On the Cliffs of Marble

When I left France for the US in 1972, as it turned out never to come back, I packed a poster of the north wall of the Eiger and a copy of my favorite book of all times: Ernst Jünger “ Sur les Falaises de Marbre”[1].

This extraordinary book recalls the last days in an imaginary land before its invasion and destruction at the hands of the Great Forester, a cunning and ruthless tyrant who lived in the vast forests nearby.  Jünger started his book while staying in a small town on the shore of Lake Constance.  Years later while on a vacation, I visited picturesque Meersburg and Lindau, drove through the rolling hills behind Hagnau and watched the sun set over the snowy peaks of the Alps beyond the shimmering lake, and memories of the book and its magic rushed back to my mind.

Some have said it was a criticism of Stalinism, others of Nazism.  It certainly was a paean to freedom, to what makes life in harmony with friends, neighbors and nature so precious, and how quickly we can lose these and how painful it then is.

I don’t believe that we are living on the banks of Jünger’s vast Marina.  But I do feel that we are in danger of slipping into a period of greater tension, greater division and failure to address our most pressing problems.  Before too long, and unless we regain our senses, the time for a Great Forester could arrive.

For many reasons, we are left with four candidates to the presidency: a populist and demagogue and Forester apprentice, an aging career politician with truth telling issues, an ex pot entrepreneur, and an activist who spray-paints bulldozers of companies she disapproves of (sadly, the Democrat, Republican and Green VP candidates are probably better than the top of their tickets).

It is difficult to imagine how any of these candidates could unite the country.  Hillary Clinton is probably the one more likely to try and build consensus because she is the one who most lacks a committed base, but can she bridge the trust gap?

Meanwhile, Americans are more divided than they have been in decades.  It is both ironic and sad that they were most united when President Obama took office in 2008.  Responsibility for this can be spread wide, and because of that, redemption will be hard to reach: Tea Party extremists unwilling to compromise, main stream Republicans unable to deal with them and the opposition, Democrats in Congress and the White House enamored with diktat and income redistribution without GDP growth; most of all, politicians deaf to popular angst and aspirations.

Against this dreary political background, the economy and the financial markets have been operating with a high degree of wariness, where extreme monetary policies have attempted to offset the absence of fiscal reforms and pro-growth policies.  The fix has carried increasing risks: financial assets are overpriced, public pension funds are hugely under water, the insurance industry is at risk and even consumption is threatened by the need for households to save more when 10 year Treasurys yield a meager 1.7% p.a.  

So we have a divided political class, a divided nation, a subpar economy and stretched financial markets.  I might add that the same combination of slow growth and excessive indebtedness is pressuring governments and traditional parties and giving openings to populists of all kinds around the world.

As an investor, I would think that prudence is in order.  Sure, stocks are not as expensive as bonds, but does that make them attractive, as a class?  Not really.  There is nothing wrong in keeping stocks of steady performing companies, or in buying into carefully chosen turnarounds.  But if one keeps a large exposure to equities, buying some protection seems advisable to me.

Alternatively, cash does look like a good temporary alternative.  Another one is real estate.

History shows that people and countries don’t change until they have to.  In America, I don’t think we have reached that point, nor do I see anyone able to mobilize the nation.  History has also shown that it takes time for a large country or economy to change direction.       

Caveat emptor!

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[1] On the Marble Cliffs.

A flash in the sky

65 million years ago, the dinosaurs ruled the earth. No other specie could compete in diversity, dominance nor offer surer prospects for more of the same for eons to come. And then, suddenly, they were gone. A catastrophic event, perhaps a large asteroid crashing into the sea off the coast of Yucatan. The world would never be the same after that.

For decades, macroeconomic management in western economies was carried out through the competing and complementary efforts of business practitioners (mostly ex-bankers) and economists. The final arbitrages were made by elected politicians.

This balance of influences served us well. “New” ideas were thoroughly debated between theoreticians and practitioners, with the most toxic ones being filtered out. This didn’t prevent preeminent economists like Paul Volcker or bankers like Robert Rubin from making key positive contributions to the economy.

But then came the financial crisis of 2008 and the ensuing Great Recession, and the banker specie became extinct, figuratively speaking.  (Investment) bankers[1] had been playing with fire, resorting to dizzying debt leverage, funding huge quantities of dodgy mortgage loans with overnight funding, betting on derivatives without properly hedging themselves, and the list goes on.

