Ian Nar­ine

Those are the words that are found on the back of all Unit­ed States cur­ren­cy. It is now more rel­e­vant than ever af­ter last week's glob­al stock mar­ket sell off. Last Fri­day, the US stock mar­ket has giv­en up its gains for the year with the mar­kets down al­most five per cent on Thurs­day and in­tra-day move­ments of a sim­i­lar amount on Fri­day. The prob­lem fac­ing the US and oth­er ma­jor de­vel­oped economies is one of un­sus­tain­able lev­els of debt. You do not solve a debt cri­sis by shift­ing debt around from one bal­ance sheet to the next, but that is ex­act­ly the so­lu­tions that have been put for­ward to date, both in the US and in Eu­rope. That will buy time, and it has, but it does not solve the prob­lem, and it is quite like­ly that the time that is bought to­day will man­i­fest it­self in an­oth­er prob­lem down the road.

Fi­nan­cial re­pres­sion

Take, for ex­am­ple, the chal­lenge now be­ing faced by savers. The term "fi­nan­cial re­pres­sion" has been mak­ing the rounds in fi­nan­cial cir­cles. In the cur­rent en­vi­ron­ment, it speaks to the al­most decade-long move by cen­tral banks of de­vel­oped na­tions to keep in­ter­est rates low. These low in­ter­est rates re­duces the debt ser­vice bur­den of the state, but low rates al­so push up as­set prices, lead­ing to in­fla­tion.

In T&T, it is a mat­ter of years since savers were able to get a one year in­ter­est rate that was high­er than the an­nu­al rate of in­fla­tion. It is on­ly now with an in­fla­tion rate of 0.8 per cent that a re­al re­turn is on of­fer. How­ev­er, one can ques­tion the sus­tain­abil­i­ty of a 0.8 per cent in­fla­tion rate. Ap­pre­ci­ate that it was sig­nif­i­cant­ly neg­a­tive re­al in­ter­est rates (in­vest­ment rates low­er than the rate of in­fla­tion) that saw many in­vestors climb on board the Cli­co train wreck. The sub-prime cri­sis was the re­sult of ex­treme­ly low rates for an ex­tend­ed pe­ri­od, hence, my point of cre­at­ing an­oth­er prob­lem down the road. Tak­ing the in­ter­est rate dy­nam­ic in the US, one would have to go out to the ten-year bond in or­der to get an in­vest­ment rate that is in ex­cess of the rate of in­fla­tion. Neg­a­tive re­al in­ter­est rates is the equiv­a­lent of a tax in that it trans­fers wealth from savers by pay­ing them a re­turn be­low the rate of in­fla­tion to bor­row­ers, in­clud­ing the gov­ern­ment. To il­lus­trate, a debt of $100 fixed to­day and payable in one year's time in a five per cent in­fla­tion en­vi­ron­ment means us­ing $95 of pur­chas­ing pow­er to pay a nom­i­nal amount of $100. That is a ben­e­fit to the bor­row­er, but a dis­ad­van­tage to the lender (the saver), who is get­ting $100 at a time when the pur­chas­ing pow­er of that $100 is re­al­ly $95 be­cause of the move­ment in prices as a re­sult of in­fla­tion dur­ing the year. This hid­den tax on savers is now a glob­al phe­nom­e­non and was es­pe­cial­ly acute in T&T dur­ing the pe­ri­od 2005 to 2008.

Grid­lock

Over time a gen­er­a­tion will re­tire with in­suf­fi­cient sav­ings be­cause of the ex­tend­ed pe­ri­od of ex­treme­ly low in­ter­est rates. The cur­rent debt bur­den of­fer low­er lev­els of eco­nom­ic growth and high­er lev­els of un­em­ploy­ment, which im­pair the abil­i­ty to save even fur­ther. It will come back full cir­cle where the state, the en­gi­neer of mod­ern day "fi­nan­cial re­pres­sion," would have to cough up re­sources to sup­port the mass­es or risk so­cial un­rest. We are al­ready seek­ing sparks of such un­rest in Eu­rope. The for­mer In­ter­na­tion­al Mon­e­tary Fund chief econ­o­mist, Raghu­ram Ra­jan, in his 2010 book, Fault Lines: How Hid­den Frac­tures Still Threat­en the World Econ­o­my, points out that cap­i­tal­ism in a democ­ra­cy is re­al­ly the bal­anc­ing of the roles of the mar­ket and gov­ern­ment, but sug­gests that while there may be an in­com­pat­i­bil­i­ty be­tween cap­i­tal­ism and democ­ra­cy, they are of­ten found to­geth­er be­cause they re­duce the de­fi­cien­cy of each oth­er.

While, his­tor­i­cal­ly, this is true, the re­al­i­ty of to­day is that politi­cians in a democ­ra­cy are un­able to get ahead of the fi­nan­cial cri­sis be­cause the mea­sures that are re­quired are un­pop­u­lar thus lim­it­ing their chances of get­ting re-elect­ed. This was ev­i­dent in the re­cent debt de­bate in the US. The eco­nom­ic chal­lenges of the day has al­so put in mo­tion a trend that sees more rad­i­cal move­ments com­ing to the fore and this ranges from the Tea Par­ty move­ment in the US to the ex­treme and vi­o­lent event in Nor­way a cou­ple weeks ago.

