Thursday, 29 January 2009

The Clouds Gather

We wrote last year about the New Nationalism (see post) as the force that would diminish the process of Globalisation. Two recent events have brought the New Nationalism into a sharp focus.

First, the new US Secretary to the Treasury has accused China of manipulating its currency against the dollar (see article). This talk is both silly and dangerous. It is silly because any financial relationship of the scale that is being discussed involves the voluntary actions of countless thousands of people. China is only able to maintain a soft peg against the dollar because the Federal authorities have a seemingly insatiable appetite for borrowing Chinese funds. Had the US raised taxes in the period 2004-07, had the US authorities tightened monetary policy, the appetite for Chinese funds would have been more limited.

The statement is dangerous because it is confrontational at a time when the premium has to be on co-operation of all nations. Who, does Secretary Geithner think, is going to lend the Federal government the funds it needs to finance the fiscal stimulus? The only nation in the world with those sums available is the Chinese government. In a rare, but candid, interview for The Atlantic (see article), Gao Xiqing - who controls $US200 billion of the Chinese Sovereign Wealth Fund in the US - warned the Federal government to "be nice to the countries that lend you money". In the UK we call this biting the hand that feeds you.

The second event that causes concern is the requirement that only US steel and iron is used on infrastructure projects financed by the bailout package (see article). Ignoring the obvious points of silliness - in a globalised world, what exactly is a 'US company' - this provision is dangerous to the extreme. The great fear is that we are starting to head towards the naive protectionism that made the Great Depression so 'great'.

We have also been here before. When George Bush came to office, he imposed punitive tariffs on foreign steel with the result that US consumers of steel had to pay more than necessary for their steel. The matter was resolved through the WTO in favous of the EU, and Bush only relented when faced with the prospect of legally imposed punitive tariffs on Foridian Orange Juice (remember Jeb Bush?).

The fear across the world is that we have yet another US President who will not honour international obligations (the WTO rules on state support), who acts unilaterally, and who acts with disregard to the interests of his close allies. In a recent post, we asked where the change was (see post). This is still a valid question.
We take the view that the clouds are definitely gathering, and that the storm could strike sometime this year. This is not a good time to have a novice at the helm of the ship of state.


© The European Futures Observatory 2009

Wednesday, 28 January 2009

The Penny Starts To Drop

Poor President Obama. The shine seems to be coming off his his Presidency after only a week. In a previous post (see post) we commented upon the impossibility of the task that he has set himself. This theme was taken up by The Economist this week (see article). It would appear that the strategy of seeming to please as many as possible on the way into office has created a problem of failing to please so many when in office.

I was out for a meeting this afternoon. As I drove home I managed to pick up a bit of the debate on the fiscal stimulus in Congress. Should the stimulus work through tax cuts? Should it work through increased Federal spending? If so, on infrastructure projects? Or on welfare projects? There certainly seemed to be a good deal to argue about. And yet, the supporters of each of these positions appeared to believe that the candidate Obama had promised support to their pet projects. President Obama appeared to be letting them down.

I think that is the basis of my Obamascepticism. He appears to have promised so many mutually exclusive entitlements to so many groups that he can only fail to deliver. And that is only within the US!

Tuesday, 27 January 2009

On To 3 Million?

One economic indicator that we are following closely this year is the UK unemployment figure. This is important for a number of reasons. First, it gives an idea of the pressure on government spending to rise. It lets us gauge how hard the recession is biting. Second, it provides an early warning of the direction in which tax revenues are heading. The unemployed tend to have less to spend, so VAT receipts, followed after a while by Corporation Tax receipts and Schedule D Income Tax receipts, fall away as unemployment rises. Together these give us an indication of where the PSBR is going - and how readily the Government will be able to repay its borrowing.

The figures published last week (see article) indicated that unemployment had risen by 77,900 in December. This is a real tragedy to each of the individuals who make up this statistic, and we would not want to downplay any of the suffering that they are now going through. However, in a previous post (see post) we suggested that, in order for unemployment to reach 3 million by the end of 2009, the figures would have to increase by 100,000 a month.

