Strategy Economics Blog

How To Fix The Stock Market

In Money Week, Matthew Lynn looks at how to fix the AIM market. 

 

It is probably only because I am a lifelong Spurs fan that I noticed the story at all. Last month, the club announced that it was planning to de-list from the junior AIM market. Why? Because the manager Harry Redknapp had met some bloke in a pub who promised he could make a market in the shares at half the price? Or because some Mongolian mining billionaire had decided he’d always had his heart in North London and planned to spend a few squillion buying up half the Brazilian team and getting then up to the Lane?

            No. According to the statement put out at the time it was because the company wanted to press ahead with building a new stadium, but the stockmarket quote was in the way. “The AIM listing restricts our ability to secure funding for [our] future development,” said the chairman Daniel Levy.

            Yes, you read that right. An AIM listing it turns out doesn’t make it easier to raise capital at all. It actually makes it harder. Crazy. A stock-market listing should be all about raising new investment. If it actually makes it more difficult to raise money, there is hardly any point in it.

            It is no use pretending that a football club is a special case. There was a time when sport wasn’t a proper business. That isn’t true any more. The Premier League is one of the UK’s most successful industries, exporting itself around the world, and generating huge amounts of wealth for everyone involved. Tottenham, despite their air of world-weary resignation that tends to infect this supporter along with the rest of their fans, are one of the best managed clubs in the League, both commercially and on the pitch. A new stadium holding another 20,000 to 30,000 fans should be precisely the kind of clear business opportunity the stockmarket exists to support. The fact that the Spurs decided to go for private funding instead shows something is clearly wrong.

            In fact, the AIM market is dying a slow death. Figures for last month showed that more companies left the market in November than joined it – 10 were admitted, but 12 left. The total number of companies on the market is down by 46 in the last 12 months, and is now at its lowest level for seven years. According to the accountants Hacker Young, even when they do list, the amounts of money raised are declining all the time. The average amount raised per IPO was £8 million in 2011, down 20% from last year.

True, this isn’t a good time for entrepreneurs. Typically, an AIM listing is going to be a three or four year old company that wants to expand. 2008 and 2009 were such bleak years that there are not many new companies coming through. And of course some companies are leaving the maker for perfectly respectable reasons. Many AIM companies that do well get taken over by bigger rivals, and everyone makes money. That is all part of quite a healthy process.

            Even so, there is clearly a problem. The London market is doing fine at attracting new Russian mining conglomerates. But it is doing a terrible job of supporting new British companies – which should be its real lifeblood.

Can anything be done about that?

            Here are three good places to start.

First, offer AIM investors a genuine tax break. When the market started it was free of capital gains tax so long as you held the shares for a set period of time. Changes to the tax system mean that is no longer worth very much. So how about offering tax relief to anyone investing at in an AIM IPO? The government has already launched a Seed Investment Scheme to offer tax relief on start-ups. But a public market is actually a much easier place for people to invest in promising new businesses – and there are few better ways of attracting new investment than by offering a juicy tax break.

            Next, cut the amount of regulation dramatically. One of the problems for AIM has been that the corporate governance crowd have piled more and more regulations on quoted companies. That’s fine for Tesco. It can afford to have a whole department filling in forms. For a small company, the costs can be crippling. Even when it doesn’t cost money, compliance takes up time. AIM companies should be stripped of most of the reporting requirements of a senior listing. Sure, there will be more scandals. A few fraudsters will slip through the net, and investors will lose some money. But that’s life. An occasional scandal is better than a moribund market – and a completely dead economy.

Thirdly, how about some fresh money? The latest round of quantitative easing launched by the Bank of England amounts to £75 billion, and there might be more in the pipeline. Why not take 10% of that - £7.5 billion - and use it to buy AIM shares rather than gilts? The total value of the AIM market is £64 billion, so even that relatively small sum of money would have a huge impact. Prices would shoot up. Investors would make money, and companies and fund managers would flock to the market on the prospect of more gains to come. A lot of new investment would be encouraged very quickly – and, who know, the Bank of England might even make a decent turn on some of the shares it buys. It would certainly do more to revitalise the economy than just printing more money for the government to spend.

 The London market needs a vibrant small-cap sector to keep it alive. And the UK desperately needs more capital going into new companies. AIM should be part of a revived  enterprise culture – and, in the end, that is the only thing that is going to revive the UK economy.

 

How To Invest In a FiskalUnion

On WSJ MarketWatch, Matthew Lynn looks at how to invest in a German-led fiscal union. 

 

Plans to save the euro are a bit like very cheap Christmas toys. There’s a lot of anticipation, a brief flurry of excitement, but they are usually broken by lunchtime, and completely forgotten about by the next morning.

This week’s plan, likely to be pushed through at the latest summit, is for a German-led ‘fiskalunion’, as it is known in that country. A fully-fledged budgetary policy for the single currency, with central control of tax and spending decisions, will be created.   

Investors could be forgiven for not paying very much attention. We’ve seen so many plans by now, and they have lasted so little time, it is hard to keep taking them seriously.

            This one is not as flimsy as some of the earlier attempts, however. In fact, it looks like it might go ahead – and could even keep the whole show on the road for another two or three years. If so, how should investors respond? By getting ready for a short-term bounce, backing the German DAX, supporting the peripheral nation’s banks, and going short on all of the southern European stock-markets.

            The latest deal is a ‘grand bargain’ between the German Chancellor Angela Merkel and the other 16 nations in the euro-zone. Some of the finer details still have to be worked out – and bear in mind that euro-zone deals have a tendency to fall apart as soon as anyone gets into the fine print – but the plan would see all the members of the single currency submit to centralised control of tax and spending policies, in return for which Germany will keep on supporting the bail-outs of the weaker members, and allow the European Central Bank to turn on the printing presses.

