Please don’t misunderstand me, I am a red-blooded capitalist. I always have been and always will be. I believe completely in free markets (business and financial). But even by my standards, things are going too far and somehow, a new breed of capitalism in financial markets needs to be found.

Why?

This quote is taken from EurActiv on the lead story on 29th November, “Ireland will contribute 17.5 billion euros of its own cash and pension reserves towards the bank rescue.”

Pension reserves, eh? When did that start???

And then in this story by EurActiv, “In November, Hungary and Bulgaria came up with very similar policies that embarrassed those attempting to provide an EU-wide solution to budget accounting of the cost of pension reform.” and “The move raised eyebrows in the Commission as both countries decided to nationalise their pre-funded pension schemes, thus reducing both public deficit and debt calculated by the Maastricht criteria“. EurActiv continues, “Although pension fund savings are private property, the Hungarian government pre-empted any constitutional remedies by amending the constitution, just a few days before announcing the plan.”

This all seems rather reminiscent of the misdeeds of Robert Maxwell prior to his death. What did Maxwell do? Its complicated, but in short, he used the reserves of the private pension plan of the Mirror Group to prop up the price of shares in the company. When he died / drowned off his yacht, the charade was exposed as only he seemed to know what was going on. The company then really started to struggle and as the share price collapsed, pensioners in the company scheme saw the majority of their pension fund vanish.

Parts of this are similar to the collapse of Enron in the United States. As Enron collapsed, most employees had used wages and bonuses to purchase equity in the company and it then transpired that the company pension scheme owned a very large amount of company stock. The share price had in part been propped up by the buying of the pension scheme.

These acts were considered to be illegal. Luckily for the rest of society, they caused retirement issues for thousands of people, rather than millions of people. But it seems as though the financial crisis is causing European governments to up the stakes.

We all know that the demographics of Europe suggest that funding the retirements of millions of people – as we all live longer – is becoming harder and harder. We also know that most state pension schemes are very similar to Ponzi Schemes in nature. The phrase ‘pension fund’ is often applied poorly to state schemes. The vast majority have no fund. All the money that comes in via social security payments, then goes out in the form of benefits.

But if those that have some form of fund start to prop up their economy with the money, are we moving into the government sponsored worlds of Maxwell and Enron? This cannot be a good thing for the majority of society, can it?

If these actions were illegal and ruinous on a much smaller scale, what makes sensible and educated people think that they will work when scaled up to a national or continental level?

Obviously, there are differences. Propping up a share price is different to propping up an economy, but it still sounds very much like a misuse of funds.

EU Blogger, Michael Berendt, in his recent post highlights a few of the potential social problems. And in content from earlier in 2010, the European Economic and Social Committee held an entire event to investigate the social costs of the financial crisis.

My real question then, relates to moral hazard and to the fundamental nature of the euro currency. At what point is enough enough? At what point is something not worth saving? At what point is the cost of saving bankers and investors not worth paying? Who is deciding who ought to be saved and why? At what point is the cost of saving the economy of a nation not worth paying?

Bearing in mind that I am an investor (and I own some shares in a bank!) this is hard for me to ask. But ask we must.

When is the juice no longer worth the squeeze?

As if this all was not bad enough, there are a number of very sensible financial people (the FT has been quite vocal on this for example), suggesting that the cost of servicing the interest bill for Greece is unsustainable and that they will default. It is a matter of when and not if. The cost to Ireland of servicing their IMF and EU bailout bills may also be unsupportable.

These bailouts might simply be bankrupting nations, slowly sucking the blood from them, whilst we wait for their total financial collapse (as suggested about Ireland by Wolfgang Munchau in the Irish Times here). This would be terrible.

Even worse, I don’t think I have yet spoken to anyone that believes that these bailouts will work in theory. If people don’t have even that basic faith, what must the hedge fund managers with their billions looking for ‘opportunity’ be thinking? They must be rubbing their hands with glee at the thought of the tens of billions in profits that they will make over the next few years. That is ‘our’ (and German!) money. Bonus time anyone?

