DABERIAM XLVII

April 2009

Since putting pen to paper in February, Spring has arrived! The flow of events, announcements, actions, conferences and other motions - signifying action - has been a torrent. The global economic data has relentlessly kept to its downward path and the economic crisis grinds on and fear stalks the lives of millions of people around the world as job losses rise. The politicians are becoming complacent and they are also running out of new ‘new ideas’. 

The world’s economies are driving inexorably through the process of adjusting to the bursting of the financial bubble that has given the appearance of prosperity over the last five years. The asset price boom that enabled massive borrowing to take place has been well reported and blamed on those “greedy bankers”, the politicians have as usual avoided blame for their part. It is politicians and Government who failed in their job to manage the regulation and enforce the necessary disciplines in the financial systems of the world. There is much analysis and report on the breakdown of the financial system and much more to come. The question though is how the world’s economies will develop going forward. 

There seems to be a bifurcation appearing in the world’s economy. On one side the USA and China appear to be stabilising, although there is still a lot of historical bad news to be reported, covering he first quarter of ’09 which will roll into the second quarter. By contrast Europe is in a much greater mess and has probably got another three or four quarters of horribly negative growth. 

Starting with the USA, the property crash looks as though it is starting to stabilise, the banking system and the Government’s actions to support it is beginning to function, industry has de-stocked and the public is starting to save and is repairing its balance sheet. The final problem to be addressed is the disaster called the motor car industry. In China the Government after considerable deliberation is now pouring huge resources into redirecting the economy from being export led towards internal consumption. The process will be painful but it appears to be beginning to work. The process will spill over into the rest of Asia and in all likelihood, we will see stability beginning to appear, albeit at a low or zero growth rate for the time being.

Global Economic Indicators

World Economic Growth (IMF Figures + Projection)	2009	0.50%	2008	3.40%	2007	5.20%
Base rates: 31 March 2009	USD	0.25%	EUR	1.25%	GBP	0.50%
MSCI World Equity Index	31/03/2009	166.12	31/12/2008	181.894	YTD %	-8.67%
Gold (PM London Fix $ per ounce)	31/03/2009	916.50	30/12/2008	869.75	YTD %	5.38%
Oil (WTI Crude $ per barrel)	31/03/2009	49.66	31/12/2008	44.60	YTD %	11.35%

Europe has the greatest structural problems in that it has an extraordinary and novel system of Government. The massive EU bureaucracy is politically unaccountable and basically insensitive to the plight of the constituent countries. Labour laws, environmental rules and gratuitous regulations continue to pour forth hampering the ability of business to adapt to the changing world. Unit labour costs continue to rise inexorably across Europe and the trend will increase as productivity declines draining corporate liquidity. Germany, the main motor of the European economy will continue to contract rapidly as its economic growth from export industries collapses further. Similarly, Britain’s economy that has been driven by its financial and property bubble, will continue to deteriorate with the added problem that it will be the first country to experience rising inflation as a result of the depreciation in its currency. UK is also likely to be the country that suffers the biggest Government deficit as a percentage of GDP, owing to the near complete loss of control of Government finance.

The simple problem facing the world is the asymmetric effect of borrowing to finance current expenditure by individuals and the corporate sector, and then repayment of the debt. Profligate lending enabled individuals to borrow money in increasing amounts every year enabling individuals to spend their income plus the extra borrowing. While borrowing is treated as tax free income and spent, its repayment has to be made out of after-tax income, i.e., A dollar or pound that is borrowed and spent costs approximately 1.35 dollars or pounds to repay, before even any interest has been paid. My calculation is obviously a generalisation but it indicates the cause of the huge reduction in retail sales that the indebted economies are having to adjust to. This is before the impact of the rise in unemployment is taken into account. 

At the moment there is considerable complacency regarding inflation. De-stocking of the retail and manufacturing sectors produce downward pressure on prices, not only of finished goods but also commodities. As industry adjusts to the lover level of sales, production capacity is reduced. The complex technology and supply chains of modern manufacturing means that once production has been shut down, it is very difficult to re-start in the short term. For example, the computer systems that run a modern factory are exceedingly difficult to re-start if it is closed, and the technical skills dissipated by redundancies. The same problems apply in the supply of raw materials and commodities. Mines and oil-wells can be closed down relatively quickly, but they take much longer to re-start. 

The world going forward is likely in the near future to become inflationary for the reasons described. Added to this, the same Governments that enjoyed the recent boom years will not be averse to a considerable amount of inflation which will help them avoid the consequences of the Government debt that is being piled up. 

While these observations predict a shift in the economic paradigm of recent years, it is not a prediction of doom and gloom; it is more the natural ebb and flow of economic trends. Growth and the appearance of prosperity will be more muted in the foreseeable future but that is not necessarily a bad thing.....

Damon de Laszlo 
April 2009