RMF NOV2011 Update

8/3/2019 RMF NOV2011 Update

http://slidepdf.com/reader/full/rmf-nov2011-update 1/11

November Economic update 2011

The Euro Mess

When Germany unified in 1990 it began a substantial transfer of income from West toEast. With typical German efficiency, they put themselves through an economic boot

camp. The SME sector underwent radical change, supported by the regional banks whowere underwritten by the 16 regional Governments.Real wages fell as unions agreed to pay cuts. State benefits were reduced, particularly forsickness and disability. Companies invested in R&D, new plant and equipment andapprenticeships. The result was a 20% drop in unit labour cost compared to the rest of theEU, and a rise in unemployment to 12.1% by 2005. This was the year Angela Merkelcame into office.

Meanwhile the club med countries became increasingly self-indulgent ( not Ireland it wasindividuals there) as their Governments found they could borrow at German rates ofinterest. This happened because the world markets were beginning to believe that Germangrowing economic strength would underwrite the system. And French and German Bankswho were short of capital, needed no capital to support Sovereign lending.

Germany increased its exports to the fringe, and France, itʼs biggest trading partner.

France meanwhile hung onto German apron strings and fought against EU enlargementand the desire for greater competition by the Commission. France believed thatGlobalisation was a threat which needed to be managed, rather than an opportunity to beembraced. As the EU was enlarged, with British support, France lost power and influence.

The aging Europeans were enjoying a comfortable lifestyle, their companies askedBrussels to protect them from the Asian onslaught and in many areas they did. The Frenchwished for more control of Brussels ( i.e. more protection).

Last year, France was the only large EU country with a retirement age of 60. And theFrench, Belgians, Italians and the Polish all stop working in their late fifties. See the chartson the next page.

Angela Merkel is fond of saying that if the Euro fails then Europe fails. However if the Eurosucceeds Europe is likely to fail anyway because the Euro was introduced on the back of

two lies.The first lie was that monetary union could exist without political union. The second lie wasthat Euro and Non-Euro countries could sustainably co-exist. This was based on the viewthat the EU is a club of clubs, all members share the single market, but otherwise coexistwithin a flexible framework of labour laws, immigration, financial regulation and bilateralagreements.

In the last week of October 2011 European Leaders agreed to leverage the EuropeanFinancial Stability Facility ( EFSF) boosting its lending potential from 300Bn Euros to 1.1trillion Euros. This is the first big step on the path of divergence between Euro and non-Euro members. It is the beginning of joint liability for Sovereign debt guarantees, thuspaving the way for the creation of a Eurobond.

1



2



If this happens the ECB will require each Euro member to solve their underlying structuralproblems. They will be required to harmonise their financial sector, to co-ordinate theirlabour market rules and become more competitive. Eurozone level taxation will have to beintroduced to ensure income is redistributed from North to South. Brussels will sendeconomic policemen to oversee errant countries.

But all these measures are diametrically opposed to the founding principles of the singlemarket. A monetary union in trouble has very different needs than a club interested in freetrade. The Euro members will ( under the influence of France) decide that it was free tradewhich caused the imbalances in the first place ( Germany and France are convinced it isfinancial institutions based in London who are major contributors to the problem).

The Eurozone will have to create a common financial platform to ensure macroeconomicstability and the Eurobonds sell at a good price ( low interest rate). Non-members have noneed for such structures and would resist strongly a regime run by and in the interests ofthe Eurozone. There are 10 such countries, they are smaller than the 17 Eurozonemembers and less homogeneous.

The Lisbon treaty allowed member states in groups to enhance co-operation in selectedpolicy areas. This will allow further divergence between Eurozone and non-Eurozonemembers. It could even allow non members to gang up on the core.

Over the next five years the microeconomic club will turn into a macroeconomic union. Atwhich point Denmark, Sweden and the UK will have to decide whether they want to remainin a club with which they have increasingly less in common.

The biggest failing of all is that the technocrats in Brussels believe that prosperity andgrowth derives from treaties and agreements. 70% of EU prosperity is created by firmsemploying less than 200 people, who day after day strive to create better products andservices for their chosen customers. And yet to a man they will tell you that the biggestcost imposed on their enterprise comes from Brussels in the form of Health and Safety,Employment, and Harmonisation Reporting.

The likely outcome

Greece will leave the Euro within the next 18 months.

The Greeks will force conversion of Eurodebt into Drachma. This will be a technicaldefault.The Drachma will trade at a 60% discount to the Euro. This will impose losses on Greekbusinesses with overseas operations, but there will be much bigger gains as Greecebecomes the no 1 tourist destination.

