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Tears in the material

My laptop finally came to the end of its life last week. The accumulation of viruses, a full registry and programs that take up gigabytes of memory have filled its brain to overflowing. I finally fell into the arms of Apple, much to the delight of my daughters.

But the whole process set me thinking about our time together. I bought my laptop out of savings. Another Stewart Cowley in a parallel universe would have bought it with credit. At the end of four years, we would both have a virus-riddled collection of useless plastic and semiconductors but I would have cash in the bank plus interest earned while my quantum mechanical doppelganger would have debt plus the interest paid.

We would have looked the same to the outside world, maintaining the illusion of material equivalence but I would have savings and my alter ego would be enslaved by debt – the gap between us would actually have widened.

The illusion of material equivalence is writ large in our society. It is an idea promoted by governments (that everybody can be equal all the time), facilitated by finance (through the provision of credit), serviced by the producers of products, gobbled up by consumers and bailed out by central banks when it goes wrong.
It is the origin of the problem we have at this time, that the lack of widespread wage growth has been inoculated against by the widespread use of debt.

Depending where you are in that chain of events, you will either blame governments, bankers, creators of goods with built-in obsolescence or the naivety of consumers who do not know their limits. In reality, everybody was in on it. It was a monumental failure of imagination or, more generously, proof that you cannot be in a system and observe it at the same time.

The debts we built up are everywhere – in government expenditure, in the salaries of our teachers, nurses and doctors, in our houses, in the redundant consumer goods that clutter up our houses and even in the degrees of young people who were persuaded that university was for them.

In the next two years, $3.6trn of US government debt will mature and need to be refinanced. This is before the $2.2trn expected deficits, suggesting a total funding requirement over the next 24 months for the federal government alone of $5.8trn.

Eurozone governments will need to refund maturing government debt to near $2.3trn over the same period before starting on their deficits.

Meanwhile, bank balance sheets have hardly declined in size yet and their maturity profile means they are also facing bumper years of funding needs.

In the top 23 banks in Europe, this amounts to $1trn in 2012 and 2013. If the process of balance-sheet reduction is to occur, asset sales will surely follow and with it an intensifying reluctance to lend.

The competition for funds between the private and public sectors is about to become volcanic, adding to the confusion as Europe struggles with its identity and the US grapples to find a new president in the face of a mounting economic crisis.

As everybody tries to reduce debts at the same time as competing for essential funding, there is a delicate balance at play. Unemployment and social unrest will be a feature of our lives for some time.

This would argue for low interest rates and bond yields. Certainly, official interest rates are going nowhere and it is unimaginable that a Western central bank will
But looking at a number of valuation metrics, there is little leeway for

oney market interest rates or bond yields to fall too much further from here. Head of the German Finance Agency, Carl Heinz Daube, has called this the German “luxury problem”. Investors love their bonds but they are just too expensive – bond yields are too low to be credible in the long term.

An economist would argue that low growth, high inflation and high unemployment warrant negative real yields but it seems more likely the focus will be on the competition for funds that could increase bond yields and borrowing costs. Bank deposit rates are already rising in an attempt to attract funds as an alternative to the punitive rates sought from the senior bank debt market.

We have all been mesmerised by a year that has successively thrown at us Australian floods, New Zealand earthquakes, a Japanese tsunami, the Arab Spring, a series of eurozone debt crises, downgrade of the US credit rating, the overthrow of European governments and a global economic slowdown that has propelled bond yields to close to record lows.

If we continue to cling to the illusion of material equivalence, we will always be looking to the next upgrade, constantly on shuffle but we should not be too complacent that this course is constant. Funding pressures in 2012/13 could yet reverse the gains made in 2011.



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