Whatever next?

Do recent market falls and the economic outlook leave investors with nowhere to run and nowhere to hide?.

Like many others, I suspect, I am inclined to despair at the Stock Market, which has gone precisely nowhere in the ten years since I shuffled off the employment scene and topped up my equity holdings with my tax free cash. Desperate for any sort of good news, I hung on every word from a chap on Bloomberg, who said that the 20 years up to 1990 had been really good, and that after this long pause equity returns would revert to their longer term trend: six or seven per cent per annum.

All well and good, except that some of us won’t be here in the long term. And, of course, the future may not be like the past. In any event, if you come out of the equity market, where do you put the cash? If we’d all bought gold at under $400 an ounce we’d be sitting pretty, but we didn’t and we aren’t.

The economic outlook, globally and domestically, is not very sunny, and many of the problems seem to be associated with a striking weakness in our western democracies. Voters want better public services, and they don’t want to pay more tax. Politicians get elected by promising the people what they want.

So the politicians get power, spend the proceeds of the taxes, find that they’d like to spend more, and borrow so that they can, as Gordon Brown was fond of saying “invest in our public services”. The growing public debt doesn’t matter, because it won’t hit the hustings at the next election. But the public finances become less resilient.

In theory, faced with an economic shock, Governments can use monetary policy. They can lower interest rates. Or they can use fiscal policy. They can lower taxes. Or they can spend big on public works. They have to borrow a bit to tide them over, but the increased spending power in the economy creates the growth that increases the tax take that pays off the extra borrowing. Or they can grit their teeth and actually cut public spending.

Even before the last election, it was fairly clear that none of these options was a runner. Interest rates were at rock bottom and public borrowing was already sky high. And you couldn’t get elected even if you promised to maintain the funding of the three so called National Health Services (or is it four, I’m not sure how it works in Northern Ireland).

So public spending continues to increase, in nominal terms. Public debt therefore continues to increase. With a fair wind, in four years’ time, the budget will balance, but only if you exclude interest payments on debt. In other words, it still won’t balance. And the debt will still be rising.

The Tories, the Labour Party and the Liberal Democrats all know that the Government has precious little room for manoeuvre. They also all agree that it is right to use inflation to redistribute wealth from the prudent to the profligate. They all know, but don’t appear to care, that inflation will also demolish whatever advantage we may have gained from devaluation. There are no dissenting voices, doubtless because the voting public actually want to continue to inhabit a dream world. No wonder the Chinese aren’t that impressed with democracy.

I believe that we can only spend what we earn. Put it another way: the budget has to balance over the economic cycle, and national debt shouldn’t exceed 40% of GDP. Right wing nonsense? Maybe, but it’s where Gordon Brown started from. I never did understand why he changed his mind.

The bottom line is that I wrote here earlier this year that interest rates would have to rise before we saw 2012. I was wrong. I thought enough of the suits in power would remember what inflation did to us in the 70s and 80s. I was wrong. We’ll have to get used to 5% inflation.

Does that mean that we should change our approach to managing our money? Probably not. Real assets are usually a better bet than financial assets when inflation is running high, but remember that housing is still almost certainly overpriced.

Should we be sucked into really big risks to try to beat the inflation rate? I don’t think so. Some gamblers win. Most lose.

So perhaps we should just hang on to the equities, try not to be upset by the current volatility, and remember that there are plenty of people in the world who would swap their lifestyle for ours.

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