DABERIAM XXXVIII

March 2008

Visiting China two weeks ago, to see companies around Shanghai and Chonqing, one was constantly reminded of the incredible progress made in the last fifteen years, bringing an enormous increase in living standards to hundreds of millions of people. The consequences for some are awful, Tibet being much in the headlines, but the old moral dilemma remains - how to reconcile the benefits that the regime has brought to half a billion people with the downside for relatively few.

The consequence for the West, however, of the Chinese Government’s strategy is worth constantly reiterating. We have benefited from ten years of Chinese industrialisation, which has produced huge amounts of innovative goods as well as reducing the cost of products that contribute to the West’s high standard of living. Western Governments have taken credit for the low inflation that this has brought. 

We will not be so happy with the next phase. Chinese wages are rising; amazingly there is a shortage of labour. The Chinese people are benefiting from the products that used to go only to the West. They are also enjoying more and better food and the other material benefits that come with rising prosperity. The RMB is also rising inexorably as the Chinese Government increase interest rates to dampen down the economic expansion and is encouraging industry to look inward as the US and other western countries bring pressure on China to reduce its trade surpluses. China’s increase in consumption of food and raw materials for the enormous infrastructure - building programme is putting huge upward pressure on commodities. The combined pressure of increases in the cost of Chinese products and the continuing increase in commodities is going to bring in a new inflationary era.

Global Economic Indicators

World Economic Growth	2007 (IMF Estimate)	4.90%	2006 (World Bank)	4.00%	2005 (World Bank)	3.60%
Base rates: 27 Mar 2008	USD	2.25%	EUR	4.00%	GBP	5.25%
MSCI World Equity Index	29/02/2008	284.474	31/12/2007	299.916	YTD %	-5.15%
Gold (PM London Fix $ per ounce)	29/02/2008	971.50	28/12/2007	833.75	YTD %	16.52%
Oil (WTI Crude $ per barrel)	29/02/2008	101.85	28/12/2007	96.01	YTD %	6.08%

The good news from the China story, which also applies to India, is that there will be a movement of industrial production back to the West. This, however, is only of small comfort as the US, in particular, has got to digest an enormous pile of debt. The impact of this on US GDP is likely to be several percentage points over the next few years. 

Looking at Europe, Britain is in the same position. While UK private borrowing is probably not as extreme as in the US, the Government borrowing requirement is far, far worse. The UK position is further exacerbated by an apparent lack of understanding of what has been the successful part of the UK economy, i.e. international financial services and the specialised manufacturing and chemicals industry. By creating tax rises and more importantly tax uncertainty and confusion, these parts of the economy are being destabilised by political mismanagement. 

In February, it looked as though there were still some downdraughts in the world’s financial sectors. We are now fairly certainly at the bottom. Going forward, everyone now knows that there is a financial crisis; this probably means that while there will be turmoil, things will start to get better. The speed of recovery in the US will be slow for a year or two; as I have said the general level of debt that needs to be reduced will impact GDP. Europe, which as a whole was growing more slowly, will also gradually turn round, but the future does not look exciting. 

The biggest dangers to world stability this year will come from the political efforts to destabilise China, with the Olympic Games acting as the lightning conductor. While the Chinese government may not be “nice”, it is effective, and the Chinese economy is critical to the West’s economic stability. If China were collapsed, the economic consequences would be very serious.

Damon de Laszlo 
March 2008