DABERIAM LXIV

September 2011

Everywhere you look gloom is in fashion. The glass is half-empty in the West. While none of the problems are insurmountable, comparisons are being made with 2008, but there is very little relevance in this comparison. The present situation can be summed up as follows:

Europe has been in structural treaty problems for a number of years and so far the European constitution has made it difficult to address the core issues of the individual European governments’ financial deceit. France and Germany both broke the borrowing rules some years ago. At the other extreme, Greece was accepted into the Monetary Union even though it clearly did not comply with the rules from its published government accounts which subsequently were shown to be falsified with some possible connivance of Brussels. Today, it is generally accepted that Greece will have to default, however politically the leaders of France and Germany don’t want to be seen to accept reality in the fear that they may be blamed for the default and the potential damage to their own banking systems.

This dance has been gong on for nearly two years and is very unnerving, both to the public and to European business managers. The financial uncertainty created by the political paralysis causes long term business decisions to be put on hold and also encourages excessive private saving.

The crisis in the banking sector caused by the failure of banks to mark-to-market their holdings of Europe’s sovereign debt will be resolved in the fairly near term, hopefully by the political leaders, failing that by a disorderly default and a full blown banking crisis. The separate problem facing Europe is the fixed exchange rate that means the Mediterranean countries have become very uncompetitive compared to their northern neighbours and they cannot devalue. Relative inflation, pay freezes and massive loss of jobs is the only way to drive down their costs; a horrendously difficult political and socially painful process.

The black swan events of 2008 – the unknown unknowns which led to the freezing of the banking system around the world, and the subsequent freezing of world trade bears little resemblance to what one can only describe as the white swans, or known unknowns in the European system.

By contrast the USA’s problems are much more recent and created by the paralysis in Congress during the July and August budget debates. As I mentioned last time, the childish and partisan debates in Congress turned into a T.V. soap, broadcast across the Nation. This meant that the nascent recovery that was well under way stalled as business and the general public started to realise that their Government could actually shut itself down and default.

The economy stalled and the numbers are appearing in the statistics. They are, however, not nearly as bad as many of the predictions, but what has changed most is the mood and perception of forecasters. The predictions of the pundits have gone from underestimating the high growth, a phenomenon of the first half, to downgrading everything in the second half, which adds to the general feeling of nervousness and uncertainty. The numbers that are currently coming out only show a lowering of growth expectation, but it’s difficult to remember things are better than they were a year ago. The flames of uncertainly are being further fanned by huge volatility across all markets.

The vast amounts of cash that have been pumped into the system, added to the computer driven “high frequency trading” is causing unheard of volatility, further unnerving those that have to take serious decisions on investment.

It is ironic that the US President is focussing his ire on the European crisis, when his own back yard is in a state of self inflicted government economic chaos. Political ineptitude in the West is having a serious long term impact on the respect for democracy. The public distrust of politicians both in Europe and USA is causing enormous problems for the democratic system. This disenchantment and distrust is leading to people voting for wacky parties: in Germany we see the rise of the Pirate Party and in the USA the Tea Party. The members of these parties tend to be way outside the normal political spectrum and seem to be largely made up of people who have very little concept of the role or responsibility of Government.

The good news is the problems of the noughties (‘00s) fall into the category of white swans; Western business is gradually seeing its way through the problems of economic mismanagement and regulatory incompetence.

Gradually, the excessive debt built up in the system is being absorbed. Hopefully, the current political tensions will make the West’s politicians address their responsibilities- this is a big hope - and show some leadership. There is underneath this no reason why economic stability and slow and steady growth cannot continue. I suspect by the end of the year, and probably one or two more economic earthquakes, there will be a realisation that the system isn’t broken and the economies will stabilise. The longer term worry is the reputational damage that the West is suffering in the Middle and Far East. The governments of the rest of the world are showing , with some justification, more and more disdain, which will end in disrespect for western democracy and values.

Damon de Laszlo
September 2011