Another Chain Of Events In Africa

This map shows a tragedy in the making – a point where the future is about to crash into the present. The causal chain is quite simple, but the implications are very complicated. If we accept the case of climate change and the desertification of the Horn of Africa, then we can expect to see an increase in the years in which the rains fail. It is likely to induce a negative feedback loop – less rain means crop failures, which induce greater soil erosion, which act to lower crop yields per acre, which serve to reduce familial incomes in the Horn of Africa. We have the prospect of hunger today and hunger tomorrow as well. However, from the safety of the West, we need to consider the geopolitical implications of this.

The drought is being experienced in two very fragile states – Somalia and Ethiopia – and one state that, though not fragile, could well become fragile if it experiences too much economic stress – namely Kenya. This, perhaps, is the more worrying development. Kenya is a viable state. However, it does suffer from the legacy by being a political entity that stitches together a complex patchwork of tribal relationships. In periods of fragility, those relationships can boil over into inter-tribal violence. If that happens, then we could possibly see the de-stabilisation of East Africa.

This ought to be concern to us for two reasons. The first is that those likely to benefit from this de-stabilisation are likely to be hostile to Western interests. The second is that the area occupies an important point in the global supply chain upon which the West relies. The impact of piracy and disorder emanating from Somalia is currently interrupting trade flows from the Indian Ocean through the Suez Canal. A potential ds-stabilisation of East Africa would give the pirates a greater operational area in the Indian Ocean, which could disrupt global trade flows even further. It would certainly increase the cost of the naval policing of these waters at a time when budgetary constraints are limiting the abilities of Western navies to respond to this challenge.

This is why the alleviation of global poverty ought to be fairly high on our list of things to do. Strangely enough, spending public money on overseas aid and poverty relief may actually save us a greater sum of money not to be spent in dealing with the disorder coming from failing states.

 

http://www.economist.com/node/18929467?story_id=18929467

© The European Futures Observatory 2011

An American Default?

Whilst most eyes are fixed upon the possibility of a Greek default at the moment, the possibility of a far more serious default is looming. The Federal government in America is scheduled to hit its borrowing limit – the maximum that Congress allows the government to borrow – this summer. It is possible that Congress will allow the limit to be raised, but the political strings attached seem to be causing political gridlock in Washington at the moment. Congress has tied the increase in the borrowing limit to a deficit reduction plan. There is no real consensus at to whether tax increases or spending cuts should form the prime feature of the deficit reduction plan, and lines are drawn broadly on party lines.

The interesting question is what happens if America defaults? It should be noted that in terms of sovereign debt, a default occurs when an interest payment is one day late. It appears that a major interest payment is due on August 15th and the CDS markets are pricing in a default. Volumes of CDS trades have increased dramatically over the past couple of weeks and the one year CDS spread is now priced in similar terms to the five year spread. This does not augur well.

Evidence suggests that if the US does default, then US Treasuries could be subject to an additional risk premium of about 60 basis Points (i.e. of 0.6% per annum). This doesn’t sound much, but it is an additional cost of $86 billion a year to the Federal exchequer. To put this into perspective, it’s roughly the size of the Federal spend on pre-primary to secondary education in 2011. The cost of gridlock in Washington roughly equates to the Federal education budget.

I find it hard to believe that an advanced society will allow such political brinkmanship. If there ever was a case for the institutions of a New Enlightenment, then this is it!

http://www.economist.com/node/18866851

© The European Futures Observatory 2011

Is The Well Running Dry?

This little graph tells us quite a large story, not only covering the past sixteen years, but also for the rest of this decade and possibly beyond. It shows two distinct phases in the recent economic history of the US. The first was between 1998 and 2001, a period where the actual output of the US economy was appreciably greater than the potential output. This shows the unsustainable boom of that period, leading to the inevitable bust at the beginning of this century. The second phase is from 2007 to the present, and possibly beyond. The credit crunch, financial bust, and the resultant recession have resulted in actual GDP falling appreciably short of potential GDP. In ball park terms, the US economy could expand by about three quarters of a trillion dollars just by fully using the unemployed and under-employed resources within the economy.

