Terry Smith Straight Talking

UK should leave the EU and join NAFTA

There is a good article in the Wall Street Journal suggesting that the UK should consider leaving the EU, which has strayed a long way from its free market origins and is set to go further, and join NAFTA:

http://online.wsj.com/article/SB10001424052970204791104577110163558996698.html

Exchange controls may be introduced within the Eurozone

There is an interesting article by Bill Jamieson in The Scotsman. He discusses preparations for the possible introduction of exchange controls and controls on the international movement of capital in Europe which I have been saying for a while may be a necessary response to a run on Euro deposits in the other PIIGS if or more likely when Greece exits the Eurozone:

http://www.scotsman.com/lifestyle/arts-blog/bill_jamieson_apocalypse_could_be_now_for_euro_1_2028344

Climate Change: 1%+1

When I posted my first comment on this subject on this blog and said I was a climate change sceptic I acknowledged that it was a dangerous thing for me to do. As expected, I have come in for criticism from some of those posting comments, and from others. Much of this criticism uses the language I predicted in that post: I am described by many critics as a climate change ‘denier’. This shows the nature of the approach of much of the climate change lobby.

Firstly, they asserted that the science on this matter was settled. When a number of scientists pointed out that this was not so, they have moved onto the language of religion. Climate change for many of them has become a belief and anyone, like me, who still required proof was a denier-someone who refused to accept a belief or assertion.

I was told in a recent comment on my blog that ‘It has been agreed by 99% of climatologists that global warming is man made.’. I asked the person who posted the comment where the 99% number came from (I could equally have asked for the evidence of global warming, let alone the man made assumption) but have yet to receive a reply. Even if this were correct, which I doubt, the number of sceptics/deniers in the scientific community just gained one rather important public addition.

Last week Professor Richard Muller, of Berkeley University in California, and his colleagues from the Berkeley Earth Surface Temperatures project team (BEST) published a paper claiming to have shown that the planet has warmed by almost a degree centigrade since 1950 and is warming continually. The findings were reported uncritically by BBC, The Independent, The Guardian, and The Economist, and The Washington Post said the BEST study had ‘settled the climate change debate’ and showed that anyone who remained a sceptic was committing a ‘cynical fraud’.

But yesterday’s Mail on Sunday revealed that a leading member of Muller’s team - Professor Judith Curry - has accused him of trying to mislead the public by hiding the fact that BEST’s research shows global warming has stopped. Curry states that the project’s research data show there has been no increase in world temperatures since the end of the Nineties and now Muller has admitted that the BEST data suggested that world temperatures have not risen for about 13 years.

The full Mail on Sunday article is a must read: http://www.dailymail.co.uk/sciencetech/article-2055191/Scientists-said-climate-change-sceptics-proved-wrong-accused-hiding-truth-colleague.html.

Others have also found misgivings in the BEST paper - http://thegwpf.org/the-observatory/4230-best-confirms-global-temperature-standstill.html. “Indeed Best seems to have worked hard to obscure it. They present data covering more almost 200 years is presented with a short x-axis and a stretched y-axis to accentuate the increase. The data is then smoothed using a ten year average which is ideally suited to removing the past five years of the past decade and mix the earlier standstill years with years when there was an increase. This is an ideal formula for suppressing the past decade’s data.”

I wonder if The Washington Post stands by its editorial now? As the BEST report has shown, there is a serious debate still to be had and we should not be afraid to have it.

BBC Radio 4 Today Programme, 27 October 2011

This morning I was interviewed on the BBC Radio 4 Today Programme. Twenty five years ago today, the Big Bang completely changed the face of British finance. Here is what I had to say on the matter (click here to listen to the full clip):

EVAN DAVIS: Well, we go straight to the City now, Simon Jack is there. He’s not in a tent or outside St Paul’s but he’s down there to gauge the market’s reaction.

SIMON JACK: Morning, Evan. Yes…

EVAN DAVIS: Morning Simon.

SIMON JACK: Good morning. I’m on the trading floor of RBC Capital Markets in the City. Initial indications are that the deal has been received positively. Shares in Asia – the Nikkei, for example – up nearly 2% and all indications are that we’ll get a strong opening on financial markets here in Europe when they open at eight o’clock, so a big day for the market.

