Your Pay, Frozen Or Cut Sir?

1st July 09 - Your pay, frozen or cut Sir?

Hard on the heels of yesterday’s diary entry about the fall-off in graduate recruitment, comes the result of a new employment survey by the Confederation of British Industry (CBI) and recruitment group Harvey Nash. It reveals that the same proportion (60%) of businesses that have put recruitment on hold are also planning to either freeze pay or negotiate a cut.

More than 700 companies employing around £3million people took part in the survey and John Cridland, deputy director-general, said that the research revealed that the recession had dramatically altered the workplace landscape. It had been a "particularly bruising recession, but one of its most positive and striking aspects has been the commitment of businesses and their staff to work together to try to trim costs and save jobs." Another key finding was that where jobs could not be saved, the cost of individual redundancy averaged £12,000. One could add that "redundancy" per se in terms of statutory pay is not the only element. It can reach a maximum of 30 weeks pay at a maximum figure of £350 per week (£10,500) but added to this is notice period that can be up to 12 weeks of basic pay.

More than half the businesses surveyed expected recruitment to take more than a year to return to 2007 levels and about half of those though more than two years. Whilst there is clearly a level of self-interest on his part, Albert Ellis, chief executive of Harvey Nash, warned that the UK economy was in danger of losing its competitive edge if British companies failed to take a more "proactive approach to training, accommodating and retaining talent."

Then again Mr Ellis, lose out to whom? There are a few shedding issues elsewhere too.

Visit http://www.jgwalkersmith.co.uk for more topical comment and articles about finance & business.

40 To 1 Against

30th June 09 - 40 to 1 against

Martin Birchall, managing director of High Fliers, which specialises in graduate recruitment research, says that the recruitment situation is bleak. "The graduate population has doubled - but the number of graduate jobs certainly hasn’t. There are now 40 or 50 graduates chasing every job in the market." It is not surprising in this aftermath of the credit crisis that a big casualty is investment banking. According to High Fliers, investment banks have cut their recruitment by almost half, while high street banks and other financial organisations have also decreased their graduate numbers.

Cynics have always said that if you cannot do it yourself, then teach it. Now it seems that one can add: if the teaching job is there, grab it. Teaching is the top destination for the first time. Job security over high salaries. But what is the teaching for or perhaps better put as "of"? It is to be hoped it might be back to basics with a touch or morality thrown in for good measure. Before we move on, it has to be said though that there is obviously the silver lining of vulture work and re-structuring and insolvency. The UK’s two largest recruiters of graduates namely PricewaterhouseCoopers and Deloitte are holding their recruitment programme at last year’s level. Both are taking on 1,000 graduate trainees. Sonja Stockton, head of recruitment at PWC said "The market has certainly shifted . We’ve taken some of the best talent from investment banks."

The worry is twofold. First, it is the commercial organisations (let’s call them the wealth creators) that have lowered their graduate intake significantly and some have stopped altogether. Secondly, there is the affect upon a normal process of building a longer-term talent pool. Stephanie Bird, a board member of the European Association for People Management (EAPM) and director of HR capacity of the Chartered Institute for Personnel Development says "It’s short-term gain, in exchange for long-term pain."

Perhaps this is the second biggest casualty of the credit crunch crisis. First the experience and skills built up over many years is cast aside into the unemployed queue and then those that should be the next generation of technicians and managers are not set on. Big shame.

Visit http://www.jgwalkersmith.co.uk for more topical comment and articles about finance & business.

Between A Rock And A Hard Place

29th June 09 - Between a rock and a hard place

The trouble with borrowing is that it presupposes that the good times will keep on rolling. It also presupposes that one must have had good times in the first place in order to have been allowed to borrow because the capital element of borrowings has to be paid back over time and the cost of that capital namely interest has to come out of the good-time pot too. That is of course unless you are a sovereign state when the good times can grind to a halt and you simply use your monopolistic power to make your customers (sorry citizens) pay more. This pay is called taxation, whether of the direct or indirect sort.

But then comes the rub. Let’s say some of your customers are sent off the field and some that stay on develop debilitating injuries such that their game suffers. Will you have the will or the ability to stop the borrowing so that the existing debt can still be afforded by the remaining players bearing in mind the law of diminishing returns? Diminishing since there are few things more demoralising than the monopolistic sovereign state grabbing your hard earned bread before you even see it hit the bank balance.

We are of course talking about the UK. Latest figures from The Office of National Statistics show that the Government borrowed a record monthly level of £19.9bn in May 09 compared with £12.2bn in the same month of 2008. That is an increase of 63.1%. No hike in taxation could practically cover such an increase. The borrowing of £19.9bn was the highest monthly figure since records began in 1993. The economic brakes of the credit crisis has caused tax receipts to fall sharply (all manner of taxes - income, corporation, vat, council collected, stamp duty, capital gains) while the hard place has been the benefit payments to those thrown out of work.

