DABERIAM XXIV

March 2006

It is a good moment to make some observations on the UK - before the Chancellor presents his new budget later on in the week. It will not be possible to make an intelligent comment on the budget for several months after its announcement, as it is now the customary habit of the Labour Government, and the Chancellor in particular, to make grandiose announcements, the real meaning of which will not be apparent until after the detailed legislation has been published. 

Over the last ten years we have seen a Government that has gone from having some good ideas and honest political intent, to one of extraordinary arrogance where the public announcement of usually ill thought out initiatives, framed in sound bites, don’t materialise as actual deliverable policy. Over the last few years Government action has amounted to serial meddling with every instrument of state, reducing the health service to a shambles, the education system to chaos, and the social security system that supports the poorest and most disadvantaged in the land to a complete farce. 

The Chancellor, who will no doubt announce in his budget rafts of reforms, has, over the years, made the tax system so complex that it is now almost impossible for any individual or company to comply with the rules. At any time the tax authorities can haul a company over the coals for breaches in the now endlessly complex waivers, calculations and allowances that even the best accountants don’t understand, let alone the revenue officers themselves. Non-compliance is called fraud, and the numbers of co-called cases of fraud have skyrocketed.

Global Economic Indicators

World Economic Growth  (World Bank figures)	2005 (est.)	3.20%	2004	3.40%	2003	2.90%
Base rates: 28 February 2006	USD	4.50%	EUR	2.25%	GBP	4.50%
MSCI World Equity Index	28/02/2006	210.596	31/12/2005	203.143	YTD %	3.67%
Gold (PM London Fix $ per ounce)	28/02/2006	556.00	31/12/2005	513.00	YTD %	8.38%
Oil (WTI Crude $ per barrel)	28/02/2006	61.42	31/12/2005	61.04	YTD %	0.62%

As a digression, arriving back from Singapore the other day and after a long flight confronting the chaos of London Airport, when they couldn’t get the jetty to the aeroplane, the Hostess announced "Welcome to the Third World" - a frighteningly true statement! 

While starting the year feeling optimistic, it is difficult to maintain this optimism as the day to day experience of running a company in Britain and Europe gets more and more difficult owing to the legislative overload that continues to pile up. Having said that, business opportunities around the world continue to improve. China, Japan and the rest of Asia continue to grow steadily and the underlying strength in the US economy continues to confound the pessimists. 

The US domestic economy grows and evolves according to basic economic theories. The efficiency of the US banking and industrial sector continues to evolve, as is the case in Germany and Japan. The legacy problem of old age pensions and Union intransigence gradually get solved. 

This compares with the huge growth in China and the other Asian countries with new capital investment, and new entrants into the workforce, but rather inefficient banking and capital allocation systems. Nevertheless, the China and India growth will drive the world economy for some considerable time. If we include Japan and Russia, it is possible that in the near future these groups will become self sustaining and will not require USA and EU as their primary markets. 

The twin American mysteries of the US negative savings and huge balance of trade deficits continue to defy reason. There must be a possibility that the report of these two deficits is skewed by a lack of good data. The most peculiar of the two deficits is on the current account, where China and the Middle East governments continue to buy US Treasury Bills with the dollars they earn from exports to the United States. As I mentioned last month, US politicians are doing their best to discourage this flow of dollars back into the US but the difficulty for countries outside the US is - What else do you do with dollars! While this is a difficulty in the longer term, in the short term a disruption to the dollar flow would be very damaging to the US economy and the stability of the dollar. The US Senate‘s continuing flirtation with the 27.5% tariff on Chinese imports would also impact US inflation and the inevitable Fed response. Hopefully we will continue to muddle along, and the markets will continue to rise as companies embrace new technology. There are still enormous productivity gains to be made from capital expenditure and we are only at the beginning of this cycle of increasing profitability. There only remains the question of the rather cavalier Western attitude to the Global economy, which could be a worry.

Damon de Laszlo 
March 2006

DABERIAM XXIII

February 2006

It’s a funny old world, where the great advocate of world trade and open markets, the USA, is adding notch after notch to its gun opposing globalisation. 

Hard on the heels of Congressional opposition to CNOOC bids for Unocal, we have opposition to Toshiba’s bid for Westinghouse, a subsidiary of British Nuclear Fuels and now Congressional opposition, lead by Hilary Clinton, to Dubai’s D P World takeover of Britain’s P & O’s US container ports. 

