Evercore Pan Asset

On Monday the slide in sterling speeded up, with the pound having its worst day since the collapse following sterling’s troubled times within the Exchange Rate Mechanism in the early 1990s. This is no surprise. We have been recommending investors to avoid sterling assets all year.

The Monetary Policy Committee of the Bank of England turns out to be as ill-judged as the ERM. The ERM led to inflation first, then recession, by forcing the country to take interest rates which were too low, followed by rates that were too high. The Monetary Policy Committee has done exactly the same thing, without the excuse that they are on autopilot determined by the value of the currency. They have resolutely steered the vehicle by looking in the rear view mirror. They are now about to make their third big error, of setting rates too low for the extent of government borrowing and the fears in the international community about the UK’s financial situation. They left lowering rates too late, helping push us into a bad recession. Now they are taking undue risks, because of the fiscal expansion. Fear of low rates is one of the factors behind the sterling collapse, because investors think the UK is still borrowing too much.

The truth is that both the UK and the US have to cut living standards. For years both these economies have been living well beyond their means, thanks to easy access to credit from the strong exporting nations and commodity producers who were generating big surpluses. It has been possible for both the great Anglo Saxon democracies to run large balance of payments deficits, large government deficits and large deficits in the personal sector. People and governments have spent too much and borrowed to do so.

Now the world’s markets are saying enough is enough. Living standards in both the public and private sector have to be brought down. The private sector has to sell more abroad and consume less at home. The government sector has to get closer to just spending what it can collect in taxes.

The problem is that whilst the recession will force the private sector to contract, there is currently no mechanism to make the public sector take some of the pain. The outgoing President, Mr Bush, is a high spender who sees no need to rein in spending at the end of a long period of overspending. The incoming President, Mr Obama, was elected to spend more. The Prime Minister in the UK thinks spending and borrowing more is the right thing to do in the circumstances, and is busily trying to bail out chunks of the private sector which would otherwise have to adjust more quickly to the painful reality that we have been living beyond our means.

On both sides of the Atlantic the authorities have made the decision that most manufacturing will simply have to contract, shedding jobs, closing factories, putting people onto three or four day weeks to slash pay. Meanwhile they have perversely decided to feather bed the bankers, who are arguably more inefficient and much more highly paid than the manufacturers. Both administrations have poured money into banks which should have been told to raise their own capital by reining in their expenditures. The authorities should have given them temporary loans, not permanent capital. I see no reason why taxpayers should pay bankers bonuses in these conditions, when the finance industry needs to get its pay down quickly to sort itself out.

This week has seen bad figures from the UK’s Purchasing Managers Survey, pointing both manufacturing and service sectors into a bad recession. Confirmation has come that the US is in recession and has been there all year. The authorities are now beginning to accept on both sides of the Atlantic that the Paulson and Brown packages have not so far unfrozen bank credit. In the UK many companies are reporting withdrawal of bank facilities or big increases in charges and interest rates. We continue to advise a cautious approach to investment, with high cash positions, avoiding sterling based assets. There are opportunities on bad days to buy Asian assets at better prices, even though these too are adversely affected by the stresses in the US economy.