Archive for October, 2010
CurrencyShares British Pound Sterling Tr (FXB)
iShares MSCI United Kingdom Index (EWU)
Security was unusually tight to get into the Houses of Parliament in London last Tuesday. Although the guards gave me a nod of recognition, a new machine gun-toting colleague still frisked me thoroughly. That’s what I get for not wearing a tie, I thought. Taking a wrong turn to the right, I ended up near the entrance of the House of Commons, standing under the statue of the “Iron Lady,” Margaret Thatcher herself.
“It was a dark and stormy night”
That seemed particularly apt. I had been invited by a member of the conservative Tory party to take part in a discussion group in one of Westminster’s Committee rooms and chime in with my views on what they called “The Grand Experiment.” Earlier that day, Chancellor George Osborne had detailed the massive government spending cuts that set the United Kingdom firmly on the path of austerity. This stood in stark contrast to the “tax-and-spend” approach taken by his U.S. counterpart, Timothy Geithner.
“The Grand Experiment”
The “Grand Experiment” refers to the two competing approaches of governments around the world to the handling of the global economic crisis.
On one side stand Keynesians, who support massive government spending to kick-start their economies. Such was the approach taken by the Obama administration, with its seemingly endless spending and projections of trillion-dollar deficits. Although you’d have to look hard for any lasting effects of this approach on the U.S. economy, Keynesians like Paul Krugman, rather than admitting defeat, now want to double down their bets, insisting that the problem is, if anything, that government spending was too little.
On the other side stands the European Central Bank, whose leaders preach the gospel of austerity. Thanks to the successful example of Germany’s economy — which now boasts a lower unemployment rate than the United States — many of Europe’s peripheral countries like Ireland, Greece and Spain have agreed to take the bitter medicine of economic austerity. The spending cuts outlined by U.K. Prime Minister David Cameron and Chancellor George Osborne last week now put the United Kingdom firmly in the austerity camp.
Great Britain: Can’t Afford “Cool” Anymore
The Labor party’s expansion of government after the election of Tony Blair in 1997 was remarkably surreptitious. As recently as 2000, government spending accounted for only 34.75% of the United Kingdom’s gross domestic product (GDP). That figure exploded to a remarkable 45.53% in just 10 years. But David Cameron’s election as Prime Minister in May of this year sounded the final death knell of a tax-and-spend party in “Cool Brittania.”
Our group bandied about the details of the government’s cuts back and forth — 25% to 66% cuts in the Home Office, Ministry of Justice, the Department of the Environment and the Department for Communities and Local Government. The government also froze the salaries of public-sector workers for two years. With some elementary school teacher/administrators taking home 283,000 GBP ($447,000 last year) — a number that is on par with what an average Goldman Sachs employee is set to get this year — it was hard to shed crocodile tears for victims of austerity. And for all of the handwringing about government cuts — total government spending still will be 6% higher in nominal terms in 2014-2015.
The Canadian Model: The “Greece” of Its Day
What impressed me was how aware the British were of Canada’s experience 15 years ago, and how ready they were to learn from it. Meanwhile, I doubt more than a handful of U.S. Congressmen even are aware of what happened to our neighbors to the north.
In the mid 1990s, Canada was in worse shape than the United States. Government spending accounted for 53% of the economy. The country had lost its AAA-credit rating. A full 30% of its budget was going toward servicing interest costs. (The comparable interest-cost figure for the United States is 10%.) Canada’s debt-to-GDP ratio was a Belgium-like 120% — twice the current U.S. level. The Wall Street Journal called Canada “an honorary member of the Third World in the unmanageability of its debt problem.”
Yet in a few short years, Canada managed to engineer the most under-reported turnaround story among the world’s major economies. In 1995, Paul Martin, the finance minister for the national Liberal Party, prepared a budget that reduced program spending by 8.8% over two years. It reformed its welfare, “blank-check” system. Federal government employment fell by 14%.
The results of these reforms were nothing short of astonishing. The federal budget was balanced within three years. Federal debt was reduced to 45% of GDP. And instead of collapsing over the coming decade, Canada’s economy grew 3.3% per year — exceeding the developed-world average of 2.7%. And Canada never suffered from the sub-prime fiasco in the United States. Canadian banks were models of fiscal prudence.
The “Secret” of Economic Recovery: “Eat Less and Exercise,” Not “Magic Pills”
Austerity is a tough sell — especially if you want to get elected. After all, Keynesianism is a lot like a magic weight-loss pill. If it gives you a quick, painless and easy solution to your weight problem, why would you want to spend your time dieting and sweating in a gym?
