All I want for Christmas

Just a small government hand out would do nicely. After all the banks have had largesse pored on them one way or another and now car manufacturers and even hedge funds are getting into the line up. But is this benefiting the average “Joe”? Well some mortgage rates have come down but as with the falling crude oil price what you pay at the pump hasn’t quite matched up. In January crude was $110 a barrel so at $2 to the pound as it was then that’s the equivalent of £55. Today with crude at $40 and sterling at $1.50 that makes it £30 a barrel a fall of 45% in sterling terms. Back in January the average pump price for petrol was 110p; today 90p, a fall of 18%. I am sure there is a logical explanation…please let me know unless you work for an oil company.

In fairness to the banks (not a phrase you hear often these days) mortgage rates for those lucky enough to be on trackers have tracked Bank of England rates reasonably well. For those on fixed our sympathies, but in future remember that it is never safe to make assumptions particularly about interest rates. The “top” in government bonds has been called every month since the middle of last year and yields are still falling. The UK 10 year gilt yield is getting preciously close to 3% and with spreads on investment grade corporate paper looking increasingly attractive the whole world is talking about the only trade in town. Sell governments and buy corporate bonds.

Well it hasn’t worked yet but as fund managers are wont to remind us they are never wrong just early! Long Term Capital Management (LTCM) believed they could never be wrong betting against interest rate spreads but proved spectacularly that in some cases timing is everything. With deflation the number one enemy at the Federal Reserve government yields could continue to fall. No one is quite sure whether or how the huge “support” operation is going to work. In fact neither it would seem does the government. The TARP pool has had at least three changes of direction; the latest being to fund the loans to General Motors and Chrysler. In this environment safety is still at a premium and government paper is still in much demand.

The purveyors of corporate bonds say that the Treasury and Gilt markets will be swamped with new issuance but given where cash rates are, government bonds are still attractive to those of a nervous disposition, i.e. those who used to believe that bank deposits and money market funds were safe. So 10 year yields at 2% (or below if you have a suspicion we are following the Japanese example) would give a mighty attractive return. But Economics 101 says that a “great inflation” is coming as the Fed’s printing presses glow hot; quite possibly but not for a while yet. Unemployment is rising rapidly around the globe, GDP is falling and retail spending would have ground to a halt had it not been for Christmas. Even so, to get people in the shops, and parting with cash, has meant the New Year sales starting early and with Woolies and MFI closing down the prospects for 2009 look bleak. House prices continue to fall and motor dealers are “giving cars away”. Inflation? Show me!

“Soul” Searching

 At this “festive” time of year we pundits like to look back on the year that’s gone and ruminate about the one to come. Not that the market cares for calendar years or any other marker in the sand and never has it been so hard to divine the tea leaves, so it is tempting not to try; in fact knowing that we know nothing about tomorrow is getting to be strangely comforting.

Even looking back is an experience that almost defies belief. There are unfortunate folk who used to work at Bear Stearns, Lehman Bros and a whole raft of other financial institutions who are still shaking their heads and we feel for them deeply as many were innocent bystanders. Some of course were not but it is difficult, and in the short term pointless, to point the accusing finger, but there will be a day of reckoning and the Book of Revelations will seem like a fairy story for a number of the heroically greedy. The tech bubble in 2000 threw up some guilty parties and this time around we have the mother of all Ponzi schemes as your starter for ten; there will be more revelations…and worse to come.

The “prize” for drawing the shortest straw in 2008 has to go to Barack Obama. GW is positively ecstatic to be on his way out. After his trip to Iraq though he may want to consider some further “soul” searching – not of the size 10 variety – to contemplate the mistakes he made during his presidency and how he might have achieved some better marks. The President Elect has not only the biggest financial catastrophe to deal with, but there is still Iraq, Iran, Afghanistan and Pakistan and we haven’t even got started yet! To the south Mexico is disintegrating as the drug cartels take over and Ecuador has defaulted on its government debt (to be followed shortly by Argentina, Venezuela et al). In China the peasants are revolting and the Russians have become born again colonists.

Even amongst his “friends” in Europe he will find much discord and disharmony. He may want to be firm with the Russians but as the Germans rely on them for gas supplies support from the EU will consist of a Kirkcaldy kiss from Gordon and an autographed copy of “I am Napoleon” by N. Sarkozy. Not a lot of help in other words. Europe of course has its own problems which look very much like the American ones except they are denominated in euros, which brings us to the $64,000 question. Back in the ‘50s there was a game show by that name (yes I do remember it!) and people struggled to understand how anyone could possibly spend that amount of money. How times change; even a million doesn’t buy you much these days.

The question is, “Are you happy with paper dollars, euros, yen or pounds?” Central banks have ridden to the rescue of some major global banks and the mantra “too big to fail” applies to almost any financial institution (ex Lehman’s which was arguably “the” mistake of 2008) so the security of ones deposit seems to be, well, “secure”. Doesn’t it?

Well what else are the Central banks up to and the Federal Reserve in particular? They are printing money. Isn’t that their job? Of course we all like a crisp new tenner but they are adding new ones to the old stuff; increasing the money supply in the vernacular. Text book economics tells us that this is “bad” as more paper means the value of the “pound in your pocket” goes down so you have to use more of them to by the same stuff as you did before ie you get inflation. 

In Zimbabwe this has worked to a tee. The Governor of the Bank of Zimbabwe, one Gideon Gono – believe me that is his name – has presided over an inflationary bust that has put the Weimar Republic to shame. He has printed so much money that inflation has reached a meaningless number as there is nothing on the shelves to buy and, irony of ironies, they can no longer afford to buy the paper on which to print more of the wretched stuff. Hopefully their long suffering citizens will shortly be put out of their misery as their truly awful President gets his comeuppance.

So if the Fed are at it as well won’t we get galloping inflation here too? Maybe, but not just yet. The Japanese tried a similar experiment back in the 90s after their property bust led to a rapid contraction of the economy (as we are currently witnessing now). To get things going they spent trillions of yen on infrastructure projects building, amongst other things, bridges over every small stream and puddle across the country; just what Obama has suggested too. But Japan is still verging on the brink of deflation eighteen years later. Recession coupled with deflation is a pernicious thing. You can’t make banks lend, nor make people borrow for that matter if prices are falling, whatever you do with monetary policy (rates in the US and UK are lower than they been for a very long time); Keynes called it pushing on a string.

So unless all this money that the Fed and others are printing gets some traction, ie the velocity of circulation picks up, the danger in the short term is deflationary hence the record low yields on government debt. The price of gold, the traditional inflation hedge, is some way off its $1,000 high, despite there being an acute shortage of physical bullion in denominations that the “man in the street” can afford; Central bank and rumoured IMF selling are the likely culprits here. How long will this last until we get a real blast of inflation? How long is your piece of string?