2 July 2010
For to day’s update, we’d like to reproduce, with permission, the recent excellent piece, from our perceptive fiend, Tim Price of PFP.
Not inspirational
“The announcement of the rescue package failed to stabilize the situation, perhaps because more people knew how deep the problems went than the government realized. None of the central bankers had faced an international financial crisis before; they therefore had to make things up as they went along.”
From ‘Lords of Finance: 1929, the Great Depression, and the bankers who broke the world’ by Liaquat Ahamed (Windmill Books, 2010).
Communiqués from government conferences tend to recall the words of Ralph Waldo
Emerson:
“The louder he talked of his honour, the faster we counted our spoons.”
The latest official statement from the G-20 in Busan, South Korea, does not disappoint fans of irony expressed on a magnificent scale. Among the highlights from this vapid exercise in giving voice to messianic delusions of relevance, international finance ministers and central bank governors agreed to:
• “firmly secure the global recovery”;
• “put in place credible, growth-friendly measures...”
• rather wonderfully, ensure that “Monetary policy will continue to be appropriate to achieve price stability” and “reduce moral hazard associated with systemically important financial institutions”;
• hysterically ,to “accelerate the implementation of strong measures to improve transparency, regulation and supervision of hedge funds, credit rating agencies, compensation practices and OTC derivatives in an internationally consistent and non- discriminatory way”.
There was no commitment to deliver world peace or universal wealth and health, but that may just have been an oversight. The problem with these sorts of statements was well expressed in a letter to the editor of the Financial Times last week from a Mr. Nigel Collin, referring to a piece, “solutions for a crisis in its sovereign stage”, written by Nouriel Roubini and Arnab Das. While acknowledging that the original article was “both illuminating and practical”, Mr. Collin went on to point out that “... a closer examination reveals that the verb “must” is used in three of the five solutions advocated. Without an explanation of how a sovereign state must be compelled to adopt a solution, the solutions are rendered aspirational rather than inspirational.”
Where to begin with the G-20’s marvellous aspirational announcement? One does not necessarily expect politicians to declare their own redundancy, but wealth creation and, in a more general sense, “recovery” are the products of private action rather than government direction. Governments take capital from their own people but they are functionally incapable of producing it. The best thing for government to do would be to get out of the way. Instead we have governments that have squandered billions in private capital (not just current billions but claims against future billions from taxpayers not even born) in supporting fundamentally bad banks. A free market has a magically effective way of discriminating between good and bad businesses. Bad businesses fail and are purged from the system and good businesses prosper, begetting more wealth in the process. Not content with their malign achievements to date, governments have now tasked the banks with mutually contradictory objectives: strengthening their balance sheets whilst simultaneously maintaining the provision of credit to the broader economy. You cannot drive a car well by concurrently slamming on both the brake and the accelerator.
There is a similar contradiction in the pursuit of credible attempts to bring sovereign finances back toward balance. In part it constitutes what economists call the fallacy of composition and the paradox of thrift. What may make sense for individual governments to do (turn off the spending taps) could be hugely detrimental for the broader international community. Politicians may not acknowledge the fact, but the world is even more closely interlinked than it was in the crisis of the 1930s, and the economic and financial interactions are undoubtedly faster. What is certain is that beyond a certain point, which Greece has now probably reached, slamming on the fiscal brakes transforms a heavily indebted government from muddle-through financing into insolvency, as the ailing economy, bereft of government spending to which it has become addicted, is unable to provide even sufficient tax revenues to allow that government to service its debts. Default follows.
While it is clear that just as in the 1930s, today’s politicians and central bankers, having no route map, are making it up as they go along, it is equally apparent to any objective observer that there is precious little of the coordination to which the G-20 communiqué so pompously aspires. Recent policy announcements do not augur well. The German Chancellor unilaterally declares a jihad against speculators in her now infamous tirade promising to beat the markets. The Australians break ranks and run the risk of killing the golden goose by unilaterally hiking taxes on the mining sector. Since world currencies are not, as they were in the 1930s, backed by the solidity and stability of gold, everyone seeks solace in currency devaluation. But by definition not every currency can depreciate against its peers. The balance of probabilities is that as this long emergency continues, the depth and breadth of the US dollar pool wins out against most of the rest of the world’s paper money, despite its own underlying fiscal precariousness.
The G-20‟s reference to regulation in a consistent and non-discriminatory way is a triumph of absurdity and bare-faced contradiction. How else to describe a regime in which badly run banks are extended indefinite and unlimited financial support, while institutional investors not fortunate enough to be deposit-takers are targeted for daring to point out the nudity of the Emperor ? And this last point gets to the real challenge for investors today. Navigating markets fundamentally distorted by government manipulation, wholesale currency debauchery and fiscal incontinence is bad enough, but we are now tasked with trying to anticipate seemingly random and often unilateral political action.
Some of the rational investor’s strategy response should by now be obvious. Avoid the debt and currency markets of the most egregiously undisciplined administrations. Buy precious metals as the ultimate in portfolio and currency insurance – their upside potential in price terms is widely understated and misunderstood. In other respects, exposure to equity markets should reflect individual risk appetite and any requirement for albeit irregular income rather than a slavish allegiance to an always volatile asset class.
The G-20 communiqué suggests that recovery is on its way, though characteristically it cites no evidence for the declaration. The evidence from, even by recent standards, unusually nervous financial markets would suggest otherwise.