The good news is that we are on course for unemployment of about 2.5 million by the end of 2009. The bad news is that the rate of increase is accelerating. Prior to December, unemployment was rising at about 45,000 a month. It is now on its way to doubling that rate of increase, which is worrying.

The implication is that the stock of debt incurred through the rising PSBR is increasing as well. Perhaps it may be beyond 2017 before it is paid off?

Monday, 26 January 2009

And Germany Too ...

In a recent post (see post) we discussed the affordability of the UK fiscal stimulus. At the time, the German Finance Minister - Peer Steinbr├╝ck - was dismissive of the policy. He saw it as a means of buying our way out of recession, which it is, and of which he disapproved.

It's funny how events catch up with us. We now find that the German Federal authorities plan exactly the same stimulus (see article). Of course, we could talk about the correctness of the arguments for the fiscal stimulus, but a more telling point is likely to be the German economy falling in an election year.

We need to remind ourselves that fiscal policy is all about politics and not economics. Sometimes we lose sight of that point.

Sunday, 25 January 2009

The Velvet Glove And The Iron Fist

One of the changes that we are to see in Washington is the United States starting to use its ‘soft power’ again. During the Bush administration, the US relied almost exclusively on ‘hard power’, which came to be equated with the use of force. As the sole superpower, without a military peer in the world, the Neo-Con agenda calculated that American policy could be forced upon an unwilling world because nobody would dare to deny them.

This strategy proved to be muddle headed on two counts. First, it did not account for asymmetric warfare. A small group of determined individuals could obtain military victories over much larger nations. The way in which the Madrid bombings knocked Spain out of the ‘Coalition of the Willing’ gives evidence of this. Secondly, Political Philosophy 101 teaches us that might is not right unless it has a backing of legitimacy. This was almost totally lacking in the Bush Doctrine, as the absence of legitimacy degenerated to include embracing illegal acts such as torture and arbitrary detention. To his enormous credit, the first foreign policy act of President Obama was to halt the kangaroo courts – military tribunals, if you like - in Guantanamo Bay, and his second was to order the closure of the camp within a year. It may prove difficult to achieve this, but it has certainly sent a signal that the US intends to seek the moral high ground – the epicentre of its soft power – in the years to come.

But what does that mean for the longer term? Two recent articles have laid out the basis of a model that explores this issue. In an article for Foreign Affairs (see article), Anne-Marie Slaughter asserts that we are in a transition period moving away from a world of hierarchies and towards a world of networks. In many ways, this is quite a reasonable supposition. Ms Slaughter then goes on to argue that the US is uniquely advantaged to benefit from the growth of networks owing to the number of immigrant diasporas living in America. The point is well made, but taken too far. Europe also has a large number of immigrant communities from as wide a range of origins as the US. There is no reason why these communities could not network European influence in exactly the same way as is suggested for American influence.

To a certain extent, the infrastructure for this already exists. I was once asked how a small, open economy such as Australia could compete and have a voice in a world of giants. I took the view then, as I still do, that the Commonwealth provides an infrastructure that could be used, very much in a way similar to the EU, to allow smaller nations to have a greater voice in the international arena. Of course, it would need to be a different Commonwealth to the one that we have now, but the basic architecture is there. One possible future would be for Europe to put its colonial heritage to use in developing this network of nations. It also offers the US the opportunity to develop within the framework of these networks, or parallel to them.

Of course, the world in which these networks are operating is in the process of changing. The second article, in Foreign Policy (see article), argues that the certainties by which the US provided leadership for the West over the past fifty years are changing. Since World War II, international discourse has been bounded by five certainties:
1. That peace is better than war.
2. That benign hegemony is better than a balance of power.
3. That capitalism is better than socialism.
4. That democracy is better than dictatorship.
5. That western culture is better than all the rest.
The move from a world of hierarchies to a world of networks is calling into question all of these certainties. Even the belief in capitalism as a means of organising an economy is now seriously in question.