The political motivation for the opposition to these takeovers is complicated and various but none of them really stand up to the strategic arguments being put forward. For example, D P World is one of the most efficient operators of Ports in the world, certainly compared with the inefficiencies in the US ports system where many local port authorities are run by political appointees. 

Added to this the string of lost cases in the World Trade Organisation that the US has suffered and you have growing damage to the future of world trade and its greatest promoter, the USA. 

Global Economic Indicators

World Economic Growth  (World Bank figures)	2005 (est.)	3.20%	2004	3.40%	2003
Base rates as at 31 January 2006	USD	4.50%	EUR	2.25%	GBP	4.50%
MSCI World Equity Index	31/01/2006	230.193	31/12/2005	203.143	YTD %	13.32%
Gold (PM London Fix $ per ounce)	31/01/2006	568.75	31/12/2005	513.00	YTD %	10.87%
Oil (WTI Crude $ per barrel)	31/01/2006	67.93	31/12/2005	61.04	YTD %	11.29%

Brussels, whose public avow is also freedom of movement of goods and services globally, and in particular within the European Union, is also sending out very mixed messages with its long standing divisive agricultural subsidies and its apparent lack of ability to prevent national governments in Europe stoppping the takeover of their favourite companies. The most recent being the Spanish Government’s opposition to the acquisition of its domestic gas company, ENDESA, by EON. Not long after the Spanish competition tribunal refused to allow ENDESA’s takeover by another Spanish group on the basis of hurting domestic competition. The list of politically opposed takeovers in Europe is considerable and runs from the banking industry to the steel industry.

Outside the US and Europe we have Russia, a highly directed economy consolidating its energy industry, its aircraft and its motor industries. China on the other hand, seems to be working towards opening up its markets and gradually adopting Western, professed, economic and management policies. The slowness of progress in China is largely due to the lack of infrastructure that can cope with free enterprise. 

A good example here is the measured Chinese introduction of flexibility into its foreign exchange markets. Giving the banking system which was primarily centrally directed, and as a result incredibly inefficient, freedoms in the foreign exchange market, would be guaranteed to create bureaucratic speculative disaster if it was pushed forward before the expertise and management abilities, that are assumed in the West, were in place 

The enormous benefits derived from global trade, a major contributor to the stable and even declining prices we have seen in the last few years, is driven by the private sector and no longer by Governments. The growth in world trade and the enormous benefits that it has brought to world prosperity over the last ten to twenty years could be threatened by the problems of energy supply and could be disrupted by the appearance of pandemics, however unlikely. 

However, the greatest threat today seems to be the growing acceptance of political interference by Western governments in world trade and, therefore, prosperity. Igniting a trade war would do far more damage to western economies than almost any terrorist threat or pandemic. 

In trying to assess future risks this political trend is the most worrying. If markets are allowed to work then, for example, shortage of oil resources will be overcome by commercial developments. Incidentally, the shortage of gas in the free market in Europe is probably a more dangerous risk than any of the other perceived risks today. A capricious Russia even threatening to cut off supplies to Europe could create major 
economic chaos in the world. 

In the same vein, Iran could more easily disrupt the world’s energy balance by cutting off oil supplies, with an economic impact far greater than the likelihood of it acquiring or being able to use nuclear weapons in the foreseeable future. 

On the economic front, Central Banks around the world are becoming more restrictive and there is now a general fashion to raise interest rates. While the tremendous growth rates in China and India are pushing down the prices of manufactured goods they are mopping up the surpluses of commodities that we have been used to over the last twenty years. The rise in commodity prices is not feeding through into inflation yet as the Asian manufacturers’ massive industrial investment pushes down the price of goods in our shops. There are also perverse effects in that the rise in the price of oil is making the production of ethanol an economic source of energy. Ethanol is produced from high starch agricultural products such as sugar and maize. This, plus the increase in cost of fertiliser, which is derived from oil, will push up food costs. 

The response by the World’s Central Banks is to halve the equation, the rise in commodity prices and the risk that it will feed through into the retail price indexes. But there is no indication that Western wage rates are rising faster and the Asian pressure on the prices of manufactured goods is holding retail prices down. The result of the pressure of higher commodity prices and interest rates will be an inevitable slow down in Western economies. 

However, the impact of Asian manufacture on the world economy is a phenomenon last seen over a hundred years ago when US production of manufactured goods started to have an impact on Europe. Because this phenomenon is so unusual it is likely that Central Banks will continue to raise interest rates to the point that our economies will slow more rapidly, making the picture for 2007 rather less optimistic.

