MCD BLOG – latest at top – Blog started 31^st July 2008

This is Mike Downey’s personal blog - primarily devoted to his views and forecasts on economic and world events.  The views expressed are intended to act as a record of this tumultuous period and of predictions made and to assess accuracy over a long period.  It is written with a UK perspective for interest only - not to be used for investment decisions or any other purposes! 

Wednesday, 4th August 2010

A lot has happened in the last five months, since I last put pen to paper metaphorically. The prediction on the general election result was slightly out - although I noted that Cameron was apparently taken by surprise in 'winning' it.  The coalition Government seem to have started well and are making the right noises and actions in trying to recover from Blair and Brown's disastrous governance.  I have some hope for the future, although I believe the depth of the economic problem represents such a severe risk for the UK and elsewhere that recovery will not be obtained for many years and with considerable pain.  We must hope it doesn't finish in a similar way to the 1930's depression.

On a broad scale, I think it is becoming clear that the world's economies are being manipulated massively by many governments.  They recognise that the greatest threat to the world economy is a mass-realisation by the public at large that things are really bad - leading to mass panic and literally a collapse of the whole system.  It is all very, very fragile and if sentiment turned sharply negative the downturn could become uncontrollable.

Virtually every significant part of the economy is being either actually manipulated or media-manipulated.  This applies to the stockmarket where prices are being 'supported' with quite low volumes, and of course the liquidity stimulus (QE) of the last year or so.  Gold appears to be a massive Ponzi scheme with annual sales of gold to punters greatly exceeding actual physical gold inventories - it is rumoured that paper gold bullion is only backed by about 2½% of physical gold.  Investors should be very wary about where they put their money.

As opposed to the time this blog started, there are now many good economic commentary websites, which do give a realistic view of what is happening.  The two I would recommend for those wanting to keep abreast of things are: www.zerohedge.com/ and http://dailyreckoning.com/ 

The over-riding view is that the world economy has been completely debauched by politicians and bankers, with the ready acceptance by the general populace who were enjoying the boom.  Hoping that this can be 'fixed' and everyone can go back to a roaring standard of living - as many do hope - is stupidly ridiculous.  We will have to suffer for past excesses - there is no realistic hope for anything else.  The artificial stimuli applied by governments at enormous cost has only delayed the onset of the real problems and will probably make eventual escape that much more difficult and protracted.  The jury is still out on the question of whether the dramatic reduction in living standards is going to be achieved by deflation or inflation.  There is no doubt that the core problem is major deflation, and without artificial stimulus being applied, deflation is certain.  However, it is possible that Bernanke and others will 'print' so much money that hyperinflation will result - I think it virtually impossible for a balance to be achieved.

Predictions?  I think that many governments, although 'firmly' setting-out on an austerity route will find the social pressures such that they will restart QE money-printing to at least temporarily ease those pressures.  This will of course do nothing to help the country's long-term prosperity and could lead to a hyper-inflationary outcome.

A fascinating theory came to me recently - that of using QE not for internal stimulation, but for currency manipulation.  As forecast a long time ago in this blog, the secret to economic recovery will be to arrange for the country's currency to greatly devalue - thus making exports very competitive, choking-off imports and stimulating the real economy of making things and selling to foreigners.  The way this would work is for governments to secretly 'create' more money, and to then use that created money to buy foreign currencies.  Done on a big enough scale, this would result in a depreciating currency for 'us' and an appreciating currency for 'them' - nicely shifting the problem onto their shoulders - perfect!  Apart from being 'rumbled' by foreign governments, I can't at this moment see any reasons why this ruse would not work - and it could be reversed at any time by simply selling the foreign currency, quite probably at a nice profit!  I think I will recommend this strategy to Cameron & Osborne.

Tuesday 2nd March 2010

I have been most surprised not to read any comment in newspapers, or anywhere else, on the subject that is most likely to bring UK plc down.  The media concentrates on the public deficit, but nobody mentions the real killer waiting to pounce - the UK's dreadful balance of payments situation. 

The facts: at the end of 2008 the UK's net reserves (gold and foreign currencies) stood at $60Bn.  At the end of 2009 it was down to $32Bn - a loss in the year of $28Bn.  We therefore have probably less than 12 months before we totally run out of reserves!

Public sector deficits can be covered by printing money (QE) - but foreign currency & gold cannot be artificially created.  They have to be earned or borrowed.  Despite the 25% sterling devaluation that has already happened, the UK's exports are not increasing, mainly because our trading partner countries are also struggling, and the demand is simply not there.  Imports still come in, UK oil production is dropping - so there is unlikely to be a natural rebalancing.  Overseas investors are unlikely to want to lend in sterling which is almost certain to devalue further - which would of course make borrowing in foreign currencies especially expensive for the UK Treasury.

This is all terrible news - those in the UK who are old enough will remember the balance of payments crises that continued for decades after WWII and seriously damaged the UK economy.  It is coming back, but probably in a more ferocious form than before.  Not only will the economy be blighted, but there will almost certainly be exchange restriction (remember when you could only take £50 out of the country?) with enforced repatriation and conversion into sterling of privately owned gold and foreign currencies.

The other prediction I would like to record here, concerns the UK political scene.  I have become convinced that the Tory party grandees (not including Cameron & Osborne) have decided they want to lose the next election.  This would force Brown to address the problems he has created - the depths of the austerity needed (whatever party is in power) will make Brown the most unpopular PM in history.  After a respectable period when all the really nasty moves have been taken - say after about two years - you then force a vote of no confidence and another general election.  Having already dumped the useless Cameron/Osborne, another Tory leader is anointed (possibly William Hague), producing a landslide election result.  Hey presto – a Conservative government for the next upteen decades again!  A master stroke! 

I am so certain of this scenario, I'm off to the bookies to place a few bets ...........!

Tuesday 19th January 2010

As part of the reason for writing this blog is to record my personal thoughts as we go through these tumultuous economic times, I simply have to comment about one of the headlines in today's UK Times - Goldman’s oracle says buy lots of equities - it concerns a statement by Peter Oppenheimer, Chief European Strategist, that the bull market has miles to run yet, we're only at the beginning, and everyone should buy as much equity as they can.

