bridges to nowhere and roads to serfdom - rwc · 2016-12-22 · for professional investors and...

For Professional Investors and Advisers Only

December 2016

Bridges to Nowhere and Roads to Serfdom

RWC Equity IncomeInvestor letter Q4 2016

www.rwcpartners.com | E [email protected] | Authorised and regulated by the Financial Conduct Authority

Portfolio Managers

Ian Lance, Nick Purves and John Teahan have managed funds together for over 10 years. Their loyalty and experience is leading within the industry and has awarded them a number of accolades. Ian, Nick and John joined RWC Partners in 2010 to establish the Equity Income team and now manage over £3.5 billion for their clients.The team's approach fully integrates conviction led, value-based stock selection with a distinctive and technical approach to stablising assets, with the aim of delivering investment solutions that both grow investors' assets and protect the purchasing power of capital and income.

In the Q4 2016 edition of our Investor Letter, Ian Lance considers infrastructure spending in the US. Have investors embraced a state of ‘Trump but without the bad stuff’? In which case will we see tax cuts and infrastructure spend implemented in the near term, and will wider growth be stimulated thus?

Proponents of government debt-funded programmes argue that “it has never been cheaper to borrow, so go out and borrow”. But are the threats of these programmes being thoroughly deliberated, and will we continue to see governments trying to stimulate their economies by adding more debt?

In this letter Ian will summarise and discuss some of the risks he sees as involved with such policies.

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“Spending and borrowing our way out of a recession, over and above the levels that are implied by the automatic stabilisers ... will not work and is not sustainable.”Philip Hammond speaking before he was made Chancellor.1

Since the financial crisis of 2008, the consensus amongst central bankers, policy makers and their economic advisors has been that low/negative interest rates and quantitative easing would be enough to revive economic growth. With the world’s economy still struggling to reach previous levels of growth after eight years of unprecedented monetary stimulus however, this optimism is starting to wear thin. The economic experts are now backtracking and claiming that monetary policy was never likely to work on its own and have started demanding governments ‘play their part’ by introducing ‘fiscal stimulus’ via infrastucture spend2. Figure 1 below shows the number of times ‘fiscal stimulus’ has been mentioned in the media in recent months.

2 For instance, ‘BOE’s Carney Says Governments Must Do More to Boost Growth’ WSJ 16th Feb 2016 or ‘Mario Draghi Urges Governments to Help ECB Hit Its Inflation Target’ WSJ 9 June 2016

1 ‘Hammond should ignore siren calls for more fiscal stimulus’ Ryan Bourne IEA 29 July 2016

Bridges to Nowhere and Roads to Serfdom

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FIGURE 1: “FISCAL STIMULUS” IN THE MEDIA, 2007-2016


With UK Chancellor Philip Hammond and now US President Elect Donald Trump expressing positive attitudes towards infrastructure spend (the latter promising both tax cuts and a $1 trillion infrastucture spending package), the policies originally advocated by John Maynard Keynes in the 1930s have come back into fashion3. The stock market has moved to rapidly price the positive effects of this stimulus package as four major US indices hit new all-time highs on 21st November at which point the Russell 2000 Index was up by 15% since the election. Investors have also rotated from the safety of quality stocks and bond proxies into the excitement of cyclicals and financials (the US banks index is +18% since the election4). Whilst I believe that the market can be quite efficient in reacting to these big turning points, I can’t help feeling that on this occasion the exuberance may have been over done. In this letter, I examine the poor track record of infrastructure spend in producing economic growth and suggest some reasons for this historic failure.

The track record of Keynesian deficit spending is very mixed

What is odd about the devotion of so many mainstream economists to Keynesian policies is that the track record of infrastructure spend in terms of producing growth is distinctly patchy, as I discuss below. (In fairness, I have yet to be given a single example of an economy which has printed its way to wealth and that hasn’t stopped quantitative easing being proposed by economists.)

