October 2015

Since August, the world seems to be spinning along in a happy state of political muddle. It’s difficult to see any change in the macro economic world, yet newspapers and pundits are full of reports, concerns, worries etc. Politics in the West, worryingly, is becoming more and more intellectually vacuous but politically strident. In the United States, the antics of presidential candidates are certainly worrying to their allies and must be even more worrying to the rest of the world. While Congress is gaily discussing shutting down the economy because of what appears from the outside to be petty political bickering, presidential candidates seem to be making a virtue of their lack of understanding of the importance of the USA on the world stage.

The European Union on the other hand, seems to have buried the political process. We no longer know who leads Europe and it would be surprising if even 1% of the European population could name the President who, in any event, changes every six months! European leadership has defaulted to the German Chancellor, Angela Merkel. Germany controls the purse strings and currently appears to be the only stable political government, with pragmatic and sensible policies.

When one looks at the rest of the world, commodity producing countries of South America, the Middle East, Russia and Australia are suffering from cyclical oversupply and a reduction in the rate of China’s infrastructure growth. While this is painful for commodity producers, it is actually a major plus for western and Asian countries. The large decline in commodity prices is having a beneficial deflationary effect on the majority of the world’s population, but bizarrely it has become a major worry for Central Banks and governments. Economic models in the IMF, through the Fed to the Bank of England and other western economies, are not used to dealing with this phenomenon and it is uncomfortable for spendthrift governments who in recent history have relied on inflation to mitigate their debt. It is bizarre that the Fed and the Bank of England have not increased interest rates by even a quarter percent; a rise of this size would have no negative impact on the basic economy. Companies and individuals would not borrow less and, indeed, it would be beneficial to savers and pensioners. The only negative impact would be its cost to government and this is probably where the pressure not to raise interest rates is coming from in reality. The distortions created by low interest rates on the insurance industry and the pensions industry in particular is effectively a hidden tax, hiding the true cost of government deficit. While government borrowing to finance the current deficit is itself a tax on future generations.

On a more optimistic note, one can see that the US domestic economy is growing. Statistically this is confused as the popular and published GDP numbers include the commodity based industries. Energy companies in the US make up a large percentage of the S&P 500; it is estimated that the decline in energy prices impacts the profitability of the S&P 500 by 6%, but this decline, while hidden, is beneficial to the economy as a whole. Low or

zero inflation is also beneficial in this way. While the short term impact of these statistics causes economists to worry, the benefits will start to appear in the latter part of this year and the early part of next year, as individuals and companies adjust.

China, which is on everyone’s worry list, is doing exactly what it said it would do, and that is reduce the economy’s reliance on exports and infrastructure building. The country generally is becoming more service and retail orientated, to the benefit of its population in general. The reorganisation of the economy is, as an aside, having a major impact on some of its older industries, for example steel mills in the north of the country are being shut down with the loss of tens of thousands of jobs. Courageous political decisions are being taken which would be unthinkable in the west. The intentional slowing down of the Chinese economy from the mid-teens to the 7% target will probably overshoot as the idea that you can control an economy of this size with an accuracy of a single percentage point shows the economic illiteracy of western reporting. It is unlikely that the Chinese economy will stall and even 4 to 5% growth would be remarkable in a country of this size. The growth of the Chinese private sector is likely to result in the sort of economic volatility that is experienced by the west, not a bad thing as it’s an indication of a freer and more prosperous society.

Damon de Laszlo 21st October 2015