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7th June 2010

Not inspirational
“The announcement of the rescue package failed to stabilize the situation, perhaps because more
people knew how deep the problems went than the government realized.. None of the central
bankers had faced an international financial crisis before; they therefore had to make things up as
they went along.”

- From „Lords of Finance: 1929, the Great Depression, and the bankers who broke the
world‟ by Liaquat Ahamed (Windmill Books, 2010).

Communiqués from government conferences tend to recall the words of Ralph Waldo
Emerson:

“The louder he talked of his honour, the faster we counted our spoons.”

The latest official statement from the G-20 in Busan, South Korea, does not disappoint fans of
irony expressed on a magnificent scale. Among the highlights from this vapid exercise in giving
voice to messianic delusions of relevance, international finance ministers and central bank
governors agreed to:

“firmly secure the global recovery”;

“put in place credible, growth-friendly measures..”
rather wonderfully, ensure that “Monetary policy will continue to be appropriate to
achieve price stability” and “reduce moral hazard associated with systemically important
financial institutions”;
hysterically, to “accelerate the implementation of strong measures to improve
transparency, regulation and supervision of hedge funds, credit rating agencies,
compensation practices and OTC derivatives in an internationally consistent and non-
discriminatory way” [emphasis ours].

There was no commitment to deliver world peace or universal wealth and health, but that may
just have been an oversight. The problem with these sorts of statements was well expressed in a
letter to the editor of the Financial Times last week from a Mr Nigel Collin, referring to a piece,
“solutions for a crisis in its sovereign stage”, written by Nouriel Roubini and Arnab Das. While
acknowledging that the original article was “both illuminating and practical”, Mr Collin went on to
point out that
“.. a closer examination reveals that the verb “must” is used in three of the five solutions
advocated. Without an explanation of how a sovereign state must be compelled to adopt a
solution, the solutions are rendered aspirational rather than inspirational.”

Where to begin with the G-20‟s marvellous aspirational announcement ? One does not necessarily
expect politicians to declare their own redundancy, but wealth creation and, in a more general
sense, “recovery” are the products of private action rather than government direction.
Governments take capital from their own people but they are functionally incapable of producing
it. The best thing for government to do would be to get out of the way. Instead we have
governments that have squandered billions in private capital (not just current billions but claims
against future billions from taxpayers not even born) in supporting fundamentally bad banks. A free
market has a magically effective way of discriminating between good and bad businesses. Bad
businesses fail and are purged from the system and good businesses prosper, begetting more
wealth in the process. Not content with their malign achievements to date, governments have
now tasked the banks with mutually contradictory objectives: strengthening their balance sheets
whilst simultaneously maintaining the provision of credit to the broader economy. You cannot
drive a car well by concurrently slamming on both the brake and the accelerator.

There is a similar contradiction in the pursuit of credible attempts to bring sovereign finances back
toward balance. In part it constitutes what economists call the fallacy of composition and the
paradox of thrift. What may make sense for individual governments to do (turn off the spending
taps) could be hugely detrimental for the broader international community. Politicians may not
acknowledge the fact, but the world is even more closely interlinked than it was in the crisis of the
1930s, and the economic and financial interactions are undoubtedly faster. What is certain is that
beyond a certain point, which Greece has now probably reached, slamming on the fiscal brakes
transforms a heavily indebted government from muddle-through financing into insolvency, as the
ailing economy, bereft of government spending to which it has become addicted, is unable to
provide even sufficient tax revenues to allow that government to service its debts. Default follows.

While it is clear that just as in the 1930s, today‟s politicians and central bankers, having no route
map, are making it up as they go along, it is equally apparent to any objective observer that there
is precious little of the coordination to which the G-20 communiqué so pompously aspires. Recent
policy announcements do not augur well. The German Chancellor unilaterally declares a jihad
against speculators in her now infamous tirade promising to beat the markets. The Australians
break ranks and run the risk of killing the golden goose by unilaterally hiking taxes on the mining
sector. Since world currencies are not, as they were in the 1930s, backed by the solidity and
stability of gold, everyone seeks solace in currency devaluation. But by definition not every
currency can depreciate against its peers. The balance of probabilities is that as this long
emergency continues, the depth and breadth of the US dollar pool wins out against most of the
rest of the world‟s paper money, despite its own underlying fiscal precariousness.

The G-20‟s reference to regulation in a consistent and non-discriminatory way is a triumph of

absurdity and bare-faced contradiction. How else to describe a regime in which badly run banks
are extended indefinite and unlimited financial support, while institutional investors not fortunate
enough to be deposit-takers are targeted for daring to point out the nudity of the Emperor ? And
this last point gets to the real challenge for investors today. Navigating markets fundamentally
distorted by government manipulation, wholesale currency debauchery and fiscal incontinence is
bad enough, but we are now tasked with trying to anticipate seemingly random and often
unilateral political action.
Some of the rational investor‟s strategy response should by now be obvious. Avoid the debt and
currency markets of the most egregiously undisciplined administrations. Buy precious metals as
the ultimate in portfolio and currency insurance – their upside potential in price terms is widely
understated and misunderstood. In other respects, exposure to equity markets should reflect
individual risk appetite and any requirement for albeit irregular income rather than a slavish
allegiance to an always volatile asset class.

The G-20 communiqué suggests that recovery is on its way, though characteristically it cites no
evidence for the declaration. The evidence from, even by recent standards, unusually nervous
financial markets would suggest otherwise.

Tim Price
Director of Investment
PFP Wealth Management
7th June 2010.

Email: tim.price@pfpg.co.uk Weblog: http://thepriceofeverything.typepad.com

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