I remember very clearly the Chief Economist at Goldmans saying several weeks before the market collapsed a couple of years ago that "categorically there will be no recession".  As a result the market responded upwards for a while, whilst Goldmans off-loaded much of the stock they held - the market then collapsed.  Goldmans recently admitted that at the very same time they were advising clients to buy certain stock, they were actually betting against the same stock.  Unscrupulous or what?  They claimed they had a right to offset risk.

I take today's encouragement to load-up with stocks as a clear sign of an impending collapse in the market - perhaps even the predicted (by me at least) second downward leg of the W.  Time will tell - but I for one am keeping my hands in my pockets on this!

Thursday 31st December 2009

The Financial Times on Monday this week had the headline 'Corporate optimism at highest in 6 years’, sub-headings: ‘Bosses see turning point for economy’, Number of Boxing Day shoppers up by 18.6%’.

That certainly puts me in a real minority - but time will tell if I am right or not - but I am sticking to my views; we (the UK) are in a very bad way and are more likely to descend into depression than we are to get of this mess quickly.

My End-of-year Review: it's still a lonely place being a pessimist, the FTSE closes the year on a near-record and everyone thinks the recession is over, although the UK unlike other countries has not yet emerged.  There appears to be a general optimism that things will get better - certainly the shops have been full and the pre-VAT rise sales have been going well.  Gordon Brown of course hopes that feel-good factor will continue into the next general election, which must be held by May latest.  However, why anyone would want to be PM with this almighty mess to deal with, defeats me!

Personally, I have an enormous feeling of impending doom about to break upon us.  Brown has allowed the country to run-up a staggering level of debt, to fund a highly irresponsible level of public expenditure.  In my humble opinion the aftermath of this will crucify the hopes of the British people for many years ahead.

I am reluctant to say that Brown is operating a scorched earth policy of destroying the economy to leave the Tories with a major problem, but it is difficult for me to see what other motivation he has.  When we learn that Brown deliberately let immigrants flood into Britain to rub the Tories nose in it, and to increase Labour's voting population, anything from this awful government is possible.

So, my specific predictions are:

1) There more likelihood of a March election, before the current euphoria evaporates completely.

2) There will probably be a hung parliament, which with Cameron/ Osborne's inherent weaknesses is about the worst combination given the depths of problem the country faces. 

3) As a result, external parties will be the biggest influencers on what happens to our economy in the future.

4) Those external influences will be:

a) A reduction in the UK's credit rating because of our out-of-control debt and public deficit situation, which nobody has the guts to address.

b) A consequent increase in interest rates to try encouraging overseas lenders to continue lending. 

c) However, this will only happen after a further significant devaluation of the pound has occurred.   There may also be exchange controls introduced.

d) The rise in interest rates will of course increase the adverse effects of the massive debt level now built - putting more pressure on tax increases and public expenditure reductions.  Not helpful in getting an economy going again.

e) Unemployment will zoom, and there will be many public sector strikes and great social unrest.

f) A eventual visitation from our friends at the IMF and the administration of their medicine.  Perhaps also sterling joining the Euro, if it hasn’t already collapsed!

Not a happy prediction, but one I sadly think will be proven correct.

Happy New Year - I doubt it!

Friday 13th November 2009 (appropriately!)

As predicted in MCD Blog the Quantitative Easing level has risen enormously from the original £50Bn to now £200Bn with probably another 25 or so to come - and all in such a short time.  Virtually the whole lot has gone on government spending with the private sector being starved of funding.  Only public servants and bankers are doing nicely thank you. 

A couple of weeks or so ago Gordon Brown said something I agreed with - he said that if we don't carry on spending and stimulating the economy, then things will get very bad indeed.  The only problem is that his ability to carry-on borrowing and counterfeiting our currency will reach the buffers before too long.  After that things will get very bad indeed.  Servicing the massive debt burden being run-up by Brown will be bad enough if interest rates were to stay low, but with the almost certain reduction in the UK's sovereign credit rating sometime soon, the consequent increase in interest payments the Government will be forced into, the future will be grim indeed.

It is a King Canute exercise - QE is only a viable proposition if it is used to bridge a known gap.  If it is used to defer something horrible in the vain hope that better circumstances will somehow happen - then it is just a very expensive way of mortgaging the future for a short-term and temporary respite. Our children will not thank us for doing this.

There seems to be a belief by many people including those in the City, that we will shortly be able to get back to where we were – high stockmarket prices, high property values, high standard of living, etc., as if nothing had really happened.  There is a collective failure to realise that where we were was the result of completely unsustainable liquidity levels and gross fiscal and financial mismanagement.  There is absolutely no way we will be able to get back there for many years, if ever.

This mass delusion will carry a high cost for those being sucked in.  The greed of not wanting to miss-out on a major bull run predicted by 'experts' will cause significant losses for those that succumb to the temptation.  Such booms are called a suckers rally for good reason.

The apparent wealth we all thought we had in the past was a mirage based on the fiscal imprudence of our leaders and bankers, and ourselves.  Our apparent wealth will have to be reduced down to its real level, either by major reductions of asset prices and pay, or by major inflation, or a combination of both.  Maintaining the status quo in real terms is not an option - sadly.

I am sticking by all the previous predictions made.  I believe we will be in serious trouble once the artificial stimuli cease.  By that time our resources and reserves in the UK will be exhausted in vainly trying to put off the evil day when real action has to be taken.  The risks of social break-down are very real.  Many people are going to see their lives seriously affected with not much to hope for in the future.  They will not be happy!  

As this is being written the stories that the world (apart from the UK and a few minor countries) are now emerging from the recession and will be growing strongly - are everywhere.  These reports are coming from respected organisations - OECD, IMF, etc.  I believe this is an over-rosy view that will be reversed as stimulus effects die, and debt costs mount.  But some countries - particularly the UK and USA will suffer more than most - they were the ones to let things rip (see MCD Blog Dec’08).

The other great debacle concerns the handling of bail-out money and QE which has allowed bankers such as Goldman Sachs to make obscene profits and bonus payments.  It shows the stupidity and incompetence of governmental leaders, who even have to appoint the very same bankers to key positions because they themselves have no idea how the system works or how to repair it.  I suppose it would be too much to expect the bankers not to take personal advantage of the opportunity given them.

