Tuesday, 28 April 2009

Building Bridges

“The Chinese government attaches great importance to Asia Pacific regional co-operation,”
Hu Jintao, Chinese President

Since Mao Zedong's death in 1976, China's move towards a more market centric economy has yielded some spectacular economic effects. Deng Xiaoping launched the four modernisations and began the slow process of reforming not just the economy, but the political party into accepting the new 'Social Market' system. Despite China's rise into the global political landscape, there are still numerous challenges they have to attend to domestically, such as individuals rights and the overwhelming presence of the state that still exists. China's current President, Hu Jintao seems to have the right ideas on the path his nation needs to follow, continuing with integration into the global economy and not just economically but politically also.

It was during the 1980's and 1990's that China opened up the special economic zones, areas that were designated for foreign investment and private enterprise. A frenzy of capital ensued, seeking cheap abundant labour. Some of the largest investments during this time came from Hong Kong and Taiwan, as they had large numbers of expatriates who left during the Mao era. This investment, along with Western capital, began transforming the Chinese economy from a predominantly low subsistence level of agriculture to the manufacturing hub of the world, as global business leaders outsourced many of their operations.

On Sunday, China and Taiwan signed a new set of agreements to open up their financial services and further open trade and investment with one and another. It was only last year that both declared peace and began talks as there had been diplomatic complications between the two sides in recent decades. During the Communist revolution with the beginning of Mao's various witch hunts many of the old Nationalist party members fled to the island of Taiwan, and ever since there have been unfriendly relations between the two with the US protecting Taiwan from Chinese threats.

The recent diplomatic progress between the two brings more stability to the region and potentially increased trade. It also signals China continuing to form ties beyond the US. This has also been seen in recent years as Hu Jintao has expanded relations between Australia, Venezuela and Iran. China knows that in order to continue growing economically it requires a stable region, and strategic alliances with nations rich in the resources it lacks. China in recent years has also been moving into more high tech manufacturing such as computers and semiconductors, and this agreement can only help bring about the continuing knowledge transfer over the coming years. The extra stability will also bring about increased investment in the region from overseas investors, as political instability is always an investors nightmare. With recent Gold acquisitions almost doubling, which I mentioned back in September to watch out for, China is looking to become a world reserve currency contender. There can be no doubt about that. They are long way from this goal, which will at least take a decade or two, but as the villain in the recent Bond film states "The Dollar isn't what it used to be". Euros were his choice.

Various restrictions still exist but this is the nature of how China has been moving in recent years, that of gradual change. The senior members of the party saw what happened to Russia when it introduced Perestroika and are aware of the importance to not make the same mistake. Over time, if the ruling party continues on its current course, and Chinese citizens increasingly embrace these market reforms then it is only a matter of time before China supplants the US as the global superpower. However nothing in life is inevitable. As the population becomes better educated and gains further exposure to Western culture they will no doubt demand a more democratic political structure on which the people can influence decisions. In all probability this will be years away, but when it does come this will be the next critical transition period, just like Deng Xiaoping's market reforms 30 years ago. Again here, China can learn from Taiwan who over the past few decades moved from a dictatorship to a democracy. China has a lot more to do, but she is continuing to head in the right direction. The significance of events such as these should never be underestimated.

Thursday, 23 April 2009

The Children's Budget

"I shake my head in despair. As the Chancellor faces a terrible fiscal position no one outside the Treasury will believe the forecasts. When I saw the public spending plans I nearly fell off my chair"
Michael Saunders, chief UK economist at Citigroup

"The increase in debt servicing costs alone will be between £35bn and £47bn per year in 2008 money. That is more than the annual transport budget. It is about the same as the entire annual defence budget, and about half the annual education budget."
Danny Gabay, head of Fathom Consulting

In 1909 David Lloyd George, Chancellor of the Exchequer, delivered what became known as the Peoples Budget. It's primary aim was to raise taxes on the rich in an attempt to redistribute wealth within society, which in its day was a historical and radical set of measures. One Hundred years later, Alistair Darling delivered another historic budget, however it was under quite different circumstances. With finances spiralling out of control and a country heading for the worst post war recession, there was no room for social justice. Again a Labour government had spent too much. History will judge it as the Children's Budget.

The repetition of all the budgets figures are not required here, suffice to say the numbers are truly horrendous given the optimistic forecasts the government has used. Some of the areas of worry are:

Future Economic Growth
We are in the midst of the worst recession any living person would have experienced. Looking back at history when events like this happen, economies take years or a decade or more to recover from these credit excesses. The growth projections given yesterday were lies. Not even Mr Darling believed them. The idea that the economy will grow at the end of the year, and be in the thick of a new boom within a couple of years is nonsense. The economy will continue its decline for this year and the next. If there is any recovery after - which this author does not believe - it will be weak at best. Not 3.5% growth. The IMF have recently projected -4.1% and -0.6% growth for the next two years, however they are still playing catch up and their projections have always been wrong. Expect further revisions to these numbers.

Peaking of Debt levels
The government claims that debt will peak at around 80% and again it is more lies, and the markets know it too. It will go much higher. For readers of this blog you will also be aware that this is only the official debt figure. There's many off book debts to come, just at the time they claim debt will peak.

Deficits turning to surpluses?
In order to try and pay the debt back the government needs to be running budget surpluses. Estimates again, state that the deficit will drop below the £100B mark around 2013/2014 with the admission that it may take a decade to balance the books - to just break even. Then we get to the point where we need to be running surpluses to pay for all this debt. We can let our children worry about that. Whose going to fund all this? Isn't global capital low, with the high saving nations in Asia enacting their own stimulus plans? The main buyers of Government bonds have been foreign buyers but for how long?

