DABERIAM XV

April 2005

“May you live in interesting times” is the Chinese curse. The simplicity of the debate and “worries” of the American election and Iraq have been replaced by a myriad of confusing discussions. 

The Chinese Government is talking down the Chinese economy to try and reduce the building bubble and state sector industry capital expenditure, without destabilising the private sector. 

On the other side of the Pacific, the Fed. is tightening the money supply, trying to deflate the property bubble without upsetting the rest of the economy. While the recent rapid dollar decline is, in conventional terms, likely to produce retail inflation in the US, the globalisation of production means that US retail prices are not rising as expected. The economic pressures in the world are, while keeping retail prices down, pushing up commodity prices which must be curtailing Chinese and other Asian manufacturers profitability. 

Globalisation of industry is keeping retail prices steady, a phenomenon that has not really been experienced since the end of the 19th Century. 

One can make a rather generalised observation that Pax Britannica created a free trade world at the end of the 19th/beginning of the 20th Century, we are seeing Pax Americana having the same effect. 

With the globalisation of trade also comes the globalisation of liquidity. The movement of funds around the world is today creating similar financial bubbles to those that were seen in the late 19th , early 20th Centuries. The difference today is the speed of communication, along with the increased financial sophistication of markets, creating faster market gyrations, and this confuses the analysis of the major underlying trends. 

On a world basis, the Chinese economy is slowing a little, which is a good thing. The Japanese economy is slowly reorganising itself after a long period in the doldrums and I believe will join the Asian growth phenomenon. India is also, for the first time, likely to really break out of its bureaucratic bonds as the Government is finally starting to build the infrastructure for the movement of goods and the e-communication is raising expectations. Europe has managed to create a straightjacket which is probably the dark spot of the world and the US seems to be doing fine, but is suffering from being the depository of the world’s surplus cash. 

Moving from general observations to particular issues, I am always looking for events that could upset the general market. Oil is one obvious area. It is in a tight supply situation which is unlikely to be corrected for the next ten or fifteen years. The world economy will continue to grow and the world economy will continue to waste this scarce resource by burning it in power stations, unnecessarily contributing to the CO2 overload. 

It is gradually dawning on countries that the only viable alternative is Nuclear Power. At an OECD meeting in France in March, most countries came to this conclusion. To get significant new Nuclear capacity on stream is going to take ten years plus. So for the foreseeable future a major disruption of supply would push oil prices much higher and disrupt the world economy. 

It is worth noting in passing that Nuclear Power is one of the bright spots of the French economy, generating approx. 80% of its electricity, saving the country the equivalent of 10 billion Euros over the cost of power from natural gas and delivering 25 bn. Euros p.a. in export sales. 

In America while the economy is intrinsically sound, the excesses in the financial markets could produce a crisis as interest rates rise. Startlingly the great GM is possibly an economic iceberg. In March, G E Capital withdrew a $ 2 bn. Loan Facility as GM’s credit rate fell to BBB- and GM’s market capitalisation also fell below that of Harley Davidson, a company making some 317,000 motorbikes a year, compared with GM’s 9,000,000 vehicles! 

GM, facing global competition, probably cannot trade its way out of these problems. None of its competitors has to support the incredible health care and pension costs of its ex-employees. Each GM worker must produce enough profit to support 2.5 pensioners before the company makes a profit. In reality, the story of GM is getting to Chapter 11. 

While there always are dangers, I feel basically optimistic about the US economy. The Sarbanes Oxley legislation is having an interesting and perverse effect. Companies are in a hurry to publish bad news and are more and more nervous about publishing good news. Also many companies are still grappling with publishing any information owing to the complexity of the act. We can expect the first quarter reporting season to start with depressing reports and it won’t be until we get into the third quarter that everybody will wake up to the fact that earnings are much higher than forecast. I still think there is going to be a boom in the S&P at the end of the year as it dawns on the institutions that corporate earnings growth is still outstripping economic growth and is not reflected in the indexes. Interest rates are also rising which is going to make institutional holders of Bonds wake up one day and realise that their assets are in the wrong place.

Damon de Laszlo 
April 2005