The Great Depression

One of the earliest and most visible examples of fiscal stimulus turning around an economy is, in most people’s minds, the Great Depression. Folklore has it that Herbert Hoover believed government should play no role in the economy and refused to intervene during the downturn but when this failed, the government programs implemented by Roosevelt helped lower unemployment by putting many Americans to work and the New Deal saved the country. There is, however, a deep body of work that shows not only was Hoover deeply interventionist but that Franklin Roosevelt’s policies deepened and prolonged the recession5. In 1938 after almost a decade of government pump priming, one out of five workers remained unemployed which was hardly a ringing endorsement of Keynesian stimulus. Franklin Roosevelt’s Treasury Secretary Henry Morgenthau confessed that the “New Deal” was a failure in sworn testimony before Congress on May 9, 1939:

“We have tried spending money. We are spending more than we have ever spent before and it does not work.”

5 ‘Great Myths of the Great Recession’ by Lawrence W. Reed 2010 ‘America’s Great Depression’ by Murray Rothbard ‘Meltdown’ by Thomas E Woods 2009 Chapter Five ‘Great Myths about the Great Depression’ ‘The Great Deformation’ by David Stockman ‘Chapter 8 New Deal Myths of Recovery

3 This can be seem in stories like http://www.cnbc.com/2016/08/23/ theresa-may-told-get-building-to-stop-brexit-slowdown.html and also http://www.telegraph.co.uk/business/2016/08/04/we-are-all-keynesians- now-so-lets-get-fiscal/

4 Bloomberg 25th November 2016


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Japan’s lost decade(s)

Japan has invested enormously in infrastructure, building scores of bridges, tunnels, highways, and trains, as well as new airports—some barely used. The New York Times reported that, between 1991 and late 2008, the country spent $6.3 trillion on “construction-related public investment”6 – a staggering sum. This vast outlay has undoubtedly produced engineering marvels: in 1998, for instance, Japan completed the Akashi Kaikyo Bridge, the longest suspension bridge in the world. But while these trillions in spending may have kept some people working, no one can look at the Japanese numbers and conclude that the money has improved the economy. Per capita GDP, in constant U.S. dollars, was no higher in 2009 than in 1991, according to OECD data7. The Japanese economy picked up slightly this year, but it’s fair to say that Japan has lost a quarter-century of growth. Moreover, the largesse is part of the reason that the nation now labors under a crushing public debt, worth 230 percent of GDP8.

1970s America

In the 1970s America saw a revival of Keynesian economics when President Nixon sought to boost the economy by running large fiscal deficits (after he had ended the convertibility of the US dollar into gold), and cajoled the Chairman of the Federal Reserve, Arthur Burns, into keeping interest rates below the rate of inflation. The result was the stagflation of the 1970s in which inflation and interest rates rose even as unemployment remained high which was something Keynesian economists struggled to explain. Following this failure the so-called Freshwater economists9 declared victory, with Robert Lucas and Tom Sargent writing an article called ‘After Keynesian Economics’10 in which they stated that the flaws in Keynesian

economic models were ‘fatal’ and that they were ‘of no value in guiding policy.’ Following this, Ronald Reagan explicitly scrapped Keynesian nostrums, embracing instead new, modern supply side economics, which focused on incentives for increased production to restore economic growth and prosperity, rather than increased demand. Inflation was quickly subdued, shocking the Washington Establishment, and the economy took off on a generation-long, 25 year economic boom from 1982 to 2007, which Art Laffer and Steve Moore called “the greatest period of wealth creation in the history of the planet” in their 2008 book, The End of Prosperity.

Obama’s stimulus

The American Recovery and Reinvestment Act was U.S. President Barack Obama’s $830 billion 10-year infrastructure plan which was signed into law in 2009. Opinion is mixed about whether the policy succeeded with some economists pointing to the fact that despite it: this has been the slowest post war economic recovery, that the number of breadwinner jobs in the US economy is still 2 million below where it was when Bill Clinton was in office, and that the debt to GDP level has increased to 77%11. Others claim that the economy would have been much worse without it.

Doing nothing is an option

There are some important counterfactuals such as America 192112 and the Asian crisis in the late 1990s in which Keynesian remedies were not applied following a downturn and the economies recovered very quickly. In addition, President Clinton cut spending on both defence and welfare which according to the Keynesians should have cut economic growth, but instead the economy boomed.

