A Right Royal Jelly

I had the good fortune to be invited to the first ‘Suffolk Jelly’ this week. It was organised by Suffolk Digital and hosted at the Eastern Enterprise Hub. I wasn’t quite sure what it was about, so I thought that I would go along to find out. I am very glad that I did because I found it to be a very worthwhile event. In trying to describe the event, I think that it was set in two halves. In one half was an office space which those attending could use for the day. I think that was the idea covered in the report in the local press. However, for me, I didn’t find that format at all helpful – I have a number of offices already.

My interest was aroused and inspired by the second half of the offering – the soap box section. This was a room dedicated to the attendees who were encouraged to present on any subject they liked. Most presentations were made by people telling the audience what they did. It was a bit hit and miss as to whether the subject was of interest, but it was important for allowing the presenters a bit of live practice at making a pitch. Some presentations were a bit more speculative, told the audience what the presenter hoped to do and asked for comment and feedback. This worked really well and provided the sort of feedback that one rarely obtains. My offering for the day was a short piece on why futures matter (or, more correctly, why ‘business as usual’ is not an option). The Q&A turned into a conversation about business model flexibility and adaptability. The whole ethos of the day felt a bit like those ‘Skunk Works’ sessions that some of us attended in previous lives.

What I found most interesting about the day was the opportunity that it afforded to build creative capacity within Suffolk. There are currently a large number of creative agents based in the county, but without a node around which to coalesce. The Jelly format seems ideal for delivering this. For example, I saw presentations by Jamie Riddell (basically a trend spotter/ cool hunter), Andrew Walker (whose line is data analytics), and Steve Butterworth (whose cause of citizen journalism is all about picking the story out of masses of raw data). To my mind, there is scope for these three individual agents to work collaboratively to bring to market a combined offering that would be larger than what they could achieve on their own.

And that is the challenge of building a creative community. There is more to it than simply joining the creative hotspots. Those connections need to amount to something larger than the individual parts. The first Suffolk Jelly may not have achieved that because there remains a great deal to be done. However, it was a very valuable first step in the right direction.

Click Here for details of the Jelly.

Click Here for press coverage of the event.

© The European Futures Observatory 2011

The Many and the FEW

The whole premise of our ‘Communities of the Future’ project is based upon two assumptions. The first is that, by 2025, global population will have increased from its 2000 level of 6 billion to a new level of 8 billion. These are ‘the Many’. This is a mid-range estimate, and there is a likelihood that population could be higher or lower than that figure. However, for the purposes of the project we shall assume that the mid-range figure will be more or less correct.

One of the implications of this rapid population growth is that we shall need to grow more food. In doing so, we shall use more energy and we shall use far more water. The second assumption is that the supply of these resources is either fixed or growing at a rate that is slower than the growth in demand for these resources. For our purposes, we shall assume that the growth in demand far outstrips the growth in the supply of resources, giving rise to a period of acute scarcity. These scarcities are likely to be further exacerbated by the impact of climate change and peak oil.

In the period to 2030, we do not envisage a substantial change away from the reliance upon the price mechanism as a means of allocating scarce resources. There is a case for a more formal rationing system for key resources – such as electricity – towards the end of the period, but we do not feel that a consideration of a fundamental change in the current distributional system is warranted.

In which case, the era - as we see it - will be one of high prices for basic commodities. This is likely to cause a certain degree of social stress, as we see the incidence of fuel poverty rising and we see the possibility dietary standards declining. However, it does create an incentive for the construction of social technologies to counter this. We feel that people are likely to become more communal and sharing in their lifestyles, as a means of coping with the problems that they face. The challenge to social enterprises will be to create the institutional structures to deliver a more sharing way of living.

Initially, high prices for basic commodities will act as a brake upon commerce (this is the ‘income effect’). The high cost of inputs is likely to reduce the levels of economic activity for the first part of the period under review. However, this will also create a commercial opportunity for those creative enough to find it. The initial shock of rising prices is likely to stimulate ways of using resources more effectively (the ‘substitution effect’), and those entrepreneurs who unlock the substitution effect are set to do very well.

Ultimately, the relative high price and scarcity of resources will stimulate investment in resource saving technologies. We see these as starting to have an effect towards 2030. This investment is likely to act as a stimulus to economic growth – ‘green’ economic growth!

© The European Futures Observatory 2011

Click Here for more information about the ‘Communities of the Future’ project.

Click Here for more information about the session ‘The Many and the FEW’.

China To The Rescue?