You or I would have to budget downwards (the two words suit and cloth spring to mind) but if Mr Sovereign thinks that spending on health and education should be unaffected, even advantageous, then a form of bankruptcy will inevitably occur. Net debt is now 54.7% of GDP (let’s call GDP "income"). Standard & Poor, the rating agency that has the UK on watch, forecasts this debt to income ratio as approaching 100% by 2013. If it passed it, the UK would be technically and I would think psychologically bust.

A busted flush.

Visit http://www.jgwalkersmith.co.uk for more topical comment and articles about finance & business.

Stubborn Inflation And Loose Debt

26th June 09 - Stubborn inflation and loose debt

The main idea behind monetary stimulus in the UK (quantitative easing) and fiscal stimulus (cutting the rate of VAT) was to counteract the damaging affect upon debts of rapidly falling inflation and possible negative inflation. Indeed, deflation and recession brought on by the lack of credit as a result of the credit crunch. In reality, even these many months on, the rate of inflation in the UK is stubbornly sticking above the 2% mark, at any rate as measured by the Consumer Prices Index (CPI). The figure for May 09 was 2.2% and although this was a 16 month low, it only fell from 2.3% recorded in April. Why?

The biggest factor in inflation holding up was an increase in alcohol and tobacco prices. So we are boozing and puffing our way through the hard times? Not so. The higher prices are due to an increase in duties introduced in the April 09 budget. A child of 5 years could spot the dichotomy, down with VAT up with beer and fags. A second big factor in overall prices holding up was the pounds depreciation in the currency markets so that imported goods cost more at the docks. You might ask then, why did inflation fall at all. It was because the cost of food came down slightly as did electricity bills.

Commentators are divided as to how low UK inflation will fall. JP Morgan, the leading investment bank, predicts a low of 0.8% by September this year but back up to 3.1% in January 2010. Perhaps the actual level itself is less important than the risk of further money-printing priming the pump too much. A wild-card is oil. Over the past three months it has doubled in price from $35 a barrel to the current $70. It is not just the price at the pump to you and me but the estimated 20% effect on distribution costs.

Meanwhile, back in the land of UK debt, the UK Government has sold £7bn worth of gilts in the biggest syndicated sale of sovereign debt in history. This is the first time in four years that that the syndicated bond market for 25 year debt has been tapped. The coupon is 4.5%. Something wider than the usual auction to UK clearing banks had to be tried since this year alone some £220bn of debt has to be financed.

Stubborn inflation and loose debt. 4.5% bedfellows?

Visit http://www.jgwalkersmith.co.uk for more topical comment and articles about finance & business.

Overhauling US Financial Regulations

25th June 09 - Overhauling US financial regulations

Proposals for a major reform of American financial regulations have been issued in the form of a white paper to be debated by both the House of Representatives and the Senate later this year. If approved, the new enacting legislation will change the fundamental rules in place for the past 70 years.

President Obama has a way with words. The scene-setting for the white paper were up to his now customary high standard. The need, as he put it, was to eradicate a culture of irresponsibility which had taken root from Wall Street to Washington to Main Street. He went on to state the deliverables as "strong, vibrant financial markets, operating under transparent, fairly administered rules of the road that protect America’s consumers and our economy from the devastating breakdown we’ve witnessed in recent years."

These words from the new President are not the sort to be used by the more traditional post of Governor of the Bank of England. Yet, on the very same day that President Obama spoke, Mervyn King was saying in his annual address at the Mansion House banquet in London that his central bank had not yet been given the controls it needed to prevent future crises. This coincidence demonstrates once again that the principal approach to a safer financial future is roughly parallel across the Atlantic. And note two things. First, on the American side, the politician takes the initiative. On the UK side the central banker. Second, the UK approach is as far away from mainland Europe (especially Germany) as, unfortunately, it has been on many subject over the years.

The American proposals are:-

• A strengthened Federal Reserve (equivalent to the Bank of England) to take responsibility for major banks, which will be subject to tighter regulation

• A council of regulators to identify gaps in regulation while eradicating the outdated Office of Thrift Supervision

• The development of a "resolution authority" to seize non-bank financial firms whose collapse would pose a systemic risk

• The creation of a new consumer protection agency

• Tighter rules on risky products at the heart of the credit melt-down, including derivatives and asset-backed securities

• Working with international regulators on uniform standards

Necessity being the mother of invention.

Saab Is Saved.

24th June 09 - Saab is saved

Saab, the quality and stylish car manufacturer, appears to have emerged from the chicane of the Swedish version on the US’s Chapter 11 bankruptcy. It is a case of how David caged Goliath. Saab sold 93,000 of its flying-machine cars in 2008 and is particularly popular in the UK with those wanting something a bit different. Its rescuer is a bit different. Koenigsegg, a fellow Swedish car maker, turns out just 18 models a year and employs 45 people but that has not prevented it forming a syndicate to rescue the hairy beast. The majority of the financial banking for the deal will come from a $600m commitment by the European Investment Bank and guaranteed by the Swedish Government.