The often excellent blog, The Baseline Scenario, writes of The Eurozone Endgame and four alternative scenarios, including, “Third, there is the thoughtful view of Willem Buiter – currently chief economist at Citigroup and still a brilliant critic of the global financial system. In a presentation circulating last week (not publicly available), he predicts “three or more sovereign defaults in the next five years.” His logic is impeccable – once it is easier to restructure debts, the temptation is to do exactly that; the market knows this and so brings everything forward in time.”

And the ever present Nouriel Roubini is reported by Reuters as saying, “(A bailout) happened in Greece. It happened in Ireland, and it’s going to happen in Portugal,” Roubini told a conference in the Czech capital. “The question is whether it could happen in Spain. The official funds are not sufficient for also bailing out Spain.”

Needless to say, the Portugese goverment is now expressing confidence in their economy in the hope of dispersing the blood that has already dripped into the water and started to attract the sharks.

This is, of course, manna from heaven for the eurosceptic press, such as the Daily Express in the UK who lead on their frontpage on Tuesday with, “A bail-out agreed by Chancellor George Osborne means Britain could have to find billions of pounds more to help Portugal and other debt-laden countries such as Spain and Belgium if their economies need to be rescued, as some experts are predicting.”

Are we witnessing the beginning of the end of the European political and social model? And the creation of new generations of financially underprivileged people across Europe? Are we thrusting the current generation into poverty in their retirement years?

Are banks really this important?

Clearly, I am a financial buff, so loved the original and frankly, I enjoyed this follow up as well. It may not turn out to have quite the same impact on society as the first film did, but well worth the admission fee anyway. I watched the film with a female friend that has not seen the original and is no financial expert, and she enjoyed it lots as well. Highly recommended.

Once again Oliver Stone is trying to do something with a financial film. In this movie, Gordon Gekko has several opportunities to explain elements of the financial meltdown of 2008. One presumes that Stone has strong opinions on just how the world economy functions (or not as the case may be) and he uses the slimey charachter of Gekko to make his points. And what points they are!

If Gekko thinks things are rotten, how bad must they really be?

Gekko lays the blame on the collapse of the financial system on everyone. On all of our greed to want something for nothing and being willing to remortgage their homes for that right. This ‘greed’ and lazyness is highlighted by Susan Sarandon, playing the mother of another central character. She has moved from nursing into property speculation, is losing mountains of money, needs bailouts of her own and refuses to go back to work and get a ‘real job’.

Much of the firm centres around the events of 2008 and the fall of an investment bank that seems to share a remarkable number of similarities with Lehman Brothers. Meetings – now famous – held over the weekend as banks were unable to borrow and roll over their liabilities (thus facing instant bankruptcy) between the Fed and Wall Street big shots were eye-opening, even though they were shown as reported. Of course, the names had been changed to protect the guilty…

The film also contains some interesting pointers towards green and low carbon energy generation and away from ‘big oil’. Again, it isn’t difficult to spot Stone’s agenda.

Hopefully, this film will be able to get across some important elements of basic financial education to a very wide audience and in a powerful way. If you are a regular reader of financial blogs and columns, you won’t learn much. In that case, just enjoy the movie.

However, much of the content of the conference was dominated by the role of markets and the financial crisis. Many of the speakers had the financial pitfalls in mind when they spoke about the problems being faced by poorer members of society. (For a definition, please click here – social exclusion .)

There was one speaker though, Josep Borrell, that addressed the issue much more concretely. Mr Borrell is former President of the European Parliament, so I think it is safe to presume he has some knowledge and insight to be applied.

He described the influence of the markets and how they are able to dictate policy to governments – albeit indirectly. This power to influence, by devaluing a currency when the financial policies of a government are not liked, is something that he called the “negation of democracy”.

He also highlighted the terrible inconsistency of large financial organisations and their market behaviour. The ability to punish governments in the financial markets by selling currencies down, having just needed a bailout, and using the bailout money to do it, shows the problems we have with markets currently.

If you would like to hear more, get it from the man himself. I asked him to elaborate:

Both major parties seem to have been pre-campaigning on spending cuts, fiscal restraint and responsibility. But only one of the parties is in power and could actually be doing those things right now.

I suspect that the reason for New Labour being so slow to get the scissors out to public spending is political. If things are slow in the economy now, how much slower could they be if they used some restraint? Slashing budgets and spending over the preceeding 12 months would probably have made the recession even deeper and would not have helped their re-election prospects.

