Economic Research Council: Daberiam Reports
Bi-monthly Reports by ERC Chairman, Damon de Laszlo
DABERIAM X
March 2004
The world economy continues to grow apace except in Europe. The US looks as though it is going to clock up a third consecutive quarter of above trend growth with no sign of the growth abating. Capital expenditure is up and employment is picking up as companies see continuing full order books. Shortage of capacity is appearing in the IT industry and in particular in the semi-conductor sector. The demand for commodities is exceeding supply at a time of low stocks and the Central Bank in the run up to the November election has avowed to err on the side of inflation rather than deflation.
China is experiencing growth at an even faster rate than the US but the major difference is there is no shortage of labour or capital.
Japan, for the first time in ten years, is going into growth mode. Consumer expenditure is showing the first signs of life, and export sales are growing rapidly driven by China. Japan, like China, has no shortage of labour or capital.
The UK economy, like the US economy has very little real labour capacity and very little useable manufacturing capacity. More importantly, it also suffers the same constraint as the US as far as financial capital is concerned. Both countries’ Government borrowing leaves little room for industrial borrowing for capital expenditure without pushing up interest rates.
Commodity prices have risen considerably and are likely to continue along with freight rates. Container ship capacity is at the limit having grown some 34+% in the last twelve months.
In economic cycle terms, we are at the end of the deflationary cycle and it is likely, bearing in mind the US - UK deficits that the economies are going to overheat rapidly.
China’s inflation rate has gone 3%+ positive in January after five years of deflation and the Chinese domestic demand for consumer goods now not being ‘discouraged’ by the Government means that cheap goods from China to America and Europe will start to disappear, driving consumer inflation.
From a stock market point of view, company earnings are going to grow more rapidly than consensus and the enormous institutional underweighting in equities in the US, UK and Japan is going to drive markets, certainly for the next eighteen months.
Interest rates are, however, likely to rise as competition for capital between industry and Government heats up and interest rates could rise very rapidly if Japan and China start to sell US Treasuries for their own capital investment needs. The rise in interest rates at some point will precipitate a financial crisis as those holding long term low yielding bonds experience the inevitable depreciation.
Will the pension and insurance industry get caught again? Having moved out of equities at the bottom of the market into bonds; they will start moving back into equities as the bond market starts to crater next year. This will drive equities in ’05.
These problems along with those created by rapidly rising commodity and oil and gas prices are more than likely not going to appear as serious constraints until we get to the end of 2004, beginning of 2005 when I think inflation will be back with a vengeance.
In the meantime, barring the normal desire to look for disaster, the outlook is rosy.
Damon de Laszlo
March 2004