Over the last few weeks, the outlook for many French companies has deteriorated dramatically. The Altice empire, put together by billionaire Patrick Drahi, is in big trouble, ensnared in a corruption scandal, and raising emergency cash to stay afloat. Among other assets, its 24.5% stake in BT may have to be sold off, and its shares are down by almost 60% over the past year.

Last week, shares in Worldline, the payments firm that is one of the biggest tech businesses in France, crashed by 60% as it warned about its profits for the year ahead. One of the country’s few high-tech champions, even if it dates back to the 1970s, is failing badly. 

It’s not looking much better at the drinks giant Rémy Cointreau. Over the last few months, its shares have slumped to their lowest level in 15 years due to poor sales amid a slowing global economy. Meanwhile, luxury goods empire LVMH is on the slide, with its shares down by a quarter in the last six months as demand from China slips. 

France has been riding an artificial boom
Add it all up and one thing is clear. France is starting to get into trouble and the Emmanuel Macron bubble has started to burst. In the six years that he has now been in power, the hyper-energetic French president has benefited from an artificial boom. France rode the rapid expansion of the Chinese economy better than any other major country. Sure, the Chinese bought some German cars and machine tools, but what its nouveau-riche entrepreneurs really wanted was high-status European luxury goods that allowed them to show off how rich they had become.

It was demand from Asia that made LVMH the largest company in Europe and also powered the likes of Hermès and L’Oréal. That generated vast profits, which in turn produced plenty of corporation tax: the state’s tax from companies rose by almost 50% over the last decade. But as China slows down, profits certainly won’t keep on growing the way they did and those tax revenues will dry up. 

Meanwhile, membership of the euro, and the backing of the European Central Bank as it printed vast quantities of new money, has allowed France to run up huge debts. When the euro was launched, France’s debt was just 59% of GDP. It is now up to 112%. That worked while interest rates were close to zero, and when the ECB was buying bonds. Investors have simply assumed that France is “too big to fail” within the eurozone and that in a crisis the other member countries will always bail it out, and so will the central bank. Even so, it has now reached the limit of borrowing. Its credit rating has been cut. The IMF is warning that spending needs to be reduced further. Bond yields are rising. If there is a loss of confidence there could be a rapid exit. 

Macron's close allies' companies start to unravel
Finally, a select group of tycoons close to the president, such as Drahi, built up debt-fuelled empires that are now starting to unravel. They created an illusion of a dynamic, fast-growing France. But companies that are based on borrowing cheap money are rarely solid. If a few of these close allies crash, it will be hard for the president to escape some of the blame. 

Macron has sold himself to the world as a radical reformer. He was the man who would modernise France. True, he has made more progress on shaking up its rigid labour market and burdensome welfare system than his last two predecessors put together. Still, progress has been very slow, and all the grand talk of change has disguised the fact that he has presided over a vast increase in debt and state spending, helped by the luck of a luxury boom and low interest rates. 

Through all of this, France remained stuck in a low-growth rut, with little sign of new industries emerging, and only modest reductions in a punishing level of unemployment. The luck has now run out. Money will be very tight over the next few years. With all his political capital burned up on a tweak to the pension laws, Macron has no space for any further reforms. Soon, it will be clear that the bust has arrived – and the French economy will get very messy.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.

•  Inflation is improving and economic forecasts are rising for the UK economy 
•  Sentiment remains weak for the UK market, with significant outflows 
•  Many UK companies continue to deliver operational performance ahead of expectations 

There are more promising signs emerging on the UK economy, with inflation finally falling and the International Monetary Fund (IMF) predicting that it will side-step a recession in 2023. Yet the UK market remains stubbornly unloved, with investors continuing to exit, even amid cheap valuations and sound earnings prospects. What could turn the tide for sentiment in the UK?

In May, the UK All Companies sector saw £916 million in outflows. The UK All Companies, UK Equity Income and UK Smaller Companies sector accounted for 86% of the overall outflows from equity funds over the month, capping a trend that has become increasingly persistent in recent months. It shows that despite better news on the UK economy, the UK market continues to be out of favour with investors. 

It's not just the economy that is stronger than expected, many UK companies continue to deliver operational performance ahead of expectations. Abby Glennie, manager of abrdn UK Smaller Companies Growth Trust, says the direction of earnings has historically been a good indicator of market levels: “We saw a turn in earnings revisions at the end of last year. This is usually a good sign.” 

“In the UK small and mid cap space where we operate, we continue to see good reporting out of the companies we hold, delivering in line or ahead of expectations. There may be some economic question marks, but we hope to see further upgrades.” 

This mismatch between share price performance and operational performance has left the UK market looking cheap relative to its own history, and to its international peers. Rebecca Maclean, co-manager of Dunedin Income Growth Investment Trust, says: “The UK certainly looks cheap compared to the rest of the world, but it is also obviously cheap compared to its own history as well. Its dividend yield is twice that of the US market.”

“We are increasingly seeing valuation anomalies, and a disconnect between what we hear from management teams and what the market is saying about companies in terms of valuations. It is an interesting time to look at this market afresh.” 

Innovative companies 

The UK market continues to struggle with a few myths. Notably, that it is all about a handful of cyclical, old economy mining and energy names. Maclean says that the mid cap space in particular is far more vibrant than it is given credit for, with a raft of innovative businesses, demonstrating technology leadership. 

Rebecca says that the sell-off in UK stock markets has created opportunities to buy good quality dividend-paying companies at lower prices. She points to Games Workshop, which derated significantly in 2022, alongside the high technology tools manufacturer Oxford Instruments and the accounting software provider Sage, which offer attractive growth prospects. These companies are held in the Dunedin Income Growth Investment Trust.

Glennie highlights a number of recent purchases in the abrdn UK Smaller Companies Growth Trust portfolio that demonstrate this innovation: Alpha Group, for example, helps companies to manage their FX exposure, while also providing alternative banking solutions and Hill & Smith is exposed to US infrastructure development.

Iain Pyle, manager of Shires Income, is also taking advantage of this derating of good quality growth companies: “Given the rise in discount rates, we have been buying into strong growth companies with compelling valuations. There has also been severe weakness in UK cyclicals. While there is some near-term earnings volatility, a lot of that volatility is reflected in the price.” With this in mind, he has recently been buying National Grid, which is playing a vital role in the energy transition. 

A sentiment problem 

If the UK market is cheap, earnings are improving and there are compelling growth opportunities, why isn’t it getting more attention? It is tough to predict when a market will turn, and the UK has been out of favour for some time. Nevertheless, it is already pricing in a difficult economic scenario that may not transpire. The economic forecasts have been improving and eventually, investors may catch up with reality. 

The shift in the interest rate environment might make a difference. Pyle says: “The S&P 500 delivered 4x more value in the past 15 years than in the previous 100. This was driven by a handful of growth stocks and long duration assets. It is highly unlikely that we will get the same cuts in bond yields from here. With this in mind, there is no reason to believe the next 15 years will be like the last.” This would favour a different type of stock, refocus investors on fundamentals, and could be a better environment for the UK market.

In particular, it should focus investor attention on dividends and this has long been a key selling point for the UK market. Its dividend yield continues to look attractive relative to other major markets and it is possible to find plenty of companies delivering compelling, above-inflation dividend growth. This may get it noticed in the longer-term. Glennie points out that even after difficult periods, markets can recover very quickly: “The time to reach new market highs has often not been very long, from 12 months to two years.” 

While it is difficult to time a change in sentiment, all the conditions are in place for a reappraisal of UK markets from investors. There are still economic challenges, which argues for a focus on quality companies, but opportunities are increasingly abundant. The UK market may finally be coming in from the cold.  

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Important information 

•  Risk factors you should consider prior to investing:  
• The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.  
• Past performance is not a guide to future results.  
• Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.  
• There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value. 
• As with all stock exchange investments the value of the Trust shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen. 
• The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV. 
• The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
• Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.  
• The Company may charge expenses to capital which may erode the capital value of the investment. 
•  The Alternative Investment Market (AIM) is a flexible, international market that offers small and growing companies the benefits of trading on a world-class public market within a regulatory environment designed specifically for them. AIM is owned and operated by the London Stock Exchange. Companies that trade on AIM may be harder to buy and sell than larger companies and their share prices may move up and down very sharply because they have lower trading volumes and also because of the nature of the companies themselves. In times of economic difficulty, companies listed on AIM could fail altogether and you could lose all your money. 
• The Company invests in smaller companies which are likely to carry a higher degree of risk than larger companies. 
• Specialist funds which invest in small markets or sectors of industry are likely to be more volatile than more diversified trusts.
• Derivatives may be used, subject to restrictions set out for the Company, in order to manage risk and generate income. The market in derivatives can be volatile and there is a higher than average risk of loss. 
• Certain trusts may seek to invest in higher yielding securities such as bonds, which are subject to credit risk, market price risk and interest rate risk. Unlike income from a single bond, the level of income from an investment trust is not fixed and may fluctuate. 

Other important information:

Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.

Find out more at  www.abrdnuksmallercompaniesgrowthtrust.co.uk,  www.dunedinincomegrowth.co.uk and www.shiresincome.co.uk or by registering for updates. You can also follow us on social media: Twitter and LinkedIn. 

I've said it before and I'll say it again - the US dollar is the most important price in the world.

The dollar is the global reserve currency, the international money of default.

Global commerce thinks in dollars.

It’s the pricing mechanism for essential materials. Commodities like oil, copper, gold and wheat, are traded in US dollars.

The majority of international debt - and there is even more debt than essential commodities - is traded in dollars. The IMF thinks in dollars.

It’s a determinant of international capital flows: is money flowing from or to the United States, the largest economy in the world (just)?

I can get all idealistic and say the world would be a better place if gold had this role. It should. It’s independent. It gives no nation or government exorbitant privilege. It lasts longer. It has a proven history. Its purchasing power doesn’t get steadily eroded. New gold supply matches population growth. That kind of stuff.

But the reality is that the US has got the gig, largely by having such a strong army, and also for the fact that so many around the world trust in America. (I would argue that trust is not what it was. It’s fading. But when push comes to shove it still has the gig).

A strong US dollar should be good for international stability, and thus good for America’s reputation. But the US government likes to print, spend, and then export the inflation and debasement. You just need to look at what it does to know what it prioritises.

The US dollar and the global economy

When the dollar is weak, asset prices rise – and the policy-making world sure does love a bit of asset-price inflation. Borrowing is cheap, house prices go up, stock prices go up, bond prices go up, energy and metal prices go up. The party keeps on rocking. Everybody feels wealthy.

But when the dollar is strong, the world gets the jitters. It starts to think that the asset price bubble that has been inflating since August 15, 1971, might be about to pop.

Those in charge may talk tough. They wear smart, plain suits and look respectable. But then they usually start printing again.

Here’s the thing though. The dollar has just hit an inflection point. It comes to them every now and then. And when it does, it pays to take heed.

Despite the experience of day traders, where prices flicker at you and fortunes are made and lost in tiny fluctuations, if you zoom out a bit, the dollar tends to trend for months at a time, if not years.

The US index (the dollar versus the currencies of its major trading partners) hit a high in 1985. It got so high, in fact, the G5 nations signed the Plaza Accord to get the price back down again. The eventual low did not come until 1992, seven years later.

This wasn’t a one-directional thing, except for the first move. There were counter-trend rallies that lasted several months.

Long-term dollar trends

In fact, the process of making a low lasted from 1988 to 1995. It made a low, rallied a bit, made another low and so on. It took time in other words.

But then from 1995, the dollar rallied - with the usual drawn-out countertrend moves - all the way to 2001. With the dot-com bust, 9-11, the Iraq War and all the rest of it, the dollar then saw seven years of a bear market and in 2008 it made another low. The price was 71. It rallied for several months, then declined for several months, eventually retesting the low in 2011.

So the bull trend, the bear trend and the process of making lows and highs can each take many years. If you, as an investor, trader or portfolio manager, were able to catch these trends - and be in and out of the market at the right time - you would have been able to magnify your returns many times.

The low in 2011 was 72. Many years of a bull market - with the usual drawn-out countertrend moves - followed before the dollar index eventually peaked in September last year at 114.

Here’s the long-term chart that illustrates what I have just described:

When it changes direction, this lumbering beast likes to put in double tops and double bottoms, more than any asset I can think of. Sometimes triple tops and bottoms. It reaches a level, then re-tests it, and then sometimes re-tests it again.

Here’s the thing. It might be putting in one such double bottom now.

The pain, especially of commodity prices, has been relieved somewhat these last few months as the US dollar has come off. This last month has felt particularly good with gold and silver both strong.

But the dollar index hit a low at 101 in early February. It rallied for a few weeks, then came off again. It’s retesting that low now.

Does the US dollar now rally?

I have to say it would be quite normal behaviour for it to do that from here.

I have heard a lot of excitement about silver, for example. You know my cynicism about that metal. Too much excitement and euphoria usually mean declines are upon us. In fact, in the last few days, I have taken a small short against silver in my spread-betting account.

I’m not forecasting the beginning or end of a major dollar cycle. But I do think, assuming 100 on the US Dollar Index holds, we might see a reversal in the dollar that could last several weeks or months.

It comes, interestingly, just as gold is re-testing its highs.

It’s all about that 100-101 level.

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The cost of living remains a struggle for millions – and many older workers may be looking to cash in their pension early and free up some extra money.

Inflation has slowed from a 41-year high of 11.1% in 2022, but people’s real-term income is still being eroded, and interest rates are at 4%, making it more expensive to borrow.

Meanwhile, pensions falling into inheritance tax estates from April 2027 and health issues which make working full-time a struggle could prompt others to draw on their cash earlier than planned, said Helen Morrissey, head of retirement analysis at financial services firm Hargreaves Lansdown.

“Many more people will now be looking at how to spare their families a tax bill. You may also find that you need to access your pension early due to ill health,” Morrissey said.

But for those thinking about taking money from their pension pots early, there are risks involved.

Retirement costs have soared in recent years, with many already facing a pension shortfall. Taking from your pot early could exacerbate this issue.

With the cost of a comfortable retirement now £43,900 per year for a single-person household, or £60,600 for a two-person household, we look at the benefits and drawbacks of withdrawing pension money early.

When can I take my pension?

If you have a private pension, you don’t need to wait until state pension age, currently 66, to access it, but you should think carefully about what approach is right for you before making any irreversible decisions.

Currently, you can start drawing on your private pension after you turn 55 – although this will increase to 57 in 2028. At this point, you can withdraw up to 25% of your pension pot tax-free, either as a lump sum or in instalments.

The amount of tax-free cash you can withdraw under the 25% rule is capped at £268,275. Beware of going over this 25% threshold though.

Adam Cole, retirement specialist at wealth management firm Quilter, said: “Any withdrawals above the tax-free amount are subject to income tax, which may push you into a higher tax band and result in an unexpected bill.”

When it comes to the other 75% of your pension pot, you have a range of different options:

Annuities

You could use your pension savings to buy an annuity. This will provide you with a regular guaranteed income for the rest of your life or for a set number of years, depending on the type of annuity you purchase.

For a long time, annuities were an unattractive option, but their popularity has surged in recent years. The average annuity rate reached 7.65% in September 2025, a year-on-year increase of 9.68%, according to the Standard Life Annuity Rates Tracker.

A total of 88,430 annuities were sold in 2024/25, up 7.8% compared to a year earlier, according to the Financial Conduct Authority (FCA). They spiked 39% between 2022/23 and 2023/24.

However, buying an annuity is an irreversible decision, so you should conduct thorough research before making a decision and consider taking financial advice.

For example, not all annuities can be passed on to your partner if you die, unless you opt for a dual-life annuity. The rates on dual-life annuities are often lower than those on single-life products.

It is also important to shop around to secure a competitive rate.

Pension drawdown

Pension drawdown is where you leave some money invested in the hope it will grow, and take a regular income directly from the fund. This approach gives you more flexibility compared to buying an annuity.

The drawback is that it offers less certainty, as you don’t know which direction markets will move in, meaning the value of your pension pot could go down at times as well as up.

With drawdown, you also need to consider how much cash you want to take out and at what intervals. You will need to make an assessment about your own longevity to reduce the risk of depleting your pot prematurely.

A combination of drawdown and annuity

It is possible to do a combination of the two approaches, using some of your pension pot to buy an annuity and leaving the remainder in drawdown. This can offer a good balance for some retirees.

Leave it invested

Another option is not to release your cash at all and instead let it increase in value until you decide you want to dip into it.

If you are still working beyond age 55 or have sufficient savings tucked away elsewhere to fund the start of your retirement, it might make sense to draw on other money first.

Under current rules, pension pots sit outside of your taxable estate for inheritance tax purposes, but this is set to change from April 2027 after changes announced in the Autumn Budget.

Historically, this IHT perk has made pension pots a tax-efficient way to pass on wealth after you die, but we could see a change in pension behaviour in light of the changes.

Watch out for retirement regret

Accessing your pot too early could mean running out of money later in your retirement.

Around one in 10 retirees aged 55 and older who withdraw money from their pension before leaving full-time work regret it, according to research by retirement specialist Just Group.

Its survey of more than 1,000 people found that 28% had withdrawn pension cash between the age of 55 and when they finished working full time, either as a lump sum or through income drawdown. Almost half said they received no financial advice or guidance.

Meanwhile, the FCA’s latest retirement income market data shows that in 2024/25 the number of people accessing their pension plan for the first time increased by 8.6% on the year before.

When making such a move, it can be worth considering using a financial adviser.

However, the FCA’s data shows that the number of people taking advice is falling. Only 30.6% of those who accessed their plan for the first time in 2024/25 took advice, according to the industry watchdog, down from 30.9% the year before.

Bear in mind, any money taken out of a pension early is losing its tax-free wrapper status.

Robert Cochran, retirement specialist at Scottish Widows, said: “If you are putting it somewhere like your bank account, you may be paying tax on any interest that you get on the cash.

“A good rule of thumb would be to take it if you are going to spend it and consider paying off your mortgage or other loans.”

Can I cash in my pension early?

If you want to cash in your pension before you hit 55, it gets a bit more complicated and is almost always inadvisable.

“There are only a few instances where savers can release their pension before the age of 55, such as extreme ill health or terminal illness,” says PensionBee. “If none of these circumstances apply, HMRC may view the early pension release as unauthorised, imposing a 55% tax charge on the amount withdrawn. No reputable pension provider will approve an early withdrawal unless these conditions are met.”

In other words, while it might be tempting to look at your pension pot as a way to boost your income throughout the cost-of-living crisis, the fact is you would almost certainly be losing out.