This is a cause for concern. The growth in the US economy over the past two years have been the result of a major fiscal stimulus (about $1.2 trillion) and an unprecedented monetary expansion through a double bout of quantitative easing (about $2.3 trillion). The monetary expansion ends this week. Whilst it is not suggested that a monetary contraction will take place, it is also highly unlikely that a third round of quantitative easing (QE) will take place. The removal of the monetary life support is likely to have something of a contractionary impact this winter (it takes about nine months for the impact to be felt). It may be the case that US unemployment starts to nudge back up towards 10% this year.

One of the areas in which the impact will be felt is in American fiscal policy. A good part of the two rounds of QE has been used in buying US Federal bonds. If this buyer of bonds is no longer in the market, then we can expect to start to see the yields on US Federal debt start to rise, which could start to place a strain on the US Federal deficit. At some point, the US President – if not the current one, then certainly the next one – will have to tackle this issue. It is not too difficult to foresee a period of fiscal austerity in the US, akin to the austerity measures now being enacted across Europe, in the later part of this decade.

This has a number of implications. Firstly, it means that the US will no longer be able to afford expensive overseas military engagements. Whilst this may be something of a shock to Americans, it will be a greater shock in East Asia where nations such as Japan, South Korea, and Taiwan still rely upon the US military guarantee. It will also have an impact in Europe, where the European members of NATO have been free riders on American military spending for decades. Second, it means that America will no longer be able to afford its poor. American welfare (including healthcare) is not exactly generous by OECD standards. Should that be pared back significantly, then we may see a degree of social unrest within the US that we haven’t quite seen before. Thirdly, it means that US seniors will have to rely upon their own provision for the future. In an economy where the costs of eldercare (including medication) are rising significantly faster than incomes in retirement, those retiring Boomers who haven’t laid much in reserve will face quite a constrained future. They could well become part of the poor that America can no longer afford.

And all of this presumes that US Sovereign Debt is not significantly downgraded from AAA. If it is, then all of the vicious cycle described above, becomes even more vicious and on a faster timescale. The key to avoiding this future is the generation of a political consensus in Washington that is prepared to take hard decisions about raising taxes and reducing spending commitments. It requires the sort of political courage that we can’t quite see in Washington at the moment. What we do see is a lot of partisan bickering that is putting self-interest ahead of the national interest. There isn’t even a consensus that America is facing a problem, let alone finding a solution.

But then, perhaps this merely reflects a social preference? American society seems to prefer immediate consumption over future security, in the belief that the good times will go on forever. This is not a preference that I share, but then, who am I to criticise the choices of others?

http://www.economist.com/node/18834323?story_id=18834323

© The European Futures Observatory 2011

The Cost Of PV Generation 1990-2040

This is an interesting little graph. If the assumptions are correct, it indicates that, sometime over this decade, the cost of PV generation will become comparable to that of peak power fossil fuel based generation systems. Sometime over the next decade, the cost will become competitive with the bulk production of electricity from fossil fuels. Should that happen, in reasonable quantities, then we will have started to make serious progress towards finding renewable alternatives to fossil fuels.

When that happens, we can expect the demand for PV systems to soar. Initially, soaring demand will give rise to a very profitable installation sector. One could argue that we are in that territory now. However, if the market is allowed to respond, new suppliers will enter the arena, attracted by the profits to be made. This injection of competition will serve to start lowering the long term installation cost as supply grows to meet that demand. This is exactly what happened for the supply of Satellite Dishes, and there is no reason why it could not happen for PV installations. 

In the meantime, the role of technology is to move the curves one way or another. For example, a breakthrough in PV technology could have the effect of lowering the generation cost so that Solar becomes competitive with fossil fuels sooner rather than later. As the market grows both in size and competitiveness, the way to achieve a profitable future will be to innovate newer technologies to generate more kWh per £ spent on installation. Like this, we enter a virtuous in which innovation lowers installation cost, which makes the technology more attractive compared to other methods of power generation, which then creates an innovation premium.

This is one possible way out of our reliance upon fossil fuels.

http://www.nitolsolar.com/encompetitiveness/

© The European Futures Observatory 2011

The Green House

I like the idea that the way to combat Greenhouse Emissions is to start living in a Green House! We are currently looking at a green retro fit at home, which is how we came across this outfit.