Saab has been owned by the US behemoth General Motors since 1990 but has only rarely made a profit. To pull Saab out of its enforced bankruptcy, GM is providing plant, technology and vehicle architecture. It is all part of what is looking like an increasingly successful break up of GM following its time-pressurised retrenchment. As detailed in this diary at the time, the European arm (including the profitable UK Vauxhall marquee) has gone to a strange mixture of Canadian and Russian interests, and in the US itself, Hummer and Saturn have been sold on. There is still time for someone to pick up the iconic Pontiac (that is the car that the bad guys are catching up in during that thrilling motor chase).

Yesterday we lamented over the loss of UK jobs. If this deal goes through, it will save about 3,400 employees directly and probably about twice that number indirectly. It’s all somewhat like the death of a close family member, a surprise marriage break-up, an enforced career change and perhaps even a house move. Stressful and rotten at the time, anger and resentment later but eventually all for the best. Good luck you Swedes. May your different cars and your new models succeed.

Public Sector To Fall Out Of Bed

23rd June 09 - Public sector to fall out of bed

Some people feel that the public sector is feather-bedded. This is largely because they are supposed to swap high ongoing salaries for pension and job security. This of course is a travesty. On average, public sector workers get higher salaries than their beleaguered cousins out in the cold world of reality economics.

The Chartered Institute of Personnel and Development (CIPD) thinks there is some falling out of this cosy bed to be done. It predicts that 350,000 public-sector workers will lose their jobs over the next five years and a further 30,000 in local authorities over the next year. According to Dr Philpott (quite an apt name really) there will be a "coming era of public sector austerity" and featuring a union-led fight back again of the type now largely confined to the waste-paper basket in the private arena. He thinks that as the next (note next) Government tightens fiscal policy to bring down borrowing there will be major strikes and "regular bouts of unrest." Dr Philpott might observe that there is considerable unrest now from the rest of us about the public sector cliques.

One reason for the growing us and them feeling in the UK as a whole is contained within the data just put out by the ONS. It shows the number of people claiming unemployment benefits rose by about 60,000 in May 09 to reach 1.57 million. Within that big number are many personal tragedies. Not least the skilled workers leaving my long-standing furniture manufacturer on 10th July. Les has been running the shop-floor for 23 years and can make just about anything from a beautiful armchair to a comfy sofa to posh bar stools. But he and his men will soon be part of that 1.57 million who still wonder what the credit crunch crisis is all about. They do not have a clue about bundled up financial packages. Why should they?

Land-locked Europe Misses The Boat

22nd June 09 - Land-locked Europe misses the boat

"US banks have raised $85bn since the stress tests, while Europe’s banks have raised just $7.5bn. This is going to go pear-shaped in coming months as people lose confidence in the whole crisis management in Europe." So said Hans Redeker, currency chief of BNP Paribas musing that Europe’s banks had missed a chance to build capital reserves during the credit thaw. The recently published ECB’s Financial Stability Report made much the same point, "The deterioration in the macro-financial environment has continued to test the shock-absorption capacity of the euro-area financial system. Prospects for a significant turnaround in the short term are not promising."

The worry beads of European interested parties are being rattled on a broad front. Moody’s, the leading rating agency, downgraded 25 Spanish banks due to rising defaults. It also made a somewhat cathartic statement, "The extra cushion that banks had built up over the years against such risks is becoming increasingly thin. Unless some supportive measures are taken by third parties - by owners, or likely by the government - some banks’ capital cushions will soon be affected by asset impairments." It followed up by putting the Swiss UBS on downgrade review.

After the bull run since March 09, fears that Europe will, this time around, set off another credit crisis caused an avalanche of retreats. Equities fell across the whole of Europe as did commodity prices. US crude oil price dropped $2 a barrel. The Dow went 200 points southwards, the Frankfurt’s DAX index fell 3.5% and the Euro hit a three-week low of $1.3772 against the dollar.

The affect of this fear about the overall European economy is to pressurise Germany, the largest single unit. There is a feeling that all is not revealed about the safety of its banks and that this could be political given the national elections in September. The ECB report added its sting, "There is no room for complacency."

Of course the UK is not part of land-locked Europe. Only regulation-locked Europe. That might soon be bad enough.

Your House in Gold Bars

19th June 09 - Your house in gold bars

Coming right back down to earth after all the mega-bucks of the macro-world, I have been studying the Nationwide’s Bullionvault.com graph. This graph shows over a 55 year period to 2008, the relationship between the average UK house price expressed as a multiple of the gold price per ounce in pounds sterling. The rationale is that gold is the safe haven of commodities and so if the house price multiple is high, consider that something rather artificial is occurring and beware of a crash.