Because of the hefty HMRC charges, most pension providers won’t help you release your pension early. Instead you would have to turn to a third party who could charge up to 30% to do so.

There is an increased risk with this too – most of the firms that arrange early pension release aren’t FCA authorised and so your money isn’t secure, says PensionBee.

In other words, trying to cash in your pension before you hit 55 is almost always a bad idea. Not only will it expose you to significant risk, it will also result in you giving up a large sum of your hard-earned money in exchange for a small fraction now.

Be wary of pension scams

“There are numerous pension scams which claim to help savers access their pension before the age of 55 by exploiting loopholes in the system,” warns PensionBee.

“Unless a saver meets some of the above criteria or has been explicitly informed by a provider that they qualify for early pension release, savers should never trust a third party to withdraw their pension on their behalf.”

Hundreds of mortgage products have been withdrawn after sterling crashed to the lowest levels in decades against the dollar and the Bank of England said it wouldn’t hesitate to step in and raise interest rates further.

Almost 300 mortgage deals have been pulled in the last 24 hours alone, reports The Guardian, with warnings that the base rate could climb to 6% next year.

This is more than double the current base rate, which is 2.25%.

Why are mortgage products being withdrawn?

The halt in new lending comes after UK bonds sold off, driving government borrowing debt costs higher.

“Major mortgage players are hauling in the sails after the wind changed. The dramatic overnight hike in market expectations of future rates has ramped up the cost of doing business, and lenders are taking a break to reassess and reprice”, said Sarah Coles, senior personal finance analyst at Hargreaves Lansdown.

Market watchers have become increasingly concerned about the UK’s fiscal position after chancellor Kwasi Kwarteng delivered his mini budget – a £45bn tax cut package on Friday.

The International Monetary Fund (IMF) has joined the criticism, saying the chancellor should “re-evaluate” his plan as it could drive inflation higher, reports the Financial Times. In a statement, the IMF said that “Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture. It is important that fiscal policy does not work at cross purposes to monetary policy.”

Yorkshire Building Society, Virgin Money and Skipton Building Society are only a few of the building societies which are ceasing all mortgage offers for new customers.

Santander and HSBC followed suit and withdrew mortgage products for new customers.

“We’re temporarily removing all 60% and 85% LTV products from the new business range,” Santander said.

Nationwide, on the other hand, significantly raised interest across its full line of mortgage products, and announced its two, three, five and ten year fixed rate mortgage deals will be increasing between 0.9% and 1.2% from Wednesday.

Although Nationwide has so far fallen short of withdrawing loans offered to new customers.

HSBC, Santander and Lloyds Banking Group and Nationwide account for roughly half of the UK's mortgage market, according to the Financial Times.

What does this mean for you and your mortgage?

Mortgage prices are likely to rise, but also borrowers will face a smaller pool of products to choose from.

Mortgage borrowers who are already on fixed deals are likely to be protected from much of the upheaval for now.

But when they do have to find a new deal they will face significantly higher borrowing costs after all UK Finance predicts that another 3.1 million households are due to renew their mortgages when their fixed-rate periods expire in 2022-2023.

For the 1.6 million people on variable rate deals, rates on the mortgages will see an immediate rise.

New buyers are likely to find that the maximum amount they can borrow is now lower due to affordability stress testing.

And this problem is not just confined to new buyers. Those looking to remortgage next year may find it more difficult to do so as they may be unable to pass lenders’ affordability stress tests.

“Probably more people than ever will stay with their existing lender and take product transfer rates,” said Aaron Strutt, of Trinity Financial mortgage brokers.

For some the increase in mortgage costs will mean that they need to take tough decisions and cut down spending on other things, but many people may have to cut down on essential spending and simply may not be able to weather the increases in mortgage costs.

“Households refinancing a two-year fixed rate mortgage in the first half of next year will see monthly repayments jump to about £1,490 early next year, from £863 when they took on the mortgage two years prior,” said Samuel Tombs, chief UK economist and Gabriella Dickens, senior UK economist of Pantheon Macroeconomics.

What can you do about it?

It may be worth shopping around for a fixed-deal right now, especially if you have six months or less before your fixed-mortgage deal runs out, says the Guardian.

“If you have six months or less to run on a fixed-rate mortgage it might be wise to start shopping around for a new rate. Given the market turmoil, you may want to talk to a broker who understands the fast-changing mortgage sector outlook and can track down the best rates.”

Those who have excess cash can reduce the bill by paying part of the mortgage early. While it may be rare to have the money to pay off a mortgage, you can save a substantial amount by paying off early.

With a recession looking increasingly likely in the UK, check out our other tips on how to prepare for a recession and save money during these turbulent times.

“Financial markets express their faith – or lack of it – in a country” through its borrowing costs and the value of its currency, says Russ Mould of AJ Bell. In the UK, investors “do not like what they see”. On Monday the pound slumped close to its lowest level against the dollar in 37 years, trading as low as $1.14.

Rapid interest-rate hikes in the US have seen the greenback strengthen against most currencies this year – it recently hit a 24-year high against the Japanese yen. But sterling has done especially poorly of late. In August the pound lost 4.5% against the dollar, its worst monthly performance since October 2016, and also fell almost 3% against the euro.

The pound’s fall comes despite the fact that the Bank of England has been raising interest rates, a move that would normally strengthen a currency. “Until August, there had never been a month when sterling fell by as much as 4.5% against the dollar and ten-year gilt yields rose by more than 90 basis points,” according to data going back to 1971, say William Schomberg and Dhara Ranasinghe on Reuters.

The fact that gilt yields are rising (see below) even as the currency falls “is indicative of overseas investors losing confidence in the UK”, says Mike Riddell of Allianz Global Investors. “I think the UK and the gilt market are in a degree of danger.”

A toxic cocktail

Traders are reacting negatively to Liz Truss’s proposed “cocktail of especially loose fiscal policy, attacks on the central bank and conflict with the EU”, says Hugo Dixon on Reuters. If she’s not careful “the pound could be clobbered”. Truss is not alone in wanting to spend more on the energy crisis, but the trouble is that the UK is especially vulnerable to inflation, says Ian Johnston in the Financial Times.

Core inflation is running at 6.2% here, compared with 4% in the eurozone. That means that “pound for pound, euro for euro, fiscal spending by governments will be more inflationary in the UK” than elsewhere in Europe, says Antoine Bouvet of ING. The UK’s large current-account deficit – which hit £44.2bn, or 7.1% of GDP, on an underlying basis in the first quarter – leaves it vulnerable to the whims of financial markets. The gap needs to be covered by foreign capital.

If global investors lose confidence in Britain then a “balance of payments crisis” and sharp sterling devaluation cannot be ruled out, says Shreyas Gopal of Deutsche Bank. “We estimate trade-weighted sterling would need to fall by a further 15% to bring the UK’s deficit back to its ten-year average.” Such a scenario is not unprecedented: the UK had to turn to the International Monetary Fund for an emergency loan in 1976 following “aggressive” spending, a nasty energy shock and a decline slide in the pound.

Goldman Sachs analysts recently warned that UK inflation “could soar above 22% next year”, says Liam Halligan in The Daily Telegraph. Price pressures herald an autumn of “widespread industrial action and even civic unrest”. Britain’s sliding pound risks becoming “a symbol of economic weakness and a broader lack of governance”.

The bond bear market will get worse

Ten-year UK gilt yields hit 3% on Monday for the first time since 2014. Rising yields are a reminder that there are limits to government borrowing, says The Times. With “the ratio of public debt to GDP…close to 100%, policymakers need to be wary”. For all Liz Truss’s talk of faster growth, “there is ultimately no route to national wealth by inflationary public financing and currency depreciation”.

Bond yields move inversely to prices, so it has been a miserable year for fixed income. The Bloomberg Global Aggregate Total Return index, which tracks global investment-grade government and corporate debt, has lost more than 20% since peaking last year. A decline of that magnitude marks a bear market. This is the first time the index has entered a bear market since its inception in 1990. Bear markets are “virtually unknown in bonds”, says David Randall on Reuters. Between 1990 and its January 2021 peak, the global bonds index “delivered an aggregate total return of nearly 470%”.

This year has thus proved a rude awakening, says Steve Goldstein for MarketWatch. This is likely to be “the worst year for US fixed income since at least 1928”. Bonds are widely considered to have been in a “secular” bull market since the mid-1980s, say Garfield Clinton Reynolds and Finbarr Flynn on Bloomberg. Yet soaring inflation and tighter monetary policy may have finally slain the bond bull. Bonds in Europe have led the sell-off, with a Bloomberg index that tracks investment-grade sterling bonds also falling into a bear market last week.

There could be more pain to come, says Jack Denton in Barron’s. “If there is a recession but inflation persists, forcing the Fed to keep turning the screws on financial conditions, the bond bear market might only get hairier.”

Sri Lanka will not be the last country to plunge into a debt crisis. The island nation defaulted in May this year as soaring global food prices and a tourism slowdown caused by Covid-19 collided with years of profligate state spending. Inflation is running at 54.6% and essentials such as food and medicine have run short.

Which countries could follow? The situation is especially acute in Africa, say Danny Bradlow and Magalie Masamba on The Conversation: “22 countries are either in debt distress or at high risk of debt distress”, according to data from the International Monetary Fund (IMF). While most African debt is owed to governments in rich countries or “multilateral institutions like the World Bank”, a growing share is held by private investors.

“The amount of bonds issued by African states on international markets has tripled in the last ten years.” These instruments have been bought by “insurance companies, pension funds, hedge funds” and investment banks. The countries with the shakiest debt positions include Mozambique, Zimbabwe, Malawi and Zambia. Governments borrowed freely after the financial crisis, says The Economist. “In 2019 public debt stood at 54% of GDP across the emerging world.” Budget deficits then soared amid the pandemic, but now the bill is coming due. A global slowdown and tighter “financial conditions will be more than some governments can bear”.

Debt relief is on the international agenda, but the trouble is that lending is less transparent than it used to be because of China’s emergence as the world’s biggest bilateral creditor. Work by Sebastian Horn and Christoph Trebesch of the Kiel Institute and Carmen Reinhart of Harvard University suggests that “almost half of China’s lending abroad is unreported”.

The IMF issued an ominous warning last week over rapidly-slowing global growth and the rising threat of an emerging-markets debt crisis. The fear is that the global slowdown, combined with surging inflation and rising interest rates, is likely to hit poorer and highly indebted countries especially hard by causing a slump in inward investment and driving down their currencies.

Emerging markets already facing debt distress would then be vulnerable to broader economic and social crises – compounded by emergency fiscal retrenchments – entailing the kind of food and power shortages, social unrest and political meltdown now being seen in Sri Lanka.

Haven’t we heard this before?

Fears of an immediate debt crisis surfaced at the start of the coronavirus pandemic in early 2020, says David Lubin, Citi’s head of emerging markets economics, in the Financial Times. But in the short term those worries proved overblown.

First, the dramatic loosening of monetary policy by the US Federal Reserve and other big central banks supported risk appetite globally and kept capital markets open to emerging-market borrowers. Second, massive fiscal stimulus by policymakers helped generate a surge in global trade. Third, says Lubin, the IMF supported developing countries’ financial stability with emergency funds. Now, though, that relatively benign picture has changed dramatically.

How so?

Even before the Ukraine war introduced new threats to the global economy, the combination of tighter US monetary policy and a sharp decline in global trade growth was starting to hamper the ability of lower-income countries to get hold of dollars. In 2013 just the hint from the US Federal Reserve that it would scale back quantitative easing was enough to move money out of emerging markets. What might happen now in the event of a significant unwinding of the Fed’s balance sheet remains to be seen – but the prospects are “grim”, says the FT.

The war in Europe has hit emerging markets with a “triple whammy”, says The Economist. The first blow is the potential for a short-term drying up of liquidity – and a broader “flight to safety” that raises the cost of borrowing across emerging markets and increases the burden of debt. The second is the broader macroeconomic picture of lower growth, and food and energy price shocks. The third is the likelihood of a long-term change in willingness to lend to high-risk sovereigns.

Russia’s war – and the West’s “shock-and-awe financial and economic response” – are another jolt to a global economy that has recently weathered trade wars, a pandemic, supply-chain disruptions and an increasingly unpredictable policy environment. All of that could spell a permanent reassessment of how to price geopolitical risk, increasing the cost of funding for emerging markets.

How much money is at risk?

According to the Washington DC-based Institute of International Finance, emerging-market bonds and loans maturing by the end of next year total around $9trn. Compared with the emerging-markets debt crises of the 1990s, far more debt is denominated in local currency, and fewer exchange rates are pegged rigidly to the dollar, cutting the risk. But even if an estimated 85% of that debt is in local currency, well over $1trn is directly exposed to rising US rates, says Jamie McGeever of Reuters. Total emerging-market public debt stands at around 66% of GDP, according to the IMF, virtually doubling since 2008. “That debt explosion was serviceable only because global rates collapsed to virtually zero after the 2008 crisis.” As they rise, it won’t be.

How bad are things already?

According to the IMF, the number of low-income countries at or near debt distressed levels has doubled from 30% in 2015 to 60% now. The Ukraine war, which started in late February, has created “a crisis on top of a crisis”, says Kristalina Georgieva, the fund’s managing director, with many issuers hit by capital outflows and bond yields far above pre-pandemic levels.

What makes the situation “particularly worrying”, says Simon Nixon in The Times, is “the lack of any tested mechanism for restructuring sovereign debt”. That’s bound to be needed (and has already been requested by Chad, Ethiopia and Zambia) as conditions deteriorate and the pressure on governments grows. The whole question is complicated by big changes in who’s doing the lending.

Today, the Paris Club of rich creditor countries accounts for about 11% of external emerging-market debt, compared with 28% in 2006. China’s share has jumped from 2% to 18%, and the share sold to private investors has risen from 3% to 11%. All that makes restructuring debt “a far more complex business”.

Why is it more complex?

Because the range of lenders is more fragmented and trust is in short supply. China, which has “made debt diplomacy a core feature of its global assertiveness, has made clear that it has little interest in co-operating with other lenders”. And although the G20 agreed a new framework for restructuring low-income country debt in 2020, it’s impact has been marginal.

From March 2020 until December 2021, the G20’s “debt service suspension initiative” suspended a total of $10.3bn, whereas in the first year of the pandemic alone, low-income countries accumulated a debt burden totalling $860bn, according to World Bank figures. The reason this matters so much, says Nixon, is that a debt crisis in emerging markets could readily widen – in the same way the eurozone crisis did – into a broader banking, financial and economic crisis.

The stakes are high – and the pressure is on for richer countries to work together to address the issue. “The alternative hardly bears thinking about.”

SEE ALSO:

• The bond-market bloodbath isn’t over yet

• Indonesia aims to step up its economic growth

• Why food and fuel subsidies will push up debt

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Transcript

Merryn Somerset Webb: Hello, and welcome to the MoneyWeek magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine. It is 25th April 2020, and I have yet another treat for you today. We’ve been on a good run for the last couple of weeks, and here is going to be another good one.

I have with me today Mohamed El-Erian, the president of Queen’s College, Cambridge, and we are going to talk about pretty much everything to do with the global economy and then onto investment. Mohamed, thank you so much for joining us today. Welcome.

Mohamed El-Erian: Thank you, and thank you for having me.

Merryn: Oh, a pleasure. Now, I think we’d better start with a bit of misery. I’m hoping we might end outside misery, but we’re going to have to start there. Now, let’s talk about the global economy. So, we had the new forecasts out from the IMF a few days ago. They were revised forecasts for pretty much all of the Member States, well, 85/86% of 190 Member States or so. They downgraded global growth by a percentage point or so from 4.4% down to 3.6%, and they also downgraded very slightly next year’s forecast.

So, we’re not going to gain back any of our lost growth this year. Next year, it’s all looking pretty miserable. So, let’s talk about that a little bit. What do you think are the main drivers behind that, and how bad is it going to get? How bad is it going to feel, should I say?

Mohamed: So, as you say, these are pretty stunning and sobering revisions. It’s not often that three months into the year, the IMF revises projections that it made just in January. And the extent of the revisions is what is particularly striking. As you pointed out, 86% of the member countries are seeing lower growth, and not just by a little, by a lot. And it’s not compensated next year. So, this is a major change in the growth outlook. Why? A few reasons.

One is that even before the Ukraine War, we had slowing going on in the three major economic areas, Europe, the US and China. Each had their own reasons for slowing, but they were giving quite a huge impulse, a stagflationary impulse, to the global economy, lower growth, high inflation. Then comes the Ukraine War. That entails major disruptions to supplies of a number of very important commodities. So, you have both a supply shock and inflation shock. It undermines confidence, particularly in Europe, so you have demand issues as well.

And put all that together, you get these divisions. What’s worrisome to me is, it’s not the end of the revisions.

It would not surprise me if the next round sees a sharp revision in Europe’s growth rate in particular for this year.

Merryn: OK, and again, based on the War and the rising energy prices, etc, from that?

Mohamed: Correct, and if ever we were to have sanctions on gas exports from Russia to Europe, then the revisions would go into negative, into a recession for Europe.

Merryn: OK. Let’s go back a little bit to before the War in Ukraine. You were saying that there was already a slowing impulse then, based, presumably, on the monetary authorities beginning to row back from money printing, beginning to row back from the huge levels of stimulus during Covid, and that was already giving us some kind of slowing impulse throughout the global economy. Or is there something else in it?

Mohamed: Well, there were several factors. So, if we start in China, it was trying to continue with the zero-Covid policy in the face of Omicron, a much more infectious variant of Covid. It is almost impossible to run a zero-Covid policy without disrupting the real economy when you have Omicron around. And already, China was slowing and was causing a renewed round of supply side disruptions, which were impacting Europe and the US.

So, in China, it wasn’t about monetary policy. It was about the Covid policy that was pursued. Unlike the West that is trying to live with Covid, China is trying to still eradicate, completely, Covid. That’s a significant difference in strategy.

Merryn: Mm-hmm, but it’s impossible for that not to have an impact globally, and impossible for that not to have an impact on inflation is that supply chain disruption is going to continue. And it looks like it’s going to continue, possibly… It’s hard to see how it ends, now with Shanghai being locked down on and off all the time and Beijing beginning to be concerned about rolling lockdowns there. It’s hard to see how the global supply chain ever goes back to normal.

Mohamed: That’s correct, and that was actually clear almost a year ago. I remember the time a few of us were warning against this notion that the cost-push inflation would be transitory. If you talk to the companies involved, most of them did not feel this would be transitory. They felt that it would be prolonged, it would last for most of the year and into 2022. Now, the renewed China disruptions mean that we will have supply disruptions for most of this year as well. So, yes, absolutely, the supply side is not going to heal as quickly as we’d all like it to heal.

