Jeremy Warner's Outlook: Mr Micawber would be delighted by our trade deficit. Someone else now pays the bills

The private equity party is in full swing
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The Independent Online

"Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery". That, in any case, is the way it used, and perhaps still ought to be.

Yet the world as seen by Mr Micawber in Charles Dickens' David Copperfield has changed. Were he around today, he'd be astonished to discover that it is indeed possible to live well beyond your means and still prosper. Time was when an annual trade deficit of the size announced yesterday would have prompted a fully blown run on the pound.

The unexpected magnitude of the December deficit meant that the figures didn't go entirely unnoticed by forex markets, yet the reaction was still muted considering that Britain's deficit in goods and services last year was the highest on record in nominal terms.

At 4.3 per cent GDP, the trade imbalance is also at its highest level since the mid 1970s, when numbers like these actually did trigger currency crises. Relatively high overseas earnings ensure that the current account deficit, which includes investment income, isn't quite so bad. Yet it is still high by historic standards.

In times past, the currency would have adjusted in a manner which made imports more expensive and exports more competitive, thereby bringing trade back into balance. Today, the continued robust strength of the pound is part of the problem. With the currency at nearly $2 to the pound, exports have been suffering badly.

What prevents these adjustments from happening? The mirror image of the deficits being clocked up in the Anglo-Saxon world are the massive surpluses in trade and savings coming out of the Far East. The high oil price has supplemented these capital flows by generating still greater excess liquidity in the Middle East and other energy rich regions such as Russia.

With nowhere else to go, the money spills over into London property, New York apartments, US Treasury bills and US and UK corporate assets. Ironically, our much-criticised Anglo-Saxon markets are more trusted as a safe haven for international capital than any of the alternatives. In the process they pay for our spending on flat-screen televisions, overseas holidays and German motors.

Mr Micawber would be very happy in the brave new world we now inhabit. Something has indeed turned up. For Britain, it's called the City, and although the Casandras warn that it cannot possibly last, that one way or another our profligate ways will eventually catch up with us, there's little sign of it at the moment. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result happiness.

The private equity party is in full swing

What a week of fun and games we've had over the possibility of a private equity bid for J Sainsbury, most of it signifying very little. My favourite is the spectacle of Allan Leighton, chairman of Royal Mail and a former chief executive of Asda, announcing - through "friends", obviously - he was available for the chairmanship should the private equity bidders want to give him a call.

The fact that they apparently don't want to hire him doesn't seem to have curbed his enthusiasm for the job one bit. He's even got a solution to the problem of what to do with Sir Philip Hampton, the present occupant of the chairman's suite. He can have Mr Leighton's job at Royal Mail.

Only one slight problem with this apparently neat solution. Sir Philip would need his head examined to want to take on the chalice of the Post Office and would only remotely consider it if Royal Mail was being privatised. That's not going to happen this side of the election.

All this tittle tattle is great for the general gaiety of the nation, and for deflecting attention from the main picture, but it doesn't add much to the debate. The bottom line is this. A private equity takeover of J Sainsbury, though possibly quite good for shareholders - depending on the price - would be extraordinarily bad for the company and the consumer. Loading Sainsbury's up with debt and mortgaging off its property is the very last thing this company needs at such a delicate stage in its recovery.

Round at Tesco, Sir Terry Leahy must be wondering what he's done to deserve such luck. For the first time in years, Sainsbury's was beginning to look like a serious competitor again. Now there is every prospect that weighed down by debt and a crushing rentals bill, it will be giving up the chase altogether. The difference between these two companies is an instructive one which gives the lie to the idea that private equity can somehow improve Sainsbury's competitive position.

Tesco has achieved its success not by gearing up, running the place for cash and by repeatedly returning capital to investors - which is essentially what private equity does - but by constantly reinvesting its hard-won gains in the business. The property portfolio is deliberately kept largely freehold so as to save on rents.

The consequent surpluses are then ploughed back into lower prices and improved quality, driving a virtuous circle of growth. Tesco's success has enabled it largely to resist City pressure for bigger dividends and short-term capital repayments. I may be wrong, but it is hard to see how this textbook study in retail success could be repeated under a leveraged structure of ownership. Sainsbury's wouldn't die, but it would change into something else, and in the process Tesco would further strengthen its grip on the high street.

I wrote this week that there was no more than an evens chance of private equity converting intentions into reality with J Sainsbury by actually making a bid. That position has changed, with Texas Pacific throwing in its lot with the the original consortium of Blackstone, CVC and KKR.

The effect is to limit the chances of a self defeating auction, in which private equity bids up the price against itself. In itself this is a quite suspect state of affairs which if these were trade buyers would almost certainly be illegal. What would normally be regarded as anti-competitive collusion is instead presented by private equity as an entirely legitimate way of sharing out the risk. It also further swells the available pot for a Sainsbury bid, and thereby makes it more probable.

The growing tidal wave of private equity activity depends crucially on two related phenomena. The first is today's, almost incredibly, benign credit conditions, which make debt cheap and plentiful.

The second is the trend among big savings institutions - pension funds and life assurers - to diversify their investments away from the stables of traditional equities and bonds into alternative asset classes such as private equity and hedge funds that carry the promise of higher returns.

Yet the easy gains for private equity have in all probability already gone. As their coffers swell, the private equity houses are forced to chase progressively larger and higher-risk targets. For the savings institutions that provide the money it therefore looks more and more like a zero-sum game.

In many cases, they have become the seller and the buyers of the same assets. They receive and they pay the bid premium. When private equity makes its exit through refloating the assets on the stock market, they again find themselves in the same position as the seller and the buyer. In theory they will have had a much more efficient use of capital in between. But if the assets have essentially been stripped and deprived of growth potential in the process, you have to wonder who in the long term really gains.

Still, for the moment, private equity is an unstoppable bandwagon, and until some of the bigger deals get themselves into trouble, so it will remain. The party's got a way to run yet. Best not to think about the hangover until we are in the midst of it. It's the way of the world, I'm afraid.

j.warner@independent.co.uk

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