6, 7, 8 ‘If You Build It ... Myths and Realities about America’ Edward L Glaeser Summer 2016

9 Keynesian economists tended to be based on coasts and were known as ‘saltwater economists’ whilst those who disagreed with these views were clustered around Chicago and the lakes and hence were known as Freshwater economists

10 ‘Where does the buck stop?’ The Economist 13th August 2016

11 Trumped by David Stockman Nov 2016

12 Detailed in The Forgotten Depression: 1921 The Crash that Cured Itself by James Grant Nov 2014


Lots of empirical evidence questions the effectiveness of infrastructure spending

• One of the most significant works questioning theefficacy of Keynesian theory was a paper writtenby Giavazzi and Pagano in 199013 which lookedat the performance of Ireland and Denmark in the1980s when their governments reduced their budgetdeficits which, according to the Keynesians, shouldhave reduced their economic growth but instead,their economies did remarkably well.

• In 2007, Professor Tim Congdon wrote ‘Keynes,the Keynesians and Monetarism’ which was athorough summary of how Keynesian theory hasnot worked since 1980 in Britain and America.This includes a study of the period 1981 to 1988in which Chancellor Geoffrey Howe set out howhe was going to reduce the budget deficit yearafter year. Of course this followed a period whendeficit spending by the Labour government hadled to stagflation. In a letter to The Times14 364economists demanded that Mrs Thatcher performa U-turn on her economic policy as they felt surea reduction in government spending would reduceeconomic growth15. History now shows that Watersand Minford were right and the 364, were wrong.Howe managed to grow the economy whilstreducing spending and cutting the deficit.

• Baumol, W. J. (1967), “Macroeconomics of Unbalanced Growth: The Anatomy of Urban Crisis.” American Economic Review, 57(3): 415–426showed 45 years ago that shifting resources from high productivity growth sectors to low productivity growth sectors, such as government services, willcause the growth rate of overall productivity to decline. Barro, R. J. (1991), “Economic Growth in a Cross Section of Countries.” Quarterly Journal of Economics, 106(2): 407–443 showed that government consumption has no effect on

increasing private productivity or, in other words, on restoring economic growth. Instead, Barro found that increased government consumption lowers saving and growth through the distorting effects of taxation or government expenditure programs.

• A review of data from the G-7 countries byE. Hseih and K. Lai (1994) found no evidence thatincreased government spending increases the rateof growth of per capita GDP. Barro, R. J. (1996),“Determinants of Economic Growth: A Cross-Country Empirical Study.” Working Paper No. 5698,National Bureau of Economic Research foundthat most government spending does not increaseproductivity, and that increased governmentspending relative to the economy reducesinvestment and growth.

• Harvard Professor Alesina, A., along with Perotti,R. in “Fiscal Expansions and Adjustments in OECDCountries.” Economic Policy, n.21, 207-247 (1995)found, based on a cross-country analysis of OECDstudies, that reducing the share of public spendingin the economy would increase economic growthby increasing investment. Alesina A., Ardagna,S., Perotti, R., and Schiantarelli, F. (2002), “FiscalPolicy, Profits, and Investment,” American EconomicReview, Vol. 92, no. 3, June 2002, 571-589 argue thatgovernment spending cuts are the most stimulativepolicy for economic growth in a recession.

Whilst there is not time here to examine every burst of Keynesian intervention and we are sure that advocates would be able to cite notable successes, it strikes us that the evidence in favour is far from conclusive. During the 2008 crash Lawrence Kudlow noted “At the G-20 meeting in Washington….all one heard was ‘fiscal stimulus’…. It won’t work. It never has. Hundreds of studies over the past 25 years show clearly that countries whose governments spend more grow less.16”

13 Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries Francesco Giavazzi, Marco Pagano NBER Working Paper No. 3372, issued in May 1990

14 The Spectator 1 Oct 2016

15 When asked in Commons whether there were any economists who agreed with her economic policy, Mrs Thatcher said ‘Yes Patrick Minford and Alan Waters’. A civil servant later said it was a good job they didn’t ask her for three! 16 Lawrence Kudlow Washington Times 1 Dec 2008


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What factors might explain the limited success of government funded infrastructure spend?

Charles Gave wrote recently ‘Just as attempts to stimulate the economy by maintaining abnormally low interest rates have always failed, so too has every attempt in modern history to procure growth through increased government spending. And the economic system can hardly support another massive policy failure’17. There are nine reasons below which we feel may explain the limted success of infrastructure spending.

