May 14, 2006

Economic tide is on the turn

Posted in Sunday Business Post · 8 comments ·
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Forensic science is hip at the moment. CSI Miami, with its distinctive brand of laboratory chic, is still top of the TV ratings. It has long since elbowed out traditional whodunnit-style detectives. People want other explanations, new scientific and technological possibilities. Old-school programmes built on plots, detective work, motives and grassing gangsters are out; forensics are in.

The same trend can be seen in financial analysis. I have been noticing this in recent weeks at a variety of financial conferences around the country. Investors are confused, as are their brokers and some chief financial officers. It is increasingly apparent that the traditional tools of economic analysis used by banks, financial institutions, think-tanks and brokers are not giving us an accurate reflection of what is going on in the world.

The traditional pillars of political wisdom, number crunching and company data are not telling us enough. If they were, we would not be subject to all these unforeseen shocks.

For example, when the Middle East is supposed to be pacified, why is Iran making a fool of America? Why, when we were told to expect lower oil and energy prices, are gas prices increasing by 40 per cent?

Why are the financial markets continuing to rise as interest rates head upwards? Why is Latin America turning left faster than at any time since the early 1970s?

In Europe, why are countries such as Italy and France apparently ungovernable?

Why – after almost 20 years of transition – have the eastern European nations been so (relatively) slow to grow? And why has the Irish property market surged this year when almost everyone predicted that prices would plateau out?

It seems that we need to broaden our framework of analysis and include geopolitical events, religious and cultural differences and of course, demographics in the mix. Even with these culprits rounded up, the world is still a confusing place.

There are three enormous imponderables on the global horizon that have both political and economic ramifications.

The first is resources, and the issue of whether the prices of commodities can continue to rise as they have done over the past three years. Last week, we were told that our gas bills will increase by 40 per cent next year. The implication is more inflation for us � last week�s figures show the annual rate has already climbed to 3.8 per cent � and more of our earnings going to those who produce commodities.

Unfortunately, with a few notable exceptions, those who own oil and gas are an unsavoury lot. There is a good argument to suggest that this is not coincidental and that the countries that own oil and gas are corrupt because of their mineral deposits – but let�s leave that for another day.

As a result of this, the foreign policy of every major country in the world is now driven by a desire to protect its supply of commodities.

This has weakened the US and emboldened its enemies. Washington is now on a collision course not just with Iran and Venezuela, but Russia as well (as signalled by Dick Cheney last week). The big problem for the Americans is that, post-Iraq, no one is afraid of them any more. This is not good news for us financially, as we are the most US-dependent country in Europe.

The second issue concerns interest rates. Although, judging by Irish borrowing figures, you would not think it, the great global era of low interest rates is over.

Up to now, cheap credit has offset the inflationary impact of more expensive petrol, and has allowed us to shrug off the 200 per cent increase in oil prices we have seen since Baghdad fell.

Had you suggested three years ago that oil prices would be above $70 a barrel, every economist in the world would have predicted a global recession. Today, oil prices are surging past $73 a barrel and the world economy is growing at 4 per cent.

Why? Because cheap money has allowed us to borrow to consume, making us feel richer (but more indebted), and China continues to pump out cheap consumer goods, meaning we can buy more stuff with our euros than before. Both of these factors have masked the debilitating impact of dearer oil, but for how long can they continue to do so?

Which brings us to the third imponderable.

What will the Chinese do next? Up to now, the story has been quite straightforward.

Most of the developed world understands that the phenomenal development of the Chinese economy over the last generation, particularly in the last few years, has made it impossible to maintain low-income manufacturing jobs in developed economies (and even in developing economies, as Mexico and others have discovered).

The rise of China has wiped out entire industries all across Europe, and has tipped the Irish economy away from manufacturing forever.

The idea of an unimaginably vast Chinese juggernaut sucking an additional 10-20 million peasants into its labour force every year is now understood and accepted by almost everyone, from government to business to the trade unions.

It took time for people to grasp the enormity of the threat, but now it is conventional wisdom. But, as the late JK Galbraith pointed out, this is exactly the point at which the obvious becomes obsolete and conventional wisdom loses its validity.

The latest news – unheeded, remarkably, by most commentators – is that China�s leadership is altering course: the headlong rush to economic development is to be reassessed. This does not mean that reform is dead, or even in danger of being reversed; at most, some new reforms may be delayed or watered down, but the reformists are still in firm control. They also intend to stay in control and are aware that this requires them to take heed of two growing areas of discontent.

The first and least important is the way the rest of the world, led by the US and EU, is pressing China to change its policies away from export-led growth and an artificially cheap exchange rate, towards more rapid development of the domestic economy.

The second and main source of discontent is based in the Chinese countryside, where a large and rapidly widening gap has emerged between it and the cities.

There are many indicators of this gap and the tension it causes, but the tens of thousands (no, that�s not a misprint) of riots that took place last year are by far the most persuasive evidence from the point of view of the Communist Party leadership in Beijing.

Economic policy is, therefore, changing direction: more investment are to be directed to the rural areas, while the unsustainable use of resources – energy, water and especially agricultural land near big cities – is to be severely curtailed.

