by Damon de Laszlo, ERC Chairman
It has been a long time since November, economically. December 2022 probably finally marked the end of a major economic trend. From 2009 to 2021, interest rates drifted downwards. The establishment’s answer to every economic problem was lower interest rates and, to put it crudely, money printing. In the early part of this period, there were many voices warning that the combination of these two economic levers being pushed in the same direction by central bankers would cause inflation. These warnings by the older economists proved wrong and the lessons from previous inflationary periods were discredited.
This brings us to the problem of economic forecasting. The difficulty arises from the number and complexity of the variables within an economy, overlaid with long-term underlying trends which are difficult to see. The fundamental change to the world economy that started to take place after the financial crisis of 2009/20 was the opening up of world trade to Asia, and in particular China.
A fundamental change in China’s government took place with the arrival as Premier of Deng Xiaoping. An extraordinary man brought up in the era of Mao and militaristic communism, who studied alternative systems after the mayhem of the cultural revolution. He became fascinated by the mechanisms that had been introduced into Singapore by Lee Kuan Yew to govern the country. He realized that Lee Kuan Yew’s concepts of government could be applied to China, bringing prosperity and stability to the country while keeping the Communist Party in control. Deng introduced systems of grass-root elections at local levels leading up to regional elections, albeit with the requirement that candidates had to belong to the Party, i.e., the one-party state, the appointment of government officials on a meritocratic basis, along with a policy of reindustrialization. Free enterprise was allowed to start taking place in pre-determined zones, from the neighbourhood of Hong Kong reaching up to Shanghai.
Deng retired in 1989, but his policies continued, leading up to China joining the WTO (World Trade Organization) in 2001. Over the following ten years, China’s impact on world trade steadily grew in significance, the steady opening up of China made it possible for Western and Japanese businesses to take advantage of a well-trained and well-educated cheap labour force and a growing market for their products. From 2010, the impact this had on the world’s economy grew, producing a major downward pressure on inflation and a huge new market for Western luxury goods and industrial products as well as, importantly, motor cars. This Goldilocks scenario came to a juddering halt with Covid.
Covid’s impact on supply chains for piece parts and finished goods rapidly stifled the impact of China as a low-cost producer; which was anyway waning.
The impact of Covid varied greatly from East to West. America’s decentralized and somewhat laissez-faire treatment of the disease, much criticised in the short term, probably caused a higher death toll. The UK was remarkably successful in rolling out a vaccine program, followed by Europe, and China pursued a lockdown policy which was initially lauded but then discredited as the economy cratered. Excessive demand in the West caused by low interest rates and a massive increase in central bank-provided liquidity during Covid, caused inflation to start rising rapidly. The peak of Covid, shortly followed by the Russian invasion of Ukraine, rapidly compounded the inflationary pressures as energy supplies also were disrupted.
Central banks around the world have historically had only one answer to inflation and that is to increase interest rates and restrict liquidity, causing a recession and choking off demand. This leads us into 2023 and the removal of a lot of uncertainties that have been experienced over the last few years: – It’s almost certain that current rising interest rates and reductions in liquidity will lead the economy of the West into recession, excessive debt that has been built up by the banking sectors’ financial engineering will come unravelled, low interest rates and excess liquidity have encouraged the piling up of debt against assets and the payment of excessive dividends and distributions – asset stripping. Many businesses with low profitability have been kept alive by borrowing and a lot of financial institutions have used the piling up of debt at low interest rates to improve their profitability. As the world money base tightens, the phenomenon of debt destruction will take hold, all creating a better environment for good companies to expand giving economic growth going forward. One can be optimistic that as demand is depressed and China opens up, energy supplies come back into balance as new sources are diverted, particularly in Europe things will look better. Inflation will decline rapidly as we go through the year.
This brings us back to the fundamental reversal of the trends of the last twenty to thirty years. The West will start to reindustrialize, enormously aided by computerization, artificial intelligence and robotics, producing a rapid improvement in productivity over the next ten years or so. This new trend will go a long way to helping address the problems of an ageing and declining workforce. Stable global liquidity growth and higher interest rates will mean a better allocation of capital and resources to productive activities, leading to improved productivity and better-remunerated employment prospects for the majority of the population. Along with the improvement in long-term employment prospects, there should be a reduction in the growing poverty in Western countries.
One can be optimistic that the change in the underlying trends is fundamentally good news, always subject to actions by the rogue state that Russia has become, or a conflict between the US and China over Taiwan
Damon de Laszlo
17th January 2023