Evercore Pan Asset

The British Chambers of Commerce report today that orders, investment and demand for labour all fell heavily in the last quarter of 2008. This will be no surprise to people reading this site. These declines are continuing in the first quarter of 2009. It is the inevitable result of the monetary policy mistakes of a year or so ago, and the weakness of the banking system.

The government is now rolling out a couple of additional schemes to assist in saving and creating jobs – a loan guarantee scheme, and a subsidy scheme for employers taking on new workers. Both schemes can be helpful, but both need careful work on the small print. If you are offering a subsidy for a new hiring you need to make sure you are not encouraging an old firing at the same time. If you are offering a guarantee to banks for offering credit, you need to leave the banks sufficiently on risk if the loan goes wrong so the banks do not lose interest in assessing risk properly.

As the Chambers of Commerce survey should remind us, these two subsidy schemes are not of themselves going to turn round the plunging economy. Companies need orders. They will not be hiring extra people if their order books continue to fall by anything between 5 and 75%. We heard this morning that JCB are currently producing just 25% of the volume they were making a year ago. No wonder they had to sack another 684 people this week. Companies do need overdrafts and short term loans to be able to pay the wages and pay their suppliers, but they cannot go on doing this on borrowed money if the demand is not there to justify the employee numbers and the material and component stocks.

I had a small example of what is wrong yesterday. I had to replace a computer keyboard. The new one turned up in a cardboard box marked firmly “Made in China”. This little transaction summed up so many transactions that have got us into our present plight. We no longer have enough repairers or component suppliers in the UK, and have got used to relatively cheap product from China which procurement departments find is cheaper to buy outright.

The keyboard was produced by workers probably earning around one fifth of workers in the UK. Many Chinese factory workers will be made redundant in the downturn, as there is a sharp contraction of global demand for Chinese manufactures. They will enjoy little of the benefits and safety net that workers fortunately enjoy in the UK. These hard working and successful exporters are now experiencing more personal grief than we are, as they shed jobs more quickly in their manufacturing heartlands and leave people without a western style welfare fall back. The Chinese as a whole continue to save massively, and invest some of their savings in US and other Western government bonds enabling those governments to buy their products by lending them the money.

Recently the pound has fallen. An importer told me the other day that he could go on offering low prices for imports for a bit longer, as he still had some stock bought at better prices, and had some currency cover in place. However, in a few months time this will have run out. Then the UK economy is open to the full shock of a 25% increase in import prices from the collapse of the pound in the last few months. The government hopes that this will not just choke off demand for imports, but will kick start home output at better prices to replace the lost imports. The issue is will it?

Normally such a big price movement would change things dramatically. I hope there will be some positive change this time as well. However, we need to factor in the possibility that China(and other low price producers) will actually cut their wages and do whatever it takes to lower their prices again. UK producers may find it difficult to obtain the money, the permits and the facilities to start producing the keyboards and all the other many products we have got used to relying on China to deliver. Prices and currency point to big scale import substitution, but UK companies are badly weakened by low or no profits, poor access to finance, and regulatory complications to expand capacity to drive out the imports.

There are no easy solutions to any of this. We do need a drive to substitute home made product for overseas, and need to get used to mending and improving, using local labour rather than automatically reaching for the order form for a complete new overseas product. The currency move will push people in this direction. The danger is our companies are too weakened to respond as vigorously as we would like. In that case we will simply end up buying less and having fewer modern items, and will have missed another opportunity to strengthen manufacturing in the UK.

At Evercore Pan Asset we remain of the view that the problems of the downturn and Credit Crunch are especially difficult in the UK, given the three large deficits the country was running when the trouble began. Combining a large balance of payments deficit, a large public sector deficit, and high borrowing by many private individuals and private equity backed companies has left the UK with a lot of work to do in an era of de leveraging. Equity investment opportunities should be better elsewhere.