Archive for the ‘UK Politics’ Category
One might have expected more from the Prudential, Britain’s largest insurance company. But the appetite for debt in the UK knows no bounds.
The Man for the Pru is paying $35.5 billion for the Asian life insurance business of AIG, the US insurance giant smashed to pieces by the financial crisis, and making a $21 billion rights issue and borrowing $5 billion to foot the bill.
The warning signs are obvious. AIG has only gone for a trade sale because IPOs are difficult now in Asian markets – probably because investors sense a further downturn is close.
Beware CEOs offering ‘transformational deals’ and forgetting their market timing. How can the Prudential be so imprudent, and issue its good paper to pay for something so unknown?
What if the transformation proves to be of a different kind: from a financially strong and well managed business to one carrying too much debt and with 60 per cent of its business in Asia just as that region goes into another downturn?
Prudential shareholders are not impressed and its shares lost 11.5 per cent after the announcement yesterday. History is littered with examples of big takeovers in the aftermath of market crises that went badly wrong.
From the early 90s in the UK there was Beazer’s $1 billion takeover of Koppers in the US; or UK house builder Raine Industries only too early acquisition of rival Walter Lawrence. Both proved fatal mistakes.
It is particularly ironic that the Prudential should fall into this trap and make such a classic investment error. For the Pru is a real stickler as an investor itself and you have to ask whether it would back such a deal if it was proposed by one of the companies whose shares it holds.
Usually the root cause of such mistakes is the ego of businessmen with an urge to top long and successful careers with one really big deal. This blinds them to the obvious reality of exchanging a sound financial position for a very risky one.
Markets then take their revenge in the extended downturn, and rivals end up buying those assets now regarded as a prize for a far cheaper price.
The $300 billion Greek debt crisis has thrown the spotlight on government debt as an investment class. Greece cheated Brussels into thinking its debt was lower than now proves to be the case, hence the nasty surprise.
But actually a huge question mark hangs over the viability of long-term investment in almost any government bond at the moment. Put simply it is a matter of pricing: are bonds priced too low for the inflation outlook?
Inflation as we normally understand it means upward price revisions for goods and services. But inflation is always a matter of the money supply. Too much money chasing too few goods equals inflation.
And where does the money supply come from? Well, actually the bond markets that allow commercial banks to create credit.
And what do we know that governments all over the world have been doing to counter the global financial crisis? They have been issuing more and more bonds, and even buying their own debt in a bizarre process called quantitative easing. So the money supply is rising, even if commercial credit is still actually shrinking.
Eventually that new money will find its way into global financial markets and cause inflation. How long will that take?
There is presently no immediate fear. Indeed, the most immediate prospect is a downturn in global equity markets that will rally the dollar and boost bond purchases, at least for a short time. Some think central banks are about to cause a stock market crash for that very reason.
But look at a 10-year British Gilt paying four per cent interest, or for that matter Greek bonds paying not much more. You have to be a bit of a loony to think that will represent a good buy over a decade.
In the 1970s bonds were dubbed ‘certificates of confiscation’ because inflation eroded their real value and gave them a negative yield after inflation. This time will not be different.
Bond yields are presently very low and bond prices therefore exceptionally high. What has gone up in price will go back down, not up further, or not for very long.
Deflation versus inflation
The confusing mixture is first deflation as house prices and equities fall, then inflation as governments overdo their rescues and finally something bordering on hyperinflation to eliminate debts. Timing this is very difficult.
If you are a bond holder then you hold debt, and that is not a position you want to have when inflation really roars and destroys debt.
In previous major financial crises this has always been the penultimate phase, and when the bond market implodes then comes the final, or ‘ultimate’ bubble as George Soros calls it, in gold and silver.
Thus while owning short-term bonds and cash makes sense in a stock market crash, a swift move into precious metals thereafter should be contemplated.
You do not have to go back far in history to find government bond defaults. Think Russia 1998, Argentina 2001. The wonder is surely that investors continue to believe governments have some kind of magic as creditors.
British Business Secretary Peter Mandelson was in Dubai yesterday warning the government to get its act together quickly to sort of the $22 billion Dubai World debt standstill. Coming from a government that has run up one of the largest national debts in modern history it is a bit much to be lecturing Dubai on debt.
According to the International Monetary Fund’s estimates of the fiscal adjustments developed economies need to make to restore fiscal stability over the decade ahead, the worst positioned nations are the UK and Japan. Both need a fiscal tightening of 13 per cent of GDP.
UK worse off than Greece
That is ahead of Ireland, Spain and Greece at nine per cent. And in sixth place, as Professor Niall Ferguson pointed out in the Financial Times, is America, ‘which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF’.
