The British economy

MoneyWeek Roundup: London property is about to collapse

MoneyWeek

24 November, 2012

Last week was one the French government would rather forget. It started off with a very negative cover story in The Economist.

It only got worse when credit agency Moody’s – with exquisite timing - stepped in and downgraded the country’s government debt from AAA, the top rating.

In practice, this is more of a blow to the ego than anything else. France’s borrowing costs remain low compared to other European countries – so far.

But it’s bad news for President François Hollande. His (very minor) austerity measures have not proved popular. Yet with the ratings agencies on his tail, he can’t start spending more money.

So what, you might say? This is France after all. You might even feel a sneaking sense of schadenfreude given the way the country has tried to deflect attention on to Britain’s poor finances in the past.

But what’s bad for France is bad for the rest of us too, says Bengt Saelensminde in the most recent issue of his Right Side newsletter. Hollande’s difficulty “highlights a serious problem at the heart of Western democracy”.

To prove his point, Bengt used this colourful chart from CitiGroup.

It looks confusing, but it basically shows the popularity rankings for various European leaders. “You’ll notice that new leaders come in on a high”, says Bengt. But then, when the grim economic reality prevents them from fulfilling campaign promises, their popularity plummets.

The problem is, says Bengt, that “everyone wants a slice of the economic pie”.

We’re not just talking about “welfare dependents – business is increasingly dependent on government handouts”. For example, Hollande recently launched his ‘competitiveness pact’. He “aims to lift output by half a percent over five years by granting €20bn a year in corporate tax relief and pruning public spending by 1%”. In other words, robbing Peter to pay Paul.

And it’s not just France. “In the West both industry and vast swathes of the public are hooked on government. But the only way to give to one group without having to take it from the other, is to borrow the extra cash.”

They can’t get away with it forever. Spain and Portugal, who find it hard to sell their government debt at all, prove this point. It’s only a matter of time before France - and the UK - join them.

“Western nations have been gradually bankrupting themselves for decades”, says Bengt. And “neither stimulus (more borrowing), nor austerity have shown any meaningful and sustainable impact on our listless economies.

“Ultimately, wholesale reform is required. And Western democracies are simply not geared up to delivering that. Or is it simply that the politicians aren’t made of the right stuff? Who knows? But one thing’s for sure, things aren’t getting any better.”

In the short term there are still plenty of ways to make money, says Bengt. You can learn more by signing up for The Right Side here.

But in the long run things look grim.

The Zombies are coming

Voters shouldn’t take all the flak though, says John Stepek in Monday’s Money Morning. Central bankers - who are entirely unelected - have a great deal to answer for.

Yes, “it’s easy to understand why the Bank of England acted as it did after the financial crisis”, says John. In the “crazy” autumn of 2008, when banks were collapsing all around us, “you can see why the Bank might have thought that cutting interest rates to zero seemed like a good idea.”

The trouble is, every action has its consequences and Britain is now crawling with ‘zombies’.

“Low rates and quantitative easing (QE) have delayed or prevented the process of creative destruction from taking place. As a result, firms that should have gone out of business are grimly clinging on to a twilight existence, neither bust nor solvent.

“One in ten companies are only paying the interest on their debt, according to the insolvency industry's trade body, R3. They are unable to repay any of the actual loan. So the firm sits there consuming resources inefficiently, dragging on the economy. And the zombies are spreading. Their numbers have grown by 10% over the last four months.”

Why are the zombies so bad for the economy? “A zombie company doesn’t just take up physical space. It takes up valuable bank lending capacity too. Zombies are only just able to pay the interest on their debts. If the banking system were healthier, they’d be put out of their misery.”

But with the banks in such a weak position, they’re too nervous that writing off these loans would hit their balance sheets and force them to seek more capital. So, for now, they’re content to leave businesses and mortgage holders hanging on.

And that, just drags out the suffering, says John. We explained why the UK economy is in far worse trouble than anyone believes in a recent issue of MoneyWeek magazine (if you're not already a subscriber, get your first three copies free here).

Bangkok’s JFK moment

With the UK economy weighed down with so much debt, it’s natural that some investors are looking for opportunities abroad in more dynamic economies.

