The intensity of the British media’s focus on Brexit since Friday’s surprise result has few precedents in recent times, and it is understandable, however the rest of the world still exists – and it was not, before that Friday, in good shape although it may seem to have been, in relative terms.
Sebastian Lyon, founder of Troy Asset Management and manager of Personal Assets trust and Trojan fund, thinks the focus on the referendum puts investors in danger of ignoring other threats to the world’s economic stability.
“People have been focusing on Brexit and that’s understandable; it’s a big decision and it’s important, but without rushing to demean it there are far bigger, more important, things that we could worry about.
“World trade has collapsed over the last few years and in China, particularly, growth has deteriorated a great deal. There is a real risk of China joining in with the currency wars, which it hasn’t done yet, and we got a little amuse bouche of what that might be like in 2015 when the Chinese devalued their currency by 4% and markets swooned.”
Lyon (pictured) thinks governments are likely to resort to ever strong measures to boost economic growth, and devaluing a currency is one way to do that.
China devalued the Renminbi in August last year, to howls from investors all around the world. Between the start of August and the end of September, the MSCI World Index lost almost 10%, knocking the equivalent of $1.6 trillion off global companies.
Devaluing a currency serves to boost an export-led economy by making exports more competitive, but companies which export their goods into the country which has devalued are left with major problems – the money they are being paid by (in this case China) literally being worth less. Commodities companies, many of them among the largest in the world, were hit particularly hard by the decision.
China now faces the possibility of a full blown recession which would almost certainly see currency come back into the arsenal, which could have a dramatically inflationary effect.
“Inflation is the dog that hasn’t barked.” He says: “Our view is that the world is up to its eyes in debt, whether that be private or government, and the reason for that is slow growth. There are two ways out of that – either default or inflation.
“We think that there will be a fusion between monetary policy and fiscal policy – people’s QE of a sort – via fiscal spending rather than bond buying and that has the potential to be highly inflationary, and in that scenario the longer term threat of much higher levels of inflation.”
Lyon’s views are shared by the team at Ruffer Investment Management, who spoke to us in May. Steve Russell, who manages the fund alongside Hamish Baillie, points to the fact that global debt has increased by more than $50 trillion since the start of 2008, when the Great Financial Crisis (GFC) began, largely in the form of spiralling corporate and government debts.
Cash, in their view, is no shelter from what lies ahead as they think the world’s governments – having failed to ignite inflation via QE – are unlikely to give up and will use fiscal stimulus, Keynesian style housebuilding projects in the UK for example, to inject further heat into the economy.
The inevitable result in their opinion is that inflation will take off, and do so with a vengeance, as governments will be unable to restrain it using interest rates – because any significant rise will have disastrous consequences, the UK housing market being a prime example of why this might be the case.
With this in mind the team at Ruffer have positioned the portfolio to benefit from what they forsee as a period of ‘1970’s style’ inflation – a period known in the US as the Great Inflation when it ran as high as 14% – with heavy exposure to index linked bonds.
Click here to read our profile of the Ruffer Investment Company.
