Archive for the ‘Banking’ Category

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It was November 2012 when Jens Weidmann, President of the Bundesbank, likened quantitative easing, or QE, to a Faustian pact with the devil.  But it was even earlier, back in 2010, when Brazil’s finance minister talked about currency wars.

It was during that era that QE was seen as leading a kind of race to the bottom, as countries fell over themselves to try and achieve a cheaper currency.  It didn’t work out like that, of course. It is no more possible for every country to have a cheaper currency then it is for every Premiership football team to win on the same day.

The critics of QE were legion. They said QE was behind currency wars, and that the inevitable result would be hyperinflation. And they saw the words of Jens Weidmann as a kind of official endorsement of that view.

It was in this environment that the buy gold bandwagon got moving. BUY GOLD, they said. It was the only safe refuge in a world gone mad under QE.

They overlooked that across the world there was a chronic shortage of demand, a savings glut and that the west was suffering from a balance sheet recession.

There are lots of things wrong with QE, the main critique might be that it is a blunt weapon. But it was never likely to lead to hyperinflation, not in a world starved of demand.

But what it did do was lead to a cheaper dollar. And when the dollar fell, so gold rose.

Back in 1999, when UK chancellor Gordon Brown sold the UK government’s gold supply, the yellow metal was trading at less than $300 an ounce. In the summer of 2009 it was trading at just shy of $900. Those two years stood either end of the great gold market, when it rose in value by around 300 per cent.

Gold continued to rise in the aftermath of the crisis of 2008. In September 2009 it was trading at $1,000 and in August 2011 it finally passed $1,900. That was when the gold hype was at its peak.

But in 2015, currency wars has turned to currency normality and inflation stands at close to zero across the developed world. QE didn’t create hyperinflation, it was not even enough to fight the threat of deflation.

In 2015 the US economy began to improve, the Fed made noises about increasing interest rates, the dollar rose, the euro fell, and gold went out of fashion.

As of this moment (21 July 2015) it is trading at $1,108 an ounce.

Why didn’t gold rise above $2,000, or even $3,000 as was once predicted? The reason is simple. QE was the not the devil’s tool it was made out to be, the global economy suffered from lack of demand.  The risk of hyperinflation was built upon a myth.

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For an economy to grow it needs the money supply to expand. That’s the point that those who favour a return to the gold standard overlook. In a static economy with no innovation and which will look the same in a hundred years’ time, a gold standard would do nicely. But in an economy that has this thing called innovation, a gold standard spells permanent depression. This all begs the question: if we need the money supply to grow, whose responsibility should it be to decide how this should happen and by how much? Adair Turner, former chairman of the FSA, has a plan and it involves debt forgiveness and governments funding their spending via the printing press. (more…)

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It is the new way of doing central banking. It is called forward guidance. It means that central bankers are telling us what they are going to do in the future under different circumstances. In one fell swoop they have done away with an industry; an industry called predicting interest rates. It has become a game, and in some cases a business. The media fill their pages with predictions on which way interest rates are going next. Now we know, if the data says one thing, rates will go in a certain direction. Yet here we are, just a few weeks into the era of forward guidance, and already cracks are appearing. As for the markets, rather than becoming more stable and predictable, they have become more nervous than ever.

“I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said,” or so once and somewhat famously said the former Chairman of the US Federal Reserve Alan Greenspan. This was the era when Mr Greenspan was set on a pedestal so high that it is a wonder he didn’t need an oxygen mask and climbing ropes. What the markets really loved was the way in which Mr Greenspan had a veneer of knowing something they didn’t know; of having a plan – a cunning plan if you will – that always worked the way it was supposed to.

The finance crisis of 2008, and the fact that we appeared to miss a meltdown in capitalism by a whisker did leave Mr Greenspan’s reputation a little in tatters. Ben Bernanke, his replacement at the Fed, made a great play of saying what he thought; of letting us in, as it were, on his rationale. At first it didn’t go down well. The markets concluded he didn’t really seem to know what he was doing. It is the tragedy of the modern age. All of us stumble around in the dark most of the time, but we just don’t like to admit to it. And when our leaders admit to it, we think they are weak and uncertain.

