Business

Thursday 24 July 2014

We're all muppets if we let the bankers boil the frog

Published 14/10/2012|05:00

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Far from rejecting the troika plan, we Irish Kermits are embracing a slow death by debt

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IT'S simple. In order for this Ponzi scheme to continue, it must keep expanding, ensuring there is enough money and credit manufactured today to meet yesterday's principal and interest loads.

Without endless growth, sooner or later the debt pile collapses, and truly extraordinary losses are taken by somebody.

Global growth is slowing. The IMF on October 9 cut forecasts for global growth to 3.3 per cent this year, the slowest since the 2009 recession, and said there are "alarmingly high" risks of a steeper slowdown. I believe it will be lower.

The banks and bankers around the world cannot believe their luck. For a moment they thought they might be the ones shouldering losses from their reckless gambles. But no. They have persuaded hapless politicians and friends and ex-colleagues in central banks that in order to keep the game going it is they that must be saved at all costs as without them the system would collapse.

They are keen on this charade to continue as they enrich themselves and wait for the music to stop.

Politicians too are anxious for the game to continue. They've borrowed from the future to buy votes and reward their cronies, piling up debt as they go.

For years countries such as France, Spain and Italy offered a Swedish-style social model of services and benefits, but failed to create enough wealth to pay for it (or failed to adequately collect for it). New politicians get voted in but are unwilling to make hard choices as a need to be re-elected outweighs any patriotic duty.

The financial markets are also happy as stock and commodity prices are pushed higher by massive liquidity injections and goaded to take more risk by central bankers. Many trading desks are taking more risks now than in 2007 -- fully aware that it is a one-way bet. Why not go "all in" on your country's sovereign bonds? If they default nobody will call you reckless. Any gains will be kept and all losses will be taken by central banks -- on your behalf.

The illusion must continue at all costs. Hence the biggest financial experiment of all time. Each new announcement (zero interest, quantitative easing, LTRO, QE2, QE to infinity, OMT, ESM) is heralded as the solution. But the solution to what? For who?

The central banks have two goals. They hope to create inflation to help inflate away debts. The idea being to bolster confidence and restart the same credit-fuelled spending binge that got us here in the first place. More insidiously, the living standards of the general populations must be eroded, wages decreased.

In short, they intend to boil the frog.

They say that if a frog is placed in boiling water, it will jump out -- but if it is placed in cold water and slowly heated, it will not perceive any danger and will be cooked to death. No frogs were harmed in the making of this metaphor -- but it underscores the inability of people to react to significant changes that occur gradually.

The plan is working beautifully in Ireland. The plan from our EU masters has not changed one iota from the start. They have succeeded in getting us to shoulder the suicidal losses of bank debt and if there is any sign of trouble they give politicians little victories to keep us in the pot. They say "it's the only game in town", otherwise "the ATMs will stop working".

Instead of jumping out of this bubbling pot, our chief Kermit goes on the cover of Time magazine to celebrate how well we are doing -- in the same month that we hope to sign up to a comprehensive deal on our bank debt.

Utterly incredible.

In other parts of Europe they are not so meek or spineless. As this crisis worsens we can expect social unrest to spread and more radical political parties to come to the forefront. The IMF knows this, hence last week's call for cooler austerity. They can see, like the rest of us, that if one frog jumps it will set off a chain reaction.

So what does this mean for investors?

The rising equity markets have mostly been a function of rising multiples applied to relatively stagnant earnings. There will be some global companies that will navigate through this seamlessly and be able to use low rates and easy money to their advantage. But central bank action cannot paper over the slowing global demand.

I expect stomach churning sell-offs and jaw-dropping rallies in the equity market, hard commodity sector prices to keep falling, an imploding bond market -- and I would use every rally in the euro to get into other currencies.

Above all I believe this central bank experiment will ultimately fail. And fail spectacularly.

Like a midget at a urinal, as an investor you are going to have to keep on your toes.

'Sunday Independent' readers can register for free for Paul Sommerville's next market newsletter at www.sam.ie

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