WITHER CHINA?

What I did not comment on yesterday was WHY some manufacturing is moving to Europe from China. Dr Clint Laurent from Global Demographics reports that “Asia is turning into a content of empty nesters” and that “the Chinese labour” market peaked in 2010”. In the coming 10 years he says, “ the workforce will shrink by 40 million”. China “has no spare capacity in terms of labour.  Everyone  who can work is working”. “Its industrial boom had been helped in part by an influx of people from rural areas…and that resource too had all but run out with most young people having already migrated” to the cities”.

The “current steep rises in labour costs in China are due to the ageing of the population” and are “set to rise as much as 14% p.a.” “Chinese demographic shift is real and is happening now” he says.

“He also says that “the youngest age brackets in India are no longer growing”.

This is one of the reasons that some manufacturing is moving to Europe – ageing of the population and the exhaustion of hitherto cheap labour pools is starving the Chinese economy of lower cost workers.  (www.theaustralian.com.au/

business/paulgarvey)

I have long known that the real cost of a skilled IT or science based worker is cheaper in some European countries than it is in China or India. Now that paradigm is being extended to lesser skilled workers. Hence my long standing focus on Berlin as it regains its economic hinterland.

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Yesterday, I commented on the evolving and essential role of Germany in the world economy and the move of some manufacturing TO Europe. And how present events suit  long term German political economy. Reported this week is that the German trade surplus is around USD 200 billion. For Australian readers, this is around 60% of the present Federal Governments annual budget and around 15% of Australian GDP.

THE INCREASING IMPORTANCE OF GERMANY

I opened an office in Berlin in 2000 and have conducted business in that city since 1986. Times were very different then. Some of my colleagues took a lot of convincing that we should have an office there. We did so for a number of reasons. One of them is that Germany has approximately half of the worlds’ post-doctoral talent in the hard sciences. This generates investment opportunity. I also took a long term view that Germany would regain its prewar(s) status as an economic and political powerhouse and so it has proved to be. Interesting to note that the new French President flew to Berlin within a week of taking office.

There is a report from Dr Clint Laurent of Global Demographics noting that some manufacturing production is moving from China to Eastern Europe. “There is a large underused workforce…..eastern Europe’s GDP will grow very rapidly as a result of the change in the size of the labour force of the Chinese economy”.

My long term analysis was based on the fact that East European countries are like the Mexico of Europe: cheap skilled labour, proximity to markets, the Euro (much maligned at present), great transport infrastructure, and huge manufacturing infrastructure in Germany which leads the world. Some of this is happening in former German lands: all of it is happening in Berlin’s former economic hinterland.

Add German manufacturing competence and product innovation to low cost labour: that will produce a world powerhouse of the future provided the Euro does not appreciate in value too much. Keeping some countries on life support might be a small price to pay for such a prize.

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Reality Check...

Several prominent business leaders and quality journalists this week have commented on the true state of the Australian economy as it is and as it is likely to be. These include David Murray (Future Fund reported in live interview) and Jac Nasser (reported by John Durie in the Australian). The Wall St Journal reported that the Reserve Bank cut to the Australian cash rate “may only be a band aid solution unlikely to reinvigorate growth”whilst the London Financial Times said “investors should be worried about Australia: it was dangerously exposed to China with much of the resource windfall having been squandered”….. and “Australia was one of only three countries in the world to have run a current account deficit for 30 years” (Greece and NZ were the others) and “warned Australia would suffer like Greece when access to global funds was cut”.

Many Australians – and especially in the SME (Mittelstand) sector understand very clearly that things are tough. “Blood on the streets” in that sector was a comment made to be me today. State Governments also understand that their budgets are going to be tough. They will have no option but to increase resource royalties to balance budgets.

Australia’s present political leadership in the Peoples’ Republic of Canberra will of course squeal like hell. Having squandered a sound inherited budgetary position, the ground is now laid for an Australian tragedy of operatic proportions. Turandot here we come. Except there is no magical music from Puccini to ameliorate the hurt.

Massive increases in recurrent social expenditure will bind future governments for years to come. This is the Greek route. The revenue supposed to fund this from the new Minerals Resource Rent Tax is unlikely to eventuate: the Australian States royalties will gut it. Carbon Tax revenue will not eventuate either: businesses categorised as polluters by the People’s Republic will move offshore or change their operations. The only way to fund these new expenditures is large taxation increases on the working Australian population.

That is the pain of the SME’s, their owners and employees who are now losing their jobs. Australia needs a wake-up call and the slowdown in China is likely to provide it.

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One of the ways that China manages the ups and downs in its economy is through the Reserve Ratio. In effect, this is the amount of capital Chinese banks are required to have as a prudential reserve. Last week, the ratio was lowered, meaning that their banks can lend more money per unit of deposits. This is a signal that the Chinese economy has been slowing and their government wishes to increase liquidity in the credit system, especially for businesses.

It is actually the opposite of what is happening in Europe and Australia, where Basel 3 has the effect of increasing the capital adequacy requirement of banks and thereby reducing credit availability per unit of deposit.

In Europe, there is a counter effect in that quantitative easing (printing money) is capitalising the banking system, and for those that are credit worthy in accordance with German credit standards, have access to long term finance at competitive interest rates. However the barriers to obtaining credit are historically higher than in the Anglo economies. Australia does not have quantitative easing and has higher real interest rates.

What all this means is that, for the foreseeable future, access to credit (and equity) is an international exercise for serious companies. For Australian investors and companies, domestic credit will be far more constrained, especially in the SME (German Mittelstand) sector, and more expensive. For Australian large companies with access to international capital markets, credit may be easier and cheaper to obtain.

For most Australians, the so called two tier economy is therefore likely to become more so and especially given fiscal contraction at Federal and State levels. i.e. less money will be spent by those governments with SME’s. This is likely to mirror the (North) European situation. However the big difference is that European companies are better linked into a much more substantial and broader large corporate base which can and does provide finance to SME’s. There is also more equity in the form of venture capital and true private equity.

For those of you who have been following my blogs will see that the forecasts are correct. Every day, companies in Australia are finding themselves in difficulty and the listed resources sector is finding it increasingly difficult to raise capital and operate at required levels of profitability. This is before the tax on the basis of life: Carbon and Carbon Dioxide.

For SME’s there are strategies you can put into place and networks that you can access to manage the future. The first step is to understand very clearly that the future is going to be different from the past. These steps include managing solvency and liquidity in a constrained capital and cash flow environment where you have lost pricing power.

Please contact me: dmillhouse@millhouse.co