Hamish McRae: Prepare for a period of sullen calm

I find it troubling that people think it better to have a smaller financial industry

Warren Buffett, the legendary US investor famed for his folksy homilies and his eye of the cobra, is back in the spotlight, thanks to his BBC interview this week.

The BBC billed him as "the world's greatest money maker", which seems reasonable enough, even if he has slipped from number one to number two in the wealth league table behind Bill Gates. In the States he certainly has star status. Over here he has perhaps a lower public profile than that other legendary investor, George Soros, the man who bet against sterling in 1992.

They have made their money from very different investment strategies, with Buffett focusing on long-term investment in growing companies and Soros in spotting market anomalies and exploiting them – and thereby hangs a mighty message for the whole investment community. What will lead to growth in the future? The answer has to be long-term principled investment in successful companies.

Consider where the world is now in the economic cycle. The worst of the financial crisis is past. That does not mean that there will be no unpleasant surprises in the months ahead. There will. I can see one coming when the present "quantitative easing" and other special measures come to an end. But we are not going into financial meltdown and the focus therefore shifts to what is going on in the real economy. There, some sort of turning point may have been reached but the recovery is far from secure. Even when growth has resumed it will be held back by the need to get public finances back under control.

If you want to catch a feeling for what the next few years will feel like it is hard to beat the description of the great classical economist Alfred Marshall of the world after a financial crisis. "The commercial storm leaves its path strewn with ruin," he wrote in 1879. "When it is over there is calm, but a dull, heavy calm."

The Economist magazine dug out this quote and commented that the world was facing neither a 1930s-style depression nor a decade of stagnation such as Japan experienced in the 1990s, but something more akin to Continental Europe in the 1980s, with slow growth and high unemployment.

That feels right to me. The reasons why the 1980s were so sombre on much of the Continent was the combination of the high interest rates needed to chip away at the inflation left by the 1970s, and the structural rigidities of the labour and product markets. Looking ahead the whole developed world will need to chip away at the budget deficits left over from this crisis and will have to live with inevitably risk-averse financial markets. It will be a dull and heavy period as demand is suppressed and debts are paid off.

So what can be done? Well I think we have to accept that people will continue to be angry. Right now people are angry with politicians and bankers. Clever politicians are seeking to exploit the anger at bankers and hence deflect it from themselves, hence George Osborne's attack on bankers' bonuses.

There will be a lot more of this in the months ahead. But if you find that prospect depressing, as I do, it is worth turning instead to the principles of investment as set out by Warren Buffett. We have had a period where the market manipulation approach to investment has dominated and we need one where long-term support for good companies comes to the fore.

Ultimately our wealth will be delivered by the private sector. Companies and their employees will pay the tax to underpin the services that government provides. Now whether those companies make cars or run trains – or turn people's savings into mortgages – is a secondary issue. They need capital to invest and it is the task of the financial markets, functioning properly, to provide them with that capital.

The financial markets, not the banks? Well, both of course, but we are in a period where the ability of banks to lend money will inevitably be constrained. There will, quite properly, be new regulations on them and they will have set aside more capital against their lending. In any case a lot of companies either don't want to borrow from banks or fail to meet their prudential standards.

Banks in the US and UK, though not so much in Germany or Japan, have traditionally supplied only short-term and medium-term funds for the commercial sector. Longer-term investment funds came from long-term investors, of which Warren Buffett is currently the best example. If we are going back to a more traditional allocation of financial functions – and that is what the regulators seem likely to demand – then we will need more traditional investors. That is already happening, as companies queue up to issue corporate bonds and raise new equity capital.

What can we learn from him? There are lots of Buffett quotations and here are two of my favourites: "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." And: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." But behind the quips lie a fundamental principle, which is that the point of investment is to provide capital for good companies. If the company is providing a service or producing goods that people want, eventually an investor in that company will make money out of it.

Eventually? Warren Buffett is 79 and his long-term business partner Charlie Munger is 85, so maybe it helps to be able to take a long view – it also says something about compulsory retirement ages and the youth culture of financial markets. But during this period of economic recovery it is absolutely vital for the financial services industry to demonstrate to the world that it is able and prepared to take a long view. It is in the self-interest of the industry to rehabilitate itself in the eyes of the wider community but it is also in the self-interest of the rest of us to have fully-functioning financial services.

I find it troubling that people who should know better seem to assume that it will be a benefit to society to have a smaller financial services industry. We need a more effective and secure industry and we probably need to shift the balance between banks and securities markets. But the world economy needs finance to sustain its recovery and that in turn needs investors who can look to the long term.

h.mcrae@independent.co.uk