There are those who take the view that the emerging Asian economies – especially that of China - might prove to be the salvation of Europe and America. This view rather neglects the unfortunate fact that the Asian economies – especially that of China – have problems of their own and it may not be entirely convenient for them to act as a rescuer to western economies. China, in particular, is suffering from an economy that is in danger of overheating. Inflation is rising and an awkward looking property bubble is forming on mainland China. Asking the government of China to add to that inflation seems to be unrealistic at best.

The size of trade deficits between China and both the Eurozone and the US has allowed the exchange rate to be used as a vehicle of monetary tightening. There has, in recent months, been a slow appreciation of the Chinese currency against the US Dollar and, to a lesser extent, the Euro. The main motive for this appreciation has been to act as a check upon domestic inflation within China rather than to act as a device to stimulate demand for American and European goods. However, the degree of appreciation has been nowhere near the levels needed to provide a stimulus for the sluggish Western economies. The Chinese government continues to manage the exchange rate in a way that minimises the possibility of internal unrest, which means that all changes are slow and deliberate. This is not set to change.

Monetary conditions within China now require a tightening. However, this policy also requires a great degree of finesse. The exact quantity of non-performing loans in the Chinese monetary system is unknown, but is thought to be much higher than in Europe, the US, and even Japan. Some estimates suggest that the degree of non-performing loans could be as high as a third of the assets on the balance sheets of Chinese banks. If the monetary authorities tighten too hard, this could expose the volume of these non-performing loans at exactly the wrong time, triggering a Chinese banking crisis. If the monetary authorities are lax in their tightening, then they might not deal effectively with the inflation that is weakening the Chinese banking system to begin with. In either case, a wobble in the Chinese banking system would have major global consequences.

It is worth considering how and why such a wobble might take place. In recent years, Chinese local authorities have been forming large numbers of joint ventures with the private sector bodies. A principal objective of the joint ventures has been to buy and develop property, especially throughout the eastern seaboard of China. The joint ventures have received preferential access to banking funds – often controlled or heavily influenced by the local authorities – to finance the investments. The allocation of capital has not always been on the strictest of commercial considerations. Not all of the loans made are fully performing. It would appear that, over this summer, the number of defaults in the Chinese banking system have started to rise.

We can expect this process to continue. As the Yuan continues to appreciate, as interest rates continue to rise, and as banking reserve ratios continue to creep up, the availability of new finance in China will diminish. This will have the effect of reducing demand in the property sector, which will lead to property prices softening. If panic sets in, as happened in 2009, prices could fall quite sharply to expose the weakness of many property funding arrangements. In itself, this will not readily transmit into the monetary system. One possible response by the Chinese central bank could be to ease credit in the face of a property bust. However, a consequence of that policy would be to rekindle the inflationary forces that are currently being dampened down. If, as is more likely, the monetary tightening were to continue, even in the face of a weakening property sector, the problem could easily transmit from the property sector into the financial sector.

If the property sector were to crash, it is likely that many property investors would also liquidate their stock holdings to cover their property losses, as far as they could. We could almost say that this is happening already. Since 2009, the Chinese economy has grown by over 9% per annum, whilst the stock exchange is trading at broadly comparable levels in nominal terms. If we factor inflation into the picture, then it is true to say that the stock exchange has witnessed negative real growth between 2009 and 2011. This partly reflects the flight of capital from China to the relative safe haven of the US (the Dow Jones Index is up by 20% over the same period, even allowing for a bad summer in 2011), but it also reflects the liquidation of stock holdings to cover losses in the property market.

At present, the effects of all of this have been fairly mild. There is a reasonable risk that such an event could become substantial. In April 2011, Fitch warned that it was changing its stance on Chinese local currency denominated debt from ‘Stable’ to ‘Negative’. The debt currently has an AA- rating, but could well be downgraded in the near future. If it were to happen, then the repercussions would be felt well beyond China. A run on the Chinese banking system could be accommodated by the Bank of China, but not without recourse to the repatriation of holdings of overseas debt that it owns. It is not unreasonable to conceive of a run on Chinese banks leading to a run on the American banking system in fairly short order. Beyond that, the contagion would spread to the global banking system quite rapidly.

At the moment, few observers have factored into their calculations the possibility of a renewed financial crisis originating in Asia. We feel that they ought to. There is a reasonable chance of financial instability emanating from the region, and we feel that the current view that Asia will rescue the European and North American economies is nothing more than fanciful.

© The European Futures Observatory 2011

Time For QE2?

Despite Project Merlin, it would appear that there is a problem with the UK banks lending to UK non-financial corporations. The graph indicates that, since 2009, lending has been negative in absolute terms. If we factor in an inflation rate in the region of 5%, then lending in real terms has been negative since about 2008.