There is a lot to commend this view of the world and if President Obama is to reassert American influence in the world, he will need to convince the American public of the case. President Obama campaigned on a promise of change, but now leads a society that is likely to be resistant to change. For example, in the case of climate change, for the US to achieve the reductions in carbon emissions in accordance with the Kyoto protocols, we have calculated that petrol (gas) would have to be in the region of $19.00 a gallon. All of the evidence of the past two or three years suggests that this is an unacceptable position for the American public. More to the point, will the rest of the world cede the moral high ground to a nation that persistently fails to meet its international obligations?

This may prove to be something of a dilemma for President Obama in the years to come. His desire for the US to follow one path may increasingly be bounded by his political inability to implement what needs to be done. The domestic agenda may constrain the foreign agenda significantly. This is one metric by which the decline of the US could be measured – how the US President is unable to act internationally because of domestic considerations. If this becomes obvious, then we will know that the American unipolar moment has ended.

Perhaps the velvet glove may not fit the iron fist.

© The European Futures Observatory 2009

Friday, 23 January 2009

Icarus Is In The Air!

A little while ago we posted a piece on The Icarus Effect, speculating that as the BRIC economies have soared the greatest in the past few years, so they will fall the furthest and hardest during the present downturn (see post). The Economist recently presented two cases that support this contention.

The first article was about a company called Smart Union in China (see article). During the upswing, Smart Union was something of a success story. It included a tale of rags to riches for Tony Wu, who built a toy manufacturing empire from nothing in 1995 to a HK$53mn IPO in 2006. In 2007, sales topped HK$1bn. However, it appears that the company overtraded. Rising costs - particularly labour costs - squeezed profit margins, the weakness of the balance sheet pushed the company into costly credit arrangements for working capital, and a flood led to HK$65mn stock being written off. This led the company to cease trading.

The second case is about Satyam Computer Services (see article). Satyam, India's fourth largest software and services firm, seems to be a victim of crony capitalism. It is a company that is tightly controlled by a small number of family members. One of the family members has confessed that the company balance sheet is more of a work of fiction than fact. A reported cash pile of US$1bn on the balance sheet does not, in fact, exist. This story has a little way to run, but it does highlight the downside and how it is likely to play out.

Operating in the BRIC economies has a number of difficulties for western companies. BRIC companies are often inexperienced and under-capitalised, as in the case of Smart Union. They also operate in an environment where internal financial controls, transparency, accountability, and audit independence are weak or non-existent, as in the case of Satyan. It is a small wonder that capital is flying back from the BRIC nations to a more safe haven - Europe and North America.

If globalisation is to proceed as fast as it has in the past, then there needs to be a harmonisation in the development and implementation of the rules surrounding accounting practice, corporate governance, and audit reporting. If not, the BRIC economies will always be junior players.

© The European Futures Observatory 2009

Thursday, 22 January 2009

Chalk One Up For The Awkward Squad

In a recent post (see post) we reflected that the group who will prove troublesome to President Obama is already taking form. One of the problems that President Obama faces is the ability to galvanise the European nations to follow an American agenda. It was put to me recently that "Europe is no longer willing to have its wars declared in Washington".

Whilst Europe would broadly support the objectives of the President, when it actually comes to committing troops, it is a different story. Germany is well known for not being willing to commit more troops to Afghanistan. It now appears that France is unwilling to commit further troops to Afghanistan (see report).

This causes a problem for the new President because it keeps the US committed to an expensive overseas engagement at a time when America might like to scale back its commitment. Perhaps the honeymoon is coming to an end?

Tuesday, 20 January 2009

How Long? How Deep?

Our previous post on unemployment (see post) asked if we are getting the right picture from the statistics that we have available to us. The theme of uncertainty about the duration and length of the incipient recession was taken up in an article in The Economist (see article) that reported on the recent AEA Conference in San Francisco.

It would seem that the dismal scientists are being quite dismal about the prospects for the US economy over the next few years. Part of this would reflect a reluctance to adopt an aggressive fiscal policy to resolve the matter, and part of this would reflect the structural changes that the US is currently undergoing.

We feel that America is likely to have a longer and harder recession than other members of the OECD. It has delayed effective action later than other nations, it is suffering from a structural realignment of the economy, and it is slow to grasp the 'New Normal'. In this respect, the economists at the AEA might be right.

