DABERIAM LIV

March 2010

As we approach the end of the first quarter of 2010, it is difficult to find any real changes in direction in the various corners of the global economy.

Having spent most of February away in Argentina and kayaking amongst the ice-floes in the Antarctic, there is a strange feeling that the world has stood still. There is an extraordinary constancy about the suspended financial crisis and in particular crisis talk that pervades the Press and other commentators. 

Britain in its state of political suspension rolls on without addressing any of its fiscal and financial problems. Government pronouncements are basically ignored and the Prime Minister’s ability to be ‘economical with the truth’ has become so blatant that it hardly excites comment - everyone awaits with some boredom for the announcement and onset of the election battle. 

Europe continues in its own intoroverted sweet way. In Greece nothing has changed, the economy remains a mystery, bankrupt along with its Mediterranean neighbours, but no bail out, only a smoke screen of European ministerial meetings. It seems that the core of the dilemma facing the European Central Bank and Germany is that a very large percentage of the Greek government debt is owned by Deutsche Bank and their French counterparts. For the time being, one can only guess that Greek debt will go on being absorbed by these banks and then possibly recycled into the ECB, a party that can continue for quite a long time. 

The big elephant in the room, America, and the smaller elephant, China - continue to dance, reminiscent of young and old bulls in African safari parks, kicking up dust and bellowing. Interestingly, the US government seems to have reached a state of paralysis as Congress ties itself in knots over the major issues, of health care reform and bank reform. Both are intractably complicated, and made more so by the hugely powerful lobbies in the respective industries use their weight to derail the legislation. 

Unable to address internal issues, it is worrying that Congress is focussing on the exchange rate and China. Today. it is probably in the best interests of America to have a fixed exchange rate with China; a floating exchange rate would create a situation where Chinese actions could drive the dollar up or down any time they wished by announcing or actually executing a buying or selling of dollars. Congress has forgotten the old adage that, you should be careful what you wish for! 

In the meantime China which, as I have said before, is probably the only country that has an executive that can plan intelligently for the short, medium and long term, and has a fair chance of executing those plans, is encouraging rapid growth within its own economy. To stay in power and avoid civil unrest, Beijing knows that it has to deliver steady growth. Inflation itself is growing, however, and this is more difficult to control with a fixed exchange rate against the dollar. This present currency lock does mean that Chinese inflation continues to grow as wage and food prices rise and will be exported to the US in the form of higher prices. A phenomenon that is of considerable benifit to US industrial recovery which, as it happens, is taking off at a great rate. 

The rapid pick-up in US industrial output is flowing through into capital expenditure and is beginning to stabilise the job market.. There is also a growing trend for US companies to bring home production from Asia, all of which augers well for a general improvement in the US economy over the next twelve months. As is often the case, this could be derailed by the politicians particularly if political grand standing sparks off a round of protectionism. 

With Spring in the air and the problems of winter receding, the rate of recovery in the private sector will increase. If the politicians can control their desire to spend and reign in the public sector, then there will be a general economic recovery. It is a big ‘if’ but possible!

Damon de Laszlo 
March 2010

DABERIAM LIII

January 2010

December and Christmas seems a long time ago and the new decade so far has a rather surreal feeling about it. We seem to be facing the reverse of the old adage: “if it ain’t broke don’t fix it”, as Governments and their bureaucracies are fundamentally unable to fix anything until it breaks. Europe in particular presents a bizarre picture where it is clear that the so called PIIGS (I left Ireland out of my last note) plus the UK are running Government deficits that are unsustainable. 

Britain is heading for a crisis with a Government borrowing requirement that is so large and compounding at such a high rate that it is too frightening to even try and work out how it is going to be funded and, in the run up to an election the politicians can’t even whisper that whoever gets into office is going to have to make draconian cuts in Government bureaucracy, to an extent that has never before been contemplated. 

Britain aside, the EU with its centralised bureaucracy, but no apparent political leadership is unable to propose a solution for the economically dysfunctional Mediterranean members. Greece, the current lightening conductor of economic debate is getting all the press. The publically discussed options are that it can painfully deflate its economy, be bailed out (it is not entirely clear what that means), or leave the Euro. The mechanics of painful deflation are in reality not politically possible in a democracy. Leaving the Euro is easy to say but incomprehensibly complicated and liable to lead to more anarchy than the deflationary option, and the mechanism for a bail out unclear and difficult to fund from the present EU Government mechanisms. 

