Will China Own us?

Italy have just opened talks with China on buying Government Bonds http://liten.be//0nNea.

Currently the largest holder of US bonds is China while China is actively buying European Government bonds.

It is a supreme irony that many believe the US and UK invaded Iraq as an attempt to control the availability of oil to China which is now the largest consumer. How apt that the US, after its latest budget to increase borrowing further, is getting in greater hock with the country it sought to exert control over.

If this whole scenario had been outlined as a potential reality just a few years ago, US and UK politicians would have told us we were mad. However, the reality is that few nations have the sustainable economy and cash to buy our bonds right now.

Being in large scale debt to the Chinese could produce some very interesting problems in the future, particularly if we don't get a grip on our finances and struggle to repay the debts. Imagine China telling us how we should be using our money.

The beauty for China is obvious. they lend us more money so that we can spend it on their goods and manufacturing in their country so that they make more money to lend to us.

It's a nasty spiral that may be very hard to pull out of. Who said that an ideology like Communism would never rule the world? Perhaps the way to do it all along was via trade rather than isolation - if that's right the Chinese have read this perfectly.

2010 - The Year of Growth?

I have blogged before that 'Hope is not a strategy' but it seems the only direction this Government is taking.

We have seen no initiative to cut back spend, no review, no real mention of it and no activity to make any. Yet, by 2014, there is a legal commitment to reduce the budget deficit by half. The only hope is that growth will come back into the economy and it will be enough to eat into our debt mountain. It also assumes that interest rates remain relatively low as the payments to service that debt are already forecast to be at a peak around 2013. So if growth is the plan, where will it come from, and particularly in 2010?

Retailers are still gloomy about the outlook. Households have generally started to rein back on their outlays and focused on starting to reduce their debts. Worryingly, 175% of GDP is held as principal and while interest rates remain low, the servicing is not too much of a problem, but should interest rates start to rise then severe problems will start to occur. The High Street will not be the recipient of big growth next year, that's for sure.

Many researchers say that unemployment has not yet peaked, although there are signs the rate of growth has no slowed. There is a worry here as the Government HAS to make cuts somewhere to try and service the interest on our debt and that will mean job losses in the Public Sector which has largely gone unscathed in this recession. Some predictions have put an extra half million on the current number and that will place a huge drag on benefits and lost tax revenue.

Businesses are generally holding off big investments. That is not always the case as I am working with a firm whose financials have remained good this year and is looking to grow with multiple investment opportunities this year, but their sector is generally down. That is not the general landscape - firms will be cautious about investing and the timing as there is much talk of 'double dips' and false dawns at the tail of this recession. The good news is that there is 'pent up credit' available from banks as firms have cut back on borrowing.

But the state of the inter-company lending is still very depressed. Credit insurance has taken a whipping during the Crunch and recession and overall limits are significantly down which will definitely hinder the rate of growth when the upturn comes. The firm I am working with right now has worked hard with Euler Hermes to keep their overall credit lines much the same but what has helped has been a strong policy on credit which has forced firms to pay to terms. Lengthening those credit days and decreasing cash days is not a policy that firm wants to fall back to in order to stimulate growth.

In general, fund-raising by firms has been very slow with only big banks going for rights issues mainly to boost liquidity and stave off the Asset Protection Scheme. Businesses are still keeping their powder dry.

What it points to is that there is little appetite for investment for growth right now - few companies are being bold enough to predict it is the wise thing to do. Either we are going to get a sudden massive rush for money to grow or the growth that is hoped, even preyed, for will be very slow, cautious and, in the first instance, internally funded.

You can bet your bottom dollar that such slow growth is not built into the Government's forecasts which really argues that the longer they delay making the cuts needed to balance the books, the worse they will have to be. With the Polls now narrowing, the likelihood of a hung Parliament or even a small labour victory is a possibility - given there are no concrete plans for either eventuality in terms of cuts, it may be that our attempts to balance the books will not start until the back end of next year.

That will not impress the credit agencies and it will not look good on our Bonds being as we will not be buying them in the new year with our 'Funny money'. Whichever way you look at it, this is a high risk strategy. Then again, hope is actually not a strategy.