            It won’t work in the long-term, or probably even the medium-term. Why not? Because it will do nothing to address the fundamental gap in competitiveness between Northern and Southern Europe. It will impose crushing austerity on the periphery, which will stop their economies growing just about ever. Italians have already been through a lost decade of zero growth, and have another couple of them to live through under the plans being cooked up in Berlin. And the lack of democratic control will eventually lead to popular uprisings. National parliaments will have little say in tax and spending decision – and if they try to interfere, they can expect a ‘technocrat’ to be helicoptered in from Brussels to put them back in their place. No taxation without representation has been a good rallying cry for insurrectionists for a few hundred years: it will work as well in Greece, Spain and Portugal, and indeed France, as it has done everywhere else.

            But, and this is the important point for investors, it may work in the short term – say between now and 2015. So, if goes ahead, what does that mean for investors?

            They are four big trends to watch for.

            First, look for a bounce in the markets. If the plan shows any signs of working – indeed if it shows any signs of lasting beyond the usual thirty-six hours before someone presses the auto-destruct button – there will be a visible mood of relief. Avoiding an apocalypse is always good news. True, the medium-term outlook will be just as bad, and perhaps even worse than ever. But the stockmarket doesn’t worry about the medium-term. If everything looks like it will be okay until Christmas, sentiment will improve.

            Second, get behind the DAX index. The big Germany exporters have been the only real winners from the euro. An artificially low exchange rate has kept their goods a lot cheaper on the world’s markets than they otherwise would be. There are a lot of BMW’s in China precisely because of that. At the same time, southern Europe hasn’t been able to devalue against Germany they way it always used to – and the way it needs to again to get its economy back in balance. The result has been that German manufacturers have flooded the world with their exports. The German trade balance has gone from zero when the euro was launched to more than 8% of GDP. A ‘fiskalunion’ will be the continuation of the same polices, except on steroids. More exports for Germany, and more austerity for everyone else. It is isn’t going to be much fun for the rest of the world, but so long as that can be sustained, the big German companies that make up the DAX  will do well.

            Three, get into the peripheral country banks. No sector of the stockmarket is more bombed out that Greek, Italian or Spanish banks. Shares in the huge Italian bank Unicredit, for example, are down from two euros in February to less than a euro today. But under the ‘fiskalunion’ the banks will start to recover. The bonds markets will never believe the euro-zone is permanent: once the prospect of countries quitting is raised, it won’t be forgotten. So real interest rates in all those countries will be very high, but the banks will get low-cost funding from the ECB. That is bad news if you happen to be a small business looking to borrow money to expand your business. But it’s great for the banks. The margins on loans will be sky-high. Profits will recover and so will share prices.   

Four, short the rest of the southern European markets. All the peripheral countries will have grinding austerity packages imposed on them. The German take on the crisis is that it was created by irresponsible government borrowing in the peripheral countries – even though Spain ran a surplus, and the Italian debt was run up before it joined the euro. If countries have to be stuck in permanent recession, that is the way it will be. It will be very tough for any companies operating in those markets – and their share prices can be expected to suffer.

The Fiskalunion will be inherently unstable – but it may stagger through two or three more years. It will be the world’s largest economic bloc, and impossible for investors to ignore. Played right, there will be money to made from it – so long as you get out before the inevitable implosion. 

IMF Rescue of Italy Will Spark an Uprising

On WSJ MarketWatch, Matthew Lynn argues that an IMF bail-out of Italy would be a mistake. 

 

Soviet Russia didn’t produce much of enduring value. No one drove its car, or flew in it planes if they could possibly avoid it. But it did have a good line in cynical world-weary humour. Among the many jokes that circulated in the country was one that went like this.  

 

Every philosophy is like looking for a black cat in a dark room; Marxist philosophy is like looking for a black cat in a dark room, but the cat isn't there; Soviet philosophy is like looking for a black cat in a dark room, the cat isn't there, but you keep shouting "I've found it! I've found it!"

 

The search for a solution to the euro-zone crisis is starting to sound very similar – and might soon start to develop its own brand of morose gags. Every week we get another big search for a smart-sounding scheme to rescue the project. Every week, officials proclaim they have found it – when, of course, they haven’t really. .

 

The latest wheeze? Getting the International Monetary Fund to bail-out Italy.

 

Italian borrowing costs have now broken decisively through the 7% barrier. At an auction on Monday, the country had to pay 7.3% to get away a small bond issue of 567 million euros maturing in 2023. A year earlier it paid just 2.9% on bonds of similar duration. If my borrowing costs tripled in a year, I’d be broke. There is no reason to think that Italy – with one of the highest government debt to GDP ratios in the developed world – can survive either.

 

In effect, the country is being locked out of the credit markets. That is bad news for just about anyone, whether a government, corporation or individual. For a nation such as Italy with a big budget and trade deficit to fund it is catastrophic.

 

Now, however, there are reports that the IMF will come to the rescue. The Fund last week announced a new-fangled piece of financial engineering called the Precautionary and Liquidity Line. No doubt, those Soviet humorists would have had fun with that piece of bureaucratic newspeak – the Reckless and Broke Line might be a better name for it.

 

But whatever it is called, it is not going to work.. Why not? Because it puts too much financial strain on the rest of the world. Indeed, if the IMF goes ahead with the plan, it might well finish itself off as a serious custodian of the world’s financial stability.