The fourth option, which for some reason cannot be discussed, is old-fashioned Government default - a black swan event. It is difficult to see why this option isn’t the simplest and most likely. The Government bond holders take a haircut; the pain is felt domestically by savers and pension funds, the usual sufferers in an economic crisis. The Government then has the breathing space to reorganise its finances and will be able to usefully use new money from the European Central Bank. It is not obvious why the default of a small European area member is any worse than the default of a large corporate in any other country. 

This scenario, of course, while being discussed at the moment vis-à-vis Greece, could possibly happen to any of the other countries in the same predicament. Leaving Europe aside America continues to reinvent itself and restructure itself. Obama is proving to be a refreshing President and seems not only prepared to take on the big banks and the “Masters of the Universe” but also the political class in Washington. While the sparks fly in Washington and Wall Street, US manufacturing industry continues to grow in competitiveness. 

China, the leader elect of the Pacific Rim countries, continues to develop and focus on its plan to improve the lot of its people, a notion taken very seriously by the Government in Beijing, and use its economic power to gain political influence. The Government is careful and sensible in avoiding getting sucked into the global political debates and for the foreseeable future is unlikely to want to become one of the world’s policeman. 

There is a feeling of being part of a theatre audience waiting for Act II to being - Act I ‘Murder in the Banking System’ has been played out and we are left with two mysteries. Act II has begun with political sirens ringing and lots of rushing around of politicians in various parts of the world proclaiming solutions, slightly before the real problem has been discovered. 

The bodies that we can see are massive Government deficits which are not being addressed but will soon burst on the consciousness of Governments and Regulators, who are the actors in this scene. 

My apologies for stretching the analogy to the extreme, but until the deficit problem is brought home with a vengeance, the air cannot be cleared of the economic mismanagement of the last decade. Hopefully a year to eighteen months from now we will be able to look back on another short sharp economic crisis, and only then will we be able to get back to the economic and social improvements that need to be made to make the present decade a New Beginning.

Damon de Laszlo 
January 2010

DABERIAM LII

December 2009

As we head to the end of the year it does not seem that much advance has been made in returning the global economy to “normality” - whatever that is. 

The US economy is stabilising. That is the deteriorating trends have now flattened out but the piling up of debt at National Government and State level still continues. China with its huge resources is pouring money into infrastructure and primary industry - steel, aluminium and concrete etc. Russia seems as determined as ever to destroy its economy by creating uncertainly in the Courts; one of the first needs of economic growth is certainty of the enforceability of contract. Europe is a special case; the great concept of a free market for goods and services seems of late to have been entirely lost in battle between the political elite of the various member states as they manoeuvre to get position at the top of the EU hierarchy. Europe also seems to have totally forgotten the concept that leaders are best selected by democratic process. 

Continuing thoughts on Europe, it seems clearer and clearer that the union is becoming economically, as well as politically, dysfunctional. The so-called PIGS - Portugal, Italy, Greece and Spain - are heading towards economic disaster as their Governments fail to address their 
burgeoning deficits. 

As always, France paddles its own canoe, really very successfully, while Germany takes the strain. The German economy, however, is facing enormous strains. It relies on exports to a greater extent than any other advanced economy and the decline here has been dramatic. German companies have not downsized but have been relying on their economic fat to sustain them. German banks have still not addressed the high level of unrecoverable debt and derivative instruments that they hold on their balance sheets. Add to this the high level of the Euro against the Dollar means in all probability that Europe will be the last region to recover from the present crisis. 

The economic debate about the probability of a Dollar devaluation seems to centre around whether it will be fast, ie a crisis, or slow, the least painful way of dealing with the Government debt build up. What is forgotten is the Chinese have the ability to keep their currency pegged to the Dollar and their seeming determination to do so. This means that the Euro and the Yen, along with a few currencies primarily linked to commodities will be on the other side of the equation. Unlike Europe, Japan’s Government and economy is switching focus to China, and will continue to be one of the primary beneficiaries of Chinese industrialisation. 

Strangely, the beneficiary of the current economic realignments seems likely to me to be America. The American population have moved from a five year borrowing and spending spree into savings mode. This will reduce imports. US industry is rapidly restructuring and will over the next few years gain market share in both domestic and in the export markets. I think US financial markets will also benefit as it becomes clearer that the only place to invest surplus cash is in the US. Dubai has thrown sand in the wheels of the fascination with alternative markets for the time being. 

In finishing, it is worth a quick thought on the UK. As I have said before, the UK Government has effectively ceased to function in the run up to the next election. The lack of coherent policy offered by the political parties is likely to lead to a hung Parliament or at best one party with a minute lead. 

