Thursday, 26 February 2009
Monday, 23 February 2009
Sunday, 22 February 2009
We are probably all aware that the Arctic ice cap is melting, at an increasingly accelerating rate. By 2020 the degradation of the ice cap is likely to be sufficient for the Arctic to be open to sea traffic for most of the year. There are two key shipping routes. Heading north through the Bering Sea, if you turn left across the northern coast of Russia, you would be following the Northern Route between East Asia and Europe. The Northern Route should reduce the shipping time between Japan, China, and Korea to Europe by about three weeks. Had you turned right at the Bering Sea and followed the northern coast of Canada, you would have followed the North Western Route between East Asia and the East Coast of the US. The North Western Route is likely to reduce the shipping time between Japan, China, and Korea to the East Coast of the US by about three weeks.
Two key advantages of these northerly shipping routes is that they by-pass the pirate infested waters of South East Asia and East Africa, and they also diminish the importance of the strategic bottlenecks of the Suez Canal and the Panama Canal. In terms of operation, owing to a thinner ice sheet, the Northern Route is likely to be open appreciably sooner than the North Western Route.
As the ice recedes, the energy and mineral deposits of the Arctic will become more open to extraction. The present economic recession has lessened the imperative of extracting these deposits but, as the global economy moves into recovery over the next decade, the issue of mineral rights is likely to dominate the agenda again. The problem is that there are no settled international borders to the North Pole. The issue is further complicated by the Lomonosov Ridge, to which Russia claims ownership.
At present, there are six nations with an interest in the Arctic. We like to measure the weight of this interest in terms of ‘Degrees of Influence’, which are determined by the ‘slice’ of the Arctic controlled by them. The six nations, and their degrees of influence, are: Russia (160°), Canada (85°), US (30°), Greenland (35°), Norway (35°), and Iceland (15°). This pattern is changing due to the current financial crisis.
The viability of Iceland as an independent sovereign nation has been called into question after the collapse of the Icelandic banking system. Already Russia has provided a bailout of €4bn. It is likely that these funds have strings attached, possibly in terms of Arctic mineral rights and possibly in terms of the use of former NATO airbases (see report). However, the Russian funding is unlikely to be sufficient. A more permanent solution is likely to be EU membership for Iceland, which is currently being fast tracked (see report). This rather changes the complexion of things.
One of the interesting consequences of the current financial crisis is the potential it has for strengthening the Federalist case in Europe. The direction is towards a tighter and more co-ordinated foreign policy for Europe, with a tightening of the institutional framework to give it substance. As the recession grips, Greenland and Norway are reviewing the exact nature of their independent foreign policies. If this trend were to gain hold, then, by 2020, the complexion of the Arctic could well change to Russia (160°), Canada (85°), EU (85°), and US (30°) in terms of degrees of influence.
We are not suggesting that this will happen. What we are suggesting is that the scenarios regarding the Arctic, which rely upon six nations as the basis for the scenarios, might need to be reviewed for the possibility of consolidation of the European interest in the Arctic. This consolidation would be the direct consequence of the recession.
© The European Futures Observatory 2009
Saturday, 21 February 2009
Friday, 20 February 2009
Thursday, 19 February 2009
Monday, 16 February 2009
Sunday, 15 February 2009
When considering a loan application, bankers apply two key principles of lending – does the borrower have the ability to repay the loan and to service the debt, and what security can the borrower offer to cover the lender’s position if events turn out worse than planned. These areas, in recent years, have broken down. Indeed, one could argue that it is the malfunctioning of these basic principles that has undermined confidence in the whole financial system
The ability to service the debt and repay the loan is generally determined by the accounts presented by the borrower to the lender. In recent years, in the domestic mortgage market, we had seen the growth in ‘self-certification’ mortgages. These are mortgages underwritten by the statement of the borrower that they had told the truth in their statement of income on the loan application. Needless to say, there was a certain degree of exaggeration of income in this process. That didn’t matter to the average lender. In a strong housing market, the increase in property prices would underwrite the veracity of the income statement through the collateral of the property. As the property market has stuttered and fallen, these mortgages have been withdrawn. Self-certification mortgages are now rare birds.
Instead, lenders now resort to the accounting history of the prospective borrowers. This is not without hazard. In the background, there is a debate quietly raging between ‘Principle Based’ accounts – mainly used in the UK and Europe – and ‘Rules Based’ accounts – mainly used in the US. Rules based accounting had been gaining the upper hand until the case of Enron. The Enron accounts had satisfied the rules based accounting principles, but not the principle based accounting rules. This difference between the two is one of those obscure and arcane accounting issues that are likely to dominate our world in the next decade.