In truth, bankers were not the only ones responsible for the crisis, but they were the richest, they were politically tone deaf and they were the ones standing among the ruins. Politicians were equally despised, but since they couldn't be fired, knew how to quickly blame somebody else, and fake compassion by writing new regulations and imposing huge fines on bank shareholders to atone for the sins of bank executives, they survived.

The economists were neither rich nor elected, and they had two hands (“on the one hand…on the other hand..”). And so the new era of the homo economicus began.

Unchecked, unchallenged, economists rose to the status of doers, saviors, and seers. They were empowered to carry out real life experiments on a massive scale and test their theories in the real world.

The last act of the banker/economist tandem (Paulson/Bernanke) of opening the liquidity spigot and forcing a massive recapitalization of the banking sector was appropriate at the time.

But subsequent and continuing experiments in printing huge amounts of money, forcing interest rates down to zero and even below, and in having central banks buy hundreds of billions of shaky sovereign and corporate bonds have hardly been conducive to inspiring confidence.

Under such altered financial states, home owners may see their equity go up (because of rock bottom capitalization rates), but they also see their investment income collapse to a trickle.  Not likely to encourage splurging.

Working people, if they pay attention, worry that their pension plans are way behind in building up the kind of retirement assets they will need later in life.  In all, some five trillion dollars in public and private US pension plans are affected.  It is even worse in Europe.

While governments have taken tens of trillions in new debt, they expect their national currencies to weaken just enough to facilitate exports but not enough to trigger capital flight.  Good luck with that.  And whose currency is appreciating to soak all these exports?

The current economists’ bold plans remind me of the Collor Plan in Brazil, back in the early 1990s.  One of its key measures to crush inflation was to drastically reduce demand by freezing financial assets.  All of a sudden, households couldn’t touch their investment accounts, could only withdraw US$600 from their savings accounts and up to 20% of their interest-bearing checking accounts!  That monetary freeze was to last six months!  And ultimately the frozen money would only have limited use.

Debasing the currency, targeting private savings, encouraging excessive risk taking may help balancing some equations on paper, but they destroy confidence, and without confidence there is no economic growth.

In fairness to economists, bickering politicians had left monetary policy as the avenue of last resort. But the adepts of the Dismal Science didn’t need much encouragement.

And now these sorcerer’s apprentices must undo their clever constructs, like Disney eponymous character.  I may be wrong, but the reign of the economists is unlikely to challenge that of the dinosaurs.

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[1]  By and large, the most egregious excesses were committed b investment bankers, but some commercial bankers joined the fray.

Revisiting privatizations

Over the course of last year and this year, I have advocated that European countries facing excessive indebtedness and sub-par growth should consider selling public assets.  In the case of Greece, I noted in 2011 that ex-ECB board member, Juergen Stark, had estimated Greek public assets available for sale at around €300 billion; this was to be compared with a national GDP of €240 billion and an overall sovereign debt of €320 billion.

I also advocated the same course of action for others, such as Italy, Spain and France.  The benefits of such a policy would be to increase overall economic efficiency and to raise funds to reduce national debt.  It could also help develop a large and stable pool of savings for future retirees.

I also noted that the best example of what this policy could yield was the Chilean experience in the 1980s.  This is one in which I was closely involved as a banker and investor.  Back then, Chile received no outside financial help, in stark contrast to the current European situation.  Yet, thanks to well conceived debt-to-equity and debt prepayment programs, it managed to reduce its external commercial debt by one third without alienating international markets.

Therefore I was happy to read an interview of Mexican billionaire Carlos Slim in which he too advocated the sale of public assets as a necessary although not sufficient condition to get European economies back on track.

Countries are often reluctant to part with public assets, for very human reasons:

1.      Bureaucrats will lose a sinecure and a power base while employees may see their benefits cut back and even be terminated;

2.      Selling assets during a crisis is bound to bring less than optimal prices;

3.      Deep pocketed foreigners will take advantage of their momentary weakness to take control of national assets;

4.      Public services, once privatized, will be rationalized, resulting in higher tariffs and smaller geographic coverage.