The current Government having lived off the service sector, and the City in particular, has through taxation and legislation slowly strangled UK industry and so far produced no policies for the future. 

The Conservatives have succumbed to lobbying from the City and embedded Greens within their party, seems to have decided that industry is bad, finance and shop-keeping is good, and the lights will be kept on by windmills! Their tax policy of reducing Corporation Tax by a few percent and removing the ability of companies to write-off Capital Expenditure means that the prospect for industrial growth and re-building of our energy and transport infrastructure will go out of the window. The new year brings the prospect of higher prices in the shops and rising unemployment caused by a large increase in insolvencies as companies find it more and more difficult to meet their pay roll and taxes and the Revenue get more desperate to collect everything they can. 

While the above may seem depressing, I feel optimistic. There are likely to be less surprises as the world hunkers down to dealing with the economic surprises that have been the hallmark of the last eighteen months. While things may be dreary and difficult, some semblance of certainty will return.

Damon de Laszlo 
December 2009

DABERIAM LI

October 2009

The beginning of the fourth quarter brings with it a rather surreal polarisation of economic thought. On one side the prediction that deflation is the greatest danger and that monetary authorities should continue to stimulate the economy. The deflationary argument suits politicians and bankers: the first are enjoying the largess of profligate Government expenditure and postponing the need to address the massive deficits; the second, who necessarily need to repair their balance sheets, can take advantage of loose monetary policy to make enormous profits. The deflationary argument is primarily based on two premise – first, that the high unemployment level will hold down wages, and second, the apparent availability of under utilised global manufacturing capacity. The argument is also bolstered by the convenient exclusion of food and fuel from most inflation calculations. 

On the other side, the inflationary argument is premised on the phenomenon that the creation of excessive amounts of money by the Central Bank and the banking system will, over the long term, cause prices and wages to rise. The simplistic summary being too much money chasing too few goods and services. There is also a line of argument that relates increasing interest rates to rising inflation. Again, simplistically, if Governments go on overspending, their borrowing will drive up interest rates when the Central Bank attempts to tighten the money supply. Rising interest rates and Government borrowing crowd out other investments which makes it difficult for those that supply goods and services to meet demand. The present financial crisis is, however, already making it difficult for individuals as well as corporates to borrow. The downturn in the economy, as well as borrowing constraints, are causing bankruptcies and the destruction of productive capacity. As a side issue, it is likely that the rate of corporate bankruptcy will rise over the year end; in the retail sector this is the moment at which banks historically tend to foreclose as shops have sold their stock by Christmas and it’s the moment when they have the most cash. In the industrial sector, as the economy starts to improve, companies are unable to finance their increased turnover causes them to breach their banking covenants. 

The interesting thing about arguments that are polarised around two extremes is that they tend to create a simplistic list of apparent contradictions. The wide ranging thought goes out the window as each side lob simplistic statements at each other, while ignoring what is really happening around them. 

Leaving aside technical arguments about deflation and inflation and looking around the world, it appears that prices being charged by Chinese exporters are rising as the Government encourages domestic expansion. It is also likely that the RMB will rise against the euro and the dollar as the Chinese Government is concerned about domestic inflation. Historically the West has been enjoying the benefits of “cheap” industrial and retail goods from China. Food prices are rising around the world owing to shortages, some caused by a lack of planting and fertilisers as farmers face financial constraints, and in other areas by bad weather conditions. Raw material prices are rising and the mining industry can only increase production slowly. In the same vein, oil at US$70/brl. is historically high for the middle of a recession. It is likely that commodity prices will continue to rise as the recession ends.

Inventories around the world are very low and the global supply chain has been destocking, recently at a faster rate than the decline in end sales. The computerisation of the supply chain has meant that businesses are run much more efficiently and leaner than in previous recessions. This phenomenon is particularly visible in the US where increased productivity and profitability in the industrial sector has been maintained even as the economy has declined. 

One can guess that nasty surprises will appear as these trends reverse. If lead times for your product in a downturn drops from eight weeks to four weeks, you only need to carry half your normal inventory. However when things pick up the lead times go from four weeks to eight weeks, you need to double your purchase requirement in order to double your inventory. This will give your supplier pricing power and also increase your need for capital. 

At the moment the retail sector is carrying very low stocks - ask any shopkeeper. This implies that it is unlikely that there will be broad scale sales in the Christmas period, something that has driven down prices in the last few years. 