The policy of quantitative easing, where the Bank of England injected £200 bn into the monetary system, lowered interest rates to an effective nominal rate of about -2.5% in nominal terms and stimulated GDP by about 1.5% to 2%. This was a great success. It meant that we suffered a recession instead of an economic slump. However, it was also something of a blunt instrument in that much of the injection did not make it to the real economy. The policy also diverted cash from one idle pool of money (the gilts market) into another (the stock market). It is no accident that the FTSE 100 share index rose by 50% during the period in which the Bank of England made its purchases.

That, of course, does not mean that the policy would continue to work if it were to be repeated. For the policy to work, there needs to be a more direct link between bond purchases and bank lending. The proposal for QE2 to but bank bonds rather than gilts might go some way to address that problem. It would be a way to give Project Merlin some teeth. There is the possibility of some capital loss on the part of the Bank of England, but given the levels of profit made during the onset of the credit crunch, these do not need to be substantial.

If monetary policy is to be the chosen route - and I have to say that a fiscal stimulus aimed at low income families would be more preferable - then a monetary easing directed at small business is unlikely to do much harm. It may even help to boost growth a bit.

© The European Futures Observatory 2011

Tackling the slump: Money for something | The Economist

Not Quite The Whole Truth

This is a curious example of a story not quite telling the whole truth. We are told that "Britain's banks, moreover, are not among the most exposed to Greek debt. " That part is true. But it is not the whole truth. French and German banks hold about two thirds of the Greek sovereign debt. Any action to prop up Greece, is also action to prop up the French and German banking systems - a point missed by many French and German voters.

However, from where did the French and German banks get the money to buy Greek sovereign debt? It is the case that British banks lent the French and German banking system over €1 trn. Any pain felt by French and German banks will be quickly transmitted to the UK banking system. From this, we ought to deduce two conclusions. First, nobody can afford to be smug about the pain of others. We are all in this together. Second, any politician who claims that the cost to their constituency of a Greek failure would be minimal either knows the truth and is not telling it, or doesn't know the truth and really ought to.

© The European Futures Observatory 2011

£1.75 trillion deal to save the euro - Telegraph

Who Will Look After Little Brother?

One potential debt crisis that has escaped our attention so far this year is that of the US States. An interesting feature of the American political system is that the political sub-units – the US States – enjoy a greater deal of fiscal freedom than many political sub-units elsewhere in the developed world. Whilst US State governments follow a more integrated monetary policy, which tends to reflect a national agenda, they also have the ability to pursue a more independent fiscal policy.

To this extent, the US system is comparable to the Eurozone. We must not follow the analogy too far because the American States are different to the Eurozone nations in that they have more of a common heritage, a common language, and a tradition of openness within a broader economy than the EU has yet to develop. And yet, we cannot but help to think in terms of California having a GDP similar to Italy, or Wisconsin the size of Ireland, and so on. It is instructive to do so when considering the issue of potential monetary instability.

The average fiscal deficit to GDP ratio in the Eurozone is about 4.2%. This average hides a wide dispersion of results, from a Greek deficit of about 10.0% of GDP to a German deficit of about 1.7% of GDP. The situation in America is slightly different. The estimate for US Federal debt is about 9.0%, which is in the ball park in comparison with some of the Eurozone nations. However, the average State debt is about 16.5% of State GDP, which is a figure that makes Greece appear to be fiscally prudent. There is some debate about the accuracy of these figures (State GDP is very hard to measure in a fluid and open economy such as the US), and we have to remember that there is also a political agenda to their estimation. Additionally, there is also a greater deal of dispersion around this mean, from Wyoming (with a deficit of about 6% of State GDP) to Massachusetts (with a deficit of about 25% of State GDP).

If we believe that the US State deficits and the US Federal deficit are additive, that would imply total public debt in the US of about 25%. This seems rather large to us, and suggests that an element of double counting has crept into the estimations. Nonetheless, we are comfortable with the conclusion that US States deficits are worse than those of the Eurozone nations, and that there is a greater variation of experience with the deficits of the US States. All of this remains hidden by the US Dollar being the world reserve currency. Just as the weaker Eurozone nations have hidden behind the collective strength of the Euro, so the US States have hidden behind the US Dollar being the world reserve currency. This has kept down the cost of borrowing for US States and has made funds more readily available than the fiscal environment would otherwise have offered without this feature.

Looking into the future, one wonders how long this will last. If the US credit rating suffers further deterioration, then there may well come a point where the position of the US States is re-evaluated in the bond markets. Just as the more vulnerable Eurozone nations have suffered the scrutiny of the bond markets, so could the weaker US States, such as Michigan or California. If that were to happen, then rather unfortunate consequences could result. In thinking about what could happen next, we have found the case of the near bankruptcy of New York City in the 1970s to be instructive.