All of the above is based on government estimates. Estimates that will prove to be as wrong as the estimates of 2008, or the ones in 2007 and so on. There were no proposals to try and balance these figures, which is to be expected as the election looms with unpopular decisions being put back. However the longer the government postpone action, the worse the hardship will be. By not creating a credible framework for balancing the books the risk of further gilt strikes are inevitable. David Cameron again had no polices that would attempt to rectify the perilous position as he follows the focus group discussions not wishing to disturb his poll leads, sending signals to investors that Britain has no intention of paying its creditors back.

The budget was full of contradictions. We had the various environment measures for wind power and then there were incentives to build more Coal power plants along with tax breaks for Oil and Gas. They announced they will pay people to buy new cars, which is in effect throwing money away. We may as well employ some people to dig holes and another set of people to fill them in, rather than subsidise car purchases - at least it will keep the unemployment figures down. If double glazing sales start dropping is the government going to pay people to smash windows in order to create artificial demand? There was extra money for the Job Centre network, when the job market is shrinking. A scheme to back mortgage backed securities, dead assets, further preventing liquidation that is needed in order to bring about the recovery Darling mentions. However the biggest move was an introduction of a new high income tax.

The 50% rate of tax was welcomed by many - "get the rich, they got us in this mess" as many will say. However readers of this blog will be aware it is government that got us in this mess. Unsound money, central planning price stability created huge distortions in the economy. However this tax increase is just a foot in the door. We will all be paying much more in tax in the coming years like I have previously mentioned - crushing any recovery for a generation or more. It was the increase in income tax by Herbert Hoover and then Franklin Roosevelt that assisted in the prolongation of the great depression. By hitting wealth we are also sending a signal to the rest of the world, that if you work hard in the UK we will confiscate your earnings. Suggestions of a brain drain has begun before any of the real hardship has even started. Before our boomers begin to retire. Before we run out of cheap energy. Before printing money has had its full ruiness effects and so on. It also marks a further nail in the coffin for the city of London as a financial center of the world.

With the above there is no hope of retaining quick growth again. By taxing the entrepreneurs who create jobs and wealth for us all we are further impoverishing ourselves. Then there's the point will they pay? There could be a negative effect with more people looking to avoid the tax. Tax revenues could actually fall, as less jobs are created as successful business leaders and entrepreneurs wonder what will happen next. The IFS has recently supported this claim, however I don't think they appreciate the full damage of a policy such as this.

Healy or Howe?

There were discussions about if the increase in income taxes represents a return to Old Labour, or if the cuts to come in spending represent a return to Thatcherite economics. We are a long way from Old Labour 83% high tax brackets, but we are heading in the same dangerous direction. Then there's the myth of the supposed Thatcher Monetarism economics that prevailed during the eighties. Government spending barely moved during her time as prime minister. Standing at around 42.5% in 1977/78, it was 41.7% ten years later. She actually spent more than Ted Heath and Harold Wilson as spending on government rose 32% in real terms through the eighties credit boom. Thatcher kept this fact quiet as she prided herself on the illusion of getting government out of the way, controlling the money supply, the Milton Friedman philosophy. In Milton Friedman's later life he would be critical of the governments and central banks who inflated in his name, rejecting his original ideas that they could be trusted to control the money supply. The Austrian Economists always told him governments could never be trusted. Nevertheless taxes and unprecedented public spending cuts will be required - both of which we have never experienced in tandem. We will need more substantial cuts then just "savings efficiencies" to balance the books and tax rises that can actually make an impact on the deficit.

The government are also starting to admit they may have to take losses on the bank bailouts they carried out, rather than the profit many believed. As I have said before I will be happy to get half the money back. Wait until the losses really start stacking up. There will be an incredible strain in the gilts market for years to come, with further money printing to cover the shortfall as investors appetite for our debt wanes. Indeed questions of Britain's AAA rating has become mainstream news now, as a ten year old could do the sums and realise they don't add up.

Green Shoots?
Before the budget there had been more discussions of green shoots of recovery or the bottom of this and that. These green shoots will be mentioned for years to come as I have mentioned before, many will be fooled by the bull moves in this bear market we find ourselves in. I started this blog around this time last year and everyone was saying the same. The 'worst is behind us', 'the credit crunch won't effect us', 'the UK has sound fundamentals' with everyone having an almost religious belief in the state of the economy. There is plenty more pain to come. Mistakes of history are being repeated which are once again impoverishing society. Unemployment has only just begun its climb. The next bubble, government debt has yet to pop and cause havoc. Energy prices and commodities are historically low. Retirement has yet to set in. As the year goes on the FTSE will hit new lows possibly hitting levels around the mid 1990's in a best case situation.

So the Children's Budget has been announced. A decade of deficits, and a generation of hardship. These were the debts I have been talking about. The debts I knew were in the system, waiting to hatch out and there's much more to come. The debts that are now staring my generation and future generations in the face. Many Western Governments will find themselves in a similar situation, but Britain has managed to come up with the largest deficits of the developed world, even without the substantial stimulus packages other nations are putting in place. The greatest asset we have is a long history of democracy and peoples individual rights, but we have a government that is continuing along the path towards bankruptcy. It's all unsustainable and must be stopped, immediately, if not for our sake then for future generations sake.