And in this week’s edition of our free New World email, Lars Henriksson outlined one of the most exciting investment stories in Asia.

In 1963 President John F Kennedy went to Berlin and delivered his famous “Ich bin ein Berliner” speech, says Lars.

He was there because Germany “was rebuilding rapidly after the war and joining the rich, free countries of the West [and] America wanted in on that story.”

Now something similar is happening is Southeast Asia. “Barack Obama was re-elected less than two weeks ago”, says Lars. “And what was his first order of business? He jumped on a plane to Southeast Asia – with plans to deliver a speech in Bangkok, and then meet Aung San Suu Kyi in Myanmar.

“A week later, Bangkok welcomed the next most powerful man in the world, the new Chinese president Xi Jinping. Everybody wants to deal with the countries in this region – just like the great powers jostled to get close to Germany in the 1950s and 60s.”

Investing and politics are closely intertwined, says Lars.

“Last year, the US military issued its first new overall strategy document in six years. It called for more focus on Asia to balance the increasing power of the Chinese military, since China could, in the future, threaten global trade routes where Southeast Asia plays a ‘pivotal’ role.

“This courtship is being closely watched by China, whose turn it was to visit the King of Thailand, Bhumibol Adulyadej, just days after Obama.”

The reason they are so interested is that Thailand is the gateway to a massive swathe of Southeast Asia that looks set to enjoy an incredible economic boom. Burma, for example, is making great strides, says Lars.

“The Myanmar government has approved the long-awaited Foreign Investment Law. The law allows foreign investors to own 100% of most businesses, offers tax privileges and security of investment and the rights to lease land for 50 years, extendable for an additional 20.”

Neighbouring Laos is also opening up. “On 26 October, after 15 years of negotiations, Laos agreed to join the World Trade Organisation in early 2013. Laos agreed to cap its tariffs at an average of about 19% and expand market access.

“It has also passed, or is working on legislation to boost protection for intellectual property, improve customs procedures and otherwise bring the country into line with international trade norms. Laos GDP is expected to reach 8.8% in 2012, making it the fastest growing economy in Southeast Asia this year.”

It’s all very well identifying growing economies. But working out how to profit from them is another thing altogether. Lars has some good ideas.

And if you would like free weekly analysis of investment opportunities in Asia and Latin America, sign up to The New World here.

Call that a mansion?

Merryn Somerset Webb took to her blog to rail against the ‘mansion tax’ being proposed by the Liberal Democrats. She starts it off with a game, called ‘Spot the Mansion’.

It’s a bit of tongue-in-cheek fun and I’m not going to ruin it for you now so, to read the piece here and play along: Spot the Mansion.

Without spoiling the game too much, Merryn points out that a lot of the houses that the Lib Dems want to tax aren’t exactly what you’d call ‘mansions’. The whole thing makes “the idea of a mansion tax seem a bit silly”, says Merryn.

Particularly “if you marry the idea of taxing apparently high-end property with whopping rises in stamp duty, as today’s papers suggest is about to happen again with the data emerging from the London market at the moment”, says Merryn.

“In the third quarter of this year, transactions fell by 9% in prime central London to a mere 5,226. But look at Greater London, and in particular at the £2m-£5m sector, and you can see just how the effects of the new tax legislation are beginning to bite (these put stamp duty up to 7% for people and 15% for companies on property valued at over £2m). Transactions are down 53%.”

That’s a huge fall, says Merryn. It’s not that she’s against changes to property tax. Indeed she’d “swap the lot for a location tax or for a capital gains charge on first homes”. But she thinks that the mansion tax proposal is not the way to do it.

Readers were quick to chip in with their views. “I don’t understand why the conservatives are so against a Land Value Tax. Those on low/middle incomes are overtaxed, our savings are taxed - surely it is about time that property was taxed,” said 'Nick'.

However, ‘GFL’ is completely against the proposal. “Any tax on a house or location or land that has already been purchased post-tax pounds is deeply immoral. Also it also makes the government unpredictable, which is not good for investors. Council tax is a little different, since it's directly paying for local services (well, in theory anyway).”