The relative fiscal independence of the US States means just that – they are responsible for themselves. If their finances were to come under pressure, then there is no automatic mechanism whereby the Federal government would have to bail them out. If the Federal government took a position of moral hazard – that those who made the mess have to clear it up – then it is quite likely that the State governments would respond by increasing revenues (charges as well as taxes) wherever possible, along with the more likely policy of cutting back expenditure very hard. Even today, it is not entirely unknown for the staff in some States to be paid in IOUs, which are redeemed for cash by a credit union or bank. We could well see a lot more of this. It is at this point that one of the great strengths of the US economy becomes one of its weaknesses.

Although there is some migration between nations in the EU, by and large, European populations are having to bear fiscal austerity. The tax base is relatively stable and the pain of spending cuts is simply endured. This is not so in the US. Given the open nature of the US economy, given the fluidity of its labour market, and given the relative homogeneity of the population, it is far easier to move house. Often to a different State. It is relatively easy to move from fiscally imprudent New York to fiscally prudent Connecticut – you would simply be moving further up the commuter line. This feature creates an instability to the State finances. It is generally the case that the tax base is highly mobile (and will pack up and leave if taxes are seen as too high), whilst the spending base tends to be immobile. The tax base moves out, whilst the spending base stays put. For a State under pressure, this will make the situation worse.

In this future, if it came to pass, the Federal government would have to bail out the State, much as it eventually had to with New York City in the 1970s. Not because it has to, but because it is in its interest to do so. The cost of such bail outs would be truly staggering, and we can see why the Federal government is reluctant to contemplate it. This completes the circle, because a failure to contemplate the downside of the finances of the US States may well lead to a further downgrading of the US by the ratings agencies.

Most visions of the financial future do not account for adequately the inherent instability that the US State finances could contribute to the global monetary system. We feel that this is a mistake. We fear that the realisation of this weakness could lead to a sudden correction in valuations that itself could become a destabilising factor. Then we will all be wondering who will look after the little brother.

 

© The European Futures Observatory 2011

Has The Giant Stumbled?

The US has had a poor year to date. The American recovery started to run out of steam in the spring, the second round of Quantitative Easing ended in the first half of the year, and the question of Federal debt has come under the spotlight. The key debt issue was the raising of the Federal debt limit. Eventually, a temporary compromise solution was found, but the process of reaching this compromise has demonstrated the polarised nature of American politics and has weakened considerably the position of President Obama. It was for this reason that the US credit rating was downgraded from AAA to AA+.

The long term consequences of this downgrade have yet to emerge, but there are three factors to be aware of as we move into the future. First, could we take this as the opening move in the US Dollar losing its status as the global reserve currency? It is not quite a ‘Suez Moment’, but has the potential to start the process by which one emerges. How America would respond to these events is uncertain, but the world needs certainty right now, not more uncertainty. Second, the cost of borrowing in America is likely to rise in the long term, thus muting the economic recovery – which is already weak. It means that the world can no longer rely upon the American consumer to generate a recovery. Exactly where we should look for this engine of growth has yet to become clear. Thirdly, the political intransigence in America makes effective US Federal debt reduction appear even more remote. One political grouping will veto all tax rises. Another group will veto reductions in defence spending. And a further grouping will veto spending reductions on healthcare and welfare spending. It is not helpful for America to have a polarised and intransigent political system, but that is exactly what it has.

The political classes in the US are rather hoping that growth in the economy will move them out of the difficulties which they now face. With growth, overall tax revenues will rise, leaving the spending commitments much more affordable than they presently are. The question then is whether or not a presumption of growth is reasonable. In assessing this question we need to consider the point at which we are starting. The US has been hit hard by the recession. According to the US Bureau of Economic Analysis, GDP (which it measures in 2005 constant dollars, a practice which we shall continue) fell by about 6% between 2007 and 2009. During this time, US unemployment roughly doubled from abut 5% to about 10%. A recovery has been under way, but the level of GDP is still below the 2007 level and unemployment remains about the 9% level. The growth there has been is well below trend.

More worryingly, this growth has been achieved with the benefits of a $1.2 trn fiscal stimulus and two bouts of quantitative easing to the tune of $2.3 trn. The prop of quantitative easing has now been removed for the moment. Some of the temporary fiscal stimuli are also now coming to the end of their mandate. On top of this, the agreement to raise the debt ceiling institutionalised further cuts in federal spending of between $2.1 trn and $2.4 trn, depending upon whether a consensus is reached about where spending cuts and tax increases are to be incurred. Either way, the public sector support for the US economy is likely to become much reduced this year. It is for this reason that a softening of the US economy looks likely, and a double dip recession is not exactly off the agenda.

