by Damon de Laszlo, ERC Chairman
While the weather looks better and we can hope for the balmy days of summer bringing relief from Covid, the Ukraine nightmare drags on. Russia seems to have resolved to destroy Ukraine and its infrastructure by targeting the civilian population, housing, factories, and supply chains. Russia also seems to have decided to weaponise food by blocking the movement of grains and other agricultural products by both sea and rail. No doubt, they will arrange for supplies to be released, by sea, as the food crisis and starvation start to emerge around the Mediterranean.
In Europe, the problem of energy supplies is rising up the political agenda as governments start to heed the warnings of electricity generators and the fuel distribution industry. All of a sudden, pipelines and LNG supplies have risen up the National Grid’s agenda and it would seem that even the regulators have woken up to the complex issues of landing Natural Gas in the UK and distributing it. The regulation and regulators involved in electricity generation and distribution make decision-making more difficult as any change to the status quo is usually viewed as risky.
On the financial front, Europe and the UK are suffering from their central banks’ declining independence in the face of political pressure. Quantitative Easing has been a wonderful drug and has helped politicians take credit for relatively benign economic performance. Rising interest rates, needed to start the process of controlling inflation, will cause huge problems for those holding debt, this includes the central banks themselves.
Pension funds, the insurance industry, along with central banks will have to take big write-offs on their bond portfolios as interest rates rise during the summer. The rolling back of Quantitative Easing is already driving down M2, the money supply. This will make borrowing more difficult, not only for those who have taken advantage of the ability to issue covenant-light junk debt, but also for the more profligate countries in the so-called Club Med region.
The aftermath of Covid and the unwinding of the supply chain bottlenecks means that a huge quantity of goods is clearing through the ports in the US and Europe, and arriving in retail warehouses and shops. Produce that should have arrived for late winter and spring seasons is arriving at the same time as goods needed for summer and the coming autumn. This is coinciding with a downturn in retail sales as customers tighten their belts to afford the rapidly increasing prices of food and fuel. We can expect heavily discounted goods of all kinds in the summer sales, which will help to counterbalance the enormous inflation in essentials. The disruption in supply chains over the last two years, added to the sanction regimes triggered by the Russian invasion of Ukraine, as well as causing supply chaos, is creating confusing statistical economic numbers, making most predictions even more unreliable than usual.
The good news is also adding confusion to economic statistics as businesses react to the supply chain problems, particularly in America. The manufacturing sector is ramping up production and re-shoring production from Asia. Well-run businesses are investing in advanced manufacturing. One can expect to see increased productivity and a reduction in the reliance on imports, particularly in the US. This revival will be less conspicuous in the UK where the industrial base has been shrinking for over twenty years. Political meddling, alternating with neglect and a focus on the City and Financial Services, has caused damage to the industrial sector which will take much longer to correct. The “post-industrial society” is going to find the new world uncomfortable. Europe will also have major problems weaning itself off the German motor car sectors bonanza achieved by its great success in exporting to Asia, and China in particular.
The rapid rate of growth in inflation in 2022 should be flattening out by the third quarter but we can expect a severely disrupted summer and autumn with civil unrest and, more to the point, aggressive unions taking advantage of the general malaise. Hopefully, Russia will not compound Europe’s problems by expanding the war in Ukraine but, even in its present form, this will add an enormous drag to the European economy.
China’s policy of locking down whole towns in the face of Covid instead of a meaningful vaccination program is going to make its recovery considerably more difficult. The President has to find a way of getting out of the lockdown policy, but moving the bureaucratic supertanker onto a new course will be slow. Nevertheless, one can expect the Chinese economy to get into a steady slow growth pattern and start a recovery in early 2023.
The next few months are probably going to see the bottoming of the downward economic cycle. The uptrend will take everyone by surprise as economies embrace new technologies which are growing rapidly but do not appear in economic data. The most fascinating statistic to look at is the supply of semiconductors, now above pre-Covid levels and growing rapidly. Understanding where they are going will give an insight into the technology revolution that is starting to unfold.
Damon de Laszlo
13th June 2022