London property is about to collapse

Maybe the mansion tax wouldn’t hit as many properties as the government reckons, though. Because - as my colleague Matthew Partridge noted in one of the most popular articles of the week - London property could be heading for a big fall.

London has seemed immune to the crash, But with financial firms in the City starting to feel the squeeze, even London prices will start to drop.

“Investment bank UBS recently announced it will cut 10,000 jobs worldwide, many of them in London. And this is only the start.

“The Centre for Economics and Business Research (CEBR) thinks a further 12,476 financial sector jobs will be lost next year, with more to come. The fact is, with investors rattled and paralysed by fear, there’s just not enough work to go around.”

In itself this doesn’t have to be bad news. The UK economy became over reliant on finance so a bit of rebalancing is probably healthy. But, like it or not, it will have an effect on house prices.

The pound is heading for a big fall

Money Week,
24 November, 2012



The British economy is in a mess.

Most of us know it isn’t growing much. We also know that the government’s finances resemble those of a credit card junkie.

But you wouldn’t know it to look at the pound.

Yes, it had a big slump after the financial crisis. But for the last three to four years or so, sterling has been a very uneventful - even boring - currency. Its value hasn’t changed much at all. It has moved around in a pretty narrow range.

Don’t let that lull you into a false sense of security though. We think there’s big trouble ahead…

The pound has gone nowhere for nearly four years

Sterling index

Have a look at the chart above. The sterling index shows the effective value of the pound against a basket of currencies.

As you can see, the banking crisis and the deep recession that followed saw the pound plummet in value during 2008. People sold the pound as Britain teetered on the brink of financial meltdown. It lost nearly 30% of its value against both the US dollar and the euro (see charts below).

Euros to pounds

US dollars to pounds

But since then not much has happened.

Unfortunately, this isn’t because the outlook for the British economy has improved. Instead it’s due to the fact that there are lots of games being played with the world’s exchange rates.

Lots of countries want a weak exchange rate right now. Economies that are struggling to grow want to export their way back to prosperity. One way they hope to do this is by devaluing their currencies. This will make their exports cheaper in foreign markets.

The trouble with this policy is that if everyone devalues at the same time, nothing really happens. The relative exchange rates don’t change that much and no-one ends up better off. And that’s exactly what’s been happening.

A lot of exchange rates are at similar levels to four years ago. It’s not just the UK, the US and Japan who are printing money. Switzerland has also been printing to stop the high value of the franc from crippling its exporters. So currency devaluation hasn’t really helped anyone that much.

Strange as it may seem, Britain has also acquired a kind of safe haven status as people fret about the eurozone. Other countries are using the pound to diversify their foreign exchange holdings, and so reduce their exposure to the euro. This has helped prop up the pound too.

"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd

Weak economies create weak currencies

So what’s the ‘fair value’ of the pound, if you will? Trying to work out what the value of currency should be is not easy.

The Economist’s Big Mac index tries to do this by working out what exchange rates would be, if the price of a Big Mac were the same everywhere. This is a nice way to explain the economic theory known as ‘purchasing power parity’. And on this basis, the pound looks fairly valued against the US dollar.

But we’re not convinced.

Broadly speaking, weak economies lead to weak currencies. Britain is unquestionably a fragile economy. And it’s only going to get worse.

The UK is stuck in a debt trap. A large chunk of growth in the boom years was phony. It was created by excess credit, and borrowing by governments and households. This borrowed money was spent on increasing the size of the state and trading overpriced houses with one another.

The money was consumed – it’s gone. But the debt has not.

Had the borrowed money been invested in productive assets then it would now be producing cash flows to pay it back. The economy would be in a far better state. With households and banks paying down debt instead, there is no more phony growth or indeed any growth at all.

More money printing is on the way

The only thing that has stopped the economy collapsing is the Bank of England’s printing press. But creating £375bn of money out of fresh air has to eventually make a currency fall in value.

We expect the bank to go on printing money. The government’s deficit cutting plan is based on forecasts of economic growth that are not remotely realistic. So the overall debt will continue to rise. And standing by will be the Bank of England as a convenient source of cheap - even free – money.

