The importance of ability to service debt.....

I have just been reading a Times columnist, the Business Editor, who is seeking to explain why it is that the UK will not be the next Iceland. The reason why I highlight this article is that it seems to express the profound denial of the reality of the situation.

In his introduction he has the following to say:

The economy is in a bad way and government finances are in an awful state, but let's get a sense of perspective. The City is not Reykjavik on Thames. Britain is not Iceland. Sterling has fallen a long way and may fall further. But Britain is not bankrupt.

The first thing to consider is that the idea that the UK is bankrupt has now gathered enough traction that the subject is now being considered and discussed in the mainstream media. Even six months ago, this would not have been a topic for 'serious' discussion (I have been discussing this for a long while, and this would not have been considered 'serious').

The columnist goes on to point out that, whilst there are some serious problems in the UK economy, they are not as dramatic as Iceland. He then makes the following comparison:

The housing market here may be in a worse state than in America, as claimed by Jim Rogers, the US investor and former partner of George Soros. But the outlook is nothing like as dire as in Spain or Ireland.

The City will go through a terrible time, but the prospects for the German car industry look just as bad.

In this case what we are seeing is something that I have seen through several reports, and even some comments on this blog. This is the idea that country x, country y, country z, are is a worse state than the UK on factor a, or factor b, or factor c.

This is a non-argument. It is a bit like going to a casualty room in a hospital, taking a look at the patients, and saying patient 'a' is okay with his broken arms, because patient 'b' has broken legs. In both cases the patients are not in a good condition. The only way that a reasonable comparison can be made is to compare them to the notion of a healthy patient (i.e. a patient with no broken bones at all).

The columnist goes on to offer this rather extraordinary statement:

By international standards, Britain's government debt is not that high compared with the size of the economy, although the picture does change if all corporate and household debts are included.

In saying this, he is hitting the nail on the head, as the debts of corporations and households in conjunction with large government debts is exactly the point. Every section of the UK economy has been running large deficits. As for government borrowing, one of the oft cited examples is the state of the Japanese governments debt, but the people who cite this forget that much of that debt is funded from within Japan. The problem in the case of the UK is that large tracts of the debt is funded externally, including government borrowing.

We then come to another non-argument as follows:

Standard & Poor's recently reaffirmed Britain's triple A credit rating, just as it was downgrading Spain. And after the mauling the rating agencies have received, they are not in the business of giving anyone the benefit of the doubt.

This is a non-argument on the basis that Standard & Poor, and all of the other ratings organisations have got so much so very wrong, that they should be given very little credence.

Having so far given not a single good argument for the UK not being bankrupt, the commentator then goes on to a complete distraction from the subject at hand. In this case he discusses the problems within the Euro area. The interesting thing is that he should think that the woes of Euro area economies have a bearing on whether the UK is bankrupt. However, he throws in some figures, makes it all look well grounded, and so it all looks very credible.

The only trouble is that it is completely irrelevant to the state of the UK economy. From discussing the troubles of Europe, he jumps into his conclusion as follows:

Britain does not have that alternative to the IMF, but it is hard to believe that we will need it. The hard to believe does happen a lot these days, though.

I strongly recommend that, if you have not done so, you read the article in full. The reason why I am doing so is that this article is fairly typical of the kind of article that can be found claiming that the UK is not bankrupt. When you examine all of the arguments, they always come back to the same method, which is to propose that country 'x' is worse on factor 'a', and figures are then trotted out to support the case.

These arguments are quite simply missing the point. For example, there seems to be a grim satisfaction underlying the collapse in the exports of Germany, and the contraction of the German economy. Last week's Economist was highlighting how quickly manufacturing turned down in comparison to services. In another article (which I can not seem to find) they mentioned how much more resilient services were in a downturn.

What they are all missing is that these economies may suffer now, but they have the means to repay their debts when the global economy starts to recover. As I have been saying for a long time, the UK does not produce enough of value to ever repay the debts that it has rapidly accumulated, let alone the debts that it is adding.

