17/08/2011 - 08:52

Why this time really is different – Act 2

17/08/2011 - 08:52


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Why this time really is different – Act 2

Given a choice, would you loan money to BHP Billiton or Italy? It is an odd question but it is also another example why this phase of the financial crisis is different because the company and the country share an A+ credit rating.

Standard & Poor’s, the rating agency which downgraded U.S. debt two weeks ago, currently ranks the big miner, which is earning record profits, and the deeply-troubled European country, as being of equal risk.

Under normal circumstances it is not valid to compare a company with a country, but these are far from normal times with dramatic shifts underway in the flow of money and power, as explored here last week in the way global trade, as measured by the Baltic Dry Index (a measure of ship hire costs), has been unaffected by an ocean of government trouble.

The biggest of the shifts is the migration of cash from the western world to the east with China amassing a mountain of savings while the U.S. and Europe drown in a sea of debt.

But, the question of BHP Billiton v Italy provides a glimpse into a separate aspect of the changes underway because we are entering a time when companies look to be more financially stable than governments.

There is a reason for this reversal of roles and it is directly linked to decisions made in the wake of the 2008 Global Financial Crisis, a time when governments bailed out failing banks and big companies such as General Motors and the insurance giant AIG.

In hindsight, all that really happened was the governments swallowed a poisoned debt pill which was intended for the companies and changed the nature (but not the initials) of the mess we see today – a Government Financial Crisis.

Investors are reacting in an entirely predictable way as the world lurches from one item of bad news to the next; they are panicking.

Extreme volatility on stock markets is one example of the herd stampeding for the exits. The price of gold is another, and the “price” of cash a third example.

Gold has soared to record highs and cash deposits in the U.S. have fallen to record lows with one major bank in the U.S. charging customers a fee to hold their deposits rather than pay interest.

Knowing where to invest (or save safely) is the critical question for everyone with that BHP Billiton v Italy question providing a clue because it’s a fair bet that most people would choose the company over the country – and isn’t that telling you something about the strength of equities (shares) over government bonds and other promissory notes, including paper currencies.

Earlier this week an example of the shift out of government paper was noted in Britain when the canny managers who run Scottish Widows Investment Partnership shifted millions of pounds under their management from government “gilts” into British equities.

Other funds are following the move from gilts to equities as concern about government debt grows and confidence in corporations rises, partly because companies find it easier than governments to make big cuts in their cost structures – which is what Qantas is doing and what government ought to be doing.

Reallocating risk weightings, started by Standard & Poor’s in the U.S., is one of the best indications that the focus will remain squarely on governments over the next few years as the GFC (government variety) forces European and American politicians to cut spending.

To underline the point about risk weighting consider a few more Standard & Poor’s comparisons, such as: Rio Tinto sharing an A- with Thailand and Malaysia. Alumina sharing a BBB with Morocco, Lithuania and Croatia, and Fortescue Metals Group sharing a B+ with Kenya, Uganda and Cambodia.

Investors might have strong views about FMG, but to assign it the same risk weighting as Uganda and Cambodia, two historically unstable countries, is interesting to say the least.

The company v country ratings, plus the gold price, and super-low interest rates, can be added to the Baltic Dry Index as examples of why this time is really different.



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