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22 January 2014

Money Makes the World go Round

“Money makes the world go round” sang Liza Minelli in the film version of Cabaret, based on Christopher Isherwood’s ‘Goodbye to Berlin’. Perhaps that’s why politicians are so keen to control and regulate the banking industry, which is, after all, where most of the money (theoretically) sits. The latest wheeze, courtesy of Ed (“Is that a Bandwagon? Hang on while I jump aboard”) Miliband, leader of the UK Parliamentary opposition, is a proposal to force banks to sell off branches to make them smaller and then limit their market share, all in order to promote competition. As an aside, UK readers will recall that this is the same Miliband who was a minister in the previous Government, the one that knighted Fred Goodwin for ‘services to banking’ (honestly, I’m not making it up) and nodded through the merger of Lloyds and HBoS. That was the merger that virtually literally decimated shareholder value in Lloyds, until then a steady FTSE performer and a strong dividend payer. That was a great blow for consumer rights and competition then, wasn’t it?

Changing Times, Changing Players

Parochial UK issues aside, there is a relevance in this, since one of the effects of the combination of greater scrutiny and a pull back towards more traditional activities is that we have seen a number of banks scale back or indeed cut off their metal trading activities. I first discussed this – as a trend I expected – back in May 2012. We know what is happening – US and European banks, having been caught by the LIBOR scandal, having been threatened by the LME warehousing issues and living in fear of, perhaps, problems emerging in the gold market, for example  - have begun retreating from commodity trading activities. In their place are beginning to appear institutions from outside the traditional financial powerhouses of Europe and the US. Now the second part of that – new entrants from newer economies – is probably a good thing. I’m in favour of competition, seemingly – and disturbingly – like Ed Miliband, although frankly his way of achieving it seems patently absurd. The first part of the change, though, that older names are pulling out to make space for the new ones, is a little more concerning. Is that the way regulation in Europe and the US is supposed to work?  To cause local players to quit the market, while those from further afield are happy to step in? Has the urge to control overtaken the need to allow businesses to operate?

Blame Shifting?

Now, I’m no apologist for the banking industry and I didn’t agree with Bob Diamond that it was time to see them as all cuddly again (I paraphrase). There has been some outrageous behaviour, for which the world is still having to pay. At the same time, though, I wonder if there is some shifting of some of the blame. Let’s take a look at the LME warehousing issue. There has been an effective, successful metal financing business operating for years, without significant side-effects. However, the crisis of 2007/08 changed the landscape. Weakening consumer demand meant a potential (without cutbacks) glut of material. At the same time, Governments (and I make no apology here for lumping Governments and regulators together: they are interdependent) decided that the way out of the problem was to start QE programmes. That had two effects; one was to inflate the price of hard assets (to maintain their value against a weakening currency) and the other was to provide a supply of cheap money to the banks. The banks behaved rationally in using that money to finance hard assets – in this case mostly aluminium – since that trade produces a low-risk return for their shareholders. So that surge in financing and the concomitant warehouse queues are a logical product of Governmental policies. 

Regulation...or Tilting the Balance?

And yet it’s the banks who are, in the eyes of the world, the bad guys. They are the target of the majority of the lawsuits and Governments set regulators on them like a courser sets his greyhound on the hare. Surely there is an element of scape-goating here? I agree, the banks have done a fine job of setting themselves up for it, but there is a wider concern. If European and US regulators drive their own banks out of the business, only to see them replaced from newer economies, who is the real loser? And if this applies in the metal financing business, which we know well, is not likely to be happening elsewhere? Perhaps Ed Miliband won’t have to break banks up to shrink them – regulatory pressure will do it for him. And new competition? Well, from areas with different requirements, perhaps.

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