 

Technically, the IMF might be able to pull it off. Under the Precautionary and Liquidity Line, which allows a county to borrow via the IMF based on its quotas to the Fund.  Italy could receive as much as 333 billion euros of financial assistance over a two year period. Italy is going to have to borrow 461 billion euros over 2012 and 2013 – slightly more than the GDP of Switzerland, which is why everyone is getting so nervous – so the IMF would be covering 72% of that. The European Financial Stability Facility, assuming it manages to tap the Chileans or the Nigerians or who ever it is asking for money this week, should just about be able to cover the rest.

 

To a corporate financier doodling on a spreadsheet, it might just work. In the real world it doesn’t have a chance.

 

According to calculations by the London office of the investment bank Daiwa, that amount of money would consume 64% of the IMF’s available resources. But Italy contributes just 3.1% of the IMF’s money. So just to get this clear, a country that chips in 3% of the money in the pot gets to take out 64% at the other end, roughly 20 times what it put in. Does that strike you as fair? No, thought not.

 

Next, pause to think about some of the country’s that are making the contributions.

 

Many of them are significantly poorer than Italy. According to the World Bank, Italy has a GDP per capita of slightly under $34,000. China contributes 6% of the IMF’s funding, but it has a GDP per capita of $4,393. India and Russia contribute 2.3% each, but they have GDP’s per capita of id="mce_marker",447 and id="mce_marker"0,440 respectively. Indonesia is nobody’s idea of a wealthy country (its GDP per capita is $2,946) but it pays 1% of the IMF funds so it will be subsidising a country more than ten times richer.  

 

True, some countries might be in a better position to afford it -- the US for example, which contributes 17% of the IMF’s total funds. It’s GDP per capita is $47,184, so it is a fair bit richer than Italy. But does it really want to dip into its pockets to rescue out what is after all a perfectly well-off nation at a time when it has massive debts of its own to deal with? It doesn’t sound like a policy you would want to have to defend going into a Presidential election year.

 

In truth, complex financial engineering involving the IMF is the last thing the global financial system needs this year. The poor bailing out the rich is immoral; it should, after all, be the other way around. Worse, it is also completely unsustainable. Very quickly, the poorer countries are going to take their money off the table – and who could blame them?

 

Likewise, the richer countries. Of the top five contributors to the IMF, the US and Britain will struggle to get it through their legislators. Japan probably can’t be relied upon either. So any money used to guarantee Italy will be constantly in the balance, dependent on reluctant electors withdrawing their support.

 

If the IMF pushes ahead with the scheme, the entire organisation could collapse amid a rolling wave of protests. That would be tragedy. If ever the global financial system needed a body to promote co-operation and stability, it is now.

 

The dilemma in the euro-zone remains the same as it has been for months. Either Germany pays for the bail-out, or the thing gets broken up. Everything else is just shouting that you’ve found a black cat in a dark room – when, of course, it isn’t there. 

Subsidised Mortgages Are The Wrong Answer To The Housing Crisis

In Money Week, Matthew Lynn argues that subsidised mortgages are the wrong answer to the UK's housing crisis. 

 

True, these are fairly desperate times for the Chancellor George Osborne. Growth is stagnant, and the economy may slip back into recession next year. The euro-zone could implode at any moment. The deficit targets look likely to be missed.

            Still, even desperate men have little excuse for making a bad situation worse. In an attempt to get some favourable headlines, and to make the outlook seem a little less bleak, the government this week unveiled proposals to guarantee mortgages for first time buyers, and so help more people onto the housing ladder.

            It is a terrible idea. In the US, it was the political push to turn people who couldn’t really afford to buy a property into home-owners that led up to the sub-prime crisis. Extraordinarily, the UK has decided, only three years after the crash, to repeat the policies that led up to the credit crunch.

            It is certainly the case that twenty-something’s face bleak prospects right now. The jobs market is tougher than ever, and house prices still look high by any historical standards. Many of them face paying expensive rents for years, and won’t be able to start building up equity in their own home until they are in their late thirties or even forties. Whilst their parent’s generation might have expected to have largely paid off the mortgage by the time they hit fifty, this generation will still be burdened by huge monthly payments just to keep a roof over their head even as they approach retirement.

            Interest rates are at a three-hundred year low and don’t look likely to go up any time soon, but that is not much use if you can’t get a loan. The lenders are demanding huge deposits – at least 20% of the purchase price of the property, and more like 40% if you want to get a decent rate of interest. With the average house price now £232,000, that means getting together a deposit of £46,000 – a struggle on most wages, particularly when there are student loans to pay back as well.

            In response, the coalition has come up with a scheme to help. On Monday, it announced the government will guarantee part of the mortgage for first-time buyers, so that the banks can offer loans closer to 100%. If there is ultimately a loss on the loan, the government will be on the hook for it. It is, in effect, a subsidy. Any kind of guarantee reduces the cost of lending below what it would be in a free market. Government money is being used to reduce the price of something – and that is a subsidy.

            And yet the history of subsidised mortgage lending is well known.

            In the Great Depression of the 1930s, the Roosevelt administration created the Federal National Mortgage Association, known and Fannie Mae, to help local banks make more mortgages available, and so increase the supply of affordable housing. Over the decades that followed, the US government got more and more involved in ‘guaranteeing’ mortgage finance for the banks. Fannie Mae was joined by Freddie Mac in the 1970s, as the government tried to make mortgage loans available to everyone, regardless of whether they could afford them. As state-back entities, they encouraged lenders to view mortgages as if they were as safe as government bonds.

            The result? Disaster. There were many causes of the sub-prime mortgage bubble in the US, including greedy bankers and gullible home owners, but the determination of the government to widen home ownership, and to subsidise mortgages to help achieve that, was clearly one of them.

            Admittedly, the UK scheme does not go as far as that. There are restrictions. The loans are limited to first-time buyers, and the government’s potential loss will be restricted to the 20% stake they guarantee.