It’s a big day for another reason as well. Twenty-five years ago today was the ‘Big Bang’, that’s when rules and regulations were stripped away, open outcry was replaced by the banks of screens I can see in front of me now. The Square Mile since then has been a hotbed of financial innovation. I met Terry Smith, the Chief Executive of Tullett Prebon in the City, he’s a veteran of the City and I asked him how life and work here has changed since that day.

TERRY SMITH: It’s become more professional, in most senses at least. People used to get in late, go home early and have a long, often liquid, lunch, now it’s quite an intense working environment. Secondly, the ownership has changed. The City was dominated by partnerships owned by individuals who took unlimited liability often for their actions; and of course, the really big change was that people either acted for clients or they traded on their own account as a principal and they didn’t do both. And that’s the big thing that changed because I think it introduced some quite big conflicts of interest.

SIMON JACK: Do you miss the pre-Big Bang days?

TERRY SMITH: Yes, I think anybody who was there before is bound to have a touch of nostalgia for it. I mean, it was much more of a club and people knew each other and it was a jolly environment. I mean, everybody had a nickname in those days. There was a member of the Stock Exchange who had a Victoria Cross and his brother who had the Military Cross, and his brother’s nickname was ‘The Coward’, and it was just a bit of… a bit of fun, that kind of thing really.

SIMON JACK: What was your nickname?

TERRY SMITH: I think it was Top Cat actually, if I think back to it.

SIMON JACK: That’s not a bad nickname.

TERRY SMITH: Well, my initials are TC, that’s why. The Coward’, I like that.

SIMON JACK: Now, we’ve now come inside to one of the City’s well-known restaurants, we’re now heading towards lunchtime. This would have been quite a big part of the day, wouldn’t it?

TERRY SMITH: Yes, it would. Lunch was a very important part of doing business prior to Big Bang. Cheers.

SIMON JACK: Cheers.

TERRY SMITH: And it would have been quite normal for people to be lunching with clients and it would have been quite normal for them to be drinking.

SIMON JACK: Has the fun gone out of it, and how did that happen? Was it the arrival of American, more professional organisations, in the ‘80s?

TERRY SMITH: Yes, it was really. The working day expanded; people started earlier. The lunch went out of the window, so to speak, and the trading day just continued to go on. Once people were no longer subject to going on to a floor to trade with each other, they could do it electronically, you’ve got to the point now where people will quite regularly trade on their BlackBerry from home.

SIMON JACK: And 25 years on have things changed for the better?

TERRY SMITH: No, I would say they probably haven’t. There were certainly some things that needed reform - Big Bang - but it basically took away the regulation based upon principles where people knew what was right and wrong and didn’t need a rule book and it took away people acting in the interest of customers, people started to act for their organisation trading against the customers.

SIMON JACK: And ‘twill ever be thus?

TERRY SMITH: Yes, I think it will ever be thus unless you go back to a world in which you just had a set of very loose principles and you have a wise man or woman at the top. The thing that used to exist before Big Bang was the Governor’s eyebrow. If the Bank of England Governor in a meeting with you raised his eyebrow when discussing what you were doing that was enough to make you stop.

SIMON JACK: Both eyebrows raised at the moment I think.

TERRY SMITH: I would think the Bank of England Governor is in danger of getting into the position of the boy with the chemistry set who blows both eyebrows off in the lie of events.

SIMON JACK: Terry Smith, thank you very much.

TERRY SMITH: Thank you.

George Osborne’s speech

This evening I am speaking at a Centre for Policy Studies fringe event in conjunction with Tullett Prebon in Manchester at the Conservative Party Conference called “Be bold for cuts”.

I’ve just been listening to the Chancellor’s Conference speech in which there was much to both agree with and with which to differ.

It was good to hear George Osborne acknowledge ‘You can’t borrow your way out of debt’. This point has yet to register with Ed Balls and the pseudo Keynesians who have not figured out that we are in a debt crisis and that further deficit spending will have less and less effect in stimulating the economy. They ignore Einstein’s maxim that to repeat the same actions and expect a different result is insane.

It was also good to hear him acknowledge that the Government was not willing to increase deficit spending and so gamble with its credibility in financial markets, although it may be a mistake to assume that those markets will continue to allow us the luxury of reducing the deficit as and when it suits us.