In 1953, the index stood at 150 and after rising to about 310 in 1971, fell back to just less than 100 in 1980 before an inexorable climb to (wait for it) 700 by 2004/5. The descent was like coming off striding edge of Helvellyn, that is to say, very steep and after stopping for breath in early 2007 precipitous to stand by the first quarter of 2009 at 220. One can look at this data in at least two contrasting ways. Either we are now back to something approaching sanity with house prices or, even today’s depressed housing market post the credit crisis, is till only just lower than the long-term average relative to gold bullion and has much further to fall.

This bricks and mortar/gold price relativity is particularly interesting given that the UK’s largest building society Nationwide put May 2009’s rise in house prices at 1.2% and this at a time when GDP grew by 0.1%. It would be wise to be cautious in fishing for the bottom in the domestic housing market. The big difference between today and the housing slump of the 1980’s is that interest rates are much lower now since the Bank of England’s base rate is 0.5%. It is therefore less painful to be in debt now all ye first-time buyers but beware the trend line. Unemployment is still rising like the housing/gold graph up to 2005 and interest rates can only go up and indeed as this is written, they are doing so in relation to fix rate mortgages.

Adrian Ash of bullionvault.com claims that if you had sold the typical home five years ago and used all the cash to buy gold, you could now afford to buy 2.7 of those properties. The problem with that of course is that we all didn’t.

Of Barclays Coup de Grace

18th June 09 - Of Barclays coup de grace

It is about the free market and brainpower beating the interventionists hands down. Our friends at Barclays have done it again. Not content with refusing the taxpayers’ shilling in favour of largely Middle Eastern investors funds to shore up the balance sheet and ignoring shareholders’ pre-emption rights, as described in this diary at the time, the mavericks at Barclays have done a deal to sell their fund management arm to America’s Black Rock. The numbers are staggering, as is the new partnerships being forged.

Black Rock will pay $13.5bn to buy Barclays Global Investors (BGI) and so bolster its balance sheet by a net financial gain of $8.8bn to increase the tier 1 ratio from 6.7% to 8.3%. Bob Diamond, Barclays group president explained the reasoning behind the deal as follows "It’s increasingly difficult for a bank like Barclays to have a top-tier position in institutional investment banking and in institutional investment management." There are two elements to the funding of this enormous sum pouring from Black Rock to Barclays. First come shares. Barclays will receive 37.8 million Black Rock shares giving it a 19.9% stake in Black Rock plus two seats on the board. Secondly, the cash. The total of the hard stuff is $6.6bn and here is the deal making surprise. Of this sum, $2.8bn is coming from three sovereign wealth funds. They are believed to be (not formally confirmed at the time of writing) The Kuwait Investment Authority, the Government of Singapore Investment Corporation and the China Investment Corporation.

What is really surprising is that these sovereign funds have had their collective fingers burned in the past by investing in Western financial services and corporations. But that is only to strengthen a view that the long-term interest of these creditor bodies is to move funds out of sovereign debts and natural resources and into what we might think of as working capital.

The moral to this story is to do with the pre-eminence of specialisation, the lack of sacred cows, the motivation from independence and perhaps a bit of self-interest. The latter in that a group of 410 Barclays bankers are reported to be in for $607.5m profit from the sale of their shares in BGI. Take your pick.

17th June 09 - The one that got away

It is hard to keep China out of the news especially as the credit crisis reaches some form of mature phase. From its huge internal stimulus packages of infrastructure programmes, through overtaking Japan as the world’s second largest economy, via its increasingly dominant currency to its great ambition to secure supplies of the raw materials it continues to need to fuel its growth. Yet, just two weeks after the 20th anniversary of the Tiananmen Square massacre (the "incident"), one has got away.

Some fourteen months ago a state-owned group named, not surprisingly, Chinalco, made a move on the leading FTSE mining and exploration company called splendidly Rio Tinto. This is no under the arches business. It has a market capitalisation of £29bn and turns over US$29bn. A long geo-political and regulatory saga unfolded and earlier this year it culminated in Chinalco acquiring 18% of its target. This stake cost $19.5bn of cash injection to ease Rio’s massive debt still standing at $38bn and the impending deal would have allowed the Chinese behemoth to take minority stakes in some of Rio’s mines. It was this aspect that put certain countries in alert mode. Uppermost in the cautious camp was Australia where many of the biggest mines are located.

Up pops the Australian giant miner BHP (that used to be known as Broken Hill after its biggest site) and tries to take over Rio to form such a large miner as to arm the commodity supply chain against even the dominant customer called China. It could be added that the cause of Rio’s debt vulnerability was its earlier purchase of Canadian Alcan at the top of the market in 2007 and employing in full measure our old friend Goodwill.

The story all along from Rio has been that its investors could not stump-up enough cash to ease its debt burden and so its cap-in-hand approach to or by Chinalco was the best strategy. But, Rio’s share price has risen by 86% in the last four months and commodity prices that had been on the slide have steadied off. The end game is that the Rio board has caved in and bowed to shareholder power (remember the Barclays story that only this week has fed massive profits to the Middle-Eastern investors that moved in when the ordinary shareholders were denied pre-emption rights) and there is to be a rights issue and a joint venture with? You guessed it, BHP.