Dubai just does not come into this league. Indeed, as a part of the United Arab Emirates Dubai is a constituent city of a net creditor nation, that is to say a rare country whose debts are more than cancelled by credits held overseas, not to mention $3 trillion in oil reserves.
No wonder that Mr. Mandelson said that Britain ‘wants to be there’ for the recovery in Dubai. But it is laughable to have the architect of New Labour in Britain, and one of the men most clearly responsible for the debt mountain of the UK, to tell Dubai how to tackle its problems.
No banker or businessman
It is not as though the Business Secretary has any business or banking credentials. He is a career party man and politician and has not an inkling of entrepreneurial insight. And even his political capital is running out as his government faces annihilation at the next general election that cannot be postponed beyond June.
But where Dubai could learn from the man known as the Prince of Darkness is from his media manipulation skills. The Dubai ‘debt crisis’ that never was last December has entered the annals of PR history as among the worst examples of crisis management.
Good professional PR advice is needed in Dubai. But never make a PR man your Business Secretary – that is a sure route to national bankruptcy.
It is fairly easy to understand the obvious link between the greater availability of credit and rising asset prices. But less obvious is the rolling up effect or compounding of relatively small annual gains in value over very long periods of time in a credit boom.
In June this correspondent will go for a reunion of alumni in Oxford after almost 30 years of absence. Since then the price of a cup of tea on British Rail is up six-fold. The value of our former family home by a factor of 18.
Precious metal prices static
Silver is actually worth less than it was in 1980 and gold is only slightly higher. Graduates are paid around five or six times more than in 1980 when they start their first job.
Share prices are another interesting comparison to make, up around 12-fold since then but unchanged over the past decade. Houses do seem to stand out as exceptionally overvalued, at least in relation to precious metals, British Rail tea, average incomes and even stocks.
The UK housing market is a classic credit-driven asset bubble. Over time the banks have worked tirelessly to keep mortgage debt at a constant proportion of income, thus most of the benefit of falling interest rates has been lost on the general population and pushed up house prices instead.
People have also been brain washed over time into thinking a home is your best investment and can not go down (despite the 1991-3 evidence to the contrary). It is a national mania for home ownership, and even in a massive recession people are very reluctant to let go of their dream home or loss-making investment.
Of course looking back to 1980 that was the very moment to buy a UK property and sell up gold and particularly silver – which were then in an investment bubble after a decade of inflation and recessionary conditions.
Sell property, buy gold
Is not the lesson now that those caught up in the global property bubble – which is still only in its early stages of deflating if history is any guide – ought to be selling up and buying precious metals next for the upcoming multi-year upward compounding of gold and silver prices?
It is never a straight line up for any asset class. But for example that nasty 1991-93 phase in UK housing only looks a blip on the chart, although it bankrupted many young property owners at the time.
However, getting on the right side of the rising trend (and getting out of a falling trend) is the key to successful long-term investing. Ask anybody who bought a house in Britain over the past 30 years. But a rising trend is never without an end.
For stock market investors the long-term trend is surely also a warning sign. The credit inflation of the 2000s has barely managed to support price levels, so how can they possibly be maintained in an era of de-leveraging and tight credit?
Surely anybody can see that near zero rate interest rates cannot last forever. And if asset prices are only being held up by low interest rates what will happen when they go up? Asset prices have to come down. This is a selling opportunity for property and stocks, and a buying opportunity for gold and silver.
New York University’s Nouriel Roubini has not had much luck with his pessimistic forecasts since correctly calling the sub-prime crisis. His repeated calls for the bear market rally in stocks to end are only just now being heeded by global financial markets.
Now he is launching a broadside against the European monetary union, telling Bloomberg that Spanish economic problems could be its undoing ‘down the line, not this year or in two years from now’.
At the moment Greece looks the more immediate problem nation with a 12 per cent budget deficit and debts due to exceed 120 per cent of GDP this year. However, European Central Bank president Jean-Claude Trichet said it is ‘absurd’ to imagine the break up of the 16-nation currency bloc.
Even the Greek central bank governor George Provopoulos said it will be ‘unequivocally easier to solve’ his country’s problems inside rather than outside the eurozone.
For Roubini to be proven right then nations like Greece and Spain would have to be ejected from the euro, something that is not even being considered or actually politically or legally possible. California might be running a big state deficit but that will not result in the biggest US state issuing its own currency. How could it?
More likely in the humble opinion of ArabianMoney is that other beleaguered European nations will eventually seek shelter under the euro umbrella. Recession-hit Britain would be a prime candidate if it was not for national pride and chauvinism. Joining the euro with the pound undervalued would be great real politique and excellent economics.