As Jim Rogers, who is now quoted all over the media, has said:

He says his view reflects the UK's dire economic situation: "It's simple. The UK has nothing to sell."

Mr Rogers says the two main pillars of support for sterling have been North Sea oil and the strength of the UK financial services sector, in particular, the City of London's role.

But Mr Rogers says just as North Sea oil is running out, so London's standing as a financial centre is set to suffer: "I don't think there is a sound UK bank now. At least, if there is one I don't know about it."

"The City of London is finished, the financial centre of the world is moving east. All the money is in Asia. Why would it go back to the west?" says Mr Rogers.

This has been one of the central themes of this blog from the very posting. In other words, it is not just a question of comparison of country 'x' on factor 'a', which is always about relative levels of debt, relative state of housing markets and similar arguments. It is also about the ability to pay off debts. What matters is the ability to generate income with which to pay the debts.

As an analogy, we can imagine a person with a £100,000 a year salary job who holds debts of £200,000 and person with a £50,000 salary with debts of £160,000. To look at the absolute debt level would considered to be an unusual method of making a comparison. The only way to look at the debt is to consider the ability to repay the debt, and in the case of the UK that is a very poor prospect.

As a summary, I have yet to see an argument that persuades me that the UK is not in reality structurally bankrupt. Whilst the arguments presented all look very plausible on the surface, they are either comparing basket cases with a basket case, or they are not offering a serious consideration of debt in relation to income.

Note 1: I have had a large number of comments on my last post, and will therefore just have time to answer a few of the comments and questions.

Note 2: Lord Sidcup has the following question:

If the government is printing money and giving it to the banks, but the banks don't circulate it (won't lend) isn't this money irrelevant in causing inflation?

This is a perfectly reasonable point, which is actually quite challenging. Yes, if the government is lending to the banks and the banks are not lending, it would appear that the money will not have an impact. However, the banks do not sit on that money, but are using it to buy government bonds and other so called 'safe' investments to restore their base of capital.

The government then uses the money lent to it by the banks to lend into the banks, and it appears that the money goes in merry-go-round, albeit with the supply of money steadily inflating. This is why the government needs to print more money, to break this cycle, and create a greater impetus to get money into activity in the economy. They are literally going to deluge the banks with so much liquidity that there will not be enough government debt to buy with the money.

The only trouble with this plan is that so many other countries are also selling huge amounts of debt into world markets. As fast as the government might print money, the amount of debt being issued by governments across the OECD will be able to mop up that money. The bottom line is that the banks do not want to lend to business and consumers because they rightly recognise that there are considerable risks in doing so. This is why the government is considering measures to 'force'/encourage the banks to lend into the UK economy, such as reductions in capital adequacy requirements and so forth.

As I have pointed out many times, the problem with government borrowing is that it crowds out lending to the private sector.

In this circumstance, how will the money printing lead to inflation? The printed money is still going to be used but, instead of being used by business and consumers, it will now go through the intermediary of the government, as the printed money eventually ends up back on the government's books through their borrowing. This creates a time lag, as the government must find ways of using that money in various guises of 'stimuli'. There is also a time lag as the money goes through the lending / borrowing merry-go-round.

Within this rather odd scenario is a possibility that the banks in the UK will start to worry about the solvency of the government, and will therefore stop lending to the government. They might instead use the borrowed money only to finance debt of other governments. This is, in principle, possible, but is also highly unlikely. The banks are now effectively clients of the state, so I believe that they will be expected/forced to support the state with continued lending. I do not know this, but I think it is a reasonable assumption.

What we have in total is a situation where some of the printed money will be returned to the government, and some of the printed money will be used to finance the governments of other countries, and some will eventually find its way into private lending in the UK. In all cases, the money will appear in the market place.

