DABERIAM XXII

January 2006

2005 ended on a high note as the pessimists in the investment community moved into the market and rolled forward their pessimistic prognostications to the middle of 2006. One of the problems of forecasting is that if you are constant, like a stopped watch, at some point you will be right. In the case of the watch, once every twelve hours! 

Looking forward into ’06. I have to say I feel extraordinarily optimistic, as always exogenous shock could derail the world, but barring earthquakes and pestilence and provided the politicians and bureaucrats in Washington and Brussels don’t start derailing world trade, it seems that we are in for continuing prosperity. 

In Europe, Germany is at last showing signs of life as German industry reorganises itself, as Japan has done over the last ten years, moving production to Eastern Europe and Asia and increasing its expenditure on new industrial plant and machinery, improving productivity and profits. 

Japan now focuses on the rest of Asia as its primary market and Chinese capital investment is one of the main drivers of this economy. Perversely, the economic improvement is bringing with it rising interest rates in Japan, which in turn means that people do not need to save so much for the future. In addition the slow down in the savings rate is encouraging their domestic economy and this trend is likely to continue as industrial prosperity recovers and the consumer spends a bit more. 

The USA, as every newspaper keeps reminding us, is facing major economic imbalances. A lot of these imbalances, however, are not as critical as they would first appear. US personal savings rates are down and property prices have risen substantially in the last few years. However, the statistics on savings are very misleading and do not show the true increase in personal assets accumulated over the last year or so. For instance contributions to Pension Funds and 401Ks are not recorded as savings in the statistics – just two areas where the numbers are misleading. 

The balance of trade is also an over simplification of a complex issue. US imports are growing and, in crude terms, are out of balance with exports, but the accumulation of foreign assets by US business investment should be regarded as an improvement in the balance sheet of the US. This to some extent compensates for the loss on P & L account and makes the picture less black than the headlines would have us think. That is not to say that the situation is sustainable in the long term, but there is no need to anticipate a crisis in the next few years. 

US industry is restructuring, as is European industry, and the major problems of dealing with an ageing population and providing pensions are being addressed. Provided they are dealt with slowly the painful process can be accomplished without excessive hardship. The pension problem in the UK, for instance, has been greatly exacerbated by Government action. It is worth remembering that it was the Tax Authorities that made it impossible for companies to add to their pension funds in the ‘90s by disallowing what they called over-funding of pensions as a charge against Revenue. Pension schemes then had a second whammy when, a few years ago, the Chancellor started to tax the pension schemes on dividend income, and more recently the regulator has confused and greatly added to the difficulties of spreading out pension contributions into the future. 

The UK pension fund problem is a good example where Government has turned a difficult and complex but manageable problem into a crisis, and it is Government action around the world that is today the major threat to world economies. The US Congress call for punitive taxes on Chinese goods of between 20-30% would be something of an own goal as it translates into a 1–2 % rise in US consumer inflation. This would drive up US interest rates and further encourage China to embrace Russia as a friend, and who knows what could happen to the dollar, not to mention the knock on effects on global trade that would derail Japanese and other Asian countries’ growth. 

As things stand, it is likely that the US will slow down a little but world economic growth will continue as the Asian economies grow their domestic demand. 

One can’t avoid a comment on oil, but here again the normal process of economics will mean that the higher prices will dampen demand, introducing stability into the demand/supply situation. Again, the big ‘but’ is Government Action. Current supplies are curtailed by inefficiencies that have arisen from Government action from Russia to Venezuela and Western intervention in Iran would light the touch-paper under oil prices. It’s hardly worth contemplating but we have been warned that Russia could react and, at the extreme, turn off 25% of Europe’s gas supply if it decided that we were being unfriendly to its friends in Iran, or anywhere else for that matter. 

As I began, apart from natural disasters or Government miscalculation, 2006 should be an economically prosperous year, continuing much in the same way as 2005. Capital investment in China will continue, reducing the cost of consumer goods and keeping inflation down; and the employment situation in Europe and the US will continue to improve as industry and commerce reorganises, bringing with it a better year for everyone - let us hope!

Damon de Laszlo 
January 2006