librarium associates horizonscanning 2013 q2

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librarium annual report 2013 Q2

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librariuminsights.com

librarium annual report 2013 / Q21

Horizon Scanning



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Contents4 Introduction 5 What is on the horizon? - The spotlight segment : China - Circular Reasoning

6 The spotlight segment : China - Unsustainable model - Challenges to increased internal consumption 7 The Outlook

8 The spotlight segment : China - Illustrations 9 The spotlight segment : China - Illustrations

10 Review of the Global Economy

11 Review of the Global Economy

12 NAFTA - Overview - Review - The U.S

13 NAFTA - Review - The U.S - Canada

14 NAFTA - Mexico - Mexico: Sharpening the claws of the Aztec Tiger 15 General Review of the global economy Q2 2013 - The EU - Overview - Review

16 The EU - Will the safety net continue to carry the increasing weight? - More or less Union?

17 The EU - Will the safety net continue to carry the increasing weight?

18 The EU - Bad debts, Consumer trends and Demographics

19 The U.K - Overview - Review

20 The U.K - An uneven Recovery - An unsustainable model

21 Japan - Overview - Review

22 Japan - Review - continued

23 South Korea - Overview - Review

24 China - Overview - Review

25 India - Overview - Review

26 India - A Stalling or Falling outlook?

27 Brazil - Overview - Review

28 Brazil - Review - continued

29 Russia - Overview - Review

30 Russia - Quis custodiet ipsos custodes? Or Who watches the watchmen?

31 Turkey - Overview - Review



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Contents32 MENA & AP - Overview - Review

33 MENA & AP - Review - continued

34 South Africa - Overview - Review

35 Geopolitical Focus - MENA & AP = High Risk Region

36 MENA & AP = High Risk Region - continued

37 Our Conclusions 38 Our Conclusions - continued

39 Our Conclusions - continued 40 About Librarium

41 Disclaimer



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Introduction

The Librarium Associates Quarterly Horizon Scanning Series is a publication cre-ated by our team highlighting core global trends and projecting future paths on a geopolitical and macro economic level.

We are constantly engaged in active horizon scanning while adhering to our belief that students of the lessons of history and permanent features such as geographic realities can provide superior insights.

From these broad scenarios we work to identify investable trends and specific op-portunities. We find that such a broad approach provides an ‘early alarm’ system for risk management and an indicator of attractive price/value situations across asset classes. These conclusions can be found in our Librarium Investment Monitor publications.

The intention of our research and the basic premise of this publication is to pre-sent rational perspectives based upon diligent analysis of historical data. Through organizing the data logically, information is created. Through understanding and developing perspectives on the information, knowledge is generated. With knowl-edge, one can then start to make informed decisions.

The most practical way to imagine the future is to question the expected, this is best done making use of what we call ‘critical thinking’ - Critical thinking is the careful, deliberate determination of whether one should accept, reject or suspend judgment about a claim and the degree of confidence with which one accepts or rejects it.

Critical thinking employs not only logic but a broad intellectual criteria such as the one outlined above. Critical thinking requires extensive experience in identifying the extent of one’s own ignorance in a wide variety of subjects which is often cap-tured in the following sentence; I thought I knew, but I merely believed.

As J.F. Kennedy put it; “Belief in myths allows the comfort of opinion without the discomfort of thought.” Our aim is always to avoid this trap of the mind, when one attempts to look into the future one is better of exhibiting a more intellectually humble approach and challenge one’s beliefs and opinions by asking the question; What if we took the opposite view? This leads to a more balanced set of insights in our view.

The insights and opinions offered in this document are meant as a summary of events and our views – not a conclusive or exhaustive overview or for that matter a specific investment recommendation.

We hope it will offer some food for thought and that it can form the basis of con-versations between our clients, interested parties and ourselves.

Sincerely Yours,

Mr. S.H. SorensenSenior AssociateLibrarium Associates Ltd.