Merryn: Yes, I looked, and I saw a number this morning that made me think, people talk at the moment about inflation peaking and how we’re near peak inflation, it’s going to turn around, the Fed will be saved, etc. But the price of farm inputs in the UK has gone up 23% in the last six months alone. Now, a lot of that is fuel, but also in there you’ve got feed and fertiliser, etc. With those kinds of numbers, it’s impossible to look at that and go, yes, OK, inflation’s probably peaked.

Mohamed: That’s absolutely right, and the same with wages. Now, it’s important to distinguish which inflation are we talking about. In the US, headline inflation at 8.5%. Has that peaked? Maybe. It could well have peaked, but if we get another disruption, that would be reversed quite quickly. But if you look at the core measures, which are influenced less by energy in particular, that has not peaked. So, we should expect inflationary pressures to persist.

Now, there’s a camp, it used to be the transitory camp, now it’s called the immaculate disinflation camp, that believes that somehow, inflation’s going to come down very rapidly, not just because of base effects, which will be in play, but because we will see all these inflationary pressures just disappear. It is highly unlikely, and keep an eye on the labour market because so far, wages have been lagging inflation in a serious way, but there are signs that wage growth is picking up, especially as people change jobs, which they’re doing much more frequently now.

Merryn: And what are these signs? When you say there are signs, you mean just that you can see in the data that when people move jobs, I’ve seen this data, they’re getting fairly impressive uplifts, 10/20/30/40%, on shifting jobs. But you’re not necessarily seeing the rises come through for people who remain in steady the employment with the same employer?

Mohamed: Correct. So, the first round is those who change jobs. And there’s been a recent survey done of over 2,000 US residents who changed jobs, and about 30% of them gained 6 to 10% increases in their wages.

Another 25% saw 11 to 25% gains. Over 10% saw 26 to 50% gains, and it goes on. So, round one is job hopping, if you like, but if you’re an employer and you’re hiring people at a higher entry wage, it’s only a matter of time when you have to adjust everybody else’s wages.

Merryn: Yes, it’s interesting, isn’t it? When we’ve been looking, at MoneyWeek, at what happened in the 70s, etc, and everyone just slightly behaves, when they look back at the 70s, as though it was unionisation that drove wage increases. The unions were the first point, but actually, of course, the unions still existed in the 1960s, and you didn’t see this huge wage inflation then. So, it is entirely possible that it’s inflation that drives unionisation, which drives wage rises, rather than the other way around. So, we may just be at the beginning of this cycle.

Mohamed: We could. The one big difference with the 70s, and I think it’s why we’re not going to see the sort of spiral we saw then, we’ll see one, but much smaller in magnitude than what we saw then, is you don’t have indexation. That was a turbocharger in the 70s. We don’t have that today, but we will see a cascading of wage increases throughout the labour force.

Merryn: OK, because we have an unpleasant dynamic now where real wages are falling, and of course, that’s an obvious recession sign. But there’s a chance that real wages will at least catch up.

Mohamed: Oh, absolutely. Remember, there are three distinct phases in the wage adjustment process. One is, they fall behind because inflation surprises them. It is unanticipated. Second, they look to compensate for past inflation, and then, third, in addition to compensating for past inflation, they look to compensate for future inflation. You get anticipatory demands. That happens when inflation remains high and when inflationary expectations are the anchor.

So, that’s why it’s really important that central banks try to catch up with developments on the ground. The Fed in particular is very late.

Merryn: Well, this is the problem, isn’t it. They spent a very long time last year saying this is transitory, this is transitory. It’s going to go away, therefore we don’t have to do anything about it. And obviously, the markets have been way ahead of the Fed, and now are at the point where the Fed has, A, lost credibility and, B, has got so much catching up to do, that if they try and do that catching up, they will definitely cause a hard landing.

Mohamed: That’s absolutely right. I’ll give you two things that really caught my attention. It’s not that it took until the end of November for Chairman Powell to, quote, retire, unquote, transitory from his vocabulary. He should have done that way earlier, and he should have started adjusting policies before, but the week in March, the week, in which we printed a 7.9% inflation print, the Fed was still injecting liquidity into this economy.

QE hadn’t ended yet, which gives you a sense of how disjointed monetary policy has been from inflation.

Merryn: That’s a stunning kind of complacency, isn’t it?

Mohamed: Yes, I think they got caught hostage by a monetary framework, just a so-called new monetary framework that was designed for a world of deficient aggregate demand. And they didn’t quite realise that we had deficient aggregate supply. So, they got caught. They shouldn’t have, but they did, and catching up is hard, and now you’re seeing a bit of the typical developing country dynamic, which is worrisome for the world’s most powerful central bank, which is, every time they speak more hawkish and try to catch up with the market, the market runs away from them.

And the day last week, in which Jerome Powell sounded more hawkish than people expected is the day breakeven inflation went higher, not lower, and reaching a new record level. And you talk about ten-year breakeven inflation, so that’s the implied market probability of inflation over a ten-year period.

Merryn: OK, so they’re definitely in the can’t-win zone. Now, there is an idea that there’s a woke element to this kind of inflation, in that one of the reasons that the Fed left it so long to start acting or to really accept is that they wanted to be sure that they had full employment in advance of raising rates or tightening up monetary policy. It’s all, the idea being, they wanted to make things more equal, fairer. But of course, there is nothing that intensifies unpleasant inequality more than very sharp inflation, particularly, as you say, very sharp core inflation.

So, again, they’ve got this the wrong way around.

Mohamed: Yes, and I think there’s something else, if I may, which is that they were held hostage by markets. The Fed has been worried that if it moves to tighten policy, if it moves to tighten what are historically, still very loose financial conditions, it will cause unsettling volatility in the marketplace, because that’s what has happened in the past. We have the example of, not just the taper tantrum of 2013, but we have the example of the fourth quarter of 2018, when the Fed was tightening policy for good reason. That’s what the economy needed.

The markets did not like it, and in January, the Fed had to undertake a very embarrassing U-turn, even though the real economy was doing fine. So, I think there’s also the influence of markets and the fact that the Fed fell into these very unhealthy interdependencies with financial markets.

Merryn: OK, so what is the best thing for them to do from here? To just accept the hard landing, to accept higher long-term inflation, maybe change the target? If you were the Fed, it’s too late to say what would you have done, but starting from here, what’s the best thing to do?

Mohamed: So, I would hate to be the Fed at this stage.

Merryn: Oh God, me too.

Mohamed: Yes, absolutely hate it. And this is important because this is a problem of their own making. They could have very easily started ending QE in the middle of last year. Everything was fine, and they should have, and many people, well, some people, were urging them to do so. And even when they declared inflation not to be transitory they should have started then aggressively, but they didn’t. They were very, very slow.

Look, I don't think there is an easy pathway to an orderly disinflation. The first best policy responses, I don't think are still available. It was. It is no longer available. So, what would I do if I were the Fed? First I would be honest. I would explain why I got my inflation call so wrong. They haven’t yet. I would explain how I have modified my models and my thinking to make sure that I don’t repeat the mistake, which they’re still repeating.

I would alter the new monetary framework, which is problematic in this environment. So, I would first do all this in order to regain some inflation credibility. Then comes the really difficult issues. I would ask myself the following. It is likely that I’m going to make a mistake because I am really late. I don’t want to make a mistake, but it’s likely that I will make a mistake. If I end up making that mistake, which mistake can I live with, that of creating a recession, or that of having high inflation persist into next year?

And I would be very clear about how I measure the likelihood and the implications of those mistakes, and I would then make a courageous choice, I would say, and then go out and communicate, saying, we are aiming for an orderly disinflation.

We will need a combination of luck, skill and time. To the extent that time is no longer available, I would say I would rather err on a little bit more inflation for longer than pushing this economy to recession. That’s what I would do, but I want to stress, it’s not a first best, and unfortunately, I don't think that first best is available.

Merryn: Is there not a horrible possibility that we might be both a hard landing and inflation, a longer-term stagflationary environment that would come with, as we just discussed, this changing globalisation shift of China, involuntarily, out of the supply chain, which, by the way, we wrote about even before Covid, and you were probably talking about before Covid as well, that barriers around the world were already coming up.

The great age of advancing globalisation, it was already coming to an end even before Covid and even before the War in Ukraine. So, we have that. We have this business where we can’t really do much with monetary policy to help anything out. And of course, we have what, you’ve written about this as well, I’m not sure what you call, or other people call, temporal dislocation, the pulling forward of growth so that we haven’t got much left for the future. So, we may end up with both inflation and recession.

Mohamed: So, you ask me what would I do. If you asked me what is likely to happen, I would say you’re absolutely right.

Merryn: Oh, well, that’s depressing.

Mohamed: And it’s not only because of the factors that you’ve cited that are absolutely correct, the changing nature of globalisation being one, the fact that we’ve borrowed growth from the future to a large extent, the fact that we have conditioned market for too long to depend on ample and predictable liquidity injections, and all this is changing. But in addition to all that, I suspect the Fed will do the following. Having failed to ease its foot off the accelerator, it will slam on the breaks. It wouldn’t surprise me if we see two to three 50-basis point increases by the Fed.

And then there will be concern that the economy is slowing too much, so they will take their foot off the brakes a little bit, and then later on, they’re going to have to put their foot back on the brakes, and the stop-go monetary policy is the one that will accentuate the stagflationary forces that you’ve talked about. So, if you ask me what is likely to happen, as opposed to what should happen, what is likely to happen is that we go into next year with both a growth and an inflation issue.

Merryn: OK, so stop-start, stop-start, stop-start. You know, if you drive your car like that, you end up with clutch burnout, which is something I found out last week. And probably the lack of parts available around the world, burning out your clutch and needing a replacement is really expensive.

Mohamed: And how do the people in the car feel?

Merryn: People in the car feel cross, but maybe the driver feels really cross about the roadworks in Edinburgh and sometimes is a little bit too stop-starty on the clutch.

This stuff happens. So, I have sympathy for the Fed. I also wonder, when I look at central banks around the world, if perhaps we always thought that, perhaps, independent central banks could do more than they could, in that we gave them credit for the very long period of low inflation and disinflation, when, in fact, that may just have been a global dynamic with the disinflationary impulses coming out of China, the opening up of the world to become a global labour market, etc.

That low inflation was going to happen anyway. Absolutely nothing to do with the central banks, and this new age of higher inflation will have absolutely nothing to do with the central banks, and they’ll end up with no choice but to raise their inflation targets to 4 or 5% and be done with it for a decade.

Mohamed: So, you’re even harsher than I am. No, I do think there were secular disinflationary forces in play. You mentioned the globalisation. First, we brought in Eastern and Central Europe into the global labour force, then we brought China into the global labour force, and that was disinflationary.

Then we had what I call the Amazon, Google and Uber effects, which is technology allowing us to be better in price discovery, allowing us to use existing stock of assets like cars to deal with excess demand. So, we had these massive disinflationary forces, and then central banks, on top, did earn inflation credibility.

I think the problem was that they got co-opted by markets, and it started in 2010, when a decision was taken by the Fed, August 2010, to use unconventional policies, not just to fix dysfunctional markets, not just to address market malfunction, but also to pursue macroeconomic goals. At the time, if you recall, the summer of 2010, Congress was horribly divided, we had the Tea Party that had emerged, governments were going to be shut down.

And the Fed made the decision that there needed to be a bridge to a better world when fiscal policy and structural reforms could be implemented. What they didn’t realise at the time was that bridge would be very, very long, a decade’s worth of a bridge. And in the process, they would condition markets to be like little kids expecting sweets all the time. And they became hostage to the marketplace, and that has caused monetary policy to be run much more expansionary than before.

Remember, we continued running emergency measures when the economy was fine, and the only reason we did that is because central bankers were worried about the impact on the markets if they were to go back to conventional monetary policy.

Merryn: Mm-hmm, talk about reaping what you sow. Right, let’s talk about how we can possibly invest into this kind of misery. We know that MoneyWeek readers are very much equity and equity market investors, and I think we all know that valuations are still high, by historical standards, in pretty much every market. Maybe the UK and maybe Japan, etc, there are a few markets that are knocking around fair value, but in general, everything’s still quite expensive. Where do we go?

Mohamed: It’s a very difficult investment environment because the safe asset has been completely distorted, so you get the following conversation. And I’ve been on investment committees where the conversation goes as follows. We start with the view that equities are overvalued, and therefore, we should reduce our exposure. Then the question is, where do we go? So, let me tell you what a recent not-for-profit US investment committee did.

US, we should go into cash. Oh no, we can’t go into cash. Inflation is now 8.5%. that’s a guaranteed negative real return. You’re right. We should go into bonds. No, we can’t possibly go into bonds. Bonds are adjusting. Not only are yields still too low, but in addition, there’s a capital loss as yields go up, so we can’t do that. How about commodities? Oh, they’re really volatile. How about crypto? Oh, there’s a reputational issue there.

And that committee, which started by seeking to lower equity exposure ended up increasing equity exposure because equities are viewed as the cleanest dirty shirt. They are not clean, but they’re cleaner than many other assets. So, if you solve that problem in relative space, you will end up by not just keeping high equity exposure, but by viewing equity as perhaps your best defence against inflation.

Merryn: Interesting, and did that group stay in mainly US equities, or did they spread more globally?

Mohamed: So, in that case, they stayed in US equities. Now, the problem with that… And we are seeing this play out, and I’ve been urging since five months, to just take some chips off the table. The problem with that is that the moves in equities can be much sharper than the loss in the value of your cash over time. And that is what we have seen. So, depending on how heavily invested you are, and it varies from investor to investor, and depending on whether you’re confident, you can avoid the behavioural traps.

You know better than anybody else that we tend to fall into all sorts of behavioural traps that make us do the wrong thing at the wrong time. Selling at the bottom of the market. That happens a lot. So, people have to ask the same question that central banks have to ask, which is, can I live through a very unpleasant period, because things are really distorted right now? And if you cannot, then ask the question, what is your recoverable mistake, and what is your unrecoverable mistake? And let that enter into your calculation as to how you should change your asset allocation.

Merryn: So, again, the best we can do is ask ourselves the question, which mistake would I rather make?

Mohamed: Yes, and as bad as that sounds, that’s what happens when the safe asset has been distorted so much by central banks, that in the old days, it would have been, let’s go into cash. We may not have the upside of equities, but at least I’m protecting against the downside. And I still have my equity exposure that gives me an upside.

I just have less of an upside. And that was the good old days when cash wasn’t being eaten away by inflation and when bonds weren’t heavily distorted by years of asset purchase buybacks. So, in the old days, you had correlations that would allow you to take some chips off the table and retain a claim on the upside. Not as big, but still reclaim a claim on the upside. Now people are paralysed because the safe asset is distorted and cash is subject to being eaten by inflation.

Having said that, that’s the world we live in, and still, it does make sense. If you’re 100% equities at this point, there is an argument for taking some chips off the table.

Merryn: And the bond market, some value is gradually emerging there, particularly in corporate bonds, yes?

Mohamed: It is. When I want to sound positive, which I try to…

Merryn: We would like that. Give it a go.

Mohamed: I call it a restoration of value. So, we are seeing a restoration of value in both bonds and equities that will serve us well in the future. Now, we haven’t finished the process of restoring value. It’s still going to take some time. But the good news is that, as bond markets become less distorted, as equity prices start to reflect fundamentals and not just liquidity, that’s a good thing for future investments.

Merryn: OK, well, that’s a very positive thing to say. What about gold? Can we protect ourselves with gold? Obviously, we did in the 1970s, but that was connected to the end of gold standards and all sorts of other things going on at the time. Can we protect ourselves with gold today, do you think?

Mohamed: We can, to some extent. Recently, gold has played a better role in protecting us as people got rightly concerned about inflation. But the role of gold itself is now being challenged by crypto, and therefore you no longer have the dominance of gold that it used to have. It now shares this with crypto because a lot of people believe that crypto is a better way to defend yourself against inflation than gold is.

Merryn: But that’s interesting, and I’m really interested that you say that, because from what I can see, what has happened over the last three or four months is that crypto has proved itself to be exactly not that, in that it’s moved almost in lockstep with risk assets, as opposed to in any kind of way that suggests it offers diversification from risk assets.

Mohamed: That is correct, and that is because there’s a common global factor. And that common global factor is the change, the ongoing change, in the liquidity paradigm. I’ll give you a very simple example, if I may. When I was at Pimco and someone was presenting an investment case, we would, of course, look at the fundamentals, we would look at the balance sheet, we would look at management, we would look at the business prospects, etc. And even if we ticked every single one of these things, there was still one question that was always asked.

Who will buy after us? The subsequent buyer does two things for you. First, they validate your purchase and push the price higher. Two, they provide you liquidity in the event you have to change your mind. Now, imagine I come to you and I say the subsequent buyer is a central bank with a printing press in the basement, an infinite willingness to use it, and they are non-commercial. They don’t care about price. They are non-commercial buyers.

That will make you buy assets across the piece. You will go and buy everything. So, crypto was also heavily influenced by these massive injections of liquidity by a predictable and non-commercial buyer. They weren’t buying crypto, but they were buying part of the capital structure that cascaded throughout the remaining elements of the capital structure. That is going away, and that’s why crypto is showing to be as sensitive to that factor as equities have and bonds have.

Merryn: OK, so there will come a point when crypto is something you want to hold to diversify and protect yourself once this dynamic has worked itself through?

Mohamed: That’s correct.

Merryn: And is it in your portfolio?

Mohamed: It was, then I sold too early and saw the price go up.

Merryn: Of course. How could you not?

Mohamed: How can I not? And I’m waiting for a better entry point at this stage.

Merryn: OK, so when this dynamic that we’ve just discussed plays through, that will be a time when you think it will be time to get back into this market?

Mohamed: Correct, as a small allocation. I want to stress, this is not your 20/30% allocation. This is up to 5% allocation.

Merryn: Yes, OK, well, we always say, with gold, 5 to 10%. So, if crypto is the new gold, I’m not sure I agree with you, by the way, but we’ll wait and see on that one. I hold, like you, a little bit of a crypto, but we’ll wait and see.

Mohamed: So, I don't think it replaces gold. I think it plays along with gold. But it has reduced some of the people who’d normally buy gold.

Merryn: Mm-hmm. So, you didn’t see quite the amount of cash coming into the gold market as you’d normally expect when inflation became obviously high?

Mohamed: Correct.

