Economic Update February 2015

As I write this the wind is icy cold, the snow is intermittent; there are no real signs of life in the
garden. The snowdrops are struggling.
But if we turn to the manmade UK economy, it is warm, no longer struggling and now showing
every sign of a sustained recovery. In the last quarter of 2014 UK retail had its best sales for 12
years, even with the supermarket price war and the price cuts on so called Black Friday. Investment
spending picked up strongly as did business cash flow. We also received new data from the ONS
showing that earnings (this includes any overtime and bonuses) for people who have been in
continuous employment for more than a year were growing at 4%. This is a return to normal.
The overall growth rate for 2014 is estimated at 2.6%, subsequent revisions may push that a little

higher. Nominal GDP (this is the gross value added in the economy before adjusting for inflation)
grew by 4.7%. Both these figures are now in line with long term trend.
The chart shows quarterly growth, 0.6% per quarter would produce trend growth.
The chart below shows actual spend which improved on non-food items from last September.

The biggest boost to consumer purchasing power in 2014 was the 22Bn payout by banks for misselling financial protection products. In 2015 we will get an even bigger boost from lower oil and
energy prices. The drop in energy prices will be worth 750 for rural dwellers and about 600 for
city dwellers, and lower energy prices will boost the global growth rate despite what the IMF think! I
think well see 4% real growth this year which is a little above the global trend.

The Eurozone
The ECB (European Central Bank) will create 1.1 Tn at the rate of 60Bn a month. The main
impact of this monetary boost will be a devaluation of the Euro, but it will also allow banks who hold
Sovereign debt to sell it to the ECB and release capital, which will underpin new lending to
businesses. A lower currency boosts exporters profit margins; greater availability of credit boosts
money supply. In combination and over time, confidence should pick up. The only offset to this
would be an agreement with Greece to give it an interest rate holiday until nominal GDP is growing
at say 5%.
A Greek exit would result in Greece defaulting on the 256Bn of debt that it currently owes its
European creditors. Germany holds 72Bn, Italy holds 48Bn and Spain 33Bn. The German
banking system I think could handle it, but it would give Italy and Spain problems. We will wait and
see.

The graph shows the impact a reducing inflation rate on reported real growth. It gives the
misleading impression that the Eurozone is growing strongly. Nominal spending in Q3 2014 was
only 1.6% higher than a year earlier. Inflation was 0.8%, hence real growth is up 0.8%.

The USA
The USA will be the engine of world growth in 2015. The dip in Q1 2014 was entirely due to
weather conditions. Economic conditions are similar to the UK, except bank lending is growing
more strongly. The biggest risk is highly leveraged oil and gas companies defaulting on their
interest payments. This is highly likely if the price of a barrel drops below $30 for a sustained
period.
As the Saudis are determined to win the price war, we could see $30 this year which might remain

for
a

couple of years. A collapse in exploration budgets will guarantee a return to $100 in 6 years time.
Shell recently announced they were reducing their global exploration budget by 12Bn this year.

.
A look at the ASEAN Region
This year the members of the Asian Economic Community will finalise their plans to create the
equivalent of the EU but without the straitjacket of a single currency. They will have five pillars
similar to those of the EU: free flow of goods; free flow of services; free flow of investment; freer
flow of capital; and free flow of skilled labour. But there are some subtle and important differences:
freer flow of capital (not free) and free flow of skilled labour (not all labour). They will also remove
almost all internal tariffs by the end of this year, this always boosts intra regional trade.
The area consists of 602 million mostly young people(unlike the EU, 500m and rapidly ageing).