            The trouble is, bad ideas always start small, and then they grow and grow. It will be hard to draw the line at first time buyers. What happens to people who buy a property on a state-backed mortgage, then need to move for a new job, or need a bigger house when they have children? They will need another subsidized loan. In a few years, we’ll be hearing complaint about how the scheme restricts labour mobility and stops people starting families. It will be extended to everyone.

            After that, why stop at 20%? It will only make a small dent in the problem. In time, the government will end up under-writing the entire mortgage industry.

            That, surely, is a mistake.

            There is a reason why lenders are now reluctant to offer mortgages to many people in their twenties. The jobs market is too insecure, and their earnings prospects too poor, to make many of them a reasonable risk.

            And there is a reason for demanding a 20% deposit. House prices still look high in the UK, even if rapid inflation is starting to bring them down in real terms. They could easily fall by 10% or perhaps 20% in the next few years, particularly if the Bank of England has to start raising interest rates to control inflation before we have emerged from this recession. Lenders need a substantial amount of equity in a property to make sure they are protected against that.

            There are plenty of things the government could do to make property more affordable. Relaxing planning restrictions to allow more homes to built is a good idea – more supply will mean lower prices. It could open up more competition in the mortgage market. Or it could lower taxes so that people kept more of their wages. If homes were cheaper and people had more money then we wouldn’t have an affordability problem.

            But, in the end, if people can’t really afford a home then it is better not to subsidize them. A distorted market is one that stops working properly – and that is always dangerous. The UK has just taken the first step towards its own sub-prime crisis – and that surely is the last thing we need.

The UK Isn't Immune To The Euro Crisis

On WSJ Marketwatch, Matthew Lynn argues that the UK is not immune to the euro crisis. 

 

Money Week: The City Should Learn From The Failure of EMI:

            There isn’t much shortage of bad news about the British economy right now. The trade gap keeps widening. Growth is slackening, and we may be about to go into another recession. Unemployment is up, and the euro-zone remains on the brink of a messy, chaotic implosion.

            But, in truth, the most disappointing news was the sale of EMI.

            Last week, one of our best companies was split up and sold to two foreign conglomerates. That ended a long and sorry saga of takeovers, bids, deals, and reconstructions. It has been a tale of the City at its worst, focussing on financial fixes rather than helping what was once a great company through a difficult period in its history. There is a lot of talk about reforming the way the City works – but actually what needs to happen is finding ways of making the equity markets work better for businesses such as this one.

            EMI was once one of the most iconic brands in the UK, and a huge player in one of the few major industries this country happens to be very, very good at. It has been around since the start of recorded sound (it was formed as The Gramophone Company in 1897). It virtually invented the modern pop business. Long before any of its rivals, it recognised this was a global industry, and one that was going to last, so the trick was to build the business around artists of stature. It pioneered album-orientated music, from The Beatles onwards, and was the first label to sell more albums than singles. For the best part of a century, there was very little it didn’t know about getting ahead of the curve. When something new came along, it grabbed it, and figured out how to make money from it.

            That was true even with the internet. EMI was experimenting with digital music when most of us were still wondering what an e-mail was. It was the first label to make a whole album available for digital download. It turned Lily Allen into one of the first MySpace stars. All through that, it remained pretty good at is basic business. There is no bigger music brand in the world today than Coldplay, a band EMI discovered and turned into international stars.

            What it couldn’t do was keep the support of the City through what was always going to be a difficult transition from a CD-based business to one that is largely digital.

            EMI used to be a major FTSE company, but as soon as it got into trouble the City started pressing for deals. As early as 2000 it planned a merger with Warner. It had another go with Warner in 2002, and when that failed again, tried to merge with Bertelsmann in 2004, before finally giving up the attempt to stay independent and selling itself to Guy Hands’s Terra Firma private equity firm in 2007.

            It was always a crazy idea. What EMI required was a long period of support by people who understood the music industry inside out. A private equity house that knew nothing about music, loaded the company up with debt, and started stripping out costs as if it was running a cardboard box factory in Middlesbrough was the last thing it needed. In the end, Terra Firma lost control of the business and the company ended up in the hands of its bankers.

            The result? Last week, EMI was split in two and finally sold off.  The recorded music division was sold to Universal, a division of France’s Vivendi, for £1.2 billion. The publishing business was sold to Japan’s Sony for £1.3 billion. The chances are that both units will disappear within huge conglomerates. EMI will effectively cease to exist as anything more than a subsidiary brand. Shockingly, the UK will have no major music company left -- even though it is indisputably one of the industries where this country leads the world. 

There is a salutary lesson in that about how poor the City is at supporting British companies. True, the music industry went through a seismic shift. The explosion of the internet was a challenge to everyone in that business.

But it was only to the British company that it proved fatal.

There are already signs that the music business is turning the corner. Worldwide sales of albums – which includes traditional formats as well as digital downloads – are rising this year for the first time since 2004. They are only up by 3%, but that compares with a 13% decline in 2010. Digital single sales are up by 10% this year, to more than a billion tracks. And services such as Spotify are starting to make real money – and paying a share of it to the labels. It already has two million subscribers paying $5 to id="mce_marker"0 a month to stream digital music. After a decade of decline, it looks as if the industry has touched bottom, got to grips with new business models, and is about to embark on a decade of solid growth.

Japan managed to support Sony through that process, and France managed to support Vivendi. In this country, the shareholders went into a panic, and decided that something had to be done immediately. What EMI needed was a big supportive parent company much like Vivendi. But imagine it was owned by United Utilities or British American Tobacco? The shareholders would have been complaining it was a distraction from their core business – and demanding it be sold off right away.

