Kleinwort Benson: A run of bad luck for the world economy
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By Jeremy Beckwith, Chief Investment Officer Kleinwort Benson IN the years up to 2007, the global economy found itself subject to several key trends which boosted “disinflationary growth”. That is they were good for growth, but also helped to keep inflation low. The transition of the Chinese population from farms to cities was the key force here as 20 million workers every year were able to leave work which just managed to feed them to find new jobs in manufacturing in the cities at wages they could only dream of previously but which were fractions of the wages paid to similar workers in developed economies. The resulting massive Chinese trade surplus was reinvested into Western economies which kept down both the Chinese exchange rate and interest rates in the developed economies, which could then go out, borrow more and spend more on Chinese imports. Inflation, as seen in the cost of goods in the shops was held down, wages in the West were also held down as jobs were outsourced and yet global growth was strong. Other factors such as the steady freeing-up of world trade and the transforming power of the internet on all human interactions were also similarly positive “disinflationary growth” forces. Life was good and Gordon Brown told us that he had abolished “boom and bust”. The Crash of 2008 severely weakened the global financial system and it required global government stimulus of unbelievable scale to pull the world economy out of recession and back onto a path of growth. We are now approaching the critical point where that government stimulus is either expiring (as in the US and China) or is being reversed (as in the UK and Europe). This means that the world economy is more than usually vulnerable to external shock factors. Now shocks can be positive or negative – the impact of Chinese urban migration was a positive shock for the world – but so far in 2011, the shocks have been negative. Instead of enjoying “disinflationary growth” shocks, we are enduring “stagflationary shocks” – these are events which are simultaneously bad for global growth and tend to push up prices. Political unrest in North Africa and the Middle East has hit oil production in Libya and Yemen, and Bahrain’s troubles reminded investors that it lies just 60 miles from the world’s largest oilfield. Sharply rising oil prices have always been intensely stagflationary for the world economy. The reasons are fairly obvious – as a key input cost into most manufactured goods and the key cost in transportation, higher oil prices translate very quickly into higher end prices for all goods. Without any compensating higher wages, consumers then have less disposable income to spend on other goods and services and so overall economic demand declines resulting lower growth and higher prices. The earthquake, tsunami and nuclear meltdown in Japan is also a “stagflationary shock”. Although there will be a boost to economic activity when the rebuilding of homes, roads and power stations is undertaken, the immediate result is a very severe hit to economic growth in Japan. It is the nuclear fallout aspect of this that is potentially the most harmful. Many workers, mostly foreign but also some Japanese, have left Tokyo because of fears of radiation in the capital. Fears over the spread of the radiation will have long term effects on the demand for Japanese-produced food and water. Electricity production is down by 25% because of the disaster. This is now a key supply constraint for Japanese industry – they will struggle to produce more and their costs of production will be higher since overheads will be spread over lower volume of production. Rising food prices are another example of this “stagflationary shock” idea – poor workers are forced into demanding wage rises when food prices rise in order to survive. The world economy has however, at the very least, stumbled into a run of bad luck with these shocks – this isn’t necessarily a trend, but the timing of these shocks is not helpful when it comes at such a critical point in time for economic policy. This note is intended to give an insight into the thought processes that lie behind our investment views and our investment strategy. They do not necessarily reflect the current investment policy of Kleinwort Benson. This note is intended for information purposes only and does not take into account the investment objective, the financial situation, or the individual needs of any particular person. Investors should obtain independent advice based on their own particular circumstances before making investment decisions. More articles in
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