for the Conservatives 258 (instead of 307); Labour 200 (258); and the Liberals would still trail badly at number 3 with 155-odd seats (against an admittedly paltry 57). No change there then. But the noise about PR – which is currently a practically irrelevant issue – is deafening.

The problem with coalitions is that they focus on the noise, not the policies, and at the moment the time honoured lesson of politics still holds true: ‘the economy still comes first, stupid!

A Greek tragedy

April 29, 2010 In a Greek tragedy, as with a Shakespearian tragedy, all of the characters die by the end.

Hopefully the Greek debt situation will not be as final, especially as their Prime Minister, Georges Papandreou, seems to be doing a pretty good job. However, the downgrading of their debt to ‘junk ratings’ is a big issue for two key reasons – and many smaller ones not mentioned here.

Firstly, it is still rare for a Sovereign to have its debt rated as junk. However, it is something that is going to become more frequent as GDP growth trends towards 2% in developed countries; as the proportion of the government in total GDP hovers at around 60%; as debt levels exceed the annual size of the economy; and as (or when) interest rates start to rise. The debt burden in many countries is going to become intolerable. Sovereign credit assets are going to come under pressure.

Yes, countries have defaulted despite their ability, maybe, to tax their population to cover debt. Try that in a democracy. In 1976, even Britain went cap-in-hand to the IMF during the last phase of Labour administration. Latin American countries have provided regular unpleasant surprises to their bankers over the years. Greece however is in the EU – supposedly the bastion of prudence; and the Euro – under some sort of protective umbrella. To misquote Churchill, “some protection; some umbrella”. Nevertheless Greece still expects to be bailed out by the rest of Europe.

There are many who ask why Europe should bail out Greece, who mismanaged their economy and lied about it. Indeed Portugal are themselves are now in a position of borrowing at a higher rate of interest than they can receive by lending to bankrupt Greece.

There is a strong chance that Greece will default – and indeed leave the Euro. that will lead to severe economic and social – and political hurt in Greece but may protect the Euro and other countries.

But will the rot stop there? This is the other key point. We have seen contagion sweep the financial markets before – as recently as 2008. These problems are unlikely to lead to global meltdown as we saw in October 2008 but they are serious. They may be enough to see Portugal or Ireland default as well and leave the Euro. These Sovereign domino’s will stop toppling after hopefully just a few small ones (though Spain has been downgraded too). Though those that do fall will experience highly damaging domestic economic crisis – but that is not the point of this note.

Those countries defaulting will create further holes in balance sheets of the foolish banks that have lent to these Sovereigns. Other countries will see the wisdom of tightening their belts, reducing budget deficits and increasing taxes. All of this will further impact both Main Street and Wall Street. So there will be contagion coming from the Greek crisis – no doubt it will be slow at first and may take some months to develop but we should continue to see some bearish bias to the markets for a good period of time.

As we have said, the debt mountain has not gone away. Like Titanic’s iceberg, it is just resting below the surface and will take a few ships along the way. I would not be committing new money at this stage and would be consolidating my investments into cash and inflation proof assets.

Fewer bombs more inflation

April 25, 2010 The last week has seen good economic news coming from almost everywhere. it has seen good geopolitical news coming from almost anywhere – Obama, the Russians and the Chinese getting on well with each other has to be good for us all. The threat of terrorism has no favourites and is as big a problem for China as the other two. So the BIG Three have much to agree on and the Domesday Clock should be moving back a minute or two (Google Domesday Clock).

The prospect of healthily performing economies is putting pressure on inflation – quite severe now in China – and in other countries with official rates starting to go up or on an upwards bias. Debt is going to continue to be an issue with the Greeks paying double figures for their latest loan. We have survived high inflation and high interest rates before and will have to do it again. We have survived.

The Greeks going cap in hand to the EU and the IMF is a further spiral in that story. It may not be as easy as merely asking – EU taxpayers are unlikely to want to support Greece who so clearly has lied about its true financial position and the IMF is going to expect the Greek budget deficit to get back in line. As it is running at officially 14% – and who knows after last week it might be 20% per annum – there is likely to be more than blood on the street – probably half of the bloated population of government workers. How many Greeks work in government service – less than half of them!

As Charles Gave said the other day, if you live in Europe, you’d better be buying a bicycle as public transport and public services are going to be strike-bound for the foreseeable future.