There is a view afoot that because the bankers have not admitted to all the losses that are actually in the system; they have effectively been over-reporting their profit.  They should have been making massive loss provisions, but they have not, and have instead awarded themselves enormous bonuses based on profits that are not actually there.  If that scenario is correct, the bankers will be coming back for yet another bail-out by taxpayers.

It is difficult to write a blog that repeats itself, but the views expressed before do not, in my opinion, need changing.  The principle of going with the flow and taking advantage of current stockmarket 'strength' seems the best approach as long as it is recognised that this is an artificial situation that will reverse at some stage in the not-too-distant future, and to get out quickly at the first signs of trouble.  Personally I believe the current stockmarket surge has gone as far as it will (the Dow closed at 10,270 today), so now would probably be a good time to take profits.

The danger of a collapse in Sterling is still there, probably more so especially when the awfulness of the UK's situation is more widely realised.  It is a hopeless case, with such an over-large, overpaid, over-pensioned, unproductive public sector.  An enfeebled manufacturing base following transference to China, etc.  A large benefit-dependent population fuelled by Labour's grossly irresponsible immigration policies, which we now know from leaked documents were inspired by a desire to rub the Right-wing’s nose in multiculturalism.  Add-in the collapse/ expiration of North Sea oil production (which saved us last time), and you have an unholy mix of incompetence and circumstances.  The UK's people will be paying for Blair/Brown's imprudence for a very, very long time.

Personally, I find it difficult to see any sector of UK activity that is likely to 'pull' us around.  Certainly the financial services 'industry' that were supposed to have been our major strength, have been exposed as a bunch of unprincipled 'gangsters' happy to pillaged our futures for their own greed, aided and abetted by a government besotted by spin and riddled by an incompetence that defies belief as the facts become known.

It is such a desolate scene that will only be relieved by a return to true values and the rebuilding of our core strengths and a desire to achieve real success, rather than the vacuous aspirations of our politicians.  So far, no politician has yet emerged with the personal strengths (like Thatcher) to carry this through.

I fear a level of austerity that will test the fabric of our society, which I believe is now not capable of adjusting to the new reality - we have become too used to the soft life and our poor standards of education and backbone are just not up to the job.

To take a phrase from 'Dad's Army' - we are doooomed!

Thursday 25th June 2009

The last few months have been difficult for pessimists.  The markets have surged, the pound sterling has zoomed upwards, and announcements of the recession being shortly over have been coming thick and fast from many different and respected pundits including even the Bank of England - although in the last few days they have been back-tracking.  It has indeed been a very lonely place not joining in with the 'party is resuming' brigade.

Can we have been so wrong?  Are the excesses of the past going to be eradicated by the strong V shaped recovery the B of E now predicts? 

When in doubt the best route forward is to revert to commonsense and ask the question; does it make sense?  Partly in answer I give the link to a recent article written by Toby Birch - the author of 'The Final Crash' which accurately predicted over two years ago all that has happened.  He makes the valid point that we should not expect things to resume back to where they were before the crash.

This makes sense to me, given that the whole global liquidity scene was so artificially inflated by the out-of-control banking and derivatives sector.  For us to go back to those asset prices and boom conditions would take a similarly irresponsible stimulus to be applied to the economy.  Surely no government is going to sanction that?

But maybe they will!  I do believe there is a real danger that Anglo-Saxon politicians (especially USA & UK) may find the prospect of 'quantitative easing' just too irresistible'.  What a super deal it is, especially for a relatively short term politician - you print your own money (just like counterfeiting), can pay your entire public sector with it, it doesn't feature on any public borrowing statistics, you don't have to pay interest on it, and beauty of beauties, the downside effect doesn't kick-in for quite a time.  Perfect! 

So, I think the green shoots being seen are a combination of the end of destocking which gives the perception of an upward bounce, plus the opening effects of printing money going into the economy.  This is all very well if everyone is happy to play the game, but there are already the signs that our external creditors (Chinese, etc.) are not going to play ball. 

So, I think we are seeing the rush of those people who failed totally to see the crash coming, who now don't want to miss-out on the bull market that everyone knows has its biggest lurch upwards in the first few weeks.  Greed has overtaken fear at least temporarily.

It has been a little like having a very boozy party funded by money out of thin air (the banking fiasco of derivatives) which shuddered to a halt in August 2007.  The boozy party has now recommenced with more money out of thin air - this time from printing money and taking-on unaffordable government debt.  And some see this as green shoots of recovery appearing!

It is time for me to go on the record and stick my head above the parapet and say this is complete tosh.  I predict we will suffer for a very long time - it is far more likely to be an 'L' non-recovery rather than a 'W' recovery.  The idea of a 'V' recovery as predicted by the BoE is absurd.

Of course it is in the interests of the City and the government to talk recovery up especially as sentiment is often the most important factor in influencing markets.  But the latest news that UK government borrowing is at a staggering £30Bn per month must mean the buffers are going to be hit fairly soon and hard.  And yet the FTSE is still buoyant!  Daft!

So, the bottom-line from me is that the predictions made earlier in this blog are still on track to happen.  Once UK public sector redundancies get going together with pay and pensions restrictions, and union action - we will see a truly torrid time for all in the UK.  At the time of writing all of these effects are hidden from view - in fact there are many households where disposable income has actually shot-up as mortgage interest has dropped and few have yet been made redundant. This is indeed the phoney period before the onslaught to come.

I think the most likely scenario is a growing resistance of overseas creditors to fund the UK government's bond issues - probably following a down-grading of the UK's credit rating. Once the slide gets going, sentiment will start collapsing and the rest of the scenario will happen.  A sterling crisis and perhaps even exchange controls are on the cards.

Because sentiment has the biggest effect on short-term trends, and has been the predominant factor over the last three months, my personal investment strategy is to go with sentiment, but at the first sign of trouble to immediately default to the doomsday action of hunkering-down.

Wednesday 25th March 2009

Quantitative Easing has now started in the USA, UK and Switzerland, and perhaps other countries too.  This is the start of the great experiment in economic management/ mismanagement!   We are about to enter uncharted waters where nobody really has a clue what will happen.  However, I will give my opinion on what will happen although I do hope I am wrong - but haven't been so far!

