Where are we now in Europe?

Europe continues its fudge and bodge, it continues to ignore the core problem which is that the Monetary Union just cannot work under the current framework.

The Core Problem

Under a system of freely floating exchange rates (the dollar and sterling are free floating, the Renminbi is not) the market on a continuous basis bases prices in a combination of factors. These are: the level of domestic interest rates, the inflation rate, the Government’s budget position, the balance of payments, in particular the current balance (this is the net of visible and invisible flows), and the way in which this is being offset through the capital account (in particular by Government borrowing from outside the economy).

If the market decides that in combination, the country is in an unsustainable position, they sell the currency. There is a devaluation. This with time lags results in an adjustment via more profitable exports, more expensive imports, higher interest rates, and for a time, lower growth. It takes about three years for the rebalancing to work. But it does work. We in the UK have been doing this on and off for the last 45 years.

The Eurozone problem is that this adjustment mechanism doesn’t exist between Euro member countries.

In any currency union the balances of the public sector, the private sector and the external sector must sum to zero.

From the beginning of the Euro, the following countries ran surpluses on their external account (i.e. with other countries): 

• Netherlands
• Germany
• Belgium
• Austria
• Finland
• and only just, France

They were selling more than they were buying.

The following countries ran deficits on their external account.

• Italy
• Greece
• Ireland
• Spain
• Portugal
• Estonia

They were buying more than they were selling.

The balance of payments for any country must balance each month. This is a feature of double entry book keeping. The surplus countries exported capital (money) to the deficit countries. These flows were organised by the private sector with bank lending, through M&A, and the middle classes buying property abroad. The flows were large and deemed low risk because there was no exchange rate risk.

When the credit crisis hit in Oct 2008, these private sector flows ceased. Individuals in the deficit countries stopped spending and began to reduce their debt as their wealth collapsed. As individuals and companies moved from deficit to surplus, their Governments moved deeper into deficit (it happened in the UK too!). So debt moved from the private to the public sector.

No longer is the private sector in the surplus countries willing to finance the debt of the deficit countries. Instead it is a combination of the European Central Bank (ECB), the International Monetary Fund (IMF), and the European Support Fund (ESF).

Germany is a third of the Eurozone. It therefore is the dominant underwriter of the ECB. Germany is adamant that the ECB should not buy sovereign debt, apart from to supply short term liquidity.

The latest EU agreement is that the size of Government deficits will be limited, and policed by Brussels. The limit is current borrowing to be no more than 3% of GDP, unless there are exceptional circumstances! This does not address the current problem.

Deficit countries within the Eurozone must reduce their external deficit, i.e. they must sell more and buy less from outside. Because they are so uncompetitive, their only way forward is a deep recession, i.e. buying less because their wages are falling. Germany doesn’t seem to realise that its exports to the deficit countries will collapse. So ITS surplus will fall due to lost sales.

What can be done?

The ECB should be allowed to buy sovereign debt. This will give the markets confidence and ensure private sector flows return. It will reduce the cost of funding for the Club Med countries. It will not be inflationary. It will also prevent a meltdown of the European Banking system and give UK Banks a boost (because the credit default swaps payments will not be triggered).

The alternative is chaos and a horrendous feedback loop which would run as follows. Italy would only be able to borrow at 8-10%, Standard and Poors would then downgrade their debt because tax income is insufficient to cover payments at such a level. It would apply to the IMF for credit. The IMF would impose very tough conditions. Even more of the Italian Economy would go unofficial further depressing tax receipts. The same for Spain.

Will the ECB Act?

Yes but not before Europe as a whole is in recession. The change will come at the end of this year when Germany has experienced zero growth due to a sharp reduction in exports to the Eurozone.

What does it mean for UK Business?