Honouring Debts

The one thing that is becoming apparent about the Dubai World debt crisis is that Governments are getting tired of just accumulating more debts.

The governments of Dubai and Abu Dhabi are taking a pragmatic view on the debts at Dubai World - they basically say they will pick and choose where to bailout but creditors need to front up to their responsibility as well as Dubai World doing so. While there have been some short term liquidity measures taken by the UAE banks, effectively Dubai World is a pretty unsafe bet and no one is going to step in and pick up a full tab.

At last, some sanity. It finally shows, if a company or entity recklessly gambles on growth via continually rising asset values and creditors lend them money because they think they cannot lose as they can trade and trade the debts, perhaps the Dubai hiccup has taught us the lesson that a debt is just a debt. The even better news is that just because Dubai World is big and important, Governments are in no way going to just save it when it makes stupid decisions.

The fall out of this crisis, being downplayed in most quarters as a side show and trivial in the great scheme of lending, has yet to be really felt. I suspect that credit agencies and creditors will be taking a great deal more interest in what the British Government is doing in order to secure its ability to repay its growing debt. Hope isn't a strategy, as I have blogged before, and it is high time we saw some action on curbing and cutting costs as well as strategic spending to stimulate the economy rather than just shoring up the balance sheets of banks who risk the free cash to make more profits while no real effect is felt in the actual economy.

I still believe that Dubai is a salutary lesson once again that not enough is known about our financial system, locally or globally, and there are few safeguards against high risk products being traded.

Dubai Wobbles - What Does It Mean?

Two authoritative bloggers, Robert Peston and Stephanie Flanders on the BBC site have given the conventional view that the Dubai debt repayment blip is merely that.

They also argue that if push comes to shove then the European banks which are estimated to be exposed to around 50% of the total $80bn that Dubai owes, then they can absorb those losses well within their stride. In reality, they say a big Sugar Daddy in Abu Dhabi is on hand to pick up the tab anyway and they are just toying with Dubai.

It sort of shows just how punch drunk we have become to big numbers. This is a sovereign state - and a rich one at that - delaying loans because of excessive debt.

Hello!

Substitute any rich nation having trouble repaying their loans - and there may be a fair few soon - and you have the real picture. Countries all across the globe, with few exceptions, have vastly increased their borrowing to support the bank meltdown. In doing so, they have burdened their taxpayers with extraordinary new debts and, for the most part, they have underwritten the future debts of the entire global banking system. And we are in the final throws of a recession so there is no growth to offset these debts.

To my mind, Dubai is a stark reminder of how precarious the global economy has become and how interdependent we all are on one another. The butterfly wings beating in Dubai could have a dramatic effect on the world economy and particularly if we remain unimpressed by the magnitude of the numbers involved.

A sovereign state has found repaying its debt hard. It's a wake up call for us all - you don't need many more countries announcing the same for the world to become a pretty shaky place.

It's a real reminder to our Government - plan to repay those debts and take action now. Delay, and we could be in the same boat with no Sugar Daddy oil state locally to bail us out. It should make us think hard.

Debt - The Business Viewpoint

As the Government hit an unpleasant new record on borrowing in October taking borrowing to £175bn for the year, it seems that the mantra is that debt is good.

Meanwhile, out in the world of business, we seem to think the opposite. In the building sector, companies like Persimmon who were particularly debt laden at the start of the recession have slashed their debt by 58% or £960m. Other builders like Barratt and Taylor Wimpey have followed suit but on not such a grand scale.

But across business generally, borrowing is down - £4.6bn down in September, sending the 12 month growth rate to its lowest level since 1999. RBS has over £27bn of approved credit not being used while other banks have a similar situation.

The situation runs at loggerheads to the Government viewpoint as Alistair Darling marched smartly into the banks in July and told them that he was very angry about them denying businesses credit. The simple fact is that businesses are reining in their borrowings in and not asking for more credit.

Here lies the gap between Government and business thinking. In a recession, businesses look to conserve investment as there are fewer opportunities. It's all very well famous entrepreneurs like Lord Sugar telling us the recession is non-existent and opportunities are high, the reality is that few companies thrive in a recession - and it isn't for the lack of trying. The markets are down - that's a simple reality and businesses have to cut their cloth accordingly. They have conserved their cash and credit lines for the upturn and that is good business sense.

