DABERIAM XLV

December 2008

In the last couple of weeks of 2008, it is worth remembering that the Western economic bubble plateaued in 2007; I was expecting it to deflate in 2008 (For those of you with time to read, attached are my comments from December 2007.) Unfortunately the economy in general continued to glow in 2008 - instead of deflating it burst in September/October with the total collapse of the banking system. To mix metaphors, the tide went out very suddenly leaving the banks, the private equity magicians, the hedge fund managers and financial markets in general, naked. The total breakdown of the banking system around the world brought global trade and industry to a juddering halt. 

The mountains of debt that fuelled the Western economies for the last five years collapsed, leaving a black hole in the world’s financial system. We now have the rapid appearance of deflation taking hold around the world. Prices and wages are being forced down and debt is being repaid or written off. On the other side of the balance sheet, asset values are being destroyed which in turn is wiping out people’s savings and pension schemes. This downward spiral will at some point stop, probably as suddenly as it appeared, but the global economy is in uncharted waters. 

Global Economic Indicators

World Economic Growth	2007 (IMF Estimate)	4.90%	2006 (World Bank)	4.00%	2005 (World Bank)	3.60%
Base rates: 28 November 2008	USD	1.00%	EUR	3.25%	GBP	3.00%
MSCI World Equity Index	28/11/2008	188.488	31/12/2007	299.916	YTD %	-37.15%
Gold (PM London Fix $ per ounce)	28/11/2008	814.50	28/12/2007	833.75	YTD %	-2.31%
Oil (WTI Crude $ per barrel)	28/11/2008	54.44	28/12/2007	96.01	YTD %	-43.30%

Around the world the Central Authorities are reacting in different ways depending on each country’s individual economic profile. The US started by throwing liquidity into the system but is now focussing on the real problem, dealing with a credit crisis. It is interesting that Treasury Bill rates have gone to zero or minus interest rates, that is lower than during the Depression of the 1930s. This coupled with the underwriting of the banking system will force the trillions of dollars in Money Market funds to place money back in the banking system. It is worth noting that the Government is effectively borrowing money at a minus interest rate and lending it out at 4 or 5% to the banks, making a huge profit in the process. As I mentioned, there are mountains of debt that have to be repaid or literally written off, in the early ‘80s bank crisis, this was called Debt destruction. 

On the other side of the world, China recovering from the Olympic Games and the industrial shutdown, as well as a massive earthquake, is grappling with the fact that a large percentage of its economic growth was export driven. The Chinese economy, which suffers from both the advantages and disadvantages of central planning, has to reverse its direction, from exporting consumer goods to internal consumption. It has the Central Government controls to do this as well as the reserves. The Chinese Government stimulus package, broken down roughly, is allocated 45% to railways, roads and airports; 25% to the earthquake recovery areas; 9% to rural infrastructure; 9% to energy efficiency and environment; 7% to low income housing and 4% to technology and R & D. This augers well for China’s future growth. 

By contrast, the UK’s reaction to the problem, apart from the necessary support for the banking system, was the announcement to bring forward infrastructure expenditure, which is unlikely to happen as they simultaneously announced the postponement of major industrial military expenditure on aircraft carriers and in any case most infrastructure projects are stalled in interminable planning enquiries and debates, eg. Runways at London Airport and Stansted. Along with this, a VAT reduction that will cost the Government billions and have no commercial impact apart from the huge bureaucratic burden it lays across industrial inter-company prices. In any event, private individuals should sensibly be paying down debt rather than being encouraged to spend. The UK Government debt going into the coming year of some £145 bn. is unlikely to be fundable and can only lead in due course to rising interest rates and devaluation. Not a recipe for an industrial renaissance.

Germany by contrast, has a less hysterical Government that is watching its banking system carefully and will probably support, where required, its industry so as to get the country on to a sustainable recovery path. 

While there are many, many anomalies and dangers in the fabric of the world’s economic systems, I take an optimistic view, rightly or wrongly, an entrepreneur has to deal with risk all the time, risk-taking is not compatible with pessimism. However, I am having a struggle remaining convinced that we will be over the worst by the 3rd / 4th quarter of 2009. Unless the banking system unglues itself very soon, the global network of interrelated industrial companies that support our modern lifestyle will start to break. Repairing the extraordinarily complex computer controlled industrial networks will take time and will add to the inflationary pressures that are being built into the system at the moment.

Damon de Laszlo 
December 2008