Merryn: Yes. I think we will have to leave it there, but that was so interesting, absolutely fascinating. Got to say, you’re one of the first people we’ve had on in a long time who’s been quite positive about the long-term future of crypto, so it was very interesting to hear and distracts us slightly from the depressing stuff in the first 25 minutes.

Mohamed: Yes, I would be even more constructive on the technology underlying crypto. I think that blockchains and other associated innovations are going to spread a lot.

So, if you are interested in crypto, you should really decompose what crypto is. And for goodness’ sake, don’t buy crypto if you think that that’s going to be a global currency. That’s not going to happen. Crypto will exist in the ecosystem, in the payment system, but it’s not going to be a global currency. So, my support is bounded, OK. I’m not a buyer of, this is the next global reserve currency.

Merryn: OK, that is also good to know. Mohamed, thank you so much for joining us today. We have really enjoyed that, and I hope you will come on again one day.

Mohamed: Thank you very much for having me.

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

After a lengthy period in which the fortunes of individual countries were broadly synchronised, the pandemic has created real differences in the prospects for individual countries. Shifting monetary policy, deglobalisation and shorter supply chains are changing the landscape. This is good news for investors, with global investing now holding greater potential for diversification and access to new sources of growth.

For several decades, the world has been moving inexorably closer. Companies have moved supply chains to the cheapest location, creating inter- dependence between nations. Geopolitics were, as far as is ever possible, benign. While China and the US would exchange tough words, it had little impact on the flow of goods and technology between the two countries.

This world was already changing prior to the pandemic. Tensions between the US and China had begun to rise under the Trump administration, as US policymakers increasingly recognised that the trade deficit between the two countries was unsustainable. For its part, China had started to move to a model of growth that didn’t rely on the US consumer buying cheap goods, but was more self-reliant.

Pandemic: a permanent change

However, the pandemic has accelerated the diverging fortunes of individual countries. The IMF says that the economic impact of Covid-19 has varied depending on the “susceptibility of the population, the severity of mobility restrictions, the expected impact of infections on labour supply, and the importance of contact- intensive sectors”. The access to the vaccine, distribution and uptake has also been vitally important in how quickly economies have recovered. The IMF warns that the vaccine divide and variations in fiscal policy will make for hugely uneven outcomes in the years ahead. (1)

The pandemic has also seen a sea- change in international relations. It has brought about domestic tensions that have put policymakers under increasing pressure. It has changed labour relations, with shortages becoming commonplace and wages rising. It has been difficult to make goods, because of manufacturing interruptions, and then to get those goods across borders. Companies with long and complex supply chains have been hit hard and businesses have had to re-think their existing sourcing models. This is shifting the relationships between nations.

The pandemic has created other fissures. The inflationary pressures that have emerged in the wake of the crisis have had vastly different impacts on individual countries. This may depend on whether they are a commodity importer or exporter, how they source their energy, or the make-up of their economy.

This has influenced monetary policy. Developed markets – particularly the Eurozone - have been able to take a ‘wait and see’ response on inflation, while emerging markets have been pushed into a sharp increase in rates. Brazil, for example, has been forced to hike rates from 2% in January to 9.25% in December (2) as inflationary pressures have hit. This means these countries are further ahead in their monetary policy cycle and may see interest rates peak far sooner. China has already started to loosen its policy to stimulate its economy.

Innovation

Another argument for looking globally is that innovation is emerging in new places. In China, for example, the government has committed to increasing its research and development (R&D) investment by 7% each year, leading to interesting developments in key areas such as artificial intelligence, biotechnology, quantum computing, and robotics. (3)

India has seen a number of exciting new companies come to market in 2021. Dealogic reports that $15 billion was raised in Mumbai through initial public offerings, of which around 40% went to tech companies. (4)

For investors, it is not enough to focus on Silicon Valley when searching for the next innovative company.

What does this mean for investors?

This global dispersion should ultimately offer more opportunities for investors. The world had become increasingly correlated, making it harder to achieve true diversification by investing across borders. However, as the economic fortunes of different countries fracture, that diversification is easier to achieve. This is important both for capital growth and for income.

Finding these opportunities is not straightforward. Every country comes with its own idiosyncrasies. It takes a presence on the ground in individual regions to understand the strengths and weaknesses in each area and uncover the unique companies in each market. At BlackRock, our investment trust managers can call on analyst teams in every region across the world. We believe this gives us meaningful insight and helps our investors tap into some of the most exciting companies around the world.

Financial markets are entering a more complex time as the world emerges from the pandemic, inflationary pressures mount and the interest rate cycle starts to turn. Investors will need to cast their net widely for opportunities and draw from across the globe for diversification and innovation.

For more information on BlackRock’s range of investment trusts, please visit blackrock.com/its

(1) The Economist, October 2021

(2) Reuters, December 2021

(3) CNBC, March 2021

(4) CNN Business, December 2021

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In January 1965, Graeme Dorrance, chief of the Financial Studies Division at the International Monetary Fund (IMF), wrote an article called Inflation and Growth: The Statistical Evidence for an issue of IMF Staff Papers.

It might not sound particularly exciting (it is not an easy read). But it was, as the IMF proudly pointed out when he offered up his next paper, “widely reprinted” at the time – something I suspect you didn’t get much with IMF papers in the 1960s.

It was so popular because it made something almost ridiculously complicated suddenly look very simple: Dorrance introduced the idea of a magic number for economic management – 2%. This, he said, in relatively advanced economies at least, looked to be the optimum inflation level, for “encouraging growth in output”.

He figured that deflation was impossible given that developed economies were jammed by trade unions and monopolistic price-setting companies. Totally stable prices were possible (zero inflation) but not particularly desirable – if prices can’t fall, you need a little inflation to allow relative prices to adjust. Two percent seemed to work for that – and seemed to be working for Italy, Denmark, Japan and Nicaragua at the time.

The magic number isn’t quite so magic after all

So there you have it. Fiddle with interest rates until you get your magic number and the rest would take care of itself. Hello, long-term economic growth.

Or not. Not everyone was impressed by the argument at the time – an article in the now defunct Statist magazine a year later dismissed the whole thing as a confusion between correlation and causation combined with the careless use of averages.

The author, who doubted “there is a link at all” between inflation and growth, said you can’t take all the complications of an economy and boil it down to 2%.

Fifty-five years on, most major central banks claim an inflation target of 2% – everyone likes magic numbers. But it is beginning to look like they might be coming around to the Statist view too.

Look to the UK: here CPI inflation is running at 3.1% and the Bank of England expects it to peak at 5% near year. That’s more than double our magic number – so you’d think that rates would be on the up at some speed.

Yet despite heavy hints from various policymakers that we would on Thursday see a rise from the lowest-ever base rate of 0.1% to 0.25% we saw no change.

“Supply problems” only explain so much

There is some sense in this. The inflation we see at the moment is based on supply problems, rising energy prices and increased labour costs. A 0.15 percentage point rise in interest rates can’t do much to help with these things. And if they are related in the main to pandemic policies and are therefore temporary anyway, why not just ignore them – and let inflation naturally fall back to earth next year as shortage turns to surplus?

The first problem with this argument is that it only partially holds good. You can’t have supply constraints without demand for the goods in the first place – so to the extent that a rate rise would curtail demand it would at least slightly damp inflation.

The second issue is that almost as soon as the “it’s just a supply” block argument was made, the Bank of England effectively dismissed it. Rate rises might not be necessary now it said but “providing incoming data is consistent with forecast” they may be “necessary over the coming months”.

There is no suggestion that the BoE expects the drivers of inflation to change, so why not act now?

The third problem is about reputation and expectation. The Bank has told us for ages that the inflation we feel all around us is transitory. But it is also now telling us that it is “materially higher” than expected.

If officials believe in their magic number – and want us to feel certain in their confidence in it – they should surely confirm that to us with at least a small rise in rates now.

That’s particularly the case given that with most mortgages fixed and household finances reasonably healthy, the negative impact of a tiny rise would be fairly limited. Pantheon Macroeconomics points out that bank debt as a percentage of household annual disposable income is slightly lower than in 2017 and much lower than in 2008.

So how can you get an income from your investments?

On the plus side, there is useful information in all this for investors. The key takeaway should be that while rates will rise from here (fix your mortgage fast if you are one of the few who has not) there is going to be some epic foot dragging along the way – and you are very unlikely to see them near or above inflation for the foreseeable future.

Anyone expecting to make a real return on cash on deposit any time soon will be sorely disappointed. This brings us to the dilemma of how those looking to get an income from savings or investments can actually get one.

The answer here might be to think about why so many equities are so low-yielding in the first place. Low interest rates make dividends more valuable and so force up share prices – effectively turning what was yield into capital gains.

If you can get your head around this, the next step is to think that it makes perfectly good sense to treat some of those gains as though they are income. Hold that thought and have a look at Alliance Trust (LSE: ATST). The trust (big, global, diversified) has just announced that it is to reset its quarterly dividend at a materially higher level – up about 30% to 2.3% – with the intention of continuing to increase it every year as well.

That dividend will not be covered by the income the trust receives from its investments every year – so its introduction effectively represents the conversion of some capital into income. Back in the days when savings accounts paid interest at higher than the rate of inflation and stock market valuations looked vaguely reasonable, that might have looked like a bad thing. Today it seems perfectly reasonable.

• This article was first published in the Financial Times

On August 15th, 1971, Richard Nixon took the US off the gold standard.

It didn't quite all happen at once. But by 1973, the global monetary system was backed, not by gold, but by the US dollar.

That's the system we've had ever since.

So what happened? And what might be next?

Why Bretton Woods was always a bit of a bodge job

Just before the end of World War II (in July 1944 to be more precise), Allied policymakers – notably John Maynard Keynes, working on the behalf of the UK Treasury – met in Bretton Woods in the US to map out a new monetary system for the post-war world.

To cut a very long story short, the outcome was that the US dollar would be tied to gold, and everything else would be tied to the US dollar. (It also established the International Monetary Fund and the World Bank).

The dollar would be fixed to gold at $35 an ounce. (Only central banks would be buying or selling – US private citizens had been banned from owning gold bullion since the 1930s, a right they only gained back in 1974).

Other Allied currencies would be fixed against the dollar, although they could be adjusted within a 1% band. (And there could also be "one-off" devaluations if considered necessary).

The full system actually became operational from 1958. (Up until then, countries had maintained exchange controls). So the reality is that Bretton Woods in its fully-fledged form didn't last for as long as it might look.

In fact, it had problems almost immediately, and by 1968, it was on the rocks.

Again, to oversimplify things, the US – which was in many ways, the last man standing after the war – had started out with an overvalued currency relative to the rest of the world.

This was partly deliberate in order to help rebuild Europe. And it was fine, because the US held about three-quarters of the world's gold reserves, so there was plenty of backing for those dollars and plenty of demand for dollars to swap for US goods and services.

But as the world recovered, the US became less dominant in terms of global GDP and far less competitive in terms of exports. So US dollars became less important to other countries at a time when more and more of them were leaving US shores in the form of import demand.

Thus converting US dollars to gold became "more desirable", as the Federal Reserve History website puts it. As early as 1960, there was a run on the London gold market which led to the leading central banks establishing the London Gold Pool in 1961. Essentially this was a price-fixing mechanism whereby central banks would sell gold into the open market to keep it at $35 an ounce.

The Fed also had to establish currency swap lines in 1962 with foreign central banks in order to shield its gold reserves while maintaining the fixed exchange rate system.

Meanwhile, under Lyndon Johnson in 1964, the US embraced a "full employment" agenda. That meant running much looser, inflationary monetary policy. The Vietnam war also meant a lot of public spending. And all of that meant a larger global supply of dollars.

The threat of a run on gold was enough to delay Bonanza

By 1965 the volume of dollars held by foreign institutions which could conceivably swap them for US gold reserves, outstripped the actual amount of gold the US had.

Hence, by 1968, as Adrian Ash of BullionVault puts it, the gold standard system was "divorced from reality but crashing into it, upsetting everyone."

By 1971, the US was facing a run on its gold reserves (led by France, though Britain was in the queue too), alongside rising inflation and weak growth. Nixon also wanted to get re-relected in 1972. So he had to do something.

So, using the age-old scapegoat of "international money speculators", he told the American people in a televised address on the Sunday night – delaying that night's repeat of Bonanza – that he was "temporarily" suspending the convertibility of gold.

He also instituted price and wage controls, among other things. Indeed, as Ash points out, the word "gold" is mentioned only once in his 18-minute address. But that's the bit we all remember today and it's the bit that had the most impact in the long run.

The US stock market was actually very pleased with the move. It went up 3% on Monday. That might sound surprising - it was quite a radical decision - but no gold standard meant looser monetary policy, and we know that markets are fond of loose monetary policy.

There was a brief attempt in late 1971 to re-fix the dollar to $38 per ounce of gold. In other words, the severing of the link was seen as a way to devalue the dollar to a more manageable level, rather than to end Bretton Woods altogether.

However, by February 1973, the US had devalued the dollar again to $42.22, and the gold price was already fetching much more than that in the open market. In March 1973, the fixed exchange-rate system was abandoned, and gold was no longer an official part of the global monetary system.

Three big picture lessons from the end of the gold standard

So what should investors take from this?

There's so much we could talk about. But I think today, rather than delve into the mechanics of inflation or what the end of the gold standard meant for markets, I just want to make three very high level points.

One key point that I've also discussed this in MoneyWeek magazine this week is that when a monetary system comes up against reality, reality wins.

A perceived benefit of the gold standard is that it imposes discipline. But when that discipline gets too much, the gold standard gets dumped. (And this is hardly the first time it had happened).

It's a bit like independent central banking. Central banks are independent right up until the point where they do things that governments don't want them to do.

So when push comes to shove, the rules change. You can't rely on the old certainties.

Secondly, the long term is a series of short terms. Nixon did what he did for the usual reasons that politicians do things: he wanted to get re-elected. This speech and the change it made had such a geopolitical impact that we're still talking about today, but Nixon's eyes weren't on 2021, they were on 1972.

And while you might not have entirely followed the summary of Bretton Woods outlined above, I hope that one thing is clear – it never really worked smoothly at any point. It might well have been the best solution in the circumstances, but as things changed and the world recovered, it became inadequate to our needs.

The good thing about this for investors is that, while the tipping point is always going to be hard to pinpoint (and might never be possible to pinpoint, even years after it arrived), the direction of travel is often very obvious, so you can at least prepare for it if you think ahead.

Thirdly, and a continuation of that point – we talk about monetary eras, and I think that can be a useful thing to do. The pound was the global reserve currency, then World War I came along, then we had a transitional period, and the US dollar became dominant after World War II. It's clear that reserve currency status is linked to economic and military might.

However, this can give us a false impression of periods of stasis punctuated by epochal shifts. Whereas the reality is that the monetary system is evolving all the time.

As an example, I'm reading Russell Napier's new book, The Asian Financial Crisis (it's excellent – inevitably – and if you are happy to embark on a chewy financial topic with an extremely articulate and likeable guide, then you should rush out and buy it. Even if you don't want to get into the guts of the crisis, you should definitely listen to Merryn's recent podcast with Russell).

But one thing that's very clear is that the Asian crisis represented a major shift in the running of the global monetary system on at least as big a scale as the Nixon shock.

What's next? Watch the yuan plus crypto

Where are we headed to now? I think I'll have to save that topic for another day. But the obvious contenders to play a larger role in the global monetary architecture are China's yuan and all manner of digital currencies, from decentralised crypto to central bank-backed ones (which are the absolute polar opposite to one another and which also promise to be a raging battle ground in the not-very-distant future).

More on all that in future Money Mornings. Meanwhile, all the upheaval is one reason why, for all that it's an endlessly frustrating asset, I still think it makes sense to hold some gold in your portfolio. It might not be money anymore, but there's a reason central banks still hang on to a lot of it in their vaults.

ESG (which stands for environmental, social and governance) investing has become the new “new” thing in the trend-driven world of investing.

Data from Google Trends shows that searches for the term “ESG” increased threefold from January 2016 to June 2020.

So how can bond investors who are interested in ESG issues go about ensuring that their own investments are in line with their values?

More and more bond managers are adopting ESG principles

The growing interest in ESG investing is having some real-world impacts.

For example, the International Monetary Fund’s annual Global Financial Stability Report estimated that more than $9trn, cumulatively, had been divested from fossil fuel-intensive activities by the end of 2019. As recently as 2013, that number was almost zero.

For much of the last few years, the interest in ESG investing has been most apparent in stocks and shares – the number of ESG equity funds has mushroomed in the UK over the last five years and now stands at more than 400.

According to one survey from 2019, sustainable investments accounted for $1.8trn (€1.6trn) of total assets in markets. Yet strategies based around bond (fixed-income) investing made up only a fifth of that, despite the huge scale of global bond markets.

Another survey, by Dutch group NN investment Partners, showed that only 26% of professional fixed-income investors have a clearly defined responsible investment approach, compared to nearly 50% for equities.

Yet despite this slow start, ESG-focused strategies are becoming increasingly common in the world of fixed-income investing. According to researchers Broadridge, the volume of assets under management in ESG global bond funds has grown by 19% a year since 2015.

Of course, this growing interest also introduces an obvious challenge – ethical investing broadly, and ESG investing more narrowly, can mean different things to different investors.

This definitional challenge can in part be solved by breaking down the various ideas into distinct strategies.

Most ESG-focused bond managers operate some form of screening system: this means that they exclude or include sectors (oil businesses for instance) or securities based on pre-defined, number-driven ESG criteria.

Other bond managers might not openly operate as ESG funds, but do integrate some ESG criteria into their traditional financial analysis when buying or selling securities.

Still another group of bond investors might adopt a thematic strategy, where they align their fund allocations with a particular ESG theme, such as clean energy or even “green bonds”.

This group overlaps with yet another group of investors who engage in what’s called “impact investing”. This is where the manager seeks to deliver positive societal outcomes as a key investment objective.

Last, but by no means least, there’s a wide group of managers who seek to engage with a bond issuer to influence what’s called “sustainable behaviour" and practices. In this last category, for example, you might have a bond fund manager who invests in bonds issued by a car company, but who will push the board to reduce its reliance on diesel, say.

Clearly there’s some overlap between all these different strategies, and still plenty of room for confusion. Some bond investors might for instance be perfectly happy to deploy money into an oil firm that is looking at ways to cut emissions (on the basis that if we still need oil, you might as well try to extract it as cleanly as possible), whereas other bond managers might specifically exclude investing in any fossil fuel business at all.

ESG can help to minimise downside risks while supporting positive change

But whatever strategy is used, these fund managers all share one overarching objective which is hugely relevant to every bond investor – the reduction of risk.