While Friedman may be the mantra at the Government level, just wishing companies to grab credit and spend it for the sake of it is not just wishful thinking but it shows a complete lack of business acumen on behalf of ministers. Businessmen understand that profitable sales drive their business and without them they have to make sure they can survive until they increase. Sure, some companies may miss the odd opportunity for growth in a recession but it is the wise businessman who survives.

I may not agree with David Cameron's total argument on the economy but I do believe that you cannot solely wish for growth to solve this country's debt problem. You have to make cuts - that is a reality. And the longer we leave it, the worse it will get.

What I would like to see is an emergency budget that identifies immediate savings through slashing inessential costs, wastage and inefficiencies and then puts more spend directly into areas that will help boost business such as cutting tax in the short term and offering subsidies to firms on wages to keep people employed.

The two different mindsets are dangerously polar and too much money has been sunk into banks in preference to general business for zero return. Businesses understand the need to get sales before they invest - the Government is going down completely the wrong direction by wishing only for growth when they should also be driving down costs.

It's a recipe for disaster in the long term.

The Danger Of Big Debts

I blogged only this morning on Alistair's Darling's dogma about borrowing to rescue Britain from the recession - 'borrowing to grow' is the mantra that he and the PM repeat endlessly.

I had a discussion with someone today about my negative response to this sentiment. And I tried to explain, beyond Alan Greenspan's gloomy view about borrowing too heavily as to why I believed it is not the only way out. I acknowledge that running a business is not the same as running a country but certain principles about debt are true no matter how you look at it.

Today, Government debt has been easily 'sold' as bonds as the main buyer in recent months have been ourselves - Quantitative Easing (QE)has allowed the UK to buy its own debt and so make it look very attractive. QE is drawing to its conclusion and the Government has indicated it will not spend any further than the £175bn already spent. Some speculate that when our bonds go on the wider market there may not be the enthusiasm by institutions and other Governments to buy our debt so willingly.

The reason is this, in my view. Anybody looking at loaning a person or a business more money will look closely at how it is run. If the lender (effectively the buyer of the bonds in our debt) sees that the person or business is not making efforts to create cash of its own, then there are warning signs about the long term ability of the person or business to keep up the payments on the debt. For an individual, a lender will look at income, savings, assets, prospects, other loans and current spending habits - indeed, new mortgages are rumoured to require much more rigorous scrutiny of how income is disposed of before assessing how much can be afforded. Business has the same scrutiny - the last thing that any lender wants to do is to lend money for an expensive lifestyle or wasteful use of money by a business. So if the MD wants a loan to buy a yacht to take customers around the Mediterranean while business is bad, the lenders will not be keen, just as Citigroup could not buy Corporate jets during the credit crunch.

What lenders would certainly want to do is to see how an individual or business accommodates their lifestyle or business to service the debt. If an individual receives the money and blows it on champagne and high living, the lender will not be happy as this is not helping the servicing of the debt and may well end up with the individual getting into more difficulties financially. For a business, if the business does not look to its own cost line, income or cashflow to maximise the use of the money, lenders, particularly in austere times, may not believe the business is going to be able to keep servicing the debt without coming back to ask for more.

A good example of this for our Government is the fact we borrowed, yet again, at much higher rate than previously forecasted in September, once again missing our forecast on borrowing and requiring us to borrow yet more. This lack of understanding of our own 'business' by the Government has to make lenders think twice about our long term ability to run the 'business' that is Britain. Further, we are not growing - despite spending astronomic sums pushing our borrowing sky high, Britain's GDP contracted again last quarter when other countries emerged from recession. Time and again, our Government has repeated the views that Britain's economy was strong and resilient to the recession and we were not overly reliant on the house market.

Time and again, the Government has been wrong.

Like a bad management team in any business, a lender will take a dim view of those managers who do not fundamentally have a good grip on their business. It is clear that our finances are run more in hope than in knowledge and lenders cannot lend endlessly against such poor management. The fact that there is a clinging belief that growth will come so just spend more, is a sure symptom that our 'management' has little clue as to what is going on.

