There has been an interesting pattern of boom and bust over the decades. The early 80's and 90's both suffered with significant falls, but then the pattern was seemingly broken in the early part of this century.

Gordon Brown had often stated that it was his intention to break the cycle of boom and bust, and so it seems he had. You may also recall his comments often in Budget speeches, about there never having been a quarter without growth since 1997 in the UK economy under his stewardship - and that too is true; however, upon closer examination you will note that there hasn't been a quarter without growth since 16th September 1992 ( perversely called Black Wednesday) when we were unceremoniously tossed out of the ERM (Exchange Rate Mechanism), and the subsequent fall in Sterling formed the base of the nation's economic recovery thereafter. Although the Lamont stewardship of the Chancellor's office were hardly glory years for the Tory reputation for financial management, his successor Kenneth Clarke certainly set in place a recovering economy for Gordon Brown to inherit in 1997.

So how did we avoid the next recession? Certainly from the US data in the first two years of the new century we could see a significant slowing in the US economy and this was certainly further impacted by the bursting of the TMT (Tech, Media and Telecom) bubble in 2000 and the shaking of capitalist confidence with the attacks on the Twin Towers. The action taken by the central bankers was to directly ensure that stability and confidence was restored as well as making sure recession was avoided. Rates were cut significantly, to the extent that for the period from late 2002 to mid-2005 US “real” interest rates (rates less inflation) were in fact negative for a while. Yes, offering people what was in effect “free money” has an effect - they borrow and spend - and they did - enthusiastically. Thus with the US and UK economies dependent on the consumer for some 2/3rds of their GDP, their economies grew significantly from 2002, recession was avoided and the “boom and bust” cycle broken - or rather maybe just delayed?

Now we find ourselves in the position with a slowing economy in the US and now a similar position in the UK, but this time without the same abilities to address the problems in the same way. Rate cutting will be difficult whilst inflationary pressures are around, and if that wasn't enough we then found ourselves hit by a ferocious financial tempest in the form of the Sub Prime Debacle.

The idea that the Central Banks would always ride to the rescue with the provision of oceans of liquidity - cheap money became the (in)famous “Greenspan Put” that my colleague Peter Sleep referred to a few weeks back. This led to profligate lending policies and other dubious practices across the financial spectrum.

So what is a central banker to do? Raise or hold rates against inflation? Then you could push the economy into recession. Maybe cut rates to encourage spending, growth and investment? Then you could be accused of bailing out the greedy banks and investment houses that developed those toxic products in the first place, or possibly “pushing on a piece of string”... in other words, rate cuts might head off recession, but the point must come where overstretched consumers tire. Damned if you do and damned if you don't.

The main issue must be to preserve the integrity of the main banking system and the integrity of the pound, and ensure that the credit system and its liquidity and solvency, surely the life blood of capitalism, is maintained. However, after that, then the policy should be not to provide support for those failed hedge funds and their backers - and no bail outs - but it remains to be seen quite what damage this will cause to some of the high street banks. This is the opportunity to clean out the financial Augean Stables of all the putrescence that emanated from the capitalist greed and to start again with some of the more traditional prudent investment principles.

***

Following on from last week's comment on financial services jobs, Lehman Brothers in the US have announced a 3% cut in its work force and there are signs of more to come from others. I suspect the UK will not be far behind.

***

And finally….the Chinese have come up with an ingenious answer to the problem of plagues of rats. Instead of the traditional approach of scattered and sprayed poison, often from planes, which as we know in the West seems to have little effect, a greener approach has been adopted.  The authorities in grazing lands of Xinjiang Province have introduced over 1000 eagle's nests and stands and released 200 foxes. Apparently in one area the number of rodent holes has dropped by 70%. Perhaps they might like to address some of the bedraggled scavengers lurking around my bins in Hammersmith?

Have a good week,

Justin A. Urquhart Stewart
Director
Seven Investment Management