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Yi fang jiu luan, yi luan jiu shou, yi shou jiu jiao jiu fang, yi fang jiu luan.

(When policy is relaxed there is chaos; when there is chaos policy is tightened; when it is tightened people complain; when they complain policy is relaxed; when it is relaxed there is chaos.)

- Ancient Chinese Saying

Deng Xiaoping liked to say that it was necessary to “seek truth from facts” which is a quote from the second-century chronicle The Book of Han. The facts about China’s economy and investment cycle show that much of what has been claimed about the Chinese model is wrong. The country is not following a flawless master plan. Its progress is erratic. Investment decision making is no more rational in China than it is on Wall Street. Nor does the central government have any more effective means of smoothing fluctuations than do its counterparts in other countries.

Looking at the Chinese investment cycle also teaches us an important lesson about the effects of government involvement in the economy. Contrary to what many imagined, socialism can produce booms and busts as extreme as anything gen-erated by economies based on private enterprise. There can be no presumption that a heavier government hand at the economic tiller leads to smoother sailing. Any serious analysis of the Chinese investment and economical cycle of the last 50 to 60 years clearly shows that the country’s socialist economic institutions lead to booms and why these are inevitably followed by busts resulting from central gov-ernment interventions.

The central government’s ability to control the economy is relatively weak and re-actionary, as it has always been. Booms are mainly the result of local government initiatives, which often directly violate central government policy. Busts result from the re-imposition of the central government’s authority. This requires strict auster-ity measures and harsh crackdowns on violations.

Global Horizon Scanning Q2 2013

The spotlight segment : ChinaCircular Reasoning

What is on the horizon?



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Currently China appears to be faltering in its efforts to install some economic matu-rity, especially in the face of the general global economic downturn and increased international skepticism over China’s self-reported data. Concerns over a hard land-ing for China have prompted calls for the Politburo to ease its commitment to hard-line restructuring in favor of some relief measures. Such a move would temporarily relieve economic problems, but could have a negative effect on the credibility of China’s reform efforts.

The unavoidable truth is that the growth model China has carried for about the past decade is no longer sustainable. This reality check can be a dangerous thing for a country as beholden to foreign investment and low unemployment as China. The country’s new leadership is focused on reshaping the expectations of break-neck growth that were for years the key to the central government’s legitimacy. It has signaled its intent to carry out structural reforms to reinvigorate its economy, which is currently beset by overcapacity, inefficiency and overwhelming financial malaise.

Europe’s financial crisis shows no sign of relenting, while the U.S. economic recov-ery remains modest. China therefore must acknowledge that a significant part of the external demand that once supported its economy will not come back. This effect will be compounded by the declining pool of cheap and accessible labor on China’s coasts and the enormous challenges that accompany the development of the interior as a viable basin for investment and exports manufacturing.

The spotlight segment : ChinaChina today – Unsustainable model

Increased internal consumption is the alternative to a falling export model, but the central government’s structural reforms have had a constraining effect. Despite the leadership’s efforts to build up a strong consumer base in China, average consump-tion has decreased as wealth allocation imbalances have deepened. The purchas-ing power of the country’s middle class, which is still in its infancy, is shrinking.

Additionally, China’s drive toward an internal consumption model had been hin-dered by long-held social challenges. For example, the Hokou (household registra-tion) system prevents rural migrant workers from accessing social services in cities, thus constraining the process of urbanization, a key driver of domestic consump-tion. Another example is China’s underdeveloped social welfare system, which forces people to save a significant portion of their income as insurance for health and retirement costs, discouraging unessential spending and slowing growth of the domestic Chinese economy. These two issues also contribute to an overarching and growing imbalance of wealth throughout the nation that must be addressed if a stable domestic economy is to be achieved.

Challenges to increased internal consumption



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China can prevent the kind of crash that struck East Asia in 1997. Their currency is not convertible, so there can’t be a run on it. They continue to have a command economy, they are still communist, after all. But they can’t avoid the consequences of their economic reality, and the longer they put off the day of reckoning, the harder it will become to recover from it. They have already postponed the reckon-ing far longer than they should have. They will most likely postpone it even further by continuing to support failing businesses with loans.