In income terms, at the top are Singapore and Brunei with per capita incomes equal to the EU, at
the bottom are Myanmar, Laos and Cambodia all three will post growth rates in excess of 7% as
they catch up. There are three key per capita income levels: $1000 is the personalised transport
trigger using a small motorbike; $4000 is the beginning of the small car market; $10000 is the
trigger for a broad based service economy with rapid growth in banking, insurance, and wealth
management. The middle income trap is between $4000 and $8000 to break out of it the rate of
innovation has to increase.
As growth takes off, incomes become more unequally distributed, primarily as a consequence of
survival of the fittest, applied technology, bribery and luck. Of the top 100 wealthiest Chinese
people, 80 made their money out of property. We see the same pattern across the world. This
produces a paradox: low average per capita incomes, but evidence of huge wealth and
conspicuous consumption. Rolls Royce, Bentley and Ferrari will attest to that! The Gini index
measures income inequality, not wealth inequality. The higher the number, the greater the
inequality of incomes.

English is the language of business and widely spoken throughout this region, which is the next hot
growth area of the world. It will grow faster than China for the next 10-15 years.

School Report on performance in 2014

A year ago:
I forecast no increase in interest rates. Correct. There will be no increase this year either.

I forecast real GDP at 2.25%, the actual is 2.6%. I say 2.7% for this year.
I forecast a significant fall in the price of oil, possibly to $60 per barrel. It is now $50. This year it will
go lower to $35-$40.
I forecast -$ in the range of $1.50-$1.60, average $1.64. Correct. For this year, range $1.38-1.50,
average $1.47.
I forecast 1 = 1.26 but with volatility. For this year, plenty of volatility around 1.32.
I forecast a sharp Chinese slow down. Electricity consumption supports this although Government
official data does not.

I forecast strong USA recovery, which has happened. It will strengthen to 3.4% this year.
I forecast no growth in the Eurozone. Correct. In 2015 it will grow by 1% at best.
I forecast UK inflation at 1.8%. Correct. This year I expect 1.7%.
I forecast UK average house prices at 3-5%. Wrong. It was 7%, but this year is likely to reduce to 3
5%.

So all in all a set of lucky guesses! This does happen occasionally. I was forecast to get a D or E at
Economics A level. I actually got an A. I wasnt surprised, but my Economics master initially
thought it was a mistake!

A look around the world

The Conservative party will win an outright majority of between 4 and 10 seats in the UK.
The hottest growth region will be ASEAN countries, averaging 6%.
The Middle East will slow sharply as a consequence of social unrest, low oil prices and
war.
Brazil will struggle. Its promised offshore oil bonanza is now in question.
Venezuela will implode.
Russia will shrink by 5% and there is a risk Putin will push into the Balkans.
China will continue to slow down, settling at around 4-5% GDP, and punch its weight in the
South China Sea.
India should see a surge in growth to 6-7%.
Australia will experience much slower growth and a weakening dollar, but shell still be
right mate!
Mexico will grow around 1.7%; the fall in the price of oil is the main depressant.

Companies who borrowed cheap USD are faced with a significant increase in financing
cost as the dollar rises against the basket of world currencies. The IMF say $1.8 Tn in
loans are affected.
The collapse in commodity prices is hurting companies in the value chain Standard
Chartered Bank is placing the whole of last years profits as a provision for bad debt.

Overall Conclusion
The US and UK banking systems are now fixed. The EU system will mend more quickly
with QE but it will take a couple of years.
Oil-importing countries will grow faster than the big macro models forecast, while oilexporting countries will contract by more. Notice that for China and the USA the effect is
broadly neutral.
Top Ten Oil Importers

Top Ten Oil Exporters

EU
USA
CHINA
INDIA
JAPAN
S KOREA
GERMANY
ITALY
FRANCE
NETHERLANDS

RUSSIA
SAUDI ARABIA
USA
CHINA
CANADA
IRAN
IRAQ
UAE
VENEZUELA
MEXICO

UK is 13th

UK is 19th (OK Scotland!)

I am the most optimistic I have been since 2007. Increasing confidence has a powerful
effect on investment spending and company growth forecasts. New technology is being
applied across a range of industries, increasing both efficiency and effectiveness.
However, changing technology continues to cause greater inequality of income and wealth.
I guess this will be the big issue for 2015 and beyond.
rmfagg@aol.com 29 January 2015