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Monday, 11 December 2017

Promises, promises

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  • Peters 475px June 2014

Borrowing always fills the gap when expectations about living standards run ahead of reality.

IN ONE OF the many incarnations I have been through in my long but exceedingly undistinguished career in the City, I once masqueraded as a lecturer at City University Business School (now Cass Business School), where I spoke – among other things – on the rather obscure subject of “Economics for Traders”.

The main syllabus focused on the principal economic indicators, where they came from, what they told us, and how markets read them. The lesser, but in many respects more important, element of the course was trying to explain why and when markets jumped around after the various data releases.

The explanation was, of course, simple. Traders would position their books based on what they expected a release to reveal and, if wrong, they would be forced to cover quickly. In other words, markets would not move on the outcome as much as on the basis of how the Street was positioned, what it had to do to cover in the event of a surprise, and how many people had to do it.

Unfortunately, traders rarely position themselves as their economists would have it, and thus Street positioning and consensus forecasts can often be very different. The skill of the trader is to anticipate the Street’s positioning as much as it is to get the number right. It is from this that I learnt that disappointment is not an absolute value but a function of reality relative to expectations.

Yes, the key to life, the universe and everything is and remains expectations.

THE MOST PERNICIOUS of factors leading to the global economic crisis was the level of expectations which were created in part by our respective leaders and held by broad swathes of the population. When expectations about living standards – not the same as quality of life – run ahead of reality, the difference has to be made up by borrowing.

It is barely a secret that even among supposedly well-educated and sane money men there were some who found themselves in the deepest trouble when the crisis hit our industry. Far too many didn’t live as they could afford to live, but lived as they thought they ought to be able to afford to live. If bankers can’t distinguish between dream and reality, what chance the impressionable masses?

Far too many didn’t live as they could afford to live, but lived as they thought they ought to be able to

As I say, the difference between what we make and what we spend, as a society or as individuals, has to be made up by borrowing. Borrowing can – as bankers we should all know this – take two basic forms. The first is for the purpose of investing upfront the net present value of future cashflows which should be self-amortising and which are intended to be used in order to repay the debt and leave a profit for both the investor and the lender. The second is spending what you haven’t got in order to bridge the gap between realistic needs and desires and future expectations. Upfront spending like that requires reduced spending in the future in order to compensate for any shortfalls. That model works until clever (or not so clever) politicians decide to call the latter investments.

This brings me back to the matter of expectations and disappointments. Disappointment is not an absolute value but is relative to expectations. Bankers, more than most, directly live and experience the effects of expectation management – for instance, when listed companies deliver their results, or when we are given our bonus numbers. It is there that they learn that the outcome is less important than the manner in which the ground was prepared. Those of us who have led teams understand the value of “managing down expectations” and the cost of not doing so.

WHEN LOOKING BACK at the eurozone crisis and now at its recent major incarnation, namely the tragedy of Greece, it becomes obvious that the weakest link in the EU is the way in which citizens’ expectations are raised to levels which can never be achieved.

Of course we must aspire to better, but it is incumbent on our esteemed leaders to manage expectations too. Of course we want the best possible health service, education system and welfare structure, but the difference between the desirable and the achievable must be much more clearly staked out.

Whatever the fiscal crisis is that Europe finds itself in, it is surely much more a function of people having been promised what the economy can’t afford as it is of poor use of the area’s productive capacity. If we can’t grow our way out of the problem, we’ll have to shrink our way back into it. People will, I believe, accept that if it is properly presented and if we can finally acknowledge that austerity is status and not process.

Central bankers are civil servants and thus they are paid to implement the policies of their governing masters, irrespective of how independent they purport to be. Since the outbreak of the crisis in 2007, governments have relied on their central bankers to keep the ship afloat. The gap between reality and expectations has been left for them to fill and they have had no better means than to use their own balance sheet to that end. Their success has had the effect of giving politicians the option not to recalibrate the people’s expectations.

It seems as though that even with all the willpower in the world, economies refuse to grow to match planned expenditure. Maybe, therefore, the time has come to go the other way round. Alas, before that can be done successfully, citizens have to grasp that they cannot have what their countries haven’t got.

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