I thought his views on interest rates were less sound. ‘Nothing would be more fatal for an economy as indebted as ours than a sharp rise in interest rates.’ He went on to say that ‘because banks are damaged they won’t lend at the current low rates’. This confuses two concepts-whether the banks can raise deposits to lend at these low rates, which they clearly can’t and the damage which has been done to their capital bases and creditworthiness by the crisis. Low rates do not adversely affect banks’ capital or creditworthiness, but since no sane depositor would put money in a bank at the current virtually zero rates, raising rates would help banks to gather deposits and lend them. It is worth bearing in mind that 20 years of low rates do not seem to have done much for the Japanese economy.

George Osborne’s solution to this weak bank lending so-called ‘credit easing’ or government guarantees of some business loans is totally misconceived. If you thought the banks were bad at lending, wait until you see what happens when the government try it.

It was, however, good to hear him say ‘I’m a believer in tax cuts’ even if no meaningful cuts can be forthcoming until the deficit has fallen significantly. The surest way to stimulate an economy is to leave as much money to be spent by those who earned it.

He is right ‘For generations to come, people will say: thank God Britain didn’t join the Euro.’

He was also right that the public sector unions are wrong to strike for pension rights which are more generous than those of their paymasters-those of us who work in the private sector.

But it was disappointing to see the Chancellor join the ranks of the warmists with his statement that ‘climate change is a man made disaster’. Assertion Mr Chancellor is not the same as scientific proof. The taxpayer and business can ill afford more totally irrational subsidies to wind farms, solar power and biodiesel or support for the frankly fraudulent carbon trading scheme. Stick to the day job: make some real cuts, get the deficit down and then cut taxes to stimulate the economy. Leave the weather forecasting to others.

ETFs - you were warned

The losses of $2bn incurred by an allegedly rogue trader on the Delta One desk at UBS have again raised the subject of the (lack of) risk controls by banks dealing in opaque instruments, the need to separate investment and retail banking and the risks inherent in ETFs.

I have written over the past year about the unappreciated risks in ETFs and it is probably time to bring these thoughts up to date.

ETFs are regarded by many investors as the same as index funds. They clearly are not:

1. Some ETFs do not hold physical assets of the sort they seek to track. They are "synthetic" and hold derivatives. This gives rise to a counterparty risk, and as we saw with the UBS incident, some interesting risks within the counterparties supplying the basket of derivatives. What if (when?) such ETF trades cause such a mammoth loss in a counterparty which does not have sufficient capital to bear the loss and pay out under the derivative contract? Answer-the ETF will fail.

2. ETFs do NOT always match the underlying in the way people expect. Because of daily rebalancing and compounding, you can own a leveraged long ETF and lose money over period when the market goes up but during which there are some sharp falls. Equally, you can own an inverse ETF (which provides a short exposure) during a period when the market goes down but there are some sharp rallies and lose money. This actually occurred with some inverse ETFs in 2008. I would strongly suggest that people would not expect to be leveraged long and lose money if the market goes up or short and lose it when it goes down.

3. Because you can exchange trade these funds, they are used by hedge funds and banks to take positions and they can short them. Because they can apparently rely upon creating the units to deliver on their short, there are examples of short interest in ETFs being up to 1000% short i.e. some market participant(s) are short 10 times the amount of the ETF. If the ETF is in an illiquid sector, can you really rely upon creating the units as you may not be able to buy (or sell) the underlying assets in a sector with limited liquidity? The danger of allowing short sales which are a multiple of the value of a fund in an area where it may not be possible to close the trades by buying back the stocks are clear, but amazingly, during the debate in which I have been engaged by various cheer leaders for ETFs, they have claimed that there is no such risk in shorting ETFs. They clearly do not understand the product they are peddling, and if they can't what chance has the retail investor got?

4. Although ETFs are billed as low cost they are also the most profitable asset management product for a number of providers. How can this apparent contradiction be so? The answer is that the charge for managing the ETF is only one part of he cost. There are also the hidden costs in the synthetic and derivative trades which the provider undertakes for the ETF.