The exchange rate risk is increasing, particularly Sterling-Euro. Ideally business would match income and expenditure by currency type, thus neutralising the impact of currency movements. For many this is impossible. They have only two options, buy forward (expensive) or make sure the margin is sufficient to cover the swing in rates. The average for 2012 I guess to be 1.18, but it could go as high as 1.26 and down to 1.08. There are many who would suggest 1.30 plus, but this is highly unlikely because the finances of the UK are fragile and we have a difficult year ahead. S&P are downgrading sovereign debt in the Eurozone primarily because, unlike in the USA and the UK there is no lender of last resort i.e. a central bank willing to purchase significant amounts of Government debt from private sector investors. This action creates liquidity and confidence so that at auction Government can get the credit they need at a price which is manageable.

The French seem to think that their recent downgrade is due to some Anglo-American plot, rather than the simple fact that quantitative easing is an essential monetary tool which the ECB is forbidden to use and therefore financing the French deficit is more difficult.

How Deep Will the European Recession be?

It is my opinion that it will be deeper than many expect for the following reason: since October last year European banks have been shedding assets at the rate of 35Bn Euros a month. They have sold these assets on. This doesn’t reduce the supply of credit or money, but they are doing the easy bit first as they try desperately to meet the July 2012 deadline for their core capital to be at least 9% of their balance sheet. From now on they will be reducing their net loan book, and withdrawing credit from central and Eastern Europe. In the last two weeks (January 16th) they stopped lending to each other. The wholesale money market is key to the proper functioning of the credit system. The UK market seized up in October 2008, the impact on growth was quick and substantial. The same is happening today in the Eurozone. On January 16^th 2012 Eurozone banks had parked 501 billion Euros at the ECB. This is money which should be oiling the wheels of commerce. The chart on the next page illustrates my view.

My guess is the Eurozone will shrink by 1.5% by the end of 2012, and with no change in ECB policy, by 2.0% in 2013. We have to hope that this will cause Germany to rethink its current stance on lender of last resort for the ECB, but once credit crunch begins the feedback loop is powerful in a downward spiral.

The Impact on the UK

The EU is the largest importer and exporter on the planet. 50% of UK exports go to the region. Of our top ten markets, 8 are in the EU. This trade is worth 3.5 million jobs, and around £2300 per household. So a 2% contraction in the Eurozone, translates into a 4% nominal drop (assume a 2% inflation rate in Europe) which is in round figures £100 per household income contraction. This is on top of the increase in income taxes which Gordon Brown announced three years ago would apply in 2012.

The Euro Mess

When Germany unified in 1990 it began a substantial transfer of income from West to East. With typical German efficiency, they put themselves through an economic boot camp. The SME sector underwent radical change, supported by the regional banks who were underwritten by the 16 regional Governments. Real wages fell as unions agreed to pay cuts. State benefits were reduced, particularly for sickness and disability. Companies invested in R&D, new plant and equipment and apprenticeships. The result was a 20% drop in unit labour cost compared to the rest of the EU, and a rise in unemployment to 12.1% by 2005. This was the year Angela Merkel came into office.

Meanwhile the club med countries became increasingly self-indulgent (not Ireland, it was individuals there) as their Governments found they could borrow at German rates of interest. This happened because the world markets were beginning to believe that Germany growing economic strength would underwrite the system. And French and German Banks who were short of capital, needed no capital to support Sovereign lending.
Germany increased its exports to the fringe, and France, its biggest trading partner.

France meanwhile hung onto German apron strings and fought against EU enlargement and the desire for greater competition by the Commission. France believed that Globalisation was a threat which needed to be managed, rather than an opportunity to be embraced. As the EU was enlarged, with British support, France lost power and influence.

The aging Europeans were enjoying a comfortable lifestyle, their companies asked Brussels to protect them from the Asian onslaught and in many areas they did. The French wished for more control of Brussels (i.e. more protection).

Last year, France was the only large EU country with a retirement age of 60. And the French, Belgians, Italians and the Polish all stop working in their late fifties.

Angela Merkel is fond of saying that if the Euro fails then Europe fails. However if the Euro succeeds Europe is likely to fail anyway because the Euro was introduced on the back of two lies.

The first lie was that monetary union could exist without political union. The second lie was that Euro and Non-Euro countries could sustainably co-exist. This was based on the view that the EU is a club of clubs, all members share the single market, but otherwise coexist within a flexible framework of labour laws, immigration, financial regulation and bilateral agreements.

