Friday, 21 January 2011

Timeo Danaos (Again).

The future has caught up with the present quicker than we might have thought. Just as we were writing about the rise of the ‘China Price’, the markets caught hold of a bout of Sino-scepticism. An overheating Chinese economy is bad for China. It is also not too healthy for us either. We seem to be in danger of finding ourselves in a situation where economic performance is quite volatile – we rapidly go from boom to bust, and back to boom again. I wonder if this is a pattern that we shall have to endure for a few years?

Interestingly enough, the government of China has decided to act upon the domestic inflationary pressures. It has taken steps to provide financial assistance to Chinese farmers in the form of subsidies to cover the cost of diesel, fertilisers, and pesticides. Whilst this may have some impact in the short run, it is not a long term solution. In the long term, food prices are being forced up through growing prosperity in China. A long term solution needs to address the demand for food, not its supply.

Although Chinese inflation may abate, it is only likely to be temporary. And there still remains the issue of the asset bubble that is developing.

© The European Futures Observatory 2011

China's overheating economy stokes fears for global inflation - Business News, Business - The Independent

BBC News - China offers financial help to drought-hit farmers

Thursday, 20 January 2011

Timeo Danaos … And All That

China has started the year with a charm offensive across Europe and the US. In Europe, the Chinese were placing orders with exporters and their central bank was mopping up Euro-bonds in the Portuguese and Spanish bond auctions. This has led to speculation that China will be the engine that draws Europe out of recession whilst it props up the Euro with its bond purchases. Time will tell if this is right.
In the US the story is slightly different. China has placed itself as an engine of growth, China still likes to buy US bonds to help lower US interest rates, but it also seeks to reassure Washington that its rise should not be seen as threatening in the west Pacific. There are parts of this story where the rhetoric is different to the actions that the Chinese government has undertaken. A key issue that is looming is to find a permanent settlement for the Korean peninsula.
Many futurists take the continued rise of China as axiomatic. We are a little bit more sceptical of the conventional wisdom. This week, three pieces of the jig-saw fell into place. It appears that, in 2010, China attracted record levels of inward investment. Much of that investment was originated in funds seeking returns higher than those prevailing in Europe and the US. Of these inflows, one fifth were destined for the Chinese property market.
Cue the next piece of the jig-saw. It appears that Chinese property prices continue to rise. This looks very much like a dangerous property bubble taking form. The Chinese government has reacted by raising interest rates and by raising the reserve requirements of its banks, but with the flow of hot money flooding in, can it really stem the flow without adjusting the exchange rate? The government has ruled out an important policy tool at just the wrong time.
And this leads to the final piece – China is still inflating at too rapid a rate. Although the headline inflation rate is slowing, the core drivers of inflation – mainly food prices, fuel prices, and commodity prices – continue to rise. Once again, the Chinese government has refrained from dealing with this problem through an exchange rate adjustment. And this is where we get excited from a futures perspective – is this the beginning of the end of the Chinese titan?
Will the mighty China be humbled by a runaway inflation exacerbated by a bursting property bubble? It is certainly a scenario worth exploring.
© The European Futures Observatory 2011
BBC News - China attracts record foreign investment in 2010
BBC News - China's property prices still increasing
BBC News - Chinese consumer price inflation 'down to 4.6%'

Monday, 17 January 2011

The Pace Quickens

We are all starting to feel the impact of China on our daily lives. For example, the ‘China Price’ is rising, which means that we are feeling its effect in falling disposable incomes (through higher inflation). It does not mean, however, that all is lost. One beneficial effect of the China effect is that the government of China can now look to Europe for investments and purchases. Purchases help European exports, but, more significantly, Chinese investments are providing a prop to the Euro at just the time that it is needed.
Of course, good news for Europe is bad news for the US. As Euro denominated bonds become the choice of Chinese investors, so they are moving away from investments denominated in US Dollars. This will give the fed a refinancing headache in the near future. As it does so, the geopolitical decline of the US will be shown in a more stark light, counterbalanced by the stark rise of China.
To this extent, the pace of change will appear to quicken.
© The European Futures Observatory 2011
BBC News - China's Hu Jintao: Currency system is 'product of past'
Charlemagne: Mr China goes shopping | The Economist

Sunday, 16 January 2011

Business As Usual?

