The Pendulum - Spear's Magazine

The Pendulum

Stephen Hill swings between pessimism about the West’s bloated balance sheets and optimism about the chance to reshape our economics. What to do?

the global credit-crunch crisis, it’s time for one of those retrospective exhibitions which puts things into perspective on what has happened, what is happening now and what is going to happen in the current Short Cycle, from 2008-2018. It is not a pretty picture, but it’s best to take a good hard look at what is happening before our very own eyes, so as to be somewhat prepared for what is inevitably coming down the pike — it’s an essential part of wealth management after all.

In the first decade of the third millennium we saw the benefits of globalisation — expanding global GDP, the rise of the BRICs and emerging markets, plenty of cheap global credit and everything looked rosy — until we hit the credit crunch of 2007-8, and discovered that globalisation came with its own risks and problems that we had not foreseen and did not understand.

These problematical risks for the Western economies come under four main headings:
• Banking inter-connectedness and regulation;
• Public finances and indebtedness;
• Monetary policy;
• Ageing demographic costs and unemployment.

No one was prepared for the credit crisis and the reaction was a series of knee-jerks. The first was to shore up the busted banking system with TARP and other taxpayer-funded bail-outs; then politicians, chasing the feel-good factor on which their votes and re-election depend, let borrowings in relation to GDP get out of control; and then came quantitative easing and the perceived necessity for ultra-low interest rates, despite rising global inflation, as the US, for example, tripled its monetary base via the Fed’s balance sheet.

In the eurozone, the banking crisis is far from over, and we have already seen that the state support of banks has led to unsustainable state bail-outs in Greece — now in selective default — and in Ireland and Portugal, whose GDPs are collapsing into the dreaded double-dip recession, no doubt to be followed by Spain and Italy — all the PIGS in the euro-sty in fact. This is all while the eurozone is desperate to shore up the public finances as some of the regions’ banks, especially in France, Germany and Spain, could otherwise fail as a result of their eurozone state lending — conveniently missed out of the latest EBA banking viability tests — and lead to Banking Crisis 2.

In America, the new monetary policy in vogue, or QE, started as a way to inject life-saving liquidity into the banks, but has now become a means of funding the growing federal deficit while doing nothing to spur the hoped-for growth, and the same is true of the UK to a lesser extent. Bernanke announced QE2 for another $600 billion, just one day before the US mid-term elections. Now he has hinted that QE3 may be needed as the economy sagged again in June, with only 18,000 new jobs created and an annualised GDP growth rate of 1.3 per cent.

Unfortunately, the American presidential election is not until November 2012, so Congress’s maniac dancing with default (even if they did finally secure a debt-ceiling deal) and the swelling federal deficit look likely to take US federal and private debt to over 400 per cent of GDP, a very dangerous level.

In pursuing these monetary policies, all the central bankers and politicians are seeking growth in GDP as the traditional answer to all their problems. Before the global crunch, the advanced economies accounted for 80 per cent of annual growth in global GDP and their central bankers managed monetary policy with the prime objective of maintaining growth. All this changed, however, in 2008, as the growth in global GDP since then has been 80 per cent from the emerging economies.

But the central bankers of the advanced economies are still pursuing the policies of yesterday, in order to achieve growth which cannot be there as the pendulum of economic expansion has swung away from their economies to the East and the BRICs and other emerging markets, such as Africa and South America.

SO THE DOLLAR against gold, now at an all-time high, is a one-way bet for the hedge funds to keep making money. The eurozone is still set, as currently constituted, either to collapse amid enormous losses, the first of which has been announced as a €106 billion write-off over eight years by Greece’s creditors, or by stealth to become an economic transfer union, assuming the electorates go along with this drift, which was never previously canvassed and in fact was positively banned under the Maastricht Treaty. All of which, uncomfortably, could lead to Great Depression 2, as there is no new thinking to embrace the four main areas of uncertainty that I have mentioned.

The problem is that today’s central bankers were at university in the 1960s and are hide-bound by the doctrine of growth, which is no more in the West or advanced economies. Indeed, on the day the bureaucrats announced their salvation — with many hurdles yet to be crossed — of Greece, the purchasing managers’ index showed growth contracting across the EU.

Indeed, the ageing demographics of the advanced economies, and China as well, are going to require material fiscal tightening just to stand still. Take the UK as a typical example: the UK’s OBR has recently forecast that these mounting costs, mainly for healthcare and social security, will require 13p on income tax, or 13 per cent on the rate of VAT, meaning that the coalition’s spending cuts of £100 billion will effectively be unwound. Drastic changes to lifestyle are in prospect for both the public and private purses.
And the issue of the Western and Chinese ageing demographics is beginning to take centre stage in the debate on public finances. Interestingly, governments are seeking to delay the retirement age to cut the pension costs, which are unfunded, like healthcare costs — with the notable exceptions of Switzerland and Norway — but this is only exacerbating their other problem, namely structural unemployment, particularly among the youth. In the US, U6 as it is called, namely long-term full time unemployment, is at 16.2 per cent, while in the PIGS youth unemployment (under-25s) is running at between 20 and 40 per cent.
WHAT IS NEEDED is a new economic intellectualism, according to Stephen Lewis of Monument Securities. There has been no real advance in thinking since the credit crunch on bank regulation, control of public debt, nor any serious questioning of QE monetary policies. This new economic intellectualism can only be fostered in the universities. The problem is the time that this will necessarily take before central bankers reared in the new realities of global risks and the consequent new policies emerge and take up their positions. It will take at least a generation. And in the meantime, where are we heading?

How does all this affect the private investor/saver/pensioner? Spear’s does not give investment advice, but here’s an agenda for your next discussion with your authorised investment adviser: a percentage of not less than ten, or perhaps more, should be held in gold, where gold-mining stocks look cheap in relation to bullion, and avoid ETFs as they are unproven as regards delivery in a real crisis of fiat currency collapse; with equities, stick to food supply and distribution, energy and utilities, including mining and telecoms, pharmaceuticals and healthcare, and defence; and for currencies, stick with the one in which you pay your bills to the extent you need to, but then only look at currencies of countries that are productive and full of natural resources, are politically stable and with controlled public finances, so it’s worth taking a look at the Norwegian and Swedish kronors and the Malaysian ringit, but avoid the dollar and the euro for the time being, and the Swiss franc as well — it’s too expensive!
Stephen Hill’s book Countdown to Catastrophe (2010) analyses the post-war booms and busts and the causes and course of the credit crunch. Copies are available via Spear’s at £12 each (RRP £20).