Damon de Laszlo 
February 2006

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

DABERIAM XXI

December 2005

"The intensity of the political divide has done more than alarm foreign investors and diplomats. It has crowded out practical policy debate and made consensus on important issues difficult. It has undermined the reputation and independence of public institutions. Finally, it is threatening to damage the economy by contorting electoral politics into a populist game of chicken. “By failing to address the real situation and by raising the wrong questions, politics in [.........] tends to create more problems than it solves" 

The above quote from Christopher Condon’s article on Hungary in the F.T. earlier this week seems to me to be equally applicable to the leading countries in the Western World. 

Political in-fighting a hundred years ago was much less of a problem as by and large countries got on with the business of commerce and creating prosperity without Government interference. When the size of Government is restricted to 10% of GDP the politics is less important, with the exception of when leaders go to War. Today where Government expenditure for US is 36% of GDP and Europe is in the high 40%s, Governments’ inability to direct resources efficiently is critical. Europe in particular seems to be incessantly mired in ridiculous squabbles about subsidies, which not only damage domestic economies but also the rest of the world, and a fascination with applying ever more complex rules to the shrinking productive sector is alarming for long term growth. 

By comparison China and India have, to a greater or lesser extent, Governments that can think strategically and at least have a vision beyond the next publicity event. Are we in the 21st Century embarking on a competition between methods of Government? Democracy came out on top in the struggles of the last Century between totalitarian regimes and democracy, but given no current competition the democratic states seem to become mired in petty politics, while failing to address the major issues of our time and ignoring the focussed but relatively benign Governments of China and India with their fast growing economies. 

On another tack, it is interesting to ponder on Western Central Banks apparent lack of interest in the questions of broad money and credit development to the point that the US Federal Reserve Bank is going to discontinue publishing M3 next year. 

The growth in money supply in the last few years has led to enormous rises in asset prices and commodities. I have for the past two years expected this increase in the money supply to drive up the cost of goods and services. As a dangerous generalisation I think this correlation seems to have been broken by China and India. These massive economies are relentlessly driving down the prices of goods and many areas of the service sector. Both economies are focussed on improving the well being of their people. This takes the form of an economic policy of encouraging capital investment, enabling people to work in comfortable conditions in factories, compared with the awfulness of life in paddy-fields and the like. The consequence of this investment is an enormous increase in the production of goods in China and of computer based services in India. 

These unbalanced investments, particularly in China, are deflationary and it is difficult to see how most of the new industrial production will be profitable in the short to medium term. 

The good news for this Christmas season is that the Western standard of living continues to improve in the short term on the back of these developments. 

A good point to leave you with my best wishes for a marvellous Christmas and a prosperous New Year.

Damon de Laszlo 
December 2005

DABERIAM XX

2005

Since October I have been from Bermuda to Beijing via New York, Los Angeles and Singapore and back to Hong Kong. America left the impression that the world was rocking along just fine. Hurricanes have come and gone and oil prices have declined, the consumer has recovered confidence and US company earnings continue to grow at a steady pace. The US’s ability to take advantage of technology and improve its national productivity is intact and ahead of the rest of the world. The biggest worries that Americans seem to have amount to food fetishes and avian flu. The worry from the middle of the year on the economic front has abated strangely as interest rates have risen, driving up the value of the dollar. Asian product continues to keep prices down for the retail market so there seems to be a glow that will probably run into the second quarter of next year. 

Asia is astounding, flying into Singapore one can see container shipping reaching for miles in every direction. This micro-nation, the model for Deng Xiaoping’s new China gives one insight into the Asian mentality. Meeting Academics and one of the Government Ministers, one realises that the primary object is prosperity and a strong understanding that this must apply to the whole community. In both Singapore and Beijing, one meets this attitude across Government. Supporting it, are highly intelligent and well-educated Government officials who have a cohesive vision running into the future and strategic planning that support the vision. This cohesion is startling coming from the chaotic political and muddled administrative thinking in Europe and the US. 

In a fascinating meeting with Kishore Mahbubani, Dean of the Lee Kuan Yew School of public Policy and author of “Beyond the Age of Innocence”, a book that everyone who is interested in US/World relations should read, one realises that Asian cohesion is growing at many different levels. The only cloud on the horizon is the danger that the US Congress will start a protectionist war. Even this concern is becoming less of a danger as inter-Asian trade grows. 