But there is another big issue. The Government's stubborn refusal to cut costs is a major factor in putting doubt into would-be lenders' minds. Just like a person who takes a loan and blows it on champagne and good living, lenders will want to see where our money is going. If all we do is support the lifestyle of rich bankers, it has to be a worrying sign. The fact that we have written an open cheque to underwrite banks' bad business for the future is another serious issue - this is not supporting growth, this is supporting liability - to a lender for a mortgage this would be akin to another loan having a preferential or equal charge on your assets, this would have to limit the size of available loans and the appetite of the lender to risk it. Further, the Government just keeps avoiding the issue of making efficiencies and saving money. We need to show that we can create cash to help service debts so that if the economy remains in recession for longer, we can at least cover part of the 'miss to the forecast' if nothing else.

Finally, there is the taxpayer. While we are the 'collateral' for the loan as Britain has few assets left to sell, if growth is slow or the debt burden gets too high, then the Government will keep turning to us to get more of the money in tax to service the debt. If unemployment continues to grow, less tax is taken and the burden on the welfare state increases as a result, then we can borrow money to pay for the 'miss in forecast' but the debt servicing on the increased borrowing comes from increased taxes. It isn't rocket science. Lenders will observe that as time goes on and the tax burden increases, the appetite of British people to continue paying will decrease and this spells danger to the country's ability to service the debt.

Today, the Government are acting as if there will never be a time when it cannot go to the open market and raise money or take it from taxpayers. I think that lenders will start taking a dim view of Britain's ability to repay soon. From my own perspective, I am getting more shirty about where that increase in tax would be spent - if it is on wars I don't agree with or MP allowances or bureaucracy and inefficiency, I will not be happy to pay it.

I believe that making cost savings on our budget is essential to the country's good let alone to prove we can manage ourselves. We have too much flowing through the public sector and too much inefficiency - we can easily save money if we want to. We must prioritise what is important and cut costs where we can meaning some services will be affected, that's just a fact. Only when we have our house in order will be be able to see where we can invest money that we may have to borrow to create growth. Today it is just pure guesswork and it has almost exclusively been wasted on the financial sector.

Given that everyone pounds on that the financial sector is only 9% of our GDP is has taken a disproportionate amount of money on a grand scale to bail it out. This means that our dependency on this sector is far greater than its contribution to our wealth would suggest. That also suggest that we are pouring money down a drain in saving it - this is not good news for would-be lenders as right now we are funding lifestyles in the banking sector as much as if the Government borrowed £100bn before the crash and handed it all back to us in tax cuts to spend on what we wanted - they wouldn't have done it as it made no sense. But that's what they have done - but the billions have gone to a small percentage of people to not just save their careers but to make them far richer than they were before. It is that stupid.

In simple terms, if Britain were an individual wanting a mortgage and it had a budget and sources of income as it is today, our finances would not stack up. The lender would want to see how we adjust our spending and plan to grow and to be right on top of our 'managing the debt' before lending us more money.

Because the prospects right now are not good. We need to staunch the losses we are making as a nation to slow down our rate of burning money which is fuelling our requirement for more debt. Until we get that balance right - Britain is a bad debt in the making.

Who Should We Believe?

Depending on which set of figures you look at for the economy, you could be verging on the suicidal to the ecstatic. Certainly, we seem to be clutching at straws if we think Britain has emerged from its recession yet.

In the week, I highlighted The Sunday Times Appointments Section as being devoid of private sector jobs and full of public sector senior appointments, arguing this was a bad sign. Yet for the second month on the trot, there has been a marginal increase in the number of appointments available generally according to Government figures. Encouraging, if fragile.

But, the National Institute of Economic and Social Research (NIESR) has calculated that our GDP did not rise a jot in this last quarter. This falls in line with the worrying industrial output figures reported for August which were sharply down on July. True, we could argue it's holiday time but the level of drop, some 2.5%, surprised most economists. Bizarrely, the Government's response was to say that this prediction of stagnated GDP showed that the Government's policies are working.

