DABERIAM LXVIII

April 2012

Looking back to the beginning of the year I have a vague feeling that we continue to live in the world of Alice in Wonderland. Perhaps since my thoughts in February, we have advanced into the world of Alice Through the Looking Glass!

Europe is at the centre of this world, the construction of the EU is generally acknowledged to be a bureaucratic entity and does not have the required political and economic integration that is needed for long term survival. Every instrument in Europe is being used to maintain a broken economic structure which is gradually unravelling. Politically the elections in Europe are likely to throw up rebellious minority parties as the general electorate is dissatisfied with the conventional parties of the centre-left and centre-right.

Massive unemployment across southern Europe, including large segments of France, is most likely to produce incoherent results which will add to the difficulty of trying to manage a coherent European economic policy. If one wants a nightmare scenario, think of Germany and Italy in the 1930s.

Britain’s election of just less than two years ago saw an expression of dislike for Labour, but no great liking for the Conservative Party, and the result is something of an incoherent government lacking much vision and drive along with an economic policy that seems to be able to produce the maximum amount of smoke but minimum amount of fire. Phrases such as “re-balancing the economy” followed by a budget that is beneficial to the banking and retail sector but penalises the re-building of the manufacturing sector, coupled at the other extreme with announcements about wanting a bigger charitable sector and then curtailing large donations to charity, give the impression of a lack of cohesion and intellectual rigour!

Underlying this a lot of announcements about massive cuts in government expenditure, has created an enormous political fire, but the actual cuts don’t really bite until the latter end of this Parliament, extraordinary political timing as they will hit at the moment elections will have to be held in two to three years time.
The Pacific Rim countries are all motoring along nicely with mostly stable governments and mostly enjoying growing prosperity. This also applies to a considerable extent to the South American continent. 

The US had a good first quarter but political jitters remain and as I have said before, the dysfunctional nature of Washington is hampering business investment. While the private sector is sensibly paying down its debts, the housing market has stabilised and the overhang of property is beginning to clear as a result of the considerable fall in house prices, the corporate sector which is relatively flush with cash, is holding off investment owing to the uncertainty created by the lack of clear fiscal policy. The impact of this uncertainty can best be seen in the gyrations of the stock market.

Apart from the political risks in the EU and the US, there is a real black swan lurking at the centre of the financial system. For a number of years “investment advisors” have been advising individuals and institutions to shift from equities to fixed interest. Since 2007, interest rates have declined producing a rise in the capital value of fixed interest instruments, creating better profits than those to be had in the equity markets and the appearance of safety. A reversal in the interest rate trend will cause a dramatic destruction of value for bond holders.

Asia, by and large, is progressing well and on a recent visit to Singapore and Thailand most of the industrial and commercial companies I met were moderately confident about the future. The worries expressed in the West about the new government coming in in China don’t seem to be shared by Asian businessmen. 

The banking crisis of Europe and the US affected the rest of the world but was not fundamental to their economies. One has to include in the term “banking crisis” the unspoken element of profligate and irresponsible government borrowing in the West which has not yet been dealt with. In recent history, irresponsible governments have had to default. IMF impositions on Asia and Latin America facilitated defaults which cleared the economic air. So far, Europe has pushed this can down the road. It’s difficult to see, however, how at some point several European countries can fail to default. The experiment of the partial Greek default has solved no problems, and this is the crisis that is still waiting to happen and may now be precipitated by chaotic political outcomes in the next spate of elections.

Not a happy prospect for the summer, but the good news is that Asia and the rest of the world is not in bad shape

Damon de Laszlo 
11 April 2012