December 2012

The atmosphere of economic gloom that surrounds western economists and journalists is beginning to feel like a comfort blanket. Those who have to take decisions today about future investment, particularly investments that may take a year or more to mature, have to be exceedingly cautious of current economic fashion. To make decisions the examination of economic numbers needs to be done in great detail along with an assessment of economic crowd psychology to see how far down a particular line popular opinion has gone and where it might turn. “Look through the noise to find the signal” is a useful old radio operators rule.

Today we have a world in roughly three pieces – Continental America, North and South; Continental Europe from Russia down to the bottom of Africa; and, Continental China down through the Pacific to Australia.

The lead taken by China to develop itself encompasses the Pacific Rim. The north south flows of goods and raw materials and the development of China’s domestic market is going well, and worries about the change of Government are past. The Chinese policies to raise wages, build out infrastructure and housing on a massive scale and reduce its balance of trade surpluses, particularly with the USA, seems to be on a steady path.

As an aside, India (one could call it the ‘ever hopeful Continent’) happily muddles along in the slip stream. Its growth could be prodigious but sadly it suffers from European style government. Massive bureaucracies block change and development, stifling the potential for economic progress.

The USA is set for a dramatic recovery. The American corporate sector and the private sector have paid down debt and hugely increased liquidity. Its banking sector has by and large written off its bad debts and bad mortgages, unlike its European counterparts. US wages have remained flat for a number of years and there is surplus labour which roughly costs the same as German labour, but works longer hours. The fact that Washington is dysfunctional, as is well reported, is possibly not that important. While there is much glee in the economic and popular press about the fiscal cliff, this in reality is more likely to be a Y2K type phenomena.

The Government will either smooth it a little or they won’t, but taxes have to rise and expenditure has to be reduced, and the psychological fear is far greater than the reality of the problem. Raising taxes to where they were under the Bush regime is hardly a major crisis and an unpleasant and somewhat random cut in government expenditure will,

together with the tax increases, produce a short term and what one could call technical drop in GDP. Headline GDP is a bizarre number anyway as it includes the Government deficit. Chancellor, and later Prime Minister, Brown in the UK, like President Bush, was able to boost GDP by running an irresponsible deficit in the years running up to their hoped for re-election.

The much more dangerous ‘elephant in the room’ is the government debt ceiling of some 16.4 trillion dollars, an eye-watering number estimated to be reached in February. If Congress does not gets its act together this brick wall could bring the Government to a juddering halt and would cause genuine economic dislocation.

Given the above, the picture for the USA for 2013 and onward is a country where the private sector is ready and able to expand rapidly and, apart from capacity in the labour markets, the fuel for this expansion will come from the country’s cheap energy supply, causing an ever increasing number of companies to repatriate manufacturing. US natural gas prices for manufacturing are roughly 3 dollars per MBTU, compared with 10 in Germany and 13 in Korea. US industry electricity prices are heading towards 50% cheaper than in Europe. Major companies have already announced the building of new facilities in the US, e.g. Airbus, Toyota, Samsung, Apple, as well as a number of major chemical and motor car manufacturers, with many more to follow.

Europe, with Africa and Russia to the north, seems to be the third of the globe that really specialises in bureaucracies and in the not too distant future will be more aptly described as the Third World. Even Germany, quite the star in this rather arbitrary segment, is being dragged down by the need to support the EU, a fascinating experimental area where democratic governments have abrogated responsibility to unelected bureaucracies.

Private endeavour, and business, can only flourish in an environment of legal stability. Businesses like individuals cannot make decisions in the face of public uncertainty and this applies particularly to innovative and imaginative investment where the returns are more difficult to calculate owing to market uncertainty. Corrupt government where personal and business assets can be taken by politicians and bureaucrats demonstrably produces poverty. Massively bureaucratic governments have the same result over a longer period as they glue up decision taking and take an excessive slice of profits while absorbing none of the risk from business.

It is worth reminding ourselves of these observations as there is a danger that Europe could implode under the weight of all the various phenomena mentioned.

The UK, slightly to one side of Europe, is also sadly going down a path of bureaucratic overload and government by public opinion. In spite of political phrases such as “a bonfire of red tape”, we have seen in the last couple of years budgets which have failed to roll back

government expenditure on the one hand and have massively increased the complexity and uncertainty of doing business on the other.

Politically led witch-hunts of legitimate businesses that are compliant with law but don’t seem to be paying enough tax is undermining the reason why so many businesses come to the UK or are successful in the UK. This is a very dangerous trend, particularly from a Conservative Government, that traditionally championed legality and the rule of law. Hopefully, Europe will muddle through its current crises but one can definitely be less optimistic about Africa and the current trends in Russia.

Not all, however, is gloom as America and Asia’s economic growth improves. Europe is capable of recovering and the downward slope of prosperity can be stemmed.

It’s ten days to the shortest day of the year, Friday 21st December. From there on things should look better and certainly after we get through the first quarter of 2013 the current economic gloom is likely to start receding. The second half of 2013 is likely to see growth picking up quite fast as inventories are low and capital expenditure is way behind normal replacement levels.

Damon de Laszlo 11 December 2012