These days, however, Ben’s stock is high. It was he, first among the central bankers, who came up with the idea of forward guidance, when he revealed that the Fed would keep pumping money into the economy via QE for as long as unemployment remained high. Now they are all at it. The Bank of England – under the leadership of Mark Carney – is now saying that rates will stay at half a per cent as long as unemployment is over 7 per cent.

It is just that the minutes from the latest Bank of England Monetary Policy Committee (MPC) meeting revealed that one member of the committee – Martin Weale – voted against the policy. It was not so much the idea of forward guidance he was against, it was the perceived timing. He appeared to fear that the 7 per cent target was too loose. Er, or maybe you could say that actually he was against forward guidance, because he wants a policy that one might describe as always flexible.

His dissent is important, because it rather put a question mark over the viability of the policy. You can interpret the Bank of England as saying if the economy does this, we will definitely do that, unless, that is, we change our mind. There are also hints that UK unemployment is set to fall much more rapidly than has been assumed. A survey from the CIPD and the latest Purchasing Managers’ Index both point to positive changes in UK unemployment in the pipeline. See: The UK jobs market boost . This has led to speculation that rates might be rising much sooner than the Bank of England has been suggesting.

It appears that the industry that grew up predicting what the MPC might do next has changed into one predicting what unemployment will do. If nothing else, jobs have become a more important economic indicator – and maybe that is no bad thing; after all common sense suggests it should be the most important indicator.

In the US, recent data has pointed to a sharp improvement in the jobs outlook, with the latest survey suggesting US unemployment is now at its lowest level since October 2007.

So let’s review the situation. The signs, both in the form of hard data and from surveys, point to a labour market that is improving faster than many had dared to hope for. That means monetary policy might be tightened faster than many had feared. The markets are spooked by it all. ‘Better than they dared hope for’ jobs data turned out to be less of a boon than ‘rates rising faster than they had feared’, – at least that is what they are saying at the moment.

But then the markets are fickle and how they react one day can be quite different on another. If you think the markets are making themselves clear, it probably means you “misunderstood what they are saying”.

© Investment & Business News 2013

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Imagine you asked your bank for a business loan. Your bank manager – if indeed there are still members of the genus ‘argentaria procurator’ (that’s Latin for bank manager) left – might ask for the spreadsheets. If they revealed a big fat salary for you, the ‘procurator’ might say: “My Dear Homo Sapien, it appears you expect the bank to take all the risk.” You may well have found you were out on your ear (pércipe) before you could say “ego odi bancarii” (I hate bankers).

Imagine, with the help of your bank, you were trying to arrange one of those MBIs (management-buy-in), MBOs (management-buy-out) or indeed a BIMBO (buy-in-management-buy-out). You would be expected to chip in an amount roughly equal to your annual salary. Nassim Taleb would refer to it as “skin-in-the-game”. Shakespeare’s Shylock might have called it a “pound of flesh.”

Barclays is raising money to bridge a shortfall in its capital ratio. So far we have heard not a dickey bird about how management at the bank may contribute; not a hint about whether this year’s bonuses might be in the form of shares contributing to the fundraising.

Some might respond by saying “nam hypocritae.”

© Investment & Business News 2013

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The problem with banks lending to small businesses is that it is not often a good idea. Business loans are risky, of course they are. Mortgages are less risky because for one thing there is the property they are secured against, and for another thing there is the fact that to the people who own the homes keeping up mortgage payments is just about the number one priority. But there is a third far more important point. Businesses create wealth; mortgages don’t. And the creation of wealth is incredibly important, but also by its very nature risky. Banks have become the bogey men of the 21st century. The public hate them. The truth is, however, that small businesses, the type run by entrepreneurs and that create wealth don’t really need banks at all, not banks as they are these days anyway. They need something far more. And curiously enough the venture capital industry has just been spelling out what it is.