Equity investors are, of course, worried about downside risk as well. But at the risk of oversimplification, their main goal is that a share’s price increases by as much as possible.

Bond investors by contrast, are much more concerned about a) making sure they get back the same amount of money that they initially invested, and b) ensuring that the borrower has enough cash to make the regular interest payments.

So managing downside risk is essential for all bond investors, which explains why ESG concerns arguably impact on all bond strategies.

For example, looking out for deteriorating governance at the governmental (sovereign bonds) or board level (corporate bonds) can help bond fund managers to avoid nasty surprises, either in the form of future corruption scandals or corporate negligence.

But as well as avoiding bad news, the rise of ESG also offers up a more positive vision too – that whole new forms of business activity could be financed by issuing bonds. Key here are the UN Sustainable Development Goals (SDGs), a set of standards established to help guide investments that can deliver solid returns as well as a positive societal impact.

The 17 SDGs – adopted unanimously by all 193 UN member states in 2016 – are in effect an official statement of ESG priorities, with the added benefit of targets and even indicators.

The UN reckons that in order to achieve the SDGs by 2030, $3trn to $5trn a year will be required, with the majority of this investment to come from the private sector. That policy push has already resulted in a series of new bonds being issued, such as the Asian Development Bank’s gender bond, issued in late 2017.

These social bonds – bonds issued with the funding of a specific, socially desirable outcome in mind – have become even more popular as the impact of Covid-19 has become more obvious. This year has already been a record one for social bond issuance, with more than $20bn raised for social projects globally.

That said, most of the interest in new bond issuance has focused on green bonds i.e bonds with the specific objective of combating climate change. One widely-watched green bond index (the ICE BofAML Green Bond Index) has shown that the amount invested in bonds with an environmental impact has grown from $55bn in 2015 to $345bn at 31 October 2019.

That astonishing ramp up may just be the beginning of a much bigger push to raise capital for the impending energy transition. Green bonds in particular may be about to become even more mainstream. We’ll have more on those next week.

Latin America has suffered more from Covid-19 than any other region. The Financial Times points out that Peru and Ecuador have the world’s highest number of excess deaths per capita, while Brazil has the second-largest total of coronavirus deaths. The botched public-health response has also exacerbated the economic impact. According to the International Monetary Fund, a combination of a 9.4% drop in 2020 GDP followed by an estimated weak recovery of 3.7% in 2021 means Latin America will have incurred greater economic damage than any other region in the world.

But there is one bright spot among the carnage: Latin American metals mining looks set to benefit from the pandemic. The economic crisis has pushed investors towards gold, helping the yellow metal reach a new record high. Meanwhile, copper prices have eclipsed pre-pandemic levels, supported by stimulus packages in the EU and China.

I suggested MoneyWeek readers invest in Latin American mining in June 2019, and in October 2019 I looked at Ecuador's mining sector – nearly all the shares I tipped then have risen strongly, with some doubling. The long-term fundamentals I highlighted back then still apply, but the pandemic looks set to give the sector a further fillip, so this is a good time to revisit it.

Profitability is on the rise

The immediate impact of coronavirus was disastrous for Latin American mines. Despite being categorised as a strategic industry by governments conscious of the need to maintain export earnings as other sources of revenue dried up, many mines, particularly in Peru, were forced to close. When they did reopen, it was with elaborate coronavirus measures – such as keeping workers in a seven-day quarantine before they were allowed to start work – that added to costs.

Analysis of 15 gold majors by S&P Global Market Intelligence found that costs increased by 2.5% in the second quarter of 2020. However, the shutdowns cut supply, which eventually led to higher metals prices that outweighed the extra costs. Other elements of the coronavirus fallout, such as lower oil prices and declining local currencies, have provided a further boost. As a result, profit margins have increased for gold and copper miners across Latin America.

Metals were also given a boost by the unprecedented stimulus unleashed by governments in response to coronavirus. In the first few months following the World Health Organisation’s declaration of a pandemic in March, more than $13trn of stimulus measures were announced around the world. For the first time, emerging markets such as Chile and Colombia engaged in quantitative easing (money printing), while developed countries tried everything from wage compensation to boosting infrastructure programmes.

The first direct impact of this splurge of money printing and borrowing was that gold’s value against paper currencies began to rise. In addition to gold’s typical function as a safe haven during crisis, this was also a case of simple arithmetic. The yellow metal is priced in dollars, so if there is a finite amount of gold and a sudden increase in the amount of dollars then it makes sense for the paper money value of gold to increase. Indeed, analysis from the World Gold Council reveals a massive increase in demand for gold from financial products, such as gold-backed exchange-traded funds (ETFs).

That helped gold climb by 34% from the start of the year to August and reach a record nominal price of $2,061. It has since cooled off to around $1,921. Buying an asset when it’s near a record high is never normally a good idea, yet if you take inflation into account then gold is still well below levels it reached in 1980 and 2011. And with stimulus packages set to be extended in the UK, EU and the US, gold should receive more support in the years to come, especially as all this printed money raises the spectre of a nasty jump in inflation. That’s good news for Latin America, which produces 12% of the world’s gold.

Accelerating the shift towards electric cars

The region is even stronger in copper, where it produces 44% of global output. Indeed, just two countries, Peru and Chile, account for 40% of global copper production, a similar level of market domination that 13-member cartel Opec boasts with oil. Here prices will be supported by the green nature of Covid-19 stimulus packages in the EU and China. Improving infrastructure, including telecoms upgrades through 5G networks, will underpin demand for copper – as will incentives to encourage the spread of electric vehicles (EVs).

Covid-19 is therefore accelerating the shift towards EVs that was going to happen anyway. That’s why US electric carmaker Tesla has been the standout stock this year, overtaking Toyota to become the world’s most valuable car firm despite making a fraction of the cars. Analysts debate whether Tesla’s early lead in EVs will be overhauled when the established car producers switch to electric.

But either scenario will be good for the raw materials that go into EVs. A battery-powered EV uses about 83kg of copper, compared with 23kg in an internal combustion-engine car, with hybrids such as the Prius somewhere in the middle. But it’s not just copper that should benefit. Cobalt, nickel and lithium are also heavily used in different parts of the electric car and battery.

To give us some idea of the impact EVs will have on demand for metal let’s run through the numbers for nickel. Today there are between four to five million EVs on the road. By 2030 that figure is expected to have risen to between 40 and 50 million. At present the world consumes 2.34 million tonnes of nickel per year, with just 5% being used in EVs. By 2030 the growth in EVs will have added one million extra tonnes of annual demand.

Latin American mining’s competitive edge

The coronavirus factors I mentioned above apply to miners around the world – so why am I so bullish on those in Latin America? The first is that Latin America, which accounts for roughly 10% of the world’s GDP and a similar share of the planet’s population, produces a disproportionately large quantity of metals. In addition to its strong position in gold and copper, it currently accounts for 20% of zinc output, 51% of silver and 20% of iron ore. As for lithium, set to be another beneficiary of green stimulus, the lithium triangle of Chile, Argentina and Bolivia holds more than 50% of global reserves. The mismatch between the region’s output and domestic demand makes it a natural exporter.

It is also a low-cost producer. A renewable-energy revolution in Chile means miners in the country can now access cheap, green solar power. Peruvian, Ecuadorian and Brazilian operations can access low-cost hydroelectric power. Being powered by renewable energy is especially important for miners producing metals such as copper, zinc or lithium for EVs. As EVs become more common, their environmental benefits will come under more scrutiny and manufacturers will pay a premium for metals with a low carbon footprint. The same applies with social responsibility. Mining investors sometimes complain that Latin America’s myriad rules and regulations hold up new projects.

But at least that ensures that legal mining complies with global best practices. For example, much of the cobalt that Tesla or Apple currently use in their products is mined in the Democratic Republic of Congo, where child labour is rife. That doesn’t happen in legal Latin American mines, giving cobalt from the region an advantage in the market place.

Latin American taxes are also surprisingly competitive. For example, Chile has a lower fiscal burden for mining companies than Australia, while Peru and Ecuador have cut taxes in recent years. Indeed, Latin American countries have climbed up the rankings of the influential Fraser Institute’s Annual Survey of Mining Companies. Chile and Peru are the top-ranked in Latin America, while Brazil and Ecuador have made the most dramatic improvements in recent years. The region has steadily increased its “investment attractiveness” score in consecutive surveys, which is impressive when you consider that it has basket cases such as Venezuela and Guatemala weighing it down.

Huge potential in mega-deposits...

In mature mining jurisdictions – say, Canada, Australia or even Chile – you tend to have older deposits that have been mined for many years or even decades. Over time the grade of these deposits falls, meaning miners have to dig and process more ore to get the same amount of metal, which leads to rising costs. What’s exciting about Latin America is that it is home to some of the world’s latest discoveries of mega-deposits. These newly-found ore bodies have much higher grades, ensuring low-cost production when the mine comes online.

And more discoveries are on the way. The Andes copper belt has given Chile and Peru the world’s first and second-largest reserves respectively. Yet political and social factors have prevented the exploitation of large stretches of the Andes in Argentina and Ecuador. Now Ecuador has rewritten its mining code and enticed more than a dozen mining majors to set up offices there, while smaller explorers are searching for copper and gold. London-listed copper and gold developer SolGold’s recent Ecuadorian discovery, Alpala, due to begin production in 2025, could become the world’s largest underground silver mine, the third-largest in gold and sixth-largest in copper.

...implies vast scope for growth

And that’s just one discovery. To give some idea of the potential, mining accounts for 15% of GDP in Peru and Chile, but just 1% in Argentina and Ecuador. Given that they all share the same metal-rich Andes (indeed Argentina’s stretch is the largest of the lot), it seems fair to assume that there are plenty more discoveries waiting to be made in Argentina and Ecuador. Even in Peru, which has a well-established mining industry, there are $57bn-worth of stalled mega-projects – defined as deposits awaiting the green light for construction or held up by social protests or bureaucracy.

In recent years Peru has doubled its copper production to 2.5 million tonnes per year, making it the world’s second-largest producer. However, if it were to exploit all of its discovered deposits it would be able to double output again to five million tonnes and keep that rate of production going for 40 years without any new discoveries. That matters because analysts predict a crunch in both copper and gold supply in the next few years – perhaps as early as 2023. According to S&P Global Market Intelligence, 2010 to 2019 was the worst decade for copper discoveries since 1990, contributing only 16 major discoveries to a total of 224 over the last 30 years. The commodity-price crunch at the start of the decade forced majors to impose financial discipline and stay away from risky greenfield projects. As a result, “the sector faces a drop-off in mine supply in a decade or so, with few major copper developments entering the project pipeline”. Something similar happened in gold, where majors’ gold reserves fell by 26% between 2012 and 2017. Given that it takes between 15 to 20 years to take a gold or copper deposit from discovery to production, mining companies will focus on jurisdictions such as Ecuador and Peru, which already have plentiful resources waiting to be developed.

The prevalence of abundant deposits, high ore grades and low energy costs mean that Latin America will make the most of the coming metals boom. EVs may take decades to become a significant demand driver for metals such as cobalt, zinc, nickel, lithium or copper, while the inflation likely to boost gold could take time to materialise. And in the intervening years the prices of these metals is sure to fall as well as rise. But Latin America’s competitive advantages means that its miners will be best able to ride out the lows and benefit from the highs. We look at some of region’s best miners below.

What to buy now

All of the companies I tipped in my Ecuadorian mining story in October 2019 have risen by between 50% and 100%. I will now focus on just two. The first is Canada-listed Lundin Gold (Toronto: LUG), which since I wrote my piece has put its flagship Ecuadorian gold deposit into production – the country’s first large-scale gold mine. Now that Lundin has an operating mine it is a less risky prospect. One remaining risk is community protests, but here the firm has gone out of its way to keep neighbours onside. It even shut down its mine during the crisis – despite the government imploring it to remain open – out of respect for local concerns that its trucks would bring the virus to their remote communities.

Up by 84% since I tipped it, Lundin has more to offer as there is plenty of exploration potential around its gigantic Fruta del Norte deposit. And as Ecuador establishes itself as a mining jurisdiction, the shares will be perceived as less risky.

SolGold (LSE: SOLG) is the only UK-listed Ecuadorian pure play. The firm’s main target is 85%-owned Alpala, which will become the country’s largest mine when it begins production in 2025. Despite its name, SolGold is more of a play on copper than gold. Not possessing an operating mine makes SolGold riskier than Lundin, but it also has more upside. It is the largest exploration concession-holder in Ecuador. The share price has increased by 60% since the end of September on the back of recent discoveries at other targets. The big risk is getting the financing together to build its multi-billion dollar mine. But given the shortage of quality gold and copper projects it seems likely that majors or the market will support it. Indeed, Australian majors BHP and Newcrest have already bought big stakes in the firm. Even though it has doubled since I tipped it in October 2019, at the current price of 42p you will still be getting a discount on the 45p per share that BHP paid in 2018. Elsewhere in Latin America I would advise taking stakes in a handful of miners to diversify your risk. On the safe end of the spectrum is Fresnillo (LSE: FRES), the world’s largest silver producer and Mexico’s second-largest gold producer. It is up by 51% since I tipped it on 27 June last year. It’s a well-run major with lower debt and production costs than its peers and remains a solid way to play Latin American precious metals.

A new tip is Yamana Gold (LSE: AUY), which has mines in Chile, Brazil, Argentina and Canada. It has just floated in London. CEO Peter Marrone founded Yamana in 2003 and sees it as his baby. As a major shareholder he has “skin in the game” and has done an incredible job of building up an Americas-focused gold major.

At the other end of the precious-metal scale is tiny penny stock Rio 2 (Calgary: RIO), which is developing a gold mine in Chile. Its CEO and major shareholder is Alex Black, a man well respected in Latin American mining for turning one of his previous tiny explorers into a billion-dollar goldminer. The stock has jumped by 107% since I tipped it. But if Black repeats his successes it will go much higher. A similar small base-metals play is Brazilian nickel and cobalt developer Horizonte Minerals (LSE: HZM).

Antofagasta (LSE: ANTO), the copper giant, is up by just 9% since I tipped it. Yet the long-term rationale for owning this low-cost copper producer remains. Half of its output comes from its Los Pelambres mine, which is in the bottom quartile of production costs of copper mines globally. Peruvian miner Buenaventura (NYSE: BVN) was my only disappointing pick, down 24%. Being based in the world’s most severe coronavirus hotspot wasn’t good for a firm with nine mines dotted around the country. Now is a great buying opportunity.

We have been gold bugs since 2001 (and still are). Another longtime favourite of ours is Vietnam. In 2005 we noted that it was Asia’s “other communist dynamo” (it still is). In 2007 the International Monetary Fund’s (IMF) chief economist referred to it as an “emerging China”. The IMF may have failed to forecast the global financial crisis in 2008, but that time it was on the money.

Vietnam piqued our interest because it seemed to be following in China’s footsteps with a ten-year delay. It embraced the free market in the mid-1980s, and since then has attracted attention as a cheap manufacturing base: wages are around a third of Chinese levels. It has also moved up the value chain as foreign investment and expertise has flooded in. Most Samsung smartphones are made there and it is a major electronics exporter.

There is also ample scope for consumption to expand given a demographic backdrop more favourable than China’s: almost 75% of the population are between 15 and 64. Annual GDP growth has eclipsed 6% over the past five years; GDP per head almost tripled between 2002 and 2018. It also seems to be coping pretty well with Covid-19. All this makes it the star of Southeast Asia, a region that many have written off as a perennial underachiever because recurrent political upheaval undermines solid economic prospects. Thailand, the Philippines, Malaysia and Indonesia have certainly struggled over the past few years, but as Cris Heaton points out in this week's cover story, there is still considerable potential here if you tread carefully. Valuations in these emerging markets now seem to price in much of the recent turbulence.

A broader point to keep in mind about emerging markets is that they are usually touted as sources of fast growth. Their rapid development is certainly impossible to ignore: they have grown so fast that they make up around 60% of global GDP today, compared with 48% in 2005 (measuring GDP in terms of purchasing power parity, which takes into account differences in the cost of living). Industrialised countries’ share is 38%. Still, several studies have noted that capturing emerging-market growth in equity returns often isn’t as easy as you’d think. Not only is there always the chance of political upheaval and economic mismanagement, but some of the fastest growers are often unlisted.

So it may be more helpful to think of emerging markets as a good source of income in the years ahead – especially now, with dividends in Britain and Europe butchered by the crisis. Emerging Asia looks most appealing in this regard. Growth tends to be brisker than in eastern Europe or Latin America (the latter is highly susceptible to commodity cycles), implying ample scope for dividends at least to keep climbing even if yields are not all that high.

It is the effect of compounding – the eighth wonder of the world, said Einstein – that makes reinvested dividends so crucial to healthy long-term returns. Cris looked at emerging Asia in a recent cover story and highlighted his favourite investment trusts to play the income theme: the Aberdeen Asian Income Fund (LSE: AAIF) and the Schroder Oriental Income Fund (LSE: SOI). That reminds me: emerging Asia as a source of income is another theme we have liked since 2005. What goes around comes around. Solid investment ideas, like Chanel suits, always come back into fashion.

In July 1944 America and the UK spearheaded an attempt to agree a series of rules for the post-war global monetary system. The United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire, brimmed with good ideas for a better world. The best of them was to make the US dollar the de-facto world currency. All others were then pegged to the dollar at a fixed rate while the greenback in turn was linked to gold at $35 per ounce. Member governments could demand that their dollars be converted into gold in certain circumstances.

In the context of the time it was a brilliant plan, ushering in a period of relative exchange-rate stability. Unfortunately it eventually came unstuck: huge increases in US expenditure, on the Vietnam War and various welfare projects, destabilised the dollar. The agreement was suspended and then collapsed between 1971 and 1973. The dollar standard designed at Bretton Woods ushered in a Cinderella moment for the global economy. Unfortunately, the conference also produced Cinderella’s two ugly sisters: the International Monetary Fund and the World Bank.

The International Monetary Fund (IMF) was originally set up to oversee the fixed-exchange rate system based on the dollar. After the collapse of the Bretton Woods currency agreement it no longer had a purpose, but it promptly reinvented itself as a new body with the following grandiose mission statement: “to ensure globally the stability of the monetary system, foster co-operation, stability, trade, high employment, growth and reduce poverty”. In short, God-like powers. The third creation of the conference was the World Bank (WB). Its more modest mission is “to reduce poverty and build prosperity in developing countries”.