In the last week of October 2011 European Leaders agreed to leverage the European Financial Stability Facility (EFSF) boosting its lending potential from 300Bn Euros to 1.1 trillion Euros. This is the first big step on the path of divergence between Euro and non-Euro members. It is the beginning of joint liability for Sovereign debt guarantees, thus paving the way for the creation of a Eurobond.

If this happens the ECB will require each Euro member to solve their underlying structural problems. They will be required to harmonise their financial sector, to co-ordinate their labour market rules and become more competitive. Eurozone level taxation will have to be introduced to ensure income is redistributed from North to South. Brussels will send economic policemen to oversee errant countries.
But all these measures are diametrically opposed to the founding principles of the single market. A monetary union in trouble has very different needs than a club interested in free trade. The Euro members will (under the influence of France) decide that it was free trade which caused the imbalances in the first place (Germany and France are convinced it is financial institutions based in London who are major contributors to the problem).
The Eurozone will have to create a common financial platform to ensure macroeconomic stability and the Eurobonds sell at a good price (low interest rate). Non-members have no need for such structures and would resist strongly a regime run by and in the interests of the Eurozone. There are 10 such Countries; they are smaller than the 17 Eurozone members and less homogeneous.

The Lisbon treaty allowed member states in groups to enhance co-operation in selected policy areas. This will allow further divergence between Eurozone and non-Eurozone members. It could even allow non members to gang up on the core.

Over the next five years the microeconomic club will turn into a macroeconomic union. At which point Denmark, Sweden and the UK will have to decide whether they want to remain in a club with which they have increasingly less in common.

The biggest failing of all is that the technocrats in Brussels believe that prosperity and growth derives from treaties and agreements. 70% of EU prosperity is created by firms employing less than 200 people, who day after day strive to create better products and services for their chosen customers. And yet to a man they will tell you that the biggest cost imposed on their enterprise comes from Brussels in the form of Health and Safety, Employment, and Harmonisation Reporting.
The Likely Outcome

Greece will leave the Euro within the next 18 months.

The Greeks will force conversion of Eurodebt into Drachma. This will be a technical default.

The Drachma will trade at a 60% discount to the Euro. This will impose losses on Greek businesses with overseas operations, but there will be much bigger gains as Greece becomes the no 1 tourist destination.
The Greek Government will have to impose strict limits on cash and credit withdrawals to protect their banks, plus capital controls.

Inflation will rise to 15%, wages will not, so very quickly Greece takes the pain of a lack of competitiveness. Meanwhile Costas finds all his Villas fully booked, the fish he catches cost a little more to get (fuel and spares for his boat), and he makes a fortune selling a bit of land to a plumber from Telford, attracted by cheap sunshine, and the new Ryanair routes from Birmingham City Airport. Within two years Greek GDP is growing at 3%.
Savvy businessmen will be already asking the Greeks to pay for imports in Dollars, and probably cash up-front.

The ruling Greek families who bought 10% of the London property market, will sell their house in London, buy drachma and then the assets of Greek state industries at knock down prices, thus ensuring that the market for “in yer face” Yachts booms.

Meanwhile the German and French Governments ignore Brussels and put massive support behind their local banks who book big losses on Sovereign debt. And the Bank of England has to supply circa £150Bn to the London market as the Credit Default Swap issuers are required to pay up.
Then what?

In three years time France and Germany announce a Nordic Euro system, and a Clubmed Euro system. The latter will trade at a 30% discount to Nordic Euro. And Europe will become three clubs. Inner, fringe and outer. The outers, Denmark, Sweden and the UK will expand their trade to the East, where the money is!

It will take this long because Brussels will resist it every step of the way.
What does all this mean for the UK?

The growth in our material standard of living depends on the growth in real wages, this in turn depends on the growth in productivity (except Directors of FT100 companies who have their own reward system). Productivity is measured as output per person per hour of work. For the UK growth is usually 2.3% per annum, but since 2007 it has fallen by 2.6% per annum.

