by Damon de Laszlo, ERC Chairman

Damon de Laszlo

Damon de Laszlo

We seem to have drifted from September to November in a kind of suspended animation.  The US recovery has held up remarkably well despite Trump-created uncertainty and a worry that ten years of improving stock markets should herald an end to a period of growth and bring in a cyclical re-balancing – in other words a recession.

The US stock market has gained new heights as the Fed has poured more cash into the economy, but capital expenditure and productivity growth is running at a low ebb.  The big worry here is that with full employment and an ageing population, the lack of productivity improvement means the economy is heading into demographically induced decline and low interest rates are supporting too many effectively zombie companies crowding out potential growth.  The problem of ageing populations is also affecting China, Japan and Europe. The lack of productivity with its improving wealth effect is a major cause of unhappiness in the west amongst the majority in the middle-income band.  This growing unhappiness brings with it the political fragmentation of the established parties and public volatility as we have seen in demonstrations in France and Britain, and which has also probably contributed to the problems in Hong Kong. As an aside it is interesting that China has not intervened. The demonstrations are encouraging financial institutions to consider moving out and in some cases to mainland China. Something Beijing has been trying to encourage for a long time!

In the UK the “establishment”, and Parliament in particular, has managed to derail the Brexit process.  Boris Johnson’s “renegotiations” produced a package that was far superior to May’s agreement to agree, but nevertheless alienated Ireland and provided a means for the Remain groups to derail the process by forcing the government to ask for an extension.  The extension was surprisingly short to my mind as luckily the French desire to extend for another year was turned down.

Looking back over the last three years, regardless of which option you would prefer, Remain or Leave, the behaviour of Parliament has greatly undermined Britain’s image as a democratic state.  Parliament, having called a Referendum on a complicated subject, regardless of whether you think it is a good or bad idea, accepted the outcome; on several occasions voted for ‘Leave’ legislation, then proceeded to undermine the processes by which Leave was to be implemented.  Basically, making a farce of the Referendum and the parliamentary voting system.  Add to this the language, sadly particularly of the Remainers, along with the editorial coverage in world circulating newspapers such as the Financial Times, has been vitriolic and disrespectful of the office of Prime Minister etc.  The extraordinary language and immoderate accusations made have created an impression in less democratic parts of the world that democracy is dysfunctional and as a system of government to be avoided, damaging the cause of democracy  and the reputation of Britain.

Leaving aside America, the piling up of debt by the European Central Bank and China’s Central Bank is creating a potential minefield.  At some point this excessive supply of cash in the monetary systems will precipitate a crisis, it causes extensive misallocation of resources into non productive areas. Central Bank’s intervention is depriving the insurance industry and pension funds, along with the banks, of appropriate places to invest their cash at risk-free or near risk-free interest rates.  As the Central Bank mops up Government debt, the private institutions are forced to buy lower and lower quality debt in the hunt for yield to sustain their commitments.  When new regulations that are restricting the banks ability to provide short term liquidity to the market through their trading desks are added to the mix, a potential crisis is made more toxic if institutions start to try to liquidate their holdings.

There is also the growing problem that cheap money is being used to expand the business of so-called private equity.  Private equity companies, that have grown out of all proportion in the last five or six years, can borrow cheaply to buy the shares of Private and Publicly quoted businesses. The process is then to arrange for the company to borrow excessively and pay out this cash to the shareholders. This leaves the target company heavily over-geared and exceedingly vulnerable to collapse, which we have now seen in the UK in three major bankruptcies.  This trend along with other financial engineering techniques is becoming enormously damaging to the British economy, European and, to a lesser extent, the US economy particularly as it discourages managements willingness to embark on R & D and capital investment. Without this investment and the resulting productivity improvements it will be impossible to maintain let alone improve the developed world’s standard of living, particularly in the face of the deteriorating demographics.

My apology for adding further to the “Wall of Worry” but climate change is also a serious issue that is high on the agenda, particularly of the young. Here again it is a problem best addressed by Corporate R & D. Political flag waving and demonstrations will not help particularly if it encourages bureaucratic restrictions rather than investment and innovation.

These are major structural issues that are building and are likely at some point to cause a crisis. However the timing as always is wholly unpredictable so we should enjoy the current calm and can probably ignore the squalls and political chaos for the time being!

 

 

Damon de Laszlo
7th November 2019

 

Posted by Aimée Allam