But while the bank might be able to carry on rigging the bond market, money printing can’t be good for the value of sterling in the longer term. And raising interest rates to defend the pound – by giving holders a decent return on their money – is a non-starter. Our debt-laden households and banks simply couldn’t cope.

We don’t produce enough stuff

As if a weak economy and a money-printing central bank weren’t bad enough, the other main reason why the pound could go a lot lower is that we don’t sell enough to the rest of the world.

UK current account as % of GDP

Even although the pound is a good deal weaker than it was five years ago, the UK continues to suck in far more imports than exports. It has not had a trade surplus (where exports are higher than imports) since 1983.

These persistent trade deficits mean that we have to keep on selling pounds in order to get our hands on the foreign currencies to buy other people’s goods. This puts downwards pressure on the pound.

This is only going to get worse. Our North Sea oil and gas reserves are running out, meaning we will have to buy more of our energy from abroad. The City is also shrinking and can no longer be counted on to bring in lots of foreign income.

Get your money out of the pound

In short, the outlook for the pound is grim. So it makes sense to protect yourself. You can do this by putting some of your savings into foreign assets. As the pound falls in value, they will be worth more to UK residents.

There are many ways to do this. You could buy shares in UK companies that earn lots of its money abroad. Or you could buy foreign stocks or bonds, which is quite easy to do through most online stockbrokers these days. Or you could buy a cheap tracker fund or investment trust that invests abroad.

But where are the best countries for your money?

You need to look for countries that have trade surpluses and strong government finances. These countries should have stronger currencies than the pound. In Europe, countries such as Norway, Switzerland and Sweden fit the bill. Singapore in Asia may also be worth a look.

What next for the British and American economies? Where should investors look for profits? John Stepek talks to our roundtable panel of experts to find out what they're buying now.

The challenges facing this small-cap company are typical of those faced by other small businesses. The difference is that this chairman tells it exactly like it is, says Tom Bulford. And a fat lot of good it’s doing him.

Work Programme: 70% still unemployed after one year

Seven out of 10 unemployed people have failed to find jobs despite being on the government’s flagship back-to-work scheme for more than a year, according to figures released today.

The Telegraph,

27 November, 2012

Ministers are expected to confirm that they have missed a key target for tackling long-term unemployment through paying private firms and voluntary groups to secure work for jobseekers.

Unofficial figures released ahead of the government’s own results showed 71 per cent of those who joined the £5 billion Work Programme when it started in June 2011 had not found employment by September this year.

This amounted to about 53,000 individuals. About 22,000, or 29 per cent of those who entered the schemes in June last year, had successfully started work.

Out of the 248,000 long-term unemployed adults who joined the programme in June, July and August 2011, about 180,000 were still out of work in September 2012.

The analysis is based on figures compiled by the Employment Related Services Association (ERSA), representing the “welfare to work” groups running the programme.

They showed that a total of 207,883 individuals – about one in five of the total who have enrolled - started work since the programme launched last year.

However, the results did not indicate how long the jobs lasted.

Under the Work Programme, companies and voluntary organisations are paid by results if they succeed in securing work for clients that last more than six months.

Ministers are expected to confirm that fewer than five per cent of those on the programme have subsequently been employed for that long, meaning a key target will have been missed.

The employment minister, Mark Hoban, insisted that the scheme was making a difference as he prepared to publish figures showing that progress has been slower than initially hoped.

Speaking ahead of the official results, Mr Hoban welcomed the early findings from the ERSA.

“The Work Programme has already helped more than 200,000 of the hardest-to-help unemployed people into jobs. This is great news,” he said.

“ERSA's research also shows the Work Programme is giving better value for money than previous programmes, thanks to its payment by results model, with every job start costing the taxpayer £2,000.” This compared well against the £7,000 per job that the Labour government’s Flexible New Deal cost, he said.

“It's still early days, but it's a welcome sign that one year in providers are getting more and more people into sustained jobs.”

The ERSA figures showed that 29 per cent of people who have been on the work programme since it started in June 2011 have been supported to find a job so far.

Kirsty McHugh, the chief executive of the ERSA, predicted better results in future.

“There is clear evidence that month on month performance is building which means there will be a consistent rise in sustained employment numbers in the future,” she said.