One consolation for Chinalco is a $195m break fee. The one that got away - but not entirely free, mate.

Who Was A Millionaire?

16th June 09 - Who was a millionaire?

According to HM Revenue & Customs, the number of UK citizens in the top income tax band will fall by one million this tax year, that is 2009/10. This represents a quarter of those who paid the top rate of 40% last year. The reason is pretty obvious. Bank workers bonuses gone or down, white collar workers not actually working and many professionals on short-time or reduced profit share. If we add to this the reduced take from corporation tax as company profits fall and much less stamp duty due to the fall in house prices and number of transactions, it is obvious that total tax take will be well down.

John Whiting of PricewaterhouseCoopers (Pwc) warned that the Chancellor’s plan to raise the top tax threshold to 50% next year may well backfire. "These predictions show how significant a contribution higher rate tax payers make to the Exchequer - and how important it is to keep them contributing. There is a risk with increasing tax rates that some of the higher rate geese will waddle off and lay their tax eggs somewhere else." The point about contribution can be supported by figures in that even with one million less payers, the top band of tax will still generate about 39% of all income tax receipts.

It is interesting how the "haves" and the "have nots" seem to perpetuate whatever the economic climate. While the figure might not be quite right, the same Pwc has so far billed around £74 million on the Lehman Brothers administration and it apparently has a good two year to run and is for the UK part only (there are some eight other administrators around the world). Maybe that is why if one strolls on the Southbank of the Thames any weekday evening from 5 pm onwards it has all the attributes of New York city at the height of the boom times. No vacant seats at the Thames-side watering holes, no spare seats in the sea-food lounge. You can bet that most of these are not on the van production line in Luton, never were and never likely to be.

Eastern Europe Has The Shakes

15th June 09 - Eastern Europe has the shakes

This diary entry leans heavily for its factual content on a piece by Ambrose Evans-Pritchard of the Daily Telegraph and for which full credit is given. Latvia has become the first EU country to face a sovereign debt crisis. A $100m treasury auction failed totally. Bartosz Pawlowski of BNP Paribas said "Latvia may be a small country but it has vast repercussions for the region. If the currency breaks in Latvia , it is likely to break in Estonia and Lithuania as well, and perhaps Bulgaria, with effects on other countries like Romania." The situation in Latvia is that the central bank has been using its reserves to defend the lat in the ERM but the markets seem to doubt that there is the will to carry through the draconian cuts in spending that are needed.

It is as much the knock-on effects of such a currency failure that is the major worry. Swedbank, SEB and other Swedish banks have collectively $75bn of exposure to the Baltic states and face catastrophic losses if the currency peg fails. The shakes have hit Swedish bank shares and set off a sharp fall in the krona. For West European banks as a whole, there is thought to be 1.3 trillion euros exposure to the ex-Communist bloc. Latvia blazed the trail of euro, Swiss franc and yen mortgages and Fitch Ratings says foreign debt maturing in 2009 is equal to 320% of foreign reserves.

Some of the consequences of the over-borrowing by little Latvia are eye-watering. GDP is forecast to fall by 18% this year, house prices have fallen by 50%, a third of the country’s teachers are being sacked and public workers’ salaries are being cut by up to 35%. All this to meet the bail-out conditions imposed by the IMF and the European Commission. Tim Ash of RBS said the crisis was playing out much like the final days of the Russian debacle in 1998 and the end of Turkey’s crawling peg in 2001, with momentum building until a critical point of no return.

It’s either the Latvian economy or Swedish banks. What a weird choice: who would have thought the credit crisis could lead to this?

More On Motors

12th June 09 - More on motors

The motor trade might be micro in the scheme of things but it affects so many people’s life that there is no apology for recounting the latest events. The UK van-maker LDV (that was spun out of the old British Leyland) was reported in an earlier entry of this diary to have been saved by a Malaysian company. But, the potential buyer, Weststar, has been unable to secure financing for the deal. This Malaysian organisation has already used £1.4m to pay workers and preparing to resume manufacturing and the British Government provided a £5m bridging loan that may well now be recalled. The failure is apparently due to the pulling of three major Malaysian investors.

LDV hit a roadblock when its Russian oligarch owner Oleg Deripaska withdrew his funding support amid a stated financial self difficulty and the falling sales of vans. The funny thing is that this gentleman has reappeared as an industrial partner in Magna’s acquisition of the European arm of GM (see the diary entry for 8th June). As was surmised in the earlier entry, the most vulnerable part of the GM’s European arm namely Vauxhall, is the van plant in Luton. Siegfried Wolf, the chief executive of Magna told Bloomberg "At the end of the day, companies have to be profitable. Companies that are not profitable are not good for society." There may be a double irony here. First Magna itself is not exactly flush with profit and secondly, could we have one Russian effectively killing the two big UK-based van businesses?

