The Daily Reckoning UK - Macro-Economics, Gold, Inflation, Debt
The "Wall of Costs" Awaiting Consumers
- "Something odd" going on in the oil market...
- How China lost one fifth of its land since 1949...
- The Treasury: a kindergarten of politically correct spin merchants...
The internet is playing wrecker ball to the once robust walls of the publishing business. A subject we’ve commented on before as newspaper subscriptions slide relentlessly taking circulation and advertising revenues with them. Now even Hugh Hefner is having trouble making money from his adult brand of publishing. His Playboy publishing and media empire posted a quarterly loss on weaker TV and publishing revenues reports Yahoo Finance. “The worse-than-expected results illustrate the trouble that Playboy and other publishers and television companies face as more people get their entertainment online, and often for free.”
And that’s the beauty of the ‘net for consumer. A lot of what you fancy with little of what you don’t i.e. paying for stuff. Not so great for the publishers who have been struggling to figure out how to make the internet pay. Expect to see a culling of national newspaper as they stop printing in the next few years and as for TV, well one glance at the schedules tells us the medium is beaten.
Returning for a moment to the subject of ballooning commodity prices... The week-end FT finds an indication of the increases in speculation - the futures market. Commodity futures have increased fivefold in the past three years says John Authors in the FT citing energy consultant, Philip Verleger.
Originally commodity futures were used as a hedging tool for producers against a change in prices, now they are considered an investment in their own right. And The Sunday Times’ David Smith notes “something odd” going on in the oil market following last week’s announcement of a large rise in crude stocks by the US Department of Energy. “Instead of falling, prices hit a new record.” A rampant bull on the charge..? Oil is down a little today to $125 against something unusual in recent times, a stronger dollar.
News from China: it gets hit by an earthquake felt in Beijing measuring 7.8 and inflation measuring 8.5%pa. The official response to the food price driven inflation problem has seen the authorities slap on the fourth increase in bank reserves this year. Its exports rose by nearly 22% over the previous year to April as its latest trade surplus surprises on the upside. More on “unbelievable” China in Bill’s notes below.
And some news closer to home...
The damage caused by rampant commodity prices can be clearly seen in the latest government statistics. UK producer prices rose 7.5% year on year - their fastest pace since 1986. Comments Geoffrey Dicks, and economist with the Royal Bank of Scotland:
“There is a wall of costs out there waiting to dump on the U.K. consumer.”
Recent soundings of sentiment suggest consumers have a good idea of what’s coming. One such dumping looking to be coming soon are higher energy bills. They could rise as much as 46% this year reports The Telegraph.
As for the wider economy it will “skate close to recession” over the next 6-9 months says the British Chamber of Commerce in a new report. Quarterly growth will hover a little above 0% and if oil maintains its current elevated level expect 4% CPI inflation in the second half of the year. Against this backdrop, life doesn’t get any easier for Mervyn King and co trying to coax UK plc. back to at least trend growth with further cuts in interest rates.
More billions in bank losses, today... HSBC plc. revealed another $5bn in bad subprime debt and write downs to take its total losses up to $20bn (how they must rue buying US subprime lender Household International). The bank comments the US is likely to go into recession this year and doesn’t see a US housing market recovery until next year.
On the subject of house price crashes, research from Goldman Sachs finds this is the first suffered in the US since the 1970s based on their definition of a 15% fall in inflation-adjusted prices. During that period most other industrialised countries have suffered at least one and Canada, Finland, Germany, Italy, Japan, Korea Sweden
Switzerland and the UK have had two. Yes, there are still those of us around who remember the value of your home can fall as well as rise.
Finally, some news of our own. This week will be our last. The Daily Reckoning is closing on Saturday but dear readers will continue to hear from us on a daily basis as the Fleet Street Daily from next Monday.
Regards,
Rob Mackrill
The Daily Reckoning
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Bill Bonner in Ouzilly:
An old friend gave us a subscription to the National Geographic. When an issue comes, Henry takes it and spends hours reading. This month, the magazine devoted the whole issue to China and Henry passed almost all of Sunday afternoon studying it.
“ China is unbelievable,” was his judgment by evening.
Every detail is a superlative...bigger, faster, higher, more...more...more. Things are happening so fast that in just 10 years, China will be the world’s biggest economy.