Moving to Beijing, I met with Professor Li, who is DG of the Institute of Finance and Banking at the Chinese Academy of Social Sciences, formerly holding a number of Government positions, and Professor Lin, who sits on a number of the national committees on economics. Both men are well versed in the higher levels of Chinese economic planning and reviewed the “suggestions for the 11th Five-Year Plan” which will go to the People’s Congress in March 2006. The extraordinary process of generating consensus and then driving through Government policy on a five-year basis enables China to deal with the vagaries of the rest of the world. These plans are not always perfect, but they are the result of long deliberation by people who have a deep understanding of the way economics works.

The most interesting part of these meetings was the review of the social problems and the way they are being addressed by the Government. Within the strategy going forward, it is accepted that “the urban-rural disparity is increasing. The disparities may cause social instability!” This statement refers to a study that commenced in 1978 and concluded that if the level of income disparity between urban and rural areas exceeding .45, this was alarming. This is currently at .47 and is causing considerable worry. 

One of the by-products of this thought process is that the industrial development of China must continue apace. In economic terms there is a need to get some 300 m. people off the land and into factories. The dual social consequence is the improvement of agricultural efficiency along with a huge improvement in the working and living environment of the people. Chinese factories are of high standard, but any factory beats a paddy field as a working environment! All of this is encapsulated in a new part of the next Five-Year Plan: “putting people first and achieving a balanced growth.” This follows the older statement “The Government should rely on economic development and reform to solve the emerging problems.” 

One problem that is causing a lot of debate is the lack of a Western style banking system. In discussions there was an indication that Chinese financial management will shift towards Hong Kong to take advantage of the sophisticated banking system that is in place. Shanghai is not likely to develop fast enough to provide a stock market that could absorb the privatisation of state industries as well as the necessary infrastructure to run a debt market. Hong Kong can also act as the experimental ground for loosening up the exchange rates. At the moment there is considerable concern that a free RMB would cause a massive exit of currency into dollars where a reasonable rate of exchange can be had. This would have the effect of driving down the RMB, cause havoc in the banking system, and antagonise the US and the rest of the world, all those prospects are not considered desirable by the Government. 

The global economic effect of Chinese planning is that there will continue to be little inflationary pressure in world-traded goods. China invests in the most modern equipment for its factories; combine this with the Government policy of getting people into employment, and there is a low, or as I commented before, a ‘not for profit’ economy in the near term. Another fascinating discovery that came out of my visits was a major drive into the software industry. Chinese industrialists have looked at India and are going to compete head to head.

This brings us to an interesting question of India versus China. Close relations between the two countries are being developed, as is an ever-closer relationship between China and Russia, driven by American Congressional attitudes to China. India’s advantage of English and its enormous pool of management talent is rapidly lifting India’s GDP. By contrast, China is short of English language speakers and management. This lack of management is a major problem for Chinese economic development. India, on the other hand, suffers from a huge and corrupt bureaucracy, which historically has killed off economic reform and development, but owing to the opening up of world trade and the Internet, may not do quite so much damage this time. 


The other problem for India is the lack of a modern infrastructure. In 2003, India’s infrastructure spending was US$21 bn. (3.5% of GDP) compared with US$150 bn. (10.6% of GDP) in China. While China’s infrastructure spending may be to some extent wasteful, it still leaves India with a lot of catching up to do. 

Japan is the other major player in Asian development, and here we see economic growth showing definite signs of recovery and zero inflation. China is a major market for Japanese industrial products. While deflation is a threat across Japan and China, it probably won’t remain so for much longer. The area is awash with liquidity and at some point inflation will reappear. There is cause for optimism as a hugely increasing industrialised population with a growing disposable income takes hold. 

A word on oil. There is a growing lack of spare capacity, partly due to the lack of exploration over the last twenty years and partly due to the inefficiencies of the nationalised oil industries from Russia to Latin America. However, the reason rocketing prices overshot was as a result of subsidies in the fastest growing consumer markets in Asia, with a final spike created by the hurricanes in the southern States of the US. Rising prices in the US and Europe dampened demand relatively quickly, but the downward pressure has now come from reduced demand owing to increased prices in China and Indonesia. 

Longer term, we do have a supply problem, but in the short term the economic damage of high oil prices has been mitigated. At some time, however, the US trade deficit will become an issue, but probably not until interest rates rise in Asia.

Damon de Laszlo 
November 2005