Monday, 19 January 2009

America At The Crossroads

All eyes turn to Washington this week for the inauguration of President Obama. In winning the election, he has done much to impress. The campaign has set all sorts of records for fundraising, galvanising grass roots support, mobilising the popular vote, and taking on the vested interests in Washington. It is so fitting that the Senator from Illinois will become the first Afro-American President of the United States. At this point, it might be helpful to take stock about why this Presidency in particular is likely to be pivotal in the story of America.

President Obama will inherit two sets of problems – the US economy and the position of the US in the world. The US economy is in a dire position. As the global economy moves into recession, there is evidence to suggest that the US economy is one of the hardest hit in the OECD group of nations. It has not benefited from the fiscal stimuli that other economies are starting to feel. Much of the benefit of the financial bail-outs has been devoted to shoring up the balance sheets of the banking sector rather than getting the economy working again. There is a great deal of anger in the US about the way in which Wall Street has been bailed out and Main Street has been left to its own devices.

This erosion of trust, and its consequential impact on confidence, is the first thing that the new President will have to tackle in his fiscal stimulus. Even if the US has a ‘good recession’, there are a number of longer term adverse factors that will start to arise during this Presidency. Last year the first Boomers reached retirement age. The numbers achieving this status over the next four years will rise dramatically, and even more will join their ranks should President Obama be re-elected in 2012. There are likely to be a number of very unhappy voters in the next few years. The financial crisis has severely reduced the value of the Boomers retirement accounts at exactly the wrong time for them. As a generation, the Boomers have been led to expect a comfortable retirement, but the prospects are not favourable for this outcome.

In addition to that, the expectation of medical entitlements has risen just at the point where the demands on the system are likely to take it towards breaking point. The health and retirement entitlements in the Federal Budget are likely to place it under considerable pressure in the coming years. Healthcare reform has been a central promise of the Presidential campaign. However, the realties of office, combined with the entrenchment of vested interests, lead us to think that major reform could well take longer than a single Presidential term and that the pressure of growing entitlements will cause the federal deficit to grow during this Presidency.

Of course, the US does not face these problems in isolation. They are a common set of problems experienced across the OECD. It is unlikely that any one nation – even the US – will be able to solve these problems in isolation. This is where the position of the US in the world might start to be problematical. The ‘awkward squad’ are already forming. The Financial Times reports that Germany and France have warned President Obama that the EU intends to set the agenda for reform at the G20 in April (see article).

In a different article the FT also reports that the Saudis have reduced oil production by an amount greater than the amount agreed at OPEC in an effort to force up the price of oil (see article). This is significant because the Wall Street Journal reported an estimate that oil at $80 a barrel gave the US economy a stimulus of $275 billion (see article). One way of interpreting this news is that the covert stimulus of $150 billion given by the Saudis to the Bush Presidency – by holding oil at $40 a barrel instead of the target $75 a barrel – is not going to be given to the Obama Presidency. Indeed, one consequence of filling the State Department with people sympathetic to the pro-Israel lobby is likely to be that the Arab members of OPEC are unlikely to be greatly sympathetic to the plight of the US economy.

This interplay between global geopolitics and the global economy is likely to dominate the next Presidency. In Afghanistan, the US would like to see greater NATO involvement and a commitment of more European troops. The European refusniks – led by Germany – are unlikely to respond to this call. In turn, this circumscribes any attempt to reduce the cost to the Federal budget of overseas engagements. We seem to be at a time where two certainties of the past have become very uncertain.

For the last twenty years we have relied on the certainty that market capitalism is the best way to arrange our affairs, and that the US would take the lead in making market capitalism work. Events of the past two years have demonstrated that market capitalism, as a system, has its deep flaws. In dealing with these flaws, the economies of the world are heading towards a more socialised arrangement – market socialism, if you like. In this, the US does not have a great deal of authority, Europe does.

