DABERIAM LVII

September 2010

Now that the Summer and the silly season are drawing to a close, the gloom merchants may start to get some competition. While there has not been any startlingly good news in the last month or so, the promulgators of misery have largely had it their own way. The financial gloom has also been fed by the enjoyment of politicians and the media in holding the banking industry as a whole up for ridicule. Added to this has been the evident glee and righteous indignation of the US President’s endeavour to publically humiliate BP. An American oil man pointed out to me some months ago that BP was the predominant company which brought America oil from the hostile environment of Alaska and is the leading company at the cutting edge of deep sea oil drilling. While BP may have made mistakes, it has to be remembered that deep sea oil drilling is as complex and dangerous as space shuttles - sadly these too can blow up!

The doom scenario has precipitated a ‘flight to safety’ by investors. This flight to safety, which looks more like a stampede, seems to be akin to joining a migration of lemmings. The rising value of bonds is inverse to the decline in interest rates, a phenomenon of the last 20 years. The more recent decline in interest rates has been due to central bank policy, both Greenspan and Bernanke flooded the markets with cash to deal with the present and previous crises and as part of a political push to encourage home ownership. But the trend line of lower interest rates and rising bond values cannot be extrapolated beyond zero. On a purely technical basis it is highly unlikely that bonds can rise in value much further. Purchasers of bonds are also assuming near zero inflation and are therefore happy with a yield of 2-3%. The inflationary evidence to date hardly backs this benign assumption. While central banks may be keen to show that they can help the economy they are also keen to be favourites with their political masters who do not have a great desire to curtail government profligacy and would like to postpone the political backlash from rising interest rates that excessive government expenditure will precipitate. At some point the ‘flight to safety’ will end at the proverbial cliff-top that has made the lemmings so famous.

While stocks and shares that represent productive enterprise have been very volatile in the last 2-3 years they look like a much safer bet than government debt in the longer term.

Looking through the fog of gloom, most businesses have stabilised and a great many are prospering. There are, however, a number of companies that are in a so called zombie state, ie they survive but will inevitably collapse either when their sales pick up, because they will not have the funds available to finance the increase of work in progress or because at some point their bankers and backers will get fed up and just pull the rug. This group of businesses will probably provide some horror stories at the end of the current year and early next year. For the rest there is evident growth in much industry across Germany and Northern Europe to America with the main drive coming from Asia. Companies are naturally nervous as the political climate in the West is creating continuing uncertainty in general and for obvious reasons among businesses that rely on government expenditure. This nervousness is naturally greater in countries where the government represents 50% or more of GDP.

The overall GDP growth in the over borrowed West cannot improve greatly until the huge borrowing, both private and governmental, is reduced. This will cause a bifurcation in Western Economics as it is likely that sectors that grow and are successful will not be able to absorb the large numbers of people that will be left behind and unemployed, particularly those from the public sector.

Unemployment is likely to continue to be a major social problem for the foreseeable future, particularly in Europe as governments continue to increase the employment tax that businesses have to pay.

It may be optimistic to think that the Autumn will see an enormous increase in economic growth, however betting on disaster and catastrophe looks to me like a no-win bet. While the future may be difficult for a lot of people one can be, in general, much more optimistic than a year ago.

Damon de Laszlo

September 2010