The trouble is, magic pills never work as advertised. No pill ever really is going to replace good, old-fashioned diet and exercise — just like no amount of government stimulus can replace the pain of economic austerity. Like a hard work-out routine, austerity is painful in the short run. But if you want to get your economy back into shape, you can’t avoid it. Historically, countries willing to bite the bullet — like Canada and, to a lesser extent, Sweden — turned out to be among the most-resilient developed economies during the Great Recession.
Assuming the U.K. government sticks to its guns, that bodes well for both the British pound CurrencyShares British Pound Sterling Tr (FXB) and the U.K stock market iShares MSCI United Kingdom Index (EWU).
The bottom line? No country in history has ever taxed and spent its way to prosperity. It was good to see that my friends in the United Kingdom have stopped trying.
iShares MSCI Emerging Markets Index (EEM)
ProShares Ultra MSCI Emerging Markets (EET)
Last week, my friend Angelina, a leggy brunette and one of the world’s top hedge fund marketing gurus, was briefly back in London from her tax exile in Monaco. She called to invite me to a book launch party for “The Gathering Storm,” edited by Lee Robinson and Patrick Young. The book features a collection of essays on the global financial crisis by big-name hedge fund types. Of course, I said yes, as exclusive parties in the Mayfair section of London allow me to mingle and meet with the great and the good of the financial world, ranging from Goldman Sachs partners to the top traders at the world’s biggest hedge funds. And the insights from lively discussions with these otherwise publicity-shy Masters of the Universe over a glass of Veuve Clicquot champagne also have made both my subscribers and investors a lot of money.
High on the list of topics for these Mayfair millionaires was plotting their escape to Switzerland from the United Kingdom’s onerous tax system. But we also spent time swapping investment ideas, and the two words on everyone’s lips were “emerging markets.”
That did not surprise me. I’ve always felt that emerging markets were the place to be in the last quarter of the year. After all, when I was sitting on $1 billion-plus a decade or so ago, this was the time of year when we’d get together with my partners and — often over a “boozy” lunch — decide where we were going to place our bets on the planet in the coming year. That same process — repeated in Tokyo, San Francisco, New York and elsewhere — always gave global stocks a big boost in the last quarter of the year. That’s why it seems anything that I’ve recommended to my subscribers in emerging markets since late summer has shot straight up.
I managed to corner one prosperous-looking Swiss “hedgie,” sporting a pair of über-fashionable, square-rimmed glasses. Let’s call him the “gnome of Zurich.” In his clipped Swiss accent, he made his case for emerging markets. Unlike back in the 1990s, emerging markets today have debt-to-GDP ratios and budget deficits that put profligate, champagne-swilling Westerners like him to shame. And that doesn’t even account for the rainy-day fund they have in the form of $5 trillion in foreign-exchange reserves. No wonder emerging-market, equity-fund inflows hit a 33-month high of more than $6 billion just the previous week.
But there was one piece of news that the gnome was almost euphoric about — the one thing that he thought just might help him earn a bonus big enough in 2010 to buy that red Ferrari he’s had his eye on. Fed Chairman Ben Bernanke, running printing presses overtime for the U.S. dollar, has sparked a fire under emerging markets. And that, to the gnome, could mean nothing but blue skies ahead, as far as the eye can see.
Frankly, all of this boozy optimism has me a bit worried. The sovereign debt of Indonesia, a market I’ve long recommended in Global Stock Investor, now is barely considered riskier than that of boring old Belgium. Mexico, yes, the country that has claimed the lives of 29,000 people in a drug war just since 2005, recently issued 100-year bonds. If you have a hard time imagining what Mexico will look like in 2110, consider that 100 years ago, William Howard Taft was U.S. President, TV and penicillin had not yet been invented, and the globe had two world wars ahead of it.
Having lived through at least four emerging market booms and busts over the past 20 years, I agree with the gnome that investors are set to make a lot of money in emerging markets between now and the end of the year. I’m also sure that Ben Bernanke’s bubble-blowing experiment will end in tears… but just not yet.
Buttressing the gnome’s position, I pointed out that the MSCI Emerging Markets Index has more than doubled from its bear-market nadir in October 2008. The Chinese market alone would have to double to get back to where it was in 2007. But unlike, say, in the U.S. bond market, I’m not seeing silly valuations typical of a bubble. The MSCI Emerging Markets Index is on a forward price/earnings multiple of 11 — less than its 20-year average of 13.7. And earnings in the MSCI Emerging Markets Index will increase 28% in the next 12 months. That makes emerging markets a steal.
Upon hearing my onslaught of statistics, the gnome’s attention quickly wavered. He gave me a knowing smile, and slid past me to turn his attention to Anastasia, a Russian temptress of uncertain means, who had been ogling him from the other end of the bar.
As he left, he turned back and said, “My friend. Here’s a toast to your countryman, Mr. Bernanke. The end may be nigh. But for now, it’s time to party like it’s 1999.”