If this deterioration is allowed to reach its natural and logical limit, we will likely see a full-scale recession as well as a collapse in asset and real estate prices in the near future.

China’s direct contribution to global growth is enormous, but perhaps equally as important is its role in generating growth in developed and emerging economies. A slowdown in the Chinese economy heralds very bad news around the world. Such a growth crisis centered in Asia will further exacerbate the instability and vol-atility in Japan and have a serious impact on second derivative marketplaces such as Australia, Brazil and developing economies in South East Asia, Latin America and Africa.

The outlookThe spotlight segment : China



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IllustrationsThe spotlight segment : China

Source: Bloomberg Briefs

Illustration 1 - China’s export machine is stalling

Illustration 2 - Elevated levels of loans to GDP

Source: CEIC, Morgan Stanley Research

Structural reforms have had a

constraining effect.



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IllustrationsThe spotlight segment : China

Source: CEIC, Morgan Stanley ResearchNote: Numbers at the top of each bar indicate the total leverage. Debt data refers to only domestic debt, with the exception of central government debt.

Illustration 3 - China: Where is the leverage?

Illustration 4 - Credit productivity declines

Source: CEIC, Morgan Stanley Research

The unavoidable truth is that the

growth model China has carried for the

last decade is nolonger sustainable.


A Review of Core Segments of the Global Economy

GDP Annual Growth

Gross Goverement Debt to GDP

The World is no different from any other object in that we can make more sense of it by view-ing it from different angles. In our quest for in-sights we cover global macro economic trends and geopolitical events, our core parameter monitors the worlds leading nations and en-compasses around 4.7 trillion people and has a combined annual economy of $63.5 trillion.

This visual overview of developments is fol-lowed by our thoughts on all the nations we cover.

Visual Insight

100+%

80-10060-8040-6020-40

0-20

Current Account Balance % of GDP

General Goverement Total Expenditure % of GDP

Unemployment Rate

7+%

6-75-64-53-42-3

45-50%

40-4535-4030-3525-3020-25

> -3%

-3-1.5-1.5 - 00-1.51.5-33 >

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librarium annual report 2013 Q2librarium annual report 2013 Q2

ChinaIndia

JapanSouth Korea

The EUThe U.K

BrazilRussiaTurkeyMENAAPSouth Africa

NAFTAThe U.SCanadaMexico

-1 - 0%

0 - 11 - 22 - 44 - 66 - 8



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The first key component of the global economy and the geopolitical reality is the NAFTA Economy.

Today NAFTA covers a North American economy with a combined output of US$17.0 trillion. The NAFTA region is home to 444.1 million people, 33.3 million of whom live in Canada, 304.1 million in the United States, and 106.7 million in Mexico. NAFTA is the world’s largest free trade area and home to the world’s key military and economic power, the U.S.

NAFTA

Overview

During July the 5th round of the U.S – China Strategic & Economic Dialogue took place in Washington. The context of the current meeting is far different from the first dialogue in 2009, when China appeared to boast the only encouraging econ-omy amid the global financial crisis. 5 years later, the U.S. has seen slow but steady economic recovery and growth, while China expects its slowdown to continue with all the potential pitfalls which we outlined in our Spotlight Section.

The 1st Strategic & Economic Dialogue came during the global economic crisis, and China used the opportunity to highlight its model of economic growth in what it deemed a corrupt and declining Western system. The 2013 meeting sees China and the U.S. in opposite positions. In his opening address, U.S. Treasury Secretary Jacob Lew noted that the U.S. has now seen 40 straight months of economic growth, has gotten its economic house in order and that it is now China whose economy is “un-dergoing a systemic transition where significant and fundamental shifts in policy will be required to sustain growth in the future.”