Meantime, as part of the GM in Chapter 11 bankruptcy phase, the off-road Hummer brand is being sold to Sichuan Tengzhong Heavy Industrial Machinery as the first acquisition of a US car maker by a Chinese corporate entity (refer back to yesterday’s entry). The brands left in a "bad GM" are Pontiac, Saturn and Saab.

Oh what a tangled web we weave when the motor buyers they do leave.

The World Is Tipping Eastward

11th June 09 - The World is tipping eastward

The Centre for Economics and Business Research (CEBR) has been predicting for some time that the Western world would at some stage drop below a 50% share of total world GDP. In fact the share was about 60% in 2004 and dropping but the tipping point was not expected to occur until 2015. However, the effects of the credit crunch has put paid to all that. The downturn coupled with the economic resilience of China now shows that the combined output power of the US, Canada and Europe will drop from 52% last year to 49.4% before 2009 draws to a close.

"The recession has brought forward the time when the non-Western economies produce more than half of World GDP, for the first time since the middle of the 19th century. We had expected this to happen, but not quite so soon. The West will have to start to get to grips with the fact that we are no longer dominant and cannot expect to have things our own way," said Douglas McWilliams, CEBR’s chief executive.

The think tank predicts the West will account for just 45% of the world economy by 2012 and also expects global GDP to fall by 1.4% this year, the first decline since 1946. Other predictions are that the global market will start to grow again in the second half of 2009 and will moderate in 2010 as governments start "fiscal retrenchment". China will overtake Japan in 2009 to become the world’s second largest economy in dollar terms. The fact that China’s economy has bounced back so rapidly will have a favourable impact on the price of oil and other commodities and is one reason why the CEBR ends its latest report by forecasting a price of oil of $80 a barrel by 2012.

The China described by Jung Chang in Wild Swans and the China I used to read about in the Far Eastern Economic Review is economic centuries ago from the China of today. One does not have to be a think-tank to appreciate that Mandarin and the Yuan move ever closer to domination. Go East young man, go East.

Reasons To Be Cheerful, Part 2.

10th June 09 - Reasons to be cheerful, part 2

This diary entry is all about the USA because, short of charting the remarkable resurgence in the Chinese economy, all the big news is in America at present especially since the UK’s so called government is economically moribund as mired in the expenses scandal. Expenses that are actually, as it turns out, never actually incurred by politicians.

The US equity market rose by 2.9% in a single day as GM moved into an orderly bankruptcy filing and the manufacturing sector started to pick up. The Institute for Supply Management has a forward looking "new orders" index which rose to 51.1 from 47.2 for April 09 and Nicholas Tenev, a Barclays Capital economis,t said it was "the first reading above the break-even point of 50 since November 2007 and suggestive of future growth." A further set of data measures national factory activity and this rose to 42.8% in May from 40.1% in the previous month. A reading above 50 suggests economic expansion so while that has not occurred yet, it was the closest since September 08.

Reading this data, Brian Bethune of HIS Global Insight said "The healing process in the manufacturing sector has started and we should see less downward pressure on employment levels in June." This was borne out by personal incomes rising by 0.5% while consumer spending fell 0.1% so indicating that saving rates are increasing. Another interesting event for shareholders is that the two erstwhile top guys of the Dow Jones Industrial Average namely GM and Citigroup were relegated in favour of Cisco Systems and insurer Travelers. How times change!

It is important to keep ones feet on the ground however. US Treasury Secretary Tim Geithner was speaking at Peking University and telling his audience of politicians and academics that he still supports a strong US dollar and insisted that the trillions of dollars of Chinese investments would not be unduly damaged by the economic crises. "Chinese assets are safe." There was loud laughter in the audience.

Fiscal, Vote Yes: Monetary, Vote No!

9th June 09 - Fiscal, vote yes: Monetary, vote no

Richard Koo, chief economist of the Nomura Research Institute, is well known for his examination "Japan’s Great Recession" covering a prolonged period starting in 1990. He has an interesting theory concerning the credit crunch in that we must pay attention to the "cycle" we are in to determine whether a fiscal or a monetary stimulus is the right approach. He considers that the UK is in a "yin" or shadow phase where debt minimisation is to the fore. When this cycle occurs, the economy falls into a "balance sheet recession" and asset prices fall pushing personal and corporate balance sheets into the mire. This is his view of where we are now.

The logical conclusion from identifying the cycle phase as in shadow is that more fiscal stimulus is needed simply because borrowers are few. Once asset prices have fallen substantially, the business (say) is transformed from one concentrating on making money to one that is paying down debt and so diverting cash flows from future growth paths. When this happens (on a personal as well as business front), cash remains in the banking system. It follows that looser monetary policy, for example the current quantitative easing by the Bank of England, has very little effect. It does not matter how low the cost of money becomes due to the reduced demand for debt.