We don’t have to tell you what that means, dear reader. Give a guy some money and it’s not long before he thinks he can tell other people what to do and how to live. The US became the world’s largest economy by around 1900. By 1918, Woodrow Wilson was headed to France with his “14 Points.”
“God himself only needed 10,” said Clemenceau.
But America had lent a lot of money to the French and English; they had to listen politely, even if they thought Wilson was a fool.
Now, China has the money – the biggest pile of dollars in the world. And soon it will have the most powerful economy. It won’t be too much longer before Chinese leaders will want to throw their weight around. And they’ll have plenty of pounds to toss wherever they want. There are only five girls for every six boys. By the time China has the world’s largest economy; it will also have 30 million young men who cannot hope to find a wife. What will they become? Soldiers! Then, China will have the world’s biggest and most modern military...and a keen desire to show the rest of the world how things should be done.
How do you say “we surrender” in Mandarin? We don’t know, but the Pentagon may want to look it up, just in case.
But don’t worry, that’s still a long way away...with many a slip betwixt the cup and the lip. Oh yes, China is headed for trouble too...you can’t have that kind of growth without trouble. In some ways, China is the biggest bubble the world has ever seen – bigger than dot.coms...bigger than US housing...bigger than credit, finance and derivatives. Not only is it expanding rapidly – it MUST expand or it will blow up. Like a credit bubble, it can’t rest...it can’t stand still. If it stops expanding...bad things happen. In a credit bubble, people need more and more credit to service the bad loans and bad investments they’ve made. If they don’t get more money, the credits go bad. Businesses go belly up. People miss their payments. Loans get marked down. Pretty soon, you have a recession...or worse. China’s bubble is far more dangerous... because it has hundreds of millions of people who have come to depend on high rates of growth.
They can’t stay where they are...they’re not peasants anymore. They’ve moved to the cities to join the international proletariat; they need work! They need progress! They need to build giant roads and aqueducts...airports and factories. They need to produce more things. They need to contribute to the global economy. They need jobs. And if they don’t get them, China could blow up. What’s more, China’s economy is run – at the very top – by officials who are even more blockheaded than our own. If trouble fails to find them; they’ll find it.
What caught our eye was a chart of China’s oil use. Ten years ago, China imported 165 million barrels of oil per year. Today, the total is more than 1 billion. What does it do with all that energy? It grows...it develops...it chugs...it thumps...it soars.
Looking at the photos (we haven’t been to China for more than 15 years), the replace reminds us of a teenager – sassy, obnoxious, and outgrowing his pants. It is an adolescent nation, growing so fast it must eat all the time. In addition to the oil, China has opened 229 new coal-fired power plants since 1990.
Wonder why the price of oil hit a new high last week – above $126 a barrel?
Well, China is a big part of the answer.
And rice is now selling for twice as much as did last year. Could that too be blamed on China? Well, partly. When the Chinese lived on the land, they fed themselves with what they produced. But once in town, they become more customers for the globalised market...competing for their daily bread with people in Des Moines and Dubrovnik .
Oh yes, you’ve heard the expression about land – ‘they’re not making any more of it.’ Well, in China, they’re actually losing it. Since 1949, says National Geographic, China has lost one-fifth of its farmland to dust-storms, desertification, pollution and urbanisation. Each year, the country loses more ground – an area approximately as large as the state of Rhode Island.
Let’s see, more and more people moving to the cities – hundreds of millions of them. Building factories...building houses...buying cars...washing machines... computers... More and more people competing for the world’s resources...less and less farmland...
Oh we’ll do the math later.
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More thoughts from Mark Siara...
A short quiz to start this week’s article. When looking at their respective capital cities, which of these countries is the odd one out? Australia, Canada, the United States or the United Kingdom? I’m sure there are many and varied answers to this question, but the answer I’m looking for is the United Kingdom. For those of you that chose correctly well done, go to the top of the class and I’ll expect an apple on my desk in the morning.
And for the swotty types out there, the corollary is this: why is London an odd capital city? Again many and varied answers can be given and, depending on your location and disposition, you’ll either be positive about the place or not. In order to give you the answer, I’ll illustrate by way of a list:
Australia : Canberra and Sydney
Canada : Montreal and Toronto
United States : Washington DC and New York
United Kingdom : London and
The answer being that London is the only capital city in the list that doesn’t have a strong second city to contend with. Apologies to Birmingham ( England’s second city – by population at least), Glasgow, Cardiff and Belfast, fine capitals all, but it’s true. There’s no city in the UK that can keep London in line so to speak.