The un­will­ing­ness of politi­cians to treat de­ci­sive­ly with the is­sues at hand is sup­port­ed by cen­tral bank­ing as­sis­tance in "kick­ing the can down the road." The fre­quent chang­ing of rules and ma­nip­u­la­tion of mar­kets through var­i­ous pro­grammes have sti­fled the "an­i­mal spir­it" of cap­i­tal­ism, so that cur­rent­ly, the on­ly en­ti­ty with a sound bal­ance sheet is the US cor­po­ra­tion col­lec­tive­ly sit­ting on more than $2 tril­lion in cash, but un­will­ing to de­ploy it. To­day, cap­i­tal­ism and democ­ra­cy are find­ing them­selves at odds with each oth­er. The cash be­long­ing to cor­po­ra­tions is not be­ing put to work be­cause of the fre­quen­cy of rule changes, the propen­si­ty for high­er tax­es and the lack of fi­nal de­mand. This all speaks to un­cer­tain­ty and the cur­rent re­turns on of­fer are in­suf­fi­cient to com­pen­sate for the risks in­volved.

The re­al is­sue

Last week the US debt ceil­ing de­bate would have stolen the head­lines, this week it is the down­grade of the US cred­it rat­ing to AA+ from AAA. In my view, both of these were non-is­sues as far as the fi­nan­cial mar­kets are con­cerned. The debt ceil­ing de­bate made for a good po­lit­i­cal dra­ma, but lit­tle else, as it was in­con­ceiv­able that the US would vol­un­tar­i­ly go in­to de­fault. A cred­it rat­ing is re­al­ly a bench­mark to show how far the rat­ed en­ti­ty is from de­fault sta­tus. Giv­en that the US is­sues its debts in its own cur­ren­cy, it can­not de­fault on its debt, for if it ever comes to that, the US Fed can sim­ply crank up the print­ing press and print mon­ey to ser­vice the debt. Mar­kets are for­ward look­ing and so the re­ac­tion from last week had more to do with three fac­tors. The first was the re­al­i­sa­tion that eco­nom­ic growth in the US is de­cel­er­at­ing rapid­ly. The ques­tion of a "dou­ble dip" re­ces­sion, which was my base case sce­nario since 2008, has now come to the fore. Low­er eco­nom­ic growth will be re­flect­ed in cor­po­rate earn­ings, which is bad for stocks.

The sec­ond fac­tor is the prob­lems in Eu­rope, in gen­er­al, and Italy, in par­tic­u­lar, where high debt lev­els, cou­pled with a decade long pe­ri­od of ane­mic eco­nom­ic growth, have tak­en its toll. The bond mar­ket has re­act­ed push­ing yields on ten-year Ital­ian debt above six per cent in the process in­creas­ing the cost to the gov­ern­ment of fi­nanc­ing this debt bur­den.

Ac­cord­ing to IMF es­ti­mates 47 per cent of Ital­ian debt is held abroad so the is­sue is two-fold. Hold­ers of ex­ist­ing debt will be book­ing loss­es on that debt and there may not be buy­ers in suf­fi­cient quan­ti­ties to pur­chase new is­sues at more rea­son­able in­ter­est rates. This en­vi­ron­ment is ripe for a liq­uid­i­ty cri­sis and, if it per­sists, an­oth­er in­sol­ven­cy prob­lem. An­oth­er round of bailouts could be on the cards, with most like­ly the Eu­ro­pean Cen­tral Bank buy­ing Span­ish and Ital­ian bonds.If noth­ing is done over the first part of this week, then by the time you read this ar­ti­cle there is the re­al pos­si­bil­i­ty that Uni­Cred­it Ban­ca and So­ci­ete Gen­erale, the largest and sec­ond largest bank in Italy and France, re­spec­tive­ly, will be in dis­tress. Silent bank runs are tak­ing place all across Eu­rope and this is un­set­tling the stock mar­kets. An­tic­i­pat­ing the next move by the US Fed­er­al Re­serve was the third fac­tor in last week's mar­ket ac­tion. The po­lit­i­cal grid­lock has made fur­ther fis­cal stim­u­lus an un­like­ly event, but this is com­ing at a time when the econ­o­my is al­ready slow­ing. The on­ly game left in town is the US Fed and the pres­sure is in­creas­ing for fur­ther ac­tion.

Any form of in­ter­ven­tion is like­ly to at­tempt to push long-term rates low­er and the mar­ket has an­tic­i­pat­ed this move with the US ten-year bond yield­ing as low as 2.4 per cent last week. The bot­tom line is that times are very un­cer­tain. It is be­com­ing in­creas­ing­ly ev­i­dent that nei­ther the politi­cians nor the cen­tral bankers of the de­vel­oped na­tions are able to work on a gen­uine so­lu­tion to the on­go­ing debt cri­sis. It brings the re­al­i­sa­tion that for a last­ing so­lu­tion-put your trust in God.

Ian Nar­ine is a bro­ker reg­is­tered with the Se­cu­ri­ties and In­dus­tries Com­mis­sion.