Boondoggling around the world

There are many similarities between the two. Both are owned by their 189-country members, each of which has a seat on the board of governors. Both are stuffed with economists. They comprise nearly half of the IMF’s 2,800 employees; the WB is four times larger. Most staff are based in the organisations’ Washington headquarters, which are on the same street. Being multinational agencies their structures are bureaucratic and politicised. By an arcane gentlemen’s agreement, the president of the IMF has always been a European, the managing director of the WB (with one exception) an American citizen.

There is a strong whiff of a boondoggle surrounding both. Pay and perks are lavish. On my occasional visits to their headquarters, the atmosphere was one of catatonia, with decision-averse staff focused on internal politics. I never saw the same person in the same role twice.

Structurally both look out of date, reflecting world economic power 50 years ago. America, Europe and Japan have the largest votes (but still also pay in the most money), with China only grudgingly allowed a bigger vote two years ago. The US, Germany, France, UK (and recently China) are the only countries with permanent executive board directors in both bodies, with Japan on the IMF only. America has a de-facto veto over decisions. Yet for all the overlaps and confusion in most people’s minds, the differences are significant.

First the WB. The larger of the two, with a wider brief, greater financial firepower and more real roles than the IMF, it is usually below the radar. The financial model is excellent, providing long-term loans and investment to poor countries at interest rates well below those they would have to pay if they borrowed directly from capital markets. The WB can borrow from markets at ultra-low rates because it has a triple-A rating (the best). Last financial year it had an “active portfolio” – loans and investments in projects – of $244bn, ranging from infrastructure and energy to hospitals and agriculture. Bad debts are few and it often makes a profit from its own investments and from co-funding successful projects. Too good to be true? Of course.

Ignoring constructive criticism

Although it has undoubtedly improved lives for many people, the WB’s own Independent Evaluation Group reports show an inability to learn from previous mistakes, poor credit and investment controls and ineffective measurement of results – all accompanied by self-congratulation. Most proposed improvements are ignored.

Developing nations resent that the organisation remains dominated by North Atlantic countries, which are perceived – often correctly – to be using the WB and its programmes to fund their allies, supporters and interests. The WB has consistently lent to dictatorships where cronies siphon off funds as advisers, suppliers and contractors, making London and Switzerland major accidental beneficiaries of its largesse to crooks. Worse perhaps, projects have involved the wholesale removal of local populations and considerable environmental damage, all swept under the carpet. Change may come as the result of a Trump appointee, David Malpass, becoming the 13th leader last year. With a long record of being against multilateralism, he may bring in some necessary rationalisation before going native like his predecessors.

Turning to the IMF, like most bureaucracies it is keen to trumpet its successes and bury its problems. Of the three IMF managing directors between 2004 and 2019, one later went to prison for embezzlement, one was a sexual predator forced to resign and the third, Christine Lagarde, was convicted in 2016 by a French criminal court for “negligence in a public office” when as finance minister she approved a €403m bung to one of President Nicolas Sarkozy’s supporters.

The IMF’s principal purpose is to act as the World’s bad cop. Occasionally downturns risk spreading economic depression and bankruptcy. This is usually the result of a domestic credit cycle that has spun out of control. Sometimes foreign investors have pumped in so much money that local interest rates are forced too low and the exchange rate too high. Either way, the government or international creditors then call for the IMF.

This is one reason why the IMF tends to be unpopular. It appears only when there is a crisis and before providing credit lines from its own and other sources insists on “conditionality”, also known as the Washington Consensus. This requires that the recipient country implement certain reforms. Governments are told to slash expenditure on pensions, welfare and subsidies, cut the number of employees and increase taxes.

Attaching conditions to any bailout makes sense and is required within the IMF framework. Its sole source of funds is the amount (so-called quotas) on which it can draw from its member countries, who in turn don’t want to see their money disappear. The major benefit of conditionality is that it forces incompetent administrations into necessary reforms while providing a fig-leaf for politicians who can claim that these reforms were forced on them. Yet this medicine often fails, not least because the cuts crush domestic consumption, the key growth driver for most economies.

The prescriptions for small economies involving little money have tended to work out well; recent examples include Iceland, Cyprus, Jamaica, Portugal and Ireland. But the results of larger bailouts are at best equivocal. Greece and Italy’s economies, for instance, are smaller than before the financial crisis. The only major long-term changes have been higher debt and unemployment.

This highlights the true purpose of the IMF: to prevent sovereign default out of fear of a domino effect. Yet this often involves repaying foreign lenders in full for their bad gambles while making recipient countries worse off than if they had defaulted and started from scratch. Worse, it distorts international capital markets by encouraging lenders to pour capital into the riskiest countries with higher interest rates, in the knowledge they’ll be bailed out.

A self-induced crisis

Now the IMF is trundling towards its own self-made crisis. It has a history of glossing over bad debts with new loans: Pakistan has borrowed 22 times since 1958. The top five borrowers – accounting for nearly three quarters of the IMF’s outstanding credit lines – in order are Argentina, Egypt, Ukraine, Greece and Pakistan. None has the ability to repay. It’s a giant hole. Alarm bells should also be ringing for investors over the IMF’s gradual policy reversal from capital without borders to allowing capital controls.

More than any other event these spell the end of global markets as, for the first time in 22 years, investors rediscover that in a crisis they won’t be allowed to repatriate their money. This will change the whole approach to assessing country risk. Now in their 70s, the IMF and WB have become sclerotic and in the former’s case, potentially dangerous. With the global slowdown that began last year now seriously exacerbated by the current pandemic, two key institutions set up to mitigate the worst effects are dangerously weak.

• Jonathan Compton worked in investment banking and asset management for 35 years and now writes and lectures on financial markets as well as managing some pubs and farms. (jlcompton@outlook.com)

Emerging markets have been flattened by investors’ stampede for the exit. The Institute of International Finance estimates that overseas investors pulled $95bn from emerging markets in the first quarter of 2020 – a record quarterly outflow. Investors are right to be worried. Emerging markets tend to have poor health systems and cash-strapped governments, which make it harder to battle coronavirus. That’s especially true in Latin America, which seems the most vulnerable region. The International Monetary Fund (IMF) thinks Latin America’s economies will contract by 5.2% this year, worse than Africa or East Asia and as bad as eastern Europe.

But don’t be discouraged by those grim numbers. The sell-off has created an opportunity. Some Latin American countries – in particular the Andean Three of Colombia, Peru and Chile – look well placed to contain and recover from coronavirus. The pandemic won’t alter their strong medium-term growth prospects, but it has given us a chance to buy in at rock-bottom prices.

Lessons from Ecuador

The money managers and analysts were quick to react, but the virus took its time to travel west to Latin America and will wreak further havoc. I write this in the city of Guayaquil on Ecuador’s Pacific coast, the early epicentre of Covid-19 in the region. According to excess mortality data analysed by the Financial Times, during a fortnight spanning March and April the city had the world’s largest increase in extra deaths, with a 485% jump in fatalities from the historical average for that time of year. Unfortunately, the factors that exacerbated the crisis in Ecuador are commonplace across Latin America.

One problem is weak health systems. In most Latin American countries expensive private clinics – offering decent care by international standards – operate alongside underfunded public hospitals. The rapid collapse of Guayaquil’s health services, where there was a shortage of hospital beds, drugs and medical oxygen, will be repeated in other countries. Corruption and inefficiency in public health bodies hardly help.

Of course, these problems bedevil all emerging markets, but Latin America looks particularly susceptible. It has two of the world’s five largest cities, which will make social distancing difficult. Obesity, which early studies find a significant contributor to coronavirus cases needing critical care, is higher in Latin America than Africa, Asia or eastern Europe. And the IMF found more Latin Americans work in the informal sector than any other emerging market. That matters in a pandemic because it’s much harder to give informal workers the financial assistance they need to observe the quarantine.

The biggest lesson from Ecuador is that money matters. Ecuador’s economy was a mess before coronavirus arrived; it was struggling to maintain the terms of an IMF bailout. A lack of money hits countries in two ways. Firstly, it makes it harder to control the pandemic as there isn’t the cash to upgrade health systems, import equipment and give people the financial assistance needed to maintain lockdown. Secondly it exacerbates the economic impact, as in the absence of stimulus measures, more companies go bankrupt and more jobs are lost. That means that the eventual economic recovery will take longer.

Why the Andean Three will bounce back

So far, the article makes pretty grim reading, so congratulations if you got this far – your perseverance will be rewarded. Because although Latin America is in for a huge recession, there are some countries that will bounce back quickly. Chile, Peru and Colombia are long-term favourites of mine because they are well-managed, open economies, with positive demographics and great growth potential. They are also the best-placed major economies in Latin America to control and quickly recover from coronavirus.

The key factor with the Andean Three is that they entered the pandemic from a position of macroeconomic strength that allowed them to respond effectively. Peru’s combined fiscal and monetary package is worth 12% of GDP and is the region’s largest stimulus. The largesse is possible because its 2019 fiscal and current-account deficits were just 1.6% and 1.5% respectively, while its total debt-to-GDP ratio was only 26%. Its reserves comfortably cover external financing requirements, while it bolstered its position by securing an $18bn precautionary credit line with the IMF.

Chile also responded strongly, with a fiscal stimulus worth 6% of GDP, while its central bank launched the country’s first-ever quantitative easing (QE), or money printing programme, spending $4bn on bank bonds. Following political protests last year, Chile was already beefing up welfare payments and social services and the pandemic will merely accelerate that trend.

With a 2019 public debt-to-GDP ratio of just 28%, the country can afford to spend its way out of the crisis. Moreover, thanks to its strong institutions it is spending wisely. It has conducted more coronavirus tests than any other nation in the region, allowing it to implement a sophisticated partial-lockdown strategy.

Colombia’s situation is the most precarious of the three, but still positive compared with the rest of the region. Public debt-to-GDP stood at 51% in 2019, although growth reached 3.3% and the deficit just 2%. Moreover, the collapse in the oil price hit the country’s main export. These factors limited Colombia’s fiscal stimulus to 1.5%. However, the central bank was the first in Latin America to implement QE with a $3bn programme that covered private and public debt.

The three countries’ solid financial position entering the crisis allowed them to take strong measures to contain its economic impact and speed the future recovery. The IMF projects a fall in 2020 GDP of 2.4% for Colombia and 4.5% for both Chile and Peru in 2020, which is better than the regional average of -5.2%. (It has pencilled in a 6% contraction for the UK.) And crucially, all of the Andean Three will see a strong rebound in 2021. If the IMF is right in its estimate of 3.7% expansion in Colombia in 2021, 5.3% in Chile and 5.2% in Peru, then all three economies will be bigger at the end of next year than they are now.

A compelling structural growth story

The main reason to invest in the Andean Three is their growth prospects over the next decade. All three are commodity powerhouses. Chile has the world’s largest reserves of copper and lithium, while Peru has the most silver on the planet, third-most copper and fifth-most gold. Colombia has a more varied commodity export basket that includes iron ore and oil. Many countries boast plentiful raw materials, but these three are very well run: they survived the last decade’s commodity crunch without succumbing to recession.

They have also diversified significantly in the last decade, with non-traditional agricultural exports such as blueberries, avocados and grapes becoming the second or third-largest foreign-currency earner in Peru and Chile. Chile is the richest of the three, while Colombia and Peru have the best demographics, with young populations and expanding workforces. Covid-19 is wreaking havoc in the short-term, but over the coming decades the world will still need the food, energy and metals that these countries have in abundance.

If you accept that, then you should buy into the Andean Three now – they are going cheap. One of the best ways to see if a stockmarket is good value is the cyclically adjusted price/earnings (p/e) ratio (Cape). This compares the current market price with average earnings over the last decade, thereby smoothing out any impact from abnormal years. German asset manager StarCapital has just crunched the Latin American Cape numbers and Colombia is the cheapest on 10.1, while at 10.8 Chile is around half the level it was in late 2018. Peru’s 10.9 is down from almost 17 just six months ago.

What to buy

The easiest way to invest would be through exchange-traded funds (ETFs) for each country. Unfortunately, current regulations mean that UK retail investors can’t access the Peru, Chile or Colombia ETFs. However, a Latin American fund manager gave me a good tip to get around the situation: buy banks. If it’s a well-run bank in a prudently regulated financial system then it’s like buying an ETF, as it will have exposure to every sector of the economy.

So how safe is the financial system in the Andean Three? “Latin American banks are generally in good shape,” says Quinn Markwith, Latin America analyst at Capital Economics, a consultancy. “Stronger public finances mean Peru and Chile are better placed to support their banks than Brazil and Mexico.” His analysis of Latin America’s financial sector shows that “banks are in similar shape to how they were on the eve of the Great Financial Crisis” – which they all survived comfortably. They are well capitalised and non-performing loan ratios are generally low at 2%-4%.

So Latin America’s banks aren’t going bust. But their share prices have slid, which gives us some bargains. Peru’s largest financial institution, Credicorp (NYSE: BAP) has dropped by 42% since January. On a forward p/e ratio of nine it gives us a cheap way to play Peru’s recovery. In Colombia, consider Bancolombia (NYSE: CIB), which has fallen more than 50% since mid-February and trades on a forward p/e of eight. My Chilean pick is Banco de Chile (NYSE: BCH) on a trailing p/e of 9.6.

Analysts are always telling us what they think is about to happen to economies or equities. Ignore them.

"The only function of economic forecasting is to make astrology look respectable," said JK Galbraith. Investors are constantly bombarded with predictions about stockmarket index gains or losses, corporate earnings or macroeconomic developments so it's important to keep in mind (especially if you're a picky, over-analysing Virgo like me) that they can be safely tuned out.

"The data overwhelmingly shows that as a species, we are simply awful at [forecasting]," says Barry Ritholtz on Bloomberg. Let's start with the economy. The International Monetary Fund (IMF), the European Commission and the US Federal Reserve all missed the global financial crisis. Despite ample evidence of financial turbulence, in the spring of 2008 the European Commission predicted that the eurozone would expand by 2% that year and 1.8% the next. The actual respective figures were 0.4% and 4.5%. Analysts also missed the oil-price collapse of 2014.

Every Christmas investment banks and fund managers produce stockmarket index targets for the year ahead. One study of S&P 500 predictions made by 22 strategists at major investment banks between 2000 and 2014 revealed that they were off by an average of 14.6% a year. They didn't foresee a single negative year, even though the span included a market slide of around 60% in 2008/09. They also underestimated good years.

Stock ratings aren't much help either. Stockbroker AJ Bell notes that the ten stocks in the FTSE 100 that received the highest proportion of "buy" ratings from analysts fell by an average of 9.5% in 2017. The ten with the most "sell" ratings actually rose by a similar average amount.

In short, a blindfolded child throwing darts at a board is likely to give you a better idea of how indices or economies might move. A key problem is the herd mentality. Analysts cluster together (if everyone gets it wrong, you won't get fired) and the group instinctively resorts to extrapolating the trend of the recent past because this is the safest, least controversial approach. They are also too cheerful because predictions tend to be part of a marketing effort.

Furthermore, the year or so these forecasts cover is a very short time in which just about anything can happen to throw predictions off course. Knowing what the consensus is expecting may help you anticipate a short-term slide or bounce when the figures are under- or overshot. But investing is about years and decades, and as we often point out, valuations are the best guide to long-term stockmarket movements. Short-term market and economic forecasts need not feature in your research.

"It has been too long coming," says the Financial Times. After suffering the equivalent of America's Great Depression a 25% fall in GDP since its debt crisis began eight years ago, and three emergency bailouts, Greece is now finally emerging from its financial rescue programme. It exits the European Union and International Monetary Fund's bailout package in August.

Last week's deal with the EU stretched deadlines on €100bn of bailout loans. The repayment period has been extended to 2033; the grace period for interest payments has also been pushed back by ten years, so the average loan maturity is now 40 years.

Some of the last tranche of bailout cash will be allocated to servicing debt. The upshot is that Greece "has very little to repay in the near term and enough reserves to run the country for nearly two years", says Lex in the FT.

But the good news ends there. Greece "is swapping bailout hell for eternal purgatory", as Neil Unmack points out on Breakingviews. It will have to keep a tight lid on spending for years: the Europeans have insisted on a primary budget surplus (before interest payments) of more than 3.5% of GDP, three times the eurozone average. After that until 2060 the primary surplus falls to 2.2%.

Greece's debt pile is too high

Throughout the years, every plan to deal with Greece's recurrent drama was heralded as the ultimate solution. It never was and this one, despite EU economic affairs commissioner Pierre Moscovici's insistence that "the Greek crisis ends here", will also prove a false dawn.

As usual, the plan is based on "forecasts of strong growth and large budget surpluses that [are likely] to prove too optimistic", says Capital Economics. Greece doesn't have a hope of growing fast enough to work off its unsustainable debt pile of 180% of GDP. This package has alleviated but not solved the problem; the debt burden has just been pushed "further into the future". At some stage, however, "either a managed haircut or a disorderly default seem inevitable".

The economy has returned to growth, but still looks fragile. The 2% growth rate depends on ultra-long debt maturities and low interest rates. The banking system is still grappling with bad loans. Unemployment remains high at 20%; corruption is endemic. Political support for ongoing austerity is hardly guaranteed either. An unpopular pension reform, due to be implemented next January, "will test" people's inclination to make further sacrifices, says the FT. Once again, Europe has bought itself some time. And once again, a problem is being managed, not resolved.

You wouldn't think investors have become concerned about Turkey, says Swaha Pattanaik on Breakingviews. When President Recep Tayyip Erdogan won last Sunday's election, the Turkish lira bounced by almost 3% against the US dollar, and the stockmarket ticked up.

But the reaction reflected "relief that the country had avoided political gridlock", not an endorsement of an increasingly authoritarian president's policies. "How much he compromises the independence of the central bank will be fundamental" in Erdogan's next five-year term, says Marcus Ashworth on Bloomberg View. He has become notorious for picking fights with the bank, always insisting on keeping interest rates low to bolster growth. This has undermined confidence in the bank's efforts to quell inflation.

It has raised rates by 5% since April, but it may be a case of too little, too late. Prices are rising at an annual rate of 12%, propelled partly by overspending and a government-induced credit boom. Investors fearful of a hard landing have begun to vote with their feet, sending the lira down by a quarter against the greenback in 2018.

Turkey is especially vulnerable to money leaving the country owing to its current-account deficit, which must be plugged with foreign capital. It is in debt to the rest of the world, and much of the debt is in (increasingly expensive) dollars. The International Monetary Fund estimates that Turkey relies on external financing for about 25% of its national income, notes Ashworth.

So as rattled investors flee, they make a nasty recession all the more likely. Of course, Erdogan could suddenly learn to stop interfering in the economy. But it's not the way to bet and it may be too late now anyway.

