Canary in the Coal Mine

June 15, 2011

To : All Shareholders

“The moving finger writes and having writ moves on”


China faces a multiplicity of problems – housing boom, commodity price rises, infrastructural costs of its demographic shifts, all these and much more – but it is a typical story not a new one. Singapore, Hong Kong, Indonesia – there is long list of population centres where labour was once cheap and which became target countries for corporations seeking to reduce production costs.


Sooner or later these places catch up with the rest of the world and the finger moves on. The Chinese government is now faced with a serious dilemma. Credit has been tightened, their currency has been held down, all in an effort to preserve export advantage but tight credit also depresses domestic demand, which is one of the ways out of the dilemma. The reckless scramble for growth in China has sparked off the commodity price boom which eventually dampen demand for Chinese goods, both for export and home consumption, but the Chinese government cannot simply put the brakes on to reduce global inflationary pressures, and why should they? Other BRICS countries are experiencing similar scenarios, but in a small scale, particularly India, which brings me to the main point of this letter. Employment costs and wage inflation.


India has been our chief source of skilled and professional workers. Technical skills, good education and training, the English language have been major advantages playing a part in this selection process but low costs have also been a prominent factor. The low-cost aspect is rapidly evaporating : wages have risen sharply in the home market and highly trained Indians no longer have the same incentive to move abroad. As the Indian economy expands this trend will continue and eventually lead to a skilled labour shortage and then to a significant rise in employment costs for us, unless we do something about it. While Asia is booming, Europe is emerging only slowly from the recent economic turmoil. Unemployment levels are very high and growing higher so there is at present no pressure on wages, even at upper skill levels, suggesting to me that we should be looking at selected European countries as a potential source of professional employees. Language, higher benefit costs, will all have to be taken into account but with a long-term view I think you will come to see the potential advantages of casting our net a bit wider.


“What goes down must come up”


I am fearful that we are heading towards a period of violent fluctuations in currency exchange rates.


For a long time I have been expecting a significant fall in the value of the US dollar, which is essentially our currency, against other major currencies especially the Asians. I think this could come soon. The parlous state of the US economy, much worse than Greece, tells me that it should have happened some time ago but other factors have come into play to prop it up. Questions hanging over the Euro still act as a prop for the dollar but there is a gradual creepage in hard currency/dollar rates which cannot be ignored, threatens to accelerate, and which could lead the Fed to employ it quickest remedy to halt the decline, namely to raise interest rates. The US should do this soon to begin to combat its deficit problem and if it hangs back, as it will tend to do, and leaves it too long the remedy will have to be so radical it could push the economy over the brink into a double –dip. This all ties in to what I have said about commodity prices, many of which, and notably oil, which are priced in dollar. There is a distinct risk that they will hang back for political reasons thus affecting prices and labour costs worldwide. The US government is unlikely to act wisely, partly because it seldom does but mostly because election is coming around again and it has few options for dealing with the situation. Tax rises, cuts in public programmes, all kinds of austerity measures including defence cuts, are all off the table until the elections are over, leaving only interest rates and money supply as weapons for the fight. The money supply card has been played and so badly that it is now at the root of the US inflation risk, so that leaves interest rates as the most likely remedy of first resort. This will affect us, in our businesses, less than it would have done in the past because we have been very prudent in managing our leverage, but rate rises will still have a broad effect across our market and we need to be wary.


On a happy note, I am looking forward to the publication at the end of this month of our results for the year 2010/2011 and I anticipate impressive figures, thanks to your efforts which I applaud as always.


My present concern is for the unmistakable signs of rampant inflation. Not just for price inflation, from which businesses often benefit quite a lot, but from the more insidious and damaging wage inflation which follows. While price inflation waxes and wanes and can be managed by a variety of economic tools, wage inflation comes and stays and remains an extra cost no matter what happens later to prices. Price inflation is the trigger for wage inflation to occur and there is evidence to suggest that we are in for a stiff bout of it, not localized in small pockets but global this time. Early signs were evident in world food prices which have soared by about 30% this year, fuelled in part by irrevocable trends, such as climate change and the economic bias away from agro-foods to agro-energy. ( For further evidence just look at our own local cost of electricity. ) Falls in food prices, in general, are now extremely unlikely. Industrial commodities – fossil fuels, base metals, natural chemicals – are also on a rising path and, while business presently lacks pricing power, these costs cannot be contained indefinitely and will eventually filter through into a permanently higher price structure for the production of goods. I have said that this time the condition is global, and mostly it is, but there are some areas of the world where it promises to be worse than others. China.

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