One of our contentions is that the financial economy and the real economy each run to a different rhythm. At times when both of the economies are synchronised, tremendous gains are made. When they are out of step, then problems arise. Our current economic difficulties originated in a hic-cup in the financial economy. There was an edifice of credit given too easily to people who were patently unable to repay the loans (what Will Hutton calls the ‘Ponzi Economy’), regulators who were unwilling to regulate this lending, and  a financial sector driven by greed and personal enrichment to expand this lending beyond safe limits. All of this came tumbling down when the financial economy hit a speed bump.

It was by no means certain that the contagion in the financial economy would need to spread into the real economy. After all, the bursting of the ‘ Bubble’ only had mildly recessional implications. However, a combination of a poor and tardy policy response – particularly in the US – allowed the contagion to bleed from the financial economy into the real economy. And here we are, where we are – the worst recession since the 1930s.

The financial economy and the real economy are still out of step. Across the OECD, unemployment remains high, there is still a relatively large debt overhang in the public and household sectors, and the output gap remains higher than previously experienced. All of this suggests that the real economy needs further fiscal and monetary stimulation. The financial economy, on the other hand, has largely recovered from where it was during the credit crunch. Credit is flowing again - albeit at much reduced trading volumes - the financial system has been shored up, bank profits have returned, and even large bonuses are back on the agenda of bankers. The danger, as the financiers see it, is the nascent inflation that could result from the recent monetary expansion. The financial economy needs interest rates to be increased as part of a monetary contraction.

In many respects, this reflects a desire to return to ‘business as usual’. Of course, if I were an investment banker, I would see the logic behind returning to stellar salaries as quickly as possible. However, the policy of ‘business as usual’ implies that we continue to make the mistakes that put us into recession to begin with. This suggests that the financial economy has yet to come to terms with the paradigm shift that the recession has caused.

For example, the conventional wisdom that proved to be unwise in 2008 states that if inflation is building, then interest rates should be increased and monetary policy should be contracted. If the MPC were to follow the suggestion of Andrew Sentance to increase interest rates, would it work? We think not. The main inflationary pressures that we are currently experiencing are structural in nature caused by rising food, energy, and commodity prices. Raising interest rates may cause Sterling to appreciate a little (or it may not), taking the pressure off those food, energy, and commodity prices denominated in US Dollars, but the impact on global food, energy, and commodity prices is likely to be negligible. UK interest rates would have to rise very far in order to have an impact on global commodity prices.

Instead, such a policy is likely to do severe damage the real economy. Low inflation rates and a low value of Sterling, which fell by between 20% to 25% in the period 2007-10, have stimulated the UK manufacturing sector that exports to Europe, the US, the Middle East, and the Far East – i.e. those economies based around the Euro and the US Dollar. Whilst the cost of imported materials have risen, this is unlikely to lead to a domestic inflationary spiral because of the sheer size of the output gap. There is too much slack in the economy, particularly with the public sector redundancies starting later this year, for inflation to get out of hand.

And this is the point at which we arrive. If it is UK policy to nurture the exporting manufacturing sector, then interest rates need to be held low for some time to come, despite the occurrence of structural inflation. If, on the other hand, interest rates are raised, then it signals a surrender to the financial economy and a return to ‘business as usual’.

If this occurs, the we ought not to complain too much about bankers bonuses. After all, that is part and parcel of our economic policy.

© The European Futures Observatory 2011

BBC News - UK interest rates remain at 0.5%

The Economist | The outlook for exports: Trade winds

Wednesday, 12 January 2011

A Chinese Endgame.

