By Erol Riza
The famous phrase which has been used many times since it was first uttered dates back to the 1992 presidential campaign of Bill Clinton who successfully unseated President George Bush. With the current financial mess which was created by the financial sector and has plagued the world economy, the phrase seems to regain importance.
The recent stock market rout which started in China has brought to the surface the biggest bubble in recent history and is due to the quantitative easing (QE), according to some financial analysts, which central banks have embarked upon to help economies recover since the financial disaster which started in 2008. This new financial distress has brought to the fore emerging market currency problems and we are now witnessing the inability of the European Central Bank (ECB) to get prices rising in the Eurozone. These developments are symptoms of a malaise which is linked to the conviction of some governments, and central banks, that austerity works and no aggregate demand support must come from increasing public spending. The only thing that QE has succeeded in doing in the EU is to make the holders of financial assets richer and thus broaden the inequality of societies. As a byproduct of QE, the euro has weakened and some countries’ exports may seem more attractive.
The key ingredient in recent economic history, which is a testament to bad economic governance of governments and stewardship by the central banks, is that all the money they have thrown at banks and financial institutions has not translated into the much needed investment needed to boost growth and employment. To add insult to injury many US corporates have chosen to borrow money, given how cheap central banks have made it to borrow, and use funds to buy back their shares. The most notable example is Apple, with a cash balance of possibly USDS40 billion, which has recently borrowed in euros for tax purposes.
Lawrence Fink, chief executive of BlackRock, Inc, the world’s largest money manager, argued as much in a March 31 2015 letter to S&P 500 CEOs. “More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while under investing in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
Thus, instead of seeing corporate investment to boost growth and employment, we see that the low cost of borrowing is creating the biggest ever bubble in bond markets, real estate and a misallocation of resources.
The ECB had hoped that by buying bonds off the holders such as pension and insurance funds the “animal instinct” to invest risk capital would lead to more lending to SMEs and to growth. It is hard to believe that the ECB and the EU Commission feel the SMEs need more debt when in fact what is missing is equity capital.
If the wake up call from China is not fully appreciated then we will see more attempts by central banks to cheapen credit more, when in fact, after seven years of cheap credit, the time is for interest rates to rise, at least in the USA and UK. It is important to note that events in the Chinese and emerging markets made it difficult for the Federal Reserve to raise interests last week due to concerns about the global economy. The concerns will linger so long as investment is missing and, thanks to austerity, the only investor that could make the difference is the public sector which can borrow at historically low rates.
If the governments of the world have forfeited their responsibility to promote growth, investment and employment then they should tell their voters. It beggars belief that when many Eurozone countries can borrow at ridiculously low interest they take measures to help SMEs to borrow when the governments know that the world needs infrastructure investment. The madness of the EU Commission has gone far enough to hope that the private sector will help the raise funds available for the Juncker plan (not new funds but cut from other budget items) to finance infrastructure investment. It takes several years to prepare the necessary conditions for large investments to take place and it is arguable if such investments will help the south of Europe which has a bad record of investment standards.
The current crisis can get out of control and it is no surprise that Carl Icahn, a famous savvy investor, has predicted a catastrophic turn of events thanks to central bank mismanagement. The irony is that when the FED in the US saw the reaction of the equity markets to concern about global growth (stock markets fell sharply thanks to no change in interest rates) the FED officials, or at least some of them, suggested rates will go up before year end.
When the central bank of the largest economy in the world, and a trend setter in global interest rates linked to the US bond market, behaves in this clumsy way how can any private sector investor such as a pension fund or an insurance company (the patient capital that can invest in infrastructure) have confidence in the economic and financial environment.
For those who wonder why this should bother the government in Cyprus, in my view, warning bells should ring loudly. When risk is not taken globally due to uncertainty, the foreign direct investment, so necessary for Cyprus, will not be available. I think that there has to be a reality check over Cyprus’ dependence on what happens in the Eurozone and the world at large. Cyprus banks cannot finance growth with long term investment capital due to regulatory issues and to their decision to keep the non-performing loans on their balance sheet; in fact banks in Cyprus may need to be recapitalised due to valuation of their collateral undertaken now by the ECB.
There is a compelling need to have viable projects that can attract funding and provide sustainable growth and employment; these are typically infrastructure and require long term capital. Instead we have seen that foreign investment has taken place in banks and real estate. Unless public investment is increased, and there is a refocusing of the economy to boost investment and growth, unemployment will remain stubbornly high. The big challenge for the Cyprus government is to promote the sectors that can attract sustainable investment and not opportunistic investment in the financial sector and real estate.
Erol Riza is the founder and managing partner of SME Markets Ltd and former member of the interim board of the Bank of Cyprus