Recovery worries
June 25th, 2010
As the Leaders gather for the G8 and the G20 there are reports of a rift between the US view and the European view over how to proceed. The Americans are wedded to continuing with fiscal stimuli – running large state deficits - to grow their way out of trouble. The Europeans, stung by recent market attacks on individual country bonds are urging spending cuts and less borrowing.
The Americans are right that the best way out of the current situation is through growth, and that growth requires stimulus. The Europeans are right that many countries have overdone the government spending stimuli and need to rein back before markets force them to with higher interest rates and refusal to buy their debt. The best combination of policies for recovery from here is sustained progress to lower borrowing by governments, allied to easy money to finance a private sector led recovery.
We remain nervous about prospects for the main equity markets of the US, UK, Europe and Japan because the banking system does not have a lot of credit to extend to the private sector. Past mistakes of banks are being compounded by Regulators who are now much more cautious about allowing credit expansion, and by governments keen to tax banks more to get some repayment for all the subsidy they offered in the Credit Crunch. The dash to prudence in the West is reinforcing the actions of the Chinese and Indian authorities to rein in credit to head off worse inflationary problems. None of these matters is about to be resolved, so we continue with relatively low positions in general equities.
This week in the UK we learned that one member of the Bank’s Monetary Committee wanted to put up interest rates last month. Mr Sentance was rightly concerned that inflation remains well above target, and dares to question the Bank’s orthodoxy that because there is such a large amount of spare capacity around that there should be no price increases to worry about. We have queried the whereabouts of all this spare capacity, and pointed to the inflationary threat, for many months.
Although Mr Sentance predictably lost his skirmish this month, he did some good. He reminded markets that the next move in UK interest rates will be up. Coming in the same week that the government announced a substantial move towards lower borrowing, this was sufficient to put the pound up a bit more against the dollar, on top of its recent rise against the Euro.
Much of the current inflation has come from the big fall in the pound in the year or so prior to the Election. A rise in the pound will relieve inflationary pressures on imported commodities, raw materials and finished goods, and will likely be visible to us all at the petrol pumps.
Today the Bank decided to warn us all that banks are still weak thanks to the weakness of the Euro area in general and the threats to government bonds in particular. Their remedy is yet more cash and capital to be held by the banks. That is code for saying they want the banks to lend even less to the private sector, at a time when credit is already too scarce.
Recent news reinforces our view that Uk sovereign debt and the currency are no longer in the high risk category they were in before the last Budget, and before the argument began in the Bank’s Monetary Committee over the correct level of interest rates. We have reduced our exposure to foreign currencies and taken some more profits on real assets where appropriate in sterling gross funds.
