May 2013

Following a trip to Asia in March, I was on the east and west coast of the USA in April with a side trip to Bermuda. It is interesting to note, as an aside, that Bermuda, an idyllic island with an enormous income stream as a corporate headquarters, is slowly strangling itself with socialism.

The USA continues to grow along the lines I mentioned in March. The cheapest energy in the world, a predictable legal system and a relatively well trained and competitive labour force, is gradually producing industrial regeneration. The banking system has, by and large, reserved for or written off its bad debts and consequently is lending again (without any government intervention). State Governments are well on the way to balancing their books, and the Federal Government deficit is enormously reduced, now running at around 51⁄2% of GDP down from some 10% three years ago. It is also worth noting that household debt is now down to 2006 levels. With a small amount of monthly variation all sectors are improving. The enormous rise in the stock market brings it up to pre-crisis levels. Company earnings are keeping up and, indeed, the forward price earnings ratio is still under its historic average.

On the domestic front, household debt is down at a sustainable level relative to income and businesses are flush with cash, although some of it may be stuck in the wrong part of the world. In spite of this, capital expenditure is only rising slowly. While companies are taking on employees, they are not investing so productivity at the moment is declining. There is a perverse incentive in the system; large companies incentivise their management on a short term basis. Return on capital is a large element of the incentive and this discourages long term capital investment and R & D. In other words, in the short term financially it looks better to take on labour and not invest in plant and machinery. The drive for short term profits also seems to be impacting R & D in the large company sector. This phenomenon seems to be to some extent exacerbated by private equity groups, who can take over businesses reducing their R & D and capital expenditure programmes and give the appearance of improving profitability, albeit in the short term. Both of these trends are also affecting companies in the UK.

On a political point, while President Obama has a log-jam on his hands in Congress and the Senate, he does at least seem to be taking a more cautious approach to the situation in the Middle East, and has so far avoided the political temptation to militarily intervene in Syria. While the liberals and the military hawks love sending in the soldiers, he is so far resisting, noting perhaps the not-so-glorious interventions of his predecessors in Libya, Iraq and Afghanistan. Hugely complex situations with all sorts of historical cross-currents are not easily solved by the simplistic call to armed intervention. It is also interesting and heartening that we are not hearing bellicose noises about the situation in the South China Sea between Japan and China and, indeed, he seems to be leaving the problem of North Korea to the Chinese to deal with. All of this is good for the global recovery.

This brings us to Asia, where China is keeping a steady course and the Asian economies have got through a couple of elections without mishap. Japan has embarked on a quantitative easing experiment on a gigantic scale, flooding the market with liquidity and driving down the value of the Yen. Japan’s QE experiment is far in excess of anything attempted by the Fed in the USA and the ECB in Europe. The leap in the stock market is predictable as is the rise in interest rates and inflationary expectations. How this exercise turns out in the longer term is less predictable but it could I think be the trigger for a perverse rise in world interest rates. Institutions in most countries are overweight in fixed interest paper and, in particular, government bonds. Most would agree that at some point interest rates will start to rise, in any event it is difficult to see how the ten year down trend can continue. The question is, however, do interest rates rise slowly or suddenly? A change of institutional investment fashion could mean there is a rush to dump short and medium term paper, which would rapidly drive up rates.

Jumping back to Latin America, there now appear to be a growing feeling of confidence and cohesion on the South American continent with Brazil’s Roberto Carvalho de Azevêdo taking over presidency of the World Trade Organization. This is a change that could have long term ramifications for world trade and the West; particularly Europe which may find itself being marginalised on the world scene.

Many of the Latin American countries are growing rapidly and while they have a sometimes uneasy relationship with North America, Europe is of declining interest both as a source of goods and services and as a customer for their raw materials. Also there is a trend to divert oil from Venezuela and Brazil around the Cape and into the Pacific for consumption in Asia. In the not too distant future with the widening of the Panama Canal, Europe could find itself wholly dependent on Russian and Middle East oil and gas. Russia is also more and more focussing on China as a major customer for its gas.

Europe continues to muddle along. While the fundamental issues are being discussed, it is difficult to see any real action being taken, particularly as German policy is now beginning to be paralysed by the forthcoming election. The European region would seem to be taking over Japan’s role as it settles into a stagnant decade.

The UK Government continues to muddy the waters of recovery. The lack of political leadership along with incoherent economic and infrastructure policies is not helpful. Political attacks on business do not encourage investment, political polarisation and slanging matches over Europe are also not helpful. The lack of government grip discredits the country in the eyes of Asia and the new world. If you can’t franchise a railway line, let alone build one, and in spite of a crying need you can’t even build an airport or authorise any new power stations, it’s difficult to hold up our democratic system as a role model to countries who are endeavouring, successfully, to improve the lot of their people.

Damon de Laszlo 15th May 2013