The rise of China over the past couple of decades has been quite relentless. Year after year the Chinese economy has grown, year after year Chinese commercial influence has expanded. Sino-sceptics point to the apparently rigged exchange rate between the Yuan and the US Dollar as the source of China’s financial might – the origins of the huge currency reserves – which has un-balanced the world economy.
The US would like China to allow the appreciation of the Yuan faster than it is currently appreciating. The Chinese government is reluctant to do so, fearing the political consequences of a slowing in the growth machine. However, this does create another problem in its wake. A high Yuan may help Chinese employment, but it also hinders the attempts of the Chinese government to keep a lid on domestic inflation.
China imports many of its raw materials. The weight of Chinese purchases in global markets has given rise to demand led price inflation for those resources – from food to metals to oil. This is starting to push an inflationary spiral in China. Normally, governments would counter an inflationary spiral by raising interest rates and allowing the exchange rate of the currency to appreciate. This policy has effectively been discarded.
The policy is to do nothing. Normally this is not a bad option, but in this case it might not be. If inflation takes root, then it could become as equally destabilising as rising unemployment. The prospect of an impoverished middle class is just as unattractive as the prospect of an unemployed middle class. However, this fuse is burning slowly. We are unlikely to see great change in the near term, but in the longer term this is a problem that will have to be dealt with.
In the meantime, we should note that the “China Price” is rising.
© The European Futures Observatory 2011
Price rises in China: Inflated fears | The Economist

Friday, 7 January 2011

Happy New Year

It’s about this time when many forward looking pundits outline their views on how the year ahead will shape up. These forecasts are not always very accurate – the example of the forecasts of UK unemployment at 3 million at the start of 2009 come to mind – because they turn out to be an expression of hopes and fears rather than a serious examination of the forces and trends that will dominate the year ahead. I try to avoid making predictions because it is too easy to be wrong. Flying cars and robot house servants come to mind of examples where the speculations of futurists have been wrongly taken for predictions of the future. Instead, I try to consider what the forces are that will shape an emergent future – to look at possible futures rather than predicted futures. We are currently working on a project that examines the forces that are likely to shape the coming decade. As this is the forward looking time of year, we thought that we would share these observations.
We have identified five key trends that we think will shape the coming decade. These are quite broad trends – almost mega-trends, if you like – and are likely to have a substantial impact upon how we live through the coming decade. The five trends are:
1. The Great Re-Balancing Act: There is much of the global economy that is unbalanced – Asian savings, North American and European debt, the levels of household indebtedness, the imbalance between the public and private sectors, productivity differentials, and so on. These imbalances are unsustainable in the long term. The re-balancing of the global economy is likely to dominate the next decade in various shapes and forms.
2. The Reform Of Big Brother: The public sector in Europe and North America has grown substantially over the past couple of decades. It is set to grow even further as the Boomers move into retirement, through the expansion of spending on retirement benefits and age related healthcare costs. At the same time, the prospect of muted recovery will act as a constraining factor to the tax base. As public finances are squeezed, reform will become inevitable and is likely to feature as a trend in the next decade.
3. The New Enlightenment: Our public infrastructure reflects a set of institutions that arose out of The Enlightenment. There are those who believe that this institutional infrastructure is inadequate for modern society. Some look to reform the existing infrastructure, whilst others look to establish new institutions. This is given a sharper edge by the need to reform the public sector, and is likely to be a feature of the coming decade.
4. The New Nationalism: Over the next decade, the best part of a billion souls will be added to the population of the world. This will place acute stress upon all sorts of resources that could result in their prices rising considerably. The traditional response of nations to such stress is to retreat into a nationalist cocoon, a feature likely to be made worse by a muted recovery in the global economy. If so, then the process of globalisation may stutter in the coming decade, with all sorts of consequences.
5. The Icarus Effect: Prior to the global recession, a number of economies were growing and developing at a rapid pace. As recession hit, the growth trajectory of all economies dipped. Some economies have bounced back from that dip (e.g. China), whilst other economies have simply hit the ground (e.g. Ireland). As this trend unfolds further, it is likely to be affected by the re-balancing of the global economy, which could call into question whether this is really the ‘Asian Century’.
None of these trends is set in stone. Events may occur that lead to sharp discontinuities in the trends – we only have to look back 10 years to see what a discontinuity 9-11 was. However, they do provide a useful device by which we can examine current events from a long term perspective. In doing so, we need to be sceptical about our work. Whilst the trends seem to be evident now, they may become less evident as time goes by, as new trends emerge. We see the trend identification as a road map looking into the future, a map that should help us to see where we are going.
Of course, we also need to remember that all maps become out of date over time.

© The European Futures Observatory 2011