The U.S



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NAFTA - ReviewThe U.S continued Canada

The Canadian economy grew 1.7% at an an-nual rate in Q2 as flooding in Alberta and a construction strike in Quebec took their toll, but as both theses events where irregular in nature the economy should revert back to a more positive trend during Q3.

The need for the economy to reduce its reli-ance on spending by heavily indebted con-sumers and shift its focus back to stronger exports and business investment is still re-quired.

Canada’s recovery from a mild 2008-09 re-cession was quick and job-filled, the coun-try added 900,000 jobs and cut jobless rate to 7.2% from 8.7% at the depths of the downturn. No bank needed a government bailout, the housing market did not col-lapse and Canada has generally been out-performing other G7 nations in most met-rics.

Even if one factors the high level of con-sumer debt, a bubbly housing market in some parts and China’s reduced demand for many of Canada’s raw materials one can see many comparative strengths which should continue to provide the Canadian economy with a sturdy foundation from which to grow.

Central to Canada’s continued economic expansion is the health of the US economy and a resolution to further expansion of the pipeline network which enables the nations energy producers to export their oil and natural gas in increasing amounts as North America becomes self-sufficient in energy and as it continues to build an expanding manufacturing base around low energy costs.

The durability of the U.S. economy relative to the rest of the world has become in-creasingly pronounced. Unlike the rest of the world, the U.S. has dealt with the over-hang of bad debts from the housing bub-ble through a vicious house price correction and resulting bust and the recapitalization of its banking system. Wages have come down sharply relative to Asia, the shale gas boom means energy is now far cheaper as well, and the resulting lower cost base is allowing the U.S. to reclaim market share within the global economy. As such, U.S. real GDP is 3.3% above the pre-crisis high of Q2 2008, whereas the European economy is still languishing 3.1% below the all-time high recorded in Q1 2008.

Certainly the U.S. is still faced with a compli-cated political reality as society and Wash-ington appear increasingly polarized as well as one must consider that the FED appear to have been erecting ‘Potemkin villages’ * in order to resurrect the confidence amongst the populace and to weather the storm of international questioning by the interna-tional community during the global eco-nomic crisis. The real economy as opposed to the S&P500 is still struggling to find its feet and move forward to a new sustainable paradigm but a blueprint is developing and progress is being made in spite of the politi-cal ineptitude and shortsightedness of the political establishment.

* The phrase, Potemkin villages, was origi-nally used to describe a fake village, built only to impress. According to the story, Rus-sian minister Grigory Potemkin who led the Crimean military campaign erected fake settlements along the banks of the Dnie-per River in order to fool Empress Cath-erine II during her visit to Crimea in 1787. The term, however, is now used typically in politics and economics to describe any con-struction built solely to deceive others into thinking that same situation is better than it really is.



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NAFTAMexicoThe Mexican economy unexpectedly contracted for the first time in nearly four years in Q2, adding to the recent string of disappointments from Latin America’s previously fast-growing economies, and from other emerging markets. Latin America’s second-largest economy shrank by 0.7% compared to Q1. On an annual basis the economy grew by 1.5%.

Stagnant exports to the US and muted public spending held back Mexico in the first half. Growth is expected to accelerate later this year as the eight-month-old administration of president Nieto gets budgeted spending under way after gov-ernment shrank by 5% in real terms over the first 5 months. Furthermore, an indus-trial recovery is expected to gain traction in the US, the largest market for Mexican exports which are dominated by manufactured goods.

Mexico : Sharpening the claws of the Aztec tigerPresident Nieto has made some significant progress with his reforms, including managing to continue to grow the economy broadly while balancing the budget and introducing much needed reforms to governmental spending and logistical aspects. The economy is likely to expand at around 3% this year after growing 3.9% in 2012.

The result of measured budget tightening measures, smart economic policies and a further integration into the US economic realm has been comparatively sturdy growth, an enviably low total government debt level of 36% of GDP and good FDI levels which was 3 times the amount which went to Brazil during Q1.