I believe there will be four primary stages to this economic depression:

Stage 1 - this has largely already happened - securing the banking system by throwing previously unimagined amounts of money at the problem.  This has been successful, although at what ultimate cost is impossible to say - but it will be enormous.

Stage 2 - Attempts to stimulate growth by reducing interest costs and by 'quantitative easing' - this is the stage we are now entering.  These will largely fail for two main reasons; a) People will want to pay down debt and reduce spending just as the Japanese did - they will certainly not want to continue borrowing and accumulate more debt.  b) the pace of industrial collapse is increasing to a point where continued financing of the losses being incurred in the private sector is no longer possible - leading to much higher levels of unemployment and corporate insolvency - which in turn increases the downward spiral.  Consider the plight of the car industry - but only as an example of similar situations in many other industries; no company can survive a 50% reduction in sales which lasts for more than a few weeks - the inherent fixed costs of continued operation become simply unfundable.  Pouring public money into such situations only defers the evil day but at tremendous cost.  If people don't want/ can't afford new cars even with government grants, there is no point in trying to keep the factories going.  In my opinion the only sensible thing to do is to mothball the assets until demand makes the operation viable again.  The speed of collapse now happening makes immediate recovery very unlikely.  We will instead see a form of severe stagflation or possibly deflation - depending on whether the stimuli produce any worthwhile increase in demand.

Stage 3 - With the failure of governmental stimuli there will be a growing awareness that the excessive effects of the global boom have to be reversed before any real recovery can commence - there is no easy or painless way to undo the damage caused by the unrestrained excesses of the past.  There will eventually be a realisation that standards of living will reduce until the point at which equilibrium is restored - i.e. that people live within the bounds of what they produce - not what they borrow.  With the alarming collapse in production that means a very significant drop in wealth and income.  In my opinion the reduction in both, in real terms is going to be at least 50% and probably much more.  These reduced levels of wealth from stockmarket valuations and sterling devaluation have already happened with some more to come.  Property values will follow soon - just as they did in Japan, as will income levels - salaries and wages as workers scramble for the few jobs going.

This is a nightmare scenario because it would mean that many families will see their wealth and income reduce back to the postwar period, especially when the effects of debt repayments are taken into account.  Poverty will become widespread in developed countries and starvation in the third world. 

Stage 4 - Only when bottom is reached will a genuine recovery commence – as always there will be several false dawns.  As said before in this blog, the components needed for success are still there in the form of labour, innovation and capital, although the latter will be a scarce resource in the early stages.  The pendulum effect will apply - meaning that things will over-correct and for a time will become worse than they should.  This is the time for wise people to invest.

Timing on all this will probably be faster than most expect as the snowball gathers pace.  The UK government can be expected to try deferring the worst effects until after the next election, but they will start coming under great pressure as the problems of trying to borrow more money become apparent, and they are forced to drastically cut back on public sector spending.  That is when the fireworks start in earnest and civil unrest becomes a further restricting factor on governmental options.  The warning given today by Mervyn King, Governor of the Bank of England that the UK has reached the limits of its ability to stimulate the economy, reinforces that view.

Thursday 5th March 2009

I have just reviewed the earlier parts of this blog to see if any changes of thought are required – I don’t think so!  The situation currently looks as dreadful as predicted!  We are continuing to tumble down the spiral to who knows where.  There is good reason to believe we are witnessing a major rebalancing of our whole economic system.  Of course, that may not be an overly gloomy view because eventually the actual components of wealth will re-assert themselves - labour, innovation and capital - but we will have to reach bottom before that happens.  We have had an enormous boom (despite Gordon Brown’s claim) and in my opinion there is no alternative but we have to have a subsequent enormous bust – and almost certainly the quicker the better. 

The experience of Japan has some guidelines for us in how this depression will pan out.  The Japanese were historically a frugal people, just as the British were - when the Jap boom collapsed in 1990 amid ridiculous asset price inflation - property and stockmarket, the population went back to the happy frugal life they had before.  They rejected rampant consumerism and realised they didn’t need the new car each year, new clothes, and to spend, spend all the time.  As a result their government's attempts to re-stimulate the economy failed spectacularly.  The Japs had received such a shock that they preferred to rebuild savings rather than resume spending.

I believe we will see the same mindset in the western world, which will have dire consequences for our level of production and apparent material wealth generation.  I deliberately used the term material wealth; because I believe we will see a retrenchment back to the old values of pre-consumerism days.  This will be forced upon many people by their circumstances, but probably also becoming the fashion for others.  We may even return to a happier way of life.  For these reasons I believe the current governmental efforts to stimulate the economy will fail, leaving an even more massive debt mountain overhang for our children to pick-up.  I watched Gordon Brown’s address to the US Congress today – he got many standing ovations for giving a seriously upbeat speech – I suppose he has to, but I think in reality his delusion continues!  The following day the Dow crashed, which was a more appropriate reaction.

In my opinion, the destruction of apparent wealth will continue for some time yet - many who previously regarded themselves as wealthy will no longer be so.  Many of course will actually be destroyed by the effects of negative equity, investment losses and unemployment.  Only those who divested themselves of shares and property before the crash and have no reliance on pension investments will be spared - but even they must be wary - the hyper-inflation to be unleashed by current governmental action, quantitive easing and more, will also soon destroy those who currently feel comfortable – unless they take action.  The 'international' losses to UK based investors has already been considerable - an average 40% drop in the FTSE combined with a 30% devaluation in sterling represents a massive destruction of wealth.

I hope by writing this blog to better identify the time to switch from liquid assets into those investments that are likely to protect against the awful effects of hyper-inflation.  The time is not yet in my opinion - the world still needs to adjust to the new reality.  I believe in the comment made nearer the start of this blog that those countries that have let things rip, will be the ones to suffer most.  That means the USA, UK and many others - the device that will effect the wealth destruction will be devaluation and inflation.  Only when that rebalancing has happened will those countries and the rest of the world be able to stabilise and recommence growth.  It will not happen for a considerable time yet.

