David Stevenson assess the economic outlook and finds reasons to be cheerful although there may be troubles ahead.
City Insider: Cause for optimism despite economic headwinds
David Stevenson assess the economic outlook and finds reasons to be cheerful although there may be troubles ahead
Readers of this column will hopefully realize by now that I am a cautiously optimistic type who believes that the economic recovery will be sustained over the next year or so.
I also recognise that there are a great many headwinds here in the UK, many of them centered on the likely impact of spending cuts on consumer discretionary spending in 2011 and 2012.
I’d also suggest that we’re only a few years into a decade-long process of unwinding of huge debt positions in all walks of life – the corporate unwinding has already begun, but the consumer and government unwind has a long way to go.
I’d also maintain that in a lower growth environment the challenge for travel companies will be to struggle in a services sector where margins will be under cost pressure as deflation takes hold.
But even with these headwinds I believe that we’ll see a surprisingly strong 2011 and especially in the mass affluent and high net worth market segments where demand should start to pick up sharply.
All this may come to pass but I’m perfectly willing to accept that my crystal ball gazing is at best guess work, based on a series of hunches, backed up by data and informed by past historical trends (i.e most recoveries from deep recessions are usually fairly long lasting and sustained, though necessarily volatile).
There is though a damned good chance that something far worse may happen, and any sensible businessman has to plan for the worst.
If you are in the business of thinking the unthinkable then I suggest you track down a book called The Gathering Storm (How to avoid the next crisis for the Altana Charitable Trust Project), published by Derivatives Vision Publishing.
This is a bit of an ‘underground’ City book, published by a small hedgie orientated publishing firm and written by a collection of uber-bears who believe something very nasty is on its way.
It won’t make very amusing reading on the train into work and it’s not exactly a classic airport business book, but its various contributors weave together a fairly convincing string of arguments to suggest that we haven’t seen the worst of it yet.
At its core, this ‘awkward’ squad believe that one very simple experiment has now gone badly wrong and is about to be replaced by an even bigger experiment which has the potential for catastrophe.
The failed experiment is an attempt by the leaders of the developed world to hook the middle and upper working classes on debt.
Back in the grim early 1980s, a conscious decision was made to free up markets and let inequality rip. The rich started to get much, much richer while the middle classes looked on in awe.
In order to redress the imbalance – and to control any future dissent – a decision was made to liberalise capital markets and encourage an orgy of debt.
Every Tom, Dick and Harry was encouraged to take out huge credit card loans and pump up their mortgages. This sparked a huge asset price bubble in housing and a massive consumer boom.
Suddenly the middle classes felt a bit richer, if only because they could buy lots of cheap Asian goods and their houses seemed to be their pension pot.
This decades-long credit boom infected large parts of the economy and bought social peace – helped along by low inflation and interest rates.
And then starting in 2005 this great experiment began to unwind. In the US the housing bubble started to burst and by 2007 even my Great Aunt could have spotted that something nasty was coming.
This massive orgy of debt had been facilitated by grossly over-extended investment bank balance sheets that could not take the strain of customers collectively asking awkward questions about their liquidity position.
The rest is all history and we’re now all, collectively, starting on a painful road of debt mitigation, lower asset prices, and higher savings.
The new experiment is as a direct result of this deleveraging. Governments know very well that bank balance sheets are contracting, because they’ve told them to.
They know that consumers are cutting spending to boost their balance sheets and they’re doing everything in their power to make saving a fruitless exercise by cutting interest rates and increasing taxes on saving, i.e financial repression.
The governments of the developed world have no other choice than to flood the global markets with the proceeds of government debt because everybody else is busy paying down their debts.
Government debt must rise in order to fill the gaping hole in consumer and capex spending. But these deficits cannot continue ad infinitum and already some governments – including our own – are beginning to make a painful structural adjustment.
They’re cutting spending and increasing taxes, bit by bit. But the danger here is that these structural adjustments, though necessary, are also ill timed and dangerous and could plunge our economies back into recession.
Cue the central bankers restarting Quantitative Easing Mark 2. This massive exercise in confidence boosting involves central banks buying all manner of bonds (again) to encourage the banks to lend more and to force bond yields to even lower levels.
The hope here is that is that investors are pushed into making risky investments (buying shares, investing in new capital) in order to kick-start growth, which will inevitably slow down as government spending cuts kick in. Government bond yields – and interest rates – will be crushed to incredibly low levels and stock-market bubbles may start popping up everywhere.
But the Uber Bears maintain that there’s a problem. None of these boosts to the financial markets will overcome a profound structural shift away from consumption and debt towards thrift and saving.
Each boost will keep running into the ground of weak demand, prompted by consumer fear of the future. Each monetary easing experiment will involve more paper money being dropped from helicopters with ever-diminishing effect.
In effect we in the West are stuck in a ghastly form of Ground Hog Day where nothing seems to change much but it all feels as if it’s getting progressively more depressing.
Very soon cracks will start to appear in this picture. Gold prices will keep on rising, maybe hitting $6000. Stock-markets will boom and bust.
Currency wars will break out as the US government tries desperately hard to finger a villain in the shape of China. Every major currency will try its damnedest to devalue, prompting trade wars and protectionism.
Perception of risk will rise inexorably and then suddenly investors will start to fear that their coveted bonds are not paying them enough in these dangerous times. Cue a bond vigilante’s strike on the FX and debt markets, an attack on the Euro (again) and rising government bond yields and higher interest rates.
This will prompt a massive stock-market run – one analyst I respect thinks we’re still due another 40% fall – and another leg up in gold prices as real panic sets in. Investors will run scared of ‘paper currencies’ and we’ll overnight find ourselves hurtling back towards a deep recession as consumers sensibly decide to cut back their spending and pay down even more debts.
The only debate then amongst the bears is whether this nightmare is an inflationary one – where RPI shoots past 15% – or deflationary one where key money supply measures keep on falling, and bank balance sheets keep declining. Cue the next crisis as the Great Impoverished Middle Classes in both the UK and the US rise up in revolt at their diminishing living standards.
I’ve walked you through this nightmare scenario not because I personally think it is going to happen – there are too many forks in the road where only bad things seem to happen – but because it has lots of fascinating themes built into it that should be warning signs even for bullish types. There is a real chance that discretionary consumer spending will remain incredibly weak as savings rates start rising.
I also think there’s absolutely something in the idea that the great Debt Fuelled Consumer Binge of the last decade is over and that the middle classes are now in real trouble.
This will have a huge knock on effect on discretionary spending for high-ticket summer holidays. I also think we need to be collectively very wary of a massive bout of currency devaluation, pushing up import costs and triggering trade battles – this is a very real possibility at the moment.
Cutting across these big trends will be some crucial exceptionals here in the UK. The Principality of London and its Outer Provinces will remain out of kilter with this low growth world. What moves London is its role as a global city and rich, hot money will continue to seek out safe havens – with the inevitable filter down effects on the suburbs.
The wealthier end of the mass affluent spectrum in the South will I think carry on getting even wealthier and quite possibly enjoy this New Austerity – all of which suggests that real premium travel is the place to be in the coming years.
Last but by no means least this gloomy outlook completely misses the real possibility that companies will start slowly investing again, that the emerging economies are not mired in debt, and that we’ve only just started a massive decades long capital investment boom in a new energy infrastructure – a huge process that will see the airlines renew their stock and the cruise line industry invest in a new energy efficient ships.
