Bulletin - The Credit Crisis Part IV
"Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry." - Polonius, (Hamlet, Shakespeare)
With whom does one start? Self-acclaimed "prudent" Gordon Brown is now exposed as not understanding husbandry at all. The Government finances enter recession already substantially overdrawn, without including their off balance sheet items of PFI debt and unfunded state pensions. The combination of this week’s stimulus, falling tax revenues and higher social security payments have at least caused the admission that taxes will have to rise. In the medium term, new issues of government debt will flood the market.
Central banks kept interest rates too low for too long, while banking regulators allowed the banks to dissipate their capital with lax monitoring, poor accounting standards and eroded capital requirements. This is now in the process of being rectified, and is costing more than $1,000,000,000,000, probably substantially more.
How was it ever remotely sensible for banks to provide mortgages of 100% of a property's value, let alone more than 100%? Consumers who borrowed such sums are equally to blame, and British consumers are now the most indebted in the developed world. They will discover the consequences of their actions, as banks restore profitability.
Globally investment managers have urged corporate managers to run "efficient balance sheets", which means less equity, less accumulated cash and more debt. Now companies are desperate to maximise their cash and looking to their operating practices to find it, as banks are making loan facilities increasingly expensive, and so unattractive. There may be rights issues ahead.
The greatest culprits are anglo-saxon economies, and their mimics. They, after the fiscal stimuli take effect, will have to rebuild their ability to consume. Rebuilding will initially entail higher taxation, higher savings rates, reduced discretionary income, and lower consumption growth. It would not be remotely surprising if governments allow slightly higher inflation to reduce the real cost of repaying all the debt. This would be the natural eventual outcome of having expanded money supply so much recently. But the shorter term pain is deflationary, and good for fixed income.
In the UK we can expect continuing large numbers of job losses, a falling housing market, and a dearth of consumer confidence for some time to come. At least fuel, food and energy prices should fall! When discretionary income growth returns it will be muted and consumption will be less invigorated by debt than in the recent past. We should expect interest rates to fall further, while the long term prospects for the national balance of payments are not positive. Sterling will be weak in the long term, although trading rallies will occur, and sometimes they will cause people to think the weakness is over.
Savers should find alternatives to cash, and a higher than once normal exposure to foreign currencies will become the norm for British investors. For long term investors the market dislocations, which may continue for many months, should prove to be an excellent opportunity.
28 November 2008