DABERIAM LXXX

December 2013

It seems a long time since October when the US government decided to frighten the world’s financial systems by taking party political bickering to within a whisker of causing the government to default.  The pantomime passed and the curtain came down but the lasting impression left on thinking people in the rest of the world is that the US system of Government is dangerously dysfunctional.  The extraordinary discovery from Washington’s behaviour is that while the credibility of US politicians is nearing rock-bottom, the country as a whole can get on with life pretty well.  The political chaos is more and more ignored and the corporate sector is beginning, albeit slowly, to use its earnings to invest.  Corporate profits are likely to continue growing steadily and the pick-up in employment overall in the private sector is exceptionally good as it is absorbing the lay-offs in the public sector.  Consumer sales are developing steadily and housing is still improving, while the population continues to pay down debt.  The government sector expenditure is declining and tax revenues are improving, reducing the borrowing requirement to less alarming levels.

The next hurdle for the economy will be the reduction in the Federal Reserves’ purchasing of government debt - “Q.E.”.  A change of policy has to happen and will probably take place towards the end of the first quarter next year.  The Q.E. by the Fed has become a fascination for the stock markets and the anticipation of the change in policy has caused some fairly wild fluctuations.  The reality, when it happens, will probably be something of a non-event.  The level of worry and the forecasters of doom in the US are sufficiently strong to give me confidence that next year is going to surprise us on the up-side, particularly as the consumer and industry get the advantage of cheap energy form shale and fracking.

On the other side of the world, the new Chinese Premier, President Xi, and the leadership team have laid out their economic and political plans.  The reforms and the political manoeuvring by the President are “quietly” impressive and we will, I think, see dramatic changes in China over the next five years, but they will be made by incremental steps.  The most fundamental changes are designed to reinforce the Communist Party’s authority by rejuvenating support of the growing Middle Class and the young.  The leadership is having a major crackdown on corruption which is already apparent in the declining sales of expensive luxuries.  The sales of products, from champagne to handbags, have declined dramatically.  Administrative reforms will be put in place to reduce red-tape and allow market forces to determine prices and resource allocation.

Government, centrally and locally, will be reformed to define divisions of responsibility and the tax system will be overhauled to reflect this.  Probably the more far-reaching reform will be with regard to land rights and usage.  A lot of unrest in the last few years has been caused by local government depriving the rural community of the profits from transferring land from agricultural to industrial and residential use.  In future, the agricultural communities will be allowed to develop their land and local authorities will be restricted on how they can take it over.  The other deeply significant change will be addressing the problem of surplus capacity – mostly in primary industries.  This will create some head on clashes between Beijing and state and regional governments.

Over the next ten years these reforms will have a dramatic impact on China’s development and will, as they succeed, reduce the distortions that have built up in the economy over the last twenty years.  China is indeed becoming a world power and the West is going to have to adjust to accommodate this return to a bi-polar world, particularly as China is consolidating its influence in the Pacific from the North and down to Australia.  Japan and South Korea will have to work out how to deal with the “elephant in their room” as the US treads a more cautious course.

Europe has been quiet, one could say too quiet, for most of the year.  The Mediterranean countries are becoming more and more detached from the North and whilst Spain and Italy are adjusting, Greece is, as they say, on another planet.  A crisis rarely has a single cause.  It is usually the result of different fault lines meeting in a single moment.  The financial system in Europe is deeply flawed as banks have, by and large, greatly under-reserved for their non-performing debt, the private individual borrowing is still way too high and many companies are only able to service their debts because interest rates are so low.

Five years after the world’s financial crisis, the only change across most of Europe is that banks have been buying their own government debt and shrinking their activities to within their country boundaries.  The other phenomenon that is unlikely to help Europe is the round of elections in May 2014.  It is likely that the winners will be the fringe parties, who are mostly anti-Europe, as mentioned in my last report.  Here again it is difficult to predict how de-stabilising it will be to have large numbers of disaffected Euro MPs, many of whose pronounced policies are primarily anti-Europe.

The UK is hardly a bright spot, but the economy is looking better; the government has at least curtailed the rate of growth in its deficit but government policies are nowhere near to producing a balanced budget.  While the Labour Party seems incapable of any coherent economic thought, they have to some extent distracted the government by making populist announcements such as freezing the price of energy, etc.  The good news is that the Chancellor, after initially being distracted, has reiterated his main theme that government expenditure must be curtailed.  If he can focus on policy and keep away from political gesturing, it is hoped that the population will see the government as the safe pair of hands.  This is a hope rather than a forecast!

In all, and in spite of the potential for a crisis in Europe, 2014 could be a steadily improving year. There are many good omens: the tentative rapprochement with Iran would help stability in the Middle East, and the new World Trade agreements will be a boost to trade, particularly helping the poorer countries.