It looks as though we are in for at least six to nine months of statistical economic growth which will not help employment, in fact unemployment will tend to continue on its rising trend. There is likely to be upward pressure on prices, and increases in taxation coupled with increases in personal savings. Somewhat bizarrely this is likely to be coupled with increased profitability in the corporate sector for well capitalised and well managed companies. 

The prospect of continuing and possibly rising unemployment is likely to have serious social consequences, particularly in the UK where the next Government will also have to constrain the bloated public pay-roll, which will lead to industrial unrest. Europe is not likely to fare much better, whereas we can expect the USA and Asia to have brighter prospects as the Government takes a smaller slice of the GDP cake and China in particular has better control of its economic policies. 

The good news is that improvements in stock markets are likely to continue as people wake up to the fact that holding cash is probably not a good investment over the next few years.

Damon de Laszlo 
October 2009

DABERIAM L

September 2009

Global Economic Indicators

The summer months have slid by without any new major economic mishaps. Stock Markets drifted higher and the statistical recovery started to appear. That is the rate of decline year on year flattened out giving a warm impression that the end of the crisis was at hand. 

September and the return to work has brought a little reality back into the Stock Markets which are likely to be confused over the next month or so as everyone waits to see what the autumn brings. While the US economy has stabilised and Government stimuli begin to take hold we are seeing both 
a real and statistical upward movement in the economy; however real GDP growth is unlikely. Private sector borrowing, which was adding 1-2% to US GDP over the last 4 to 5 years, is now quite naturally turning into savings to pay down debt. These savings must produce a very considerable drag on US GDP growth. The good news is that the US will import much less and its balance of trade will improve. The savings in the short term will help considerably towards funding the Government and State deficits. The US business sector reacted exceptionally rapidly to the economic downturn with the result that the majority of US industry has cut its borrowing requirements and maintained productivity to a remarkable extent. All this sets the stage for an improvement in the Government’s revenue from corporate taxation, a rising stock market over the next few months but little comfort on the employment front. The 2 icebergs, clearly visible in the economic sea, are the Government deficit, how fast will it melt away, and the huge liquidity bubble that the Fed has pumped into the system which could turn into inflation if it is not reabsorbed.

World Economic Growth (IMF Figures + Projection)	2009	0.50%	2008	3.40%	2007	5.20%
Base rates: 31 August 2009	USD	0.25%	EUR	1.00%	GBP	0.50%
MSCI World Equity Index	31/08/2009	201.726	31/12/2008	181.894	YTD %	10.90%
Gold (PM London Fix $ per  ounce)	28/08/2009	955.50	30/12/2008	869.75	YTD %	9.86%
Oil (WTI Crude $ per barrel)	31/08/2009	69.96	31/12/2008	44.60	YTD %	56.86%

China, a country whose economic management should be a case study for all central banks and Finance ministers, seems to be reducing Government stimulus in order to prevent an asset price bubble developing. The Government’s effort to redirect the economy from export led growth to internal growth is gaining momentum. Chinese Government initiatives to collaborate with Taiwan and Japan are particularly pragmatic. The same drive to work with India is more difficult owing to political tensions along the Himalayan border and potential conflicts over water which is in short supply on both sides of the mountain range. China’s efforts to redirect its economy will have considerable impact on the prospects for inflation in the West. The supply of consumer goods to the Western market, which has been a major contributor to lowering the price of goods over the last 5 years or so, is declining. 

South America and Australia did not fully participate in the economic boom that was driven by the 
borrowing of the Anglo-Saxon world, prospering as with China. However they continue to prosper as China and the other Asian countries stabilise and increase their imports of food and raw materials. Europe, on the other hand, is suffering with its Governments of economic ostriches. Germany, unlike China, plans to continue promoting its lopsided economy by favouring exports over internal growth, ignoring its massive internal imbalances. The Mediterranean countries continue to hide within the € currency their massive Government deficits leaving France in the middle pursuing its own, and I have to say, pretty successful brand of state sponsored corporate socialism. Britain remains the oddest animal in the Zoo. Its unfundable Government deficits, without the protection of being in the €, could at any moment collapse Sterling and ignite inflation. We will, as a country, have to wait and hold our breath until after the next election before there is a chance that a coherent economic policy can appear. 

In general we go into the autumn with an improving Global economic picture but with the worry that the pain after the party of the last 5 years is going to be felt by the most vulnerable parts of society. Unemployment is likely to be the biggest social problem in the aftermath of the boom 
years.

Damon de Laszlo 
September 2009