BBC News 24, 01 December 2011

On Thursday afternoon I was interviewed on BBC News 24 about the recent action taken by the central banks and comments made by Mervyn King, the governor of the Bank of England.

 

Here is the full transcript:

JON SOPEL: Presenter
Well, let’s speak now to Terry Smith, the chief executive of City brokers Tullett Prebon. He’s in our central London studio for us now.
Very good afternoon to you, thank you very much for coming to talk to us. Listening to Mervyn King today, it almost sends a shiver down the spine.

TERRY SMITH: Chief executive, Tullett Prebon
Yes, it’s a pretty grim set of circumstances that we face, and I think the governor of the Bank of England has been pretty clear about it recently in terms of those conditions.

JON SOPEL: Presenter
Should we feel reassured or worried by the concerted action of central banks?

TERRY SMITH:
I would be worried. The reason to be worried is that they have clearly foreseen some pretty grim circumstances in which banks in Europe, in particular, can’t fund the assets which they’ve got in dollars – their loans and bonds that they’ve got in dollars – in the normal markets by borrowing money. Therefore they’ve had to supply – or put in this potential supply – to prevent those banks going bust.

JON SOPEL: Presenter
Yes, because there was a rumour that one was wobbling.

TERRY SMITH:
Indeed. There’ve been rumours from people who track the borrowing rates that the banks pay for those funds. People have highlighted one of the banks as apparently paying a bit more, and therefore maybe in difficulty; but I think – even if that’s true – there’s a more general problem. Funding may be necessary for quite a few banks, not just for one.

JON SOPEL: Presenter
Now, help us with this. The governor of the Bank of England has said, ‘right, you’ – the banks – ‘you need to reinforce your balance sheets because you don’t know what’s coming down the track’. At the same time we’ve got the Chancellor saying banks need to lend more to customers. Now, are they going to be able to do both?

TERRY SMITH:
No, you can’t do both. The capital is only a ratio, in the end. Banks hold a percentage of capital – usually around 5% – of their total assets, or their loans. There are two ways of correcting the capital problem that the Bank of England Governor’s talking about. One is to raise more capital; that’s not always easy, who’s going to supply it in these circumstances? The other way they could do it is to shrink the denominator in that ratio calculation, and not lend as much. Frankly, that’s what they’re doing and they’re helped in that by the fact that, quite honestly, people don’t want to borrow money anyway. When the Chancellor talks about ‘banks should lend more and support the economy’, I think you find that, actually, quite a lot of people don’t want to borrow. And there are now net repayments going on in mortgages in the UK.

JON SOPEL: Presenter
Which, in turn, might be re-helping the balance sheets of some of these banks. I mean, the other thing that Mervyn King said was, ‘well, slash bankers’ bonuses’. Now, I’m sure that has a great popular appeal; but I would imagine an awful lot of these banks are tied in contractually. If banker A or banker B or C achieves certain things, he or she will get this bonus.

TERRY SMITH:
Yeah, there are problems. You can’t just unilaterally – however popular or even sensible it may be – go and change people’s employment contracts. If you do, I’m afraid they’ve got recourse. That’s one issue with it. Another issue with it is these banks pretty much all operate in genuine international money and capital markets, and of course at the moment there’s no sign of anybody in the other major areas of operation for them – like the United States of America – doing anything like that. So you do face competitive problems in doing that.

JON SOPEL: Presenter
And when you talked about one of the choices for the bank being to borrow more – presumably the governments aren’t that willing, because they’ve got huge debts themselves, as we’ve seen in the whole Eurozone crisis?

TERRY SMITH:
Yes. There isn’t a third party outside the banks and the governments that can supply money here. Whenever people talk about ‘a new supply of debt to rescue this situation’, what you get back to is its circular, and many of the banks around Europe have had to have liquidity and capital supplied by their central banks and their government, and that’s really the only source of capital and liquidity they’ve got at the moment. So you are in this closed system now, where there isn’t some outside new source of financing. You might recall, a few weeks ago, there was talk about the European Financial Stability fund going up 1 trillion euros in order to support the Eurozone bond markets of governments and so on. The immediate question which sprang to mind is, where’s that money going to come from? And, of course, it’s not coming from anywhere.

JON SOPEL: Presenter
Right. So there’s less to that than meets the eye.

TERRY SMITH:
Yes. There’s less to almost all these things than meets the eye. You can’t borrow your way out of a debt crisis. If you were to stop a selection of people in the street and say, ‘I’ve borrowed too much money and I’m living beyond my means, what do you think I should do? Do you think I should borrow more money and continue spending?’ They would rightly look at you as if you were mad. That’s collectively what people are trying to do here.

JON SOPEL: Presenter
I’m tempted to wrap this up with the happiness index that the Government has also been looking at. You don’t seem very optimistic at the moment?

TERRY SMITH:
No, I’m not very optimistic. I’d be quite happy to be proved wrong, by the way. It would be nice in terms of my own net worth and companies that I run, to be proved wrong about all this; but I think the facts are pretty clear here. You can’t borrow your way out of a debt crisis. Whilst measures these central banks are taking will hopefully prevent there being some sort of financial armageddon with the banking system collapsing and so on, I think it’s still going to come down. When people ask, ‘what’s the solution’, there isn’t one in the sense of a painless way out of this. You mentioned, in the earlier part of your report, the fact that people in Britain in 2015 are expected to be worse off than they were in 2002 – I think that will be quite general. We will end up accepting that we were living beyond our means, we’ve mortgaged the future, and we’ll be quite a lot poorer for a while.

JON SOPEL: Presenter
Final thought, if we could – on the euro itself, do you think it’s going to survive?