Before we go any further let me make it quite clear that I have no problem with London as a place or Londoners as a people. This isn’t a North vs. South type debate. Furthermore, as what some of the less polite down South may call “a <expletive deleted> Northerner”, but also as one who once lived in and around the London suburbs, I would hope that my view is more balanced than most. London is a remarkable place and, as the father of the dictionary Dr Johnson once stated “When a man is tired of London, he is tired of life; for there is in London all that life can afford” (especially if you’re a multi-billionaire Russian he would have to add today)
So, having laid out my non-biased credentials on this matter at least, what is the reason I believe London needs a strong counterparty? Mainly it’s because of the unhealthy concentration of power and influence in one place. In the UK the capital contains the centre of politics, finance, the media and entertainment. Nowhere else in the UK can rival London in any of these regards. Compare that to, say, the United States where politics is centred in Washington DC, finance in New York and of course entertainment in Hollywood in Los Angeles. It’s all much more dispersed.
London dominates Britain to such an extent that, for many foreigners, the two are synonymous. On my last visit to the US, I lost count of the number of Americans who asked me where about in England I lived. My answer of ‘ Manchester’ was greeted with one of two responses. Either: “Is that near London?” or “Oh, you must know my Uncle Billy, he lives there” as if they think London is the only city of any size or consequence in the UK. I politely pointed out that Manchester is a city of a similar size to Seattle, so I was unlikely to run into any of their relatives as they suggested “in one of your quaint pubs”.
Partly it’s the media’s fault, with their continuing focus on London. It’s all a bit parochial. Take the recent local elections and the drubbing the Labour party received (there’s no truth in the rumour however that Gordon Brown is going to have a recount done by Robert Mugabe).
Looking at some of the recent reports you may be forgiven for not knowing that there were elections all over the country – it was all about the Ken and Boris show. One big advantage that the regions have, though, is that none of their big cities are controlled by a mayor. Looking at the candidates that were available to the poor Londoners in the recent election and at the credentials of the winner, I think that’s probably a good thing. It’s an interesting experiment however.
There is also a perception in the Provinces that Londoners want to have their cake and eat it. From Hammersmith to Hampstead to Hackney complaints about congestion charges, the level of immigration or house prices emanate. These grievances particularly grate in the regions because they all basically about stem from the fact that there is near-as full employment in the capital. A decade of rising employment and prosperity has attracted people from all over the country and from abroad. And with all the cheap money sloshing about within the M25 (aka Britain’s largest car park), it’s no wonder that assets have become so expensive. You can’t have it both ways – if you concentrate all the jobs in one small corner of the country, goods and services in that locale will become more expensive. Companies should take a leaf out of the BBC’s book, as they are currently in the process of relocating several of their television and radio departments into Salford (next to Manchester)
The other complaint recently made was that Londoners effectively subsidise the rest of the country through their proportionally greater levels of taxation and also through their significant contribution to the nation’s GDP. This argument is fatuous and divisive. Is the London-based financial sector going to only offer mortgages to people who live within the capital’s boroughs? Will there be a ban on the sale of Jersey potatoes or Sheffield steel or electricity generated in Wales to Croydon or Camden or Chelsea? Shall we send just Londoners over to Iraq or Afghanistan to fight in a war agreed upon in Westminster? It’s nonsense.
Of course the London economy has a huge impact on the UK, with the financial sector contributing much of that benefit. Unfortunately, now that the UK is an “eggs-in- one-basket” type of economy, the coming downturn in the City will hit the entire country hard. We need diversity to protect the country – a downturn in one area can be mitigated by an upturn in another. Even the BoE governor Merv the Swerve has recognised that London is becoming too influential. He recently attacked the City's economic dominance and recognised that the high level of City salaries has a negative impact elsewhere in the economy.