On Friday, the Lloyds Banking Group lost a third of its share value because the board of Lloyds did not fully grasp this point (see report). Lloyds had previously been lent on by the UK authorities to absorb HBoS, a large UK mortgage bank that had pretensions to become a more general corporate lender but failed to do so. It appears that the board of Lloyds relied upon a set of accounts produced by HBoS, and had not conducted full due diligence in pricing the merger. Laying aside the wisdom of this, the veracity of the accounts is worth considering.
From Parliamentary evidence last week (see report) it seems that the Head of Risk at HBoS at the time warned the Board that he felt that the bank was taking excessive risks in their lending. His reward – according to his version of events – was to be made redundant. He wrote to the audit committee, who then asked the auditors to investigate. The auditors investigated the claim, and found that the claims were unfounded. Three years later the bank went bust. What is called into question is the role of the auditors in the production of the accounts.
If lenders are to rely upon accounts, those accounts must provide a true and fair statement of the financial position of the entity. There are now calls for reform of the audit process. In particular, three reforms come to mind. First, there is the issue of the automatic rotation of auditors every three to five years to prevent the development of a cosy relationship between the auditors and the management upon whom they are auditing. Second, there is the issue of limited auditor liability. At present there are moves to cap auditor liability for mis-statements on the face of accounts. This trend is likely to be reversed. And thirdly, there is the issue of Chinese Walls within audit firms. Many allege these not to exist. To assure the probity in the production of accounts, there is likely to be a trend towards the banning of audit firms providing consultancy services to those entities that they audit. These trends could well come to dominate the corporate landscape in the coming decade.
When we return to the original question, one of the reasons that the banks are restricting their lending is because they cannot quite trust the accounts that are put in front of them. As the recession bites and asset values fall, the valuation of collateral is likely to become a key issue and the independence of the accounting profession is central to this. It would seem that the world needs the accounting profession to become a bit more disagreeable in producing accounts over the next decade or so. Once confidence in financial statements returns, a more general business confidence will follow.
If not, the business of lending is likely to remain a bit like buying a pig in a poke. You will not be sure of what you are getting in a transaction, which will serve to keep credit conditions tighter than they otherwise would have been.
© The European Futures Observatory 2009
Friday, 13 February 2009
Thursday, 12 February 2009
Wednesday, 11 February 2009
An interesting question is why it is that the contractors found it necessary to bring in non-UK labour to undertake the contracts. Apparently, it is better to use Italian and Portuguese labour not because they are necessarily cheaper than UK labour, but because they are more productive.
Labour productivity on the job is broadly comparable - after all, the time differences to lay a brick are unlikely to differ that widely. However, the problem is the amount of time actually spent on the job. It would seem that the UK workers were striking because they have tea breaks and their continental colleagues do not.
A winter of discontent, strikes over tea breaks, it's almost like a replay of the 1970s. This is bound to have inflationary consequnces a little way down the line.
Tuesday, 10 February 2009
However, for the Irish economy to become a full PIG, it needs to exhibit the characteristics of a Mediterranean economy on the upside (low rate of job creation, low rate of poverty elimination). In recent times, the Irish economy has been quite good at job creation on the upside, which is why it was classed as an Anglo-Saxon economy.
If it remains so, then perhaps it is a bit premature to call it a PIG. It would remain the only Anglo-Saxon in the Euro zone.
Monday, 9 February 2009
There is currently a situation of contango in the global oil markets – an inverted price curve where the future price of oil is higher than the current price of oil. For example, the spot price of oil is currently about $40 a barrel and the 5 year price of oil is currently about $80 a barrel. If we have a discount rate of, say, 5%, the 5 year price should be about $32 a barrel (i.e. something costing $40 in 2014 has a present value of $32). This presages a steep rise in the price of fuel in the coming years. Looking at the question the other way around, a 5 year price of $80 a barrel now implies a spot price of $102 in 2014, at a 5% discount rate. In many ways, this takes on an aspect of Peak Oil – a point at which the oil will be worth more in the ground than in use, but it also serves as a reminder that inflation is a feature with which we will have to deal in the medium term.
This thinking has been reinforced in other areas recently. Since the meeting, I have been noticing petrol prices at the pump. Over the last four weeks, petrol has increased in price by 1p per litre per week, from 82.9p per litre to 86.9p per litre. This may partially reflect increased demand for oil products over the recent cold snap, but what is significant is that the price of petrol has increased by 5%, almost un-noticed, in a month. This increase may or may not fall back again. However, if our hypothesis is correct, it may indicate that recession induced price drops may have found their bottom.
Just as I was mulling this over, we received our January gas bill (for domestic natural gas). This quarter, the bill was £576, which I thought was rather a steep increase. Looking back, our January gas bills were £306 in 2005, £339 in 2006, and £430 in 2007. At this point, we restructured our household heating to use alternative sources – electricity powered radiators and a log fire – so that our 2008 bill came down to £342. This year, we are using fewer cubic metres of gas, but our bill rose by 68%. I see a pattern emerging.