It follows that real wages must fall by the same amount. And they are, inflation at 5% and wages growing at 2.2%. But not if you are a FT100 Director, when your real earnings have increased by a staggering 70%.
In the depth on the recession, the lowest bonus paid was 134% higher than in 2000. For the record, Directors always state that they are rewarded according to shareholder return. The evidence is against them. The overall reward to FT Directors has exceeded the growth in earnings per share by 640% since 2000. (Source: Hansard).

With the exception of FT 100 Company Directors, real wages will remain depressed until productivity increases. It is worth noting that productivity is falling because SME owners are trying to hold on to employees for as long as they can afford to. This is a considerable social benefit.

The UK loss of productivity is reflected in the falling value of Sterling (25% over the last 3 years). This allows us to adjust without nominal wage cuts, unlike Ireland where nominal wages have dropped 10%.
The key question is over the value of Sterling given all that is happening in Euroland.

In essence, Sterling will rise against the Clubmed Euro, and fall against the Nordic Euro. At a guess, 25% stronger against Clubmed, and 7% weaker against Nordic.
UK Growth Prospects

 I think a mild recession is 2012, followed by flat line certainly until 2014. There will be some quarters when commentators will suggest the worst is over, then it will fall back again. The cause of this flat line will be the lack of credit and money in Western economies. This in turn caused by the drive to compliance with Basel 3 by western Banks. We know from history that when banks need to make major adjustments to their balance sheets, economic growth is well below trend for 5-7 years. We are about to enter year 4, and next year the Government’s austerity measures will be biting hard.

For any improvement on this the following needs to happen. Firstly earnings need to rise by 2% above inflation. If not, then taxation needs to fall by 3% of incomes. If neither of these are possible we are left with credit needing to grow by 7% per annum (currently it is shrinking by 3%). Fat chance.

Interest rates will remain at 0.5% for certainly another two years. The mortgage rate will remain at an average of 4% providing the nation retains its AAA rating.

The recent market turmoil

The collapse and current volatility in most western equity markets is consistent with what we know about how our brain works in times of stress.

During our evolution our brains developed three distinct parts. The first to evolve is a central core which is structured to ensure our survival. It responds rapidly to perceived danger and controls reflexive behaviour by shutting down bodily functions which are in shock: this is the basic instinct designed to allow us to survive.

The second part came later; this controls social desires and emotions such as intuition, sexual urges, anger, unhappiness and so on.

The third part which is the last to evolve is the rational, sophisticated thought section. Under normal circumstances this part dominates, but in a crisis we revert to the central core and go into survival mode. This is why the model of rational market behaviour is so flawed. Markets are driven by individuals who can quickly switch from the rational assessment of the environment to the irrational, instinctive and herd like response. This is what we have witnessed and will continue to witness as individuals begin to realise that their very little the Government (i.e. other people) can do about the macro-economy.

When this happens our time horizon moves from the longer term considered view of things to an immediate knee-jerk response. And we cry out for leadership ie for another human who can show us the longer time horizon and create in us a greater sense of security. When we are in this state of mind we tend to believe anything if we think it improves our chance of survival.

Alas all the economic forecasting models do not embody this thinking in any way. Expect a lot more turbulence, but remember keep your head when all around you are losing theirs.

The UK Economy and its prospects

The immediate outlook is poor, unless fuel and food prices fall significantly in the next three months. Household real incomes are falling by nearly 3% year on year. This is reflected in retail sales data: sales volumes are flat. We will experience a mild double-dip at the end of this year; the economy will shrink about 0.7% in real terms. Many will not even notice it, but the political impact could be considerable with the opposition claiming it could have been avoided. This isn’t true, but the point will be made ad nauseam. Base rate will remain at 0.5% for another 12 months at least.

As I have said before, the problem is corporates hoarding cash. Good for them, bad for the system. Western Governments cannot do anything about this apart from taxing cash holdings which I wouldn’t advise!

