DABERIAM LXII

June 2011

Since April there have been few significant events compared with the first quarter. The earthquake in Japan and the tornadoes in the USA have had considerable economic impact. The Japanese disaster will continue to affect the major economies in the world for some time to come. Japan itself, in spite of optimistic noises, is unlikely to be able to grow its economy in the near future. The loss of electricity generating capacity has far greater long-term significance than is being accounted for. The effect of this loss of capacity on the economy should be a warning, which is not being heeded, to western governments of the relationship between electricity generation and economic growth. The lack of coherent government energy policy in the US, UK and Europe has very serious implications for western economies five to seven years from now. Germany is heading for a major economic slowdown if the Chancellor’s policy of closing its nuclear capacity is implemented. No amount of political hot air is going to turn wind energy into a reliable and constant source of industrial power.

It’s also worth noting that the Green band-wagon is doing increasing damage to economic growth by pushing up energy prices as well as food prices by promoting biofuels. The conversion of corn, sugar and palm oil into ethanol, apart from the subsidies required, is having a larger and larger impact on cereal and meat costs, not to mention the side effects of fertiliser run-off and deforestation in developing countries.

The increase in demand for oil is not sustainable and prices of this commodity will inexorably rise. In the normal course of economic development, rising prices encourage trade and industry to develop more resources or find alternatives. However, in the energy sector it is so tightly controlled and regulated by governments, the free market for innovation has little room to operate. The peculiar paralysis of western democracy to produce coherent policies, particularly in areas where scientific and engineering knowledge is required is worrying for our medium term future.

On a brighter side, the economies around the world are doing pretty much what was expected. The impact of the banking failure that almost stopped the global economy in its tracks in 2008/9 is wearing off. Industry and commerce is recovering steadily; the US in particular is showing signs of steady industrial growth and as American companies gain confidence and start to invest again in capital equipment, the economic growth could accelerate. While Washington is in a state of appalling political paralysis, the American political class seems to be determined to demonstrate a level of childish squabbling that would not be tolerated in a school playground, while industry gets on with its task in an extraordinarily efficient manner.

Europe, sadly also demonstrates a political inability to function efficiently and address the economic problems of their respective governments. The level of worry created by feckless political behaviour disguises the underlying performance of the economy. There are, however, areas where recovery will remain slow as the damage done by incompetent bank regulation and profligate Government expenditure will take time to repair. This includes: the building industry, encouraged by huge amounts of borrowing, which has to deal with excessive supplies of unwanted or unusable property; unemployment, particularly for the large number of people who have suffered from bad education, unlikely to decline in the near future - modern business needs literate and numerate staff even for the most mundane jobs; and inflation which will impact the living standards of the majority of people in the west for some time to come.

In the short term government deficits in the US and Europe are the greatest cause for concern. It is almost impossible for Greece to resolve its problems without removing a large percentage of its debt. If the German government and the ECB do not agree a plan for this, the Rating Agencies will further downgrade the debt. This will make it impossible for European banks to hold it under the rulings that pretend Sovereign Debt is secure and a de facto default will ensue, with economic consequences that will be difficult to control.
The US is in a similar position, if the government does not deal with the issue of raising the debt ceiling and controlling government expenditure a default with unanticipatable consequences will ensue. The political complacency with which these two very serious issues are being treated is extraordinary. We seem to have a large number of politicians who are far more concerned for their personal political postures than the interest of their countries. Economic and business literacy does not seem to be part of a modern politician’s education!

In the meantime it is important to note that the Chinese economy is slowing, as per Plan, and while they have serious inflationary problems, which will have a knock-on effect on the rest of the world, their economy remains sound. Whether in the long term the political system can satisfy the demands of a growing well educated and prosperous middle class is another question, but one that probably need not concern us for the next four or five years.

If there isn’t a political financial miscalculation in the next six months, then we can expect a general improvement in the world’s economy, at least for the time being.

Damon de Laszlo
June 2011