To try putting a date when bottom may be reached, it would be worthwhile looking at what is likely to happen before the bottom is glimpsed.  Certainly unemployment must reach levels not even envisaged in the past, and there will have to be acceptance that real wages have to drop considerably - the UK's minimum national wage will have to be abolished or drop considerably in real terms.  The forthcoming hyper-inflation will provide the mechanism for effecting the changes needed.  A bigger barrier to cross will be dismantling the grossly excessive public sector infrastructure we can no longer afford (if we ever could!).  Given the resistance of the vested interests involved (public sector unions, left wing politicians, etc.) and the 'fact' that no effective action will be taken before Gordon Brown is ousted in 2010, I personally do not see much progress until 2012 at the earliest – for the really pessimistic this is the year some believe the world will end! (check it out on google).  The scale of the problems faced by virtually all major countries I think means that timescale will apply to most - and frankly it could be a lot longer.

Going back to a previous blog theme, the name of the game at this stage of the depression is the preservation of wealth rather than trying to make money - at the moment that would be pure gambling.  Cash is still king, but where to keep it is the question.  We are about to enter a period of competitive devaluations and probably protectionism, as countries try to get the most of whatever declining trade there is to be had.  It is important to look for those countries/currencies that are likely to do better.  We are looking for places that have not let rip, and are not so vulnerable to the massive readjustments now underway.  My personal favourites are Switzerland and Norway, although the former is affected by its runaway bankers, and the latter is sensitive to any further fall in oil prices.  Gold might be a refuge but I am always worried when I see so many people rushing in - is another bubble being built?

For many people there will be no escape.  They are trapped in their country, their property, their investments, their pensions.  The changes underway will wreak havoc with many people's lives, and will probably induce a complete readjustment to the way they live and their thought processes.  Back to basics may be the key phrase, and quite likely a rejection by younger people of their parent's values, or lack of them.  There has to be a good chance of inter-generational conflict, especially as many expect the next generation to pay the cost of the now excessive pension benefits of the baby boomers, who might also be blamed for causing the problems in the first place.  This is a nettle the UK government has not even started to address - in fact they have consistently run away from it, as evidenced by the refusal to do anything about the massive/grotesque and completely unfunded public sector pension liability.  There is of course good reason for that - the government knows for sure that any attempt to rein back will provoke unprecedented union action in the form of highly damaging strikes and disruption.  They don't have the balls or the desire to address the issue - but this depression will force their hand – the government will simply not have the funds to continue as they are.  I fear that Britain will not be a particularly pleasant place to live in the future once these problems start.

For entrepreneurial types the changes now being wrought will create new opportunities, as they always do, and eventually there will be a recovery – always assuming of course that war does not break-out – a distinct possibility for the future.  Massive unemployment has always been a spur to entrepreneurial recovery and this is one hope for the future.  In some ways, the quicker we get to bottom however bad that is, the better – we can then all get moving again.  The stimuli being applied by governments will probably only succeed in dragging out the timescales involved and probably making the eventual bottom further down.

Wednesday 4^th February 2009

This piece is on the subject of commonsense, and its potential use in determining how the future will shape-up.  Probably like most other people, I find the current economic situation quite bewildering – all these billions, even trillions being thrown around with gay abandon – I don’t really know what the end result of all this will be, and worryingly, I suspect our political masters don’t have a clue either.  I think that probably it’s being done to try solving today’s problems, with a lot of crossed fingers behind backs that it is not going to have some nasty after-effects later.

I have been alarmed for a long time to see in the UK a quite gross lack of commonsense in the way the government acts, and the horrendous growth of the public sector – unbelievable amounts being spent on bureaucracy, silly useless PC job titles, massive salaries and of course gold-plated inflation-proofed pensions that ordinary taxpayers could only dream of.  And it’s still increasing – a look at the job adverts in the Sunday Times last week reveals that over 80% are for public-sector – i.e. non-productive jobs – the private sector is on its knees, but the public sector is still roaring away.  Gordon Brown seems to have latched-on the Keynesian ‘lets borrow and spend our way out of this’ idea, and he thinks that continuing this particular form of profligacy is a good idea – putting more money into employing largely unemployable time wasters.  I’m very unimpressed with most of the public sector employees I have ever met – I certainly wouldn’t give them a job.

Commonsense says this can’t be right, and I think it is that thought we need to hold onto in trying to peer into the future.

In reading the obituary last week of Sir Alan Walters – Thatcher’s economic guru, I came across this paragraph in The Economist:  ‘At the time of their meeting, in 1974, he was beginning a total re-evaluation of economic policy provoked by Edward Heath’s disastrous government, in which he had served. That had ended with a Keynesian public-spending binge, the orthodoxy of the day, to stimulate the economy. But instead of helping, it had caused runaway inflation and a rash of strikes. Surely there was another way?

I suspect we are in for a serious bout of déjà vu, which will only end when we hit the IMF brick wall or similar obstruction, or if we finally get a politician with both brains and guts – there are none currently on the horizon in my opinion, and that includes the spineless smoothy Cameron or his useless side-kick Osborne.

I have been reading a number of optimistic economic opinions recently that forecast a fairly short recession before we return perhaps next year to the sunny uplands.  Several have forecast a recovery of sterling, and indeed as I write the pound has been heading upwards – today at $1.45/ €1.12/ CHF1.68.

Does it make sense?  Not to me it doesn’t – until we get back to doing sensible things that contribute to the wealth of the country and its people, and leave behind the political spin and prolific waste of resources, this country will continue to descend back into being the basket case it used to be in pre-Thatcher days.  We are doomed until then!

Conclusion:  We are by no means out of the wood, and things will get much worse before getting better.  Eventually sterling will be worth holding again – when it reaches bottom - but it still not there yet even after the fairly significant devaluation already suffered.  The only redeeming factor for sterling is that many other currencies are not in good shape either.

Saturday 24^th January 2009

Every so often a piece of news comes into one’s knowledge base that fundamentally changes one’s views.  That happened this last week – I read the article by Ambrose Evans-Pritchard in the Daily Telegraph which introduced an element of the UK’s bank bailout that I had not considered before – I had naively assumed that bailing-out banks was just a matter of printing pound notes, which of course is in the remit of the government to do, even though it could have nasty after-effects later.  Ambrose (and I would strongly recommend him as probably the best economic commentator – see http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/ ) wrote that the effective take-over and ‘guarantee’ of the UK’s banks involves taking onto the UK’s balance sheet the foreign debts and foreign assets of those banks – these amount to over £4.4 trillion, compared with UK’s foreign currency reserves of only £60Bn.  The problem is the same as an accountant gets when looking at a struggling company’s balance sheet – the liabilities/ creditors are always 100% good, but the assets and debtors are never all good!  In this case, given the intellectual diarrhoea and lack of caution exhibited by our banks, there is every chance that a fair proportion of those assets are bad, if not very bad!  Set against the miserably tiny reserves the UK has, the foreign currency obligations will swamp the UK government's ability to meet the guarantees they have been issuing - it is clear that the government simply cannot print pound notes to sweep away this problem.  

