Was in London for much of the last week talking to old friends about how the recession is playing out. Britain never changes - a few inches of snow and the infrastructure comes to a grinding halt. Interesting to note how quiet the shops were after the January sales - Fortnums on Thursday lunchtime was almost deserted an impression I got in the other stores along Jermyn Street.
Economic news has been as dire as might be expected at the front end of a deep recession or a proto-depression as a number of City folks are now calling it. Everyone seems to be panicking about the downturn but the Darwinian laws of economics are simply re balancing the economy after a decade of excessive debt extension. This isn't much fun for the 20 million laid off in Guangdong and Shanghai in last years final quarter but is a necessary step in forming a base.
My guess is that we will see a 10% destruction of global installed capacity within the next year with weaker players going to the wall and consolidation reinforcing the stronger market participants who will be able to hike operating margins. Governments will of course try to keep some of the no hopers like Chrysler and Saab going but the writing is on the wall. Taxes will need to rise to pay for structural unemployment levels of 10-15% ( excluding those deemed unfit for work ) and a reversion to the 60%+ tax rates of the pre-Thatcher era in the UK are just a matter of time. This draining of personal cash into the governments coffers to pay for all the new debt issuance would indicate that the recovery when it comes will be more gradual than many are forecasting with the consumer yoked to debt repayment for the next decade.
After talking to those at the coal face in the markets I'm more than ever convinced that the banks will still need to be taken into government ownership - pre-privatization is a new moniker for the unspeakable term 'nationalization'. So far we've seen write downs by the banks of $1 trillion of which 68% has been taken by the US firms with the Europeans only writing off 29% of this total. It can't be long before the Europeans and the continentals in particular start to match their American peers - a total deleveraging through the global banking system of $2.5 trillion isn't impossible.
Weaker companies are also likely to find this a challenging environment. 30% of installed US factory capacity is idle - a figure not seen since the early 80's. Too much capacity and too little demand underlies the implied 40% default rate over the next five years in the corporate bond market. Government debt is also a worry. Italy with a debt level of 109% of GDP has to refinance Euro 377 Billion of borrowing in 2009 so expect yields on Rome's debt to balloon.Ireland is perhaps the most exposed Euro member and continues to worsen- 25% of exports go to the UK and have become prohibitively expensive since sterlings fall against the Euro- further help from Europe will be needed if the Lisbon treaty is to be passed. At least Ireland has a modern educational system and will ultimately be able to work its way out of the problems - countries like Italy have much greater challenge ahead of them.
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