There is evidence to support this theory. While money supply from central banks has grown, broader money supply is lagging. The expansion of commercial bank money into the real economy is actually modest since the banks want to hoard capital and restore profitability. Taken to the personal level, consumers will remain reluctant to shop as the sword of Damocles called unemployment hangs low.

The warning from Mr Koo is that the Japanese great recession could be a harbinger of a UK one.

Bankruptcy, The Bumpy Or Smooth Road

8th June 09 - Bankruptcy, the bumpy or smooth road

If the market for your products falls by 40% to 50%, and suddenly as distinct from gradually, it is hard to survive even if the balance sheet at the pre-stage is strong. When it isn’t, the road to bankruptcy looms. So it is then for the automobile industry, whether cars, vans or trucks. There is a touch of irony in that on a single day, three major events are occurring. Honda workers at the Swindon plant in the UK have returned to work on a beautiful spring morning with a spring in their step having taken four months off to garden and paint the house. It is true that some 1,300 have lost their jobs and the remaining 3,500 or so have taken a 3% (5% for managers) pay cut but nevertheless, the production lines roll again for the small and efficient Civic model with all that Jazz to come in the autumn.

Concurrently, a bankruptcy judge over the pond has decided that Chrysler can sell the bulk of its operations to Italy’s Fiat (diaried earlier) and so arrive after a rather bumpy ride through Chapter 11 bankruptcy. Thirdly, is the big one. In the diary entry of 5th June 09, the likely outcome of splitting off the European end of General Motors (GM) was detailed, bearing in mind that the UK Vauxhall marquee is at risk. Now for the iconic US main business of GM. A filing is being made under Chapter 11 bankruptcy protection in a court in the Southern District of New York. It will be the largest industrial bankruptcy in US history. $82bn of assets are lined up against $172bn of liabilities. The arithmetic is not difficult. Whatever happens from this point, ordinary shareholders will get nothing.

The idea is simple, the numbers staggering. All US auto plants will close (47) for the bankruptcy process duration of about three months. A slimmed down meaner machine will emerge. Emerge from what? More than 20,000 North American factory workers and 8,000 white-collar jobs will disappear, more than a third of 6,000 dealerships will close along with 14 factories across the US and Canada. It is being reported that the US government’s total financial commitment to GM is of the order of $60bn and for that it will get 60.8% of the new company. The Canadian government will receive 11.7%. The United Auto Workers union will receive a 17.5% stake as compensation for reduced payments to a healthcare trust to cover 460,000 retired workers. Over time, bondholders will be able to expand their initial 10% shareholding by a further 15% out of the government’s holding.

GM’s drive through bankruptcy looks to be smoother than that of Chrysler but it is a sad day for what was, until just one year ago, the largest car manufacturer in the world. The future is small fuel efficient autos with at least one new plant being tooled for a car that might well have been made in China were it not for this great pressure for change.

Italy 0, Canada 1 (with a Russian mid-field)

5th June 09 - Italy 0, Canada 1 (with a Russian mid-field)

The cars and vans made by General Motors always had a good engine. It was the bodywork that often let us down. Now the corporate bodywork at the European end is a bit bent but apparently still in one piece. It is, however, a complicated piece. Fiat were thought to be the front runners to grab control of a slimmed-down Opel/Vauxhall business but Sergio Marchionne the chief executive left the table in a huff saying "This process is taking on the air of a Brazilian soap opera in an election year." This arose at the eleventh hour when it emerged that the US Treasury would not allow the parent company to fund a separate foreign entity. It blew a $415m funding hole. The feeling of xenophobia was strengthened when back home in the US of A, GM revealed plans to build compact cars on home soil rather than import Chinese ones. This will be the subject of a separate diary entry.

What has happened is that a Canadian car parts group called Magna International has won out in a battle by five players to take over GM Europe. The clincher seems to have been that the Canadians (not known as world leaders in take-over battles) vowed to keep all four major car planes in Germany open. This will have had big political as well as economic sway since of the 55,000 workers in GM Europe as a whole, 25,000 are in Germany. The rest are in Belgium, Spain and the Vauxhall marquee in Britain (5,000 head count). Magna has proposed up to 10,000 job cuts overall and the Vauxhall van production line in Luton looks vulnerable even though the UK government is prepared to consider offering loan guarantees to support the deal.

The overall structure does not, in fact, give the Canadians overall control in terms of ownership. It appears more like a management deal. GM would retain 35% of its erstwhile European branch and up pops the Russians via the largest state owned bank Sberbank also with 35%. Magna will get 20% and the last 10% goes to the workers in compensation for their welfare rights. 

We said before in this diary that if Fiat had won through and given that it has already taken a slice of Chrysler, the task of management would be enormous. Dare one say that with the ownership structure as described, a certain parts company from Canada might have a few headaches of its own?

