DABERIAM XIV

February 2005

My note last November ended with Russia as a question mark. It still is - Russia has never been a country where the “Rule of Law” applies, except for a short period at the end of the last Czar’s reign. Not unsurprisingly, this coincided with a huge burst in industrial innovation and middle class prosperity. 

Typically business in Russia has been conducted under bureaucratic fiefdoms with the Czar, or today the President, at the head. Putin is reverting to mean by effectively renationalising the major oil producer, YUKOS. Dictating the direction of oil and gas pipelines and negotiating what amounts to private contracts with the big oil companies for exploration. The sadness is that the Kremlin will not be able to manage these resources efficiently, and investment in other areas will be discouraged. We can expect political instability around the peripheries of Russia as improvements in the economy fail to materialise. 

Leaving Russia to its own devices, the rest of the world looks quite good. The Governments of the United States, China and India are steadily getting on with the business of encouraging enterprise and doing their primary job or running stable economies. Bush has said that he is going to address the Government deficit by curtailing expenditure and, if history is anything to go by, he will succeed. There are also signs that the Federal deficit is turning and it will decline steadily over the next few years. 

Law Reform is rising up the Agenda and will be addressed and there is an increasing understanding that personal savings and an ageing population, along with the health issues that they bring, are all needing attention. The argument is only in the detail. Consumer expenditure is likely to grow at a slower rate, if at all, but capital expenditure will take over as the engine of the US economy, fuelling GDP growth and productivity. Some three or four hundred billion of cash will be repatriated by Corporate America and turned into capital expenditure in the current year. 

The Iraq elections happened and, by all accounts, were popular and relatively fair to the disappointment of many who were hoping that it would turn into a shambles and discredit American policy. The elections will help the phased withdrawal of US troops from the front line of internal security to holding areas close to the Saudi and Iranian borders. 

The Fed continues its policy of ratcheting up interest rates to dampen the mortgage refinancing market and the housing boom. It seems that the Fed is fully aware of the enormous amount of liquidity in the system that needs to be slowly reduced. There is a danger here that they miscalculate and there could be a market accident in the debt area. There is a lot of paper in the system that is over-rated and, as interest rates rise, holders of heavily geared funds are likely to receive a “haircut”. 

The big worry, the US balance of trade, is likely to improve with a decline in retail growth, the impact of Chinese consumer goods will flatten out and, as China encourages its domestic consumption, the cost of these goods will tend to increase. This, as well as the global appetite for dollars, means that demand for the currency will continue. There is really no alternative to US Treasuries and Bonds for the World’s Central Banks, which is why US long yields remain stubbornly low. 

China and India are continuing to discover that economic growth and freer markets feel nice. Barring a political miscalculation leading to military threats, Asian economic growth is becoming the driver of the world economy. The good news is that China has slowed a little and this has brought relief to the commodity markets. However, there is a general global concern with the huge amounts of liquidity in the world system. Asset inflation is a problem. 

On a world basis surplus liquidity generated by Central Banks in 2001/02 has in turn driven up property prices in the US, UK and Europe. The same is happening with a vengeance in China where a seven to eight year building boom shows no sign of abating. The same liquidity has been pushing the trends in the commodity markets. 

Europe is another matter. While there are signs that Germany and France are trying to loosen up their labour markets, the process is painfully slow, and the bureaucratic restrictions on entrepreneurial activity are stifling. Both countries have huge unemployment, particularly among the young. Both countries make it difficult to start businesses, and both countries are running a huge Government deficit, as a percentage of GDP, similar to the US. 

Britain, by adopting European habits, is itself stifling entrepreneurial activity and the Government, in true Socialist fashion, is resorting to meddling with the official data. The revisions and rebasing of information from the Office of National Statistics makes year on year comparisons difficult, and in some areas impossible. The vast increase in resource directed to the government departments has been largely responsible for the declining unemployment in the UK, and a large amount of the economic growth. 

The robust and entrepreneurial economy that the Labour Government inherited is being stifled, with the result that national productivity is declining along with Government revenue, which will lead to massive Government deficits in the next year or so. 

All in all the investment prospects around the world look good and the stock markets, particularly in America, I believe are set to rise impressively as productivity and profits continue to beat expectations. 

There is a likelihood that the Euro has peaked. There is an old adage that, when a retail chain builds a flagship store, or a company builds a new HQ, it is often the ‘kiss of death’! As the famous Peter Drucker would say, “an excessive investment in managerial ego!” What does the building of a new massive Euro Central Bank HQ foretell?

Damon de Laszlo 
February 2005