In the longer term, US politicians are relying upon the private sector to generate the growth needed to jump start the economy. This is unlikely to come through US exports – the overseas customers of US firms are likely to be facing the pinch just as much as US consumers. A weakening dollar may provide some relief to US exporters, but not at the levels needed to revitalise the economy. Both the private household sector and the private corporate sector are currently looking to repair their balance sheets, which has led to some poor consumption and investment figures. As households retrench, so will the corporate sector, as the prospects for future profits become even more limited. If there ever was a case for a fiscal intervention, now would be it.

Which brings us back to the political malaise in Washington. One of the interesting things about the American Constitution is that it is the product of conscious design. It hasn’t evolved and fallen together as the British Constitution has, but was actually designed in a way that checks and balances would prevent too great an accumulation of power. It was, however, based on a presumption of a willingness to compromise, and that willingness has been lacking in recent months. To an outsider, it seems as if the political system has been hijacked by extremists who would willingly destroy their country rather than reach an accommodation with those who do not share their view. If the extremists fare well in the elections next year, then we can expect the US economy to show sluggish growth for the rest of this decade. A modicum of common sense is a necessary, but not sufficient, condition for an American recovery.

It is possible to design a fiscal stimulus that does not increase the US federal deficit. For example, renewing the mandate to extend unemployment cover, to be paid for by a tax on the idle balances of the rich or a levy on tax-payer funded banking profits is not beyond the scope of most governments. By definition, the taxes would be levied on dead money and given to those who are most likely to spend them. If the idea of giving money away sounds too socialistic, then the unemployed could be asked to work for their benefits on a myriad of socially useful, but commercially unattractive, projects. Surprisingly, this is exactly what the financial community is looking for – a credible deficit reduction plan that enhances growth.

There is the possibility that if America does not find this way internally, then it may be enforced by an external authority. The Chinese Government – a principal creditor of the US – has already expressed its displeasure at recent events in Washington. There is evidence to suggest that China has fallen out of love with US T-Bills and is currently diversifying into other currencies. If this were to become a more clearly defined trend, then the prospect of rising interest rates in the US would be a very unwelcome turn of affairs. It is within the gift of China to force the issue through the bond markets and it is important for the political classes in America not to have the issue forced. Again, Washington needs a credible deficit reduction plan that enhances growth. We fear that if this is not achieved, the the AAA  status may not be regained, and the US may even be downgraded further.

This is not to say that the future for the US economy is all bleak. It is entirely possible for the US to enter into a virtuous circle by resuming a growth path. However, to do so will require very skilled political leadership, and that is what we are looking for when we review American economic prospects in the medium term.

© The European Futures Observatory 2011

How Deep Are A Gnome’s Pockets?

Harold Wilson once famously railed against Swiss bankers – who he dubbed the ‘Gnomes of Zurich’ – when he felt that they were unfairly driving down the value of the Pound. How things have changed. Bankers other than the Swiss variety have recently been depositing their funds in Swiss Francs as a result of the uncertainty over the Euro and the US Dollar. The Swiss Franc has been seen as a ‘safe haven’ currency, which attracts large volumes of liquid funds when the financial environment seems excessively risky. The result of this has been to drive up the value of the Swiss Franc, causing the Swiss Central Bank to worry about the deflationary and recessionary consequences of a general deflation.

What to do? The traditional response would be to reduce interest rates, to make the Swiss Franc less attractive to overseas investors. The problem is that Swiss interest rates are, like those elsewhere, virtually at rock bottom. If the Swiss authorities could persuade others to raise their interest rates, then Swiss rates could fall in relative terms. The problem is that there is no great appetite for to help Switzerland in the international community. Other nations feel that they have who have too many problems of their own to co-operate with Switzerland.

That leaves managing the external rate of the Franc as the only option open to the Swiss authorities. The only tool that they have are open market interventions. If Switzerland had a regime of strict exchange controls, then managing the external rate would be much easier. It would also destroy the Swiss banking industry, which relies upon funds freely flowing into their coffers. Market intervention is a costly business. It is reported that the Swiss National Bank (SNB) has lost SwFr 10 bn already this year on defending the currency. Now that the markets sense a vulnerability – one that is possibly unsustainable – there is an incentive to bet against the Swiss Franc until the SNB runs out of money.

It is at this point that we shall see exactly how deep are the pockets of a gnome.

