Category: Blog

Bubbles are great whilst they last. Eventually hubris is eclipsed by nemesis.

In the late 1980s I was in Japan at the peak of their property bubble. They proudly told me the land surrounding the Emperor’s Palace, had it been a development site, was worth more than the state of California. I suggested to my British companions on the trip if that little thought experiment were true it was time figuratively to sell the Palace and buy California. So it proved. Over the next decade California took off, pioneering a digital revolution which left Japan standing, whilst Japan wallowed in the aftermath of her property bubble bursting.

In 1999 I could not see why people found internet based company shares so attractive – other than the bigger fool theory that they could sell them on to someone else even more love struck by them before the mass psychology changed. People piled their money in to companies that not only lacked any profit and dividend, but in many cases had very little revenue as they were offering much of their service free. Some made big money by not only buying in but selling out before the music stopped. One day people awoke from their trance, and the shares plunged back to earth.

In 2006/7 I remember several discussions with property experts in London. I asserted that £120 a square foot rentals in the West End were over the top and the market had to fall. They told me there was a continuing shortage of West End property, and the Hedge Funds, the masters of the Universe were in town and could afford it. Now those same experts tell me rents are falling and the shortage of space is mysteriously correcting itself without new build. Maybe the rents were too high after all.

Yesterday I read that people are now lending to the UK government for two years for less than 1% interest. Some seem to think this is a good deal. Inflation after all is falling. Interest rates are likely to be cut further by the incompetent Monetary Policy Committee. People are worried by any private sector risk these days, so they conclude it makes sense to lend to the government at these very low rates. After all, someone may lend to the government at a lower rate next week or next month, so grab 0.98% while you can.

On the greater fool theory this may be right. There may well be people who want to lend at even lower rates. After all, the authorities are going to effectively make the banks do this with their new proposals for banks to be more liquid and hold more gilts. Of course if people buy shorter dated gilts they can hold them to repayment so market price movements do not necessarily worry them.

Yet I can’t avoid a nagging feeling that when we come to look back on this period of our troubled financial history it will look as if there were a bond bubble in the midst of all the grief in other asset markets. Only if we go into slump with falling prices, does lending to the government at such a rate provide a reasonable real return.

If the authorities now regret the property bubble they encouraged, they should ask themselves if this growing bond bubble is healthy, and should understand just how much of it is of their making. It could be stopped slowly and gently now, or they could inflate it more and have a bond crash sometime later. If they want to begin to stop it they should announce no more interest rate cuts for the time being, and cancel their proposed new liquidity measures for banks. They should worry a bit more about the inflationary consequences of the big drop in sterling.

As always, I am not making recommendations to readers on whether to buy hold or sell gilts themselves. They may go up and down, and not necessarily in that order! As the regulators say, please take proper advice relevant to your own circumstances.

Just a few weeks after Gordon let slip that he had saved the world, we learn from authoritative briefing of the Times that Mr Darling is having to work on another bank package. The first very expensive one has not led to sensible amounts of credit flowing in the economy. Far from saving the world, it turns out Gordon has not even saved bank credit and the futures of many UK businesses. Despite all the cash and all the words and all the jet travel, the government is rightly alarmed at prospects for the UK economy in the first quarter of 2009, and is looking for more measures to prevent a large number of industrial and commercial company collapses.

We are told there are 4 possible options being considered:

1. More money being invested in bank shares by taxpayers.
2. Establishing a state owned “bad bank” to buy up and work through some of the poor loans from the commercial banks.
3. Cutting interest rates further, perhaps to around zero.
4. Revisiting the state guarantee package for private sector lending.

This is a dangerous package. I would rule out three of those four proposals, leaving just the state guarantee issue on the table. Let me explain why.