1. Infrastructure spend merely redistributes wealtharound the economy and government is not awealth-generating entity

Perhaps the most obvious reason that infrastructure spend does not boost the economy is that it merely redistributes wealth from one part of the economy to another. As Patrick Trombly at The Mises Institute says: ‘There is no such thing as the Infrastructure Fairy that takes government spending and magically turns it in to economic growth. The money to be spent on infrastructure would have to be borrowed, taxed or printed out of the non-government economy’18. In economics parlance, this is referred to as ‘crowding out,’ i.e. the public sector taking resources away from the private sector which inhibits the latter’s ability to invest. This reminds me of the broken window fallacy outlined in ‘That Which is Seen and That Which is not Seen’ by Frederic Bastiat19. What the voters see is a shiny new high speed railway line, what they don’t see is the spending cuts or tax increases needed to pay for it. But the point is that you are merely robbing Peter to pay Paul and redistributing money around the economy rather than growing the overall economy (see below for discussion of the ‘multiplier effect’).

2. Itisdifficulttojusttargetidleresourcesandhence misallocation can result

I think some economists still have a romantic notion of Keynesian stimulus taking men off the lines for the soup kitchens and putting them to work on building the Empire State Building. Franklin Delano Roosevelt’s Civil Works Administration, the Public Works Administration, and the Works Progress Administration hired huge numbers of the unemployed and built infrastructure projects across the country. Roosevelt’s friendship with New York City mayor Fiorello LaGuardia helped ensure that New York’s infrastructure got a particularly impressive upgrade. The Lincoln Tunnel, LaGuardia Airport, and the Triborough Bridge – all were Public Works Administration projects.

However as Harvard economics professor Edward Glaeser points out: ‘one should be wary of drawing infrastructure-related lessons from the 1930s for the twenty-first century20’. In the 1930s the US had real infrastructure needs and therefore it was unlikely resources would be put to use on wasteful projects. Today some areas are in long term decline, e.g. Detroit’s infrastructure was built for 1.85 million people but the population is now half of that. Secondly, in the 1930s, unskilled labourers could be taken off the unemployment line and put to projects such as building roads. Nowadays these are highly skilled jobs and in which resources will merely be diverted from other areas, sometimes from foreign firms. Finally, in the 1930s projects went ahead immediately whereas today they frequently take years to even get through the planning process.

In the 1930s, therefore, with unemployment running at 25%21 it was possible to make the case for a massive public works programs since there was clearly a great deal of slack in the economy. Today, with unemployment under 5%22, the case is much less clear and the risk is that the policy creates inflation.

20 ‘If you build it’ by Edward Glaeser in City Journal Summer 2016

21 Great Myths of the Great Depression by Lawrence W Reed 1981

22 US Bureau of Economic Analysis November 2016

17 Evergreen Virtual Advisor 28th October 2016

18 Infrastructure Spending does not grow the economy Patrick Trombly 14th September 2016

19 Selected Essays on Political Economy by Frederic Bastiat 1848


3. It is a cumbersome tool to use for demand sidemanagement

As we know by now, forecasting economic cycles is very difficult and hence using infrastructure projects to stabilise a downturn is very inefficient due to their long lead times and because of government-imposed constraints such as planning laws and meeting environmental standards. Economists tend to throw out the term ‘shovel ready projects’ but the reality is very few projects are shovel ready. Tax cuts have been shown to have much quicker impacts on the economy than long term infrastructure spending. Christina Romer, the head of The Council of Economic Advsors under Obama, studied tax cuts from 1947 to 2005 and found that a tax cut of 1% of gross domestic product stimulated three times as much GDP growth but only if the tax cut was permanent23. This is important because if tax cuts are more effective than infrastructure spending then the case for the latter falls apart. Secondly, it demonstrates that fiscal stimulus will have a temporary effect on boosting aggregate demand but once it is withdrawn, demand falls back to previous levels whilst the debt associated with it remains.

4. Oncestarteditisdifficulttoshutoff

Keynes had said that you should run a surplus during the good times so that you could fund a deficit during the bad times in order to boost aggregate demand. Politicians seem willing to embrace the latter piece of advice but struggle with the first part as cutting back spending is politically unpopular so they end up running permanent deficits.