Barclays is on a fund raising spree. It needs to find £12 billion or so to ensure it can meet the 3 per cent capital ratio that the regulators have decided is essential. So it is raising money, selling shares, and trying to get existing shareholders on board. Of course, in an ideal world its better paid staff, the ones with big bonuses, would contribute to the fundraising by receiving their bonuses in shares rather than hard cash.

But just imagine if more than 3 per cent of its loans went bad. Imagine if the 3 per cent of the people it lent to went bust, and were unable to repay a single penny. The bank would be in rather a lot of trouble. That is why banks prefer providing mortgages, over loans to businesses. Think about that. Businesses fail; it happens all the time, so is a 3 per cent safety margin really enough?

We keep reading about how banks are providing mortgages again, but are not lending to businesses. But is that really a surprise? Banks are not geared to truly understand entrepreneurs; their business model doesn’t fit.

It wasn’t always that way and it doesn’t always have to be that way. But for as long as the principal way in which banks provide money is by charging a fixed rate of interest, which provides the same return regardless of the company being lent to (whether it turns out to be the next Google, a business growing at about 0.0001 per cent year, or a company that fails outright), the most a bank can make for backing such a business is always the same and is actually quite small. The most it can lose is… well it is everything it lent.

If banks were remunerated in the form of share of profits, so that they benefitted from the upside as well as losing out from the downside, it would be a different matter.

It was not always thus, of course. There was a time when local bank mangers understood local businesses, and even if they couldn’t provide funding they might have known someone who could.

Back in November 2008, Edmund Phelps, a former winner of the Nobel Memorial Prize in Economics, said in an interview with ‘Spiegel Online’: “A fundamental issue that regulatory discussions must confront… is what function society needs the banking industry to perform. Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some [of] their credit to the business sector.”

But now the venture capital industry has spoken up.

For some companies even getting an extension on an overdraft can feel like “pulling teeth”, or so said David Hughes, chief investment officer of Foresight Group, managers of Foresight VCTs. He added: “In our experience banks seem interested only in funding mature, profitable businesses with proven management and clear growth plans… We have heard numerous accounts of banks dragging their heels on seemingly straightforward requests, where for example the request for an extension to a facility took over eighteen months for the approval to come through. … From where we are sitting, the outlook for banks stepping up to the plate remains bleak.”

Alex Macpherson, head of the Ventures team at Octopus Investments, proffered a similar opinion saying: “The banks have rarely been interested in providing debt finance to high growth entrepreneurial businesses where an equity investment is typically more appropriate.”

So what does that mean? Businesses need to court the VC and business angel market and now peer to peer lending.
As for the government, well frankly so far its efforts don’t add up. The UK badly needs a more entrepreneurial minded psychology amongst the funding community in the UK. And the government needs to put its money where its mouth is. It is extraordinary that the last Labour government cut VAT in a scheme that cost the UK government tens of billions of pounds of revenue, while it provided a few million pounds here and there for SMEs mostly in the form of training, and quite often training was not what was required. The current government spends billions on trying to get house prices up, but Vince Cable’s business bank will have one million pounds of new money. The Bank of England creates £375 billion in new money via QE, but still entrepreneurs , the people who can create wealth and make the retirement of the baby boomers affordable, are left to fight over scraps.

© Investment & Business News 2013

Money in hand

Vince Cable has a cunning plan to kick life into the UK economy. It is called a British Business Bank. “We need bold action to fix what has always been a weakness of the UK economy,” he said last week, but there is a question mark. Is Vince’s plan bold enough?

David Petrie, head of corporate finance for the Institute of Chartered Accountants in England and Wales, has doubts. “It is shaping up to be a missed opportunity to make a real difference, especially to micro and smaller businesses,” he has said. So what’s wrong?

First of all, he reckons small businesses are being side lined. Secondly, he is worried that the business bank will not work directly with businesses, but will be one step removed.

Thirdly, he says the money being talked about is nowhere near enough. He reckons the bank will need a minimum of £10 billion of capital.