            The irony is that the UK is as good at producing new pop stars as it always has been – the biggest selling album in the US this year has been ‘21’ by Tottenham’s Adele. It is just that the City is no good at supporting companies that go through a difficult time. It failed to do its most basic job. There is a lot of talk among regulators about reforming the financial sector - but it is that failure they should really focus on. 

The Lessons of EMI

In Money Week, Matthew Lynn looks at what the sale of EMI tells us about the City.

 

Money Week: The City Should Learn From The Failure of EMI:

            There isn’t much shortage of bad news about the British economy right now. The trade gap keeps widening. Growth is slackening, and we may be about to go into another recession. Unemployment is up, and the euro-zone remains on the brink of a messy, chaotic implosion.

            But, in truth, the most disappointing news was the sale of EMI.

            Last week, one of our best companies was split up and sold to two foreign conglomerates. That ended a long and sorry saga of takeovers, bids, deals, and reconstructions. It has been a tale of the City at its worst, focussing on financial fixes rather than helping what was once a great company through a difficult period in its history. There is a lot of talk about reforming the way the City works – but actually what needs to happen is finding ways of making the equity markets work better for businesses such as this one.

            EMI was once one of the most iconic brands in the UK, and a huge player in one of the few major industries this country happens to be very, very good at. It has been around since the start of recorded sound (it was formed as The Gramophone Company in 1897). It virtually invented the modern pop business. Long before any of its rivals, it recognised this was a global industry, and one that was going to last, so the trick was to build the business around artists of stature. It pioneered album-orientated music, from The Beatles onwards, and was the first label to sell more albums than singles. For the best part of a century, there was very little it didn’t know about getting ahead of the curve. When something new came along, it grabbed it, and figured out how to make money from it.

            That was true even with the internet. EMI was experimenting with digital music when most of us were still wondering what an e-mail was. It was the first label to make a whole album available for digital download. It turned Lily Allen into one of the first MySpace stars. All through that, it remained pretty good at is basic business. There is no bigger music brand in the world today than Coldplay, a band EMI discovered and turned into international stars.

            What it couldn’t do was keep the support of the City through what was always going to be a difficult transition from a CD-based business to one that is largely digital.

            EMI used to be a major FTSE company, but as soon as it got into trouble the City started pressing for deals. As early as 2000 it planned a merger with Warner. It had another go with Warner in 2002, and when that failed again, tried to merge with Bertelsmann in 2004, before finally giving up the attempt to stay independent and selling itself to Guy Hands’s Terra Firma private equity firm in 2007.

            It was always a crazy idea. What EMI required was a long period of support by people who understood the music industry inside out. A private equity house that knew nothing about music, loaded the company up with debt, and started stripping out costs as if it was running a cardboard box factory in Middlesbrough was the last thing it needed. In the end, Terra Firma lost control of the business and the company ended up in the hands of its bankers.

            The result? Last week, EMI was split in two and finally sold off.  The recorded music division was sold to Universal, a division of France’s Vivendi, for £1.2 billion. The publishing business was sold to Japan’s Sony for £1.3 billion. The chances are that both units will disappear within huge conglomerates. EMI will effectively cease to exist as anything more than a subsidiary brand. Shockingly, the UK will have no major music company left -- even though it is indisputably one of the industries where this country leads the world. 

There is a salutary lesson in that about how poor the City is at supporting British companies. True, the music industry went through a seismic shift. The explosion of the internet was a challenge to everyone in that business.

But it was only to the British company that it proved fatal.

There are already signs that the music business is turning the corner. Worldwide sales of albums – which includes traditional formats as well as digital downloads – are rising this year for the first time since 2004. They are only up by 3%, but that compares with a 13% decline in 2010. Digital single sales are up by 10% this year, to more than a billion tracks. And services such as Spotify are starting to make real money – and paying a share of it to the labels. It already has two million subscribers paying $5 to id="mce_marker"0 a month to stream digital music. After a decade of decline, it looks as if the industry has touched bottom, got to grips with new business models, and is about to embark on a decade of solid growth.

Japan managed to support Sony through that process, and France managed to support Vivendi. In this country, the shareholders went into a panic, and decided that something had to be done immediately. What EMI needed was a big supportive parent company much like Vivendi. But imagine it was owned by United Utilities or British American Tobacco? The shareholders would have been complaining it was a distraction from their core business – and demanding it be sold off right away.

            The irony is that the UK is as good at producing new pop stars as it always has been – the biggest selling album in the US this year has been ‘21’ by Tottenham’s Adele. It is just that the City is no good at supporting companies that go through a difficult time. It failed to do its most basic job. There is a lot of talk among regulators about reforming the financial sector - but it is that failure they should really focus on. 

Gold Is The Only Winner From The Euro Crisis

On WSJ MarketWatch Matthew Lynn explains why gold is the only real winer from the euro crisis. 

 

In January 1947, the American President Harry Truman came up with a bold new plan for Europe. After World War Two, the policy of the allies occupying Germany had been to, in the words of the governing decree, “take no steps looking toward the economic rehabilitation of Germany”.

            Truman could see that a struggling, chaotic Germany wasn’t in anyone’s interests. Instead, he embarked on a massive programme of assistance aimed at re-building both the German and the wider European economy. Named for the retired general who administered it – George Marshall – it was one of the most brilliantly successful policies of the last century, creating a peaceful and prosperous ally of the US out of a defeated Germany, and fending of the threat of Communist take-overs across Western Europe.

            It is a shame that Europe – or indeed the United States - doesn’t have a Truman around today. Because what Europe needs right now is a new version of the Marshall Plan – one that helps Greece out of the euro, and gets it back on the path towards stability. And that is precisely what the British government should be arguing for – not closer fiscal union and yet more funding for the International Monetary Fund’s failed bail-out strategy.

