Tuesday, July 15, 2008

Predicting the Economic Future

In my essay 'A Funny View of Wealth', I made some predictions for the UK economy - most of which have been (as near as possible) exactly right. I thought it may therefore be time to mention the things that I did not manage to predict and the events I failed to mention.

The first thing I failed to see was that consumer price inflation would be accelerating. It could be argued that, in missing this, I missed a vital part of the current crisis. However, as I have pointed out elsewhere, inflation measures are not actually measuring real inflation. As such, at present, despite the headlines, real inflation is negative. This is not to say that some goods and services are not increasing in price in a dramatic fashion, but rather that the overall cost of living is falling.

One of the disturbing things about the current state of consumer price inflation is that I did not predict this, and it will have a downwards leverage on the UK economy. As such, I think that the economic collapse in the UK will be faster and more severe than I had assumed.

The reason for this inflation is a combination of the madness of biofuels taking land away from food production, and increasing demand for food amongst emerging economies. These problems will not go away in hurry, and I had no idea that they would impact upon the economy in the way that they have. Several years ago, for rather odd reasons, I studied meat consumption in Taiwan, and noted that there was a massive increase in meat consumption over the period of Taiwan's economic development. I should have noted this trend and seen that the growth in the emerging economies would eventually impact food prices. As for biofuels, I am not sure that anyone could predict that such silliness would occur, though the consequences for food prices should have been obvious.

As for oil (and other commodity) prices, I have discussed this elsewhere, and this is a matter of capacity not keeping up with demand as the world economy expanded. As economic growth turns to contraction, this situation will resolve itself and oil prices would fall back. However, I did not manage to predict this problem, as it now stands. The reason for this is that I had assumed that high oil prices were a factor of instability in the Gulf states, rather than reaching capacity constraints. In short, I got it wrong. For other commodity prices, I just wasn't paying enough attention.

My essay was focused just on the UK and one of the assumptions was that the UK was going to suffer more than any other economy in the current downturn. I knew that the US was going to hurt, and hurt badly. However, the US economy has greater flexibility than the UK, and I therefore expect the pain to be shorter lived, albeit it will still be very bad indeed. I believed Germany and France would hurt, but not too badly. For Italy, I believe that they will suffer very badly indeed. They no longer have the freedom to use their currency to save their economy, and many of their businesses are facing tough competition from the emerging economies. They lack the flexibility or will to rise to this challenge, and will need a crisis before they can even think of rebuilding their economy.

As for Spain, this country was largely off my radar. I was aware that their economic growth was largely built on construction. However, I did not realise how reliant. I read an article in the Telegraph which suggests that Spain may be a candidate for the hardest hit in the current turmoil. It seems that they have allowed a property and construction bubble to rage out of control, and the popping of the bubble will be catastrophic.

Japan I will leave for one side, as I plan to talk about it more at a later date. I also plan to discuss China at a later date, but will just mention a couple of points for the moment. The first point is that it is quite possible that China has a construction bubble. Whilst I was in China I noted that there were lots of apartment blocks being built, and that it was very popular for these to be purchased by investors. In many cases the investors were leaving the apartments empty (Chinese people like to buy property brand new, once it has been lived in the value falls), and they were holding on to the apartments in an expectation of increases in value. In addition to this there has been a boom in the construction of shopping malls, and I noted that they were already (back in January) starting to exceed demand. If the Chinese economy is pulled back due to world demand for exports dropping, it is likely that such investments will lead to a bust. It is also worth considering the state of the Chinese banks. If they are lending into construction in this way, will there be a repeat of the previous Chinese bad lending problems of a few years ago? What other bad lending is buried in their books?

Set against this is that the finances of the Chinese government are very healthy, as are the levels of savings in China. The real question with China is how much their continued growth is reliant on exports, and how much growth can be sustained within China. I will readily admit that I am not sure on this at all. I am not sure that anyone is. My best guess is that China will also hurt, and hurt badly, with a significant potential for civil unrest as a result.

India I will leave alone, as I know very little about the economy there. I have read some reports that are suggesting that the economy is very frothy, but have little else to say.

This is a very brief summary, but it is all pointing in one direction. The world economy, not just the UK, is teetering on the edge. The big question is; Why? At a later date I hope to start to unravel just how this situation has arisen. The theme of the essay will be the imbalances in the world economy. I made a start on this with my post on the 'Cigarette Lighter Problem', but this is only a tiny element in the overall picture. The essay will explain why the economies of the West are in such deep trouble, and why the problems will not go away in a hurry.


  1. A fascinating post. I look forward to the next instalment.

  2. A fascinating post. I look forward to the next instalment.


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