The MT Diary

How high the Loony?; US's spent consumers; 'epiphany risk' syndrome; leaner times.

by Howard Davies
Last Updated: 31 Aug 2010

Ottawa is not necessarily the place I'd recommend for a restorative midwinter break. The climate is, shall we say, bracing: it hovered around minus 15 when I was there. The cold opened up a pair of stubbornly blocked sinuses (sini?), but at the cost of two nastily chapped lips.

The Loony - what currency dealers colloquially call the Canadian dollar - is flying high, now well above parity with the Greenback. A minority Conservative government under Stephen Harper is planning an early election, to take advantage of the feelgood factor, built up on the back of the natural-resources boom. Calgary, in particular, has been a kind of El Dorado with added maple-leaf syrup. And Nafta looks to have been a good deal for the Canucks.

Although political Ottawa looks increasingly to Washington rather than to London, the Canadians have taken a close interest in Gordon Brown's fortunes. Their last Liberal prime minister, Paul Martin, was finance minister and heir apparent for nine years and then, as PM, imploded within months, losing his majority in an election he seemed destined to win. So everyone you meet tells you that another Martin phenomenon is emerging in London.

I doubt if Ottawa will be on Our Dear Leader's itinerary this winter, however bad his sinuses get.

New York was generally a touch warmer than Ottawa, but not on Wall Street, where the cold winds of the credit crunch have blown away a flotilla of fixed-income traders, as well as the bosses of Citigroup and Merrill Lynch. As a result, the loudest sound is of horns being drawn in. Margin calls are tightened, credit withdrawn and lines are cut, even to important and solid clients.

How much damage will the real economy suffer from the financial turmoil? Available answers now are: 'quite a lot', 'one hell of a lot', or 'what real economy?'. The housing market is in free fall and the rapidly rising delinquency rates on mortgages suggest there's even more of a shake-out to come. The peak months for resets - when low-start or 'teaser' monthly payments typically double - are in the second quarter of this year. Interest rate cuts will help a bit, but not enough. And there are signs that the problems are extending into other asset-backed securities, especially those with a connection to the property market, whether residential or commercial.

US consumer spending could be cut back as a result, and possibly quite sharply. Much recent spending has been financed by equity release from rapidly appreciating property. That is all over, for the foreseeable future.

But won't the Asian cavalry come over the hill to bail us out? In a sense, they are already in our valley, rounding up our horses. Asian sovereign wealth funds are recapitalising US investment banks in return for big equity stakes. But it's hard to see how Asian consumers can take the strain. US households spend more than $9trn a year, the Chinese just over $1trn, and the Indians $650bn. So to offset even a 5% fall in US consumer spending, the Chinese and Indians would need to spend almost 30% more. Since the Chinese ignore even their own government's pleas to spend, that seems highly unlikely.

But amid the gloom there are always bright spots. The crisis has produced an exotic crop of useful new phrases and euphemisms that we can use, as the Americans say, going forward. We've learnt that 'super-senior triple-A mezzanine tranche' is a synonym for 'worthless junk bond'. 'We have encountered ongoing liquidity challenges in the sub-prime space' means: 'We have securities for which there is no buyer anywhere at any price.'

When I was at Stanford Business School 30 years ago, drinks parties were wittily called LPFs - liquidity preference functions. I suspect we'll hear more about LPFs as liquidity risk - a poor relation to its cousins credit, operational and regulatory risk in recent years - has shown its teeth can be sharp. They can even crack a Rock.

But my favourite new coinage is 'epiphany risk'. It doesn't have much to do with Christmas. I think it means the risk where you suddenly realise you've been doing something very very silly indeed, and which has just caused you to lose your shirt, vest, pants and socks.

Back home, a faltering economy will add another unpredictable element to a volatile political mixture. Our economy has expanded every quarter since spring 1992. Most front-bench politicos cannot recall the time when unemployment was the all-consuming issue. It would take a prolonged downturn for us to get back to 10% joblessness, but even a modest uplift, combined with falling house prices and a weak exchange rate, would alter the landscape.

For the past decade it has been hard for the Opposition to persuade voters that there's a problem to which they are the solution. Apathy has brought low election turnouts. Growing industrial unrest suggests that we're entering a more difficult period, and the tight public expenditure prospect is beginning to bite as well.

After 10 years, the Cabinet team ought to be ready for battle, but that's not the popular perception. One hears of competence risk, charisma risk and No 10 override risk. Vincent Cable's Stalin/Bean jibe was doubly clever, in that Mr Bean is a man alone. Who can name a co-star in a Mr Bean film? I except the yellow Mini, which has a mind of its own, but not a portfolio.

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