05 Nov 2010
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Person To Person
Smith on Smith - Monks Investment Trust
Sunday Times Economist David Smith talks to Gerald Smith, manager of the Baillie Gifford managed Monks Investment Trust, about inflation and deflation and whether we are heading towards recovery.
Gerald Smith: David, we seem to be engaged in a great experiment at the moment. All sorts of economic policies are being tried, some of which have never been tried before and others haven’t been tried for a very long time. What are the signs that will tell us what is and isn’t working?
David Smith: Well, the crisis and the recession created very unusual circumstances, mainly the extent to which countries went into unexpectedly large budget deficits, particularly in the UK. A certain amount of classic Keynesian policy - in other words, providing a stimulus in recession - has been one response to this. Read the article on John Maynard Keynes here.
But the monetary policy response, if anything, has been more interesting, because in most countries, interest rates have been much lower than in previous recessions or crises and as you say, we’ve had extremely unconventional measures.
Before the crisis, quantitative easing was something that Japan had tried which hadn’t really worked, but suddenly, it is something that every big central bank is looking at to prevent the money supply collapsing, as in the Great Depression of the 1930s, and I think what the Bank of England or the Federal Reserve have done has probably worked in that respect. Whether the unconventional policies worked more generally or not, the jury is still out.
GS: There does seem to be quite a difference in outlook between the UK and the US. In the UK, we have what you’d expect: you print lots of money and, hey presto, you’ve got more inflation. We’re not quite Zimbabwe, but we do have persistently higher inflation than the target. In the US though, the concern is about slipping into deflation, despite aggressive credit easing. Why do you think the outcomes are so different?
DS: Well, it’s an interesting point. What’s happening in North America and most of Europe and in Japan is the classic sort of post recession, post crisis situation when inflation is destroyed. The fundamental reason we have inflation in the UK is that we never managed to get domestically generated inflation down, and our exchange rate has depreciated. So it’s not a uniform global inflation picture and this is surely quite difficult in the investment context, isn’t it?
GS: I am surprised by the lack of inflation in the developed world in comparison with emerging markets. I wonder if the Bank of England did in fact do some quite aggressive quantitative easing with their purchases of government bonds. The Federal Reserve’s purchases were relatively modest.
DS: Yes, there’s no doubt that the Bank of England did proportionately more quantitative easing than other central banks were comfortable with, buying gilts; and that our government was more gung-ho about issuing gilt-edged securities to finance it. How do you feel about gilts as an investor?
GS: Well, I’m a gilt non-investor. Gilts, it seems to me, in common with most of the developed government bond markets, will only provide a decent return in times of deflation. The interesting thing to me about the gilt market was whether we would have ended up with a government bond market like Greece if we had not had the election result and the budget announcements that we did?
DS: I think the coalition should take a lot of credit for a responsible policy, which has helped the gilt market.
GS: Yes, I just wonder whether we could have got to the tipping point. It is one thing to announce all these cuts but to actually do it is another.
DS: I agree. A minority Labour Government led by Gordon Brown with Ed Balls as Chancellor would have been very different for the gilt market. Even so, the UK might not have been like Greece, but it would have been pretty rotten for a while.
GS: There’s now uncertainty as to whether we will experience a double dip. I find economists particularly unhelpful because they’re ideological. There’s a Keynesian view that all government spending is good so less of it must be bad, and a Hayekian view that all government spending is bad and so less of it must be good. Most of us just want to know what happens in between.
DS: Barring a new financial crisis, I think there’s very little chance, globally, of a double dip. The global economy has bounced back and world trade is doing very well indeed, led by the emerging economies. The UK is an open economy and while exports have not been as strong as they might have been, I think we will benefit. Private sector investment should also be picking up. I expect very modest growth in GDP rather than a slide back into recession.
GS: I’ve heard one argument, which is that the stimulus is affecting the wrong places. In the US, fiscal and monetary policy may make people go out and buy iPads. That’s good for the stock price of Apple, but Apple doesn’t actually employ very many people in the US. But if 400,000 people are hired in China, that’s where the stimulus will happen.
DS: Certainly in the US, we had hoped that the housing market would have turned more decisively. Housing is the kind of thing one would have wanted to respond more than iPad sales. It’s great that US companies in general have been reporting very good profits, but it would have been nice too if they had been investing and hiring a little bit more. That is why the deflation argument is very much a US story. There’s always a period after a recession in the US where everybody thinks it’s the 1930s all over again. But that talk is louder this time, the feel of recession is much more pronounced there.
GS: I suppose another surprise is Germany. There was a lot of talk of German manufacturing workers being laid off, instead of which extra shifts are being put on. The German economy, despite what may be happening on the periphery of Europe, seems to be booming.
DS: Germany is super competitive within Europe, and very competitive internationally. Germany sells the right things into global markets, particularly for a post-recession upturn, capital equipment and so on. It’s also without many of the things we’ve got used to here; German house prices have done next to nothing for 20 years, the German consumer doesn’t spend, and yet Germany is doing very well and is not held back by the rest of Europe. If you want anybody to be growing strongly it would be Germany, because I don’t think Germany is going to generate inflation or a house price-boom.
GS: But for the German economy to be dragging the rest of Europe, or on a bigger scale for China to be dragging the global economy, these countries need to move from trade surpluses to trade deficits. Will we see an adjustment of that magnitude or are they just going to continue to be export machines?
DS: Well it’s a good point, but the view for the moment is that any growth is good and that the imbalances can be sorted out later. So, on balance, it’s good that China is growing and it is good that Germany is leading Europe.
Gerald Smith
Gerald graduated MA in Philosophy from St. Andrews University (including University of California, Berkeley in 1982/83) and B.Phil in Philosophy from Brasenose College, Oxford. He joined Baillie Gifford in 1987 and became a Partner in 1998. Gerald was head of the Emerging Markets team until the end of 2008, at which time he moved to the head of the Global Opportunities team. Gerald is currently Deputy Chief Investment Officer and is a member of the Investment Policy Committee and Chairman of the Emerging Markets Investment Policy Committee.