1. The taxpayer cannot afford to own more bank shares, and should not be expected to take yet more risk. The banks may lose a lot more money before this crisis is resolved. They are currently in a vicious circle. They cannot afford to lend more, so they are forced to undermine the companies they do lend to, as these companies are starved of additional working capital by the banks, and face less and less revenue from customers who cannot get access to new loans or do not seek new loans as they fear for their jobs. It is possible RBS has already lost the £20 billion the taxpayer was made to put in recently. When you go to the aid of a bank with a £2 trillion balance sheet you need a very long pocket. The last lot of share subscriptions did not lead to more lending to the corporate sector – just to lending it back to the government. This is the worst possible option. It is so very dangerous that the government must rule it out.
2. The Bad bank idea is a variant of the original Paulson plan in the USA which Gordon Brown criticised, preferring direct injections of capital into banks. The idea is unlikely to work for similar reasons to 1 above. The potential range of poor loans is very large. It would require huge state capital to buy them up, and poses a big problem about how to value them fairly. Value them too cheaply, and you undermine the banks you are trying to help even more. Overvalue them, and the taxpayer ends up with large losses. The sums involved are likely to be too large to be realistic for taxpayers to take on such a task safely.
3. Lower interest rates is an equally dangerous idea for different reasons. The problem today is not the price of credit but its availability. Cutting rates to zero will create a bigger gap between base rates and actual rates in the market, as no bank can afford to lend to people or companies at a small amount above zero, and no saver is going to willingly put his money on deposit for no return. With sterling already too weak, it would be another incitement to people to put their money abroad.
4. The state guarantee package announced last autumn was a potentially good idea. It too requires judgement about how much to guarantee at what price, but offers the scope to help get inter bank and bank to company lending moving again at a lower cost to taxpayers. Government can secure the taxpayer interest by taking enough asset cover for the guarantees, but does need to price them sensibly do banks find the option attractive. The lack of use of them so far shows perhaps they were not sensibly priced, as well as indicating that banking regulation is at the root of the problem.

So what should the government do to ease the squeeze?

1. Open tripartite talks with the Regulator and the Bank of England over how much capital banks need to have to carry out a given amount of lending. It may be necessary to allow banks scope to have lower capital ratios for a bit as they work themselves through the bad and doubtful debts, with proper monitoring and support from the authorities. They need also to discuss how much needs to be marked to market, and how much can be valued in relation to its longer term economic value, on prudent assumptions about repayment probabilities. At the root of the current shortage of money is the authorities decision to demand higher capital ratios at the time they put more money in, which was a self cancelling move.
2. They also need to review their latest liquidity proposals, which will also limit lending to anyone other than the government. These should be binned.
3. Announce there will be no further cuts in interest rates for several months, to create some stability, and offer some reassurance to savers.
4. Alter the guarantee scheme following discussion with the commercial banks about what it would take to get them lending more, assuming the taxpayers interests can be properly protected.
5. Discuss with markets how the corporate bond market can be made more effective as an alternative source of longer term loans for companies.

The government needs to understand how so many of its economic problems are related and self feeding. The collapse in demand is leaving many companies short of cash and profit. They need to borrow more to tide them over, but the borrowing is not available. Individuals cannot borrow more to buy the companies products, and then fear the loss of their jobs when companies have to cut back. As jobs go so people spend less, feeling they need to save more. As overtime and bonus payments disappear, so people have less money to spend. Cutting VAT has not unlocked enough spending to save companies. Buying bank shares has not unlocked enough new lending to save companies. This is a big squeeze, which is going to intensify in the first quarter of 2009. Now Christmas and New Year are behind us many companies will have to face the grim reality of too few customers chasing too many goods. Shops will also have some hard decisions to face as they run out of cheap imported product to sell, and have to consider buying product which is around 20-20% dearer thanks to the collapse of the pound. Yes, they should look around for more UK suppliers, but No, they will b e unable to source a lot of what they want locally.

I was pleased to see the Daily Telegraph version of this story also included changing regulatory rules affecting bank lending as an option. Let’s hope the authorities have been listening.

The government has a policy to get us to change our lifestyles. Thin is the new green.

Most people must know that if they want to be thinner they need to eat less fatty food and exercise more. Many choose not to take this simple advice.

Is the government now going to employ a new anti fat police? Will you need to give your waist measurement before qualifying for NHS care or certain benefits? The mind boggles at what targets are going to be set to get down the national waistline, and who is going to enforce any necessary measures. At least the ad agencies and media will be thrilled at a new ad campaign to thin us down, at taxpayer expense.