If these figures are correct (I have checked the £60Bn), then it will be a foregone conclusion that the only options open are to call in the IMF, or to dishonour ‘guarantees’ as Iceland recently did.  The consequences of a sovereign default by the UK would be so dire for the global economy that the only real option is to go to the IMF.  This would probably result in the most draconian cut-back on government spending and borrowing, guaranteeing the deepest of depressions.  Scary indeed!  Writing as I am four days after the Ambrose article was published – the Daily Telegraph article has disappeared from its website – it is such strong stuff I wonder if political pressure has been applied, as it could lead to a serious run on the pound and the UK in general.  I kept the link – so the article can be read at http://blogs.telegraph.co.uk/ambrose_evans-pritchard/blog/2009/01/20/seriously_alarmed

If the above is true, the political fallout of IMF control would be immense as it would be clear that the whole Gordon Brown stack of cards has collapsed with disastrous effects for many people.  The spectre of exchange controls, compulsory repatriation of funds and 'war loan' stock - making those with more than x wealth lend it to the government on a non or very long repayable basis.  This is not a prediction and I hope it is far too extreme to become true - but just in case we need to keep an eye open and move quickly if it starts looking likely .................... 

What should the UK citizen do about this?  Sterling is almost certain to weaken further, although its drop in value so far already exceeds the 1930 and ex-EMU depreciations.  The advice given several months ago to get out of sterling was good, and those who took it are now showing a substantial ‘profit’ at least in terms of pounds.  For those still in sterling, I believe the best advice is to move into commodities – particularly those that have suffered a major price drop – oil of course springs to mind, but there are probably others like food.  The timing is somewhat critical as some of those commodities have further to drop as the global recession gathers pace, so now may not be the optimum time, but it probably will be shortly!

Monday 19^th January 2009

Announced today that there will be a further massive bailout of UK banks – the first has not achieved the desired effect, mainly because of the enormity of the (undisclosed) losses on bad investments and loans made by the banks.  In reality, probably nobody knows the extent of losses already in the system, but it is recognised that every downward notch in the general/real economy means that whatever those losses were, they will be even bigger.  This gives the impression of a bottomless pit into which unimaginable amounts of cash are being poured, without any real knowledge of either what is being achieved, nor what the ultimate cost will be - or what the long-term economic and social consequences will be.  However, the government has no alternative to these panic measures as a collapse of the banking system would be unimaginably dire.

Much emphasis is being placed on getting banks to lend again, but I am not at all certain this is the key problem it’s being made out to be.  Certainly there are good companies that need bank finance, but there must be very many businesses that are now on the road to insolvency because of greatly declining sales demand – bank lending in these circumstances is not the answer – any loans here will only stave-off collapse for a short time but will eventually go bad and have to be written-off.

Similarly, trying to increase lending to consumers so they can carry on consuming is almost certainly not going to work.  Previous, now debt-laden consumers have been given a serious fright/ lesson and are far more likely to want to reduce their debt burden than continue loading-up.  Even if consumers were given money, I suspect that many would elect to pay-off debt or increase savings rather than go out and spend.

Quantitative Easing – a convenient pseudonym for printing money, is the only ultimate ‘nuclear’ option available to governments to artificially increase money supply – but because of the above constraints is probably not going to be an efficient device for increasing demand in the short, or probably not even in the medium-term.  It will however produce a guaranteed period of hyper-inflation in the longer term – which is almost nature’s way of bringing about the drastic reduction in apparent wealth that’s necessary, and the change in attitudes that will eventually lead to a recovery.

The unhappy conclusion is that the effective collapse in economic activity cannot be prevented by the devices and actions currently being implemented.  It might slightly cushion the landing from being catastrophic to being just very hard, but will not prevent very many companies from going bust, or very many people losing their jobs.  There is a point of view that after such extreme excesses over the last decade, there is no real alternative to a fundamental rebalancing of the economy, accompanied by a lot of pain for a lot of people.  It may be that we have to hit absolute bottom before any recovery action will be effective – when people can see that sterling, house prices, the stockmarket, etc. have hit bottom – then the investment and growth path can be resumed again.  Nobody of course rings a bell at the bottom.

We can however be certain that the world’s best economic brains are now on the job, which should be encouraging.  The crisis started because of a virtually complete failure by those at the control levers to even recognise the problem until far too late – now everyone’s eyes are focussed on the issues.  I suspect that nobody knows what the long term effect of the unprecedented measures now being taken and contemplated will be – we are into uncharted waters.  The world financial system has been debased by the past excesses, and is being further debased by the panic measures now being taken.  History books will be written about this time as one of the most momentous periods ever experienced, and perhaps as a case study on how to handle such problems – or not, as the case may be.  ‘May you live in interesting times’ is certainly a most appropriate Chinese curse for where we are today!

Tuesday 13th January 2009 (Flying transatlantic)

It's surprising how lucid one feels after a drink at 35,000 ft at 11.00 am!  I have just been reading an article on bank regulation after the credit crunch.  Whilst it is obvious that the government and the 'regulators' have been asleep at the wheel - busy having their forms filled in whilst Rome burnt without even noticing! - the emphasis now seems decidedly in favour of over-regulation.  Having screwed-up one way they seem determined to screw-up in the other direction too! 

The essence of the whole banking problem is that normal retail banks who provided an essential utility service of storing and managing money to individuals and businesses were allowed to also go into the casino business of investment banking - effectively using the implied taxpayer's guarantee of their business to underpin their bets.  The first, utility banking function should be highly regulated - people need to know their deposits are safe.  The investment banking/ hedge fund business should be substantially unregulated apart from preventing fraud and perhaps limiting short selling - it should be clearly labeled as a casino with everyone knowing the risks they take by entering.  The role of regulation should not be to prevent fools from losing their money but to ensure that sensible people can rely on the probity of their utility bank.  So if a financial institution wishes to act as bank with all the regulatory protections and obligations, it should be prevented by law from indulging in casino type activities.  This will of course make banking an incredibly boring business without ridiculous bonuses - just what we want!  At least then the betting failures of the investment banking fraternity will not prejudice the entire world's financial system. 

