DABERIAM LVII

July 2010

Since May the world’s Central Banks and the respective governments seem to have split into two camps. The American government with the luxury of being the world’s reserve currency, is able to ignore for the time being both the national government deficit and the individual State deficits. There is, however, some rumbling that the individual States could go the way of Spain etc. They are required by law to balance their budgets and some States have indeed in the past gone bankrupt. One of the perverse effects of this worry is that individuals holding dollars end up buying US Treasury Stocks, keeping interest rates at historically low levels 

In Europe it has now become fashionable for governments to announce swingeing cuts to balance their books and reduce government deficits. It is yet to be seen how effective the policies will be, but the chorus of Union opposition grows louder by the day. There is also a fascinating argument that government expenditure cuts could precipitate a double-dip recession. 

The logical conclusion to this argument is that government should continue spending more than they can raise in taxes, borrowing the difference - I suppose keeping the economy apparently booming until the whole system collapses! This rather perverse argument goes along the lines that government expenditure which takes money out of the productive side of the economy and pays huge sums for “services” somehow is good. The argument is also strange as most observers and economists regard government expenditure, even on the important and vital requirements of infrastructure, health and education, as highly inefficient. 

As there is a very large number of people and businesses that depend on government payments, it is hardly surprising that the beneficiaries of government largesse are marshalling the arguments that go in their particular favour. The dilemma for governments today is that they have to correct the deficits caused by the spending binges of the last five years or so and inevitably this is painful. 

In looking for an analogy, while drinking wine in moderate quantities is possibly good for you and certainly pleasurable, a massive binge causes a hang-over which can take longer to recover from than the binge does. Of course, those marketing wine are not going to advocate a reduction in consumption. 

The complexity of the present situation and the difficulty of anticipating the direction of the global economy is exacerbated by the lack of cohesion in Western economic policy. China and Asia in the meantime, to a large extent, are led by, as I have often said, the highly sophisticated government in Beijing. China’s economic growth has been slightly dampened down and continues to be redirected towards internal growth and development rather than exports. The extraordinary drive to re-develop towns and China’s internal infrastructure is startling. The building boom to re-house the population is quite incredible, along with the road and rail networks that have been springing up in the last two or three years is an example of unparalleled 
development. 

It is more difficult than usual to map out the likely economic development of Western economies. One can only hope that government actions are consistent and relatively steady, not creating unnecessary uncertainty for those running the service and manufacturing industries that can grow and develop their companies and generate wealth. 

There is a worrying phenomenon, however, that is caused by the massive advance in technology over the last ten years. Computers are really impacting the productivity of the service and manufacturing sector, this trend requires a higher average level of skill than is being delivered by Western education, i.e., it is going to be very difficult to get back to the old accepted levels of employment. It is doubtless politically incorrect to point out that: a) bank clerks are being replaced by ATM machines; b) agricultural workers in the old sense are being replaced by highly sophisticated employees driving large, expensive and complex machines; c) the old production line “factory worker” is replaced by a complex computer controlled piece of equipment. While there is an economic tendency towards complex and sophisticated machinery to replace labour, there is also a push in this direction from governments in the West and particularly Europe 

The ever increasing tax on labour in the guises of National Insurance or Social Security etc. is really a tax on employment. When an individuals taxes are added together, with the various employer’s taxes, coupled with the employment legislation, it all adds up to a great discouragement to employment. 

There is a huge incentive to automate to make one skilled person highly productive, rather than deal with the cost and bureaucracy of employing less skilled people. If automation is not feasible, this taxation and bureaucracy provides the major incentive for sending manufacturing work to Asia. 

I am not hopeful that our government’s desire for money will, in the short term, be reduced sufficiently for taxation to be adjusted in favour of employment, so we can expect continuing high levels of “unemployment”, with the economic consequences that follow. 

In general, looking through the smoke of the present economic confusion, there is an underlying improvement in the productive sectors of both the European and the American economies which, while slow, will gradually improve general prosperity. A stock market recovery is very likely as it slowly dawns on investors that holding Government Debt is a dangerous safe haven. 

Hopefully, it will be some time before our governments embark again on unsustainable spending binges. 

Damon de Laszlo 
July 2010