Monday, 23 April 2018

Exiting the road to perdition

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It’s not about austerity, it’s about a recalibration of expectations, argues SwissInvest strategist Anthony Peters

Anthony Peters, SwissInvest Strategist

WHEN WILL IT all get better? When will the austerity end? I am often asked such questions. My answer is not a comforting one.

Indeed, the term “austerity” is misleading because the new fiscal discipline which is required by governments and households is not about a crash diet, but rather a complete and persistent recalibration of our expectations and spending habits.

Fiscal indiscipline is deeply-rooted in our society and it needs to be dealt with in a systematic fashion. In truth, it has probably been with us since the late 1960s, but the build-up of public sector debt and deficits had been gently accelerating until it finally hit warp-speed after the turn of the century.

However, just because it has been there for most of our lifetimes does not mean that it is right. Sexism, racism, homophobia or driving under the influence do not become right either, simply because they have always been there.

But whereas governments will spend endless amounts of time and effort in combating the causes of and – above all – the expression of those vices, they close their eyes to the fiscal madness in which they participate day in, day out.

I RECENTLY FOUND a piece I wrote in early 2008 which suggested that we were on the wrong highway. I argued that we could not do a U-turn on this particular road and return to the point where we had taken the wrong fork, but would instead have to find an exit slip and work our way across country in order to join the road for the destination we should have been heading for in the first place.

The most obvious effect of over-borrowing was to be seen in inflated asset prices and despite there already having been a significant adjustment in areas such as US residential real estate, it remains pervasive.  Although the central banks would have us believe that their lax monetary policy is aimed at stimulating economic activity, it takes a pretty strong pair of rose-tinted spectacles for one not to see that the primary objective remains the need to prevent further asset price declines.

The engineered implosion in funding costs to near zero masks the decline in manufacturing output by helping to boost corporations’ margins – and hence earnings – which in turn makes equity markets look better than they really should do.

Just because it has been there for most of our lifetimes does not mean that it is right

That the fiscal and financial indiscipline which led to over-inflated asset prices in the first place cannot be reversed in the short term is not hard to grasp. Still, I get the distinctive feeling that there are far too many vested interests involved to permit an open and sensible discussion of how and when we are to get off this wrong highway and what route to take in order to get back onto the road to the original destination.

NOWADAYS, ONE HEARS little of private equity, but can you remember what it felt like when every morning one read in the papers of yet another deal worth billions or even tens of billions in which a bunch of former corporate finance bankers found ways to buy companies with borrowed money. They then leveraged the balance sheets to within an inch of their lives, borrowed even more in order to pay themselves back their original stake – by way of a “special dividend” – and stuck all the enterprise risk on the providers of credit. And they did all this while making the world believe that they were better at running engineering companies than the engineers or healthcare groups better than the doctors.

Of course, the billions that these guys supposedly made were never really “made” at all – they were just projected into the sky. They never existed, these billions.

But banks, insurance companies, pension funds and many, many wealthy individuals were hoodwinked into believing all the get-rich-quick rubbish and investment managers piled the money they were supposed to be taking care of into all manner of projects which were paved with promises and edged with fool’s gold.

THE MONETARY AUTHORITIES are quite clear in their thinking that if the financial system can’t support the mark-to-market on all those overpriced assets, then the easiest way to prevent a collapse is to rig the market and to keep the projector running.

I occasionally find myself accused of being a financial and fiscal Luddite but after 30-odd years in debt markets one finds out that the fundamentals of borrowing, lending and repaying don’t change, irrespective of how many smart financial engineers get involved. An old accounting professor taught me to “follow the cash”. If you can’t find it, the company is in deep trouble.

If I apply the same test to public sector finance, I have to conclude that there is not enough cash there either and all the rate swaps and whatnot cannot alter that.

Hence my conclusion that the time has come to review our rhetoric and acknowledge that what we need is not a short sharp dose of austerity but a total recalibration of our expectations. What, in colloquial English, is known as cutting one’s suit to match one’s cloth.

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