16th October 2009

Potential Euro-fracture?

Euro fractures - whilst much blame for the financial crisis has been thrown in the direction of the mud splattered ‘Anglo-Saxon’ financial regime, that is certainly not to say that all is fine and dandy in the ‘non Anglo-Saxon’ Euro world. Previously we could identify the difference in policy interpretation and financial discipline between the ‘euro-core’ nations of Germany, France and the Netherlands as opposed to the PIGS (Portugal, Italy, Ireland, Greece and Spain). However, now there has been a worrying shift in attitude by certain members. After elections in Greece, the new left wing government seems bent on increasing debt levels rather than reining in costs, and now the French have announced that they will be no longer aiming to reduce their budget deficit to the required 3% of GDP level by 2012. This of course was one of the main planks of the Maastricht Treaty.

In effect this means that we are going to be seeing an adjustment in the two groupings within the Eurozone with Germany, the Netherlands, Finland and Austria on one side and then the rest making up the other group. The key message from this is that financial discipline across the single currency is breaking down. Whilst this may not mean the imminent demise of the currency (although many Tories would be yelping at the thought), it certainly may call into question its longer term stability. Such questions will call into question the various interest rate levels as well as sovereign fund rates and even the potential for default. The main protagonists here are Ms Merkel and Mr Sarkozy – it may well be their behaviour and attitude that will influence the next moves.

And speaking of Anglo-Saxons, the battle booty found in Staffordshire recently brings us back to the question of gold again. With 11lbs of the metal along with 5.5lbs of silver being uncovered, it was certainly not an inconsiderable haul.  As a side point you can imagine the conversation after the battle sometime in the 7th century. “So Baldric, where did you put that bag of loot I told you to look after?” Which may well have been followed by “what bag sire?” These of course may well have been his last words.

My colleague Peter Sleep, pointed me in the direction of a book called ‘The Golden Constant’ by Roy W Jastram published in 1977. In this he highlights the consistency of the metal in that even if melted down, it will never change either its weight or chemistry. Furthermore, he also highlights the consistency of its price over time as well as ‘its purchasing power in the middle of the twentieth century was very nearly the same as in the midst of the seventeenth century’.

So what’s the value of the Staffordshire haul? Well 11lbs works out as 160.416 troy ounces, and thus the bullion value (not archaeological value) at today’s prices would be approximately $159,020. Now if we applied Jastrams equation for providing the historical value, we can arrive at a figure of $569 if tracked back to 1343 when his index started. Then if we surmise, we could use the same formula to take us back to the mid 7th century, we can calculate a value at that time of just $2.0347!

Now bear with me for another leap of faith and fiction, supposing that Baldric hadn’t lost them but rather had been able to meet one of my forebears at an earlier version of 7IM, presumably VII IM, his advice might have been to go and buy some 2% Government Consols for a long term hold. With the much ignored power of compounding, that would have provided our modern day treasure hunter with a bullion value of $762 trillion (that’s 12x global GDP (IMF)), or even at 3% $568 quadrillion – not bad for a couple of bucks. If only Chancellor Darling had met Baldric on a blood soaked Staffordshire battlefield, then maybe all our national financial problems would be solved – well maybe not.

Latvian fears are rising again as their economy is sliding towards potential currency devaluation and possible bankruptcy, and with it fears that their neighbours may get dragged down with them. This Baltic crisis maybe a financial sideshow compared to the larger economies but their impact could be just as devastating if it cripples the Nordic banking system.

Proposed Latvian legislation is currently being considered which would allow banks only to claim the value of mortgage properties rather than the mortgage value itself. This could prove very damaging as many properties have already dropped by 70%. Add to this that some 80% of mortgages are denominated in Euros and thus any devaluation will only further exacerbate an already dangerous situation.

So the government faces the ‘judgement of Solomon’. Keep the Lat pegged to the Euro and suffer an extended period of rising unemployment, falling wages, deflation and no doubt civil unrest, or devalue now and face the increased economic pain but potentially for a shorter period as economic competitiveness aids recovery. A news story to watch.

At least one bank is significantly benefiting from its more pragmatic and conservative position and policy.  HSBC has of course been affected by the financial fiasco, but it has managed itself very effectively through the minefield and after a successful refinancing, now finds itself in a superb position to acquire discounted assets in strategically, for them, perfect locations.

As their name implies, their oriental pedigree is clear and thus a chance to buy up assets at, if not at distressed prices, then certainly at little premium - an opportunity which cannot be overlooked. The assets of both the distressed banks ING and RBS, in the region, would be excellent additions and although others will be in the hunt, like OCBC in Singapore and Standard & Chartered, the opportunities are remarkable for them. It’s good to be in the right place at the right time – with the right balance sheet.

And finally... good news for New Zealand patriots –  your country just got a bit bigger: bad news for New Zealand patriots - you just got closer to Australia.  Following an earthquake New Zealand has grown westwards by some 30 centimetres. That should improve the fishing and oil drilling rights then.

And another and finally…..the latest suggestion for controlling the southern march of the Sahara Desert has taken a leaf out of Emperor Hadrian’s book and proposes to build a 6,000 kilometre wall from Mauritania to Djibouti made from existing sand dunes and then covering them with the bacterium Bacillus Pasteurii which is commonly found in wetlands. This apparently will have a geological effect not dissimilar to that of ‘Imodium’ and will set the dunes like concrete within hours. Sounds like a good idea but I am sure they will never get planning permission.

Have good week.

Justin A. Urquhart Stewart
Director
Seven Investment Management Limited