If, for example, the banks use money to finance borrowing of overseas governments, this is a net outflow of currency, which will further weaken the £GB. If the money remains in the UK, it will eventually reach the economy in the form of loan guarantees, and various other government stimuli measures. In all cases, the money does eventually reach the market. The important point in all of this is that there is a significant buffer in all of this, which is the ability of the government to actually utilise the money such that it reaches both businesses and consumers in the UK.

The most disturbing part of this scenario is the impact of the government which acts as a buffer for some of the money that is created. In acting as a buffer it is possible in principle that the effects of the increase in supply will not be immediately apparent, encouraging a belief that the government can 'get away' with printing money, thereby further encouraging an acceleration of the speed of the printing presses.

What can not be hidden is that there will eventually be an increase in the quantity of £GB in the market. As I have often stressed, printing money just transfers the value of the existing money to the new money, which dilutes the value of money. This is inflation.

However, I do not think that that people are quite foolish enough to believe that printing money can be a solution to the underlying problems of the UK. This is why I believe that the £GB will collapse sooner rather than later. I do not believe that holders of the £GB will hold on to the currency, as they will start to price in the effects of both the underlying weakness of the £GB and the impact of money printing. At that point, there will be inflationary surges due to substantial increases in the costs of imports.

This brings me to another point. In my original post I pointed out that a collapse in the currency would result in hyper-inflation. I should clarify this, as I have noted comments (not made on this blog) which have imagined that the moment the currency collapses is the moment at which hyper-inflation appears. This was not my intended meaning. There will be a time lag, as existing contracts are fulfilled and so forth. Some products will see price inflation very quickly, such as imported foodstuffs, whilst other products may take a while for prices to inflate. However, the process will still be surprisingly rapid, just not immediate.

It seems that a very short question has demanded a very long answer. It is not a simple answer but I hope I have managed to be clear and consistent. Please let me know if I have been either unclear, or missed any key points.

Note 2: I have had several questions regarding the impact of hyper-inflation on ordinary people. Steve Tierney, for example, asks about the social effects, but that goes beyond the remit I have given myself in this blog. I will let others consider such impacts. However, with regards to the economic position of individuals, this is more within my scope. The problem here is that the question becomes huge, and is not suitable for a brief answer. As such, I will apologise for not addressing this question at this time, and may discuss it later. I also need to look at a few case studies of inflation to have a better understanding, as my concern to date has been where and how we are getting there, rather than what happens when we arrive.

Note 3: ChasH asks the following:

'One thing continues to puzzle me though, and perhaps you can see your way to explaining it. China is our major creditor, but they have been lending us the money to buy that which they have produced. As we cannot repay the money, they have effectively given us the fruits of their labour. Moreover as we (i.e. the west) are their main market they have no one else at present to sell to. Is China then in just as dire straits as we are?'

The answer is both 'yes' and 'no'. China has particular problems, which is the potential for instability, which could see the country fall into chaos.

However, a good way of looking at this is to think of yourself in the position of Hu Jintao. He is seeing that his exporters are collapsing, and that the growth necessary for stability is dropping away. Set against this, he has huge piles of foreign currency, a strong position to spend to support his economy. However, he has a difficult problem.

All the while his economy has been growing, it has accumulated massive reserves of foreign currency. In order to enact a stimulus, he really needs to utilise some of these reserves in order to prop up his economy. However, in order to utilise those reserves, they need to be sold into the market place to buy, for example, the commodities that will be required in support of infrastructure projects. If China starts trying to sell those reserves, he is in a position where there will be a flood of the currencies onto the markets. That flood of currency will depreciate the currency, as there are not enough goods to be purchased in the currency, and likely little demand at this time to use the currency as a reserve. During the downturn, others will equally want to use their reserves to finance their way through the trouble, rather than accumulating greater reserves.

If we look at the $US, if this is sold into the market, and sees the resultant depreciation, then there will be further troubles for exporters. Although the RMB is not a free floating currency, if the $US depreciates, and the RMB does not appreciate, the US will (quite reasonably) howl with rage, and will take protectionist measures. If that is the case, China can say goodbye to one of the major export markets.