Equally, recent events are starting to show that the US is not the unchallenged superpower that it once was. A new order is emerging. Authority is seeping away from nation states towards supra-national bodies. Even the UN is finding a revitalised role in this new order. Of the nation states, the emerging powers now want a greater say in the organisation of global affairs. The G7, then the G8, is now the G20 to include the reality of the development of India, China, and the other emerging economies. Whereas once the US could dominate such groups, now it cannot. A different conversation has arisen that few in the US have yet to hear.

And so we find America at a crossroads. President Obama has much promise in finding the right path. It is in all our interests that he doesn’t take a wrong turn.

© The European Futures Observatory 2009

Wednesday, 14 January 2009

Lies, Damn Lies, and Unemployment Statistics

Following on from our last post (see post) it has been a bad few days for unemployment in the UK. As the real economy marches into recession, we are seeing a raft of headlines announcing redundancies and job losses (see example). Whilst each one of these jobs lost is a tragedy in itself, we do need to stand back and ask what it means.

The Times report isn't very helpful in this regard. However, the report in the Daily Mail alluded to in the last post (see article) is a bit more instructive. The Daily Mail includes a visual that says that Virgin Media has announced job cuts of 2,200 by 2012. That amounts to 2,200 job losses in three years.

Averaging out, that adds up to 3 job losses for each working day until 2012. For unemployment to reach 3 million by the end of 2009, additional job losses would have to be at a rate of 4,800 every working day. This puts the 3 in the news article into perspective.

Of course, we must not lose sight of the fact that jobs are being created as well as lost every day. The unemployment figures provide a snapshot at a single point in time the reflects the balance between job loss and job creation. What the doommongers have not reported are the jobs being created at present. For example, I wonder how many more insolvency accountants would be needed by the end of the year?

The UK, along with the US, is one of those economies that is good at job creation over a very short time period. Therein lies a bit of good news for us all. We need to look for that turning point where job creation has won back the initiative from job losses.

© The European Futures Observatory 2009

The European Futures Observatory is currently co-ordinating the Europe Chapter of the World Future Society. To this end, we have arranged a meeting in Paris on Wednesday 18th February 2009 to launch the Chapter. A cordial invitation is extended to all members, friends, and supporters to attend the lunch. Further details can be found on our web site.
Click here for details.

Sunday, 11 January 2009

How Bad Will It Get?

All forecasts about the future are based upon a set of assumptions. We normally have a view of how the world works – a mental view of the underlying reality of the world and how its various components fit together. We then take in data about the world, feed it into this underlying model of the world, and out pops a view of how the world will look in the future. This method relies crucially upon two sets of assumptions – assumptions about the validity of our model of reality and assumptions about the validity of the data that we are feeding into the model. This is what we mean when we say that a forecast is only as good as its assumptions and that the way to test the sensitivity of a forecast is to test the sensitivity of its assumptions.

In a recent post (see post) we took the view that the levels of borrowing outlined in the Pre-Budget Report ought to be affordable on a horizon out to 2017. A key assumption in the scenarios that gave rise to this view was that the current downturn would not be too long and too hard. The key assumptions were that the downturn would continue until the middle of 2009, where unemployment would peak at 2.25 million. In recent weeks, we have been examining this assumption.

Unemployment is currently at about 1.8 million. It has been increasing at an average of about 45,000 a month, but the rate of increase has accelerated in the most recent months (see statistics). If it continues at this lower rate until mid-2009 the forecast in our base assumption is not likely to be too far from the mark. However, if it continues at this lower rate until the end of 2009, then our base assumption is likely to understate unemployment, which could peak at about 2.5 million.

In recent weeks, there has been some discussion in the press about the possibility of unemployment peaking at about 3 million by the end of 2009 (see references). In order for that to happen, unemployment would have to increase by an average of 100,000 each month for the whole of 2009, which is over double the current rate of increase in unemployment. While this entirely possible, we feel that it is very unlikely. Such forecasts are often associated with a political agenda hostile to the present government and are open to the accusation of being highly partial forecasts.