Please note that Government sector deficits are the mirror image of Private sector surpluses. There is yet again a feedback loop in operation: USA companies are holding on to cash because they see Congress divided and not in control of things, they see a weak President, they see an increasing number of opportunities to purchase weaker competitors at fire sale prices and finally they note that the prospects for domestic demand expansion are poor. The Obama incentives to hire more workers will fail; instead it will increase Private sector surpluses and the Government sector deficit. Most companies employ more people when the order book is growing fast and it exceeds existing capacity. Reducing payroll taxes just allows companies to increase their cash balances.

Conclusion

 The global economy will slow down to about 3% year on year growth as Brazil, India, China reduce their inflationary growth rates. Europe will stagnate with zero growth. The UK will have a mild double dip, and probably the USA too. If the oil price drops to $90 or below, Russia will slow down significantly, but the USA will avoid double dip. Over the next five years we can expect a saw-tooth pattern for GDP in the West with sustained growth not returning until circa 2015.

How to survive and expand your business under these conditions? Keep it simple, communicate with and motivate your employees, pay them what you can afford, find out what two or three things make the biggest difference for your customers, and deliver them consistently. Have fun!

Roger Martin-Fagg Sept 20 2011

“The Footsie is 5400 as I forecast it would be in January. The markets have just realized that the global economy is slowing down rapidly, again as forecast.  All this is no surprise to Vistage members; the supply of bank credit is insufficient to maintain growth in the West. The Euro system is unsustainable, Greece will default, they have just realized. Double-dip by the end of the year, my forecast will have been just three months out!!  There will be calls for more quantitative easing, but this has no impact on household real incomes which continue to decline. We must hope the oil price drops to $70 and stays there for at least 9 months, then things will pick up a little.”

Europe and the Euro

As many of us stated right from the start, the Eurozone economic model has some fundamental flaws. The recent fiscal and financial crisis confirms that the model is unworkable.

The model is this. In a single currency system a country with lower productivity than the average should experience falling wages and prices. This lower cost base encourages inward investment from other members of the system which over time restores productivity, and wages and prices rise to the average.
What has actually happened is the lower productivity countries increased their wages and prices faster than the system’s average, enabling them to purchase more, better value imports from the more efficient members of the system (but sell less to other members of the system). This created growing current account and fiscal deficits, which were financed by the banks of the whole system at low interest rates because there was no currency risk, and because no core tier one capital is required to support sovereign lending. This lending boosted the system’s money supply and inflation in the low productivity countries.
90% of the money supply in the Eurozone doesn’t exist in tangible form. It sits in the liabilities side of commercial banks’ balance sheets as deposits. In the Eurozone, any bank deposit is equivalent to any
other within the system, unless a bank is on the verge of collapse, in which case its Euro Bank deposit is not the same as a Deutche Bank deposit.
When it became clear to the commercial banks that there is such a thing as sovereign risk and that this debt may have to be written down against scarce capital, their willingness to lend evaporated, leaving it to the central banks to supply liquidity.
The European central banks have been creating massive amounts of new electronic money to keep banks afloat. The borrowing banks offer Government bonds as collateral. So the deficit countries are being financed by the central banks from within the system. The Bundesbank is the dominant creditor. Indeed the combined deficits of Ireland, Greece, Portugal and Spain, are matched by the increase in the assets of the central banks since 2008. The Bundesbank has created 325Bn Euro deposits since 2008.
A Greek default will create losses for central banks which will have to be covered by the taxpayer. So the fiscal transfers, explicitly forbidden in the Euro set up, rules at the request of Germany and will actually happen. The German taxpayer will be bailing out the Greek Government via their central bank. This backdoor method of financing debtor countries is political dynamite.

