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The Age of Austerity is upon us!

By Marco Pietropoli, August 2010

Consultation

 

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The Age of Austerity in the UK and in Europe is upon us! The markets are starting to price in the problems we face.

I must admit that initially I was quite negative about the prospect of a coalition government. But as long as we can keep it together I am quite happy with the result. I did consider voting for either the Lib Dems or the Conservatives so that fact that they are both in government is quite a good outcome.

A broad coalition has the potential to deliver more balanced legislation. It also means that there is a wider base of support for the difficult decisions that need to be taken.

Osborne's first budget was broadly in line with expectations. It is a step in the right direction. There is a lot more to do in the next few budgets. We have finally understood that we have to try to stop living beyond our means.

The global sovereign debt crisis will intensify in the coming months due to the scale of the refinancing that needs to take place. Click here for a very good explanation of the global sovereign debt problem.

The reality is that what we are targeting at present in the UK is a reduction in the deficit. There is still no talk of actual deleveraging in the near term. Big deficits will persist for the lifetime of this parliament. We will be simply borrowing less than we would have done if Labour had been in power.

                                                   Medway Independent Financial Advisor


As a country we are at unprecedented levels of per capita debt. Have a look at the following links:

• UK Personal Debt
  UK National Debt

So why am I being so negative. Debt isn't so bad surely. It means we can all "own" a property and we can all have the latest gadgets without needing to save for them. This stimulates economic activity and creates jobs so what is there to worry about.

Well at some point the debt party has to come to an end. We have to start to deleverage as a society or when interest rates go up we will simply not be able to afford to pay the interest. I know, I know I am being negative again. Surely interest rate will never rise, money should be free. But consider this, if money is free it is not worth anything and then we have much bigger problems.

Officially inflation in the UK is currently at 3.7% CPI to 5.1% RPI. I would argue that the way inflation is calculated is flawed as the fact that flat screen TVs and IPods are going down in price means very little to the average person.

The real inflation that individuals experience will largely depend on what they spend their money on. I would argue that inflation calculation should be waited more on consumer staples (like food and soap), transport (you have to get to work), mortgage or rent and utility bills. Everything else is largely irrelevant to the average family's weekly outgoings. The fact that prices for holidays have come down is meaningless to most people that are struggling to make ends meet every month.

Of course most figures produced by government can be manipulated but to make things easy let's just focus on the inflation numbers stated above. I challenge you to find a savings account in the UK that pays more than 5% net of taxes.

So what does this mean? Money is being actively devalued. Why is that? You may ask. Well we have a debt problem, so if we make money worthless then the debt will be worthless. You are guaranteed to make a loss in real terms by having money in the bank. This is why we have an asset bubble in Equities and in Property in the UK.

But you will say that property prices have to go up because there is a shortage. Well there is a shortage at present because the banks are not repossessing property as the banks are principally state owned. The government would have to house people anyway so they may as well just pay the mortgage for them and save all the bother.

Property prices cannot continue to rise for ever faster than national average earnings. Average earnings has been coming down over the last few years as unemployment has been rising, many are now on a shorter working week and bonuses are hard to come by.

So what does all mean. Well if we are serious about controlling inflation then interest rates should be about 5% higher than they are now. The longer we wait to put up interest rates the sharper the rises will have to be and that will be very damaging to the economy.

I am very happy to be short on the FTSE 100 at present and to be long precious metals (be careful of paper Gold). Other good buys at present include:

• - Agricultural Commodities
  - Natural Gas

Chinese Equities are also starting to look attractive. But be careful and keep lots of liquid dry powder for the opportunities that are to come. Sometimes being cautious is not a bad way to go. This year is about trying not to lose money. You will be well ahead of most people if you achieve this.