December 2007 - Christmas Message

Happy Christmas and a very prosperous 2008 – why?

Congratulations on achieving a remarkable investment return on your investment portfolio – not only over the last year, but in particular over the last few months for the following reasons:

1) KMG recommended moving out of the commercial property market and you gained as a consequence.

2) We predicted the credit crunch and avoided the funds and investment strategies which have collapsed because of overexposure to sub-prime assets

3) We predicted that Northern Rock would get into trouble and took precautionary action. (Similarly, many years ago we predicted Equitable's collapse long before the event occurred).

4) We predicted that the credit crunch would take a long time to unravel and had our predictions ratified by Mervyn King, the Bank of England Governor, in recent weeks.

5) Our recommendation to you to move down the risk scale particularly into gilts, investment-grade bond and index-linked funds has proved to be remarkably rewarding not only in preserving your wealth, but also in increasing value.

6) Similarly, our recommendation to reduce your exposure to equity income funds and increase your exposure to growth funds and into emerging markets - most notably into natural resources, commodities, basic industries, energy and beyond.

7) We believe more caution may be very relevant combined with a move to fixed interest funds.

Interesting observations for discussion this Christmas

Mervyn King and Northern Rock

The following observations may be an insight into what may be the truth behind the events of the last few months: Ever since Gordon Brown gave interest-rate-setting autonomy to the Bank of England, both Eddie George and Mervyn King have complained that they should have control of banking supervision as well as interest rates. Gordon Brown and the Treasury resist banking supervision insisting that this be managed by the FSA. If KMG could see dilemmas in the lending industry and that the Northern Rock model was fundamentally flawed, we cannot believe that the Bank of England were not aware of the same concerns. We think it is highly likely that the Bank of England made representations to the Treasury and to the Chancellor about their concerns in respect of irresponsible lending, and a debt bubble that would eventually burst.

It may therefore not be unreasonable to suggest that the Bank of England would also have met with the FSA and pointed out that they were not supervising banks' lending criteria correctly, and that the situation was rapidly running out of control. Why did nothing happen? On the one hand, the government may not have wanted to do anything about curbing lending because it was fuelling a growing economy! By the same token, the FSA had too many other things to do and not enough resources to supervise banking; and because they were not put under any pressure by government or the treasury to examine activity in irresponsible lending, they too did not look at reality with a sufficiently harsh and critical eye.

In the end, the government promised to protect all depositors which simply exacerbated the run on Northern Rock (after all, who believes a politician let alone the Chancellor of the Exchequer), and when it was discovered that of course the FSA didn't have the means to bail out the banking industry, it was of course left to the Bank of England and Mervyn King.

Mervyn King appears to be a principled, intelligent, human being. He was determined to stop the rot. His brief as Governor of the Bank of England is different to that of Ben Bernanke in America or Jean-Claude Trichet in Europe. Mr King knew that in refusing to support the bank, he was likely to bring about a crisis, but I suggest that he also knew that if he didn't stand by his principles the situation would simply get worse. Did he force the crisis as a means of bringing the market and the great borrowing public to its senses?

How the story will end is not yet known, and whilst Mervyn King has initially been blamed for the crisis, I think in the end, history will prove that the failure lay with the government, the Chancellor of the Exchequer (now Prime Minister) and the FSA, and not the Bank of England.

Our second story is about Gordon Brown and all the people he has upset!

What brings down a successful government? Answer: in part an incredibly disaffected civil service, party apparatus and well meaning supporters. Despite a brief interregnum following Gordon Brown's elevation to Prime Minister, the reality appears that Mr Brown is a control freak. It is widely agreed and understood that he discusses little if anything with anybody in his ministerial team or amongst his senior civil servants. He is a dictator, and his ability to convey policy particularly amongst both the Labour party and, most importantly, the civil service, leaves an awful lot to be desired. In the earlier story, we have put forward the possibility that the Governor of the Bank of England finally got his own back on Gordon Brown. I would argue that not by design but by the results of unintended consequences, (mismanagement of party workers, disaffection amongst the mandarins in Whitehall, the lower ranks finding their jobs disappearing, and poor motivation). I think it not unreasonable to put forward the possibility that the recent data loss of 25 million records was a convenient accident (after all, there is nothing stranger than the truth), in other words, relevant service departments have simply decided to allow the effects of government action to be fulfilled in reality and not to take the necessary steps to protect politicians from the folly of their activity. (The recent pre-budget report, being a classic example). The result is of course that it is very easy to pin blame on anybody, but the perception in the public mind is of poor government and somebody has to be blamed. If you want to get rid of an unpopular Prime Minister, lack of cooperation by servants seems an obvious way to achieve your objective.

History doesn't quite repeat itself

Is there a remarkable similarity between James Callaghan taking over from Harold Wilson when he retired; and Gordon Brown taking over from Tony Blair and the reign of William Pitt the Younger? If Mr Callaghan had gone to the country much earlier than he eventually did, and fought on his own terms, it is widely predicted that he may well have won the election. Had he done so, we may never have heard of Margaret Thatcher, and of course not only the UK but to a certain extent, the world, would be a very different place today. Thus with Gordon Brown, should he have gone to the country in September, and by delaying, will he now either lose the next election or be deposed as party leader before the election? William Pitt resigned as Prime Minister after many years in power only to be reinstated a little while later by popular acclaim when Napoleon appeared close to invasion.

How could Gordon lose the next election? English seats could change hands to the Conservatives and Liberal Democrats, and enough Scottish seats could change hands to the Scottish National Party leading the Labour party squeezed between a rock and a hard place, and a spectacular collapse in the Labour government. Finally, here are two outrageous suggestions:

1) Tony Blair is parachuted back into the Labour party to rescue the Party from oblivion (as was William Pitt).

2) Our predictions about the Labour party collapse are unfounded; Cameron does not succeed at the next election and another deposed leader re-appears at the head of the Conservative party, none other than William Hague (who wrote the excellent biography of William Pitt recently)!

  Have a great Christmas. We at KMG will make sure we do absolutely everything we possibly can to ensure that 2008 remains profitable, positive and affluent for you.