Thursday 26^th December 2008

Christmas Day over thank goodness – time to reflect on other issues.  I found the images of crowds pouring through shop doors at the beginning of the sales – more massive than ever of course – a quite depressing sight.  I am sure the era of acute consumerism is coming to an end. 

I feel the dawning of realisation is about descend on large parts of the population who have thought wealth and a good standard of living can be achieved without working for it and without producing anything of real value.  A retrenchment back to basics will follow.

With the distractions of Christmas over we can start to look fully at the awfulness of the economic landscape now opening for all to see.  The plunge in the value of sterling is a reflection of a growing realisation that Britain has very little to offer now that the masters of the universe have crashed – without our financial sector we do not have much left.  A crisis in 2009 will be to do with our balance of payments – it’s been many years since we last heard of that – but it is the subject that will eventually prevent our government from continuing with its current strategy of spending our way out of recession.  Sterling’s devaluation will at least choke-off the flow of foreign baubles that have filled our shopping malls – but the reverse side of devaluation of making exports more attractive will not benefit the UK as much because we now make so little that buyers overseas would want.  Scotch whisky perhaps!

With a grossly negative balance of payments, to fund its strategy the government can only borrow yet more money from abroad – or turn-on the printing-presses.  Who from abroad will really want to lend to a country already in hock, with a currency showing every sign of depreciating much further, and with a near zero interest coupon?  Sterling will have to devalue much further before it becomes attractive to hold again.  So the printing presses it is – unless the decision is taken to enter that other abomination of a currency – the Euro, or bring-in the IMF.  What a choice!  I suspect that the Euro will be adopted as an escape route.

Whatever happens to the fiscal arrangements, the shape of the landscape is now clear – massive reductions in demand and output, businesses going bust all over the place, and a level of unemployment not even dreamt about in the past.  The government’s irresponsible ‘open-doors’ policy on immigration will be seen to be a folly.  The more competent migrants will of course go back home – leaving Britain with those requiring our social-support system.  This together with the level of unemployment will produce major social disruption and discontent – I really don’t see any alternative.  We already have a significant underclass and this is likely to grow exponentially over the next few years.  I seriously fear for the quality of life in Britain.  Discontent and the lack of hope will give many social problems, of which crime and drug abuse will be the most apparent.  Adding to this will be the effect of actions taken by public sector unions – now the only ones with any power - when the government is forced (by the above mentioned financial constraints) to drastically rein back employment, pay levels and of course the pension rights they all have.  Summers and winters of discontent can be assumed.

Do I see any brightness in the near future?  No – except that eventually a realisation will dawn that our old ways have to be abandoned and we have to go back to basics of producing wealth rather than just borrowing it.  There is still a Thatcher legacy of entrepreneurial people in Britain – it is only they who stand a chance of dragging Britain out of the morass.  It is for that reason that America will come out of recession earlier than most despite the awfulness of its situation – they do have that essential resource of success-driven entrepreneurs and a can-do attitude. 

Tuesday 16th December 2008 (in USA)

The latest crisis at least in the USA is the auto industry bail-out which is a largely unreformed industry with aggressive trades unions and 'spanish practices' abounding, asking taxpayers to bail-out from an almost certain collapse of the industry.  This is interesting because it will be repeated in many other industries too, and brings back memories of the British car industry and the expensive and ultimately unsuccessful nationalisation into British Leyland in the 1970's.  The reality is that current auto manufacturing capacity vastly exceeds any likely level of demand for several years to come.  Bail-out of the industry will be a disaster, but of course not bailing-out will also be such a shock to the system that it may precipitate the domino collapse of many other industry sectors.  This will be the rock and hard place that will be present for many decisions.

The new reality is that there will simply not be the demand to support the industrial capacity and jobs we currently have, nor will it support the standard of living we currently enjoy.  The world will become poorer; we will all be much worse-off than we imagined possible.

There is a distinct possibility of serious social discontent developing that will not be able to be covered and smoothed over by governmental handouts as in the past.  The reality that there is simply not enough wealth to spread around will eventually dawn on our ruling classes.  The ability to either borrow or to print money will not in practice be available as a way out - as is currently seen by the UK government.

What does all this mean for businesses?

The most important message is not to just hope that things will not be too bad.  Assume they will!  Anticipation and action (now!) will be required to ensure survival.  There is no doubt that very many companies will experience a significant reduction in sales turnover and gross profit generation.  Whilst some of this can be covered by cost & staff reduction eventually (and probably quite quickly) the point is reached where costs have been reduced as much as possible – i.e. that further cuts will damage the company and its chances of surviving.  Further deterioration in trading circumstances will then leave company owners with three stark alternatives:

1)      Put more capital in to cover losses.

2)      Try finding a buyer – but now from a position of weakness

3)      Go bust!

This is the classic scenario for companies in recessionary times, and the result is a large number of companies going out of business, often with serious financial consequences for those involved.

Unless more capital is to be input, or a company sale arranged, the ONLY way out of this predicament for company owners is to arrange a merger of the company with other similar businesses, so that together they achieve a much higher sales and gross profit generation relative to fixed overhead costs.  In that way, they will not only survive but also go on to grow profitably.  Such mergers must be arranged very sensitively to include the interests of all parties – but this can be done.  CMR arranges such mergers - see www.cmrworld.com/CatalystGroup.asp

Cast Iron Prediction:  Very many companies will go bust unless they protect their interests – the merger route is the only way forward for many.

Tuesday 2nd December 2008

Many of our problems are caused by bankers – spelt with a ‘w’!  The system that was supposed to be overseen by governments and regulators in fact provided a seemingly one way bet and great encouragement for bankers to take ridiculous risks.  Whilst the regulators were busy having their forms filled in, the much wider and far more important picture was ignored - or more likely not even recognised.