            Just about no one believes Greece has any future in the euro anymore. Not the Greeks, judging by the turmoil within the country. The country has descended into political chaos. Even the European Union’s leaders appear to have lost faith. Last week, the German Chancellor Angela Merkel and the French President Nicolas Sarkozy raised the possibility that Greece’s future might not be inside the single currency. With the Greek economy shrinking by the day, and with the country being kept afloat on grudging tranches of bail-out money, the endgame for this catastrophe is surely very close.

            The British government doesn’t have much of a say in this. It is a euro-zone crisis, and will have to be fixed on mainland Europe. But there is one useful role David Cameron and George Osborne could play – arguing for a real rescue for the Greeks.

            So far, they have been calling for a fiscal union – and urging the world to contribute more money to the IMF for its rescue packages.

            Both, at this stage, are completely pointless.

            Perhaps if the euro-zone had been better designed in the first place, we wouldn’t have been in this mess. But when a building is on fire, there isn’t much point in calling up the architect and complaining about the way it was built. It is too late to change the structure of the single currency now. Nor is there any point in giving more money to the IMF. It has already been ‘rescuing’ Greece since May last year. It doesn’t appear to be doing such a great job that it deserves even more money to carry on with the same failed policies.

            In truth, the only thing that is going to fix this crisis now is for the Greeks to leave the euro, and bring back the drachma. There is no other way out for the country.

            It is still a terrifying prospect, however.

            The country will be bankrupt. Its banks will be ruined, and capital will flee the country. Greece runs a huge trade deficit – around 11% of GDP. Shut out of the capital markets, and with an almost worthless new currency, it would have no way of paying for the imports it needs. Some of the speculation argues that if it does introduce a new currency, it would have to be done overnight, with the military taking temporary control to maintain order, and to stop what little money remains there from fleeing the country. For a few weeks at least, there might be no currency as new notes were printed, and the country would inevitably face a deep recession – even deeper than the one it is already in – as it was forced to gets its current account back into balance in a single year.

That surely is hardly a civilised way of doing things in 21st century Europe.

What should happen is this. A date should be set for leaving the euro in three months time. New notes should be printed, the tills changed, and the banks recapitalised to prepare for the changeover. All that is going to cost money. At the same time, Greece will need generous financial assistance to help it through the first year. The current account has to be funded, and the government needs enough money to stabilise its finances and stop an austerity programme that is only sending the economy deeper into recession.

It would, in effect, be a Marshall Aid plan – a way of reviving a country so that it can stand on its own two feet again.

Within a couple of years, Greece should be in reasonable shape. With a devalued exchange rate – probably 50% or more – it should be able to start growing. Its beaches would be packed out with tourists for most of the year. But it wouldn’t just be tourism. Turkey has turned itself into a major manufacturing hub. Inside the euro, but with its own currency, Greece should be able to do just a well.

It isn’t going to happen by itself, however. Nor is the rescue package likely to come from Paris, Berlin or Brussels. The EU technocrats are still in denial about the extent of the disaster unfolding in the euro-zone. They can’t admit to themselves the project has failed. The French and German leaders both face elections next year, and their electorates are already angry about the amount Greece has cost them.

There is only one credible country to argue for a genuine rescue, and not another failed attempt to prop up the euro – the UK. Whether anyone will listen remains to be seen – but it would be a lot more useful than just arguing for more money to be given to the IMF to spend on a strategy that has only made things worse.

Greece Needs Help To Get Out of the Euro

In Money Week, Matthew Lynn explains why Greece needs help to get out of the euro. 

 

In January 1947, the American President Harry Truman came up with a bold new plan for Europe. After World War Two, the policy of the allies occupying Germany had been to, in the words of the governing decree, “take no steps looking toward the economic rehabilitation of Germany”.

            Truman could see that a struggling, chaotic Germany wasn’t in anyone’s interests. Instead, he embarked on a massive programme of assistance aimed at re-building both the German and the wider European economy. Named for the retired general who administered it – George Marshall – it was one of the most brilliantly successful policies of the last century, creating a peaceful and prosperous ally of the US out of a defeated Germany, and fending of the threat of Communist take-overs across Western Europe.

            It is a shame that Europe – or indeed the United States - doesn’t have a Truman around today. Because what Europe needs right now is a new version of the Marshall Plan – one that helps Greece out of the euro, and gets it back on the path towards stability. And that is precisely what the British government should be arguing for – not closer fiscal union and yet more funding for the International Monetary Fund’s failed bail-out strategy.

            Just about no one believes Greece has any future in the euro anymore. Not the Greeks, judging by the turmoil within the country. The country has descended into political chaos. Even the European Union’s leaders appear to have lost faith. Last week, the German Chancellor Angela Merkel and the French President Nicolas Sarkozy raised the possibility that Greece’s future might not be inside the single currency. With the Greek economy shrinking by the day, and with the country being kept afloat on grudging tranches of bail-out money, the endgame for this catastrophe is surely very close.

            The British government doesn’t have much of a say in this. It is a euro-zone crisis, and will have to be fixed on mainland Europe. But there is one useful role David Cameron and George Osborne could play – arguing for a real rescue for the Greeks.

            So far, they have been calling for a fiscal union – and urging the world to contribute more money to the IMF for its rescue packages.

            Both, at this stage, are completely pointless.

            Perhaps if the euro-zone had been better designed in the first place, we wouldn’t have been in this mess. But when a building is on fire, there isn’t much point in calling up the architect and complaining about the way it was built. It is too late to change the structure of the single currency now. Nor is there any point in giving more money to the IMF. It has already been ‘rescuing’ Greece since May last year. It doesn’t appear to be doing such a great job that it deserves even more money to carry on with the same failed policies.

