How much of an issue is Greek debt for the euro?
The problem with the Euro now is clearly political, not economic in many ways, because the budget issues are significant in the Greek sense of the word but not in the European sense of the word – Greece is only three percent of the European GDP.
If you look across the ocean, California certainly is a much greater credit risk to the United States than Greece ever will be to Europe, but the political tension that’s starting to rise is interesting and disturbing at the same time – the Greek deputy Prime Minister yesterday – it took him a month to pull out the World War II trump card where he started to accuse the Germans of robbing them of their gold etc. So there’s this hidden hostility underneath the surface that always comes up in economic crises unfortunately, that’s very dangerous because if it gets out of hand, if the political situation gets really disturbing, that’s when the Euro suffers the fragmentation risk.
So it’s not so much the economic stresses on it that can cause problem but the political stresses that do.
Of course, the other big thing that everybody is concerned about as far as the European issue is Italy.
Not so much Spain, but Italy, because Italians apparently have tremendous amount of the same type of currency swap deals on their books that they haven’t really disclosed, where they have sold forward a lot of their state revenues and have a lot of their creative bookkeeping on their finances. If those come to light and the market begins to see this, then there is a much greater big sovereign risk for Italy, which has a much higher debt per GDP ratio, then the Euro begins to suffer.
For the time being it seems that the Euro has found temporary support at this 132-134 level. That was the big level from which the Euro broke out of initially on its run to 150, so unless we have any further calamitous news out of the Euro zone we expect the pair to more or less moderate at these levels and perhaps even stage a small counter-trend rally, just because sentiment is so oversold that a bounce is due.
But Long term, there’s very little on the horizon to make you optimistic on the economic front. The only ray of sunshine for Europe right now is the fact that you have lower a euro really helping German manufacturers and they are pretty much the only engine of growth left in the whole Eurozone, so the only piece of data we have that constantly surprises to the upside , has to do with the German export sector, so from that perspective, that is the only thing you can hang your hat on.
So there is no prospect of any countries leaving the eurozone?
Well I think that the one thing they are all petrified about is not so much the prospect of a country leaving but that if one country leaves it opens the door for others. It totally destroys the whole notion of a unified Europe so I think they will fight tooth and nail to try to preserve the union. If you notice Europe actually gets stronger the more members it has. It’s kind of like social networking, the more people who join your club the more valuable your club.
I’ve never encountered more euro-sceptics in my life than I have in the UK – I guess it’s natural – but generally if you think about it the European experiment has been an un-abashed success for the eurozone. It’s been very stable for the economy, stable for inflation and more importantly if you were simply to use exchange rates then one European is still worth 1.35 Americans. In other words a euro is still worth 130% more than a dollar and still has a lot of purchasing power. So it may get a lot of complaints but the regional differences you see in the eurozone are no different to the differences you see in the USA – except that in the USA they are papered over because we are a nation, not a confederation.
Are these political problems linked to EU sceptics here or in other countries?
Yes. I think that if Europe has vulnerability its political vulnerability because generally what happens is when you look through history politicians always make the wrong choices. They always make the politically expedient choices rather than the economically proper choices and that tends to have very negative consequences.
So I think if you start to see more unrest, like social strikes – you are already starting to see the strikes in Greece – we may even start to see strikes in Germany and France and other members of the EU against any kind of austerity measures. And the fact also is that in the EU the trade unions represent a much greater proportion of the workforce than anywhere else. It creates this kind of political tug of war between the workers and the policy makers.
What’s economically proper is very often politically destabilising and what’s politically expedient is very often economically suicidal. So unfortunately that means a lot of tense policy makers. When things go well policy makers can craft proper policies with little pushback but when things turn to a crisis – and especially because a lot of the European labour force is organised into a unions – there is going to be a lot of institutional resistance.
These are all clear dangers for the eurozone. So I would not dismiss the notion that there is a risk of fragmentation but I still think its minor at this point.
What can the EU do about these political problems?