"If you are going to go, go big and get on with it," says the Financial Times. Argentina and the International Monetary Fund (IMF) have done exactly that, agreeing a large financing deal unexpectedly quickly. Argentina will have access to a $50bn credit line, and in return will give the central bank full independence and aim for a balanced primary budget (spending before interest-rate payments) by 2020. These are "wise" measures, and in line with President Mauricio Macri's plans. "He is as close to economically orthodox as any president in decades."

Why did he need help in the first place? Argentina was the victim of a panic attack among investors a few weeks ago. All emerging markets sold off as a rising dollar and the prospect of higher US interest rates reduced demand for riskier assets such as emerging markets. Argentina is among the most vulnerable due to its huge current account, or external deficit. This shortfall with the rest of the world is worth around 5% of GDP and must be plugged with foreign capital.

A hostile environment for emerging markets always leads to capital flight. Not only was Argentina unusually reliant on foreign money anyway, but it unnerved investors by raising its inflation target when inflation "refused to decline quickly enough". The Argentine peso, which has lost almost a fifth since April, looked vulnerable to a run.

Inflation is still at 28%, and the state will need to keep a lid on spending to bring it down, says Lex in the FT. That could affect Macri's popularity when elections are due next year. Still, a cheaper and more stable currency should encourage foreign investment, crucial to productivity and long-term growth. It is currently worth 2% of GDP, half the regional average. This IMF package is good news.

The special drawing rights reserve (SDR) was created by the International Monetary Fund (IMF) in 1969. It is designed to supplement the existing official reserves of member countries. But what is it?

As the IMF states, the SDR is "neither a currency nor a claim on the IMF". Multiple currencies are held all around the world in many different countries so, for example, not all of the sterling in the world is held in Britain. So an SDR allows a member of the IMF to obtain surplus currency held by another IMF member. This can be arranged by agreement.

Alternatively, the IMF can designate members with strong external positions (current account surpluses) to buy SDRs from members with much weaker positions to release the currency that they need to meet their external obligations and payments. The value of an SDR is based on a basket of currencies the euro, yen, sterling and the US dollar and carries an interest rate. The US dollar value of the SDR is available every day on the IMF website.

There has been a lot of talk about the "Norway solution" for Britain after Brexit over the last two years, but little about what the Norwegians themselves think about the arrangement they have with the European Union.

However, a few days ago I was fortunate to attend a talk by Siv Jensen, Norway's finance minister, on bank regulation at the think tank Policy Exchange in London. As well as being the third most powerful person in Norway, she's also leader of the pro-market Progress Party. This means that she's much more sceptical of the idea that regulation can solve every problem. She's also sympathetic to the British concern that too much red tape can make things worse. I was also lucky enough to grab a few words with her after she finished.

One of the main worries about the European Economic Area (EEA) option, which comes up time and again, is that being part of the single market requires full compliance with the relevant European rules, limiting our freedom to set out our own regulation (see last week's interview).

However, Jensen points out, both in her speech and afterwards, that an increasing amount of financial regulation is carried out at the global level. This process has intensified in the last decade with the G20, International Monetary Fund, and other global bodies developing "a set of common international standards and rules for the regulation and supervision of the financial sector".

The principles underlying these rules have been codified in the Basel Accords. The first set of these rules was produced 30 years ago, with the latest version appearing in 2013. Most of the world's financial centres, including both the United States and the EU, have incorporated Basel, or something similar, into their legislation.This means that it would be "in our interest" for us to follow these rules. The obvious (though unspoken) implication of this is that there is no getting away from the fact that whatever we do, we would still be a "rule-taker" to a certain degree.

In any case, while its EEA status means that Norway doesn't have a direct vote on European policies, Jensen notes that it still has the ability to influence decisions, both before and after Brussels comes up with directives. Indeed, she and her government have found the EU to be "flexible and willing to listen" to any concerns that Norway might have. Norway is also able to informally shape regulation by its participation in several meeting places and forums designed to allow Nordic and Baltic regulators to effectively supervise institutions that operate across the region.

More generally, Jensen thinks that the EEA agreement "has served our country well" giving Norwegian companies frictionless access to its largest trading partner. While some politicians talk about Norway becoming a full member of the EU, and others want to move to a looser free-trade agreement, she thinks that the status quo is supported by a "broad majority" of the population, "who understand its benefits". While the government will continue to push Norway's interests, she predicts that in ten years time, it will still be an EEA member and its relationship with the rest of Europe will be broadly unchanged.

Despite being in the single market, Norway is outside the EU's customs union. This means that there are some border controls between it and neighbouring Sweden. Jensen thinks that this is not a major problem for businesses on either side of the border, as the two countries have been able to cooperate well. On the issue of free movement, she has previously stated that Europe's rules have made it too easy for migrants to gain access to some benefits, such as child benefit for non-resident children. However, she now thinks that opinion within Europe is starting to shift on this specific issue, if not on the wider principle.

Overall, Brexit "isn't something that is frequently discussed by the average Norwegian", she admits. However, like most Norwegian officials and politicians, Jensen is keeping a close eye on developments, not least because it will affect Norway's own relationship with the UK.She refused to be drawn on how the Norwegian government would respond if Theresa May changed her mind and applied to be part of the EEA, emphasising that she can't answer such a hypothetical question before adding, "we always take the UK seriously on every question".

Funds with exposure to Latin America have had a dire few years, with many down by more than 50% since 2011, says Attracta Mooney in the Financial Times. Unsurprisingly, many investors are now heading for the exits. Total assets managed by European-domiciled Latin America funds have fallen by more than 70% in Europe since 2010 (to €7.5bn), with US-domiciled equivalents dropping by 85% to just $1.4bn, according to investment research company Morningstar. What was briefly a fashionable sector is now shrinking: more than a quarter of US and European-based funds specialising in the region have been liquidated since 2010, according to data provider Lipper.

Weak performance throughout Latin America's stockmarkets can be attributed to "the three Cs", writes Patrick Gillespie for CNN Money "China, commodities, and currency". China invested heavily in Latin America's commodities over the last decade, buying iron, copper and food. But China has cut down on infrastructure projects and is directing less cash towards Latin America. Furthermore, the dollar's strong rise has made it "more expensive for Latin Americans to buy imports and, for some companies, more expensiveto pay debt that's in US dollars", says Gillespie. The result is that Latin America officially fell into recession during 2015, shrinking by 0.2% overall, according to IMF data. Five years ago, it was growing at almost 5% per year.

Brazil, Latin America's largest economy, is to blame for much of the downturn. Fears over the weak economy have been exacerbated by a corruption scandal involving its state-controlled oil company, which has entangled a large number of leading politicians and businessmen, and has led to impeachment proceedings against President Dilma Rousseff. Hence the commodity-heavy stockmarket has fallen by almost 40% in sterling terms this year and investors are retreating from Brazil in droves: the country has seen persistent capital outflows since the beginning of 2010.

Given its significance to the region it accounts for more than 40% of regional GDP and more than 45% of the MSCI Latin America index that's holding back all regional funds. "For flows into Latin America funds to pick up, you need to see a performance improvement and that really hinges on Brazil," says Simon Dorricott, senior analyst at Morningstar. "When that will happen is anyone's guess."

But despite the gloom, "there are selected opportunities' in [Brazil] among exporting companies, which have benefited from the depreciation of the real", Claudia Calich, manager of the emerging markets bond fund at M&G, tells Attracta Mooney. And while a wider economic turnaround and a resolution to the political turmoil is likely to be some way in the future, MoneyWeek views Brazil as an attractive long-term betfor those prepared to take the risk.

One way is to invest in the Aberdeen Latin American Equity Fund. This fund has struggled over three years (down 15% per year), but it "remains poised to benefit from rising consumerism across Latin America, with exposure to companies set to benefit from increased spending, such as banks and retail businesses", says Kate Marshall of Hargreaves Lansdown. The fund has an ongoing charge fee of 1.29%.

In the news this week ...

Twenty-six MPs across five UK political parties have urged their pension scheme to divest their funds of fossil-fuel investments, says Madison Marriage in the Financial Times. Caroline Lucas, the Green's party's only MP, put forward a motion in September encouraging trustees of the £500m Parliamentary Contributory Pension Fund to "evaluate the risk of its investments in high-carbon industries" and to "divest from fossil-fuel companies in areas such as coal and oil". The divestment movement is already supported by investors controlling $2.6trn of assets, including French insurance group Axa and Norway's state pension fund.

Fund group Threadneedle Asset Management has been fined £6m by the FCA for failings that left it vulnerable to a $150m fraud attempt, writes Daniel Grote for Citywire. Inadequate security procedures allowed Vladimir Gersamia, a former fund manager at the group who has since been dismissed, to attempt to execute a $150m trade for Argentinian warrants in August 2011, at four times their market value and on behalf of three Threadneedle debt funds that he did not manage. If the deal had been completed, investors in these funds would have faced a £70m loss. The only reason why it failed was that Threadneedle's systems had not traded this type of warrant before. A spokeswoman for the group said that this weakness in its security processes had now been "fully addressed".

If you don't know who Robert Triffin is, you should read this closely.

Triffin was a Belgian economist who lived from 19111993. He was regarded as one of the leading authorities on gold, currencies and the international monetary system during his career. He made many notable contributions to international economics, but his most famous was the articulation of what became known as "Triffin's dilemma".

The paradox of Triffin's dilemma was pointed out in the early 1960s, yet its implications are just now coming into full view. Far from a relic of the past, Triffin's dilemma is the key to understanding the future of the international monetary system.

Triffin's dilemma arose from the Bretton Woods system established in 1944. Under that system, the dollar was pegged to gold at $35.00 per ounce. Other major currencies were pegged to the dollar at fixed exchange rates. The architects of the system knew that these other exchange rates might have to be devalued from time to time, mostly because of trade deficits, but the devaluation process was designed to be slow and cumbersome.

A country that wanted to devalue (for example, the UK in 1967) first had to consult with the International Monetary Fund (IMF). The IMF would typically recommend structural changes to fiscal policy, tax policy and other areas designed to cure the trade deficit.

The IMF also stood ready to offer bridge loans of hard currency to help the deficit-hit country withstand temporary stresses while the structural changes were implemented. Only if the structural changes failed and the trade deficits were persistent would the IMF allow devaluation.

That was the process for countries other than the US As far as the US was concerned, the link between gold and the dollar was fixed for all time and could never be changed. The dollar/gold link was the anchor of the entire system.

This fixed link between the dollar and gold made the dollar the most prized reserve currency in the world. That was the hidden agenda of Bretton Woods. With the dollar as the main reserve currency, UK pounds sterling, a competing reserve currency, would eventually fall by the wayside.

The UK relied on imperial preference' among its trading partners in the British Commonwealth to gain trade surpluses, and also relied on the willingness of those Commonwealth partners to hold sterling in their reserves. The Bank of England assumed Commonwealth members would not ask to convert the sterling to gold. Imperial preference came under attack by the General Agreement on Tariffs and Trade (GATT), which was also part of Bretton Woods. (Today, GATT is known as the World Trade Organisation (WTO).)

Bretton Woods was a one-two combination punch designed by the US to destroy the British empire. GATT undermined imperial preference. The dollar-gold link undermined sterling. It worked. The UK's trade deficits persisted, and the Commonwealth partners demanded their gold. Eventually, the pound sterling was devalued, and the empire dissolved. It was replaced by a new age of US empire and King Dollar.

There was only one problem, and Robert Triffin pointed this out. If the dollar was the lead reserve currency, then the entire world needed dollars to finance world trade. In order to supply these dollars, the US had to run trade deficits.

The US sold a lot of goods abroad, but Americans quickly developed an appetite for Japanese electronics, German cars, French vacations and other foreign goods and services. Today, China has replaced Japan as the main source of exports to the US; still, Americans have not lost their appetite for imports financed by printing dollars.

So the US ran trade deficits, the world got dollars and global trade flourished. But if you run deficits long enough, you go broke. That was Triffin's dilemma. Any system based on dollars would eventually cause the dollar to collapse because there would either be too many dollars or not enough gold at fixed prices to keep the game going. This paradox between dollar deficits and dollar confidence was unsustainable.

This system did break down in the 1970s. The solution then was to abolish the dollar-gold peg in 1971, and demonetise gold in 1974. But there was a third leg of the stool invented in 1969 the IMF's Special Drawing Right (SDR).

The SDR was a new kind of world money printed by the IMF. The idea was that it could be used as a reserve currency side by side with the dollar. This meant that if the US cured its trade deficit, and supplied fewer dollars to the world, any shortfall in reserves could be made up by printing SDRs.

In fact, SDRs were printed and handed out repeatedly during the dollar crisis from 19691980. But then a new King Dollar age was started by Paul Volcker and Ronald Reagan, with some help from Henry Kissinger, the king of Saudi Arabia and private bankers like my old boss Walter Wriston at Citibank.

Under the new King Dollar system, US interest rates would be high enough to make the dollar an attractive reserve asset even without gold backing. Remember those 20% interest rates of the early 1980s?

Henry Kissinger also persuaded Saudi Arabia to keep pricing oil in dollars. This "petrodollar deal" meant that countries that wanted oil needed dollars to pay for it whether they liked the dollar or not.

The Arabs deposited the dollars they received in Citibank, Chase and the other big banks of the day. The bankers, led by Wriston at Citibank and David Rockefeller at Chase, then loaned the money to Asia, South America and Africa.

From there, the dollars were used to buy US exports such as aircraft, heavy equipment and agricultural produce. Suddenly, the game started up again, this time without gold. This new age of King Dollar lasted from 19802010.

Still, it was all based on confidence in the dollar. Triffin's dilemma never went away, it was just in the background waiting to re-emerge while the world binged on new dollar creation and forgot about gold. The US ran persistent large trade deficits during this entire 30-year period as Triffin predicted. The world gorged on dollar reserves, with China leading the way in the 1990s and early 2000s.

The new game ended in 2010 with the start of a currency war in the aftermath of the panic of 2008. Trading partners are again jockeying for position as they did in the early 1970s. A new systemic collapse is waiting in the wings.

The weak dollar of 2011 was designed to stimulate US growth and keep the world from sinking into a new depression. It worked in the short run, but now the tables are turned. Today, the dollar is strong, and the euro and yen have weakened. This gives Japan and Europe some relief, but it comes at the expense of the US, where growth has slowed down again.

The new dollar-yuan peg with China has also contributed to a slowdown in China. There's just not enough global growth to go around. The major trading and finance powers are cannibalising each other with weak currencies. Soon the US and China may devalue relative to Europe and Japan, but that just moves the global weakness back to them.

Is there no way to escape the room? Is there no way out of Triffin's dilemma?

A new gold standard might be one way to solve the problem, but it would require a gold price of $10,000 an ounce in order to be non-deflationary. No central banker in the world wants that, because it limits their ability to print money and be central economic planners.

Is there an alternative to gold? There is one other way out. That's our old friend, the SDR. The brilliance of the SDR solution is that itsolves Triffin's dilemma.

If you recall, the paradox is that the reserve currency issuer has to run trade deficits, but if you run deficits long enough, you go broke. But SDRs are issued by the IMF.The IMF is not a country and does not have a trade deficit.In theory, the IMF can print SDRs forever and never go broke. The SDRs just go round and round among the IMF members in a closed circuit.

Individuals won't have SDRs. Only countries will have them in their reserves. These countries have no desire to break the new SDR system, because they're all in it together. The US is no longer the boss. Instead, you have the "Five Families" consisting of China, Japan, the US, Europe and Russia operating through the IMF.

The only losers are the citizens of the IMF member countries people like you and me who will suffer local currency inflation. I'm preparing with gold and hard assets, but most people will be caught unaware, like the Greeks who lined up at empty ATMs last month.

This SDR system is so little understood that people won't know where the inflation is coming from. Elected officials will blame the IMF, but the IMF is unaccountable. That's the beauty of SDRs Triffin's dilemma is solved, debt problems are inflated away and no one is accountable. That's the global elite plan in a nutshell.

We never take our eye off the IMF and its plans to expand the use of SDRs. The IMF will include the Chinese yuan in the SDR basket over the next 12 months to make sure the Chinese are "on the bus" when the endgame begins. That's an important step in the SDR process.

We plan to report on the IMF annual meeting in Lima, Peru, so you have a front-row seat for these developments. This story has longer to run, but the endgame is already in sight. Stay tuned

One big mystery in the gold market has kept anyone interested in the precious metal guessing for the past six years: how much gold does China hold?

Well, now we know. At the end of last week, China revealed the scale of its current gold holdings.

And judging by the market reaction, it was a massive anti-climax

China's hanging on to a lot less gold than anyone thought

Now China is holding 1,658 tonnes of gold. That's a jump of nearly 60% on 2009. By sheer size of stash, this makes China the fifth-biggest holder of gold in the world, overtaking Russia. (France, Italy, Germany and the US hold more, with the US holding the most).

Gold now represents 1.65% of China's foreign exchange holdings. That's up from 1.1% in 2009, but still way below the equivalent value for many other countries.

So in all, this is a big jump.

But it was also a great deal lower than anyone had expected. As Bloomberg reports, its own analysis service had thought that China's gold stash could have tripled to 3,500 tonnes. That's taken from looking at increasing mining output and ongoing imports of the metal.

Partly as a result of the disappointment, the gold price has slid.

You see, one of the narratives doing the rounds about gold has been that China was effectively aiming to back its own currency the yuan with gold. In some more aggressive variations of the story, China and Russia would team up to launch some sort of gold-backed currency to replace the US dollar.

The fact that China hasn't been expanding its reserves as dramatically as expected suggests that this theory is either wrong or very premature.

Why hasn't China bought more gold?

There's no doubt that China does want to increase the profile of its currency, and that's exactly what you'd expect. China is clearly competing with the US to be global superpower and if it's serious about that, then the yuan needs to become much more important to financial markets.

So while the idea that it wants to launch a gold-backed currency might be extreme, it would certainly like the yuan to be a reserve currency'. And gold is one aspect of that. It's no coincidence that the US holds the most gold of all the nations listed above.

China regards its gold reserves as a state secret. The main reason for updating on its gold reserves just now is that it would like the yuan to be included as part of the International Monetary Fund's special drawing rights (SDR) basket.

The idea of the SDR is tricky to explain, but it's almost a form of Frankenstein currency'. Its value is based on a basket made up of the US dollar, the euro, the pound and the Japanese yen the world's four most important currencies.

The IMF will be updating on the composition of this basket later this year. China hopes to be included, and most economists surveyed by Bloomberg last month reckoned the currency as much for political reasons as economic ones will be included in SDRs from the start of next year.