So the political imperative has been winning over the economic. For now.

But if the Conservative Party are elected with any level of majority, they will need to start wielding the scissors – and be seen to be doing so – immediately. This could easily be the start of the next ‘leg’ down in this recession. With public sector borrowing so high, this needs to have started months ago, but better late than never.

This might sound ‘doom and gloom’ of me, but the prospect of a devaluation of sterling, substantially increased inflation or a full-blown default on sovereign debts are not that unreal. Somehow, the UK needs to start dealing with it’s huge financial deficit before things are too late. They might be too late already, but there probably still is time to act and have a meaningful influence.

The real problem scenario lies in a hung parliament. If that were the case, the Liberal Democrats would suddenly become the most important people in town!

Broadly speaking, I quite support the occassional hung parliament. One problem with government – to my own slightly libertarian eyes – is that it always feels the need to act. But often times, doing nothing would probably be just as effective. The level of action is merely to give the impression of being vital and to justify an existence.

So when a hung parliament slows down the level of action, that can be a good thing for individual liberties and responsibilities.

However, at a time like now, a hung parliament would be a financial disaster for the UK. The one silver lining would be that Vince Cable would be propelled into a front bench position. Otherwise, any delay on financial restraint could be crippling in the long-term.

What are your thoughts? Do you have any insight into how bad the UK economy really is?

The event had an excellent array of speakers. Hosted by HRH Princess Laurentien of the Netherlands were European Commissioner for the Environment Janez Potočnik, Jo Leinen MEP, Pavan Sukhdev and others.

The TEEB project offers a fascinating insight into the “value” of nature and biodiversity. Needless to say, we humans have ignored or not even considered the economic value of the world around us. As Mr Sukhdev says, we make economic decisions with much relevant information missing. In short, without considering the full cost over a cycle of our actions, we make poor decisions.

This means that while in the short-term, we may make rational decisions (to fish in a certain area, fell trees, farm one crop ahead of another, etc) based on which action brings a greater economic value, the long-term impact may mean that we are making a poor decision. For example, over fishing generally means that fish stocks reduce, thus generating smaller and smaller catches in the future.

The event made me think a little about what a huge decision making fault this clearly is of human-kind. Any sort of understanding of the financial crisis in 2008 shows just how rational short-term decisions can lead to unintended (or ignored) long-term consequences.

By lending money now to people with no jobs and / or income, a large commission can be generated. Woohoo!! We all love large commissions!! But by doing this, we cause financial pain for the borrowers, add risk to the mortgage book, slightly weaken the overall state of the national economy and (via slicing and dicing) manage to weaken investment funds and pension portfolios around the world. Each decision in the chain was rational with a short or medium perspective, but clearly questionable over the long-term.

But hey, we love that commission payment!

And so it seems that we do exactly the same when it comes to our use of the environment. Lets be honest, we knew that anyway, we just had not had it quantified before. Every time a car engine is switched on, or a tree is felled, or, or, or, we cause a tiny little bit of damage. This damage has no immediate economic cost to us, so we ignore it. Hey, it was free!

But with climate change becoming a very serious issue for many tens and hundreds of millions of people right now, that economic cost is becoming more visible and relevant by the day.

Can you give more thought to the full cost of decisions in the future? It is difficult, but we all need to try.

Perhaps once a month, when it is time to set interest rates, people remember faintly who you are and what you do. But things are so good that don’t even need to change interest rates for months at a time.

Life is good.

Then things go wrong. Your knowledge needs to be used to fix an economy. You need to prevent a recession. There aren’t many of you and yet you are there to hold back the tide of the global economy. Suddenly, you have the weight of the world on your shoulders and your ideas need to work. They were only theoretical before…

Now you need to try and explain words like ‘Quantitative easing’ to a sceptical public. Uh-oh. Trying to tell the world that fixing an economy with too much borrowed money by borrowing a much larger amount can’t be easy. It is like a pilot telling air passengers that this turbulence is normal. You hope, you want to believe, but you are still scared by it.

That Greenspan fella had it right. Get to the top. Stay there. Watch the bull market run and run. The world loves you. Then, see the problems coming on the horizon and retire quick!

