DABERIAM XI

May 2004

Since March the world economies ex-Europe have continued to grow but the economic statistics are, in the short term, pointing all over the place. The US indicators continued to show good economic growth with employment now beginning to show a rapid upturn, however the stock market has got itself into a panic over the Fed’s indication that interest rates are probably going to rise soon rather than in the distant future! 

The markets have risen rapidly over the last twelve months so the change of direction is not surprising. What is surprising is the nervousness the Fed’s predictable statements have caused. Companies’ profits continue to rise, the lack of capacity in the semi-conductor industry created by an enormous increase in corporate expenditure on IT plus the increase of use of computers in the automotive and telecommunications industries is driving US technology. The demand for commodities, from oil to aluminium, is going to precipitate a boom in investment in exploration and this in turn will drive the need for capacity for mining and drilling equipment through to processing equipment. 

There is also an enormous shortage of shipping and port facilities around the world need refurbishing. Shipping shortages are being caused by Chinese growth in raw material imports, coupled with the increased use of coal and oil for power generation. This latter point is partly a perverse result of the green movement’s success in shutting down nuclear capacity, e.g. Tokyo Electric Power’s decision to shut fourteen nuclear stations, largely as a result of green political pressure, is producing an enormous increase in the demand for coal and oil. The delays in ports around the world are also greatly exacerbating shipping demand. The demand for shipping is far greater than supply and will be for the foreseeable future. In general, it is easy to predict that capital expenditure on shipping and the engineering industries that support it, mining, oil drilling and everything related to infrastructure, is going to grow for the foreseeable future. This in turn will have a knock on effect in all industrialised countries. 

Power consumption is also rising around the world and no country is likely to get near to Kyoto’s commitment of reducing CO2 emissions. In the UK alone coal and oil consumption was up by 7.1% in 2003 bringing a reported 1% increase in CO2 emissions. No amount of wistful thinking about wind is realistically going to change this picture. 

Luckily, from a global warming point of view, the French have announced plans to build a new generation of pressure water reactors; Finland is following suit; and even Sweden is coming around to the idea of expanding its nuclear capacity. Russia and China are building nuclear capacity and even Belgium is thinking about it. Interestingly, Britain and the new Socialist Government in Spain are the only major countries now still committed to phasing out nuclear energy. 

China’s recent announcement that firmer measures will be taken to restrain credit is good news. Chinese capital expenditure has been running out of control and a great deal of uneconomic investment has inevitably been made. The Government in China is well aware of the boom and bust cycles of capital expenditure and interestingly seems to be using the political party system to dampen down bank lending, which means it is likely to be effective. A slow down in the Chinese economy will dampen down the rapid rise in commodities experienced over the last two years. It will also tend to discourage the flow of capital into China, which has greatly contributed to the GDP growth of 17 - 18% in the last 12 months. If the Government gets its balancing act right, it will not precipitate a property crash in Shanghai and other over-built areas. China’s balance of payments and trade surpluses are declining fast and the Government’s desire to keep down inflation will encourage them to import food, particularly wheat, from the USA, helping to improve trade relations. 

A controlled slow down in the rate of growth in China will not have a harsh impact on the rest of Asia, indeed the likely reduction in commodity prices will help everybody. 

India is something of a wild card as for the first time it is experiencing economic growth that the bureaucracy has as yet not been able to stifle. Services provided by cable and telephone lines are difficult to intercept compared with goods and therefore difficult to “licence”.

The US economy is going well and, as predicted, State Governments’ incomes are rising fast and their budget shortfalls of last year are being covered. Rising Federal income will reduce the fiscal ’04 deficit forecast of some $520 bn. dramatically. To the extent that consumer expenditure slows this is being covered by a considerable increase in business capital expenditure. 

American industry is short of capacity and the productivity increases gained from equipment design in the last five years make it uneconomic to restart plant that was shut down 99/00. This observation applies to virtually all sectors of manufacturing. Corporate borrowing is also likely to pick up as inventory building spirals from a very low base. The increase in corporate profits and optimism will also fuel merger and acquisition activity. All this activity will in due course lead to a considerable recovery in the stock market after it has got over its current jitters. Inflation, of course, will rear its ugly head and is already apparent in the “benefit costs” related to employment. 

The UK is in a similar position, except that the Bank of England, unlike the Fed, has acknowledged that there is insufficient spare capacity in the economy to sustain the current rate of growth without inflation. The major difference in the UK is, however, Government action. Patricia Hewitt, the Trade and Industry Secretary’s overweening desire to “help” produces a stream of legislation that creates legal confusion for corporate management. One of the principal requirements of an efficient economy is the ability of people to know what the law is and how they can operate within it. Current proposed legislation such as the requirement for Directors under risk from unlimited fines to file an operating and financial review is a case in point. Quoted companies will have to give details of factors affecting future and past performance. It sounds simple but the Company has to decide what is relevant information in this context and they will be judged in retrospect. This will inevitably lead to masses of fun for DTI Inspectors! 

In another area a proposed equality regulator to promote human rights and back legal cases against companies sounds wonderful but is an open invitation for lawyers and pressure groups to attack the corporate sector. Patricia Hewitt’s apparent observation is that it will be helpful to companies as a single point of contact for advice on “the increased volume of equality legislation”. How helpful! 

Even the House of Lords is becoming concerned. In a Select Committee Report it warns against the danger of regulatory creep caused by an increasing number of industry watchdogs and Quangos. These are largely unaccountable and their powers to impose penalties and fines and create secondary legislation mean an increasing burden on industry. Is this part of bringing us into line with Europe? 

In another vein, the Government’s success in holding down unemployment has largely come from Government recruiting itself. Of some 480,000 net jobs created in 02/03, 360,000 were public administration etc. This statistic does not auger well for wage inflation in the near future. 

Germany is still in the doldrums with its industry in a regulatory straightjacket and its policy of raising taxes to meet the ever-growing deficit is not a pretty picture. 

But interestingly, France’s fiscal laxness and disregard for European fiscal rules is beginning to show results.

Italy would appear to be following suit and looks as though it is going to ignore the European Council’s famous 3% deficit ceiling. 

In general, the outlook remains good except for the confused stock markets and this confusion is likely to continue for a while as Hedge Funds and others sell stocks in order to unwind their borrowing position in the face of rising interest rates. This unwinding process may also cause an overshoot in the decline of commodity prices. The other area that could unnerve the markets for a longer period would be the collapse of a major financial institution that is imprudently over-geared and cannot cope with the rising interest rates, but even an event of this kind would probably not derail general economic growth over the next one to two years.

Damon de Laszlo 
May 2004