Taking Stock 13th September 2018

IF IT were ever the bizarre objective of a country, a household or an individual to achieve poverty, the paths to reach that destination would be obvious.

- Spend more than you earn, living at a level beyond your achievement.

- Borrow money from countries with strong currencies and low interest rates, promising to repay in the strong currency.

- Consume your income rather than pay your bills.

- Pretend that tomorrow’s world will be the same as yesterday’s.

Anyone challenging these signposts to poverty might want to ask Greece, or Italy, or many others of both the developed and the undeveloped world.

Those asking the questions will have a most attentive audience in countries like Argentina which, to keep borrowing costs down, agreed to huge loans denominated in US dollars.

The best sources of anecdotal evidence of how to destroy a country’s wealth may be from

Greece, from which Italy seems to have learned.

As the Greek economy has subsided, the obvious casualties have been the young people, 20% of whom have not succeeded in gaining a job (since 2008) and 500,000 of whom (in a country of 10 million) have left Greece to live in some other country where work is available.

Those young people who stayed in Greece live with their parents until they are 37, the average age to become independent in Greece and some other poor European countries.

Greece did everything wrong. It consumed everything, it neglected its infrastructure, it wanted to behave like a rich country, bidding to host the Olympics, and it succumbed to its unions, allowing excessive pay, excessive holidays, and extremely young retirement age based on excessive pensions. Manually ‘’demanding’’ jobs like hairdressers, led to early retirement concessions. (For hairdressers and physiotherapists retirement and pensions came at 55.)

You might surmise that Greece paid for this with high taxes, as Sweden does.

Yet the country’s attitude towards paying tax was scornful, cash jobs were mundane events, and any laws that were mildly troublesome were thwarted by civil disobedience.

I used to holiday in Greece each year in the European summer, expecting to see the remedial responses to obviously stupid and unsustainable practices.

A few examples come to mind.

New houses attracted a residential home tax, when the houses were completed.

In response the builders never finished the masonry on the door frames or window sills, so the house was never ‘’finished’’ and therefore not taxed.

The Greek law enabled surgeons, doctors and other medical professions to avoid filing tax statements if they would sign a document confirming that their personal income was less than $10000 euros per annum.

Trusts and other structures enabled every such professional to make such a declaration.

High earners paid nothing.

When those in wealthy suburbs were identified as non-tax-payers, the government introduced a swimming pool tax, ostensibly based on water usage.   The government advised it would use satellite coverage to identify pools and addresses.

The well-heeled, non-tax-paying citizens bought camouflage canvas as their response, rather than pay tax.

And then there were the traffic congestion laws, recognising that Athens, home of six million people, had an ancient roading network that could not cope.

The people were told that cars with an odd number as the last digit on their number plate could not enter Athens on Monday, Wednesdays or Fridays, and those with even numbers were barred on Tuesday, Thursday and Saturdays.

Within weeks hundreds of thousands had bought personalised plates with no numbers on display.

The results of this antisocial, law-ignoring behaviour was that Greece was unable to service its debt, the state had to halve its public service, pensions were cut by two thirds, and the average standard of living fell to third-world levels, as the country’s creditors took command.

Those who had borrowed money cheaply from the German-backed low-cost euro to buy German-built Mercedes Benz had to return their cars and revert to foot traffic or public transport. At one time Greece had more Mercs per head than Germany.

Rubbish collections were rare. Crime rose. Overseas suppliers of pharmaceuticals and other key commodities refused to offer credit. Public sector wages were slashed.

Greece had to pay the cost of decades of decadence.

Italy is now facing the same agenda.

It is threatening to engage in tax cuts and to increase social payments by borrowing even more, in low-cost euros, breaching the European Union’s levels of fiscal deficit to GDP.

The composition of Italy’s government has changed and is currently threatening to revert to its own currency and to exit the EU, though in recent days this bravado is being expressed in less aggressive tones. Perhaps a dose of reality has been foreshadowed.

In effect Italy would leave the EU, revert to florins (or lira) and seek the help of the private sector bond market, without EU protection. The bond market would slaughter the Italian economy.

Italy would then find its cost of debt servicing rises by several per cent, meaning it would have to follow Greece’s example, slashing costs rather than handing out borrowed money.

Argentina provides evidence of what would happen next.

The new Italian currency would decompose, its value in free fall, making bond market access even more improbable.

The only real solution, again as Greece discovered, would be a most unpleasant, machine gun-enforced, fall in living standards for many years, enabling the government to balance its budgets and eventually to reduce debt levels, so it could re-engage with other countries.

All of these thoughts are escalated when one watches the USA preparing to lift its interest rates, making the US dollar stronger and making it even more expensive to service debt when it is denominated in a strong currency.

Many countries, like Argentina, have borrowed in US dollars, to reduce interest costs. These decisions look a bit silly when the US dollar rises.

The debt looks completely stupid if the country has used it not as a means of raising business levels and national income, but as a source of handouts to people who have a lousy work ethic and a belief that the fairies will provide all the luxuries of life, including champagne, Mercedes Benz cars and free health services.

If Italy succeeds with its threat, the victory would be pyrrhic unless the EU were pushed into a cancellation of its plan to stop buying EU bonds by Xmas.

If the EU cancels this initiative and spends another few years financing Italy at 2%, then Italy might be able to defer the nasty decisions.

If the EU retains its stated intention to stop buying Italian bonds, then just at the time the UK leaves the EU (March 29, next year) Italy may also be leaving the EU.

Most of Europe believes that if the UK and Italy abandoned the EU, the Union is doomed, whatever Trump might have planned. Italy would indeed revert to its own, shattered currency. Heaven help the poor, mostly in the south of Italy.