TERRY SMITH:
No, I don’t think the euro will survive. I think that it’s…

JON SOPEL: Presenter
Sorry to interrupt, I just want to qualify it slightly: you don’t think it will survive with the 17 members that are currently there, or you think that the whole thing could go?

TERRY SMITH:
I think it’s certain that it won’t survive with the 17 members there. I think there’s no doubt that Greece, and Portugal, and Spain, and probably Italy shouldn’t really be in the euro and will have to drop out of the euro in order to become competitive economies again and survive economically.

JON SOPEL: Presenter
Timescale?

TERRY SMITH:
Well, I’ve no idea on timescale, it could be anything from this afternoon to sometime next year. No idea on timescale, I’m afraid. Whether or not some kind of central euro persists with Germany at the core of it is a more difficult question. There, I think, the real critical question is what happens to France. Because France – whilst it would, obviously, for political reasons, want to stay in a central euro – actually has more economically in common with the countries on the periphery that are in trouble.

JON SOPEL: Presenter
Terry, I’m struck by the certainty that you showed there. Normally when BBC correspondents go on the telly, we say, ‘on the one hand… on the other… it’s possible this might happen; it’s possible that might happen’. When I said to you, ‘will the euro break up’, you say, ‘it’s certain’.

TERRY SMITH:
Yeah. I regard certain facts as inevitable. I’m the equivalent of the one-armed economist that you want to employ – because he couldn’t say, ‘on the other hand’.

JON SOPEL: Presenter
What a good gag. I don’t know whether it’s politically correct, and I’ll be very cautious at the moment, given all the trouble that the BBC’s in. Right, Terry. Thank you so much for being with us.

TERRY SMITH:
Thank you.

JON SOPEL: Presenter
Very good to talk to you. Thank you.

Comments

[Mahavati]

Lots of talk at the moment about Merkel's plan for a pooled tax and spend plan for the Eurozone but absolutely no mention about whether Greece, Ireland, Italy, Spain, Belgium and who knows who else can fit into it. Merkel talks about sanctions for countries who stray but what about countries who have strayed before the system has even been set up! Italy and Greece look like they have been taken over by Brussels so that looks like the plan, but it looks like the Brussels Technocrat Monti is still stuck with the same problems Burlusconi had, tax evasion, fiscal indiscipline, etc and I can't see why Monti should be any more successful than Burlusconi in sorting it out. And if the Red Brigade rears its ugly head again, all bets are off - they shot Aldo Moro so Monti better get kevlar long johns!
We also have Sarkozy whining about control over Tax and Spend staying within national borders. He just doesn't get it! Merkel is really pushing for a U.S.E. but Sarkozy talks about clinging on to fiscal powers which have virtually bankrupted France and quite a few others. I reckon Merkel will put forward her plans with a take it or I'm off attitude and I don't blame her. This is the denouement, where true European integration has to be grasped or abandoned as unworkable and undesirable. I think it will be the latter.

[John Jolley]

I'm hoping we get that referendum long promised and leave the sinking ship that is the EU.
The Commonweath is still out there and we should focus on trade with them.
England deserves better politics than we are getting at the moment with this grubby coalition.

[Terry Smith]

Steve, I agree with you about the likely outcome. Several points strike me. One is that this is merely the latest in a seemingly endless series of summits. In October 2010 Merkozy met at Deauville in France and announced a deal in which Merkel got her way with the suggestion that private bondholders should share some of the pain and Sarkozy gained acceptance that there would be no automatic sanction on countries which failed to keep the necessary budgetary disciplines. That is the exact opposite of the positions they just claim to have agreed. Even if the latest agreement produces some actual action, which would be a first, the timescale for getting the necessary changes to EU treaties and national constitutions is hardly a short one and they seem to continue to take the view that they have the luxury of resolving these matters on whatever timescale they deem appropriate. It seems to have escaped their notice that the bond and foreign exchange markets have and will set the timetable.

Finally, even if all this comes to pass and the ECB is allowed to buy Eurozone bonds in unlimited quantities, how will this solve the problem? It is a closed system: the central bank will but the bonds issued by the governments which control the central banks. At some point the Eurozone needs to sell bonds to investors outside the Eurozone, so as long as these countries need to borrow they are spending more than their tax revenues. And there is no sign of an end to that.

There was a headline on Bloomberg yesterday that Mario Monti had agreed action to reduce Italy’s debt. Wrong. He has just agreed action to stop it growing quite so rapidly. Of course, whether he will be able to enforce the action is another matter. The only real solution for most of the countries involved in order to begin to restore the competitiveness of their economies is for them to leave the Eurozone.

[Terry Smith]

To John

I hope so too. After all, we were promised one by all the main political parties at the 1997 election. The politicians are totally untrustworthy on this point and of course the thing they fear most is the actual exercise of democracy. It is no coincidence that Greece and Italy now have unelected EU appointees running them. The Commonwealth’s contribution to supporting us in the most dire circumstances has of course been swept aside in the tide of grovelling to our new friends in Europe, and like you I hope that is reversed, although of course in the interim many of our old Commonwealth trading partners have successfully found new markets in their own regions, such as Australia and New Zealand in Asia.

[David Jordan]

Terry,

Nothing to do with your today interview (and congrats on your increasing media presence by the way, assuming you want it) - just wondering if you are worried by all the favourable publicity for fundsmith recently. There has to be a limit to the size of the fund before you end up being unable to find value without distorting (actually making more efficient, but that's not a good thing :D) the market - are you anywhere near that yet?

[Terry Smith]

To David

I am not worried about any limit on the size of fund we could run without adversely affecting the returns for the foreseeable future. The average market capitalisation of the companies we invest in is about $20billion so we could manage quite a lot more money.