In other words, what China has done is accumulate currency that it dare not use as, if it uses the currency, it will destroy the currency. The only solution available will be to try to discreetly sell as much of the currency as it can without 'spooking' the markets.

The trouble is that, with so many countries holding these $US reserves, most of whom have their own economic problems, it is likely that everyone is having the same thoughts, and confronting similar problems. What you have is a situation in which there is something like a Mexican stand-off. As soon as one starts selling, then everybody must start selling. They are all, at the same time, terrified of selling, because in doing so, they destroy the value of what they are selling. It is a time bomb just waiting to go off.

As such, the answer to ChasH is that 'yes', China is in potentially deep trouble, as their best route out of their own problems will create a whole set of new problems. On the other hand, they are also in a position where, if they manage the situation well, they might be able to at least use some of the value in their reserves to ameliorate their internal problems. The question is how much, and whether they can pull off this fine balancing act - using the reserves without destroying them.

Like so much in the current situation, it is apparent that there are real contradictions, and that the situation overall might be described as a mess.

Note 4: I am afraid I have run out of time, so that will have to be the end of this post for today. The answers to the comments are a little rushed, so I hope they make sense.

Note 5: I note no comment from Lemming on my last post, which is a surprise - are you not in agreement with the post? If so, your comments are always welcome, even if critical. Also, I have not seen a comment from Matt in Shanghai for a while. As a person actually located in China, the subject of so much discussion, your thoughts on the situation would be welcomed.

Economic Reality Bites Back!

The crisis has, in many respects, followed the course that I predicted. Economic reality intruded on the fragile (false) restoration of confidence that followed the bailout. In the UK, the economy contracted by 0.5% in the last quarter, which will come as no surprise to regular readers here, and Mervyn King has now warned of a recession. The result was carnage for the £sterling which suffered massive falls. Meanwhile around the world stock markets plunged in a state of panic. From the US there is an endless stream of bad news, an example of which is that General Motors and Chrysler are now heading fast towards bankruptcy, and the once mighty Ford is in deep trouble too. These once unstoppable behemoths are symbolic of the underlying problems that are seeing the Western economies contract. Meanwhile, US house prices continue to slump.....

So far, all of this has played to the script that I have been writing for a long time. However, not all has followed the script. The $US should also be plunging, but instead is strengthening as funds are pulled from investments in emerging economies, seeking 'safety' in the $US and Yen. As the article I have linked to points out, there is outright panic driving such moves. An analogy that might explain this is a person running from an angry bear, only to seek safety in the Bear's cave.....where mother bear and her cubs are waiting, and where father bear will soon return. The result of the flight to illusory safety has rocked the world with for example, Russia at risk of sovereign default. Once again, this is not following my script, but any script can not account for panic and emotion driven decision making. In other words, the world financial system has left rationality behind. As with the return to panic, at some point soon, events must return to the script, as there is an underlying economic reality driving events. An explanation of that reality can be found here.

As if there were not enough problems, OPEC is seeking to reverse the one positive in the crisis, the drop in the price of oil. I predicted a long time ago that oil would fall to $60 per barrel, though not as quickly as has happened. I saw the drop in commodity prices as one of the elements in eventual recovery from the crisis. I have previously described how commodity supply is at the heart of the current world rebalancing (and crisis), and in order for the world economy to return to growth it is necessary to increase supply of commodities. As such, OPEC cuts in production are just the opposite of what is needed.

