Mind the banks
July 13th, 2010
The future of the sluggish western economies depends on the banks. We are in that part of the recovery where the first re-stocking phase has been completed. The impact of monetary loosening in China, the USA, the UK and other jurisdictions has been felt. Many companies in trouble have been nursed through this far, as banks did not want to crystallise even bigger losses. Corporate cash flow has improved, and more are off the casualty list as a result.
Now the question is can the banks finance a sustained recovery? Will that recovery be at a sensible pace, or will it be slow at best? Bank balance sheets have improved. They do have more scope to lend, all things being equal. The trouble is, all things are not equal. Regulators in the main markets are keen to drive cash and capital ratios higher. Governments are enthusiastic to collect more tax revenue from banks, taking cash and profit from them that could speed the rebuilding of balance sheets.
The Regulators have to be careful not to fight the last war. The problems today are very different from the problems of 2005-6. We are not witnessing a new private sector credit bubble in the USA and UK. Property prices are not climbing giddily in the west. Regulators should not be taking action to make it more difficult for banks to lend, as they should have done in 2005-6. We need the banks to lend more money to a range of private sector companies for investment in expansion, and to pay for major projects to offer new infrastructure and energy supply.
The European governments including the UK are embarking on deficit reduction. They are taking more money from people and banks in taxation and cutting the rate of growth of public spending. They are right to see over large deficits as a threat to recovery, as Greece discovered. They need to complement this policy of retrenchment with easier money policies for the private sector. The strategy will only work if the private sector grows to take up the slack, creating the jobs the unemployed need, creating jobs to employ people who would otherwise have gained public sector jobs, and using the property and other assets that are available.
We remain concerned about the speed and scale of the western recovery. For that reason we have relatively little invested in the main western markets, and have kept out of specialist investment in European markets. If BP has succeeded in capping its wild well and can now draw income from the oil, that will help turn round the share price. Investors will at last be able to make a more intelligent guess of the total costs of clean up and compensation once the flow has been stopped. This will be mildly beneficial to the main UK indices. The future of the western markets is linked to the health and success of the banks. That should lead investors to be cautious, as the banks have lost the political argument over the causes of the crash, and are now facing further regulatory and tax restrictions, especially in Europe, which will slow the recovery.