At present, the installation cost is fairly high, which has slowed the uptake of the technology. However, this is changing - gradually at first, but it will gather pace in time. As it does so, the uptake will increase in volume. I wonder if this is a good case for a public subsidy to prime the pump and to give the technologies involved a helping hand. It could be paid for by increasing taxes on conventional energy production (e.g. VAT on domestic fuel bills at the full rate of 20% instead of the soft rate of 5%).

I see this as a technology to be exposed to over this decade, and possibly the next. It certainly addresses the issues of which technologies are likely to fit the scarcity agenda.

http://www.eastgreenenergy.co.uk/

© The European Futures Observatory 2011

Global Population 2010-2100

This table originates from the UN global population forecasts. For the first time, it extends to the year 2100 so that we can see what the shape of demographics could be for this century. As always, the figures used are the mid-point figures, around which there is a cone of uncertainty. This cone (of varying degrees of statistical confidence) can be very wide in some areas, and very narrow in others.

The short story is that this century may well belong to Africa rather than Asia. It is interesting to note that not one European country is in the top 10 for 2100. However, 90 years is a long way to go, and there are many factors that may cause these projections to run off course. One of these factors may be that the political units that we have today may change into something radically different by the year 2100.

For example, the current forecasts presume that we have seen the high water mark of European integration. Some question this. They also presume the current territorial integrity of China (i.e. no shrinkage and no expansion). Some question this. As always with long term futures forecasts, the devil lies in the details of the assumptions made. And yet, some assumptions do have to be made in order to derive these very interesting results. That does not invalidate the results, it merely defines the degree of caution that we should exercise when using them.

Source Article in The Economist

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Are We Serious About Climate Change?

Every spring the UK Chancellor (Finance Minister) sets out his plans to match income to expenditure for the year ahead in the annual Budget. As the Budget is primarily about revenue raising (the expenditures are set out each autumn) all sorts of lobbying occurs prior to the Budget as various special interest groups vie to seek tax concessions. This year, the motoring lobbies have been some of the loudest in asking for special treatment.

The plight of the UK motorist has been hit hard in the past year. Oil prices have been rising and have been passed on to the motorist. The Pound remains relatively low against the US Dollar, making the cost in Sterling of a commodity priced in Dollars that much more expensive. VAT – an ad valorem expenditure tax imposed upon petrol – has risen from 17.5% to 20% in January. To top it all, the UK Fuel Price Escalator – a hydrocarbon tax  – is now set to increase by 1p per litre of fuel from 1st April 2011. No wonder that motorists are feeling the pinch!

And yet, this gives us an opportunity to pause and think about what is going on here. The complaint of many motorists is that they are being priced out of their cars. Whilst this has many implications in terms of equity, from the perspective of climate mitigation, this is exactly what is meant to happen. As a nation, we have rejected central planning as a way of allocating resources. We could easily devise schemes to ration petrol usage but we have foregone this approach for a market based solution. The way the market works is for those with the least income, and for those who have a lesser desire for a product, to become unable to afford that product or unwilling to buy it. These are the people for whom the Fuel Price Escalator was designed to price out of motoring.

If we are to achieve our Kyoto commitment of reducing our carbon emissions by 80% between 1990 and 2050, then there has to be much less petrol based motoring undertaken as we move into the Twenty First Century. Looking at it another way, only one in five motorists, on current consumption patterns, would retain their cars by 2050. This has to imply that four out of five motorists are forced off the road. They could be forced off the road by regulatory fiat, but this is not our way of doing things. Our way of doing things is to price them off the road.

And that is the central point. If we do care about passing on a sustainable world to our grandchildren, then we do need to tackle the issue of carbon emissions. If we want to address that issue, then we need to restrict private car usage, and an effective way of doing so is to raise the cost of motoring. If we are serious about addressing climate change, then we need to welcome the Fuel Price Escalator. Rather than face a rising cost of motoring in the long term, I sold my car two years ago. I suspect that many more will follow suit in the years to come, either by choice or by financial necessity.

© The European Futures Observatory 2011

British Banks–The Gift That Keeps On Giving

The news that Mr Osborne intends to make the bank levy more stringent than originally planned. Needless to say, the apologists from the financial economy are crying ‘foul’ and warning of a mass exodus from these shores. The trouble is that they did exactly the same last year – with the introduction of the one off tax on bank bonuses – and here they are again, still trading in London.

