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Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories: Banks: there’s a black hole in their balance sheets. How will gold be affected as banks build up capital? Baby boomers sleep walking into disaster. US did better than thought. India sees growth slow again, as Sweden and Switzerland enjoy pick-up


Banks: there’s a black hole in their balance sheets  but will gold fill it?

Apparently scientists have discovered a black hole in a galaxy far far away, which is no less than 17 billion times bigger than our Sun. Of course, because of the time it takes light to travel this galaxy also existed a long time ago. But it is difficult to get your head around the size of this thing. How many times is the Sun bigger than a table tennis ball, do you think? 17 billion may be a reasonable guess: answers on a post card please.

While acknowledging that the black hole is big, however, Mervyn King said it is important to put it into perspective. “It’s manageable,” he said.

Okay, time to come clean, the Bank of England governor was talking about a different black hole; one that exists here and now, but may get bigger over the next few years.

Dr King’s black hole costs roughly 100 billion times more than a table tennis ball. That’s because he reckons that banks may be under capitalised by between £25 and £50 billion.

It’s our old friend the International Financial Reporting Standards (IFRS) – or at least it’s partly that.

It’s not necessarily the banks’ fault. They apply the accounting standards they are told to apply, but it does rather look as though the assets on the balance sheet have not been accurately measured. This has distorted profits, and may have led… cue drum roll… to distorted bonuses.

Potential fines over LIBOR and PPI come into the equation too.

Commenting on the problem, Mervyn King said: “The problem is manageable and is already understood at least in part by markets. But it does warrant immediate action.”

But the same old quandary applies. How are banks to lend more money, and build up capital at the same time? It is a little confusing. But then again, black holes are pretty mysterious.

How will gold be affected as banks build up capital?

The thing about gold is that it’s an asset. And banks are supposed to be increasing their capital asset ratio. Theoretically, gold is one of the things they might have to sell in order to improve their ratios.

The problem is compounded because, under Basel III rules, gold may be defined as an illiquid asset.

So there’s some irony for you. Gold is supposed to be a safe harbour; a place of refuge, but as banks try to reduce risk and build up capital they may be forced to sell that pretty yellow metal.

On the other hand, a number of those people who make up the powers that be who decide these things believe gold should be re-classified as a high quality liquid asset. This debate is pretty crucial and may determine the long run price, so watch this one unfold.

As an aside, it is worth nothing that banks don’t have to set aside so much capital against certain assets. Property for example is considered low risk. A bank which sees a high percentage of its assets in the form of property can enjoy higher leverage than one that has higher exposure to more risky assets. Likewise, gold is seen as less risky.

It’s all back to front of course.

In order to meet regulatory requirements, and as these requirements are changed to favour gold, banks are more likely to invest in property and buy gold, than lend to business. And what will happen to the economy if all banks do is to park their money in these so called safe assets? Well this is what would happen, just about all dynamism would be squeezed out of the economy, economic growth would be flat – that is if we are lucky – banks would start making losses, and regulators would respond by trying to get them to put more emphasis on buying low risk assets.

That is not to say that banks should not improve their capital ratios, but regulators need to face up to the fact that so called low risk assets do in fact pose massive risks to the macro economy.

Baby boomers sleep walking into disaster

The fact you are reading this means you are not typical. (Actually the fact you reading this means you are blessed with exceedingly good taste, of course.) But in addition to your good taste, you are probably more financially savvy than the average person.  Now, let’s say you are approaching retirement: how much can you expect to receive from your private pension? Do you know?

According to the Institute of Fiscal Studies no less a third of those approaching retirement find it impossible even to hazard a guess as to how much income they will receive from their private pensions.

If you want a rough rule to work out how much your pension income will be here it is. The rule is as follows: “it’s not enough.”

The retirement of the baby boomers is a common theme here, but that’s because it’s important.

Some economists still believe in the absurd idea of the efficient market hypothesis. Many of those same economists used to say we can’t have a debt crisis in the making because for this to happen households would have to borrow more than they can afford, and why would they do that? An even more extreme take says fiscal stimulus can’t work, because when a governments spends more, households realise tax will go up a later date, and in anticipation of this they will save more. It’s nonsense of course, but that’s what some highly educated people believe.

The truth is that the markets have gravely underestimated the impact the retirement of the baby boomers will have.  Anyway, a more details analysis of the IFS report will follow soon in thought for the day.

US did better than thought

If only the data had been released sooner, then Barack Obama may have won the US election. Okay, he won it anyway, but if we lived in a parallel world – one in which Mitt Romney had won – that’s what Democrats such as Paul Krugman might be saying right now.

For in the third quarter of this year, the US economy did better than originally thought.

Q3 annualised growth was revised upwards from 2.0 to 2.7 per cent.

It’s an odd thing but while the news on the US economy continues to be better than most had expected, economists keep suffixing their analysis of US data with words such as: “but, things are set to get worse.”

So while the bulls have been given yet another reason to stamp their feet, and lower their horns (remember US Consumer Confidence is now approaching a five year high, according to Conference Board data out earlier this week), the bears still find reasons to stand up.

Chris Williamson Chief Economist at Markit, said: “The pace of expansion is set to be the best we will see for a while. Austerity measures to be introduced in the New Year are set to dampen some of the key factors that have helped boost the economy so far this year.”

Paul Ashworth, Chief US Economist at Capital Economics, said: “Inventories are now estimated to have added 0.8 per cent to overall GDP growth, whereas the first estimate indicated that they subtracted 0.1 per cent. The bigger the build-up in the third quarter, the more likely we are to see a run down in the fourth.”

Truth be told, as was indicated here yesterday, there is something odd about the US economy. US consumers are still heavily in debt, but their confidence is rising. US corporates can barely move without tripping over the money clogging up their offices; can barely sleep for all that money sitting under mattresses, and yet if you drill down into the data on US GDP you find  business investment contracted by 2.2 per cent.

India sees growth slow again, as Sweden and Switzerland enjoy pick-up

It’s reforming, but is it enough?

India’s government has been beavering away changing rules on foreign ownership of multiband retailers and in the aviation business, but still India slows.

In Q3 India’s economy grew by 5.3 per cent from 5.5 per cent in the previous quarter. The OECD recently projected India’s growth will rise back up to 7 per cent by the end of next year. The US Institute of Supply Management  in that same report, which was covered here recently, forecast that France will be the worst performing economy in the world over the next ten years. It also forecast that India’s growth will slow to an average 4.7 per cent per year between 2013 and 2018, and then slow again to 3.9 per cent between 2019 and 2025.

Meanwhile, Sweden’s economy saw a 0.5 per cent expansion in Q3, from zero growth in Q2, while Switzerland expanded by 0.6 per cent, after contracting by 0.1 per cent in Q2.  In Switzerland, a boost came from government spending and businesses’ stock building. In Sweden, trade helped to give a lift, but this was largely down to falling imports.

In the case of Sweden and Switzerland, their problem next year will be the extent of their exposure to the euro area.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


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