Featured Articles

Banking Reform, Tech Giants, & Gold

The following is the text of an article written by Rory for the Sunday Independent, published on the 26th of July 2015. The article deals with: banking reform (or lack thereof) in Ireland; the question of which companies among the tech giants - Apple, IBM, and Google - will stand the test of time; and the risks of inflation in the developed world.

Lost Opportunity in Banking Reform
How very refreshing to see Toshiba executives resigning en masse this week when found to have cooked the books in one of Japan's legendary companies. No one should accuse the majority of Irish politicians and bankers who presided the nation's fiscal and banking bust of dishonesty, but what a tonic it would be to hear them admit what we all know; that they were simply incompetent. We are not the first country that did not understand money and risk, and suffered a financial crisis. In fact, history is littered with examples.

With a fixed exchange rate system post 1999, European banks didn't price the risk of lending to Ireland correctly and our banks were able to suck in finance from Europe at cheap rates. They then lent this borrowed money on against grossly overvalued property assets, and to developers that were too dependent on debt rather than having a more appropriate mix of equity and debt. The Regulator, who was supposed to understand money, banking and risk, simply didn't. Do we really need a banking enquiry to tell us this!

They say a tragedy should never be wasted. An area that I feel reform by the Central Bank has been botched is the mortgage market reforms of 2014. Many ordinary house owners have suffered significantly for the past seven to eight years. This occurred, and will occur again, as most people do not know how to value an asset or assess risk. If they can't do that how can they know what price to pay for a home and what debt to take on?

In contrast, the mortgage system in the US, I feel, better protects the ordinary person. There, banks lend against the property and not to the person. The banks are charged with valuing the asset and they generally do not have recourse to the borrower.

In implementing reforms, the Irish Central Bank has tried to lower the risk for all parties in the Irish mortgage market by restricting the amount of credit one can attain on a property. This is a woefully blunt approach as it does not distinguish between the person with resources and the person without. So now we have banks declining to provide credit to many who can easily handle a higher proportion of debt on a property due to a better quality of income or a myriad of different factors.

A system that forces the banks to assess the credit risk of one buyer versus another leads to a better functioning credit market. It forces banks to price the risk. Is that not what banks are there to do - assess the risk in individual mortgage applications? This approach leads to credit being more costly for one borrower versus another. But the price of credit (debt) should vary with the risk. The insurance market works this way, why not banking. Approach the mortgage market this way and you dispense with the need for a large portion of the regulators now employed, you force the banks to take the consequences if they price risk incorrectly, and you free the ordinary person in society from being persecuted for a lifetime for not knowing how to value an asset. What a lost reform opportunity!

IBM, Apple and Google - Clock Builders & Time-tellers
Three big tech giants reported their 2nd quarter results this week with Apple and IBM disappointing while Google returned to favour with decent numbers and, more importantly, talk of more discipline in how it redeploys its vast cash flows. After all, there's not much point in generating a 30 per cent return on capital if you fritter it all away on a constant stream of 'tomorrow's world projects. Google has yet to pay a dividend to shareholders!

That said, in a world where there are clock builders and time-tellers, I'd rather own the clock builder. A time-teller can assist you tell the time while he is around, but the clock builder is better as he builds the clock from which anyone can tell the time. Google's search engine is indispensable. IBM has being doing business with 70 per cent of the Fortune 500 companies for decades. Both look like business models that will survive and where future managers should just slot into where current management leaves off. IBM may be having some near-term difficulties in exiting its traditional hardware businesses and transitioning to cloud, big data and analytics software support services, but it should get its fair share of this evolving business from customers it has been dealing with for decades. Apple, on the other hand, looks more like the time-teller. It appears to me that management has to continually invent new products as old ones become obsolete. And the time-teller, Steve Jobs, is no longer there!

Gold & the Minimum Wage
Gold is hard money and no more than that. In a world swimming in central bank-created paper money you'd think the gold price would be riding high as the only currency that cannot be printed ad infinitum. Paper money printing has generally led to inflation, and the alternative hard currency, gold, has been a good protector against such inflation over the millennia.

But this week, the gold price broke to new lows in a downtrend that started nearly four years ago. I guess the relevant question is: Is inflation a threat or not?

The argument in favour of inflation is that money printing by central banks has never worked in history and that, as economies recover, all the excess money printed by central banks will create inflation, as it has always done in the past. Of course, inflation is needed given the debt load in most economies. A necessary start, in my view, is an increase in incomes for many in society and recent plans to increase the minimum wage in the US, UK and Ireland is a move in the right direction. How else can people pay back debt and cover rising costs (rents in particular) if incomes don't rise? But the effort much be across borders if one country is not to lose competitiveness versus another. Tricky!

The argument against inflation is that the real money printing occurred between 2003 and 2007, when the banks in the developed world over-lent to property. The resultant global credit crisis unleashed a huge credit contraction in the western banking system, which of course was deflationary. With quantitative easing, central banks have simply offset the credit contraction and inflation fears are overdone. As the saying goes this week's 'bloodless verdict of the market' suggests no inflation, not yet anyhow.

This article was written by Rory Gillen, author of 3 Steps to Investment Success and founder of GillenMarkets, Ireland's only subscription-based online investment newsletter.