Two aspects of the proposals need highlighting. First, there is a view prevalent in the country at the moment that whilst the banks caused the mess that all of the taxpayers are having to clear up, the banks are not enduring a fair share of the pain. At a time when libraries are closing, essential social services are being cut back, and education spending is being reduced, we are also seeing the prospect of record profits in the banking sector and a return to stellar bank bonuses. The banks will gain little sympathy beyond the circle of sycophants over these proposals. Many will feel that they may not go far enough.

Second, there is the question of how the economy should be balanced in the future. Many question the wisdom of returning to an economy that is top heavy in the financial economy. A reduction in the reliance upon the banking sector would actually make the economy a bit more resilient to the shocks within the global economy. Those of that view point to Germany as an example of a balanced economy that has weathered the recession quite well. This addresses the issue of bank exile. If the risky, toxic, bank operations were to be driven away from the UK – say to New York or Hong Kong – would it be such a bad thing?

To me, this seems like something of a turning point. Until now, Mr Osborne had appeared to have been a captive of the banking fraternity and the financial economy. Only recently did he say that the ‘Banker Bashing’ had gone too far. Now he is bashing banks himself. Does this represent a major change in policy? Does he realise that for his gamble to pay off, he needs to rebalance the economy away from financial services and towards manufacturing exports? Let’s hope so!

© The European Futures Observatory 2011

Increased bank tax to raise £2.5bn - UK Politics, UK - The Independent

George Osborne levy attacked by banks and Ed Balls - Telegraph

North African Dominoes

First Tunisia, then Egypt, and on to Jordan and Yemen. Ought we to have been surprised by recent events in North Africa and the Middle East? No! Despite the timing of the revolutions now under way, I don’t think that we ought to be surprised at all. Some futurists have been pointing to the fragile nature of this region for some years. In his book “High Noon: 20 Global Problems, 20 Years To Solve Them” (published in 2003), J F Rischard warned us of the potentially volatile and toxic mix of a growing cohort of young men in North Africa and the Middle East, who are impoverished (yet live on the fringe of unimaginable wealth), unemployed (who see their corrupt elders lining their own pockets), and bored.

At a seminar at the World Future Society conference in Chicago in 2009, as a demonstration of the International Futures computer simulation model, Professor Jay Gary and Dr Tom Ferleman showed us that a combination of economic and demographic trends, in conjunction with a number of social and political trends, were leading to the possibility of a significant event in North Africa and the Middle East in this decade. For a reasonably sustained period, the warning bells have been ringing and those investors and businesses that have been tuned into this potential hotspot are now able to deploy their contingency plans.

It is easy, one might object, to be wise after the event. The important factor now is to consider what might happen next – to look to the future rather than to the past. To my mind, the most significant future factor is that the ‘youth bulge’ in North Africa and the Middle East has yet to peak. Over the course of this decade, even more unemployed, impoverished, and bored young men will reach the age when they might be pre-disposed to action in changing their world. If this cohort can be fulfilled, then the prospect of the future (growth, employment, and prosperity) is very bright. If, on the other hand, nothing changes, then the prospect is quite dim.

The question with which we should be concerned is how we move from the default setting (unemployed, impoverished, and angry young men) to a better setting – both for the young men and for us. It seems obvious that such a transition is unlikely to occur without a great deal of external assistance. A consideration of the origins of that assistance is quite instructive. Let us first consider the two Asian superpower wannabes – China and India. North Africa and the Middle East is important to both China and India, not only as a source area for oil and gas, but also as part of a key trade route between their home markets and Europe. This importance to China is underlined by the region seeing the only area of naval deployment outside of the Pacific Ocean (combatting Somali pirates on the trade route). India also sees the western Indian Ocean as part of its vital national interest and has deployed its navy accordingly. The Arab world is important to both China and India, and yet both are unable to influence events there. This suggests that if this is the ‘Asian Century’, then it still has a very long way to go before it becomes apparent.