The normal control mechanisms of money supply were overlooked by everyone, with the result that debt was allowed to multiply on other debt, almost ad infinitum.  Milton Friedman will be turning in his grave – for it was he who counselled against the sort of uncontrolled expansion of money supply that Greenspan orchestrated.  At the time of writing (2nd December 2008) the true extent of debt is still unknown but is likely to run into many trillions - possibly at a far higher level than the world's total GDP.  This level of debt could and probably will destabilise the entire planet's financial systems.

In my opinion there are three levels of problems to be encountered:

1) The initial 'trigger' of dealing with sub-prime debt, with the resulting effect on bank liquidity.  That stage has been largely covered by throwing the kitchen sink in the form of unimaginable amounts of money at the problem - without any real knowledge about the economic effects this will produce – it was a panic measure.

2) The next stage of the crisis will be dealing with all the other (non-sub prime) debts and the ensuing consequences.  These fall into three main categories:

a) 'Ordinary' debt but which is now under threat because of the general economic decline - unemployment and corporate debt especially.

b) CDS-covered debt; a clever device invented by banks to enable banks to carry on lending at a ridiculous level without the normal restricting effect on their balance sheets.

c) The devastating effect of all this on the 'real' economy'.  Production levels and employment will slump to levels never before imagined. 

As with all previous economic calamities the only real escape is through the mechanism of currency devaluation.  It is those countries that have let their economies rip – especially through asset/property inflation and excessive borrowing that will be the most affected.  The effect on living standards in those countries will be terrible - back to the economic dark ages well before the last economic 'miracle' happened.  There is really no escape from the excesses of the past, and current attempts by governments to spend their way out of the crisis are doomed to failure and will only exacerbate the situation.  Apparent wealth in those countries most affected will be partially destroyed - future generations will pay the price, and in turn this could lead to inter-generation discontent – will younger tax-payers of the future be willing to continue paying for pensioners and the mistakes of the past?

What can be done?  For those with wealth the name of the game is survival and to prevent wealth destruction - forget trying to make money at the moment unless you are a real gambler.  As the primary consequence will be in the destruction of value in those countries most affected by the mechanism of significant devaluations against more prudent countries - it would seem sensible to dump/get out of the affected currencies (especially sterling).   But where to?

In my opinion there are two types of country:

a) Those that have allowed their bankers to run amok making ridiculously risky loans.

b) Those that have done a. above but have also allowed ridiculous asset inflation and borrowing.

It is difficult to find many countries that have escaped a. above but there are some that have not allowed b. to happen.  For example Switzerland, Germany, and France to a lesser extent.  The latter two are of course Euro zone, tainted by the effects of Spain and Ireland although small.  So on balance the refuge may be Swiss Francs or of course gold.  The current strength of the Yen and US $ will probably not persist – they are largely the effect of unwinding the Yen carry trade and the repatriation of dollars (at greatly reduced values) by US hedge funds. 

For the wider population things are looking desperate.  General living standards will plummet which in turn will create much social unrest.  This is particularly likely in the UK because of the predominance of public sector spending and the almost exclusive strength of public sector unions.  I confidently predict summers and winters of discontent with severe consequences for the country's quality of life. 

The extent of these ‘ordinary’ debts vastly exceeds the sub-prime debt levels which have already stretched the ability of governments to throw money.  Governments simply will not have the ability to throw enough money when the CDS-covered debt regime collapses.  The only way out is to print money to cover these enormous liabilities. 

Many governments will lose the ability to do anything meaningful about the problems.  This may already have happened in the UK - the government have announced support for banks and other institutions measured in hundreds of billions and are now planning for a deficit next year of over £100 bn.  Who is going to fund this especially when they are bringing interest rates down to near zero?  Sterling is now a deeply unattractive currency to hold or invest into.

I see 1970's style balance of payments crises but on a far worse scale.  Britain's export base has been largely destroyed - we are now a nation of (redundant) bankers and public servants.  Our productive base is completely unable to support the living standards we have awarded ourselves by borrowing.  That is the real folly of our past.

Eventually this truism will dawn on the population and at that time the politicians involved will be vilified.  Only when a clear thinking strong leader emerges not tainted by the spin culture that exists in all main parties will the country stand a hope of recovering from this debacle.  No such person has yet emerged!

The answer for many countries will be a form of competitive devaluation - only in this way will a country get an advantage over its neighbours for the decreasing amount of international trade.  There is just a possibility that a coordinated global inflation could solve the problem - inflation is probably the only way to effect the dramatic reduction in assumed wealth that is now required and if it were done in a way that prevented a country from being slaughtered by devaluation (which is a relative term) against other currencies, then there might be some hope.  After all the only components to economic growth are manpower, innovation, energy and raw materials.  We have the first three and with some ingenuity probably have enough raw materials if we avoid bubbles.  The chances of course of getting all major countries to agree are pretty slim, which is why the armageddon scenario is more likely.  Protectionism will probably be the main response of politicians – especially in the USA.

Thursday 31^st July 2008

I am starting this blog not knowing where or how to start – there are so many issues to be covered – most with potentially very significant effect on the future.  Initially this blog will probably be quite rambling but I hope that over time a more coherent style will develop.

As a kick-off, I believe the seriousness of the current economic situation has not been fully appreciated, especially by the many optimists there still are.  As a result many of the indices and factors considered by people – like stockmarket prices, etc., are still reflecting an overly rosy picture.  You only know that you’re at the bottom of a recession/ depression when there are no more optimists around – that then is the time to buy!  We are nowhere near that now.

Over a year ago I appreciated reading a book authored by a colleague in Guernsey that forecast a depression far worse than in the 1930’s – at the time (April 2007) his book was derided as being doom-mongering and total unrealistic “it will never happen” they said – see www.finalcrash.com/cmr .  Well, it is happening – all the dire predictions made are now coming true – and we’re only at the beginning. 

I have shared these views for several years, but my pessimism was ahead of its time – I received quite a lot of derision from my investor friends (I used to be Chairman of the Chiltern Investment Group which I founded in 1984) who were universally optimistic that the boom would continue ad infintum.  Sadly for them, my pessimisim was actually understated!

Mike Downey is Managing Director of Cavendish Management Resources.  He is a graduate of Harvard Business School.  So far his reputation for predicting future business and economic circumstances has been good!

©2008-9