Tough Choices, Big Opportunities
There hasn’t been a lot of good news in the financial world since the Lehman Bros crash just over three years ago started the Global Financial Crisis. But we’ve been here before. Just read Niall Ferguson's Ascent of Money – a must for anyone interested in financial history and economics.
Baby I have been here before
I know this room, I've walked this floor
To see the Katy Lang version of Leonard Cohen’s brilliant song Hallelujah, click here
There hasn’t been a lot of good news in the financial world since the Lehman Bros crash just over three years ago started the Global Financial Crisis. It’s kept the global financial markets in turmoil as it moved from the investment banking industry, to banks and availability of credit, to the bandaids like QE1 and QE2 introduced by the U.S. Federal Reserve, and now to the very financial stability of governments, as we are seeing in the current European Banking Crisis.
But just like the lyrics quoted above - we’ve been here before. Just read Niall Ferguson's Ascent of Money – a must for anyone interested in financial history and economics.
I’ve covered this subject in previous newsletters, including comments from U.S. author and financial advisor John Maudlin. John is the author of the bestselling book called “Endgame: The End of The Debt Cycle and How it Changes Everything”.
Well I’ve recently read an interview with John Maudlin by financial interviewer Kate Welling. The interview – and the book - is quite revealing and brings up a number of matters that hopefully the government here will address after our election later this month.
The message from the interview is “we’ve been here before” but this time it really does require “Tough Choices” – and will bring “Big Opportunities”. Here’s a selection of John’s comments taken from the interview (which took place over a month ago).
- What we have done is use leverage for 70 years to finance our growth.
- What we have learned (or, really failed to learn) is that it’s never different this time. There is a pattern and the United States is no different than Greece or Ireland or Italy or Japan or any other country in history. The problem is too much debt and too high a deficit. And we have to deal with it. Our choices are only about how.
- This is not a normal cyclical, or business cycle recession; it was brought on by too much borrowing, and now we have to repair our balance sheets by deleveraging at the same time that the assets we bought in the boom are falling in value. What’s more, empirically, a long period of deleveraging almost always follows a major financial crisis.
- The problem is that Europe – somewhere in the next six months to a year, maybe sooner, is going to have a true, true crisis. And for us to think that it is not going to visit our shores seems absurd on its face – after all, our subprime problems, which originated in Vallejo and Riverside and Nevada and Arizona and Florida, took the entire world of banking and credit down. It is all really interconnected.
- We have the potential for another banking crisis, at least equivalent to what we just went through. Because 80% of European banks are going to be insolvent; they are all more leveraged than our banks. They weren’t required to put up any capital against their holdings or sovereign debt because everybody knew the sovereigns are sovereign and cannot default. Well, they were wrong.
- For the Greeks, their choice is between disastrous and even more disastrous. Do you leave the eurozone, and employ every lawyer in Europe for the next 10 years trying to work out what that looks like? Do you stay inside the euro and just simply repudiate the debt? Do you tell people who are retired at 50 years old that they have to go back to work? Those are all very, very bad choices that you’re going to have to choose among. But you have to make those hard choices.
- The one thing about this process that we can learn from history is that there is an end to the endgame. We have this marvellous clearing mechanism in capitalism. The markets do get cleared out, asset prices do get cleared out. We’ve hit the reset button.
- The answer to the question “Where will the jobs come from?” is that I don’t know – but they will. That’s what free markets do – that’s what American entrepreneurs do. Create jobs. The job of every politician – the first thing they should ask themselves when they get up in the morning – is, “What can I do to make it easier for entrepreneurs to create jobs in my town, city, state, country? Because that’s how we come back from this endgame. We just have a financial bump to get over and technology will do it, just as it got us through the Depression, World War II, the Cold War, and Jimmy Carter.
To read the entire interview click here
So What Does this Turmoil Mean?
To me the immediate economic effect of all this turmoil is interest rates will remain low as governments keep them down to simulate jobs and growth. Some thoughts on this:
- Bank deposits and similar fixed interest investments currently give very poor returns.
- While interest rates are low there are opportunities to acquire assets with positive returns (that might otherwise not be profitable). Just make sure the returns remain positive when interest rates rise again.
- Interest rates will rise as risk is re-rated.
- Interest rates will rise as inflation returns – which it surely will.
- Governments thrive on inflation, as by the time they repay the government bonds the real value of the loan is lower.
- And so do home owners – for the same reason.
- The bond market is stuffed with prices going backwards when interest rates rise.
- Commercial property cap rates are too low now and will rise with interest rates.
- The listed share market is extremely volatile and is dominated by the institutions.
- Arbitrage, currency speculation, and gold are the domain of the professional players.
- Equity will return and investors with equity will be the winners.
- The only true way to value assets is their future sustainable net cash flows (excluding of course such things as the location of prime residential property).
In his 27 October BNZ Weekly Overview economist Tony Alexander summed up the situation here very well. He lists three key areas of risk to our economy from events in Europe, the U.S. and China and then goes on to say:
“Remember a key thing we should all write down and stick on our walls as we anticipate and feel chuffed about decades of strong demand for our primary produce. It is invariably short term problems which cause companies to fail, not long term issues. Plan for the long term but live in the short term. Meaning, everything we say now about China and how great things there are for us are as valid now as they were on September 14 2008 just before Lehmans collapsed and the world went into its biggest crisis since the 1930s. These past 3-4 years have been all about our short term, not our long term prospects.” To read that issue click here
With the results of his latest Confidence Survey just out, Tony says “Our monthly BNZ Confidence Survey has revealed a fall in sentiment for the second month in a row. A net 2% of respondents now expect the economy to be worse in a year’s time, down from a net 7% optimistic last month and 36% optimistic two months ago. The result is still above average however and not as bad as one might have expected given developments in Europe.”
Further evidence that we don’t feel bad about living here comes from Statistics New Zealand. In their latest General Social Survey gauging financial and emotional well-being, they report that 9 out of 10 New Zealanders purport to be "satisfied" with life. To read the interest.co.nz report click here
Even our favourite measure of economic comfort, house prices, are going up. See interest.co.nz report here
And our banks are strong. Some say too strong - see article on bank profits here
So what’s Next for Us?
During the past 70 years the western world’s used leverage to finance growth. Fortunes have been made (and lost).
In any new era there will be more new opportunities. The answer to the question “Where will the opportunities come from?” is that I don’t know – but they will.
In the next couple of weeks we’ll know who will be governing New Zealand. But whoever it is (like the U.S., Greek, Italian, French, German, Chinese, or any government in these times of turmoil) they will be creating new opportunities. Here it might be rebuilding Christchurch or investing in previously state owned assets. Ex-pat New Zealanders are looking to invest back home. See Herald article here
In my September CAPITAL COMMENT - “Inflation, Interest Rates and Borrowing” - I discussed interest rates on loans, and how we can help people borrow money. To see that issue click here
Well I think now is a good time to look at businesses or properties that do have good sustainable cash flows, or the potential for them were it not for the stifling effect of too much debt, or the requirement from banks to pay it down.
So if you have an interest in looking at new opportunities we can help you there too.