As a result of all this I have long thought and written that there is a certainty that ETFs are being mis-sold to the retail market and that the risks that are being incurred in running, constructing, trading and holding them are not sufficiently understood. After the UBS incident I think this should be regarded as indisputable.

10 January 2011: Do you know what’s in your ETF

24 May 2011: ETFs – worse than I thought

Financial Times, Letter to the Editor - We have to be told just how bad the situation is

Today’s Financial Times published my letter to the Editor concerning the financial crisis. Here is the letter in full.

From Mr Terry Smith.

Sir, I refer to the debate being conducted in the pages of the Financial Times between those who propose further Keynesian measures, such as Martin Wolf ("Struggling with a great contraction", August 31), and those who do not accept that they will work, such as Wolfgang Schäuble ("Austerity is the only cure for the eurozone", September 6).

Such so-called Keynesian measures as advocated by, among others, Ed Balls, Samuel Brittan, Paul Krugman, George Magnus and Barack Obama as well as Mr Wolf have not worked to date, and they will not work. Their advocates seem to assume that their repeated failure to solve our economic problems just means that the medicine must be repeated, which reminds me of Richard Nixon's motto that "if two wrongs don't make a right, try three".

I say "so-called" Keynesians because these advocates seem not to realise that Keynes' theories did not rescue us from the Great Depression. They are also asymmetric in their application of his theories - calling for ever larger deficit spending, having overlooked the bit about running a surplus in a boom. But above all, they do not seem to realise that they cannot work in a period of debt deflation in which a recession is preceded by the collapse of the banking system, as their current failure is demonstrating.

To the ordinary person in the street, the idea that we can rescue ourselves from a crisis caused by excessive borrowing by borrowing even more must seem mad. In this respect they are possessed of far more common sense than those who are currently advocating just such a course of action and purport to be our leaders.

The first step in rectifying this situation should be to make a clear and unambiguous statement about the actual debt the UK is carrying.

To give a lead to this, today we have circulated to every member of parliament a tin can emblazoned with the UK debt figure - £3,589bn including commitments for public sector pension commitments, private finance initiative and banking sector guarantees, so that they can see what it is they are metaphorically "kicking down the road" with their present policies. This, ahead of the party conference season, I hope might spur some considered and honest debate on this issue.

It is time for those who wish to lead us out of this crisis to tell people how bad the current situation really is and the painful remedies which will be needed to remedy it.

Terry Smith, Chief Executive, Tullett Prebon, London EC2, UK

Commenting on the euro crisis on the Today Programme, BBC Radio 4

Events in the financial markets are sometimes accompanied by similar events in the natural world almost as mood music-nature doing its worst to match man. The 1987 stock market crash was preceded by an extremely rare  hurricane in the UK. I have been in New York for the past two weeks where I have had the experience  of a rare earthquake and we are currently awaiting Hurricane Irene. I was interviewed this morning by Evan Davis on Radio 4’s Today programme about the tremors affecting the global economy and the ominous storm clouds that are closing in on the financial markets.

Credit Default Swaps (CDSs) on many banking institutions across the world, essentially the cost of insuring against the bank failing, are implying significant risks of default, similar to those after the collapse of Lehman Brothers in 2008.  This is not without good reason.  Banks across the world have significant and potentially fatal exposures to the sovereign debt of countries which are increasingly looking insolvent and in many cases have yet to come clean about the true depth of problems in their mortgage and real estate lending.  Whereas in 2008 governments had the capacity to support the debts of these ailing institutions this is no longer the case.  That particular solution or rather palliative is no longer workable as many governments are no longer seen as creditworthy and cannot borrow. There is no one else who can stump up the money needed.

As a result, the solution is unpalatable.  As I have said many times before, the Western world has been living beyond its means for a very long time and as result the debts we are now faced with are insurmountable.  In the intervening period until we work them down by the tried and trusted method of spending less and saving more, we will all be a lot poorer than we thought we were. The so-called Keynesian solutions are not working and will not work. Despite huge deficit spending to stimulate economies and support the banking system, Western economies are stalled and likely to remain so. Further deficit spending and stimuli will not change this-they will merely make the problem bigger. The problem being that we entered this depression a) with too much leverage and consequently the banking system went bust as  precursor of the downturn; and b) with existing large deficits (the so-called Keynesians are asymmetric in their attempts to apply his theories-they only want to run ever growing deficits in the downturn-they forgot the bit about running a surplus in the boom so as to prevent excesses and provide ammunition when spending needed to be ramped up).