And fourthly, he says the plans unveiled by Vince Cable amount to little more than a respray of the old Capital for Enterprise scheme.

Mr Petrie’s observations are worrying, but – sadly – probably about right. It is a sort of puzzle. The UK government throws billions at mortgages, the Bank of England prints £375 billion to buy government bonds under its quantitative easing programme, and Vince’s new business bank will have £1 billion of new money.

He says the UK needs bold action, but what we get is timid packaging and the re-jigging of old initiatives that didn’t do much the first time around. Banks have not been failing business for the last few years; they have been failing UK businesses for a decade or longer. For way too long it has much easier to get a mortgage, or even a loan to pay for a holiday than to get funding for a business.

Back in November 2008, Edmund Phelps, a former winner of the Nobel Memorial Prize in Economics, said in an interview with ‘Spiegel Online’: “A fundamental issue that regulatory discussions must confront… is what function society needs the banking industry to perform. Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some [of] their credit to the business sector.”

But the problem runs deeper than banks. It lies deep within the British and indeed European psyche.
In his book ‘Them and Us’, Will Hutton says: “The European Flash Barometer found that around 43 per cent of people in the UK (compared with 19 per cent in the US) believe that a new business should not be created if there is a risk it may fail.”

The more potentially innovative a business is, the more the chances are it will fail. Bank lending to innovative business does not make sense, because the probability that the business may fail is too high. It only makes sense to back an innovative business if the provider of capital has shares in the upside if things go well – that is to say a share in profits. That way, the successful funding deals can make up for the ones that don’t work. This is the issue a business bank needs to grasp.

© Investment & Business News 2013

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Be under no doubt, record low interest rates and quantitative easing are the main reasons why equities are riding high at the moment. There is this view that central banks control interest rates; that they can determine flows of money. So why panic about rising rates spoiling the party? Central banks will only do this once the economy is back on its feet. It is just that there are reasons to think this analysis is wrong.

It is remarkable how, in this post financial crisis era, central banks still seem to operate under a kind of halo. The media and organisations such as the IMF still suggest that these central bankers are like mini gods, moving the pieces of the economy around. They are like Zeus in one of those old Hollywood movies, in which the gods of Olympus (played by the likes of Lawrence Olivier), controlled the movements of mortal man in much the same way a croupier moves chips across a roulette board.

Maybe the truth is that central banks have about as much power as Zeus does in the real world, which is to say that the sense of the central bank’s omnipotence is based on a myth.

So did central banks create the financial crisis of 2008 by letting interest rates fall too low, or were their actions largely irrelevant? Maybe the real reason why inflation fell during the 1990s and noughties was that the Internet helped to promote price competition and globalisation – in particular the rise of China – meant cheaper manufactured goods.

At the same times, ageing in Japan, China’s policy of protecting the yuan, and rising corporate profits led to a global savings glut, meaning there was lots of money sloshing around the system, pushing down interest rates. Alan Greenspan himself alluded to it when he was chairman of the Fed and he talked about long-term interest rates set by the markets being lower than short-term rates set by central banks.

But supposing things went into reverse. The Ernst and Young ITEM Club recently forecast that inflation will rise later this decade as wages increase in China, which will lead to rises in the price of manufactured goods. It also forecast that UK bank rates will be increased to 1 per cent in 2015 and to 2 per cent in 2016. On the back of rising interest rates, it forecast that mortgage interest payments will jump 15 per cent in 2015 and by a massive 23.4 per cent in 2016.

But is it possible that it is underestimating the changes that may occur?

Zeus is a myth. We now know that bankers’ hubris gets punished, and maybe central bankers have an Achilles heel. And that heel is that actually, there are forces at work – underlying forces – that are far more important than what members of monetary policy committees say and do.

Alan Greenspan once said it is the job of central bankers to take away the punch bowl as the party gets started. Maybe changes across the global economy will do this anyway, no matter how much gin and vodka central bankers pour into the QE punchbowl.

© Investment & Business News 2013