Russia remains a significant force in the world, but, once again, seems unable to influence events in North Africa and the Middle East. Perhaps this reflects a scaling back of Russian geopolitical ambition? Perhaps it reflects an inability to project influence in the Middle East? Either way, Russia now seems less of the force that it once was during the Cold War. This naturally leads on to a consideration of the other contestant in the Cold War – the United States. America is still suffering from the legacy of the Bush years (perceived as anti-Muslim, pro-Israel). The current President has done little to allay that view and may come to rue his disregard of the Middle East. Whilst the US may have sufficient hardware to guarantee the peace of the Middle East, it does not really have the trust of many in the Arab world. It will continue to suffer from this lack of trust until its support of Israel is less uncritical.

We could almost stylise the situation as America having the hardware to guarantee a solution, but not the software to do so. The vital software could be provided by the European Union. There are key post-colonial cultural links between North Africa and some of the EU member states. Europe has started to spread its influence southwards in recent years and may be tempted to accelerate the pace of this trend. North Africa has a ready source of young people that Europe needs, whilst Europe has an abundance of opportunities that would go some way to absorb the energies of the young people in North Africa. There is the potential for a very agreeable relationship here. Indeed, one could argue that if European jobs don’t go to North Africa, then North African workers – either legally or illegally – will come to Europe.

For this to happen, prosperity and the chance of self-actualisation that democracy promises needs to spread across the Mediterranean. There is an opportunity for the UK and France (the two primary former colonial powers) to take the lead here, followed by Spain and Italy (two secondary former colonial powers). Backed by the EU, underwritten by the US, the Youth Bulge could become quite a positive feature. If not, then we open ourselves to the spread of fundamentalism and radicalism that would be harmful to western interests.

By happy coincidence, France is now due to chair the G20. Let us hope that their tenure is used wisely!

© The European Futures Observatory 2011

Manufacturing To The Rescue

Signs that Mr Osborne's Gamble is paying off. This seems to be down to the weakened exchange rate. Now that Sterling is strengthening again, I wonder if the gamble will continue to pay off?

Of course, there is a threat to this rosy picture. As factory gate prices are rising, so are the calls (mainly from the financial economy) for interest rate rises to stave off  the inflationary threat. Not to actually reduce inflation, but to show that we are serious about inflation. This is a bit like cutting off your nose to demonstrate a capacity to bleed. Anyway, if interest rates were to rise, we would expect Sterling to strengthen as well. That would damage UK manufacturing as UK goods became more expensive overseas. It would also reduce the prospect of Mr Osborne’s Gamble paying off.

I wonder if the Bank of England does want to choke the recovery, weak as it is?

© The European Futures Observatory 2011

BBC News - UK manufacturing growth at fastest since records began

Can Interest Rates Control Inflation?

As the titanic struggle between the real economy and the financial economy intensifies, the question has arisen about using interest rates as a tool to reduce the current bout of inflation. We have argued that they would be rather a bunt instrument simply because they would address the symptom and not the cause of the disease. The current bout of inflation is the result of the rising world price of commodities. This has mainly been caused by the recovery of the Icarus Economies in Asia, it is a demand led inflation.

Raising interest rates work by dampening demand to such a point that, as sales fall, companies respond by cutting their prices (or, at least, not raising them as fast). Demand is reduced by taking money out of the economy. That money doesn’t disappear though. Instead, it acts as a wealth transfer out of the real economy and into the financial economy. No wonder that it is the banks and financial institutions who are leading the charge for higher interest rates.

Which leads us back to the politics of the current situation. For Mr Osborne’s Gamble to pay off he needs the real economy to deliver growth through investment and exports. These are not helped by higher interest rates. Which creates a dilemma. In order to collect from his gamble, Mr Osborne has to turn his back on his natural constituency in the City.

We live in interesting times!

© The European Futures Observatory 2011

FT.com / Comment / Letters - Raising interest rates is a poor tool to fight inflation

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

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%'

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

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 ‘Dot.com 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

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

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

Spooking The Horses

There are times when a well intended policy can actually make matters worse. It seems to me that the European Stability Mechanism may be just one such policy. It is designed to ensure that the financial markets are operated in an orderly fashion in the face of one member of the Euro coming under pressure, but they may serve to de-stabilise the markets by being open to undue political pressure.

In future crises, the EU will require the crisis stricken member of the Euro to force losses on the existing bondholders before a bail out package would be approved. In the future, in the face of the certainty of a loss, what will those bondholders do? My guess is that they will dump the crisis stricken bonds at exactly the time when the Euro member state would want them bought. What will prospective buyers do? Sit on their hands until the price of the debt stops falling. As bond prices are the inverse to interest rates, of course rates are likely to rise.