“Should the disposition of government to spend become heated by an opinion that it is right to spend, and should this be farther inflamed by (popular support), no bounds would then be set … such a delusion … (would produce) the most baneful consequences.” James Mill, father of John Stuart Mill24

5. The Keynesian multiplier was fundamentallyflawed

One of the concepts that Keynes was most famous for is the multiplier effect i.e. the concept that money spent by the government would then be spent by recipients of it and that this would cascade through the economy, multiplying its effect. There were several issues with this theory; first and foremost, there seems to be no evidence of its existence. For open economies with floating exchange rates and high public debt levels, there is not much evidence that discretionary stimulus has very big effects on GDP25. Even economists Paul Samuelson and William Nordhaus, Keynesian authors of the bestselling textbook26, admitted that “no proof has yet been presented that the (Keynesian) multiplier will be greater than 1.”

6. The private sector is likely to allocate capitalbetter than a committee of central planners

John Maynard Keynes was known for having a fierce intellect but an enormous ego. While a student at Cambridge University, Keynes belonged to an exclusive and secretive group called the Apostles. This membership fed his egotism and his contempt for others. He wrote in a private letter: “Is it monomania – this colossal moral superiority that we feel? I get the feeling that most of the rest [of the world outside the Apostles] never see anything at all – too stupid or too wicked.”27

Given his heightened sense of his own ability and his scorn for the general public, it is no wonder that he thought people like himself could plan and run an economy better than the wisdom of businessmen guided by the free market. Subsequent performance of centrally planned economies has cast doubt on Keynes’ view but early on one of the most devastating critiques of his views came from the great economic journalist, Henry Hazlitt. In his 1959 book, The Failure of the “New Economics”, Hazlitt poured scorn on Keynes’ anti-business sentiment and fantasy that government investment was equivalent to that by the private sector.

23 The Macroeconomic effect of tax changes Romer and Romer July 2007?

24 Selected Economic Writings First Published 1966

25 Ilzetzki, E., Mendoza, E and Vegh, C. (2010) How Big (Small) are Fiscal Multipliers? NBER Working Paper No 16479

26 ‘Economics’ by Samuelson and Nordhaus 1989

27 Keynes the Man by Murray Rothbard 2010


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“So there you have it,” wrote Hazlitt. “The people who have earned money are too shortsighted, hysterical, rapacious and idiotic to be trusted to invest it themselves. The money must be seized from them by politicians, who will invest it with almost perfect foresight and complete disinterestedness (as illustrated, for example, by the economic planners of Soviet Russia). For people who are risking their own money will of course risk it foolishly and recklessly, whereas politicians and bureaucrats who are risking other people’s money will do so only with the greatest care and after long and profound study. Naturally the businessmen who have earned money have shown that they have no foresight; but the politicians who haven’t earned the money will exhibit almost perfect foresight. The businessmen who are seeking to make cheaper and better than their competitors the goods that consumers wish, and whose success depends upon the degree to which they satisfy consumers, will of course have no concern for ‘the general social advantage’; but the politicians who keep themselves in power by conciliating pressure groups will of course have only concern for ‘the general social advantage.’ ” 28

Adam Smith had already suggested that anyone who thought that he was so brilliant that he could run an economy was someone not to be trusted:

“The statesman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.”The Wealth Of Nations, Adam Smith, Book IV, Chapter II, p. 456, para. 10.

The reality is that the economy is a complex adaptive system which is far too complicated to be run by a central committee and is better left to the interactions of millions of individuals and businesses taking their cue from price signals of a free market.

7. Government is already too big and biggovernment slows economic growth

In an excellent report from the Institute of Economic Affairs,29 the authors point out that the state has become a larger part of the economy in most developed countries in the last 100 years. For instance, in the UK, the state spent just one eighth of national income at the start of World War 1 but now spends nearly half. In general terms they conclude that transfer of resources from the private to public sector has a negative impact on growth in particular where the increase in government spending is attributable to greater transfer payments.

This same point is made in a recent note from the strategy firm Gavekal who actually demonstrate how growth in the UK has been impacted by the changes in government’s share of the economy. What Figure 2 shows is that growth slows as the private sector becomes a smaller share of the economy, and they are able to demonstrate the same effect in other countries such as France.

