by Damon de Laszlo, ERC Chairman
Since October, two terrorist incursions, in Ukraine and Israel, have bogged down into wars of attrition. The final outcome of either is not at all clear, as both conflicts are the result of enormously complex histories and are subject to Western political and financial support. The support in both cases is not unanimous and will wane with time. Western governments lack strategic thinking, and their politics are subject to public opinion, which itself has no philosophical cohesion. Western belief systems are confused and uncertain, destabilised by factional rather than rational thinking.
Underlying the political instability of Western governments is something of an economic malaise. The economic crises of 2000 and 2010, along with Covid disruption, were dealt with by the flushing of cash into Western economies by the central banks. However, after each crisis, the same bankers failed to fully, so to speak, turn off the spigot. The consequence of lax control of money supplies and the political inability to control the deficit expenditure, along with the Covid lockdown disrupting global supply chains, came together to restart an inflationary cycle. Today, the central banks are unsupported by the politicians, who resist the need to control their expenditure, and they are being pressured by the financial engineers in New York, London and other centres, who have made enormous, if not obscene, profits from zero, or near zero, interest rates, coupled with the excess liquidity that has been pumped into the economic systems.
Having been slow to raise interest rates, the central banks are being pressured to lower them at the first sign that inflation is coming down. There is still huge amounts of liquidity in the system, enormous amounts of borrowing by individuals and the corporate sector, that has been loaded up with debt by financial engineers. The high interest rates hurt the individual and corporates, potentially causing a financial crisis where corporate debt has been, to a large extent, misallocated. Added to this, government deficits are basically out of control and high interest rates exacerbate this problem.
The question is whether taming inflation can be done without, what is called, a hard landing, something that has not been achieved, certainly in terms of recent history. The idea that you can lower wage expectations without causing unemployment, and that better asset allocation will enable the repayment of debt and investment in productivity can be hoped for, but it assumes a direct linkage between the economy and interest rates and other factors, such as the growth in government debt, which has the effect of putting cash into the economy, is tenuous – and here is a major conundrum.
European government in Brussels has shown no ability to control member states’ deficit expenditure. The economic powerhouse of Europe, Germany, is slowing down rapidly and will not have the ability, politically or financially, to help finance Club Med deficits. This is leading to a logjam in European budgets and the crisis is developing as Brussels tries to link the various aspects of European finance to different causes. As an example, Germany’s willingness to support Ukraine financially is effectively being blocked by linking it to other budget issues, both in its domestic debate and in the budgetary debates in Brussels.
On the other side of the Atlantic, the USA is potentially heading towards a soft landing. The US economy has an enormous ability to adapt as, by and large, the country’s economic activities are dependent on the governments of individual States. If you don’t like the way California is governed, you can move to Texas, etc. There is a huge movement of industrial activity from States with excessive tax and regulatory burdens to more business-friendly States. Added to this, the Federal Government’s enormous support for re-industrializing the US is improving the country’s productivity and will continue to do so,
The US Government’s object of trying to encourage industrial competition with China is, coincidentally, greatly helping the economy avoid a hard landing. The other help to the downward pressure on Western inflation is the slowdown in the Chinese economy. This slowdown in China is also increasing the supply of goods and materials in the global supply chain.
It is important to note that there are several causes for inflation, some of which are not directly impacted by low interest rates. Chinese companies, unlike the West, are motivated more by turnover than by profit; their ability to reduce prices is greater than for companies in the West.
The comparison between the US and Europe in economic performance is becoming starker. One is basically supportive of industry, trade and commerce within its boundaries; the other overloads its private sector with regulation. The icebergs out there are primarily the danger of uncontrolled increase in Government debt and/or a major bankruptcy, but it is quite possible that the US will achieve the hoped for soft landing, while Europe has a real economic slowdown.
There is good news and bad news, but we may be beginning to turn a corner economically, all of which could be turned on its head by the Ukraine and Israel conflicts!
Damon de Laszlo
4th December 2023