The options are stark indeed.
The ECB could refuse to lend against defaulting country debt. This would cause the collapse of some French and German commercial banks and a run on the Eurozone banking system. This would be the end of the Euro as we know it.
So either the Euro system is dismantled or it moves to a fully integrated system where Brussels has direct tax raising powers and the mandate to transfer tax receipts from strong to weak. Assuming the latter is not going to happen, we can consider the options:-
1. The ECB continues to lend, thus financing the deficits of the fringe countries and through the back door, ensuring fiscal transfers take place.
2. Greece leaves the Euro and the new Drachma trades at around 40% discount, imposing large paper losses on wealth held in Greece. It will be very disruptive for a time, and then because Greek sunshine will again be a bargain, economic growth will resume as we flock to Greece for a cheap holiday.
All Greek Government bonds would be forcibly re-denominated in the new Drachma, and the interest paid in the same. This is what would be called a ‘credit event’ and it would trigger large payments to banks who have insured their Greek debt using credit default swaps (UK banks are major underwriters of these). This will cause a minor banking crisis within Europe, and a few banks will need Government equity.
3. Greece will join with Spain, Portugal, Ireland and Italy to form the Med Euro, probably managed by the Italian Central Bank. This will trade at a 30% discount to the remaining Nord Euro. And it will cause big losses for PIGS government bond holders. But growth will resume.

The Germans may not be too keen on this because their exports to the Med Euro would immediately become 30% dearer. However imports would be 30% cheaper, which would allow German consumers to buy more such goods and let them enjoy much cheaper holidays, just as they did when they had the D mark. Nord Euro interest rates would be around 4% and Med Euro rates between 6 and 7%. Sterling would rise against the MedE and fall against the NordE.
4. Germany leaves the Euro and it drops 30% in value.
The Greeks are not stupid; already 20% of domestic bank deposits have been moved off-shore, some of it into London property where above £1m prices have risen by nearly 7% in the first six months of this year. Greek banks hold 40bn of their Government debt on their books. This is 180% of their core tier 1 capital. In the event of a default, they would be all insolvent, and would need to be recapitalised,
but who by? I, just like the authorities, have no idea.
They are already excluded from wholesale markets, and have to get their liquidity from the ECB (100Bn outstanding by the end of May). But the ECB has said it will refuse to accept Greek debt as
collateral should a default be declared.
Greece is insolvent. To become solvent it would need to run a budget surplus of 7.5% of GDP by 2015. The maximum possible is 2.5%. Assuming 2.5% can be achieved, without a restructuring of debt, the ratio of debt to GDP would rise from the current 140% to 400% by 2050. There has to be a restructuring (a polite term for default). This would require that Greek bonds be reduced to 20% of face value. This would cost 140Bn Euros. Portugal and Ireland would follow, which would cost another 200Bn. The charge would be to the ECB, the banks and their shareholders. In total: 5% of Eurozone GDP.
My opinion is that Greece should leave the Euro and default.

The new head of the IASB which oversees accounting standards is throwing banks a lifeline, for when the Greeks default. He proposes that banks will be able to write off bonds by discounting the expected income stream using the original not the current rate of interest. This is a massive help to the banks. If a bank bought Greek debt at a 5% yield, it could use that as the discount rate instead of the current market rate, which is 20%. This is yet another example of how institutional arrangements are being made ready for the default, and to reduce the contagion.
The IMF undertook a post mortem following the Argentinean debt crisis in 2001. The parallels with the Greek situation are uncanny. The IMF concluded: ‘when debt dynamics are clearly unsustainable, the IMF should not provide its financing. To the extent that such financing helps stave off a needed debt restructuring, it only compounds the ultimate cost of that restructuring’
A pan-European banking sector stress test has just been published, but apparently the banks are not being forced to model the impact of any sovereign debt default. So, unsurprisingly almost all passed except for a few small Spanish Building Societies, a couple of Greek banks (!) and an Austrian bank. No UK banks failed, but Barclays Core tier one capital dropped from 10% to 7%.
The press are suggesting Italy is in trouble and could go the same way, I think not. Most Italian debt is held by Italians. Italian households have the lowest personal debt in Europe (one of the outcomes of a large cash economy) and Italian banks are mostly well capitalised. However, a MedEuro would help Italy a lot, so I guess they would be willing members.

”I am glad that Mervyn King has joined me in thinking that this year will see a double-dip. I of course cannot forecast the weather, but even without the December snow, the fourth quarter would have posted zero growth. So looking ahead. The first quarter will show positive growth at about 0.2, but Q2 and Q3 will be negative which means the UK will officially be in recession again. This is entirely predictable given the decline in real incomes which will accelerate as we go through the year. Many more UK households will experience end of the month cash shortages and cut their spend on discretionary items. There is no chance that base rate will rise this year, at existing rates credit is barely growing. As I have said, and Mr King confirmed, a rise in rates would do nothing to reduce UK inflation this year.”