29 ‘Taxation, Government Spending and Economic Growth’ October 2016 Various contributors28 1959 book mentioned in the above paragraph


8. If the problem is too much debt, adding moredebt is not the solution

Starting with the US, federal government debt will be slightly north of $20 trillion before Obama leaves office, which compares with $10 trillion when he became president. Of this $1.3bn came in the last year despite the fact that the official budget deficit was ‘only’ $600 billion. When adding the local and state debt to that figure it means debt to GDP is 121%.30

David Stockman, who as Reagan’s Budget Director should be in a good position to comment, has also highlighted how perilous the US government finances are.

“In short, baseline Federal outlays before one dime of the vaunted Trump ‘stimulus’ is enacted will come to about $4.2 trillion in the FY2018 budget being inherited by the disrupter and his team. … the new borrowing requirement well more than $1 trillion. … Here’s the thing. We do not think there is a snowballs chance that a $500 billion or even a $200 billion annualised Trump stimulus bill – on top of a baseline deficit already pushing the $1 trillion mark – can clear the Republican controlled House. And most especially not the 40-50

member Freedom Caucus which actually does believe that the nations $20 trillion public debt is already a clear and present danger.” 31

That debt appears to be slowing the economy. In the Q1 of 2016, US nominal GDP grew by $65 billion whilst total credit expanded by $645billion to $64.1 trillion. To put it another way, it is now taking $10 of addional debt to produce $1 of additional GDP.32 This means Debt to GDP ratios will continue to increase (see Figure 3).

Meanwhile in the UK, Philip Hammond has admitted to the largest deterioration in British public finances since 2011 in the Autumn Statement with forecast government finances expected to be £122bn worse off in the period until 2021 than the forecast in March’s Budget. Debt will rise from 84.2% of GDP last year to 87.3% this year, peaking at 90.2% in 2017-18. The Office for Budget Responsibility (OBR) forecasts borrowing of £68.2bn this year, then £59bn in 2017-18, £46.5bn in 2018-19, £21.9bn in 2019-20 and £20.7bn in 2020-21.33 It seems fair to say that the UK has very little scope for pump priming via infrastructure spend that so many mainstream economists have been calling for.

30 The Trumpflation Scam and the Fiscal Bloodbath Ahead by David Stockman 17th November 2016

31 The Trumpflation Scam and The Fiscal Bloodbath Ahead 17th November 2016

32 Zero Hedge 9th June 2016

33 2016 UK Government Autumn Statement

FIGURE 2: WHEN THE UK GOVERNMENT HAS GROWN, GROWTH HAS FALLEN

Source: Gavekal Data, Macrobond, 1970 - 2015

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9.Governmentinfrastructureprojectsareoftenpoorly executed and implemented for the wrong reasons

In a book entitled ‘They Meant Well’ by D.R. Myddelton34, the author examined major government project failures, including nuclear power, Concorde, The Channel Tunnel and The Millenium Dome. He shows that failure results from mismanagement, lack of clear lines of responsibility and lack of accountability. These problems have their roots in the wider economic problems of undertaking quasi-commercial ventures in the public, rather than in the private, sector. This results in well-meaning politicians and government officials wasting huge sums of taxpayers’ money. Chancellor Philip Hammond has been urged to increase infrastructure spend but the current crop of projects do not bode well. The recent announcement that the projected cost of Crossrail 2 has risen to £27 billion should be cause for deep concern within the Treasury. Added to High Speed 2 and High Speed 3, this means the total budget of just three planned or proposed rail schemes could be close to £100 billion – or perhaps even higher. One might also look at

the decision to go ahead with Hinkley Point where estimated build cost has risen from £6bn to £18bn and the electricity will be supplied at prices considerably above expected wholesale prices.35

Politicians and senior government officials have very poor incentives to invest efficiently. Instead, they are likely to allocate resources in order to boost their own positions. Politicians may seek to satisfy special interest groups and increase their chances of re-election; senior officials may seek to enhance their power and status by consolidating their department’s influence over policy. In the US, one such example was The Gravina Island Bridge, commonly referred to as the “Bridge to Nowhere”, which was a proposed bridge to replace the ferry that currently connects the town of Ketchikan, Alaska, United States, with Gravina Island, an island that contains the Ketchikan International Airport as well as 50 residents. The bridge was projected to cost $398 million. Members of the Alaskan congressional delegation, particularly Representative Don Young and Senator Ted Stevens, were the bridge’s biggest advocates in Congress, and helped push for federal funding.

