greece, the future of the Eurozone and exploring country risk were the central themes in this two-hour session with speakers divided on potential solutions, the eventual outcome and what caused the problem in the first place.
Tim Congdon was a vocal advocate of where the blame lies for the financial crisis – the very officials who have strived to solve the problems post the collapse of Lehmans in September 2008. Tim noted that in order to make banks ‘safer’ authorities have concentrated on imposing higher capital restrictions. However, he argued, this has had the opposite effect as it has reduced the rate of growth in bank deposits, which in turn has limited money growth and consequentially the ability for economies to grow.
The Great Recession
During the Great Depression the US saw money growth go from 5%pa in the 1920s to a contraction of 10%pa between 1929-1933. The situation is similar to our cur-rent “Great Recession’ where money growth has moved from 10%pa between 2005-2007 to stagnation thereafter.
“By far the most important single explanation for the sudden halt to money growth was the imposition of new regulations on the banks in late 2008.”
The banks were not without culpability in the ensuing crisis, Tim noted, agreeing they have done “silly things” in the name of competition, which led to greater risk-taking. However, he does not believe imposing greater capital requirements will do little to change things and in fact has been detrimental to recovery. “With fears of a deep recession, you don’t ask the banking system to re-capitalise in six weeks or even in six months.” Instead he feels banks should be given many years to re-capi-talise, giving them time to adjust to new regulations so it doesn’t lead to the sudden collapse in money growth we have witnessed, he said.
Tim added: “I appear to be claiming the Great Reces-sion was caused not by the greed and undue risk of the bankers but by officialdom’s appalling blunders in late 2007 and late 2008. This may make eyes pop. But yes, that is exactly what I am claiming. The Great Reces-sion was due to blunders by officialdom, blunders which could be attributed – in large part – to shocking ignorance of basic monetary economics in the world’s leading banks.”
These errors, as seen in the Spring issues with Spanish banks, continue, he concluded.
Like Tim, Torgeir Høien believes central banks have not quite done enough to resolve the issues from the financial crisis and the subsequent Eurozone crisis. However, unlike Tim he is less concerned about money growth and instead feels central bankers should be doing more with regards to interest rates, making fur-ther and deeper cuts.
“Quantitative easing (QE) is no substitute for interest rate policy,” he said, adding “effective rates should be below 0%.” He argued QE has done little more than alter the duration of debt and increase interest rate risks, which could lead to increased tax burdens down the road – canceling the effect of QE.
Fiscal inf lation in the region, as a consequence of QE, is also a concern to Høien, who said while he’s not predicting ‘hyper-inf lation’ he could see it in double digits soon if policy doesn’t change. “Aus-terity in the Eurozone has meant higher taxes rather than lower public expenditures and the Eurozone needs structural reforms to achieve expenditure cuts and lower tax rates.” Høien believes change needs to happen. “You can’t have common debt without common fiscal policy and you can’t have that without political unity.”
Despite this outlook and the stress caused by Greece he believes the Eurozone will ultimately remain intact. Much of this is down to the legal nightmare that could ensue as the EU treaty does not allow a country to be expelled, he commented.
A question of growth
The Eurozone crisis has had its impact on surrounding economies, including the UK, which is still struggling to gain traction in its own economic recovery. Jeremy Cook, chief economist at World First Foreign Exchange, noted everyone keeps talking of growth but questions where it will come from.
He believes the UK needs to make its exports more attractive by either producing better goods or making them cheaper, via a devalued sterling. However, it’s not alone in that approach as many economies, including the US, Japan and Korea, have also been engaging in such an approach in recent years. In the long run Cook feels the US will be the only winner of a currency war as despite its weaknesses, the dollar remains the world’s reserve currency. He noted: “The Bank of England has dragged the UK into a fight it can not win.”
The affect of the Eurozone contagion may also be to increase the strength of the pound as it may be seen as ‘safe haven’ as turmoil continues. In addition, Cook believes any further UK QE would be ill advised as it could have an ever decreasing effect on the economy’s growth pros-pects. The Bank of England has already forced inflation on the UK economy by trying – and failing – to force growth, making each of us poorer, he said.
Country risks
With all these various economic factors to consider in a world that remains quite uncertain, geographic expo-sure is under heightened scrutiny by investors. How-ever, as Victoria Marklew, country risk manager at Northern Trust noted, country risk is a very broad con-sideration and different financial institutions have dif-ferent approaches.
Marklew explained to delegates that many believe emerging markets are the only areas to be concerned about. “Yet a few years ago Greece would have been con-sidered a developed market. Since then there has been a shift in realisation of country risk and that it can come from unexpected areas.”
Northern Trust assesses risk in 100 different coun-tries, looking at the same set of indicators across the board, be it Zambia or Austria. Among these consid-erations are factors such as current account deficits and debt default probabilities. However, it is not just the hard numbers that should be examined but the overall trend, Marklew added. For instance, she noted Northern Trust does not just examine debt to GDP ratios but rather how fast did it get there and how is it being financed?
Macro economic features of a country are not the only areas to examine when assessing risk, she said; the level of a country’s development and political factors are just as important. Changes in regulation within a country can affect the free flow and control of foreign securities or currencies, while systemic risk may involve looking at the potential failure of a country’s infrastructure. There is also a reputational risk in doing business with certain areas or regimes and the impact of corruption on a market.
At the moment much of the world’s economies are suf-fering through a recession but when examining the risks involved an important consideration may be to look at whether a country has the political will or ability to steer through.
With all of these factors to examine, what areas look ‘low risk’ these days? According to Marklew it is a f luid assessment. “Analysis is as much an art as it is a science and ultimately much of it comes down to a judgement call.”