Another worry is that China is now feeling the pain of the crisis. I have always considered that China is on a knife edge, that it was uncertain how the country would ride out the storm. One of the positives that I identified is that China's huge reserves would allow them to cushion the impact, and the Chinese government has duly announced massive infrastructure spending to ameliorate the impact of the world slump. In other words, the money put away for a rainy day is already being utilised. Whether this will be enough to ensure stability in China remains to be seen, but they are in a position of having significant resource at their disposal, even if the value of that resource is heavily weighted in high risk $US. This reminds me of a comment / question that I received as follows:

Following on from Lemming regarding China stopping lending, surely the consequences for them will be a lot worse if they do suddenly stop? Your link points to an article that indicates that the Chinese authorities are trying to stimulate exports by increasing export tax rebates; surely if the West's economies & currencies collapsed it would make it even more difficult for China to compete in the world markets, as well as destroying their potential markets for an even longer period?

Like a bank lending to a business, I can see that it's in their interest long-term to stop lending so much to the West but surely it would be in their own interest to stop lending gradually, rather than suddenly, so they can recoup at least a portion of their previous lending?

As I have previously discussed, economies such as China which have been financing Western economies have a dilemma. If they stop lending, then the value of their holdings will collapse, along with Western economies. However, they must realise that any continued lending will throw good money after bad. My feeling is that the comment is very sensible, but China will need to utilise the resources at its disposal in the support of its own economy. They are, in effect, between a rock and a hard place. If they divert their surplus to the US and Western economies, they will help avoid a general collapse, but at the risk of a collapse in their own economy. In addition, such a diversion will only delay the onset of the rebalancing of economies. It may be possible that they can balance both internal and external problems, but I am not sure that they have enough resource to manage both. Do they have the will to do so? Recent news suggests that they do, but it is difficult to be sure.

As I have discussed before, at this point in the crisis, it is increasingly the decisions of individuals driving events, and how China acts in the crisis will be driven by a few leaders at the head of the CCP. Perhaps the most telling article in the latest round on the financial crisis is an article on the 43-nation Asia-Europe Meeting, in which the following was said:

Mr Miliband said the meeting had highlighted the significant shift in economic power towards the east but also how interlocked everybody's interests were in tackling "deep imbalances" in the system.

"I don't think it's just the fact that we are meeting in The Great Hall of the People and we listened to the general secretary of the Chinese Communist Party talking about the need to prop up global capital markets that brings home to one that there is this big shift in economic power," he said.

This has been the point at the heart of this blog. World economic power had shifted to the East, and now we are witnessing the global rebalancing. Bailouts, international talks, action plans and all of the rest of activity of Western politicians directed towards saving the Western economies are fighting against this shift. In other words, all of the activity to 'save' the economies is entirely pointless.

As I have long, and consistently argued, the only thing that will save the Western economies is reform that will allow them to compete with the emerging economies. Bailouts, more borrowing, Keynesian boosts to economies will only serve to make the economies more debt laden, and less able to adapt to the economic reality that wealth has moved East. Still, despite this reality, the politicians and economists are scurrying around, scrabbling for solutions, and imagining that there are magic wands that can change reality.

Note for new readers: I strongly recommend that you take a look at the links at the top left hand of the page. These will explain why it is that the world has changed, and why the change has led to this crisis. As far as I know, this is the only place that has a comprehensive explanation of the underlying roots of this crisis that actually explains the question of 'why?' I would expect that, if you read the explanation, you will understand my pessimism. You may want to start here....

Note: I have had a very pleasant comment (see below). However, I would caution readers to read other opinions before making investment decisions. Whilst to date my track record of predicting the economy has been extremely good I am, like anyone, fallible. As such, I would suggest looking at a variety of sources. I am personally very confident that I have understood the situation more clearly than many economists, but my views would be contested by any number of economic 'experts'. I will add this warning to each of the pages in the blog.

The US Dollar

My post on UK unemployment has received a couple of replies. In one the commentator suggested that the rise of the US dollar was a good thing, and suggested that the US economy was therefore on the right tracks. Another commentator replied to this post with the following:

'Isn't the value of the dollar (and the index you mention) just a relative measure, so it's entirely possible that all non-Chinese economies are collapsing together, with just a bit of jostling to see who can collapse fastest?'