Of Toxic Treatments

4th June 09 - Of toxic treatments

Is it possible to take an overview of how the big world economies have decided to deal with the mountain of toxic debt racked up by their major banks? The first move was Britain that, in effect, launched a take-over bid. In pumped in money in exchange for equity and purchased preference shares with such a high coupon that the swap of those for more equity was only a matter of time. It ended up owning the two big domestic banks and driving a third to middle-eastern saviours. In addition, the UK Government guaranteed assets held by a number of financial institutions. Therefore, the government manages the toxic assets and the taxpayer takes the risk. There is no separate "bad bank".

The US took a different route. It announced the formation of such a separate entity (TARP) - one of the very first entries in this diary and the subject of a separate article on this website. But, such a central pool seems not to have taken off (it did not help that meantime the administration has changed from Republican to Democrat). Instead the US is trying to entice private investors using generous public financing terms to buy troubled assets from banks. Again, like the UK, there would be no separate bad bank. The problem with this approach is that banks may well be unwilling to sell such assets if a loss would result.

A bad bank approach has been adopted by Germany, Switzerland and Ireland but "approach" is the operative word. The entry yesterday emphasises that the German way is an off-balance-sheet way and not really a bad bank at all and could lead to zombie status for affected banks. And as for Ireland - Brian Lenihan, the Irish finance minister said it was impossible to put a value on the troubled property loans that it  planned to transfer to the newly created National Asset Management Agency (NAMA). He told a parliamentary hearing that any transfer pricing mechanism would include a "long-term economic valuation" as well as an estimate of the current market valuation. Small snags are that property developers may have pledged a single security on multiple properties and given personal guarantees to numerous banks that could be used only once.

Is there a solution? A report by Pricewaterhousecoopers thinks that government guarantees could be sold to private investors and via large mutual funds that participate in the auction. It is a sort of US approach but widened. Worth some thought.

The German Bad Bank

3rd June 09 - The German bad bank

As the credit crisis moved into its action planning phase, the German authorities were highly critical of the fiscal and monetary stimulus policies adopted by the UK and US governments. The jury is still out on whether the German stance was correct or mis-guidedly piggy-backish. Certainly there are serious worries that the world will be swamped with the ensuing debt in supporting banks (see the entry dated 1st June 09). But, the Germans have done something - and maybe will soon do more in an attempt to save their domestic car manufacturers - they have created a "bad bank". 

The bad bank plan allows individual banks to spread losses over 20 years in an off-balance sheet vehicle. This approach has been likened to the error of Japan in the 1990’s in creating "zombie" banks that can only limp along unpurged. The point is that off-balance sheet stores are little different to the "SIVs" that hid the extreme leverage in the first place. We should recap that Europe has been hit much harder than was first envisaged. For example, Germany (the largest economy by far) has a GDP dented to the tune of 6.9% over the past year. The IMF has called for a stress test for Europe’s banks along the US health screen lines. It says the region "urgently needs to weatherproof its institutions."

How bad are things in mainland Europe and particularly in Germany? Jochen Sanio, the president of BaFin Germany’s financial regulator said the danger is a series of "brutal downgrades of mortgage securities by the rating agencies which could eat into the depleted capital reserves of the banks and cause broader stress across the credit system. We must make the banks immune against the changes in ratings". He went on to say that the markets will "kill" banks that try to go it alone without state protection warning that banks have 200bn euros of bad debts on their books.

So, does one hide the debt, pass some ownership to the state in return for help or run the risk of large-scale downgrades by rating agencies. The choice is yours. But the causal factors and the problem remains.

Down With Wages!

2nd June 09 - Down with wages

The Office for National Statistics (ONS) has issued data showing that payments to employees dropped by 1.1% in the first three months of this year. This was the biggest quarterly fall since its records began in 1955. The drop synchronises with the ONS’s figures released simultaneously that the UK economy is suffering its sharpest contraction for thirty years, shrinking 1.9% in the first quarter, the biggest drop since 1979. "Wages and salaries declined, with lower bonuses in the financial sector than normal, while employment also fell." Including bonuses, the average wage in the UK is now £24,000 pa.

Many private sector employers are cutting pay, often in return for avoiding job cuts, and three-day weeks are widespread. Official statistics show that consumer spending fell by 1.2% in the first quarter. This was the largest fall since 1980. As well as "significant falls" in spending on housing, household goods and services, there was a sharp reduction in spending abroad by British tourists. Also, the value of goods held by companies fell by £6 billion reflecting the fact that inventories are being run down at the expense of making new products. 

Two slightly contradictory views were expressed of the latest figures. Brian Hilliard of Societe Generale said the figures depict a "savage" contraction for the British economy but that the worst could now be over, with future falls coming at a slower rate. Willem Buiter (ex of the Monetary Policy Committee) said "The economy will be shrinking into next year. We will be in recession and have sharply rising unemployment for the next year or year and a half."

There is still, however, a schizophrenic division in UK society. The champagne bar at St Pancras International Rail Terminal in London was heaving last mid-week. A glass of the medium-grade bubbly is about £12. Bottles, plentifully in use, are a bit more.