DABERIAM XVIII

August 2005

The end of August brings the realisation that the days are getting shorter. Predictions of doom and economic disaster are now being postponed to 2006 and explanations are being thought of to justify why they didn’t happen in the first half of 2005. The problem with this method of predicting is that, like a stopped clock, they come right periodically. Secondly explanations for the lack of a predicted crisis start to generate in some quarters an air of complacency. 

I have a feeling the world is going to rock along nicely through ’05 and probably into the beginning of ’06 but imbalances are building that show little sign of being corrected fast enough not to cause a crisis. 

Economic systems work as price influences “decisions” and they work relatively smoothly provided there are no monopolies or Governments that stop the “decisions” being taken. Prices rise and fall influenced by fashion and perception as well as cost, for example house prices rise if there is full employment and rising income and/or falling interest rates, a point is reached where prices continue to rise through fashion even though economics would predict that people are getting out of their depth and then on the whole they will stabilise or drift downwards, as unemployment rises combined with falling incomes and/or rising interest rates. The market won’t collapse however, unless there are a lot of forced sellers. Most imbalances tend to correct roughly in the same way that they build up unless something inhibits the “decision” mechanism. 

Oil or, more generally, energy consumption is proving to be subject to forces outside the normal economic mechanism and a crisis point is being generated. Before the crisis is reached, however, inflation is likely to pick up dramatically, bringing rising interest rates and economic slow down along with a possible property crunch, all of which is likely, perversely, to postpone the energy crisis point. 

Present economic growth trends are outstripping the reliable supply of oil, added to this is a shortage of refining capacity, causing major bottlenecks. Refinery capacity is, by and large, in the hands of the major oil companies and Government regulation in the western world militates against building either refineries or LNG capacity. This same inhibition applies to the only other reliable source of energy, Nuclear Power. 

As an aside, while windmills and other alternatives are being heavily subsidised and make 
a contribution, they don’t solve the basic problem that people want to turn on the lights and industry wants to run even when there is no wind! 

While there are oil and gas prospects around the world, many of them are controlled by governments, which for political reasons or pure bureaucratic incompetence are inhibiting exploration. This applies to Russia, most of South America, Mexico and a great swathe of “...stans” in East Europe. China, faced with American protectionism and Congressional 

parochialism is pursuing a strategy of acquiring energy, raw material and food resources using its dollar resources, directed with a focussed Government strategy. They are negotiating with Governments or buy resources at a great rate in South American and the East Europe “..stans” that run along its border. 

The American political behaviour towards China is not improving the global situation. While China remains focussed and cool headed, congressional statements are feeding on themselves to create a potential hysteria that is dangerous to world economic stability. 

It is interesting that the Chinese responded to American hectoring on currency by revaluing, but by an amount which is basically irrelevant, making Treasury Secretary Snow’s pronouncements look rather lame. 

The rising oil prices have not yet had an impact on inflation, partly because a number of inflation indicators exclude energy and partly because Asian consumer goods are still depressing western prices. China’s ‘not for profit’ economy is shielded from rising oil and energy prices by Government regulation. The increase in the cost of plastics derived from oil has not yet fed through into prices. These two distortions apply to a greater or lesser extent to the rest of Asia and the Third World. The free market pricing of oil and energy is really only being felt in Western countries where it is a smaller percentage of the economy than in other parts of the world. 

Two consequences of this distortion are building up. The increases are not feeding through to either dampen demand in the Asian area for energy or increase prices of consumer goods in the West. Western inflation in services is being masked as demonstrated by some interesting statistics in the FT last week. In the period 1996-2005, UK incomes have risen 50%+, while items such as holidays and private education have risen between 50 and 60%. In the same period cars have effectively remained unchanged while items such as clothing have declined by approx. 40%, with electrical and electronic goods declining over 60%. 

These unusually divergent statistics are masking what could turn into serious inflation and economic disruption if energy demand is not curtailed or new capacity brought on stream. Bearing in mind that new energy capacity, whether in the form of oil wells or generating plants, takes five to seven years to develop and, in the case of atomic energy, the only real source of non carbon-dioxide producing power, upwards of ten years to bring on stream. 

While I am not gloomy about the next six months to a year, there are some potentially serious economic dislocations that could occur from the lack of the surplus capacity that gives us fuel for cars and aeroplanes and electricity at the touch of a switch, which the West is so accustomed to. 

On a local front, it is interesting how little strategy there is in the thinking of Western Governments. The UK Government, for instance, is forcing BNFL to sell Westinghouse, a major builder of nuclear reactors, much to the glee of companies in the USA, Japan, France and South Korea who want to buy this technology.

Damon de Laszlo 
August 2005