I gave the following remarks this morning in London to a meeting of British American Business an organization dedicated to supporting business and fostering cooperation between the US and the UK. As my remarks picked up some of the themes I’ve written about in other posts to this blog I include them in their entirety below.

BABI Breakfast Briefing

December 7 2010

I’d like to thank British American Business for hosting this breakfast and I’d like to thank all of you for coming out early to join us this morning.

I’ve been fortunate to be both a member of and to have worked with BABI over many years spanning the seven years I lived here in London and time in NY before and after. I do have to say that I’ve learned a lot about doing business in both great capitals both the similarities and some differences.

I’m actually sorry to see that the American business breakfast seems to be catching on here in London. I’m sorry to have infected the culture here. Business breakfasts always remind me of a true story from the time I worked as a lawyer in Paris when one of my clients told the story of a particularly overeager client from Texas who sought to organize a business breakfast with my friend.

When the good-natured and eager Texan suggested a 7:30am breakfast meeting to Jean-Claude he responded in mock seriousness “But why don’t you just join me in the shower at 6:30am. We could discuss business while you soaped my back?”

There are of course other more serious areas in which business practices are converging in the US and Europe. I wanted to talk about one such subject today. This is a topic I sometimes call “the death of domesticity” in the financial markets.

Now let me explain what I mean. In 2005 the average allocation of UK pension funds to domestic stocks was about two-thirds of their portfolio according to Mercer. Today that allocation stands at about 50%. Again according to the Mercer 2010 Asset Allocation Survey some 35% of European pension funds plan to reduce their exposure to domestic equities partly in favor of international stocks over the coming year.

While the serious recession in Europe explains some of this reallocation I think a deeper trend is at work. Again let me explain. There was a simpler time in the markets if you were an institutional investor in the 1970s and 1980s when your investments were made closer to home. Let’s say you were a pension plan you sought to match the inflation and interest rate exposure of your pension fund participants with investments in companies that were exposed to similar factors. Thus in a less global market at the time it made sense to invest the savings of UK pensioners in UK domestic companies traded on the London Stock Exchange. This original reasoning was quite economically sound.

However little by little over the years the connection between the forces acting upon the assets and liabilities sides of the balance sheet began to diverge so that companies that were formerly UK domestic businesses actually became very global enterprises that just happened to be headquartered and listed in the UK. I ran one such firm which was Reuters. But the truth even at Reuters pre-acquisition was that only 15% of our revenues came from customers in the UK. Notwithstanding this fact we were deemed a domestic investment and pension funds and other institutional investors whose mandates were limited to domestic investments could easily hold our shares if they so chose.

The UK has always been a very open and forward-looking financial market. One of the great attractions of being headquartered and listed in London is the regime of principles-based regulation practiced in the City of London and companies from all over the world seek to be listed here for that reason. At times especially during turbulent periods like these that openness is questioned. So for example when the Borealis Infrastructure Management Company from Canada recently bought up a large piece of UK infrastructure the Channel Tunnel Rail Link eyebrows were raised. This of course is nothing new as major parts of the UK banking infrastructure were bought over the last couple of decades by international banks. It was argued at the time that this so-called “Wimbledon effect” worked well enough in rising markets but as soon as markets went in the other direction continental and international banks would pull back to their home bases and fire their London staffs thereby decimating the UK economy.

Well in fact it’s hard to imagine a worse shock than the financial crisis of 2008 and I suppose you could say that the bankruptcy of Lehman Brothers did cause them to pull back from their London headquarters across the plaza from Thomson Reuters in Canary Wharf but I don’t think that’s exactly what people had in mind by the “Wimbledon effect”. The way it has worked out is that London has remained a vibrant center of international finance. However London investors just as investors all over the world are seeking better returns by investing in the most international of companies. Whether you’re a hedge fund manager in London or a mutual fund manager in New York it’s difficult to explain why you’re not invested in Asian equities if this is an asset class that is expected to outperform over the next 10 years.

Unfortunately many political leaders are resorting to protectionist policies in the light of the shrinking pie represented by their domestic economies. While this has a certain jingoistic appeal in the long run this is the surest way in which we will lower living standards for all. Finance and the internet show us the direction toward a more interconnected borderless world. Yet nation-states do still matter and many are engaged in a dangerous game of international brinkmanship.

Take for example the recent controversy over the US Federal Reserve’s announcement of its second round of quantitative easing nicknamed amusingly QE2. Chairman Bernanke as well as President Obama have said QE2 is not a deliberate effort to weaken the dollar and strengthen US exports. However numerous finance officials around the world have taken an opposite view. In fact Brazil’s finance minister Guido Montegna was quoted to have said that “we are in the midst of an international currency war unleashed by these actions”.

Unhelpfully the US and South Korea recently failed to come to an agreement on new a free trade pact and last month’s G20 summit in South Korea also failed to produce any consensus among the world’s leading economies on how to encourage global economic growth.

This is no time for parochialism. What we need instead is a system of international cooperation that makes the pie larger for everyone. So for example the China versus the rest of world tug of war on currency values is instructive. A lot of jawboning emanates from US officials seeking to pressure China to allow the Renminbi to float more freely and presumably appreciate to its full trade-weighted value against the dollar and other currencies. Much of this talk goes on for purely domestic political consumption since it is unlikely that the Chinese will actually bow to such pressures. In fact I’ve heard it said in China that the Chinese government will allow the Renminbi to float exactly one year after the US stops demanding that the Renminbi appreciate.

Regardless of your political analysis from an economic perspective it is far from clear that solely allowing the Renminbi to appreciate will solve the US export-import imbalance. This is because goods and services from other nations will likely take the place of the currently lower cost Chinese items. What is more important is that China actually develop a larger domestic consumption market and this will not occur until the social safety net in China is more developed. In the end it is not unreasonable for a people to be great savers if they have relative uncertainty concerning who will pay for their retirements in a one-child per family environment and who will pay for healthcare in a system in which there is not widespread health insurance. Once these large social issues are settled there is no reason to believe that Chinese consumption will not pick up and China will not add to global demand in much the same way they are now adding to global supply.

So the moral of my story is that the solution lies in more openness more free trade and more interconnectedness and not in the zero-sum game of cloistered domestic markets.

And this I should note with a nod to our hosts is a position that British American Business has consistently advocated between the US and the UK.

Thank you.