35 The Debt Dangers of Britain’s Infrastructure Craze IEA 16 December 201434 Date 2007

FIGURE 3: TOTAL DEBT AND LOANS VS. US GDP ($TRN)

Source: Flow of Funds Report, Zero Hedge, 1961 - 2014

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The project encountered fierce opposition outside Alaska as a symbol of pork barrel spending and is labelled as one of the more prominent “bridges to nowhere”. In addition, ideological considerations – such as a focus on ‘fairness’ or the environment – may trump economics when it comes to investment decisions. For instance, in the UK, many strategic road schemes with benefit to cost ratios above three were cancelled in the 2010 Comprehensive Spending Review but then politicians have pressed on with HS2 where the ratio is less than one.

A recent report by the IEA36 concluded as follows:

“There is little evidence that fiscal stimulus works for countries with the UK’s characteristics and no evidence that the UK is currently in need of a discretionary economic stimulus. Even if it were, playing around with infrastructure investment spending is likely to be a clunky way to manage demand. In principle, good state-led infrastructure investment could enhance the productive potential of the economy, and would be justified in areas where the market failed to provide or where the marginal return was higher to state activity than could be achieved were the resources invested in the private sector. This is a high hurdle, however, particularly when one reviews the examples of types of projects chosen in the UK. In fact, there are many reasons to expect the political process to be worse than markets at delivering infrastructure, which perhaps explains why the link between state investment levels and growth is so mixed. In fact, in the UK it is often the state that prevents significant private sector investment in power stations, airports and roads.”

Conclusion

Investors appear to have embraced ‘Trump but without the bad stuff’ and are already pricing in the liklihood that he will follow through on his promises of tax cuts and infrastructure spend, that he will be able to pass them through both houses, that it will then be

implemented in a reasonably short time frame and that it will be effective in stimulating growth. Maybe these assumptions are correct and as three separate investment banks titled their reports last week, we have reached a ‘Turning Point’. History would seem to suggest, however, that these things are not a foregone conclusion and we would suggest caution in chasing cyclical stocks higher.

We would also counsel caution to politicians seeking to stimulate the economy by increasing the governments share of GDP and adding yet more debt to what is already a very precarious situation. The argument that ‘it has never been cheaper to borrow, so go out and borrow’ is often put forward by advocates of infrastructure spending but ignores the threats of such a policy. If deflation reappears, then loading up the economy with debt wont seem so sensible (see Japan). Conversely, if the bond vigilantes ever reawaken and become wary of financing ever increasing government debt burdens then the cost of financing could increase substantially. At the very least, the argument that gearing up economies makes them more fragile is hard to avoid and opens up the possibility of a very large policy mistake which will be harder to rectify next time we have a crisis. For the moment, the stock market can see only upside to massive debt funded infrastructure programs; hopefully this note has spelled out some of the risks involved with such policies.

“What is crumbling politically is the case for deficit spending. At the end of the day, that’s what the infrastructure brouhaha is all about. It’s just another variation of the misbegotten Keynesian notion that the state can command economic growth via borrowing or printing money in order to fuel aggregate demand … In short, the infrastructure bleaters have it exactly upside-down. The economic crisis confronting the nation is owing to the state getting way too big, not because public spending on infrastructure or anything else has been shortchanged.” 37

36 Infrastructure spending and Economic Growth: A briefing by Ryan Bourne37 Stop Bleating About Crumbling Infrastructure by David Stockman

May 18 2015

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The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party. RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer. The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates. Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient. AIFMD and Distribution in the European Economic Area (“EEA”)The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it and by RWC Focus Asset Management Limited (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor). Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in SwitzerlandThe representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50, P.O Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.

CONTACT US

Please contact us if you have any questions or would like to discuss any of our strategies.E [email protected] | W www.rwcpartners.com

Unless expressed otherwise, all opinions within this document are those of the RWC Equity Income investment team.

RWC London60 Petty France London SW1H 9EU T +4420 7227 6000

RWC Miami2640 South Bayshore Drive Suite 201 Miami Florida. 33133 T +1 305 602 9501

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