The concentration of wealth generation in the UK into one geographical area ( London) has mostly occurred because of the concentration of wealth generation into one sector (Finance). The recent government have done nothing to reduce the impact of the inevitable financial downturn on the rest of the country. Indeed the recent Labour government have turned their backs on their roots, discouraged manufacture and industry and encouraged the ranks of the City to swell to unsustainable proportions; something that is bad for all of us. It’s a schoolboy error and will be punished as such by an unforgiving electorate. Gordon Brown is already standing in the corner wearing a pointy hat but, come the next General Election, he’s sure to be expelled.
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And more thoughts from Bill...
*** Today’s a holiday in much of Europe – Pentecost. Between the secular holidays and the religious ones...that is, between the sacred and the profane...it is a wonder anyone gets any work done.
But here at the Daily Reckoning headquarters, we keep our eyes open, even on national holidays.
What we saw at the end of last week was the kind of day that suits us. The Dow dropped 120 points on Friday. The dollar fell. Gold rose. And oil...as mentioned above...hit a new record. We don’t know how long this trend will last – that is, the trend towards higher commodity prices and lower asset prices – but we give it a while.
*** In China, people are working their way up – from the rice paddies to the packing plant...from the country hovel to the urban tenement. Soon, they will be moving to the suburbs and buying SUVs. Wait...they’re already moving to the suburbs. The National Geographic has a photo of a new suburban development near Shenyang. There are houses that look like they might be in a suburb of London or New London – with white picket fences, lawn chairs and satellite dishes. And what’s this...there are so many rich people eating at fancy restaurants in Beijing that a chef in the city already makes about as much as a chef in Manhattan!
In America, meanwhile, people are working their way down. We’re not kidding. Wages are stagnant. Prices are rising. At the end of the day, they have less spending power; they are poorer. Besides, it said so in the New York Times. People lose their houses...move back in with their parents...and put their stuff in a storage unit. Then, they either can’t make the storage payments...or they realise that the move wasn’t just temporary and they give up. Pretty soon, the auctioneers are selling the stuff.
Millions of people who moved up the housing ladder in the last five years are apparently now looking for a lower rung. Some are moving in with parents. Others are renting. Still others are downsizing their lives – not necessarily because that’s the way they want it. But with less money to spend, they have no choice. At first, they figure that they’ll be back on their feet in a few months. Then, it begins to look like the move is permanent. So, they don’t need all that stuff.
Of course, they didn’t really need all that stuff in the first place. But getting more stuff is what life is all about...isn’t it? So they got it, and now they have to get rid of it. If only they could hold a yard sale in China!
*** There is nothing like a national election to make you despair, sourly, of America’s future.
“Oh I don’t like Obama,” said an American colleague on Friday. “He seems like a demagogue to me.”
The comment took us aback. It had never occurred to us that a candidate for president could be anything but a demagogue. Some are better at it than others, of course.
But how could you hope to win the votes of the yahoos and cornballs without stirring their dull roots with the warm spring rain of patriotism, larceny, and the terrorist bugaboo?
“But Obama’s message is so empty...so vague... He promises ‘change.’ Who can choose a leader based on that kind of promise?”
As we’ve explained in these columns, change is the one thing almost no American wants. They’ve all got their little places at the beach staked out...heavily mortgaged, of course...and now they’re desperately afraid that someone - the Chinese, or the Arabs, or the Fed - is going to kick sand in their face.
Still they listen to Obama’s speechifying as they listen to music, without pay attention to the words. It gently lulls them, calms them, reassures them. They’re confident that Obama, if elected, will do what any of the others would do – try to prevent change at all cost.
The latest Las Vegas odds say that Obama will be the next president. All we know about the man is that he has Paul Volcker for an advisor, so he can’t be all bad. But what probably makes him more appealing than the other candidates is the very thing our colleague dislikes - the vagueness...the emptiness of his speeches...the hollowness of his remarks. Having said little; he has said little to annoy them.
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The Daily Reckoning PRESENTS: After years of above-trend growth, the UK public finances are a mess says Fleet Street Letter editor, Brian Durrant and there’s a lack of experience in Whitehall to put it right...
Government Proving Bad for Business
By Brian Durrant
If the Labour party's term in office was a round of golf, it might go something like this. A steady start, some pars, perhaps even a birdie or two. Whenever they were in trouble in the bunker, they somehow still managed to get down in two.