However, as greater risk has been introduced to the system, it is quite likely that the system will become more volatile. Just as we want to quiet the horses, there go the politicians spooking them again. At least this will give rise to some good shorting opportunities in the medium term!

© The European Futures Observatory 2010
BBC News - EU to target private lenders in future bail-outs

The Geopolitics Of Scarcity

As we start to look at the onset of scarcity, all sorts of second and third order consequences start to emerge. One such consequence is how the impact of food scarcity could undermine the authority of the Chinese Government.

The model is quite simple. A combination of globalisation and a fixed exchange rate have allowed China to develop into a manufacturing powerhouse on a global scale. This has raised millions of Chinese families out of poverty (60 million families a year – that’s a huge number). As incomes have risen, so have dietary expectations. Chinese families expect to eat more regularly, with more food, and with a higher protein content than they have in the past. All of this puts pressure on global food markets.

However, China is also a poor nation, a feature of which being that expenditure on food is a high percentage of household disposable income. As food prices rise, they have a more immediate effect on households than they would, say, in ‘Western’ economies. This is the basis for discontent, which may lead to unrest. The last time food prices rose quickly, there were outbreaks of unrest in Tibet and Xin-Jiang provinces, as the rising cost of food exacerbated an existing set of grievances.

One way in which the Chinese government could reduce the impact of rising food prices could be to allow the Yuan to rise faster than it is currently rising against other currencies. However, this policy has the risk of slowing China’s export growth, which has been the basis for prosperity so far. It would also mark a shift in China’s commercial policy away from export-led growth and towards domestic consumption-led growth, a potentially destabilising feature within the Chinese economy.

That none of this has happened suggests that the growth of Chinese exports will remain strong, that inflation will continue to be an issue, that the global financial imbalances will continue to grow, and that food prices will continue to rise. There will come a point where all of this reaches a climax and profound and sudden change will come. We are still of the view that such changes will originate in western China, and it is to there that we are looking for clues.

© The European Futures Observatory 2010
BBC News - China sees inflation jump to 5.1%, a 28-month high
BBC News - Chinese exports jump unexpectedly amid inflation fears

Finding An Alternative

The Senkaku Islands, as they are known in Japan – in China they are known as the Diaoyu Islands, are a group of unproductive volcanic rocks lying in the East China Sea. They are only remarkable because both China and Japan – and Taiwan too, for that matter – claim ownership of the rocks. If there weren’t deposits of oil shale in the island chain, then it is quite likely that their ownership would not be disputed.

At present, Japan controls the islands and recently asserted its control by seizing a Chinese trawler, allegedly fishing illegally in the disputed waters. China responded by cutting off the supply of Rare Earth Elements to Japan. The price of REEs has risen considerably in recent weeks as Japan seeks alternative sources (China controls 97% of the global production of REEs). This is very much a scarcity story.

What is interesting is the Japanese response to scarcity. The rising price of REEs has led to greater economy in their use. There has been a boost to the technologies of resource economies so that less REEs are used per unit of output (an increase in ‘resource productivity’). There has also been a race to diversify supply away from China to other areas where REEs could be found. A rising price makes more marginal deposits commercially viable. There has, finally, been a boost to the mineral salvage industry to recover REEs from discarded electrical equipment.

In many ways, this is the response that we would expect to any incipient scarcity. Perhaps this is the answer to Peak Oil?

© The European Futures Observatory 2010

BBC News - Japan seeks new options on rare earths

A Prelude To Scarcity

In recent days, there has been quite a lot of interest in the issue of long term scarcities. This is an area upon which we have been working for over a year now – longer if we include the work on the Post-Scarcity World – and it seems to be an area that is coming into fashion. The argument for scarcity is well rehearsed. In 2000 there were 6 billion souls on the planet. By 2050 the mid-estimate of the UN is that there will be 9 billion people. Balanced against this increase in potential demand for resources is the view that we are coming to the point of peak production for many resources, thus potentially restricting their supply. The result of this clash of rising demand against falling supply will be an ‘Age Of Scarcity’.