At least their timing is better on this proposal. Many people are going to struggle to pay the bills, so economies on fatty foods could be just what the nationalised bank manager ordered for your overdraft.

It is a scandal that train fares are going up by between 6% and 10%, with some off peak prices soaring. This morning on the Today programme the BBC interveiwer got through a discussion and commentary without ever once mentioning the word “costs”. There is one simple reason why train fares are so high and rising so fast – the costs of train travel are too high and rising too fast.

In the “good” years of the credit boom and higher sterling we got used to many trhings being such good value. Mass produced clothes, TVs, cars, foodstuffs and many other items in our daily budgets have been great value. They have been so because they have been supplied by a fiercely competitive world market. They have often been produced by cheap labour, they have benefitted from a huge surge in automation and from the digital revolution slashing costs and improving accuracy and efficiency. They have been brought to us by competitive retailers and suppliers in the UK, fighting to win our custom.

Train services are supplied in a very different way. There are strong monopoly elements. They depend largely on UK labour. Their management often sees satisfying the government as being more important than looking after the rail user. The UK has failed to regulate railways for better safety and fuel efficiency in the way it has regulated road travel for these requirements.
As a result we have a high cost service, which often does not look after the customer in the way we would like. It is short of capacity at peak times, runs lots of poorly utilised trains at off peak times and on less popular routes, runs many older engines which are very fuel inefficient, and pulls around very heavy carriages which again burns large amounts of fuel. The main contact you have with staff on the railway is to check your ticket to make sure you are not on the fiddle, rather than contact to enhance your journey and help you navigate the system which does not help the staff-customer relationship.

So which costs could the ralways cut?

1. The fuel bill. The UK standard of very heavy trains needs amending. Far from being green, our trains are fuel inefficient through old engine technology combined with heavy weight of carriages. The trains are usually left running when standing in stations. Switching to electric trains means even less fuel efficiency, when you factor in the large energy loss at the generating station.

2. Manning levels. Large numbers of people are engaged in ticket issue and inspection. Sometimes people check tickets at barriers before joining or when leaving a train. In addition other staff inspect tickets on trains. There needs to be a more automated way of ticket checking, and some commonsense over whether to use a station or a train based system of inspection.

3. Types of train purchased. There is not a lot of competition in the train supply market which makes it more difficult. The requirement for very heavy trains seems to have come from worries that trains can leave the tracks and when they do there needs to be a very rigid structure to coaches so they remain intact.There are lighter ways of creating this strength.

4. Regulation. Applying road vehicle standards of fuel efficiency and safety could drive much needed change. Why do I get a seat belt in my car but not on train ( I also get one on a plane)? Why does my car have a crumple zone in the event of a crash but a train does not? Why are there still unpadded and hard edges in train carriages whereas the interior of cars has been made safer? Why aren’t there tougher emission standards applied to engines as to road vehicles? That would drive fuel saving changes which would help cut costs.

In this age of spin, where appearances are preferred over reality, this site concentrates on the underlying truths of the situation. Instead of believing there will be no more boom and bust, or acccepting that we have an independent Bank which is all wise, this site looks at what is happening underneath the lies, and tells it is as it is, often from the official figures and from the official footnotes which tell a different story to the headline.

Presentation can also be important. Successful presentation presents you or the government as they are. It puts the best complexion on the purpose and the thrust of action and policy. It encourages you to put your best foot forward, or to the put the best face on something. It will not work if your foot or your face do not engage. It should not struggle to distort, cover over or divert the true course of what is happening. It strives to bring the best features out of what is there and what you are seeking to do or create. The problem with so much spin is the spinners think they can con all the people all the time. In practise they can only manage to con some of the people some of the time. In the process they can give good presentation a bad name. You need to live your brand. You cannot pretend you have a different one.

So who needs a make-over? If you wish to live your dream, you need to look the part. It is easier to command authority and respect when teaching if you wear a suit, than if you seek to look like the teenage students on a day off. You are more likely to land the job you need if you shave or make up well, put on your best clothes and turn up on time for the interview. You are more likely to perform well if you feel good about yourself. It is easier to play your chosen sport if you have the right equipment.