Vistage members have the benefit of frequent updates from Roger, all presented in a practical way and applicable to businesses and CEOs. Here’s an extract from Roger’s most recent update (published well before the recent recession figures were announced). As you will see, Roger forecast a double-dip…

Roger’s comments:
“I am almost a lone voice forecasting another mild recession in Q2 and Q3. Here is my argument.

2010 was a better year than most expected, including me. The outturn was stronger because households decided to live beyond their means (yet again). The savings ratio fell sharply as households decided that as according to the press their house was rising in price, things were on the up, and there was no need to reduce debt further. Households with no debt, I think basically said “sod it, why keep it in a bank earning virtually nothing, when it can be spent on all the bargains offered by retailers”. The velocity of money grew at its fastest rate since 1993.
The price of oil is now $100 a barrel. This will really squeeze discretionary incomes if it stays close to this level. Anyone who has filled their heating oil tank (2.5k litres) in the past 3 weeks will have noticed they are paying £1000 more than in March 2010. And the price of wheat has doubled in 2010 which will add to food price inflation which is running at 6%. RPI is 4.7% due to the cost of imports.

The chart below compares my forecast with that of the Office for Budget Responsibility, for real disposable income (income after tax).”

“As you can see, I am much more pessimistic. This is because Average Weekly Earnings are growing at 2.2%, the public sector has a wage freeze, and RPI is nearly 5%. Of course if you are on the board of a FT100 company, your earnings will be up 55% (mostly triggered by share price increases).

Consumption spending is 80% of total spending, so the following chart reflects the one above. The OBR are assuming that private investment spending will be stronger than I think it will be. Although in my forecast investment spending prevents 2011 as a whole being a negative year.”

Vistage Speaker Roger Martin-Fagg’s recent forecast is that the UK is in for a “rocky economic ride” through 2011.  Prompted by this to think about cash and banking isssues, Vistage Chair Dr Alex Kent invited Lloyds TSB Relationship Managers Dan Batchelor and Rebecca Kingdon-Saxby to meet with his members at their August group meeting.  The objective was to consider how banks and their clients can build stronger, mutually beneficial relationships a challenging economic environment.

We discovered that there are several areas of common ground.  For example the characteristics of a good business include a clear vision and strategy supported with business plans and key performance measures.  These are also the characteristics of a good business client for a bank such as Lloyds TSB.

However it seems that the strongest business relationships are perhaps only really formed when banks put the client squarely at the centre of the relationship.  We heard from Dan about one example where cash transfers from retail outlets to the client’s bank normally took 3 days to reach their account.  Using their knowledge and partners, Lloyds TSB succeeded in crediting the client’s account on the day of the transfer, resulting in better cash flow and cheaper credit facilities.

Alex’s conclusion from the meeting is that a banking relationship is not just about securing the cheapest source of finance.  A good relationship between banks and their clients could help uncover other areas of significant untapped value.

Gary Weston, Chairman of Group 19, introduced the speaker Roger Martin-Fagg. One of the most popular Vistage speakers, Roger’s talk was named How Does the Economy Work and What Causes a Recession?

They are two big and complex questions which Roger deftly explained with wit and verve. Injecting both humour and clarity into Gross Domestic Product forecasts is not the easiest of tasks but Roger’s engaging delivery ensured that even the most complicated of economic theories was easily digestible.

Perhaps the most pressing question for most of the people in attendance was ‘What stage of the recession are we in?’ Roger’s sobering prediction is that the current recession is unlikely to end before 2012 and that we then face several years in which small improvements in the economy will be countered by mini dips. The underlying trend is that the economy will grow but at a slow rate.

Roger’s message might not have been the most optimistic but its stark assessment should help Vistage members shape their strategy for the next few years.