Whilst the first half of 2009 may see the occasional monthly increase in unemployment of 100,000 or above, it is extremely unlikely that the liquidity pumped into the economy in the second half of 2008 will fail to have an effect in the second half of 2009, which is when we would expect the impact to start to be felt. There is ‘wall of money’ is currently flushing through the system and there is nothing to suggest that we will not see credit conditions easing in the second half of 2009. It is possible that the banking system might still be restricting credit, but a good deal of political pressure will be placed upon the banks to start lending again. In the New Normal, where the government owns a significant proportion of the banking sector, this political pressure is likely to be felt commercially.

It is quite important that we keep in mind the assumption about the length and severity of the recession. If we are understating the length and severity of the current recession, then the forces to increase the PSBR will be much larger than expected and the point at which the borrowing can be repaid – along with the concomitant withdrawal of the Public Sector from the financial markets – will extend beyond the 2017 horizon that we are examining. Of course, we could be wrong in the other direction and the recession may well ease before mid-2009, thus bringing forward the point at which the debt can be repaid.

It really all hinges around the question of how bad the recession will get. There has been some wild talk about a 1930s style depression. This is exactly that – wild talk. An interesting article in The Economist (see article) provides us with some perspective. The key point is that in the 1930s, the money supply contracted along with the real economy. The lesson from that mistake has been learned, and we are now seeing a monetary expansion to counteract the downturn in the real economy. Sadly, it is far from clear that the lessons from the policy of protectionism learned in the 1930s have yet to be fully absorbed.

Coming back to the original question: how bad will it get? It is hard to tell at the moment because we are in the downswing of the recession. However, we know that it will end at some point, and we know that recovery will follow. By Easter, we ought to be able to take a view on whether or not the bottom is likely to be mid-2009. At that point we shall be able to take a better view of how long into the next decade the Public Sector will dominate the economy.

© The European Futures Observatory 2009

The European Futures Observatory is currently co-ordinating the Europe Chapter of the World Future Society. To this end, we have arranged a meeting in Paris on Wednesday 18th February 2009 to launch the Chapter. A cordial invitation is extended to all members, friends, and supporters to attend the lunch. Further details can be found on our web site. Click here for details.

Monday, 5 January 2009

The Sun Also Rises

2008 is a year that most people will be glad to see pass into history. Whilst some will have fond memories of 2008 – the supporters of Barak Obama spring to mind – it is likely that the economic downturn will dominate our collective memory of the year. At this point in the cycle, it might seem that no good news is on the horizon. Indeed, a number of our correspondents have specifically asked for good news stories because they are in short supply at the moment. As it happens, something positive did happen just before Christmas, which gives me a sense of hope for 2009.

One of the services provided by our consulting arm – The Greenways Partnership – is a telephone advisory service. What happens is that executives from multi-national companies call us to have a conversation about some aspect of the future that affects their business. Normally we chat on the telephone for an hour or two, sometimes with an agenda, more often without one, and we talk around the issues that concern them, to which we provide a futures context. Like most consulting, there is a ‘going rate’ which the market bears.

At the beginning of 2008, the going rate was $250 an hour for a conversation to a US company. By December 2008, the going rate had fallen to $200 an hour for telephone advice. The impact of the recession in the US had cut the standard rate by 20%. However, another element has to be factored in that leaves me hopeful for 2009. In January 2008, with the exchange rate at roughly $2.00 to the £1.00, the $250 an hour translated to £125.00 an hour. By December 2008, Sterling had fallen against the Dollar to about $1.50 to the £1.00, which meant that my $200 an hour was now worth £133.33, a 6.6% fee increase!

This story extends right across the UK economy and applies to all of those businesses that have an overseas income stream from a variety of locations. For example, as the Chinese Yuan, a number of other Far Eastern currencies, and most Middle Eastern currencies are pegged to the US Dollar, exporting to those economies has just become that much easier. Additionally, the fall of Sterling against the Euro (roughly Euros 1.40 to £1.00 in January 2008 falling to roughly Euros 1.00 to £1.00 in December 2008) will make UK exports to our largest trading partner that much easier. We can reasonably hope that an export drive in manufactures and business services will help to pull the UK economy out of recession in 2009.