What the eurozone nations in trouble – Spain, Portugal, Ireland and Greece – will have to face up to are cutbacks in public spending and higher taxation. They do not have much alternative.
Imagine how Greece would fare in issuing bonds in a new currency. Would anybody buy them except at fantastic interest rates? Even then it would be very risky given the Greek record for overspending and the potential for devaluation.
It is indeed absurd to talk about a break up of the eurozone, and perhaps only something that an American professor looking for a headline might come up with. Why does he not stick with his call for an end to the bear market rally, just as it is coming right?
The juxtaposition of two completely separate financial transactions on opposite sides of the world are signs of our times: the $19.7 billion knock out offer for UK chocolate giant Cadbury by US group Kraft; and the filing for bankruptcy by Japanese Airlines with debts of more than $26 billion.
Both are realities and not mere pontification on the state of the global economy. Deals are the wheels of commerce. But what does this tell us?
Kraft is clearly being aggressive about global expansion and believes an economic recovery is coming. It thinks Cadbury is a good buy even if its biggest shareholder, none other than Warren Buffett reckons otherwise.
Is this another of those too-early-in-the-business-cycle takeovers that shareholders live to regret? Out of the 840 pence a share paid for Cadbury, 500 pence is in cash, so Kraft will be taking up debt and is therefore highly confident of the outlook.
So Kraft needs good luck – not something Warren Buffett has ever relied upon. In the long run bad things can and do always happen in business. Kraft is gambling on an upturn in the business cycle and has not even bought particularly cheaply at the bottom.
Then again what are we to make of the move by JAL into bankruptcy protection for a phased restructuring. The Japanese carrier is to cut around 16,000 jobs, reduce pensions for retired staff, move to more fuel efficient aircraft and restructure a $26 billion debt mountain.
That could not be achieved without $10 billion of government cash to keep the airline going during this process. Too big to fail, too important for national prestige or a state-backed dinosaur, you can take your pick.
But the JAL bankruptcy is also a symbol of everything that has gone wrong in Japan for the past 20 years: over investment in publicly funded infrastructure, market intervention, lack of innovation, price fixing, an uncompetitive currency rate and an ageing population.
At the very least the JAL bankruptcy shows that no government can support loss leaders forever, and that eventually market forces catch up with every nation. Will a new national champion emerge from the bankruptcy process? It really does beggar belief that it should be even contemplated.
But in the recent global financial crisis government support for ‘too big to fail’ companies like GM and Chrysler and banks too many to mention has become a symbol of our age. That this delays rather than avoids that ultimate end-game is clear from JAL, and in the meantime private enterprise is denied its true role in national reconstruction.
Sadly government intervention is the spirit of the age, and it never works.
Goldman Sachs is forecasting a stronger than average turnaround in the fortunes of the UK economy this year but only because the value of everything in Britain has been devalued by 25 per cent with the collapse of the pound.
This seems a high price to pay for 3.4 per cent growth which Goldman thinks the UK will achieve in 2010, although not many other forecasters are as optimistic. This will compare to 2.4 per cent growth in the USA and 1.9 per cent in the eurozone.
The fall in the value of sterling is expected to boost export growth, and attract inward investment from overseas. There are also hopes that the important UK financial sector will revive investment spending after last year recording the lowest level since the 30s.
However, export volumes will first have to make good the value lost in depreciation. Then there is a reliance on a continued upward movement in the global economy to support rising exports and inward investment. A double-dip US or eurozone recession would sink this prospect, and keep the UK financial sector on its knees.
The Goldman forecast is also predicated on a much longer period of ultra-low US interest rates than most economists accept, with effective zero rates until 2012. This would help to keep the pressure off the Bank of England to raise its rates.
However, foreign currency traders say the pound’s weakness may not last for long, and UBS is telling its clients to buy the pound against the euro. In that case the window of opportunity for UK exporters may close as quickly as it opened.
UK house prices
Some recovery in the UK housing market recently might also be seen as a harbinger of higher growth rates, with investment from overseas a factor at the top-end. But equally this is a sign of interest rates now set at dangerously low levels that are bound to result in unsustainable asset price inflation.
That is to say house prices that will come down quickly when interest rates finally go up. However, 2010 is surely a year of two halves for the UK economy: before and after the general election expected in May and by the latest in June.
Whichever party or coalition of parties is elected is going to have to raise taxes and drastically cut public spending and borrowing. That will dampen demand and return the economy to conditions that feel like a recession even if it is technically avoided. For no economy in history has ever devalued its way to growth in the long run.