 Indeed, reducing bureaucracy is one of the benefits of privatization.  In many instances, public employee benefits are far more generous than those accruing in the private sector, and the difference represents a subsidy which is unfairly borne by the latter and should be eliminated.  Privatizations often result in job cuts, but the resulting hardship can be controlled and reduced with compensatory and retraining policies and by the opening of new private job opportunities in a resurgent economy.

It is obvious that, at least in the beginning, public assets will be sold at depressed prices, but getting optimum prices is not the name of the game, putting the economy back on track is.  Besides, the cost of a weak economy with a depressed job market is far higher than the money left on the table, so to speak, by selling assets early.  And experience in Brazil and Chile has shown that, if privatizations are accompanied by sound fiscal and economic policies, markets soon adjust and subsequent asset sales command higher prices.

Rich multinationals or vulture funds are often the bugaboos that discourage countries from privatizing.  The reality is that it all depends on how privatizations are structured.  In Chile, most privatizated companies were bought by local entities, sometimes operators, sometimes financiers, sometimes by consortia which included local pension funds; in the case of the largest privatizations, special financing was made available so that local households could buy into blocks of shares that had been reserved for them (the so called capitalismo popular).  In Mexico, it is worth remembering that the largest privatization was won by a consortium of Mexican, American and French interests led by Mr. Carlos Slim who retained effective control.  I might also add that, in my experience, foreigners who have bought local companies on the cheap in times of great national stress end up paying a fair price over time, as governments find ways to extract more money or consideration from them.   One can only look at the electric utility sector in Brazil where the current government is trying to force through a new tariff regimen.

One large and apolitical source of funds to tap in order privatize public assets would be national pension funds.  These were instrumental in similar projects in Latin America and some Nordic countries.  Unfortunately, countries such as France, Italy and Spain largely rely on pay-as-you-go pension schemes, and their pension funds control very small pools of funds (0.2%, 4.6% and 7.9% of GDP respectively).   By contrast, pension funds in countries such as Chile (67%), Finland (82%) and the Netherlands (135%) are much larger and offer far more strategic flexibility.  It would be highly controversial in France in particular, but just imagine if it had a pension pool of 1 trillion euros!  If Italy had €900 billions and Spain €600 billion!  Such funds would dwarf the much maligned hedge funds and vulture investors; they would also match their long term investment horizons with the government desire to find stable institutional investors.

Finally, there is the fear that privatized public services will no longer serve the public, or that tariffs will be raised too high.  With sound regulations, the former concern can be allayed.  The real question is whether essential services should be subsidized, and if so how, or not.  If a country decides that the provider of such services should subsidize them, then privatization may not be appropriate.  Witness the continuing frictions between Telmex and the Mexican government on this issue, or worse, the case of the energy sector in Argentina or even EDF in France.  Countries can’t have it both ways: they can’t privatize and then control prices.  Ultimately though, tariffs may initially increase and then gradually decrease as most of the efficiency gains are passed on to customers.

The current debate in Europe has little chance of bringing about a workable solution to the prevailing financial and fiscal problems:  drastic austerity, be it via spending cuts or tax increases, cannot work because it is socially and politically unacceptable; fast growth is unrealistic because, in the absence of other measures, it is equivalent to Northern member countries subsidizing their Southern fellow members and cosigning their debts.

Austerity is necessary, but its focus should be a combination of shrinking the public sector and making the economy more efficient.  Privatizing public enterprises should be the key driver of this effort.

Growth based on EU subsidies and wealth transfers is a non starter; but growth based on a leaner, more flexible private sector is possible and sustainable.  Indeed, examples of this are easy to find in recent history.  Part of the privatizations proceeds should be earmarked to retrain downsized employees and to help them bridge a conversion period leading to new jobs in the private sector.

Finally, privatizations are essential to reduce sovereign debts in a manner which doesn’t disrupt markets, encourages new investments and keeps financing costs affordable.

At the end of the day, return to fundamental financial equilibrium and economic growth is possible but no single silver bullet exists that will do it all.  Rather, European democracies will need to find a workable balance of some austerity, some tax increases, gains in efficiency and delayed but better quality growth.  To that end, a broad privatization program is essential to help achieve many of these goals in a sustainable and socially acceptable way.  It would also provide the opportunity to establish a modern and potent retirement pension fund industry.