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14 May 2011

Two More Leading Ladies on the Age of Austerity.

Tag(s): People, Politics & Economics

A few months ago I blogged on the opportunity I had had to listen to two leading ladies, Ruth Lea and Baroness Hogg, express their views on the economy. Recently I have had the chance to listen to two more ladies known for their economic expertise, Merryn Somerset Webb and Kate Barker.

Merryn Somerset Webb is Editor-in-Chief of MoneyWeek and a columnist in the Financial Times.  She graduated with a First Class degree in history and economics from Caius College, Cambridge before studying Japanese at London University. In 1992 Merryn moved to Japan in order to produce business programmes for NHK and then worked in Tokyo for five years as an institutional broker for SBC Warburg. She returned to the UK in 1998 since when she has become a respected commentator on economics, financial markets and personal finance.

Kleinwort Benson invited me to an event after George Osborne’s recent budget where Merryn gave her views on investing in the Age of Austerity. She told us that she had been researching for a new TV show in which she takes the nation’s pulse with street interviews. It had become clear to her that in this new Age of Austerity actually many people were doing fine, partly because they simply don’t pay their full whack of tax. She estimates that as much as 70% don’t pay their full liability as the black economy has grown to displace much of the traditional economy, and many transactions are in cash both to avoid VAT as well as income tax.

She thought sentiment is closely linked to property where prices have fallen by 13%-16% and transactions have plummeted by two thirds to just 40k per month. The key is availability of credit and the irony is that in a crisis banks hang on to their bad books and get rid of good loans. In other words the banks' recognition of their true losses lacks reality. In the US commercial and industrial loans have contracted by 20%. Residential mortgages are still in a mess. This is echoed in the UK where she quotes her favourite economist, James Ferguson who calculates that while consumer loans are down 16% and corporate loans down 20%, residential loans are only down 6%, effectively a net rise given falls in value!

The US stock market is expensive at 24 X earnings and Quantitative Easing has not worked in the sense of expanding broad money supply. There has been a close correlation between the influx of QE and the rise in markets so when Ben Bernanke turns off the tap on QE we can expect falls in equity prices. By contrast Japan has not been so cheap in many years.

The risk of inflation remains high and the boom in prices for gold, wine, art and other non-obvious stores of value all indicate a lack of confidence in money (or at least in the ability of cash investments to make real returns.) She confesses that she does not know what the transmission mechanism is but argues that there has always been one following a deep recession.

UK PE ratios are cyclically adjusted over the long term and currently are 20X+ which represents high risk status. This does not tell you what will happen over the next six months but is a clear pointer to the medium to long term.

MoneyWeek has been bearish on House Prices, Equities, the Euro and UK government bonds (gilts) for some time. That is why it pushes gold and certainly anyone who followed its advice over the past two or three years would have done well. But in my view gold returns no income and is not of itself productive. When gold was used as a limited mineral to back currency in the late nineteenth century, for example, it helped the US rise to its preeminent position as a world economy. But now speculators trade in and out of Exchange Traded Funds which means it is just as volatile as many other investments and could be a source of massive problems if there was a sudden collapse in liquidity. 

Kate Barker is a former member of the Bank of England Monetary Policy Committee and was once described by the Sunday Times as “the most dangerous woman in Britain” after she had produced for Gordon Brown a report justifying a massive increase in house building. At the time I had serious reservations about that report and still do. I also recall that when Ms Barker advised the CBI, when I was on its National Committee, she was an advocate for Britain’s entry into the Euro, a recommendation that fortunately Mr Brown did not follow.

She addressed the recent Association of Investment Companies' Annual Conference for Directors which I attended. At last year’s conference her colleague on the MPC, Danny Blanchflower had been apocalyptic in his forecasts but Kate thinks policymakers can achieve better outturns. However, while World GDP is growing well EU rates of growth are sluggish and the UK exports 18 times as much to the EU as it does to China. (This was before this week's figures showing  a positive result in the EU in the first quarter of 2011.) She notes that the OBR is more optimistic but asks if this is wish fulfilment. After all, the output gap is out there at least as far as 2016 with trade balances remaining adverse for the long term through increased imports.

She supported QE as a member of the MPC but has doubts whether monetary policy can be really effective when rates are just 0.5%. Inflation is now volatile and rates are well above target. She confides that the committee spent most of its time on the CPI forecast. But very tight fiscal policy combined with very light monetary policy leads to a weak exchange rate and so we import inflation. The 1997 political decision to split policy between the Treasury and the Bank of England meant that the effect of mixed policy was not discussed much. In any event household borrowing rates are much higher.

The imbalances in the economy will have to be corrected. Corporate balance sheets are strong but lack of confidence in demand means that Boards are not minded to cut their savings and invest.  So households must but their income prospects are weak. So for the OBR forecast to add up households will run down their savings. House prices will move down relative to the economy. She regrets that the MPC did not look at the health of the banking system once Gordon Brown had taken away its regulatory powers and given them to the FSA. She also believes it should look at income equality where there has been no change in 20 years despite the redistributive efforts of New Labour.  If these imbalances are not managed the fiscal policy will not work.

In retrospect the Brown/Balls construct of a split of overview of fiscal policy, monetary policy and bank oversight has failed the nation badly.

Ms Barker confined her analysis largely to the UK which given her audience spreads its investment globally was surprising. But with that qualification there seems to be quite a lot of common ground between her analysis and that of Merryn Somerset Webb. Both ladies are at best cautious about the outlook, at worst much more bearish.

There are always opportunities and given the difficulties in finding suitable asset classes to invest in perhaps the best chance is to invest in yourself and set up your own business.  Many of the greatest businesses in the world were founded at times of recession.

Copyright David C Pearson 2011 All rights reserved

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