© The European Futures Observatory 2011

Switzerland abandons floating exchange rate in dramatic 'currency war' twist

Swiss move to make its safe-haven less attractive

Swiss gloves come off in battle over value of franc

A Sick Old Man?

The economic case against Europe is well rehearsed. The longer term case against Europe is one of demographics. The population of Europe is ageing, and, if nothing changes to the contrary, the dependency ratio of workers to non-workers is likely to fall to the point where a severe shortfall of workers (and their tax receipts) occurs. So far, the discussion has focused upon reducing the fiscal impact of an ageing population, without considering other remedial measures that could be taken.

In the short term, the Eurozone has become a monetary union without an effective mechanism to deliver fiscal co-ordination. As a result, the weaker economies of Portugal, Ireland, Greece, and Spain have been allowed to borrow way beyond a prudent level with very little adverse consequences. Equally, the Euro provided a vehicle whereby the stronger Eurozone economies – particularly those of Germany and the Benelux nations – could power ahead faster than they otherwise would have done. An imbalance was created between the stronger and weaker Eurozone economies that has now become unsustainable.

The present situation in Europe needs greater fiscal discipline on the part of the weaker Eurozone economies and a greater fiscal transfer system on the part of the stronger Eurozone economies. Over the course of the summer, we have been inching towards this solution. We can hope that the process will continue, but perhaps with greater speed than we have seen to date. Interestingly, this could have two important long term consequences. First, we could see an inner core to the EU that has a high degree of monetary and fiscal integration – the ‘two speed Europe’. Second, that inner core could emerge as quite a strong economic force in the global economy, particularly when compared to America. After all, the Eurozone as an economic unit has a GDP to rival that of the US, the Eurozone is more of a trading force in the world economy, and, despite all of the adverse comment in the press, the Eurozone as a whole has a lower debt to GDP ratio than the US. A more integrated European economy would be a welcome result from the present malaise.

For this to happen, a number of institutional innovations need to be devised. Presently, Europe is relying upon the ECB to purchase the sovereign bonds of the Eurozone nations – a form of European wide quantitative easing. It is difficult to see how this could go on into the long term without the re-capitalisation of the ECB (the ECB has reserves of about €0.5 trn, whilst some commentators suggest that €1.5 trn to €2.0 trn might be needed to effectively stabilise the Euro). There is a case for such restructuring to be accompanied by the issuance of Euro-Bonds. In effect, this would create a fiscal union to parallel the monetary union within the Eurozone. It could, if constructed properly, actually force the weaker Eurozone nations to adopt greater levels of fiscal discipline. For example, if the issuance of Euro-Bonds were to be limited to the Stability and Growth Pact limit of 60% of GDP – an idea first floated by the Bruegel Institute – with the excess being raised under the present conditions, then it would allow nations such as Greece to have about half the sovereign debt guaranteed by the collective Eurozone nations, with about a further half to be raised under the credit-worthiness of Greece as a sovereign nation. As things currently stand, this is a move expected by the bond markets but resisted by the national politicians of the stronger Eurozone nations at the behest of their voters.

This disparity between market expectations and the willingness of politicians to act is nudging events along the course outlined above. The last final step – the issuance of Euro-Bonds – is looking ever more likely if the Euro is to remain as a currency. If the threshold of Euro-Bond issuance is not crossed, then it is difficult to see how the Euro would remain as a currency. If Euro-Bonds were to be issued, then the Eurozone would be free to concentrate upon the fiscal impact of ageing European populations. Much of this discussion has been the result of straight line thinking. It has been concerned with the shrinking of the tax base and the expansion of the welfare base. This approach, however, might be a bit premature.

Across Europe, governments have been taking steps to make their future pensioned populations less of a fiscal burden. Retirement ages have been increased, contributions to retirement schemes have been increased, and less generous entitlements have been devised. All of which act to lessen the impact of future pension spending upon the public purse. The argument about the dependency ratio is also unlikely to ring true. When faced with labour scarcities, Europe has traditionally imported labour,  rather than relying upon the natural growth rate of the population. This helps to maintain the tax base. It can be achieved in one of two ways – the first is to increase the number of young people in the EU through the accession of nations with relatively young demographic profiles. The case of Turkey is one to watch in this area. The second way of increasing the number of young workers is to attract them as ‘guest workers’ through schemes such as the ‘Blue Card Scheme’. This may well inform EU policy towards North Africa in the near future. Together, the redefining of retirement combined with an influx of young workers are likely to reduce the fiscal impact of an ageing population.

