DABERIAM LXV

November 2011

Since September, when I last tried to string together some logical thoughts, nothing much has really changed. The fashion for gloom is still prevalent, even though news from around the world is relatively good and would be a lot better but for Europe.

The European structural treaty problems will make it extraordinarily difficult to resolve the crisis. We do, however, have the appointment of two technocrats in Italy and Greece; their appointment may help the discussions taken and lead to the agreements that need to be put in place to resolve the underlying banking crisis. The banking system in Europe is gradually unravelling as the various national banks discover prudence and how unwise it is to hold sovereign debt on their balance sheets, in spite of its preferential treatment as an asset class by the European regulators.

Apart from the sovereign debt problem of the Club Med countries, the tightening of the European Bank’s reserve requirements is enormously reducing the liquidity available in Europe. This regulatorily induced credit squeeze is compounding the economic downturn and causing the corporate sector, as well as the private sector, to lose their economic nerve and cut expenditure.

The good news, in spite of the economic disruption being created in Europe, is that the rest of the world is getting along pretty well. In China, the inflation rate is declining and the economy is growing comfortably in the 10% range with retail sales up some 17% y/y. The current 5-Year Plan seems to be working as exports are rising at a much slower rate than imports, which is eating into the Chinese trade surplus. Chinese surpluses are more and more being used to make asset related investments, largely in raw materials. The Government is still trying to reduce property prices which have remained flat year on year. The deliberate upward movement of export prices by China, and the continuing slow rise of the Chinese currency against the dollar, is building up inflationary pressures in the west.

One of the more extraordinary events of the last month or so was the suggestion that China might help bale out European countries. A thought that is particularly bizarre bearing in mind Germany is finding it politically difficult to bale out its southern neighbour, when it is enormously wealthy both as a nation and as a population. The idea that China, where average incomes are a quarter or even lower than in Greece, might bale out such relatively wealthy people is politically absurd.

While the USA’s budget problems have faded from the news, they are likely to be back with a vengeance at the end of November. It seems unlikely that the special Congressional Committee charged with finding proposals for balancing the US budget will come up with deliverable solutions. In spite of this, most US economic indicators are ticking upwards; bank loans are increasing, company earnings indications are up, even retail sales have ticked up along with house-building, trucking and airlines. There has also been a small reduction in unemployment claims, although this is an area that is unlikely to improve much in the near future as Government nationally and state-wide continues to lay people off.

The USA will have to grow a lot more to see a real pick-up in employment as there is some industrial capacity and the potential for a considerable increase in output which will require only a minor labour input, owing to an enormous increase in the application of new technology in manufacturing.

The US stock market is in a strong position, earnings keep growing, the corporate sector is buying back its own stock as it is nervous of making major capital investments. The private sector, as well as the institutional sector, is holding enormous amounts of cash and bonds, giving a negative return after inflation and is grossly underweight in equities. A situation which could be described as a negative bubble in equities, if such a thing were possible. Quite a small movement back into equities will cause a dramatic rise in the market.

With China growing steadily, the rest of Asia is fine and will gradually benefit from rising Chinese wages. Latin America and Africa are in a happy economic position, as well as being on the receiving end of the Chinese investment in raw materials of all kinds.

If one is looking for crises , there are two that have not been well trailered. One is the disenchantment with democracy causing people to vote for wacky Parties – such as the Tea Party in the USA, the Pirate Party in Germany, the Best Party in Iceland, and Britain’s own Independence Party. The other is energy which probably presents the greatest worry in the near term. . Oil availability continues to tighten and the availability of electricity in both the US and Europe is turning into a potential crisis that will manifest in the next four to five years or so. On this front America is probably a lot better placed with its production of shale gas growing rapidly. Europe, on the other hand, with its economic distractions, is gaily shutting down generating capacity without any thought of how it is going to be replaced in a secure fashion.

The year end could be exciting, a Greek default? A dramatic rise in the US stock market? Europe definitely is in uncertain times but the ROW is not a bad place to be.

Damon de Laszlo
16 November 2011