In light of these posts, it might be worth just discussing the recent recovery of the $US. In particular, how is it that it is recovering? A dollar recovery does not fit the script that I have been writing over the last few months.

As it is, the second comment is on the right track. All of the currencies of the rich world economies will almost certainly decline against the currencies of the emerging economies, and the reason for this long term trend is given here. However, with regards to the RMB it is a managed floating exchange rate, such that it can not automatically respond to market conditions. This is a big spanner in the workings of the currency system, and continues to be a partial block to the rebalancing of the world economy.

This is obviously just a very broad context and does not explain the recent rise of the dollar. My own suspicion is that the rise in the dollar is nothing to do with fundamentals but just the result of habit. In times of uncertainty, which I think would be a good summary of the current economic climate, people automatically look to the dollar as a safe haven. The trouble is that the dollar is now no such thing, and is still highly vulnerable. It's a bit like the business saying of 'nobody has ever been sacked for buying IBM', but in this case of the dollar it is flying in the face of reason. The simple question to ask is 'what has changed in the state of the US economy in the last few weeks to justify this appreciation?' As soon as you ask the question the only answer is that there has been no major change. As such, sentiment rather than reason is driving the dollar higher.

The real problem here is that the revaluation of the dollar upwards is just storing up even more trouble for the US economy. The US economy needs to be rebalancing towards export led growth, and this will delay progress towards this end. It is only through the relative impoverishment of the US that is represented by a weaker dollar that the US can regain a competitive position.

As such, the dollar may rally for a while, but in the end it can only last for so long before economic reality trounces market sentiment. At some point there needs to be an economic justification for a stronger dollar, and force of habit is a poor justification.

Comments from MattinShanghai:

I have had a couple of interesting comments from a person who presumably lives in China. I am particularly pleased to have a comment coming out of China, as it is only through seeing China 'on the ground' that the reality of that country's economic development is apparent (with Shanghai as a quite startling example).

One point of note was a link to an article/essay that Matt posted. The article can be found here. It offers a very challenging perspective on Japan, and is worth reading. I keep on meaning to address the subject of Japan, but it is on an ever expanding 'to do' list, so will have to wait a while longer.

For his other comment, I will not try to paraphrase it, but it gives an outline of a historical perspective on my post on Synthetic Economics. As such I would recommend a quick read of the comment. Matt refers to one author and his writing can be found here (I am downloading it now, so can not comment on it yet). However, it sounds like the author has an interesting perspective.

Recession Prediction

I have just been looking through the Sunday papers, and it is interesting to note that the British Chamber of Commerce is now saying that the UK is heading for a recession (article in the Times):

'THE British Chambers of Commerce (BCC) will this week become the first leading business group to predict a recession in Britain.

Its quarterly economic forecast, to be published tomorrow, is expected to say that Britain is heading into a “technical” recession of two or more quarters of declining gross domestic product over the next six to nine months.

It will say that a deep recession, of the kind last experienced by Britain in the early 1990s, remains unlikely, but that the risks to the economy have grown significantly over the past quarter and unemployment is set to climb by up to 300,000.'

On the positive side, at least they are recognising that the situation is bad, but their optimism over the length and severity is completely unjustified. I have looked at their website, and assume the source is the quarterly survey, which is only available with a subscription, so am unable to see how they reasoned their prediction. However, whatever their reasoning, at least the conclusion is positive in that they are pressing the Bank of England to ease interest rates. This is desperately needed in a sinking economy and will help the UK to adjust to the economic imbalances through weakening the £GB.

A good example of the non-argument for raising interest rates is given by Simon Heffer in the Telegraph. He calls for higher interest rates to fight inflation, but as is typical of such commentary, fails to explain (and presumably understand) by what process raising interest rates will prevent inflation. He says:

'A rise in rates, which I believe is necessary to drive the last ravages of inflation out of the system, would be the final humiliation not just for Mr Brown, but for the system of economic management that he has made his own.'