We have also heard that house prices are now nearly back to levels experienced in 2008 - certainly there are plenty more placards up in my area - but this is still some 15-20% down on prices in July 2007. The number of mortgages being approved has risen but we know that lending to small businesses, despite Government indications to the contrary, is reckoned by the Bank of England to be £14.7bn down on last year. Are we putting the credit in the wrong places, you might ask?

Bank profits and bonuses are sharply rising, the price of gold has hit a peak (perhaps I should have followed those persuasive TV adverts), car sales are up 11.4% from this September to last, inflation has fallen to 1.6%, and the Services sector, such as restaurants, showed expansion for the 5th successive month and is now at a two year high - trashing my comment on empty tables for pre-theatre meals in London last Saturday. Or so it would seem.

The figures are all slightly baffling. The reality we see is a great deal of uncertainty as we face a great many cuts to public services no matter who gets into power which will inevitably hit jobs after 12 years of growth in bureaucracy in the public sector that now accounts for 1 in every 4 jobs in the UK. Our population is rising faster than expected due a new birth rate explosion, 25% of that growth coming from couples not born in the UK as immigration takes its toll on the UK. Unemployment continues to rise to nearly 2.5m and there are predictions of over 3m by this time next year which is well above 7% of the working population.

The budget deficit continues to rise and at a greater rate predicted by the Chancellor, indicating that it may well be getting out of control, which will see Britain borrow an extra £175bn this year - and rising. Many predict, contrary to Government promises to halve it by 2015, that borrowing will be nearly 99% of GDP by 2014. As we are faced with a rising Welfare bill due to more people on the dole claiming benefits, and greater immigration numbers than ever predicted, and therefore a shortfall in tax revenue, the squeeze is on. And there will be a need, due to the heavy borrowing, to find big cuts, some 10%, to try and manage the situation down.

I find the whole situation baffling but the one thing I believe to be true is that we are paying for 12 years of unsustainable and unreal economic growth that was based on a flawed financial system that relied on the unchecked ascent of asset values and the instruments which relied upon that principle. And we have set up the remedies to start the exact same cycle again, despite posturing to the contrary - banks are once again out of control.

It seems that even if we halt the decline this quarter, we are a full 6 months behind our competitor nations in recovering despite all reassurances to the contrary before we hit the recession - the one that we were reassured that we would not hit - and I believe we are focusing on the wrong areas to manage the situation. Time will tell, but the comedy of errors by the Government, Investment Banks and the FSA in calculating a bailout of the financial system literally over a few late nights and some pizzas will haunt us for a generation. Last Sunday's article in the Times was meant to reassure us that the parties took the banks on and dressed them down for 10 years of excess. What it showed was that having ignored the banks for 10 years, they suddenly became experts in their business to save them.

If you believe that, then you will believe that little green men have invaded Uxbridge and put up the price of rail tickets.

Why We Are Not Economists

The Bank of England did two things this week. First it decided to keep interest rates at 0.5% - good news for mortgages, bad for savings. Second, it extended its practice of Quantitative Easing beyond its agreed limit of £150bn to £175bn, raising the question of will it go further?

The £175bn has been used to buy Gilts, or Government Bonds on future debt which we need to pay to off all our recent extra spending. In fact, in certain sectors of the Gilts market, the bank now owns above 70% of the available issues. On the face of it, this is econo-masterminding on a grand scale to save our economy and we feeble-minded numb skulls watching via the news articles should shut up and let the experts run the show.

You do not have to be a genius to work out this a high risk strategy. Quantitative Easing is in fact creating money out of nothing to purchase valuable things. It would be the same as you and I getting a classy money printing machine, printing off some fresh fivers, tenners, twenties and Fifties and then walking into a jewellers and buying a stack of gold. If anyone stopped us, we could say that are good for the money as we have a some savings in the bank and it is hardly likely that several jewellers would ask us to pay with real money all at the same time. Why, couldn't they just take those notes we have given them and use them to buy whatever they wanted - no one should worry as we are good for the money - and again not all vendors will come to us at the same time asking for the real money or its equivalent.