            In truth, the only thing that is going to fix this crisis now is for the Greeks to leave the euro, and bring back the drachma. There is no other way out for the country.

            It is still a terrifying prospect, however.

            The country will be bankrupt. Its banks will be ruined, and capital will flee the country. Greece runs a huge trade deficit – around 11% of GDP. Shut out of the capital markets, and with an almost worthless new currency, it would have no way of paying for the imports it needs. Some of the speculation argues that if it does introduce a new currency, it would have to be done overnight, with the military taking temporary control to maintain order, and to stop what little money remains there from fleeing the country. For a few weeks at least, there might be no currency as new notes were printed, and the country would inevitably face a deep recession – even deeper than the one it is already in – as it was forced to gets its current account back into balance in a single year.

That surely is hardly a civilised way of doing things in 21st century Europe.

What should happen is this. A date should be set for leaving the euro in three months time. New notes should be printed, the tills changed, and the banks recapitalised to prepare for the changeover. All that is going to cost money. At the same time, Greece will need generous financial assistance to help it through the first year. The current account has to be funded, and the government needs enough money to stabilise its finances and stop an austerity programme that is only sending the economy deeper into recession.

It would, in effect, be a Marshall Aid plan – a way of reviving a country so that it can stand on its own two feet again.

Within a couple of years, Greece should be in reasonable shape. With a devalued exchange rate – probably 50% or more – it should be able to start growing. Its beaches would be packed out with tourists for most of the year. But it wouldn’t just be tourism. Turkey has turned itself into a major manufacturing hub. Inside the euro, but with its own currency, Greece should be able to do just a well.

It isn’t going to happen by itself, however. Nor is the rescue package likely to come from Paris, Berlin or Brussels. The EU technocrats are still in denial about the extent of the disaster unfolding in the euro-zone. They can’t admit to themselves the project has failed. The French and German leaders both face elections next year, and their electorates are already angry about the amount Greece has cost them.

There is only one credible country to argue for a genuine rescue, and not another failed attempt to prop up the euro – the UK. Whether anyone will listen remains to be seen – but it would be a lot more useful than just arguing for more money to be given to the IMF to spend on a strategy that has only made things worse.

CNBC Highlights Our Italy Research

CNBC has highlighted our recent research note on Italy. You can read it here.

Italy Is Bust

On WSJ MarketWatch, Matthew Lynn argues that Italy faces insolvency. 

 

When a man has survived as many corruption, financial and sex scandals as Silvio Berlusconi has over two decades in Italian politics, it would be a mistake to assume that a small matter like the imminent bankruptcy of his country will be anything other than a minor setback to his career.

            Even so, the great survivor of European politics – he first assumed the Premiership in 1994 – looks close to leaving the stage. Whether he survives the latest confidence vote remains to be seen.

            But, in fact, it doesn’t make that much difference who is in charge of Italy anymore. The country is bust, and the markets have woken up to that. The only question is when.

The only remarkable thing about Italy is that it has taken it so long to become the epicentre of the euro-zone’s crisis.

The country’s bond yields have risen dramatically in the last month – yields on 10-year bonds have shot up from 5.6% to 6.6%. The main hope of the markets now appears to be that a technocratic government will come in to push through the kind of hard structural reforms that Italy needs.

You’ll hear plenty in the next few days about how Italy faces a liquidity crisis, not a solvency crisis. It just needs some help to tide it over a difficult patch.

And you’ll hear plenty as well about how Italy is too big to go bust. Well, they said the Titanic was too big to sink, but that didn’t help when it struck an iceberg.

            True, Italian government debt has been relatively stable since it joined the euro, although at a very high level. Its total stock of outstanding government debt is 129% of GDP today, compared with 126% back in 2000. Government spending has been fairly disciplined since it joined the euro. This year, the budget deficit is forecast to come in at only around 3.6% of GDP, which is modest by current global standards. The forecast is for it to run a surplus by 2014 – and although a fresh recession and the soaring cost of its debts might derail those projections

            True as well, Italy is a relatively wealthy country compared with Greece and Portugal. According to Eurostat figures, its GDP per capita is at 104% of the average for the whole of the EU, whereas Portugal is only at 78% of the average and Greece at 94%. Much of the north of Italy is as rich as anywhere in Europe – the North-West and North-East regions are at 126% and 124% of EU’s average GDP per capita, for example, which makes both of them richer than France or Germany as a whole, and richer than countries we think of as fairly successful, such as Denmark.

            Then again, Ireland is a wealthy country as well – and that didn’t stop it from having to be bailed out by the International Monetary Fund. Rich people can go broke too – just ask the Madoff family.

            The trouble is, Italy faces three big problems.

First, while government debt may have been fairly stable over the last decade – admittedly at fairly high levels – just about every other type of debt has exploded. Corporate debt has gone up from 96% to 128% of GDP between 2000 and 2010, according to figures published by the Bank of International Settlements.  Personal debt is up from 30% to 53% of GDP over the same period. Overall debt has gone up from 252% of GDP to 310% since Italy joined the euro. It is a mistake to focus just on government debt. It is the money the country as a whole owes that really counts.

Next, Italy has stopped growing. It has been through four recessions since it joined the euro in 1999. Average growth has been just 0.6% from 2000-2010. Per capita GDP growth has been 0.1% over the whole of the first decade of the single currency - a statistically insignificant figure. And, remember, the global economy was booming through the first eight years of that decade. Just about everyone else in the world was getting richer while Italy stayed still. The decade to come is going to be a lot tougher. Given how badly Italy did in the good times, it will inevitably struggle in the bad. The chances are GDP will actually contract over the whole of the next ten years. That is going to make it a lot harder to pay off all the debt.