So there is only one person who knows whether you need a new make over for a new decade. That is you. If you are fed up with what you are and what you are doing, then try something else. If you aspire for something beyond your reach, you may end up achieving something worthwhile that would not have happened if you did not bother. First look the part, then practise playing the part. Study those who are really good at what you want to do. Live, read, watch, study, breath the interest you wish to pursue. Think what you want to do is more important than another trip to the pub or another tv programme you dont really need to watch.

The better you become at something, the more fun it is. The better you become at it, the more you will learn about it.

Thanks to all the readers and contributors. I look forward to hearing your thoughts during 2009. Doubtless there is going to be plenty to talk about, when we look at the inheritance from 2008!

The government experiment with a so-called independent Policy Committee of the Bank of England has been a disaster, made worse by the way the Establishment has made it a matter principle to genuflect to its success at a time of unprecedented economic instabiliy, made worse by its actions.

Readers of this site will remember how strongly I urged them to cut rates year ago to avoid deep recession. They resolutely looked in the rear view mirrow at the inflation that had already created by low rates in 2005-6, and refused to see the damage they would do in 2008-9 with the high rates that would bring the private sector borrowing binge to a screaming halt. In the good times they ignored the asset bubble in property and private equity. Then as the bad times began they ignored the damage they were doing to the inflated asset prices.

Today they are once again looking backwards and getting it hopelessly wrong. They are ignoring the bond bubble and the government borrowing explosion. They assume the banks will stay broken by setting very low rates. They should beware. Rates should not be cut any more. Indeed, the last cut was a cut too far. We need more savings and loan repayments in this country to create stability. Savers need a reward for saving. Above all the MPC charged with watching inflation should understand the impact of the very large devaluation of sterling they have encouraged.

Imported goods will be 25% dearer in 2009 they were for much of 2008. The sharp slide in sterling was concentrated in the second half of 2008, and got worse as the year neared its end. These higher prices for importers will at some point have be passed on, meaning we buy fewer goods, more retailers go bust, and the price level will reflect the currency changes to some extent. With sterling this weak keeping rates elow Euroland and hinting they are going to fall to near zero is economic suicide. The MPC should be ashamed of itself to be so blase about this worrying development.

The government and Bank decided sometime ago they needed to cut our living standards by the interest rate and banking policies they followed. Now they have decided that much of the hit on our living standards will come from a huge fall in sterling, increasing the prices of the many items that we traditionally import, and limiting the favourable impact of falling commodity prices on the UK economy and incomes.

Just as we feared, the cost of UK government borrowing has been rising over the last year.

The cost of 10 year money has gone up from 3.5% to 4.17%.
The cost of 19 year money has gone up from 3.76% to 4.47%.

That has happened despite the huge purchases of government debt by the Bank of England. It will get worse when they stop buying government debt, unless strong action istaken to cut the amount the government needs to borrow. When you are borrowing an extra £200 billion a year, just one percent more costs you £2 billion a year extra for every year you need the borrowings. You also have to pay more when you need to renew your other borrowings as they fall due.

I am a natural optimist. I like to see the opportunity and the possibilities in life. The background as we travel through the end of the old year and into the new is not auspicious. The news background threatens worse to come on jobs, company failures, house prices and much else. Just to make it all worse, violent war breaks out in the Middle East.

Last year I urged the authorities to try to stave off recession. I explained how “If the authorities cut interest rates and make more cash available to the banks we can avoid too sharp a downturn.”

This year I am forced to write about how they could limit the damage of what is likely to be a severe downturn in the UK.

It took them nine months to recognise the dangers of the high interest rates and tight money they were offering in 2008. All too late in the day they started to shower the banks with cash and bring the interest rates clattering down. These changes will have an impact, but not in the early months of 2009. The authorities seem to have forgotten that it takes a year or more for changes in interest rates and changes to money market liquidity to work through the system. In the meantime there is the remaining problem that the banks themselves are still weak, need to write off more from their assets, and are under regulatory orders to strengthen their balance sheets at the moment of greatest difficulty.

So how can I cheer people up? There is the outside chance that Mr Obama meant it when he said he would bring change. If only he would change the US approach to the Middle East that would help. If he would seek to spend the cash the US government is borrowing to good effect that would be a miracle.