And:

'I know a rise in interest rates will cause more houses to be repossessed, more businesses to fold and more bankruptcies.

Sadly, that is what the economy needs in order to turn itself round. You can't have sustainable "growth" on the back of an economy where people and enterprises are living beyond their means. You can have it only where they are living within their means.'

He may not have noticed, but this is already happening. Regardless of the interest rate, this process is already in train, so how is accelerating it going to help? He suggests that it is better to have the pain now than later. However, an interest rate rise will have the effect of being a prop for the £GB (though will just slow the fall), and this is will only have a negative effect. I give the example of Heffer, because his line of thinking is not isolated. Underlying such thinking is a lack of acceptance of both the severity of the current situation, and the changed reality of the world economy. Britain, along with the rest of the rich world, are going through a crisis, and and this lack of recognition of the crisis is one of the great dangers in the current situation.

More on the UK

I have had several comments posted over the last couple of days, so I will try to address these briefly. The first post is provided by Anonymous, who asks:

'I would be interested to hear who you think the (few) winners will be in the UK business world. What do Asians want to buy from the West? Should business to consumer (B2C) companies look at getting their websites fully translated into Chinese/Hindu?etc.? Could they tap into that emerging market, selling collectibles or other specialist items?'

Dealing with the first question, it is actually very difficult.

The way to think about this is to ask the question of what consumers are likely to do next. In tough times, what will people spend their money on, and what will they give up? The first thing to go are luxuries such as taxis. Secondly, people will not have the money or inclination to spend as much money on home improvements, new furniture, or the latest gadget. Upgrading the car will happen less. Foreign holidays will be more expensive (a falling £GB) and are a luxury, so there may be a switch to domestic holidays, but overall less holidays away from home. For leisure, the evening in with a bottle of wine, a movie, and take-away food will replace the restaurant, cinema, theatre and bars. Designer labels will be less alluring, as people trade down the cost ladder. Where before a person might buy Gucci, they will buy Gap, where they typically buy Gap, they will buy M&S and so forth. Hobbies will come back centre stage in people's lives, replacing shopping as the number one leisure pursuit.

We can think about the kinds of companies that will benefit from such a change in consumer behaviour - those who provide for cheap entertainment. That means video games retailers, home delivery food companies and so on. The discount retailers will benefit. Think Lidl and Poundstretcher. Discount pubs and fast food restaurants will be fine, but up market restaurants will suffer a bloodbath. Retailers able to contain/lower their costs will survive, those that do not - will not.

In the wider economy, manufacturers who have a unique technology or process will improve profits as their costs fall, provided that they have export markets (where the drop in the £GB will help them). For any manufacturers who are primarily serving the UK market, they will struggle mightily. Exporters in general will benefit, and may see real growth, but the growth will be slow to start, whilst the world economy goes through turbulence.

On a more depressing note, debt collection will be a growth business, as will be the companies involved in liquidations, from the insolvency accountants through to the auction houses. Second hand stores and second hand car dealers will possibly do well, and eBay and Craigs list will do well.

What do Asians want from the West? Production machinery, high tech products, machine tools, process design, and designer goods. Pharmaceuticals, medical equipment, insurance, weapons. It is a difficult list to compile, as there are many goods and services that the West still excels at. The trouble is that, Asia is already fast climbing up the technological tree, and is already starting to compete in many of these areas. The only answer is a rebalancing of the cost base of the West to allow the continuation of the strengths in these areas, as well as starting to protect the intellectual property that is the foundation of such advantages.

As for selling through the Internet, there are some problems to overcome in this respect. If you look at China, for example, there is a problem with trust. There are some Chinese companies that are managing this, for example through Cash on Delivery systems. However, there are many challenges to overcome that require an in depth understanding of the Chinese market. You should also be aware that China already has an excellent Internet infrastructure, and already have excellent content and services. As for selling collectibles, I have no idea, but this could only be a small business.

