29 Mar 2020
On the 23rd of February I published these seemingly prophetic words.
SPLENDID ISOLATION
Another idea that we are rowing back from is internationalism. To put it another way, nationalism appears to be on the rise wherever you look. A better word might be insularity because this is not primarily about xenophobia. It is mostly an economic phenomenon again. For some reason we don’t really care about global poverty half as much as we care about global warming.
Of course I didn’t have the slightest idea of what was about to happen. So sadly this blog is not a description of how I moved all my assets into cash and am now reinvesting at a 30% discount.
While the world appears to have been turned upside down in the last four weeks, people everywhere were very already receptive to turning their backs on the rest of the world. And I was too kind when I downplayed the role of xenophobia. Every country seems to want to lie in its own dirt now and in many countries’ foreigners are regarded with suspicion or even hostility.
I am absolutely not referring to the UK, which is a highly diverse and generally welcoming country, but rather to more monocultural nations. I was in Sri Lanka last week just as the country started to go into lock down. Sri Lankans are and were almost uniformly delightful but when I found myself on a crowded bus with many people standing and the seat next to me vacant, no one wanted to sit next to the white man.
There are reports that African countries are wary of Europeans and Mexicans are demanding to be protected from US citizens.
Here is a comment found on Twitter:
Today on my final reporting trip in China, my colleague and I are eating when a man walks up: “You foreign trash. Foreign trash! What are you doing in my country? And you, with him, you bitch.” I think he wanted to fight, but we stayed silent and let him rant. Quite the farewell.
Poland closed its borders, causing huge disruption to citizens of Baltic states trying to get home. Given how many Poles work abroad, you might have thought that it would make medical sense for Poland to tell them to stay where they were, assuming it really believes that other countries are swarming with virus.
Whether free movement of EU citizens will survive this, remains to be seen (though as far as I know they will still be welcome in the UK).
MAKE ANYWHERE GREAT AGAIN
It may or may not be a coincidence that the world is starting to look as if it is influenced by the instincts of Donald Trump. He wants goods sold in the US to be produced in the US. Now, many countries are wondering if their supply chains are too widespread and unreliable.
This will be exacerbated by the shocking spike in unemployment that the lockdown tactics are causing. Until the report on 26th March 2020, the highest number of initial jobless claims in a single week in the US had been 685,000 in 1982 – that record has been more than shattered with nearly 3.3 million in the week to 21st March. Watch out for a new record next Thursday.
Local sourcing chimes with some environmental demands due to reduced transport distances and a possible return to eating local seasonal produce (a nice thought but I’ll believe it when I see it). It also implies that consumers will be forced to pay higher prices (because sourcing from abroad is usually price driven). This is an uncomfortable thought in view of the sharp recession (or depression) that is being imposed on us.
WHATEVER IT TAKES AWAY
The likely most important investment-sensitive issue is the proposed explosion in government spending. The usual question of how we are going to pay for it receives the usual glib answer – future generations will foot the bill. But there may be much more to say than that.
When the government issues debt someone or something has to buy it. Many people have become used to the idea that the Bank of England will expand QE and be the buyer of last resort. How very agreeable of the Old Lady of Threadneedle Street.
We need to remember that the independence of the Bank of England is really just an organisational definition. Ultimately it is a government department. As a funding process, it is basically the government issuing debt by selling it to itself. If you have been wondering what printing money looks like, here it is.
In economic terms, this or something like it is called Modern Monetary Theory. The positive spin says that a government, having bought its own debt, cannot default on itself. This is technically true as long as all transactions are in a currency that the government itself controls. If, for some rather easily imaginable reason, foreigners become unwilling to accept this currency in settlement of transactions, the solids will begin to bob towards the cooling unit.
DEVALUE-NATION
In order to buy stuff from foreigners, we will need to pay them in their own currency. To do that, we will need to buy their currency. The value of our currency, relative to theirs, will probably decline. Note that this can only happen because we have our own currency. If a Euro area country tries to spend and borrow with abandon, we know what happens – it turns into Greece.
The US is also different from us because the US dollar remains the world’s reserve currency for international transactions. It will be a long, long time before the rest of the world decides that it can do without the dollar.
But nobody needs to hold or accept sterling. This is the real looming cost of Rishi Sunak’s “whatever it takes” rescue package, for which, I notice, he is receiving almost unanimous five star reviews.
This is the path to devaluation (which has arguably already begun) after which inflation will swiftly follow. Unfortunately, it is highly probable that a government already committed to printing money will print more.
Meanwhile, as foreign goods become more expensive, we will again be motivated to produce more at home. As already mentioned, this is likely to push prices up. The supply of domestic produce is likely to be more limited than the supply of money.
AND IN OTHER NEWS
Most companies appear to be suspending dividend payments as they try to sit out the existential economic crisis. This is entirely understandable but it is terrible news for baby boomers (remember them?) Many retired people rely heavily on dividend income and the yet to retire will be seeing the value of their pensions plummet.
What to do? For many, their house is supposedly their pension (though the property market is currently suspended – a handy reminder that there is sometimes a reason why illiquid assets should trade at a discount). I have written before about the demographic pressure on the property market.
(This is not important now but I wrote seven years ago expressing my horror that companies were starting to buy back their own shares again. Is there any chance that these irresponsible vanity projects could be irretrievably consigned to history?)
AND NOW THE BAD NEWS
The coronavirus is 95% of the national news as I write and of that 95% is about how many people are going to die. The fact that we are entering what may well be the greatest economic collapse of anyone’s lifetime seems to be being overlooked, perhaps on grounds of taste but more likely because it is not widely understood.
It is critical to appreciate that most companies are measuring their chances of survival against a suspension of business of unknown duration. Even if the government supports all of them, there is no guarantee that their equity will survive. Remember that all creditors have priority over equity holders. If, as has been suggested with airlines, the government invests in return for an equity stake, it is probable that existing shareholders will be terribly diluted.
In short, when looking at individual share price charts, look down not up. And if you can, analyse balance sheets, debt durations and cash burn.
There are few ways of defending against devaluation and inflation. Holding sterling cash ceases to be prudent and becomes extremely reckless. Holding shares is better, subject to the caveat mentioned above. More importantly, as sterling-based investors we should be looking to invest in assets denominated in other currencies. At the front of the grid is the US dollar, despite the probability that the lack of tough decisions means that the USA may turn into the coronavirus centre of the world.
Another traditionally popular investment is property. This seems counter-intuitive at present due to the high age profile of most homeowners. But the lemming-like residential building plans of recent years may be about to be curtailed, not least because nearly everyone is going to be feeling poorer. And if you combine a buyers’ market with the possibility of fixing a mortgage rate for a decent period, you have a chance of making a trade that you can entertain dinner party guests with for years.
For every month that the virus lock down lasts, the economic consequences are likely to be measured in years (at best, possibly – I nearly wrote “week” instead of “month). Risks are always opportunities in some way, but if you are waiting for a return to economic normality, you could be waiting a long, long time. I’m really sorry to have to point this while there is already more than enough distress to go around.