Mexico will need to carry on with serious restructuring of the energy sector amongst others and the infrastructure leaves much to be desired. While government spend-ing on roads, ports and other such vital areas of activity has increased but there is still a long way to go. According to a recent report by the Council of Foreign Rela-tions, only 40% of the country’s roads are paved and severe bottlenecks remain on the 2,000 mile border that separates the US and Mexico.

The increased integration into the US energy complex also holds some good bene-fits besides the potential for technology transfers. Three new pipeline projects link-ing the US and Mexico are expected to come online over the next three years, and the projects could prove a boon for Mexican industries. When completed, the pipe-lines will double the US natural gas exports capacity to Mexico, possibly improving the cost competitiveness of Mexico’s industrial, electricity prices. The pipelines will buy the Mexican government time until the country starts tapping its own shale gas reserves which may still be some years away.

A combination of low-cost labor and energy inputs and its geographical location close to the attractive US consumer market should provide Mexico with significant competitive edge versus China and other traditional Asian low-cost exporters.



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The E.U. is a unique economic and political partnership between 28 European countries that together cover much of the continent. The economy of the E.U. gen-erates a GDP of over €12.894 trillion (US$16.566 trillion in 2012) according to Eu-rostat, which makes it the largest economy in the world. The demographics of the E.U. show a highly populated, culturally diverse union of 28 member states. As of January 2012, the population of the EU is about 503.5 million people.

The EUOverview

The outlook for the Euro area continues to deteriorate, as the region remains mired in the longest recession in its history. Detailed GDP figures confirmed the previ-ously reported 0.2% contraction in Q1, the sixth consecutive decline in economic activity.

Although we observed some signs of a timid recovery in some parts during Q2, the labor market and social conditions remain extremely challenging. Youth unem-ployment has reached unprecedented levels, averaging 23% for the EU as a whole and reaching 63 in Greece. Long-term unemployment has risen in most member states, and reached an all-time high in the EU as a whole.

Net job destruction has coincided with more precarious jobs, part time jobs, espe-cially involuntary, have been increasing even if the share of temporary contracts has fallen in the EU as they bore the brunt of the contraction.

According to a recent report from the European Commission poverty has increased in the EU since 2007. Household incomes are declining and 24.2% of the EU popu-lation is now at risk of poverty or exclusion as unemployment and jobless house-holds have increased, together with in-work poverty.

Review

General Review of the global economy Q2 2013



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The EUWill the safety net continue to carry the increasing weight?Greece, Spain and Portugal have the highest rates of unemployment in the EU, and all have relied heavily on unemployment benefits as safety net for people who have lost their jobs. Of the three countries, Spain’s unemployment system is the most generous. On average, Spain currently spends roughly Euro 800 per inhabit-ant on these benefits per month up from Euro 483 in 2007. The unemployment benefits system, along with other social benefits such as pensions and aid from family members are somewhat mitigating the social aspect of the crisis. However, these safety nets are limited.

Because of the pervasiveness of the crisis, long-term unemployment – people who have been out of work for a year or more – is growing in the EU periphery and cur-rently affects almost half of the unemployed population in Greece, Spain and Por-tugal. This means that many people will likely lose their unemployment benefits before they find a new job. Rising unemployment is also leading to a shrinking tax base in these countries, giving central governments fewer economic resources to support a more expensive system of unemployment benefits. With unemployment projected to remain well above its pre-crisis level in the medium term, questions over the sustainability of unemployment insurance will remain a key issue.

More or less Union? Milton Friedman, the Nobel-Prize winning US economist is reported to have said the following 15 years ago; “The drive for the Euro has been motivated by politics not economics. The aim has been to link Germany and France so closely as to make a future European war impossible, and to set the stage for a federal United States of Europe. I believe that adoption of the Euro would the opposite effect. It would exacerbate political tensions by converting divergent shocks that could have been readily accommodated by exchange rate changes into divisive political issues. Po-litical unity can pave the way for monetary unity. Monetary unity imposed under unfavorable conditions will prove a barrier to the achievement of political unity.”