The Greek Government will have to impose strict limits on cash and credit withdrawals toprotect their banks, plus capital controls.

Inflation will rise to 15%, wages will not, so very quickly Greece takes the pain of a lack ofcompetitiveness. Meanwhile Costas finds all his Villas fully booked, the fish he catchescost a little more to get ( fuel and spares for his boat), and he makes a fortune selling a bit

3



of land to a plumber from Telford, attracted by cheap sunshine, and the new Ryanairroutes from Birmingham City Airport. Within two years Greek GDP is growing at 3% .

Savvy businessmen will be already asking the Greeks to pay for imports in Dollars, andprobably cash upfront.

The ruling Greek families who bought 10% of the London property market, will sell theirhouse in London, buy drachma and then the assets of Greek state industries at knockdown prices, thus ensuring that the market for in yer face Yachts booms.

Meanwhile the German and French Governments ignore Brussels and put massivesupport behind their local banks who book big losses on Sovereign debt. And the Bank ofEngland has to supply circa £150Bn to the London market as the Credit Default Swapissuers are required to pay up.

Then what?

In three years time France and Germany announce a Nordic Euro system, and a ClubmedEuro system. The latter will trade at a 30% discount to Nordic Euro. And Europe willbecome three clubs. Inner, fringe and outer. The outers, Denmark, Sweden and the UK willexpand their trade to the East, where the money is!It will take this long because Brussels will resist it every step of the way.

What does all this mean for the UK?

The growth in our material standard of living depends on the growth in real wages, this inturn depends on the growth in productivity (except Directors of FT100 companies whohave their own reward system). Productivity is measured as output per person per hour ofwork. For the UK it is usually 2.3% per annum, but since 2007 it has fallen by 2.6% perannum.It follows that real wages must fall by the same amount. And they are, inflation at 5% andwages growing at 2.2% . But not if you are a FT100 Director, when your real earnings haveincreased by a staggering 70%. In the depth on the recession, the lowest bonus paid was134% higher than in 2000. For the record, Directors always state that they are rewardedaccording to shareholder return. The evidence is against them. The overall reward to FTDirectors has exceeded the growth in earnings per share by 640% since 2000. Source:

Hansard.

With the exception of FT 100 company Directors, real wages will remain depressed untilproductivity increases. It is worth noting that productivity is falling because SME ownersare trying to hold on to employees for as long as they can afford to. This is a considerablesocial benefit.

The UK loss of productivity is reflected in the falling value of Sterling ( 25% over the last 3years). This allows us to adjust without nominal wage cuts, unlike Ireland where nominalwages have dropped 10%.

The key question is over the value of Sterling given all that is happening in Euroland.

4



In essence, Sterling will rise against the Clubmed Euro, and fall against the Nordic Euro. Ata guess, 25% stronger against Clubmed, and 7% weaker against Nordic.

UK Growth Prospects

The chart is my best guess. I think a mild recession is 2012, followed by flat line certainly

until 2014. There will be some quarters when commentators will suggest the worst is over,then it will fall back again. The cause of this flat line will be the lack of credit and money inWestern economies. This in turn caused by the drive to compliance with Basel 3 bywestern Banks. We know from history that when banks need to make major adjustmentsto their balance sheets, economic growth is well below trend for 5-7 years. We are aboutto enter year 4, and next year the Governmentʼs austerity measures will be biting hard.

For any improvement on this the following needs to happen. Firstly earnings need to riseby 2% above inflation. If not, then taxation needs to fall by 3% of incomes. If neither ofthese are possible we are left with credit needing to grow by 7% per annum ( currently it isshrinking by 3%). Fat chance.Interest rates will remain at 0.5% for certainly another two years. The mortgage rate willremain at an average of 4% providing the nation retains its AAA rating.

The Bank of England forecast is on the next chart.

5



So far the actual has been at the lower end of their projections. This is because they donʼt

have the behaviour of Banks in their model.

As credit to all businesses continues to shrink we can expect a lot more asset purchasesby the Bank. This process is called Quantitative easing. It is undertaken to prevent themoney supply shrinking. Money supply shrinks when banks reduce their loan book,because they are required to reduce their leverage by the regulator.

I expect George Osborne to announce his plan for credit easing in the Autumn Statement.This will involve the securitisation of SME loans for onward sale to the Bank of England. Itis a neat way of directing new money to where it is needed most.

6



The chart below shows the relationship between money growth and nominal GDP growth.