There is no proper legal mechanism to deal with this so they really have to invent it on the spot. This is where political expediency could actually be useful. What I mean by that is that they probably should use a third party like the IMF, that’s been a suggestion floated by many people simply because you have a third party that is an outsider that everyone can vent their hatred on without really displacing the European authority and at the same time would have the ability to implement the proper procedures also without too many austerity measures. What I also mean by that is that it would act as a central bank of central banks and as a lender of last resort to modify the sovereign debt problem without creating draconian job cuts in the sector.
So I think it’s probably the best solution but I think a lot of European politicians are very weary of ceding sovereignty to a third party that will have a lot of say in how the money is spent – that is always a difficult issue.
We have been talking about debt in Greece and the problems there, there are some who point out that Britain’s debt is not that much lower than Greece’s. Is that something to worry about?
The UK is walking a very thin line financially. The UK is probably the greatest sovereign debt risk in the G20 universe because it has 13% debt to GDP ratio and a very anaemic recovery. If you look at the recovery rates of all the G20 nations, UK is the slowest, the worst. It only came out of recession last quarter and it came out on a measly one tenth of a basis point. Every other economy – as bad is it is – is doing much better than the UK. The UK is incredibly vulnerable to [problems in] financial services. The problem with the UK economy is that it is effectively a hedge fund economy. There is nothing besides finance (and maybe tourism) within the UK and that creates and incredibly difficult position for policymakers.
I was watching one of the placement recruitment companies and they said the only sector where they are seeing strong growth is in the pharmaceuticals and biotechnology. I think the challenge to the UK economy is to basically invent another sector that is going to have a lot of growth. You do seem to have a lot of promise here because a lot of pharmaceuticals have relocated here and they have attracted a lot of talent. But you really have to have some sort of growth industry aside from finance because it’s too finance dependent.
What happens with the UK economy is that because it is so finance dependent it really swings up and down with the Dow Jones industrial average for all intents and purposes. So we get into the situation where if equity markets across the world begin to stall and actually decline it’s going to be a vicious double whammy. Whatever revenue the UK government is raising right now it’s raising out of the financial sector, those revenues are going to be crippled completely once the markets decline and that could create a true sovereign debt disaster scenario for the UK – that’s why the pound is one of the weakest currencies on the board right now and it continues to be so until people begin to feel that there is some sort of structural reform that’s going to happen in the system.
So given that the UK is so dependent on the financial services sector what do you think of plans to impose heavy taxes on high earners and banker’s bonuses?
You know it’s a difficult issue because the bottom line is that government has to raise money somewhere and governments are going to go where the money is. So if the financial sector recovers and makes money, that’s where they are going to get it. They are not going to get it from manufacturing or agriculture – there is no money there.
Cry all they want, if bankers are making money, they are going to have to give it up – they have no choice. The greater problem is that 51 per cent of UK GDP is driven by public finances – in other words private industry accounts for less than half of UK GDP and that’s an incredibly high proportion – it suggests massive amounts of inefficiency in the system – so privatisation of maybe a lot of public services is going to be necessary in order to stimulate some growth and demand here.
Whatever it is, the next few years in the UK are going to be very uncomfortable for many people. There are going to be a lot of social changes that will have to come. Having said that London seems to be doing quite well and that’s because it’s a tourist city just like New York is a tourist city but I guess if you go outside of London you would probably see much greater hardship.
Unemployment is a horrible social ill. It’s not just the loss of money which is obviously substantial, but the psychological and social costs are far greater than the simple economic loss. From an investor point of view the UK represents a massive risk at this point. It’s a small country without any real diversified growth, running a massive trade deficit and continuously debasing it’s currency, because quantitative easing is simply a euphemism for devaluating your currency. So I wonder how long investors will be willing to tolerate relatively paltry yields out of the UK government bonds before you start to see a block.
As an investor which countries or currencies would you be looking at instead of the UK?
Clearly right now the growth story remains Asia-Pacific and all the data on the ground that we have is that Australia is the strongest economy out of all the G20 universe, and it’s absolutely true. They have good growth, employment is booming and interest rates are going up and if you are betting on risk, if you believe recovery is coming this year then Australia still remains your best bet.