Of course, the transition to the Age Of Scarcity is not likely to be discontinuous. We are likely to drift into a position of scarcity over a number of years, with, every now and then, a prelude of what is to come. We would argue that this is what is happening with food prices. After a long period of falling food prices in real terms, from 1980 to about 2002, food prices appear to have started to rise on a long term trend. This trend, underpinned by growing demand in the emerging economies and by modest improvements in crop yields, looks set to continue for some time to come.

Every now and then, a combination of natural disasters, the impact of climate change, the impact of trade nationalism, and so on, serves to tighten the markets a bit. It happened in 2008, and is again happening in 2010. To this extent, we are witnessing over a small period of time what may well happen over a longer time frame. We are witnessing a prelude to scarcity.

© The European Futures Observatory 2010

The Economist food-price index: Malthusian mouthfuls | The Economist

How Rich Are The Poor?

My son is currently living in Taiwan, so stories about Taiwan naturally catch my attention at the moment. There was a story in The Economist about how Taiwan is on the verge of becoming richer than Japan. The counter-intuitive nature of that comment really did catch my attention.

The Economist is quoting IMF figures when it states that the GDP per head of Taiwan is set to be $34.7K this year, against $33.8K for Japan. However, once we start to drill into the figures a different picture emerges. The Dollars used are not real Dollars but ‘PPP Dollars’ (Purchasing Power Parity Dollars). PPP Dollars are an artificial construct that attempts to weight income in terms of the cost of living across countries. The Japanese figure is discounted more heavily than the Taiwanese figure because Japan has a much higher cost of living. However, the adjusted figures do suggest that Taiwan has a better standard of living than Japan, which fits in with the impression that my son creates.

Does this matter? In a sense it doesn’t. These figures a a bit arbitrary and the PPP weightings are something of a guesstimate rather than an accurate measurement. However, there are times when it is important. According to some measures, China will move from the third largest economy in the world to overtake Japan as the second largest economy in the world this year. What we lose in this statistic is exactly how poor China is. The ranking of number two is a volume effect (well over a billion Chinese citizens) rather than an income effect. According to the IMF again, but for 2009 instead of 2010, China ranks 99th for GDPO per head in PPP Dollars (Taiwan ranks 37th and Japan ranks 17th).

Which is the rich country and which is the poor? China could be seen as a rich nation – the second largest economy in the world – whilst at the same time being one of the poorest - 99th in terms of GDP per capita. We haven’t quite come to grips with this dichotomy as yet, and some would say that this will be one of the future challenges that we face.

© The European Futures Observatory 2010

Taiwan and Japan: X not V | The Economist

The Luck Of The Irish

The case of Ireland and its present difficulties does pose a few questions that have a much longer perspective. If the Euro experiment were ever to work, then there would need to be a great degree of monetary co-ordination, along with a fair amount of fiscal co-ordination. The establishment of the ECB has, by and large, achieved monetary co-ordination. It was the role of the Stability and Growth Pact to harmonise fiscal policy by limiting budget deficits to 3% of GDP and public debt to 60% of GDP. The failure of the Stability and Growth Pact, almost from inception lies at the heart of Ireland’s present difficulties.

In recent years, Ireland has based its ‘Celtic Tiger’ credentials on a policy of the competitive reduction of Corporation Tax. Businesses, particularly UK businesses, have responded by relocating in the low tax environment. That now appears to have been something of a mistake. Now that the Irish bubble has burst, the nations bailing out Ireland – the victims of competitive tax policies – have a say in the future management of the Irish economy. Just as the Greek bailout is predicated by the reduction of public spending to more sustainable levels, so an Irish bailout is likely to be predicated by the raising of taxes to more sustainable levels.

This is of tremendous significance because it would imply the loss of Irish fiscal sovereignty. The Irish government has gambled on a low tax Tiger Economy and has lost and now it has to pay the price accordingly.

© The European Futures Observatory 2010

Hamish McRae: Sovereign defaults in the eurozone are inevitable

X Marks The Spot

When we last wrote about Mr Osborne’s Gamble (that fiscal tightening and monetary loosening will bring us out of recession), we left the issue of politics on one side. If the Gamble fails to work in an adequate time frame, we are unlikely to be able to leave politics out of the equation because this will be the arena in which the consequences of failure will be felt, as President Obama found to his cost this week. It is interesting that the political arena in the UK has experienced a significant long term change this year through the generational rebalancing of British politics.