On reading the above post, I am aware of the gloomy picture that I have painted in my other posts. However, the West does still have some outstanding businesses, and outstanding technologies. All is not lost, or at least not yet lost. There are solutions to the challenge of the East, but they require fundamental changes to the structure of our economies. As our currencies shrink (which means we get poorer), we will gain back some competitive advantage, and this will lead to an element of the rebalancing - things will get better eventually. The challenge will be to deal with our other cost disadvantages, such as over-regulation and taxation. On the plus side, we have strong legal systems and relatively little corruption, and a moderately well educated and healthy work force, as well as (variably) good infrastructure. The trouble is that, even if we get these elements right, we are shackled with bad debt, and a collapsing banking system, and that will (in any event) take time to work through the system. All of this will take time, and political will.

Dan, another poster, suggests the following:

'For the individual, asset liquidation should be embarked upon as quickly as you can. If you have got things lying around your home that you no longer need then sell them now. Toys, gadgets, antiques and all our detritus is going to be worth much less in the coming months. Sell them now, while there are still people with money to spend.'

Certainly, if you have assets you do not need, or of no value to you now, then there is no harm in selling them now if you would in any case sell them later. With regards to real estate, getting out now is better than later, if you own more than your home. However, you will be selling into a falling market so better to discount early to get the sale, rather than hang on until later, when the discount might be larger.

Anonymous2 also suggests investing into Asia. For this, I would advise caution, as Asia is fraught with political risk, as can be seen in my post on China. I have hesitated to suggest where to put money for the very reason that the world economy is now so turbulent. The interconnectedness of the world economy and trading system means that the problems of the West will have knock on effects in the East. Add to this the instability (e.g. Thailand and Cambodia are currently close to armed confrontation) - and the conclusion is that there is no safe haven.

Lemming (now a regular commentator on my posts) asks the following:

'So, would it be loosely correct to summarise that we have two trading blocks: China and the rest of the world? On paper, the rest of the world is heavily-indebted to China, but can show that China has benefitted from stolen intellectual property.

Does the rest of the world have to honour its debts to China?

Things seem so bad that the only way out of it might be some sort of drastic 'resetting' of the world economy. Or must we work through the consequences of all the millions of individual failed deals and transactions in order to preserve the purity of 'capitalism' for an eventual return to better days?'

The short answer to this question is 'yes', we must honour our debts to China. To not do so would see a complete closure of the world trading system. Without such a system, we would all suffer. The explanation for why open and fair trade works is beyond the scope of a short answer. The trouble is that the trade has not been open and fair, and this is part of the reason for the current problems. Trying to rectify previous failings by now refusing to honour debt obligations would not be a solution. The solution for the US and Europe is to give China a clear warning - fix the intellectual property problems by 'x' degree, by 'x' date, or face trade sanctions. Furthermore, give China a fixed period of time to enact a fully floating currency.

The trouble with such a scenario is that, as happened previously, China will just threaten to sell the $US that they hold onto the open market, thereby destroying the US economy (and probably other currencies too). The way that they did this previously was to use a Chinese 'think tank' to suggest that this was a possibility (I recall that it was during a period when the US was threatening action over faulty merchandise, but can not be sure I have remembered correctly), then the government denied that this was policy. This is quite a typical method in Chinese politics, as those who have studied China closely will be aware. Use a proxy to set up the scenario, rather than make a direct confrontation.

My own answer to this is that it is better to take the pain now, and face down China now, rather than later. It is to reshape the trading system such that it becomes fair. The price of such reshaping may well result in things getting much worse before they get better. It is a short term severe pain to offset longer term worse pain. My answer lies in reshaping of the structure of the Western economies to put them into shape to meet the challenges of Asia. I hope to post more on how to do that in the future.

As a note, I had the following comment on my post on the 'Economic Rise of China':

'..but shouldn't Europe be grateful that the Chinese Government are not suing us for the defects in the last intellectual property they acquired: Marxism?'

All I can say is, a very witty comment.......