Over the past week we have heard some of the leading US politicians railing against creeping socialism (that would be those reds under the beds again I suppose) and the threat posed by nationalising the main banks in the US. Hyperbole, of course, tends to take over at such moments, as no-one is actually anticipating (yet) taking over the banks, but rather taking strategic stakes in them with some specific strings attached. Given the risks to the very structure of the capitalist system, this is almost the last resort and despite the negative comments from pre-election grandstanding politicians, a very necessary one.
There were also some interesting side comments at the attitude of the Europeans being obviously a bunch of “pinkos”, but it is time for our cousins to take a bit of a check on their own structure. Take a look at the giant US mortgage guarantee companies, Freddie Mac and Fannie Mae which account for about half of the $12 trillion US mortgage book. Although always operating in the grey world of a government “sponsored” organisation, both have now been taken over and their liabilities now seem to rest quite firmly with Washington.
This may be seen as the exception because of the housing and economic crisis, but in fact state support and intervention is very much an American economic and political trait. For example, the direct and indirect support provided to key industries is well known and results in a significant amount of friction with other trading partners. For many years the Americans have argued about the level of state support for the Airbus project which could have never got off the ground (in both ways) without contributions from the key consortium member states. However, the support both direct and indirect for Boeing is rarely cited as being equally reprehensible.
Now let’s see if this spreads further? How about the steel industry, the ship building industry and then the ailing domestic car manufacturing industry all of which are the beneficiaries of various levels of state and federal support. In our own country and industry we well remember such state intervention and some may recall its effects as well as costs, but we have learnt our lessons there I believe. I dare not mention farming issues as that is a constant sore between the EU and the USA where both are probably equally at fault in protectionist policies – mostly at the expense of the desperate emerging market farmers.
From a European perspective, this would be seen as being, if not normal, then at least not unusual. In the US there appears to be denial that the state is not only influencing, but further intruding and even owning in some circumstances.
Possibly the largest area of national expenditure is that of the health service where Medicaid and Medicare are now huge financial operations drawing ever increasing sums from the already stretched government budget. With an ageing population and a weakened economy, this cannot be sustainable. However, in an election year, which politician could ever stand up to announce such cuts and reductions? We know this domestically with the trials and tribulations of funding our own NHS.
In fact when added up, the American government appears far more interventionist than one would expect as the capital of the free market and in financial terms far more than that other apparently socialist den of iniquity – Britain.
Now with the banking system coming under effective government control, one wonders actually what is left?
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And so the maelstrom moves on. Although the banks are still feeling the effect of the storm, the path of its damage is now heading for the insurance companies. This week we will see further effects falling out of the Lehman Brothers insurance liabilities emanating from their Credit Default Swaps (CDS) exposure. This will ripple through the insurers creating concerns about some of the weaker players. The FSA has already announced that it has been looking at the area, but there is probably little they can do now except to flag up any major areas of distress and try and rally support. However, I have been concerned at various industry meetings that many in the insurance world seem either supremely confident - or is it just blasé and complacent - about the potential risks. The fall out, though, may not immediately surface with the insurers as much as certain over-exposed hedge funds that may fail and thus cause further ructions.
Last week finally saw the recognition in the markets that Wall Street’s woes were now in Main Street as the Dow lurched down again, pulling the global markets down with it. Remember consumer spending accounts for 68% of the US GDP and that is roughly 20% of global GDP – so realisation of the inevitable has finally come, though that demand will be lower and that will flow back to effect both China and Japan directly.
Again all of this is to be expected, so I would ask everyone to remember that this is a cycle and the effects are quite predictable – what are not are the actions or inactions of the politicians.
However, let me proffer some good news. Oil is down and so are pump prices (eventually), other soft and metal commodities are down as well as the Baltic shipping rates I referred to recently. This is all encouraging for the passing of this inflationary bubble and next year will aid any attempt at an economic recovery – albeit a weakened one.
This will also lead the way for further interest cuts especially here in the UK as last week’s 0.5% is unlikely to have had any material effect.
There is also one other small whiff of improvement with the slightest sign that the LIBOR logjam has allowed a small trickle through and the rates have come down – a bit – actually a very little bit – but better than nothing.
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And finally.....who said and when...... “I believe that banking institutions are more dangerous to our liberties than standing armies”? Well it was Thomas Jefferson in 1816 – it is good to know that some things just don’t change.
Have a good weekend,
Justin A. Urquhart Stewart
Director
Seven Investment Management Limited