Over the course of this year, Mr Brown has been replaced by Mr Miliband as leader of the Labour Party and Mr Clegg has moved from obscurity to Deputy Prime Minister on behalf of the Liberal Democrats. There has been no change in the leadership of the Conservative Party. The one thing that all of the current party leaders have in common is that they belong to Generation X, and that they have replaced Baby Boomers as party leaders. We have already felt some of the consequences of this, but far more are to come.

To recap on generations, the Baby Boomers in the UK represent a generational cohort that has almost been a golden generation. They grew up in the rising prosperity in the 1950s, they provided the flower power generation of the 1960s, they benefitted from the great housing inflation of the 1970s and 1980s, and they are currently starting to retire on gold plated pension schemes. They are self-absorbed, self-indulgent, and spoilt.

The children of the Boomers – Generation X – have experienced a different life pattern. They grew up in a world of strikes and three day weeks, of stagflation, of youth unemployment in the Thatcher years, and of a struggle to get onto the housing ladder. They are the original punk generation who have lived a life of low paid and insecure jobs, and who have learned to get by through making the best of a bad job. This ability to muddle through is what the Xers are bringing to the leadership roles into which they are now moving.

One of the great attributes of the Xers is their pragmatism, and this is starting to show though in politics. For example, the Liberal Democrats gave a clear promise in their manifesto not to increase VAT (a UK sales tax). Within weeks of attaining power, that undertaking had been abandoned because of expediency as part of a more general fiscal tightening. Again, each Lib-Dem MP signed a written pledge not to increase Student Tuition Fees. Again, within weeks of attaining power that pledge was abandoned in the name of fiscal pragmatism. The Boomers accuse the Xers of not keeping their word, which they haven’t. However, this does not prick the Xer conscience because the situation warranted this change of heart.

When we take this thinking to Mr Osborne’s Gamble, we can speculate that if the gamble doesn’t pay off, then the policy will be changed – in short order – to a policy that does work. The most likely candidate would be that the fiscal tightening will not be tightened as hard as originally planned. There are lots of areas in which the policy can be reversed. Many of the spending cuts will adversely affect the Boomers, who are now flowing into the ranks of the retired.

As these parts of the public sector are cut back, the Boomers will howl with rage like children who have had their toys taken from them. For example, there was an absolute furore when it was suggested that free bus passes for all retirees – irrespective of their wealth or income – be removed. The Boomer sense of entitlement was outraged at this suggestion, which was made in the cause of saving public spending. There is likely to be more of this in the near future, particularly as local government works out which areas of the public sector to retreat from. Politically, it would be tempting for an Xer Chancellor of the Exchequer to buy Boomer votes by not pruning so hard if the gamble fails to work as planned.

To our view, this gives shape to Plan B. Renewed Quantitative Easing will provide an early warning signal of the gamble not paying off. If things continue to worsen, then the pragmatic aspect of the present government is likely to come into play to allow for some fiscal easing as well, possibly by spending a bit more on the ageing Boomers.

In this respect, we are fortunate to be surrounded by pragmatic Xers because the last thing we need right now are doctrinaire politicians.

© The European Futures Observatory 2010

The Pace Of Change

We live in a world that demands things to be done instantly. President Obama has just been punished for not taking the US economy out of the worst recession in recent history in less than two years. When I offer the opinion that the recovery could well take the rest of this decade, I am usually met with sheer disbelief. We want everything done now, and we expect that in others.

Of course, not all in the world march to that tune. The issue of political reform in China is one case in hand. There is much pressure from the west – principally the US, but also the European nations as well – for China to reform its political institutions. China replies that it is, but at a pace of gradual reform rather than at breakneck speed. Exactly how far things have moved can be seen in John Humphrys’ report for the BBC.

In a 30 year retrospective, Mr Humphrys reports on how much has been achieved in one generation. By comparison with 1980, China is a much more open, tolerant and pluralist society. By western standards there is still a long way to go, but perhaps the cause for political reform might be helped more by congratulating the Chinese government for what it has achieved rather than berating it for what it has yet to achieve?

Sometimes we should be a bit more tolerant ourselves.

© The European Futures Observatory 2010 

BBC News - Humphrys: 'I was wrong about China'