The environment and its ongoing degradation is no longer something to be ignored or tolerated. Banks will no longer throw cheap money at projects that will add still further to huge overcapacity – and so on. In short, the Chinese juggernaut is changing its orientation and hence its impact on the world economy.

This will take time to have an effect, but the implications are immense. For instance, China will stop exporting desperately cheap stuff, so the prices of manufactured goods, from shoes to MP3 players, will end their apparently relentless downward spiral.

All this will mean that the positive tide of cheap energy, cheap credit and cheap goods might be about to ebb. Over the past few years, these three positive factors have soothed our anxiety and deadened the pain of economic change. Not any more.

As Warren Buffett famously said about bull markets: ��It�s only when the tide goes out that you see who was swimming in the nude.�� No wonder investors are confused.


  1. John Doe

    We are entering uncharted waters.

    1. The Irish economy is hideously exposed to the fragile
    American economy, relying for 50-60% of our exports on
    American multinationals.

    2.Irish people have a very high exposure in the domestic
    and international property investment markets. Look at
    Spain for instance prices down 30% from the peak in the
    Costa’s, and falling. 40% of new builds bought by
    investors in Ireland, fly to let in Bulgaria, Dubai,
    Florida (now falling).

    3. The construction, financial services and retail
    industries are highly dependent on the continuation of
    unsustainable debt accumulation, this is at a time when
    bond markets are pricing in an acceleration in credit
    tightening.

    4.If a high tech, densely populated nation like Japan can
    have a crash amounting to 70% from the peak; when interest
    rates were below current Euro rates for much of that time,
    then Ireland can quite easily witness a 40-50% drop.

    5. Rents continue to fall in real terms as general
    inflation gathers pace in the economy, this one fact is
    the killer fact as far as I’m concerned. House prices are
    rising faster now than they ever have measured in Euro
    amounts, we have record inward migration; and rents are
    falling?

    What we are witnessing is the final manic stage of an
    unparalleled speculative bubble. Remember what happended
    to the other ‘tiger’ economies of South East Asia, a
    decade and a half ago.

  2. Billy Rae

    John Doe – I think you’ll find that about 90% (87.6% in
    2004; see FinFacts article:
    http://www.finfacts.com/irelandbusinessnews/publish/article_10004926.shtml)

    That means about 10% of our exports are by native companies!
    And worse is, of that 10%, 8.5% is argiculture or
    argi-foodstuff. So, about 1.5% of are exports could be
    classed as industrial.

    I hope David will write an article on this topic.

  3. John Doe

    This quote from Adlai Stevenson seems apposite.

    “You will find the truth is often unpopular and the
    contest between agreeable fancy and disagreeable fact is
    unequal. For in the vernacular, we Americans are suckers
    for good news.” Adlai Stevenson

  4. Aislinn Mellamphy

    LOVING YOUR WORK DAVE!!!! YOU REMIND ME OF AN IRISH HORATIO

  5. Mick Kinsella

    With regard to the excellent point made above pertaining to “real” homegrown exports. Let me share a very short story that illustrates the lunacy we have welcomed. Over a beer at Christmas, I got introduced to a young man who is an employee of Microsoft in Dublin. As a means of creating some common ground, I explained that I had been to their Redmond campus outside Seattle on business twice that year (2006) and that I had found it very impressive. At this juncture the young man in question sidled up to me, talking out of the side of his mouth and said, “we’re working on a new product”…”can’t say too much about it”….to which I replied (rather confused) ” eh…Vista ?” after a shocked pause, he got closer, “Jesus how do you know…it’s all been designed in Dublin you know”.

    Not wishing to appear rude, I suggested that I’d met a few people in Redmond that might like to take some credit.

    His blank look spoke volumes. We seem to have convinced ourselves that we are running the whole show. We’ve always been good a believing our own hype.

  6. [...] Now, can someone please enlighten me as to why we are importing all of these things? Because the vast majority of Americans couldn’t afford or wouldn’t rush out to buy it if it cost more? Because we are so materialistic that we’d rather farm out these items to China instead of pay a fair wage to workers? “The rise of China has wiped out entire industries all across Europe….” Economic tide is on the turn [...]

  7. [...] Cheap credit had the knock on effect of generating a bubble in property prices as it became easier to leverage spending, the other areas of consumer spending were equally buoyed up by the free flow of money through credit cards, cheap financing deals and other elements. As Conor has argued, the credit-led mortage boom had a huge knock on effect throughout the economy. We had the paradox of difficult inflation with little or no significant movement on interest rates. What McWilliams terms the era of cheap credit has been with us a long time, with folk discussing it in earnest as a problem almost since Greenspan embarked on the policy. Government response to the issue has been to let sleeping dogs lie and continue to allow the economy to funnel along on the back of high consumption and cheap credit. The role of construction in economic growth and job creation has been an issue around for a long time, we have known that a contraction in house building considered inevitable in light of the level of building supply and demand. [...]

  8. [...] you didn’t read it before, read it now. Your & your family’s health could depend on [...]

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