Transitions and timing

April 11, 2010 It has been an extraordinarily eight weeks of relative calm in most markets. A transition time. There are many imponderables yet the global economy continues to develop convincingly despite it all. Again a victory of Main Street over Wall Street.

As we have said, the pain of the massive leverage of the mid 2000′s has not gone away. We have merely seen a transfer from the private sector to the public sector of Western governments. How is this likely to pan out in the next few years?

Clearly Main Street is happy to ignore the fall-out at present, and why not? There are still a lot of people in jobs, companies are well financed and economic growth is proceeding apace. However there are some ugly sights in the background.

Incipient sovereign defaults, such as with Greece, are likely to be a recurrent issue looking further out. This time it is likely that this will be solved by the usual European muddle as it is unlikely that Greece will be thrown the book, or even thrown out of the Euro. Moral hazard usually doesn’t extend to governments. At least in the medium term.

There are still several letters of the PIGS (Portugal, Ireland, Greece and Spain) and even Italy whose governments have dodgy balance sheets and whose poor balance sheets are, from time to time, likely to put pressure on the Euro. This story will not be over with Greece. In the UK, the prospect of a hung parliament and weak leadership seems increasingly real, while the US gives the impression of being slightly more organised but also has an enormous debt burden that must come down.

The enormity of that debt burden cannot be overestimated. It is not that the percentage of debt as a proportion of the size of the economy that is so very large, but because it is the world’s largest numerical debtor by some margin and that is so much debt that it means – they own the world’s economy.

But any cut in large government payrolls will inevitably lead to massive civil protest on the streets. That will happen but eventually public sector jobs will be cut, reducing consumption. An inevitable reversal of Quantitative Easing will reduce liquidity, slowing economies. Taxes have to go up, real taxes, not just raising the odd billion but raising in the fifty or hundred billion levels, stripping further cash from hard pressed consumers. Whichever way you cut it the consumer is going to get hit and that bodes ill for GDP growth in Western economies. Few products are likely to do well except for the iPad, a relatively low priced, new application device for time-poor readers, like myself.

Governments will have to deal with these matters in other ways. Interest rates will inevitably go up – either because of the ‘Greece effect’, where if you continually need to borrow money it will cost you more. Or because of rising inflation. Inflation in most markets is back to levels seen during the 2004-7 boom. It will rise further in this current transition environment and because of the 2008 debasement of money.

So what is likely impact on the markets? It is all in the clever timing of these factors. A matrix of outcomes is not the subject of this piece, though we will revisit it later. But the timings of these factors will cause a variety of outcomes based around the following major factors.

In the short term, there must be significant currency volatility as the various countries sort out their debt problems at different times. The Euro has been the first to suffer but, as we all know, it will not fall forever. The dollar will be the alternative subject of focus. The RMB revaluation had better happen soon as the dollar is surely being held up by a weak Euro, and when the Europeans come to terms with themselves, it will be a lot harder to revalue against a weak dollar than a strong one.

The bond markets are of a concern, less so in the short term when bonds will be a good place to park cash, but over the next 12 months. When rates, especially long rates, start going up bonds will not be a great investment – except perhaps in Asia.

Equities are a conundrum; equities like the current strong corporate earnings and growing markets – such as we have at present. They do not like uncertainty and rising rates. They like inflation – as companies can raise their prices. Again, the timing of these factors together with other factors Commodities are also a mixed bag – gold will rise if the dollar weakens, or if we have major geopolitical issues, or if we have sovereign liquidity concerns. Industrial metals are likely to be hit by the slowdown in growth. The recent bids for industrial commodity companies are more driven by strategic rather than tactical price opportunities. Oil will be hit by a slowdown but probably not by much if the car sales in China are anything to go by. Agricultural products are weak at present and are unlikely to see great strength but their depressed prices makes me think that they are worth an investment.

So the investment future over the next 24 months is going to be affected by events, dear boy, events. And the particular timing of those events. What is likely is that in the short term – 3 to 6 months – before rates go up markets are likely to track well. We can promise volatility everywhere when interest rates do start going up, and when governments begin to cut their cloth. I would expect severe, short-term weakness such as at the beginning of 1994. We need to still purge the mistakes of the 2000′s so it is likely that we will have some new price floors in order for everybody to take the hard medicine. Then we will be better able to muddle along.

The sooner and deeper this happens, the better. The only ponderable is whether you might buy Apple before it is too late.