Smart guy.

These days there are stories like this one about Greece and how it may – or may not – need a bailout in the news. Or whether Greece was helped by Goldman Sachs with fair means or foul.

Jumping in to rescue a bank is one thing, but a country? And the stakes are high! This isn’t about saving Greece. I doubt there are many European Finance Ministers that give a fig about the Greek economy. Their main interest will be in a nice summer holiday in Crete, not salvaging a nation. They have their own problems to ponder upon. No, instead, they are worried about the potential for the euro to become unstitched and the impact that will have on their own position.

Then there is Portugal, Ireland and Spain. Then Britain! Fixing this little lot won’t be easy. Can we all rely on the German economy? We don’t need a Central Banker, we need Superman!

Will the euro survive this? Or will other weak economies (the UK?) be forced to join for safety in numbers?

It seems that the biggest beneficiary has been Scotland. I’m not going to go along with the conspiracy theorists that charge two Scottish Chancellors of the Exchequor of expanding their financial pie to secure votes at election time. But it is easy to see why such theories exist.

It is clear that the policy works however.

Your author has been to Scotland about 10 times, with another trip due this summer, and the transformation is clear. Glasgow is now a great place to visit with lots going on, great shopping, bars and clubs and a modern and cosmopolitan feel. Contrast that with the Glasgow of the 1980s! Finding links from the 80s isn’t easy, so instead I offer this link and picture as my poor attempt at proof. Needless to say, the Glasgow of the mid 1980s was a very barren place.

The Scottish economy isn’t the most well diversified on earth. At least not to the poorly informed naked-eye of a tourist like me. Now that North Sea Oil is slowing down, tourism and agriculture appear to be the mainstays. Well, that isn’t quite true or fair. Edinburgh has a financial services industry of some note. And Glasgow now has a number of call centres for nationwide UK companies.

But somehow, somewhere – and it seems reasonable to presume that the NHS and education are the locations – taxpayers money is really being spent. This post from the SNP in December is trying to highlight just how badly impacted Scotland would be if the Conservative spending cuts were implemented.

But the recent news ( here on the BBC ) suggests that there will be significant cuts in public sector positions in 2010. With public debts rising out of control, changes are inevitable – so inevitable that even President Sarkozy is having to discuss pension reform with the unions! – but the outcome of the changes may be felt much more in some places than in others, making this recession much deeper in these areas.

My fingers are crossed that Scotland fares well. But I fear that my finger crossing may not be enough.

Well the story explains a little of the real numbers. As we must all have – at a minimum – suspected by now, governments have a habit of reporting nmumbers in the best possible light. With inflation we have RPI, RPIX, ‘Core’ rates and more. Over time, the subtle changes in methods of calculations make these numbers meaningless to most of us. This post by Greg Hunter suggests that US inflation – if calculated using the same method as in 1980, it wouldn’t be 2.7% but 9.7%.

Well it is the same with US jobless numbers. As you will see from the story, and from Greg Hunter’s post, the real number is likely to be much higher. The BBC thinks more like 17%, while Hunter (via shadowstats.com) thinks 21.9%.

(It is worth pointing out that while some statistics may change in the level of their importance, when they were first invented, it was with a reason. That reason was to measure something. It seems reasonable to presume that they were invented to measure that thing as accurately as possible. Therefore, most changes probably reduce the ability of the numbers to measure accurately. So when something is compared to the (for example) 1980 method, that method is probably a much purer reflection of the underlying number. End of rant.)

It is numbers like this that will ensure that public sector debt is stubbornly difficult to reduce and that this will be a very long recession.

There are two factors that make such statistics really meaningful. Firstly, we all know just how important the US economy is to the global economy. The longer and deeper this recession lasts for America, the longer and deeper it will be for all of us. This will not be easy to shift.

Secondly, there are many developed nations that ‘massage’ their economic statistics like this. If I happened to speak several languages and read several different nations major newspapers each day, I could probably quote similar situations in many European nations. But I don’t so I can’t. But there have certainly been changes to the way numbers are calculated in the UK.

