Article

Weak currencies and over-borrowed sovereigns

April 15, 2010

After the binge comes the hangover. The Greeks have been feeling the after effects of too much borrowing, like the Irish, Icelandics and Balt Republics before them. This week the Euroland partners have rallied round and made a significant concession - they will act as a last resort lender to the Greeks, at subsidised rates of interest, if the markets will not cough up. This may be good news in the short term for holders of Greek debt and for the Euro. In the longer term it sets a dangerous precedent, that Euroland will put up with bad financial behaviour, and will subsdise a country that cannot keep its deficit under control and its financial housekeeping in order.

In the race to the bottom that we have often referred to in the currency markets, the Greek crisis has taken a little upward pressure off the Euro, weakening the currency as many of its exporters hoped. Meanwhile the pound is experiencing a modest recovery, following the large and early devaluation the British authorities supervised in recent months. Sterling started to rally because the other currencies were more in the firing line, and in the hope that any winner of the General Election would start to cut spending. When poor input and output price inflation figures came out last week the pound rallied further, with markets arguing the bad inflation prospect heralded earlier interest rate rises! Bad news was welcomed. Markets on balance seem to expect a Conservative victory at the polls, as do the bookies by a narrow margin, and assume the Conservatives would cut more and earlier to control the deficit.

The truth is that the political outcome of the election is not assured. Most polls and pundits point to the possibility of no overall majority for any party, though all seem to agree the Conservatives will win most seats and Labour will lose a lot of seats. No party is setting out how they will make large cuts in public spending to get the deficit under control. Labour, in government, have delayed a proper spending review until after the Election and have declined to publish the usual detailed analysis department by department of future spending plans. The Conservatives and the Lib Dems have followed suit, saying that if the government with access to all the information cannot say then why should they without such access?

The UK election will be more Presidential than previous ones, owing to the introduction of three Leaders' debates for the Leaders of 3 of the parties. These will give the third party Leader a bigger platform and more publicity than normal. The third party has in the past come third in General Elections, but came fourth in the most recent European election. The debates allow the third party to be a critic and commentator on the other two, more able to escape criticism as few think it at all likely the Leader of the Third party could become Prime Minister. In the debate of the "3 Chancellors" (wannabe Finance Ministers) many said the third party rep did best, because he could pick when to criticise the two main contenders, but no-one bothered to ask him much about whether his policies added up. If the two main parties do not work out how to handle the Third party participant, it could boost the chances of that party which is in effect campaigning for no party to have a majority, so they can be the power brokers. This adds more uncertainty to the situation.

At EPA in such circumstances we say keep it simple. The simple truth is the election delays making the adjustments the UK economy and bond markets need. Whoever wins has a simple choice - do enough quickly enough to prevent a Greek or Irish style crisis, or sit back and play more politics and let the markets drive their destiny. We remain of the view that there are better ways of investing money than buying UK government bonds. We have adopted a more neutral stance on UK equities in recent weeks, bearing in mind the dominance of overseas turnover and profits in the major companies.

The UK still has further to go in bringing public spending under control, and is living through a sharp decline in living standards following a long period of living beyond its means.