The UK authorities could start to get a grip on their banks, and start to make better decisions about helping nurse them back to health so the wheels of borrowing can move the vehicles of commerce again. We need a government to understand that their regulatory and monetary policies need to reinforce each other, not struggle against each other, a government which finds a way for banks to pass on some of the cash it is now tipping into the system, and then controls the amount of that cash, before we start up another damaging inflationary cycle.

Last year at this time I went hoarse asking them to cut interest rates immediately. This year I say the rates are low enough. The problem now rests elsewhere. Indeed it is savers now who need the better deal, and I would like the government to help them.

They could afford to do so, and to lower taxes on income and jobs, if only they would forgo their foolish cut in VAT. We need now intelligent and affordable tax cuts, rather than clumsy and expensive ones which are not going to lift us out of recession.

I wish you all a happy and prosperous New Year. You will need the agility of a gazelle and the solidity of the ox to survive in business in 2009. It’s the year when savers are asked to share the misery of the borrowers, as we continue to sift our way through the debris of the Credit Crunch. I just hope you and yours have jobs that survive and enough cash to see you through.

Now government and media are blessed with 20/20 hindsight about the property and commodity price bubbles, they should ask themselves when and how they want to puncture the latest bubble – that in government bonds. Or do they wish to do exactly the same with this as they did with the property and commodity bubbles – supply the cash to fuel them, create the regulatory rules to allow them and sit back and watch until it is really painful to burst them?

The government bond bubble is currently growing large. The government probably wants this to happen, as it knows it has a lot of government debt to sell. But at some point investors and regulators will wake up and see it is not healthy for too many institutions and people to be lending to the government for tiny rates of interest, especially if the government’s aim is to inflate their way out of the crunch in due course. For the moment the government can inflate the bubble more – after all there is still a positive rate of interest on longer bonds, and short term interest rates are still above zero.

So why does the bubble matter? Lending too much to any company or institution, as we have seen in the private sector in recent years is not healthy and at some point has to be corrected. All the time they can get easy credit they are happy and the system looks stable. Once they cannot get the credit any more people are amazed at how much they were allowed to borrow on such good terms in the good times. The private sector went to the borrowing party in 2005-6. The Bank of England supplied the drinks, and the banking regulator organised the tickets and watched as they arrived for the binge. They are all now living with huge hang overs.

Now the government has invited itself to a similar party. The drinks are once again being supplied by the Bank, with help from the other banks and pension funds. The regulator has not merely issued the tickets but has told the banks to bring more booze so the party goes really well. Banking regulations are being changed to make commercial banks lend more to the government (to improve their liquidity). The authorities have dreamt up a new policy called “strengthening the banks” which entails putting taxpayers cash into some of the banks, so they can lend it back to the government at a loss.

The foreign exchange markets currently do not approve. Maybe they have read the detail of the Chancellor’s statement and do understand that this year’s borrowing is not £78 billion as advertised but a massive £157 billion or more than 10% of National Income. Maybe it is just the advertised promise that the government will borrow 8% of National Income next year that worries them. Maybe it is that and the weak performance of the UK economy, though Euroland and the US will not perform well either. Maybe it is thinking ahead to the losses about to be recorded by UK banks, including those that the government has invested in. Whatever it is, something has spooked the currency markets. Sterling hit $1.45, 131 yen and 1.03 Euros yesterday. The slide continues unabated.

So what should the government do about the runaway borrowing, the bond bubble and the collapse of the currency? It should

1. Signal that interest rates have fallen enough.
2. Cancel the regulatory requirement for banks to buy more government bonds – they need to lend more to the private sector instead to start to lift the recession
3. Relax regulatory capital requirements on the banks as they declare write offs and create more realistic balance sheets
4. Get a grip on the nationalised banks costs – they need to make some money to offset the losses
5. Indicate there will be no more share capital for banks – future support for banks will be based around short term loans against proper security
6. Look for ways to get its capital back from the banks it has put share money into – through asset sales, cash sweeps and refinancings
7. Cancel the VAT reduction, and replace it with cheaper better targetted recession busting tax reductions
8. All the usual advice about how to control public spending