How we – and I include government – are meant to deal with the debts of the world and this economic crisis if we don’t really understand how bad the problem is, I have no idea. Confronting the problem is the first step in dealing with it. But still, around 2 years in, we are unable to see the real numbers. It seems that we are still hiding behind lies and statistics.

The first major shot in what will probably become a global political war to reduce deficits has been fired. President Obama has announced a new budget which contains cuts to many areas. While the obviousness of reducing debt levels is hard to deny, personal and corporate interest will create mass cries of ‘not this’ to many of the proposed reductions.

The fact that President Bush’s proposals to get NASA really moving again are for the chop is being criticised, for example. It is hard to deny that no further space flight can be seen as a disappointment. But really, when you are forecast to owe US$1.56 trillion, do you really need to send Man back to the Moon? Aren’t there more important things to do with the money?

To make this seem a little more real, an example would be a family on the verge of bankruptcy, with a massive mortgage and other unsustainable debts. The husband has just been asked to take a pay cut by his employer and to celebrate, he bought a Porsche!

If your neighbour were in such a situation, you would – rightly – blame them for their financial demise. When they ought to be switching off the cable channels and looking for additional part-time work, they are spending big money on an unaffordable luxury.

Is it really so much different on a national level?

But this is the easy end of the scale. With such high national debts, there will be many more important projects that will need to be cut. In time, a couple of years perhaps, there will be medical projects, childcare, road safety and much more that will be dumped to stave off national bankruptcy. This will be happening in many Western democracies.

And in those same democracies, there will be political argument after political argument.

Of course, this will all be very tough for private investment. When state plans change, so will personal circumstances – possibly removing vital capital from stock markets – leading to knock on effects in areas I dare not try to forsee.

This is – to my mind – the real start of the hang-over after the party. So far, we have simply been getting home to bed. But the spiral down of reduced spending from governments, causing reduced spending from corporations and the public, leading to further reduced spending from all three will take a long time to balance. Just as the party was pushed upwards by ever increasing public sector spending – based in large part on borrowing – the recession will be exacerbated by it.

Hold on to your hats…

In a blog post from Davos, the Beeb’s Robert Peston discusses the thoughts of some of the world’s top bankers about the state of things now.

It seems that these guys agree with the opinions recently alluded to in this blog in this post about Public Sector Debt and this one about my estimates for the length of this recession.

I’d like to bring your attention to points 1 and 2. “prospects are particularly poor for the heavily indebted economies of the west” and “a meaningful risk of sovereign debt crises in economies with large and rising deficits“.

Why do I do this?

Because I am mean and like to write depressing things? Because I like poking fun at politicians and their lies? Because I like to delude myself that I understand economics?

Well, yes, all of those. Of course!

But this blog is aimed and written for investors. To be an investor – especially a successful one – requires a mindset that is realistic and sees the world as it most likely is.

Making poor judgements about economic conditions or business and market reality will most likely lead to buying the wrong asset or company and – sooner or later – losing money.

Therefore, we need to see the reality. And the reality is that more and more of the people that really ought to know, are starting to say that this will be a very long recession.

It is almost a year ago that I was involved in interviewing Paul Krugman where he called it ‘The Mother of all Recessions’. Despite being a Nobel Prize winning economist, the tide was against him – as he has published a book about depressions (a clear bias). But now the world is agreeing more and more with him.

In between then and now, just about every politician in the world has seen ‘green shoots of recovery’, ‘an end in sight’ and all sorts of other hopeful things. They can’t really say much else, of course. But as an investor, it is our job to see through the smoke and past the mirrors to get to the underlying reality.

What is that underlying reality?

It seems clear – at least to this amateur economist – that real GDP growth in major economies will be hard to find and that this recession will last and last. It also seems clear that we as investors need to think very deeply about how to best manage our finances. In a world where either inflation or deflation takes hold, the correct decisions will make or break family finances.

The low interest rate ’stimulus’ environment ought to have a finite lifespan and has probably built something of a bubble in stock markets. When cash on deposit earns less than 1% pa gross, why keep money in the bank? When governments are borrowing like a drunken Admiral, why buy or hold bonds? That, in combination with quantitative easing (I suspect) has pushed money into global markets when the majority ought to be selling.

We all need to be thinking deeply and clearly about our financial positions right now.