In all of this discussion we must remember that it is entirely possible that the Euro could still collapse. Equally, we must not under-estimate the political will to keep it afloat. That political desire to keep the Euro afloat is nudging the Eurozone towards a closer fiscal union to match the current monetary union. As a result, Europe of the future could become much stronger commercially than it is today. At that point, those EU nations that are outside the Eurozone, such as the UK and Denmark, may come to regret the decision to stay out.

© The European Futures Observatory 2011

An Unholy Trinity

Few would disagree with the view that the economies of the world are in turmoil. The news this summer has been dominated by the twin sovereign debt crises of the Eurozone and the US. The case of Europe is well rehearsed. The Eurozone has become a monetary union without an effective mechanism to deliver fiscal co-ordination. As a result, the weaker economies have been allowed to borrow beyond a prudent level with very little adverse consequences. Equally, the Euro provided a vehicle whereby the stronger Eurozone economies could power ahead faster than they otherwise would have done. An imbalance was created between the stronger and weaker Eurozone economies that has now become unsustainable.

Equally, the US has had a poor year to date. The American recovery started to run out of steam in the spring, the second round of Quantitative Easing ended in the first half of the year, and the question of fiscal stimulus and Federal debt has come under the spotlight. The key fiscal issue was the raising of the Federal debt limit. Eventually, a temporary compromise solution was found, but the process of reaching this compromise has demonstrated the polarised nature of American politics and has weakened considerably the position of President Obama. It was for this reason that the US credit rating was downgraded from AAA to AA+.

It could be argued that both of these crises have been exacerbated by weak political systems, and that political reform needs to underpin any effective recovery strategy. This is what we know about already. It has our attention. As a futurist, however, I am intrigued and concerned by what I don’t know. What are the factors that we are overlooking and which may appear important in the future? There are two other major issues that have attracted far less attention – mainly because they are a lot less pressing at the moment – the financial position of the US States and the fragility of the Asian banking system.

Our focus in North America this year has been with the US Federal debt. Another sovereign debt crisis currently developing concerns the finances of the US States. The position of the States reflects the Federal position in that effective deficit reduction is blocked by special interest groups, who obstruct both spending reductions and tax increases. As a result, the levels of State debt have risen considerably in recent years. This is fine, as long as lenders are willing to finance the deficit spending. If the reserve currency status of the US Dollar is weakened, then an immediate impact for the US States is likely to be an increase in the cost of borrowing and a greater unwillingness to lend to them. If the weaker US States were to experience probing by the markets at the levels that the weaker Eurozone nations have experienced this year, then it is likely that the consequences would result in a significant disruption to the US financial system. This vulnerability and the risk of the downside has not been factored into many current economic forecasts. It is possible that US Federal debt could be downgraded even further because of the parlous condition of State finances.

There are those who take the view that the emerging Asian economies – especially that of China - might prove to be the salvation of Europe and America. The size of trade deficits between China and both the Eurozone and the US rather argues against this case. Hopes for an export led recovery in Europe and the US both require an appreciation of the Chinese currency. This has happened to a certain extent – mainly as a device for the Chinese government to keep inflation in check – but nowhere near the degree needed to do the job effectively. The Chinese government continues to manage the exchange rate in a way that minimises the possibility of internal unrest rather than to alleviate recessionary conditions in Europe and North America. This is not set to change.

Monetary conditions within China now require a tightening. Effective action will take a great degree of finesse. The exact quantity of non-performing loans in the Chinese monetary system is unknown, but is thought to be much higher than in Europe, the US, and even Japan. Some estimates suggest that the degree of non-performing loans could be as high as a third of the assets on the balance sheets of Chinese banks. If the monetary authorities tighten too hard, this could expose the volume of these non-performing loans at exactly the wrong time, triggering a Chinese banking crisis. If the monetary authorities are lax in their tightening, then they might not deal effectively with the inflation that is weakening the Chinese banking system in any case. In either situation, a wobble in the Chinese banking system would have major global consequences. The risk of an event of this type has not been factored into many economic forecasts, which assumes ‘business as usual’ in China.

We are of the view that there are three systemic weaknesses in the global monetary system at present – in the Eurozone there is the possibility of disintegration, in the US there is the risk of ineffective debt reduction programmes at both the State and Federal level, and in Asia there is the risk of financial implosion caused by non-performing loans within the financial system. Together, they provide an ‘Unholy Trinity’ of problems facing the world economy. Their resolution requires a degree of political leadership that doesn’t appear evident at the moment, and a degree of consensus building at both the national and international level. To date, that co-operation has been lacking as the various parties have been unwilling to lay aside their narrow interests for a greater common good. For that reason, we are of the opinion that the current economic outlook is likely to be a lot rougher than it otherwise needs to be.