The moral to this story is that if you want to have a life in poverty spend more than you earn, and borrow the deficit in a strong currency, with a country that will capitalise the income you owe (if you can find such a lender).

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THE last of the four paths to poverty is to ignore the certainty of change.

The transport industry might be a useful one to consider when thoughts turn to change.

A few random statistics:-

1. In developed countries, the number of young adults who obtain driving licences has fallen by 20 per cent in the past three decades. In Australia fifteen years ago 77% of young people (under 25) held driving licences. Today that figure is 65%.

2. The New York subway users are falling in numbers, not rising.

3. Personal car transport currently consumes 45% of the world’s transport fuel supplies. If autonomous electric cars were to replace that demand, that fossil fuel demand would be erased.

4. In urban areas of the developed world more than 25% of all land and building space is dedicated to storing personal transport.

5. Five million Americans are employed in driving trucks, ride-sharing vehicles, and taxis or as chauffeurs.

6. If autonomous electric cars were to achieve such scale that they were cost effective, and demonstrably reduced accidents (and insurance costs) such vehicles could reduce the need for cars by 90%. But if every household wanted its own autonomous electric car, the congestion would perhaps be worse, as empty cars buzzed around awaiting a text from their owner.

7. A personally-owned car is used on average for less than 50 minutes each day.

The point of this random data is to prompt thinking about how consumers must adapt to changes which many believe will arrive and have massive scale within seven years. Poor countries will, as Greece did with its debt, pretend that an easy solution will be delivered by the fairies.

If these changes occur rapidly, the demand for fossil fuel will fall, potentially by half. So will its price.

But millions of jobs will disappear. Currently, truck driving is still the most common job in around ten of America’s states. (Go back 40 years and the office secretary was the most common job in 21 states. The figure now is 5 states, and falling!).

Cities will have to be mapped to cater for autonomous cars.

If a country or household wishes to be poor, it can spend more than it earns, it can borrow to take holidays and it can pretend that there is no need to focus on the future.

Footnote: One argument against autonomous vehicles is that these cars often do not suit families. Nor do many ride-sharing vehicles.

BUT in one developed country the percentage of young women who state they would never have children is more than 20%, and rising.

Their demand for station wagons might change, too!

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TWO of New Zealand’s recent corporate disasters are still being examined, with somewhat different outcomes likely.

The disastrous Wynyard Group collapsed after spending extreme sums on staff and software in pursuit of what it hoped was sales for its security systems in the Middle East.

Governance 101 might include a unit warning against any reliance on expressions of interest from Middle East governments or corporations.

False sales are much more disastrous than no sales.

I know of no credible attempt to litigate Wynyard’s failure but I understand there may be a tiny sum available to shareholders, once the liquidator has completed his task.

The other recent disaster, CBL, has led to grim investigations.

The FMA and the Serious Fraud Office are both pursuing the truth about how this company behaved and why its shareholders were so poorly informed about its behaviour.

At very least I expect its directors to be absent from any other governance role, permanently.

At best I expect to see an outcome for shareholders that atones for any behaviour that is eventually deemed to be inappropriate.

Litigation funders always urge that full investigations are initiated immediately. Delays, perhaps caused by inertia, straight laziness, lack of resources or simple incompetence, can allow ‘’the bodies to be buried’’, according to skilled people.

My view is that both the SFO and the FMA owe the CBL shareholders and the general investing public a detailed update on their progress of their investigation, published every month.

The Romans used to say ‘’Beware the Ides of March’’.

Investors should be saying ‘’Remember the sort of appalling inertia that surrounded the South Canterbury Finance investigation. Beware of the Limitation Act!’’

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WITHIN a week, Synlait Milk will announce its result, expected to demonstrate that it has patiently built a model that adds value to milk products, benefitting consumers and shareholders.

As discussed last week, Fonterra moves backwards, while Synlait Milk advances. Fonterra’s result will have underlined this.

My expectation for Fonterra is that it will fail to modernise its plants, fail to convert to a value-add model, and ultimately will go the way of so many co-operatives around the world.

Lacking the capital to realign or modernise its manufacturing plants, and lacking the metrics that attract banking support, and being burdened by debt, Fonterra will eventually be forced to sell off the best of its businesses, to reduce debt.

It would then have a low-value business, managed and governed by average performers servicing those producers on back country farms, up pot-holed shingle roads.

Its farmers would have debt levels because they must hold the share capital that Fonterra will not attract from external sources. Perhaps Forsyth Barr might arrange a subordinated debt issue to meet Fonterra’s needs.

But if the value-add businesses, having been sold off, does not supplement the returns from commodity-selling, how much more debt would be needed? How many subordinated note issues could be sold?

What would break this cycle?

A mix of vision, energy, capital, patience and banking commitment would be required.

Would someone show me evidence of any of these ingredients?

Perhaps the optimists will be hoping that the money burnt on Beingmate investments in China might be recouped by litigation. The Chinese legal system would need to accommodate such a plan. Good luck with that!

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Summerset and now Properties For Industry, are tapping the market for long-term funding via senior bond issues.

More will follow.

Both of the above seem to be respected debt market participants.

If clients have an interest in these securities they should notify us immediately.

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TRAVEL:

Edward is in Auckland (CBD) on 24 September, then in Nelson on 2 October.

Chris will be in Christchurch on 18 and 19 September.

Kevin will be in Christchurch on 27 September.

Mike will be in Tauranga on October 5.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

 

Any person is welcome to contact our office to arrange a free meeting.

Chris Lee

Managing Director

Chris Lee & Partners Limited