Budget Basketcases

I haven't posted much of late. The main reason for this is that there are a couple of big topics that I've meant to post about, but knowing it would take a while I have never bothered to start writing them. So I didn't post anything...

The big topic in front of us at present is Government spending. Namely all those deficits and 'stimulus plans'. Our ever thoughtful governments taking it upon themselves to spend ever larger sums of unearned cash to stop the recession getting worse. How considerate.

Or not in my view...

Let me explain. In days gone by, we used to have something called an economic cycle, the main cycle often being 14-16 years in length. This had periods of expansion (where we lowered debt) and periods of stagnation or contraction (where we borrowed more). But now, following the inspired policies of intellectual heavyweights like Dubya Bush and our own Gordon Brown we are now trapped in a situation of ever-increasing debt.

The graph below of US spending (from http://www.mwilliams.info/images/obama-budget-deficit.jpg) illustrates the point. Governments (led by UK/US) now are just borrowing obscene amounts for which there is no plan to repay, despite what the spin doctors / idiot journalists say. If anyone dares question this, they are dubbed a doom-monger who does not understand the need to get out of recession. But there is a cost associated with debt, even if you don't repay it. The UK govt is likely to borrow £200bn this year (and probably the same again in 2010). At 5% bond rates (the current level) this is £10 bn of interest just to service. If rates went up to 10%, it would rise to £20bn. That is equivalent to 5-6p on the basic rate of income tax. Big sums. Now try multiplying it by 5-10 years of culmulative borrowing....

Problem is this can't go on forever. At some point time will be called on this nonsense. The likelihood of the above 10 year forecast coming true is low in my view. In the last couple of weeks, the UK has been put on notice of a debt rating downgrade. This is the equivalent of the bond markets telling us to get our house in order quick. Inspired policies like printing money (sorry QE) won't get us out of this pickle. Indeed they will make it worse as debasing our currency discourages bondholding, further driving up bond rates. At some point, we'll have to act - possibly drastically as in places such as Iceland (headline interest rates fluctuating in 10-20% range) or Ireland (drastic public sector cutbacks and 10% pay cuts). If we don't then we'll be consulting the Bob Mugabe book of fiscal discipline for ideas!

Meanwhile our leaders put off much needed activity - similar to my blogging really...

Fear and Greed!

Now's both a very scary and exciting time to be watching the global economy. I often find myself trying to measure sentiment - be it at a national level, corporate level or individual (people watching?). In a relatively short period of time, the mood can change noticeably. Does it follow any pattern?

The wave pattern below (hat tip to John Nofsinger) is one of my favourite charts and I mentally refer to it on a regular basis when observing situations. It's based on the Kübler-Ross grieving cycle and shows how sentiment can affect investment cycles, particularly bubbles.
You can apply this to many situations and markets. At present we are spoilt for choice as many situations are currently sliding down the euphoria-fear-despondency stage of the cycle. However, economies and markets need not be at the same point in the cycle as each other, since some things lead/lag others.

The best current example for tracking sentiment is the housing market. The UK peaked in mid-2007 when it was popular to view property as a one-way bet to millions. Since then we have started to slide down the chart. My guess is that we are (in Jan 09) in the process of moving from fear to desperation and are moving along a step every 5 months or so.
In the US, they are about 12 months ahead of us on the down curve. I'd guess that they are now at the capitulation stage and the market could bottom in the next year.

It goes without saying that everyone has their own opinion on where things are in the cycle! Still it's an interesting approach to watching the world evolve...

Edit (22/01): Just seen a forum discussion asking where we are in the housing cycle. The consensus view seemed to be between denial and fear at present and moving slower than I thought. So there you go!