© The European Futures Observatory 2011

The Output Gap In Pictures

This is a really useful chart because it shows a comparative estimate of the output gaps of various countries. In a previous post, we calculated the US Output Gap to be about 10%. Interestingly enough, this is a figure that The Economist has independently arrived at. What is of concern is the UK Output Gap, which is estimated at about 13%. We feel that this is a bit high, not because economic activity is greater than estimated, but because we feel that economic potential has been severely eroded by the recession.

To be frank, what we mean is that there are now youngsters who will never work because they haven’t developed the habit of working in their formative years. This is the human cost of recession – blighted lives. It is a legacy that far too many politicians forget about until social turbulence moves from being an abstract concept to being disorder on the streets.

© The European Futures Observatory 2011

http://eufo.blogspot.com/2011/08/risk-of-inflation.html

http://www.economist.com/node/21526392

The Risk Of Inflation

How close are we to seeing a bout of prolonged inflation in the US? This might seem an idle question, but it is one that has quite important consequences for the US economy in the medium term. The Federal Reserve has, over the past couple of years, undertaken a major monetary expansion to support the US financial sector. It has done so though a policy of historically low interest rates - which it has signalled will continue to 2013 - and a policy of quantitative easing - which has injected about $2.3 trn into the economy. To those of the monetarist persuasion, a roaring inflation is just around the corner.

This might not be the case. A monetary expansion might be a necessary condition for an inflation, but it is not a sufficient condition on its own. A monetary expansion also has to work with a combination of the right supply and demand conditions to produce an inflation. For us, the key question is whether or not those conditions prevail at the moment. There is no doubt that prices are rising on the supply side. In particular, food prices, heating costs, and transportation costs are pushing up prices on the supply side. And yet this cost push is not igniting the flames of an inflation on the demand side. Rather than seek higher wage settlements, consumers are accepting a reduction in their living standards instead. This is because a sluggish economy has had the effect of dampening down demand for goods and services. Companies are absorbing rising input costs for fear that end user price rises would drive away their customers.

In terms of economics, we are seeing a muted demand response to the monetary expansion owing to the size of the ‘output gap’. The output gap is the difference between what GDP currently is and what GDP could have been if the recession had not occurred. Using US Bureau of Economic Analysis figures (which are expressed in 2005 constant dollars), we estimate the output gap to be in the region of $1.5 trn. This is probably an overstatement of the gap because the recession is likely to have forced a number of economic participants out of the jobs market completely. Put another way, it implies that the US economy could grow up to about 10% this year before experiencing a profound number of inflationary pressures.

Of course, the risk of inflation might be low now, but it does remain in the medium term. Should the US economy return to anything like the trend growth path, then prices will harden and wage settlements are likely to start to creep up. We expect that the US politicians will allow inflation to take hold for a while. After all, the two ways to reduce the impact of the US Federal debt pile are economic growth and inflation. If the two are combined at the same time, then so much the better. However, it is easier to start a prairie fire than to put it out, and the prospect of an inflation being created deliberately for a short term gain may well come to be seen as politically irresponsible. For the moment, though, the risk of inflation seems to be quite low.

© The European Futures Observatory 2011

Joining The Dots

Sometimes, a bit of foresight is not what is wanted. As I was watching the riots in London, I was reminded of a piece that I wrote in 2008 about society moving from NICEY (the Non-Inflationary Continuously Expanding Years) to NASTY (the Non-Accelerating Socially Turbulent Years). The point is a simple one. When the economy is doing well, most improvements trickle down into most parts of society, and economics comes to dominate politics. When things are not going well in the economy, the pain is rarely shared equally, and politics become dominated by the social impacts of where the pain is felt. There was an element of this in the recent rioting in the UK.

The recent disorder in the UK, however, is not a game changer. We are currently about a week on from the disorder. The streets have been cleaned up, many businesses affected are operating again, and many of the offenders have been identified, arrested, and have made an appearance in court. In 2008, we were more concerned about the potential for unrest in China, which we felt would be a game changer. That is probably why it hasn’t happened. There are still bouts of unrest in the western provinces of Xinjian and Tibet, but nothing so far has threatened the stability and authority of the Chinese government. For this we are grateful.

Looking to the future, the risk of disorder remains, right across the world. We still rather imperiously divide the disorder into that we like, such as that in Libya, and that which we dislike, such as that in Bahrain. The root causes of the discontent – poverty, lack of opportunities, and sheer boredom – still remain. Until the world economy starts to grow again, this risk of disorder is unlikely to abate.

Those of us watching the future need to be mindful of this in our work.

© The European Futures Observatory 2011

http://eufo.blogspot.com/2008/11/from-nicey-to-nasty.html

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