There is, however, more to be said than just for manufacturing and business services. The falling Pound creates an opportunity for the UK Hotel and Leisure Sector to position itself to sell to US, European, Far Eastern, and Middle Eastern tourists. The anecdotal evidence reaching us at present suggests that the surprising buoyancy of retail sales just after Christmas was helped greatly by European tourists who now find London such an inexpensive retail experience and so accessible by Eurostar. One correspondent informed us that, just after Christmas, there were large queues for entry to Westminster Abbey and that most of those in the queue were European tourists.

Of course, as Sterling falls against a basket of currencies, not only do prices in Sterling fall to foreigners, but also prices in other currencies rise in terms of Sterling. One of the reasons why the price of oil has fallen by two thirds and yet UK petrol prices have only fallen by a third is that oil is denominated in US Dollars and that the Pound has fallen back against the US Dollar. The inflationary pressure one might expect from a fall in the value of Sterling has been kept in check by the weight of competition in an economy that is sliding into recession. As long as this happens, the UK is likely to stay an attractive destination for overseas visitors.

The world of finance is zero-sum – every credit has a debit. If our fees have risen by 6.6% in terms of Sterling, if our clients are paying 20% less for our services in Dollar terms, if the UK is such a bargain for overseas visitors, then who is making the losses that match these gains? This is a rather vexing question. In part, the banking sector will be suffering from reduced volumes of business, but we need to look elsewhere for the capital losses. Strangely enough, we are developing an hypothesis that suggests that the main losers who are paying for our good fortune are those economies that ploughed their trade surpluses into the US financial sector. As the US financial system starts to shake out its losses, we are, in effect, seeing a de facto wealth transfer across the Pacific. Only this time it is shifting from East to West. This is a subject to which we shall return in the weeks to come.

In the meantime, from the perspective of the UK, we can be hopeful for 2009 if the potential for an export drive comes to materialise. All of the benefits of the revolution in ICT of the past twenty years now mean that the UK SME sector can compete at the global level. Let us hope that owners of small businesses in the UK have to self belief to just go and do it. If they can, then we may well find ourselves coming out of recession in 2009.

After all, the sun rises as well as sets.

© The European Futures Observatory 2009

Thursday, 1 January 2009

The Kid's Inheritance II

In addition to our recent post on the impact of the UK fiscal stimulus (see post), two further thoughts come to mind:

1. Our original post assumed constant purchasing parity of the Pounds borrowed. Of course, this will only be correct in a world of zero price changes. If the Bank of England achieves it's target inflation rate of 2% per annum, then the purchasing parity equivalent of £350 billion at 2017 prices would be £297.76 billion in 2009 prices. To put it another way around one seventh of the debt will be lost to inflation. None of the press comment has taken this into account.

Of course, our assumption may prove to be quite heroic. There is a good case to suggest that the inflation out-turn for the next 8 years will be below 2% (a period of deflation ahead), which worsens the case for borrowers. There is also a good argument in favour of inflation averaging above 2% (the resumption of globalisation), which improves the case for borrowers. For those of a scenario bent, this may be an interesting critical uncertainty for the near future.

2. We are now starting to see some estimates of the reserve capitalisation that the UK banks will be required to hold in the future. In a thoughtful piece in The Economist (see article), Alan Greenspan estimates that the bank equity to assets ratio will have to rise from about 10% to about 14% in the New Normal. If this capitalisation is held in the form of gilts, then an additional £80 billion to £200 billion will need to be bought by the banks in order for them to achieve their new capital adequacy requirements.

Of course, this is all banking speak. What is important in the real economy is what this might mean in commercial terms. If Alan Greenspan is right, the bank multiplier (the number of times a bank can lend and relend its deposits) will fall from 1:9 to 1:7. For every £1 deposited, instead of £9 beng lent, £7 will be lent. In effect, this will represent a 22.2% reduction in available credit for every deposit made. It seems that the Age of Scarcity will start with a shortage of credit!

This is something that businesses might like to start factoring into their strategic plans right away. If external credit is tight (remember, our view is through to 2017), then retained earnings will have a much greater significance. Growth in the New Normal is likely to be organic rather than through acquisitions. If so, then one can question the use of share buy-backs as a financial device, and speculate upon the revision of dividend policies by major corporations.

© The European Futures Observatory 2008