As well as potential new members, those in attendance included Vistage members such as Sandra Birrell of McKinnon and Clarke; George Finlayson of Portakabin Scotland and Andy Lothian CEO of The Insights Group. They were joined by alumni such as Jim Lambert of J. Wilson Power Tools and Graham Wallace of the Filmhouse.

Steve Gilroy, CEO of Vistage International (UK), attended the event along with Chairmen Gary Weston and Alastair Muir.

Watch the video for a taste of the day and visit vistage.co.uk to find out more about our upcoming Vistage Open Days for 2010.

We’ve all seen the headlines. In the current economy, many businesses have tried unsuccessfully to raise finance. Their experiences have varied with lots of “flat no”, some “protracted maybe” and very few “definite yes” responses from lenders. The financing prospect for many businesses looks very bleak:

• Banks continue to strengthen their balance sheets. Lending is available, but is much tougher to achieve with higher rates, more security needed and more ‘setup’ or ‘consultancy’ fees than ever before.
• Government loan schemes have had a very low take-up, with demanding information requirements.
• Reduced trade credit insurance limits have increased debt requirements just to maintain existing trade.
• Venture Capital firms have focused on recovering lost value in their existing portfolios. Many funds have dried up.

According to a recent survey by the Institute of Directors, nearly 60% of UK businesses were refused credit by their banks last year, despite the government’s efforts to boost lending. The survey found that 57% of businesses were denied money, and 20% used credit cards to finance their business. The report contradicts recent claims by banks that they are lending to companies that need finance.  Recent editorial in The Daily Mail took a blunt view with headlines such as ‘SMALL FIRMS LEFT TO STARVE’ and ‘IN PROFIT BUT BANK SAID NO’ and ‘WE’VE HAD ZERO HELP’.

On the 19^th of February, the Bank of England revealed that bank lending to businesses fell by a record 8.1% last year. It also said that lending to businesses ‘fell across all the main sectors’ for the third successive quarter’.

John Wright, national chairman of the federation of small businesses said that many firms faced huge problems in raising capital.

Economists, business associations and some high-profile business leaders seem to agree that 2010 will be no different, and businesses should not expect a return to 2007: businesses need to get used to the new economic environment.

Behind the headlines, the reality is that all of the banks are desperate to lend more money to increase their profits, BUT their credit departments have raised the bar in terms of criteria and commercially they have increased their prices. So, better-presented business cases are essential.

Another perhaps surprising aspect of the current situation is that entrepreneurs and business leaders with good business cases often don’t trust the banks, and so hold back on their true business growth plans.

So, despite their thirst for more business, banks are making it harder for entrepreneurs to borrow, and entrepreneurs are being more cautious about expansion and investment, especially when this is on borrowed money.

So what can you do to maximise your chances of raising finance in the new economy?

Well, the general views of those in the finance business seem to be saying that businesses need to get much smarter about where they look for finance and how they ask for finance. The days of simply relying solely on your local bank have gone – you need to be prepared to look at other banks, other options. And whatever options you look at, they all have one thing in common – they are looking for solid business cases, with good data to support your case and evidence of having the right talent in place to achieve your goals. It seems that many business owners are woefully ill-prepared when asking for financial support – from their bank or from any other source. Simply relying on your trading history just doesn’t cut it any more – lenders need to see a good business case and have confidence that you’ll achieve your goals despite the current economic situation. It’s never been more important for your business to stand out from the crowd – so you need to have your case more prepared than ever before.

Guide to Raising Finance in The New Economy

Vistage is the world’s leading Chief Executive organization, with over 15,000 members around the world. To reflect this new economic landscape we’re now in, we’ve produced a brand new UK Guide to Raising Finance in The New Economy that tells you what your options are and how best to present your case for business finance. To download your copy, simply visit www.neweconomyblog.co.uk/rf5 and fill in your details.

I wish you the best of luck if you are currently searching for business finance. I hope that this brief article helps a little, but be sure to request your copy of our new Guide to Raising Finance in The New Economy – it has much more detail and tips that might help you.

Best of luck

Steve Gilroy
Chief Executive
Vistage International (UK & Ireland)