The lag between money supply and nominal GDP is about a year. We need money supply

to grow at 7% to produce nominal growth of 5%, split 2.5% real and 2.5% inflation.

7



The next chart shows the breakdown of lending. Literally!

And finally the prospects for the world.

8



The rest of the World

It is clearly slowing down quickly, as the next chart shows. I guess the world will avoidanother recession thanks to the East, but even they will be unable to avoid the

consequences of the recession in the Eurozone next year. The USA is in no position tooffset Europe, and China and Brazil have both slammed on the brakes over the past 9months. It is all pretty much as expected given that the west still needs to reduce its debt.

Exchange Rates for 2012

Sterling-Dollar $1.60Sterling-Euro 1.18 ( but very susceptible to any hint of a weakening of Osbornesʼ resolveto deliver the plan.Euro-Dollar 1.25Sterling-Yen 1.30

Inflation

UK 3.5% from February, dropping to 3% by year end.Euroland stable at 2.5%USA 3%UK House prices. Flat outside London, 3% growth central London

9



Finally you will note that there is no mention of the USA. We await the retail data forThanksgiving at the end of this month, then we can think through the USA outlook, Iwouldnʼt be sanguine. Bur a lot more on the USA in February 2012.

As this is the last update for 2011, I have repeated verbatim a letter sent to the New YorkTimes. It was sent by an 86 year old lady to her Bank, and the recipient sent it to thepaper.

Dear Sir: I am writing to thank you for bouncing my check with which I endeavored to pay myplumber last month. By my calculations, three nanoseconds must have elapsed between his presenting thecheck and the arrival in my account of the funds needed to honor it.I refer, of course, to the automatic monthly deposit of my entire pension, an arrangementwhich, I admit, has been in place for only eight years. You are to be commended for seizing that brief window of opportunity, and also fordebiting my account $30 by way of penalty for the inconvenience caused to your bank. My thankfulness springs from the manner in which this incident has caused me to rethinkmy errant financial ways. I noticed that whereas I personally answer your telephone callsand letters, --- when I try to contact you, I am confronted by the impersonal, overcharging,pre-recorded, faceless entity which your bank has become.

From now on, I, like you, choose only to deal with a flesh-and-blood person. My mortgage and loan repayments will therefore and hereafter no longer be automatic,

but will arrive at your bank, by check, addressed personally and confidentially to anemployee at your bank whom you must nominate. Be aware that it is an OFFENSE under the Postal Act for any other person to open suchan envelope. Please find attached an Application Contact which I require your chosen employee tocomplete. I am sorry it runs to eight pages, but in order that I know as much about him or her asyour bank knows about me, there is no alternative. Please note that all copies of his or her medical history must be countersigned by aNotary Public, and the mandatory details of his/her financial situation (income, debts,assets and liabilities) must be accompanied by documented proof. In due course, at MY convenience, I will issue your employee with a PIN number whichhe/she must quote in dealings with me. I regret that it cannot be shorter than 28 digits but, again, I have modeled it on the numberof button presses required of me to access my account balance on your phone bankservice.

As they say, imitation is the sincerest form of flattery.

Let me level the playing field even further.When you call me, press buttons as follows:

IMMEDIATELY AFTER DIALING, PRESS THE STAR (*) BUTTON FOR ENGLISH

10



#1. To make an appointment to see me #2. To query a missing payment. #3. To transfer the call to my living room in case I am there. #4 To transfer the call to my bedroom in case I am sleeping. #5. To transfer the call to my toilet in case I am attending to nature. #6. To transfer the call to my mobile phone if I am not at home. #7. To leave a message on my computer, a password to access my computer is required. Password will be communicated to you at a later date to that Authorized Contactmentioned earlier. #8. To return to the main menu and to listen to options 1 through 7. #9. To make a general complaint or inquiry. The contact will then be put on hold, pending the attention of my automated answeringservice. #10. This is a second reminder to press* for English. While this may, on occasion, involve a lengthy wait, uplifting music will play for theduration of the call.

Regrettably, but again following your example, I must also levy an establishment fee tocover the setting up of this new arrangement.

May I wish you a happy, if ever so slightly less prosperous New Year?

Your Humble Client

And remember: Don't make old People mad.

We don't like being old in the first place, so it doesn't take much to piss us off.

I hope you enjoyed this as much as I did!

2012 will more challenging than 2011, but at a time of rapid, discontinuous change thereare always money making opportunities. I wish you well.

Roger Martin-Fagg ( aged 63! )

[email protected]

11

RMF NOV2011 Update

Documents

Transcript of RMF NOV2011 Update