That'll be a sign that the yuan is coming of age, and a step towards it becoming a full-blown reserve currency.

So why hasn't China stockpiled more gold? One reason is that it might find it tricky to do so without driving up the price. As the central bank put it: "The capacity of the gold market is small compared with China's foreign reserves; if foreign exchange reserves were used to buy large amounts of gold in a short time, it will easily affect the market."

Of course, China could be fudging the figures in some way.

China is also the world's biggest gold producer. So as Bernard Dahdah at French bank Natixis put it: "It begs the question of what's been happening to the gold produced that hasn't been taken by the central bank".

Questioning Chinese government statistics is hardly evidence of a conspiratorial mindset. The data can be made to put over the message that the Chinese government would prefer markets to hear. If you assume that China wants to reveal enough gold to persuade the IMF, but not so much that everyone starts asking what they're up to, then you could argue that there's every reason for it to understate its reserves.

We'll never know for sure. But at the end of the day, as Joni Teves of UBS put it: "What matters now is whether the market believes they intend to continue buying". If these figures are accurate, then China still has a way to go before its own gold pile comes close to matching those of its closest rivals. "They do appear to leave the door open to further purchases, which should limit the downside for gold."

Our view on gold is that it's worth having about 5%-10% of your portfolio in the physical metal as insurance against another financial crash. That still holds. And this might even prove a decent rebalancing opportunity.

(By the way, if you want to know more about how you should go about building a portfolio, then we've got something that we think every MoneyWeek reader looking to invest over the long term will be interested in. It's only open to MoneyWeek subscribers you can find out more about it here).

Asset allocation is at least as important as individual share selection. So where shouldyou be putting your money? Here's our monthly take on the major asset classes.

Sensible insurance

Gold has slipped from late January's six-month high of around $1,300 an ounce.But ongoing jitters over political instability and a possible financial crisis in Europe will keep investors keen on "safe havens".

Disinflation and fear of deflation is likely to hold short-term interest rates down, which tends to be good for gold (as it pays no interest, the opportunity cost of holding it is lower when interest rates are low).

Demand from emerging markets remains healthy central banks bought 461 tonnes last year, up 13% on 2013 and the second-highest annual total since 1971. Russia, eager to diversify away from the dollar, accounted for a third of last year's total. Increasingly wealthy emerging-market consumers also bode well. So hold on to the yellow metal keep 5%-10% of your portfolio in it as insurance.

Set to get even more expensive?

Annual house-price growth slippedfrom a peak of 12% to 7% in 2014.It may tick up again: mortgage approvals rose for the first time in six months in December, while the healthy labour market and recent falls in mortgage rates bode well. But don't chase the market houses are already overvalued as it is, and London prime property is looking wobbly.

Buy the money printers

"Global growth is still too low, too fragile, and too uneven," says Christine Lagarde, head of the International Monetary Fund. Six years after the global financial crisis, the world economy is still hungover. Judging by stockmarkets' performance, however, you'd think the rebound had been unusually strong instead of unusually weak.

US stocks have almost tripled and Europeex-UK has just hit a seven-year high. Quantitative easing money printing has driven the gains, as liquidity leaks into asset markets. As far as developed-market equities are concerned, we think you should stick with the reasonably valued markets where the end of QE is still a long way off. So Europe and Japan remain the best bets; the US is too expensive and QE there is over for now.

Emerging markets are going through a rough patch, beset by the end of the commodities boom, the Chinese slowdown, structural problems, the tepid global economy and political instability. But beneficiaries of the falling oil price with large domestic markets, which can offset subdued exports, are the best bets here: enter India, the Philippines, and Vietnam. Commodities exporter Brazil, meanwhile, is cheap enough to be worth a look.

The biggest bubble of all

Bonds just keep rising in price, which in turn means that yields keep shrinking some are now even negative. European bonds have been particularly in demand. This is partly due to investors worrying about a possible euro break-up or long-term deflation.

But the main driver seems to be anticipation of European QE, and the hope of selling bonds at a higher price once the money floods in. The bubble in corporate debt continues too. This week the yield on one Nestl bond maturing in October 2016 turned negative.

A perfectly negative storm

Raw-materials prices have hit multi-year lows amid "a perfect storm of negative factors", as Societe Generale's Robin Bhar puts it. China's downturn, which last year saw local steel demand drop by 3.4% (the first fall in 14 years), higher supplies and a stronger dollar are driving the trend.The printed money created by US QE, which finished last autumn, also helped prop up commodities.

Iron ore halved last year and is down 12% in 2015; copper and lead are down by a fifth since July. But we may be at or near the bottom of the metals cycle, as we point out this week in our free daily email Money Morning. Supplies areset to dwindle as production is shut down, while European QE is about torev up. Mining shares also remain reasonably priced.

Agricultural commodities are a solid long-term bet. As the world's population grows, the amount of arable land is dwindling, so over time land and soft commodities will become more valuable. Farm equipment and fertiliser stocks are better plays on the theme than commodities futures, which are extremely volatile.

A long-term switch

Oil prices are up by more than 20% since troughing at around $46 a barrel last month, as we explain in our cover story. American natural gas has slid to a three-year low, thanks to unusually warm winter weather and ample supplies. In the long term, however, more stringent environmental regulations worldwide should encourage households and industries to switch to gas, negating the surplus.

During the Great Depression of the 1930s, the global economy was in the doldrums. Tariffs and trade barriers began to pop up all over the place. But with the end of the Second World War, many countries found themselves in a more conciliatory mood.

It was widely believed that restrictive trade policies had directly contributed to the outbreak of war. Free trade, its proponents argued, would not only aid the economic recovery of a war-shattered world, but it would also promote peace.

In 1944, at the famous Bretton Woods conference in New Hampshire, Britain and its war-time allies agreed to set up the World Bank and the International Monetary Fund. But a third institution was also sketched out: an “International Trade Organisation”, or ITO. In a nutshell, the purpose of the ITO would have been to regulate international trade. But negotiations proved to be far from straightforward.

One of the main sticking points was something called “imperial preference”. Members of the British Commonwealth already had tariff agreements with each other that put other countries (namely the United States) at a disadvantage. As part of the deal reached on 30 October 1947, “imperial preference” would go.

Twenty-three countries signed the General Agreement on Tariffs and Trade, or GATT as it became known, in Geneva. But agreement on the wider ITO stalled and the institution was effectively still-born when the United States refused to ratify the charter, hammered out in Cuba in 1948.

The GATT was all that remained. And despite only ever being a provisional agreement, the rules governing international trade remained in force for almost half a century.

Meanwhile, discussions trundled on for decades. Eight rounds of negotiations later, the GATT was eventually replaced by the World Trade Organisation (WTO) in 1995.

As I noted in our weekend round-up, the real action was in the precious metals markets last week.

Gold hit a new record high, while silver also spiked to 30-year highs. Why? Among other things, it seems that investors are still extremely jittery over the prospect of potential sovereign default in the eurozone.

While Greece was reassuring the markets that it wouldn't default, investors' actions were speaking louder than any words. It wasn't Greece they were fretting about this time, though. It was Ireland.

A piece of research from Barclays Capital was all it took to force 'verbal intervention' from the International Monetary Fund (IMF) on Friday. It's just one obvious symptom of a deeply unhealthy market...

This is not a free market

The European Central Bank (ECB) reportedly ended up having to intervene in the bond market on Friday, after Irish bond yields spiked (in other words, investors suddenly developed an even more pronounced aversion to lending the Irish government money).

The source of the sudden spasm of fear? A Barclays Capital research note suggesting that Ireland might eventually have to get "financial assistance from the EU-IMF" if there were "unexpected losses in the financial sector".

We've come to something when a piece of analyst research is all it takes to rock confidence in a developed world sovereign bond market. Analysts churn this sort of stuff out every day. And it was hardly relentlessly damning. A healthy market could take this sort of thing on the chin.

Instead, we had the IMF rushing to deny that the country was in trouble. Or at least, any more trouble than it's already in: "we do not envision that IMF financing will be needed".

And of course, we had the ECB stepping in to the bond market to prop prices up. The Financial Times report on the purchase says that "traders said the intervention by the ECB was small in the tens of millions of euros", but that's not really the point. After all, if prices had fallen harder, we can only assume that the ECB would have upped its purchases accordingly.

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The point is, it's not a free market. Whether or not you think that's a bad thing (I think it's bad, but lots of people seem to be quite happy for governments to be embedding themselves in the markets) is neither here nor there. What is for sure, is that you can't take a view on these markets without trying to incorporate what central banks might do next. That political dimension has always existed. But now it takes precedence over any economic considerations, which makes 'investing' a gamble.

As anonymous blogger 'Tyler Durden' puts it on the Zero Hedge website, we know that central banks are openly piling into currency and bond markets every day. Maybe it's only a matter of time before we find them doing the same to equity markets. Markets "have now become merely a venue for global central banks to conduct domestic policy, and have lost all traditional capital formation and forward looking properties."

Why gold is hard for governments to manipulate

This is why people are buying gold. The great thing about gold is that it's a pretty hard market for governments to manipulate. Before I get a flood of angry comments from those who believe the market is being suppressed, let me explain.

Governments want most asset prices to stay high. If you want the price of things like houses and bank debt and government debt to stay high, then there's an easy solution print money and buy them. It's not very healthy in the long run, but if you're not too worried about that, then it's easy to prop prices up.

Trouble is, governments don't want high gold prices. They'd rather the gold price stayed low. A high gold price is a clear warning that paper currencies which are ultimately just government-backed promises are losing their value.

But suppressing the gold price clearly isn't easy to do, as the past ten years demonstrate. Even if there is a grand cartel trying to keep the yellow metal down, they're not doing a very good job of it.

When Gordon Brown flogged off Britain's gold roughly ten years ago, the price hit a bottom. But now, with gold roughly five times as expensive, if Britain decided to sell the rest, I suspect we'd have a queue of willing buyers.

The fact is, the only way for central bankers to bring the gold bull market to an end, is the honest way. They have to raise interest rates above the rate of inflation, and restore the value of their paper currencies. People have to be convinced once again that paper currencies offer a better return on their savings than gold does.

Call me cynical, but I can't see this happening any time in the near future.

How high can gold go?

So how high could gold go? I'm not going to talk about where it's going to be next week or next month I'll leave that to my colleague Dominic Frisby. And when any asset class hits fresh highs, you've always got to be aware of the potential for a correction. But Tim Price, who writes our Price Report newsletter, last week put out an interesting piece about the Dow Jones / gold price ratio. Take a look at the chart below, which shows the value of the Dow Jones index divided by the gold price.

As you can see, says Tim: "At the bottom of previous equity bear markets / gold bull markets, the Dow / gold ratio has reached 2.1 (c. 1904); 2.0 (c. 1932); 3.1 (c. 1975) and 1.0 (c. 1981). It currently sits at around 8.3. The trillion dollar question is: how low can it go?"

Tim's view is that the most likely way for the ratio to bottom out, is for "gold prices to continue to rally; equity markets to continue to fall; and both markets meet each other somewhere in the middle."

If you're looking to put a price on it, then James Ferguson (by no means a 'gold bug') told readers of his Model Investor newsletter last week that judging by the technical picture at least, "the realistic three to six month target has to be above $1,500." I have to say, that sounds a pretty punchy call to me. But the point is gold is still a 'buy' here.

Our recommended article for today

The optimist's guide to the economy

There have been a lot of things to worry about in the economy over the last few years. Most of them still give cause for concern. But should we extend our pessimism to the next ten years? Merryn Somerset Webb looks for reasons to be cheerful.

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Last week Tim Geithner became the latest US Treasury Secretary to say he believes in a strong dollar. The dollar index, which tracks the greenback's performance against a basket of major trading partners' currencies, promptly hit a 14-month low of under 76, not far off its record low of March 2008.

Why the dollar is sliding

And it's no wonder. Interest rates are near zero and the Federal Reserve has been printing money to prop up the economy. Fiscal policy has been expansionary too. The "worst budget conditions for 75 years", due to the brutal recession, will result in a deficit of around 10% this year. This isn't a short-term problem. The deficit will still be around 6.5% in 2019, says Roger Altman in the Financial Times, after which healthcare liabilities will rocket. The "lack of any clear path" to shrink the deficit fuels fears that the US will inflate its way out of its huge debt load by debasing the dollar, says Edward Hadas on Breakingviews.

Then there's the carry trade. Thanks to rock-bottom interest rates, the dollar has become a popular currency to borrow and then sell, in order to park the cash in higher-yielding currencies and assets. This trend will strengthen as global risk appetite remains high: expect further dollar weakness against the high-yielding commodity currencies, says Callum Henderson of Standard Chartered.

And all the recent "hubbub" about its demise as the dominant reserve currency is also denting the dollar, says Stephen Foley in The Independent. "You would think we have passed into a new world economic order." Earlier this year, China suggested that the International Monetary Fund's (IMF) special drawing rights could be a new reserve currency, while last week Middle Eastern states and China were rumoured to have discussed trading oil in a basket of currencies rather than the dollar.

It's too early to write it off

But all this is wildly premature. For starters, the practical difficulties are immense, says Foley. The IMF seems incapable of "having a civilised debate" on how many seats each country gets, let alone what currency weightings might be.

IMF estimates suggest that the dollar's share of global foreign-exchange reserves is falling as central banks diversify their cash piles. Dollars now comprise 63% of global reserves, from more than 70% a decade ago. But China, the main buyer of US debt, increased its holding of Treasuries to $800bn in July, from $780bn at the end of June, says Capital Economics. "The dollar is still entrenched as the world's dominant reserve currency." A Chinese official told the FT in June that "in the short term, I don't think we can find another currency" to replace the dollar.

If China, the world's largest holder of reserves and America's key creditor, ditches dollars, it would prompt a sharp slide in the value of its huge pile of dollar-based assets and cause a recession in the US by driving up long-term interest rates. Even a weakening dollar causes difficulty, since China and the rest of Asia relies on exports to the US, a growth model that is likely to take years to change. Last year China repegged the yuan to the dollar and last week Asian central banks intervened in the foreign-exchange market to slow the dollar's fall. As Jeremy Warner puts it on Telegraph.co.uk, for all the talk about the demise of the dollar, "the fact of the matter is that Asia isn't yet quite ready for it".

What next?

And while the dollar remains the world's reserve currency, it should benefit from demand for a safe haven when investors are rattled, as we saw early this year. Given that the global recovery is likely to disappoint, which will reduce risk appetite, the dollar may well bounce back in the next few months, as Capital Economics points out. The greenback is down, but not yet out.

In August 2005, Fred Harrison told MoneyWeek that the UK property boom would last for another three years, before ending in 2008. Here he updates his forecast

Recent news on the housing market has been nothing but negative (see the graph below). The International Monetary Fund says UK house prices are 40% overvalued. The Nationwide building society has cut its forecast for 2008 house price growth to 0% a fall in real terms.

Yet most remain complacent. The Ernst & Young Item Club (using the Treasury's model) reassures that "it is unlikely there will be a major housing recession".

However, the truth is that the consensus view on housing has been consistently wrong.

Experts predicted a modest rise in prices for 2006 in fact, as I forecast in my 2005 MoneyWeek article there was a strong surge, with growth exceeding 10%.

Why do these experts' get it so wrong? It's because they are working with defective models, which assume that the health of the property market depends upon the condition of the rest of the economy. In fact, my research suggests that property is the key factor that shapes the business cycle, not the other way around.

My model suggests that the property market runs in 18-year cycles. There have been three in the postwar years (1956-74, 1975-1992 and 1993-2010). The operating mechanism is shown in the graph above. Earnings across the economy rose roughly in line with national income, as did the cost of building homes (including materials, and wages and profits in the construction sector). House prices, however, rose much faster, to disruptive heights, peaking in the booms that result in busts. The cause of this instability is the out-of-control rise in the cost of land. The supply of land is fixed, so when the economy is growing, it has to become more expensive. Rising land prices squeeze corporate profits, reducing the money available for wages, until prices simply can't go any higher because most people can no longer afford to buy. The phenomenal rise in land prices since 1993 is the main reason why the next downturn will turn into a depression.

That may sound extreme. After all, most of us could relax if the only issue was the trend in house prices. Negative equity will burden only those who are forced to sell properties bought in the past three years or so. But much more is at stake. Forecasters base their optimistic outlook on the belief that the "fundamentals" rule out a recession, claiming a strong labour market will offset the pain of falling house prices. In fact, causation runs in the opposite direction. The fall in house prices creates the conditions for recession, as is now clear in the US. Lay-offs in the construction industry and related sectors are curbing consumption, which discourages investment and ends in a recession.

Look what happened when the last real estate cycle exhausted itself at the end of the 1980s. In Japan, the authorities mishandled the biggest postwar boom in property prices. Bad loans to land speculators were allowed to blight the balance sheets of banks that should have been allowed to fail. The outcome? A decade-long depressed economy.

Much the same happened in Germany, and it looks like the US and the UK will make the same mistakes. In the UK, the government has already moved to underwrite Northern Rock with taxpayers' money. Reckless mortgage lending will go unpunished, leading to even worse practices in the next property cycle.

Similarly in the US, the lessons of the savings and loans (S&Ls) scandal of the 1980s were not learnt. Now Congress is heading for the safety of the hills, promising to forgive mortgage debts in a bid to deflect the heat from politicians.

I cannot forecast the depth of the looming global depression because some events are unpredictable, such as the extent to which protectionism will rear its head in the States. But a good working assumption should be: expect the worst. Sell your buy-to-lets and investing in safe haven' assets such as gold may also be a wise move.

Fred Harrison is a director of Economic Indicator Services. The second edition of Boom Bust: House Prices and the Great Depression of 2010 can be bought online at the MoneyWeek bookshop or tel 01730 233870.

Worrying times for UK homeowners

The latest data on the housing market make worrying reading for UK homeowners, writes John Stepek. Property consultant Hometrack's survey of 6,000 estate agents found that house prices fell on a monthly basis in October for the first time in two years, declining 0.1%. The annual rate of growth slid to 4.4% from 5.0% in September.

More tellingly, the Bank of England reported that the number of mortgages approved for buying a new home fell from 108,000 in August to 102,000 in September. That was 20% down on a year ago, and the lowest level of approvals since July 2005 a point where the housing market was just recovering from a year-long slump in transactions.

Recent data from the Royal Institution for Chartered Surveyors show that new buyer enquiries are falling sharply, moreover research group Capital Economics believes that the Rics data suggest new mortgage approvals will fall "well below the 100,000 mark by the start of 2008" a decline not seen since the sales collapse in 2004. It seems that Fred Harrison's prediction of a slump beginning in 2008 could well be accurate.