If on the other hand you think [things are not so optimistic] and it does look very perilous right now: the other day we had US data which was horrid as far as jobless claims go. All the assumptions that North America is going to rebound strongly in Q2 are now coming under suspicion; if that is the case the whole risk tray could be very wobbly. But if you do believe we have 3% growth, going forward Australia is still your best bet because that’s where interest rates are highest and that’s where it’s going to continue to grow.
The way the world lines up right now it’s Asia-Pacific first, North America second, Europe a very distant third and the UK a very far fourth. That’s how the global economy goes.
What are the chances of a double dip recession in Britain or elsewhere?
In the UK the chances of a double dip recession are the highest than in any other G20 nation – simply because the rebound was anaemic at best and we really have not seen UK data perform well at all. We had terrible retail sales, a lot of which was skewed by the VAT cut and the weather, but we had corporate investment numbers that were expected to come in at 0.6 per cent but they were actually minus five per cent – hugely contractionary to the economy.
There is a very strong chance that if global equity markets do not continue their rally, if the Dow gets below 10,000, then the chances of a UK double dip recession rises exponentially. So that is the one area where they are vulnerable.
But it’s not just the UK . You could begin to make an argument that if the situation in the US does not improve we are really starting to run out of momentum there. I mean jobs are the critical point that will determine whether we have a recovery or not this year. Everyone is betting on jobs turning positive in the US and so far that’s not been the reality.
Whenever people ask me what do I watch I say I watch the weekly jobless claims in the US. That number is crucial and that number needs to be at 400,000 in order for the US to generate positive job growth consistently. It’s going the other way now. It was going towards 400,000 now it’s going towards 500,000. If that trend does not change towards 400,000 the whole notion of US recovery is going to be completely thrown out of the window by Q2 and you will hear a lot more talk about a double-dip recession.
The markets seem to be a lot more cautious than they were even a month ago about all these different scenarios.
What effect will the possibility of a hung parliament have and what effect is it having already on markets?
I think it is having some effect. Currencies, unlike other economic instruments, are political as well as economic instruments. Politics matters hugely to currency markets. A hung parliament – which appears to be a stronger possibility than most people thought is certainly going to be a problem for the pound. If you have political stagnation and economic recession it is a formula for disaster so I think the markets are beginning to be concerned. But as the election is still so far away I think it’s not weighing on the pound too much. But if we get close and the polls start to show 30, 30, 30, then the Liberal Democrats are going to be wooed by both sides and it’s going to be an interesting time. I think you will start to see a lot of volatility in the pound as this scenario comes forth.
So how long will it be before we are finally out of all this economic mess?
It’s a great question – If I could tell you I would bet even money on it. I think it’s incredibly difficult – unfortunately what seems to be happening – I dread to say this almost. We all seem to be following the Japanese disease, which is that we have a massive credit crisis and in order to save the economy the government pumps a lot of money in to save a lot of very bad unproductive businesses – banks in this particular case – that remain a drag on the economy for much longer than the market anticipates and we get to a point where it’s neither hot nor cold – we are just muddling through with structurally high unemployment, not depressionary like, but still no true robust growth and I think that scenarios is quite plausible as we go forward just because the amount of due leverage, the amount of bad debt amortisation that needs to happen is quite serious. There was so much mal-investment in the boom times that it just does not go away unless we can invent a new boom.
The big hope of every dreamer right now is that green technology is the new boom. If we have a transformative technology, in Western economies its always transformative technologies that take you out of the recession into the next big wave, in the 80’s it was computers, in the 90’s it was the internet. Even in the 30’s and post WWII it was aeronautics and airplanes which took us out.
So what’s the next great transformative technology? If we can manufacture oil out of algae I guarantee you that many of these problems, bad as they are, are going to disappear. But until and unless we can find a transformative technology I think it’s going to be policy choices by themselves that are going to create this very stagnant, Japanese like situation.