If you asked a man or woman in the street if the solution to being in too much debt was to borrow more I think they would regard you as mad. Because in these circumstances the rules for finding yourself in a  hole apply-stop digging!

I will lend my full support to the first political leader of any persuasion or party who has the insight and courage to stand up and tell us the truth about the situation we are faced with.

You can listen to a clip of the interview here.

 

Tobin Tax

The “leaders” of the EU and USA continued sleepwalking towards financial disaster in the past few days.

As equity markets took fright as the Philadelphia Fed Index produced some disastrous figures especially for new orders which almost certainly presage a renewed US recession, US home sales faltered and the Fed had to lend $200bn to the Swiss National Bank presumably because a major Swiss bank was having difficulty funding itself, President Obama returned from a bus tour of the Midwest, interspersed with “town hall” meetings. How this was supposed to address the financial crisis is beyond me and it smacked of early electioneering. He has now gone on a well deserved (sic) vacation to Martha’s Vineyard.

Meanwhile President Sarkozy and Chancellor Merkel returned from their holidays to hold a summit at which they announced no substantive measures to deal with the Eurozone crisis. However, in the best traditions of shooting the messenger, they announced plans for a financial transaction or so-called Tobin tax in Europe. Their intent is clear. If they can only stop the pesky traders demonstrating that the Euro is built on sand and a number of its members are insolvent by a combination of banning short-selling and dampening all financial dealing, all will be well. The EU tax commissioner estimated that the tax could raise €30bn-€50bn.

Of course, this rather misses the point that to effect a cure you need to treat the causes, not the symptoms of disease.

More importantly, it ignores the lessons of history.

Sweden is the only country to have tried a Tobin tax, of 0.5%. It raised only one thirtieth of the proceeds predicted by its proponents and was scrapped after eight years. The taxes sparked an exodus of financial activity from Sweden. By 1990 60% of the trading volume for the top 11 most traded Swedish stocks had moved to London. Trading for over 50% of all Swedish equities had moved to London by 1990.

The capital and money markets are moveable. They mostly are only represented by a phone call between participants and some data in computers. If the EU adopts these measures, we can only hope that the UK has the good sense to ignore them. After all, it is not the UK’s job to defend the Euro. We thankfully are not members. Frankfurt and Paris’ loss will produce gains for London, Geneva, New York, Singapore and Zurich. 

The politicians who are “leading” us in this crisis have no grasp of the functioning of markets or of history.

Discussing the global economic crisis on the Today Programme, BBC Radio 4

Today I was invited back on the Today programme on BBC Radio 4 to give my views on the ever worsening Eurozone debt crisis.

However, overnight the downgrade by Standard & Poors of US debt to AA+ status brought the issue of America’s own debt situation into sharp focus.

As I said last week on my blog, it is hardly surprising that America’s creditworthiness is in doubt as it is the only major economy where government spending as a percentage of GDP has risen since the onset of the crisis. No austerity measures there yet.

I commented today that during the many years I spent as an analyst, when I issued a 'Sell' rating some companies, rather like Obama's predictable protestations, would say that my facts were wrong rather than tackle the real issues I raised.

There is a complete lack of political direction in the US and across the western world. Rather than expend energy on irrelevant hypothetical arguments over whether the US debt is to be $20 trillion or $22 trillion in ten years time, which what Obama's administration has criticised in the S&P note, the US Government, and governments across the western world, need to face up to the cold hard reality that for the last 30 years we have simply been living way above our means.

It is worth re-reading the comments I posted on 21st July explaining how the US calculates its debt to GDP figures. 16.1% of American GDP doesn’t actually exist, so their quibble over $2bn over 10 years is yet another example of politicians failing to tackle the real problem.

We have publicly and privately borrowed too much and governments have saddled themselves with unsustainable levels of debt in order to fund this wild expansion in our standard of living.

You can listen to the interview on BBC iPlayer at the following link.

http://news.bbc.co.uk/today/hi/today/newsid_9557000/9557491.stm