We previously wrote about some of the long term pressures in the global economy that were helping to drive long term inflation (see post). These pressures haven’t gone away. The UN estimates global population to have been about 6 billion in 2000, and forecasts the global population to be about 8 billion in 2025. That’s an awful lot of additional people to feed. It is small wonder that the pressure on global food prices is upwards. These extra people all need to be economically active, which is placing pressure on limited supplies of energy resources. Together, food and energy inflation are likely to be a dominant feature of our longer term future, irrespective of how loose the markets are presently.
Of course, we have not mentioned the third element of the possible global inflation – water – because, in the West, we tend to take our water for granted. If the alarmists are right and the quest for drinking water causes displacement of populations and outright conflict (it has been suggested that the incursion into the Lebanon by Israel in 2006 was about who should dominate the Litani watershed – the first ‘Water War’ of the century), then the ‘price’ of that commodity is bound to increase and to have a second order effect on inflation in the West.
This brings us back to our model of scarcity for the first half of this century. Where are the inflationary pressures? In the FEW – Food, Energy, and Water. Actually, I would add minerals to that list, but it doesn’t then have such a catchy name. Whilst the short term pressure on these prices is downwards, the longer term outlook is a little more worrying. Just to make matters worse, the monetary authorities around the world are pumping liquidity into the financial system. If they do not mop it up just as quickly when the recovery starts, then they may well be fuelling the next inflation.
Whilst not driving forward at the moment, the engine of inflation is still humming away in the background.
© The European Futures Observatory 2009
Tuesday, 3 February 2009
Monday, 2 February 2009
Sunday, 1 February 2009
We are quite convinced by the categorisation of the European economies by the Bruegel Institute in Brussels (see web site). Their research indicates that Europe can usefully be categorised as having four styles of economy:
1. The Mediterraneans (Greece, Spain, Italy).
2. The Continentals (France, Belgium, Germany).
3. The Anglo-Saxons (UK, Ireland).
4. The Nordics (Denmark, Sweden, Finland, Netherlands).
These classifications are based upon how the economies behave rather than their geographical location. As a reference point, the US would be classified as an Anglo-Saxon economy. The Mediterraneans are sometimes referred to, unkindly, as the PIGS Economies (Portugal, Italy, Greece, and Spain).
It is an interesting exercise to cast the A8 (the eight EU accession states from 2004 – Estonia, Latvia, Lithuania, Poland, Slovakia, Slovenia, Cyprus, and Malta) in terms of the more established Bruegel categories. The Eastern European members of the A8 have tended to be more influenced by the Anglo-Saxon agenda of privatisation and flat taxes than any of the other European models. In the current downturn, this leaves these economies rather vulnerable. They will suffer the loss of living standards without a fully developed social welfare system to mitigate it.
Iceland is, perhaps, the most interesting case. Traditionally, Iceland would be cast as a Nordic economy – very unimaginative and very solid. In recent years, Iceland has moved from being a Nordic Economy to being more of an Anglo-Saxon economy by liberalising its banking system and accumulating large leveraged positions. In doing so, it has become a microcosm of how the recession might play out. Financial collapse in Iceland has been rapidly followed by the collapse of the Icelandic real economy. This has led to political instability, with the fall of the Icelandic government this week. The escape route for the nation is now to accept the pooled sovereignty of the EU, which has all sorts of geo-political implications.
An alternative would be for the Icelandic people to revert to an inward focus. To retain as much independence as they have today, which is highly prized in Icelandic society, the nation would have to become far more self-sufficient than it is today. The Icelandic currency has depreciated to a point where it is effectively valueless, Icelandic trade has dropped away significantly; tax revenues are set to fall, and just at the point where pressure on government spending is rising. If foreigners are reluctant to fund the Icelandic PSBR because of the devalued currency, then the only thing that the Icelandic government can do is to tighten its belt until it really hurts.
This highlights the danger of being where we find ourselves. The popular reaction during a downturn is to rail against foreign companies, foreign staff, foreign finance, and so on. A good number of protests in Europe at the moment are specifically directed against the involvement of ‘foreigners’ in the domestic economy. To their credit, European politicians have resisted calls for protectionist measures. We can only hope that they stay on course. Already the US has shown an alarming sign of protectionism through the ‘Buy American’ clause in the financial stimulus package. This assertion of nationalist sentiment is dangerous because it is confrontational and invites retaliation, which is in nobody’s interest. In a trade war, we are all the losers.
Although Icarus has visited Europe this week, let us hope that we can avoid his fate by overcoming the dangers that we face.
© The European Futures Observatory 2009