Quantitative Easing (QE) is really like that. Except of course, that we are no allowed to print our own money. But we have a way of doing so. Many of us have indeed printed new money over the years by taking some of the equity in our houses and creating new money in its place - sadly we have cannot behave like the Bank as we have to repay the loan, the Bank apparently doesn't. Another sad fact is that many of us are in a serious situation where the value of our assets have dipped below the original debt taken to buy them or we have negative equity - some 39% of all Northern Rock customers are in that mire while around 20% of Lloyds customers are.

QE is the process of conjuring cash from fresh air and buying really valuable items with it - with complete impunity. It works on the principle used by most banks which says if I have £1m in reserves in the bank then I can lend out many multiples of that as not everyone is going to ask for their money back at the same time or create a run on the bank. Meanwhile, the more 'unreal' money you put into circulation, the less the real money is worth. That means that each time you create more unreal money, prices have a tendency to rise as vendors think if there is proportionally more unreal money in circulation, then if they raise their prices they will keep the amount of real money they want for their goods.

It's a hard concept to grasp but if for every £1 in circulation, if 10p is unreal money created by QE, then each shop should raise their prices by 10p to get £1 of real money.

Very quickly, inflation can set in as it is so attractive to print more money to to apparently 'buy' your way out of economic trouble. Countries like Argentina did this and very nearly bankrupted themselves as so much unreal money bought apparently valuable things that the country nearly collapsed as inflation went into hyper-mode to try and compensate. QE, in economic terms, is the last resort of third world countries to save themselves.

Unless of course you are the experts at the Bank of England who think Britain is rich enough to do so. With our wonderful balance of trade heavily pitted against us, our manufacturing base pretty low and our rising debt after the bank bail outs set to almost double Sovereign Debt, QE makes perfect sense. Britain can afford it.

Our Sovereign Debt is based on cashflow, largely our tax receipts to pay the interest and repay the loan at some time. As with our own households, if we leverage our equity, then we have to pay for it, whether our assets rise or fall. In reality, by creating more money to buy our own Sovereign Debt, all we have done is created the need to raise more debt in the future to pay for it, as you have bought the debt with unreal money. It is the start of a very vicious cycle.

I am no genius, and better people than I will put me right, but one thing I know for sure is that you cannot buy anything for nothing. There is always a price to pay. QE is merely a postponement to pay in the future - we buy our own debt with more debt.

Pure genius.

10 Trillion Reasons Why there Should be No Bank Bonuses

After the impassioned plea by bank CEOs for our understanding as to why investment bankers and the like should be awarded unfeasible bonuses in likening them to star performers on the football field or in movies, sobering reality arrives in the form of a report prepared by the IMF for the G20 Summit in September.

The IMF says that the cost to Governments globally for the Credit Crunch - remember not taxpayers but investment bankers caused this - has been $10 trillion so far. Think about that - it 10,000 times $1bn. The bulk has been coughed up by rich countries, 92% of it, but a large chunk has fallen on developing nations who can least afford it, as their clever little bankers wanted to share in the bonus bonanzas too.

The profits that banks are whining about bonuses on are just a few 10s of $billions and fail to make any, even minor, dent in the incredible losses they have drummed up.

There have been $1.1tn of capital injections, $1.9tn of asset purchasing, $4.6tn of guarantees and $2.5tn of liquidity provision - numbers which defy belief and the ability of most calculators to comprehend. It seems bankers can't either.

You see, they would have us believe that we should forget all that cost that has to be met by us, even though a chunk will be reclaimed when the economies recover, supposedly. They would also have us believe that the clever people who created this mess really deserve our largesse in the form of vast bonuses and that we should kneel at their feet, kiss their backsides and not get uppity when they pay hundreds of thousands and millions to themselves for the risks they take.

Another taste of reality from the IMF, whether you believe the actuals or not is neither here nor there, the fact is they say there are more problems ahead. The IMF reckons that government debt will be 239% of GDP by 2014 in Japan, it will be 132% in Italy, 112% in the USA and 99.7% in the UK - slightly out from Darling's estimates. While this may seem excessive as it means a doubling of the current debt situation in the UK, but Darling hasn't got a prediction right so far, horribly undercalling debt at every try to date.

The IMF bemoans a 'lack of policy credibility' which is making fiscal expansion less effective and is increasing interest rates and risk. I would say that by instigating largely the same fiscal policies as before seriously increases risks - but what do I know?