The round was going along reasonably and luck was on their side. Then came a nervous three putt, a ball out of bounds, the confidence began to flag and fatigue started setting in. And it got worse. The ball was 'topped' 50 yards on into the rough, next an embarrassing air shot, then a routine chip was fluffed with the ball shooting across the green at high speed.
At the next tee they didn't know which club to use because they'd been scoring so badly. The wheels on the trolley have fallen off. As any golfer will know, the simple matter of pulling yourself together is easier said than done when your round has turned into a nightmare. This is the position of the Labour government now.
The public finances are in a mess. That's an extraordinarily imprudent feat, given the years of above-trend economic growth. Chancellor Darling was forced in his recent budget to raise planned borrowing for 2008-09 and the next three years by £32bn compared with Gordon Brown's plans in his 2007 budget. And it gets worse...
According to the NIESR's central forecast, the impact of the credit crunch will mean that the Treasury will have to borrow £8bn more than it had planned in each of the next two financial years. Income tax receipts will be reduced by the economic downturn. In particular, hefty City bonuses, which provided a rich source of revenue for the Treasury, are drying up as banks cut staff and remuneration packages. In turn, VAT receipts will be hit as the squeeze reins in consumer spending.
The contraction of the housing market will also reduce Stamp Duty payments.
Meanwhile, after more than a decade of rising consumption and booming house prices fuelled by low interest rates, easy credit and cheap manufactured imports, UK households now face a fall in living standards. This is not an assessment from a sensationalist newspaper, but the governor of the Bank of England. In an uncharacteristically blunt statement, Mervyn King said that rising inflation and the fallout from global economic turmoil would take its toll on the spending power of British households.
Adding to the gloom is a sense that the management has lost the plot. Taxation policy is better when it's not made on the hoof. In the last Budget, for example, the Chancellor and the Prime Minister wanted to be seen to close loopholes that benefited private equity multi-millionaires, but they did so through a rushed change in capital gains tax that threatened regular business owners and employees in share schemes. The rules to tighten the tax rules for the non-domiciled were clumsily handled as well.
The motives behind these tax initiatives show a lack of strategic thinking that runs to the heart of government. It is Brown and Darling's willingness to play games with the tax system if they think it will win them electoral popularity. A good demonstration of this is the furore over the scrapping of the 10p personal tax band. In Gordon Brown's final budget, the Chancellor decided to make a dramatic gesture by cutting 2p off the basic rate of income tax, funded by the scrapping of the 10p rate. At the time this raised an enormous cheer from the
Government benches. Now one year on, when the measure comes into effect, it has become a millstone around the Government's neck.
It is not just the level of taxation that is driving companies and individuals abroad. It is the chopping and changing and endless gimmicks that scare businesses away. It is imperative that the taxation system is stable, clear and predictable with an absence of nasty shocks and abrupt changes in direction. Nowhere is this more evident than in the oil industry, which looks a likely candidate to be clobbered at the next budget.
So why is the Government and the Treasury increasingly prone to errors that make the UK a progressively less attractive place to do business? The blunders outlined above are ones which, in the past, Whitehall mandarins would help ministers avoid.
However, the wisdom of experienced advisors has not been valued by a government which thought it had abolished boom and bust. The average age of Treasury staff today is 34. Eighty per cent of them have only ever worked for Brown or Darling. The current permanent secretary, Nick Macpherson, is 48, while his number two, John Kingman is just 38. The latter was fast-tracked through the ranks after catching Gordon Brown's eye in the press office. It is a sobering thought that Mr Kingman would have been just a toddler when Britain was tackling its previous systematic banking crisis in the early 1970s.
In just over a decade the Treasury has been 'modernised' into a kindergarten of politically correct spin merchants. The individuals may be expert in the art of devising eye-catching initiatives, but they are too politically subservient or inexperienced to give Ministers valuable advice on serious matters. This may explain the extraordinary dithering over Northern Rock.
To return to the golf analogy, Gordon Brown is at the tee and doesn't know which club to use. His inexperienced caddy tells him everything will be fine and hands him a putter.
Regards,
Brian Durrant
For The Daily Reckoning
Editor’s Note: A Cambridge economics graduate with nearly 25 years experience in the City, Brian Durrant is investment director of The Fleet Street Letter (founded 1938). He has worked in stock broking, the foreign exchange markets, and also headed the research department at one of London's leading futures and options brokers.
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