DABERIAM XCIV

19th November 2015

Looking back over the last four weeks, there are probably two sickening political game changers - the shooting down of the Russian jet over Egypt and the horrific events in Paris last weekend.  The attack on the Russian plane, full of tourists, has dramatically changed the tone of relationships between East and West.  President Putin’s image internally has been damaged.  The impact of economic sanctions is beginning to bite and a 2% decline in GDP is hurting the average citizen.  Russia’s entrance into the chaos of the Civil War in Syria seems to be part of the building of the image of bravado, along with the swagger of brushing off sanctions.  Both these two attitudes have gone badly wrong and Putin is quite clearly now keen to cooperate with the West and become a “good guy”.  The shift in policy must have the prime objective of getting sanctions removed.

The awful events in Paris have also changed the whole tenor of the debate in Europe.  The liberal policies of hampering the security services’ data collection processes, which has made it more difficult to track terrorists, along with the policy on open borders are likely to shift dramatically.  Chancellor Merkel’s welcoming of immigration, both on humanitarian and economic grounds, while basically good, has put her on the wrong side of public opinion and undermined her authority in Europe.  This is likely to have serious consequences when it comes to dealing with the continuing economic problems and mounting debt within the E.U.

Both these dreadful terrorist attacks are also likely to have an impact on the British “In/Out” debate – more a battle of opinions than a debate.  In reality, the economic impact of either choice in the short and medium term is probably minimal.  The impact in the longer term becomes a nonsense argument as it is impossible to predict the many other moving parts of the global economy.  In Europe, Britain is the fastest growing economy and a major market for French and German exports.  It is also a large contributor to the European budget BUT in Europe the negotiating position of the Government is very weak.  Outside Europe the economy could benefit more by joining the most prosperous and fastest growing economic group - the North American Free Trade Area (NAFTA) - a subject that seems as yet not to have entered the debate. 

Energy supply and pricing is probably the biggest elephant in the room, missing from the world economic debate.  OPEC is broken as Saudi Arabia and Russia battle for the energy market share and are not going to reduce production; in any event, neither can afford to do so.  At below $80 per barrel, Saudi Arabia, Russia, Bahrain and Oman are running large deficits and burning reserves.  Currently the supply of oil is considerably in excess of demand to the extent that it is estimated there is a year’s supply of oil sitting in tanks and on the high seas with nowhere to go.  Coming up on the supply side is increased production in the US, particularly of gas, and enormous potential increases in production in Mexico, Egypt and the eastern Mediterranean.  Add to this Iran and the rest of North Africa, if the situation stabilises.  It is difficult to see any reason for oil and gas prices to rise and the global economic consequence is an improvement in living standards for the majority.  In global economic terms, the biggest impact is being felt in North America.  Oil at $50 per barrel is estimated to put $1,500 of extra spending power into the hands of the average American.  Couple this with the re-industrialisation of North America owing to the dramatically lower costs of energy and you have a new engine of world growth, taking over from China.

The US, with its bizarre system (apologies to my American friends) of gridlocked government, is actually reindustrialising fast.  It’s extraordinary to see the rate at which the world’s major motor-car companies are building factories in Mexico and North Carolina, not only to meet US demand but to act as their base for supplying the rest of the world.  The American electronics industry, both hardware and software, are also the world driving force in their sectors.

The shift in manufacturing to America from China is upending the economic belief system of the last fifteen or so years. China intentionally is re-balancing its economy, raising minimum wages, encouraging consumerism and reducing its dependence on exports.  Its adjustments are painful and economically disruptive but entirely necessary.  We can expect to see the basic GDP numbers etc. gyrate but in the longer term the government plans are clear and deliverable.  China’s thirteenth 5-Year Plan, which will be published in 2016, will give us important signals as to their impact on the rest of the world and must be taken very seriously by anyone making investment decisions.

Europe and the so-called BRIC countries are the problem; the slowdown in China and the cyclical increase in production of commodities is a really serious problem for South America and Africa.  Europe is also suffering from the change of direction in China.  German exports are down dramatically, and Europe as a manufacturing area is becoming uncompetitive with the US.  The UK, somewhere in the middle, also suffers from high energy prices and is potentially going to damage its manufacturing base if is doesn’t develop a policy to ensure electricity supplies.  It, however, has great advantage over Europe in having a very flexible labour market and is less dependant on the Chinese market.

We are in the last quarter, the future for North America looks good, Europe confused, China difficult and countries reliant on the production of commodities gloomy.  The West and Russia, however, may become more cooperative as a result of the awful terrorist attacks and this can only give one optimism going forward into 2016.