Lastly, Italy has the worst demographics in the world. The United Nations projects that the population will fall to 41 million by 2050 from its current 51 million. Even worse, a healthy Mediterranean diet – lots of red wine and olive oil – means life expectancy is rising fast. Italian women now have the longest life expectancy in Europe at 83.2 years (perhaps because they have so few children), and the men are not far behind. As the years go forward, there are going to be lots of old people and not many young ones. That would put severe strain on the finances of any government. In a country which already has a debt crisis, and a generous pensions and welfare system, it is catastrophic.

            There is no way the country can stay solvent. It is already paying almost three times as much for 10-year money as Germany. The rate of interest on government debt set the benchmark for borrowing for the rest of the economy. If Italian companies pay three times as much for finance as their neighbours, how are they meant to stay in business?

Italy might be bust this year or next or the year after. In the end, the timing doesn’t make much difference. It isn’t facing  a liquidity crisis, and the rest of the euro-zone is either unable or unwilling to put up enough money to save it. It is insolvent  - and with 1.9 trillion euros of debt outstanding that is going to be a cataclysmic event for the world economy.

 

The FTSE Becomes The Russki

In Money Week, Matthew Lynn argues that Russian listings should be welcomed in London. 

 

It is probably too early to break open the caviar, but at the very least the City’s big firms should get some expensive vodka on ice. The Russians are riding to the rescue of the London markets.

Most of the City might be as dead as those campaign groups set up in the early 2000’s to persuade the British to sign up for the euro. There is little sign of any M&A work. The markets are flat. Nervousness over the fate of the euro is preventing anyone from investing. But in the last few weeks, there have been a wave of Russian companies arriving on the Stock Exchange.

Last week, Polymetal, a huge mining conglomerate, and Russia’s fourth largest gold-miner, started trading on the London market. It is set to be followed in the next few weeks by Polyus Gold and Chelsea owner Roman Abramovich's steel manufacturer Evraz. On Monday we learnt that the Russian potash miner Uralkali was considering a London float in 2012.

At this rate, we’ll soon be referring to the Ruskie rather than the Footsie.

London has already carved out a lucrative niche hosting companies from around the world. Plenty of big companies from the former Soviet republics and the emerging BRIC countries have already listed here. The trouble is, plenty of people are complaining that they lower standards to much – and risk turning London into a spiv’s market.

That is crazy. The City needs to be an international exchange. The BRIC countries are where the growth is. The UK economy is not big enough to support a major financial centre anymore. And over the next couple of years, the British may find themselves frozen out of the euro-zone – so it makes sense to cultivate new markets.

The FTSE has, of course, been getting more and more international over the last decade. The Swiss commodities giant Glencore listed here earlier this year, and shot right to the top of the FTSE-100 index. London is already home to a whole crop of resources companies, many of them very substantial. African Barrick Gold, Kazakhmys, the Kazakhstan copper miner, and Xstrata, the Swiss-based mining conglomerate, are all in the index. Anyone investing in the FTSE-100 needs to be aware that they are buying a rather odd collection of global mining conglomerates and developing world manufacturers -- and that their performance, while it may be good or bad, is not going to have much to do with how the British economy performs.

True, the governance record of the some of the big emerging markets companies has been far from spotless. The Eurasian Natural Resources Corporation, the Kazak mining business, has been involved in a string of controversies. Bumi, the Indonesian coal-mining vehicle bought to the market by Nat Rothschild, has had a rocky ride over the last few weeks.

            But it would be a catastrophic mistake for the City not to welcome foreign listings – or to lay down so many politically correct conditions that they are effectively deterred from listing here.

There are four good reasons for that.

            First, the BRIC nations are where the growth is.

            The UK has too much debt too grow very fast. So does the euro-zone. The US is hardly in better shape, and anyway, it already has a huge financial centre of its own. The BRIC countries, by contrast, are all expanding rapidly, and are likely to carry on doing for the rest of this decade and beyond. We would think it very odd if Unilever, BP or Glaxo weren’t trying to secure a foothold in the word’s fastest growing economies. It would be just as strange if the City wasn’t doing the same thing.

            Next, the UK is not a big enough economy anymore to support the City. London might have started out as a British financial centre, mainly servicing UK companies and savers. It has long since outgrown that. There isn’t going to be enough business in this country to support a financial centre of that size over the next few years, and the City is too important a part of the economy to be allowed to shrink. It can’t afford to be too priggish about where the growth  come from.

Thirdly, with the euro-zone consolidating, the City may well find itself frozen out of the European markets. The core euro nations look set on forming an integrated economic bloc, with a common fiscal policy, and jointly-issued euro-bonds. Will they allow the City to be the financial centre for that? It is about as likely as the Greeks paying back the 50% of their debts they haven’t already defaulted on. The core euro members will make sure that work goes to Paris and Frankfurt. Worse, the Tobin tax -  a levy on every financial transaction - may well be part of new euro-zone rules. The City couldn’t survive that. If European work dries up, it will need to be replaced with something – and the new BRIC companies are the best alternative.

            Four, it’s not like our own standards are that high either. It is easy to be sanctimonious about the standards at some emerging markets companies. But it isn’t as if our own record is pristine. Banks such as Royal Bank of Scotland embarked on crazed takeovers at the peak of the market, then passed the bill onto the taxpayers. FTSE chief executives routinely award themselves millions a year in salaries and bonuses while delivering nothing for shareholders. The London market has not been short on frauds and scandals over the years – and all of them home grown.

            A London market dominated by emerging markets companies won’t be perfect. It will have its share of scandals. And it will be volatile. But over the medium term, it will be more lucrative for the City, and more rewarding for investors – and that surely is a good thing.

 

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