Mr. Friedman’s thoughts appear to have gained more and more resonance with the average person within the member states. According to a recent survey by PEW the European project now stands in disrepute across much of Europe. France, the country where the idea of a European Union commenced has shown the greatest decline in support for the EU in the past year, with just 22% responding affirma-tively to the question whether ‘economic integration strengthened the economy’ down from 36% a year ago and the largest drop of all surveyed EU member states. See the illustration below for a fuller overview.



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The EUThe natives are getting restless

The fact that the natives are getting restless is understandable as it could be ar-gued that the European crisis has transformed the EU from a voluntary association of equal states into a creditor-debtor relationship from which there is no easy es-cape. The creditors stand to lose large sums should a member state exit the union, yet debtors are subjected to policies that deepen their economic troubles, aggra-vate their debt burden and perpetuate their subordinate position.

The effects has been that the EU which was founded on the free movement of people, goods, services and capital, now appear to be contradictory to these core tenets as the free movement of people is being questioned in numerous coun-tries, while the free movement of goods and services is in part responsible for the current crisis. The free movement of capital has forced EU leaders to face the con-sequences of different national banking regulations that allow capital flight and tax evasion. While better oversight and collaboration make tax collection across borders easier, they do little to stem capital flight, which weakens banking sectors in already struggling economies.

Illustration 4 - Loosing faith?

Source: PEW Research



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The EUBad debts, Consumer trends and DemographicsThe reliance on ECB liquidity is still high especially for banks in peripheral countries. Assets continue to deteriorate and remain on banks’ balance sheets, weighing on profitability. Non-performing loans (NPLs) in EU banks continue to soar, drastically outpacing loan growth. Since 2007, loans to the ‘real’ economy have decreased by 3% while NPLs increased by almost 150%. This trend shows no sign of reversal, reflecting the continued macro deterioration in parts of the EU in the absences of restructuring.

NPLs reduce the capacity of banks to lend, hindering the monetary policy trans-mission mechanism. Bad debts consume capital and make banks more risk averse, especially with respect to lending to higher risk borrowers such as SMEs. With Italy now following the same dismal trajectory of Spain’s bad debts, the situation is rap-idly escalating at an average of around 2.5% increase per year.

The western European passenger-car market is on track this year to hit levels last seen in 1993 and even Germany’s traditionally strong carmakers appear to be in free-fall. According to the European Automobile Manufacturers’ Association (ACEA), European car sales hit their lowest level for the month of May in 20 years. Passenger car sale demand for May dropped by 5.9% on the same month last year in the 27-country European Union to 1,042 million units. For the first five months of the year, sales dropped 6.8% to 5.07 million. Not exactly a sign of strength amongst the European consumer.

Long after the current crisis is over, Europe will be grappling with an even more serious problem, how to pay for growing numbers of old people. The population of some countries is stagnant or already shrinking, notably Germany’s. That will reduce savings and potentially economic growth. The ranks of retirees are swelling. That will be threatening the financing of pensions and health care. In the 27 coun-tries of the EU, each pensioner is today supported on average by four people of working age. By 2050, this old-age support ratio will have fallen to just 2:1, accord-ing to UN and EU projections. Policymakers need look no further than low-growth Japan to grasp the economic impact of population decline and aging.



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The U.KOverviewThe U.K. has the sixth-largest national economy in the world (and third-largest in Europe) measured by nominal GDP and eighth-largest in the world (and second-largest in Europe) measured by purchasing power parity (PPP). The service sector dominates the UK economy, contributing around 78% of GDP, with the financial services industry particularly important. London is the world’s largest financial cen-tre alongside New York and has the largest city GDP in Europe.

According to the 2011 U.K. census, the total population of the U.K. is around 63,182,000 It is the third-largest in the European Union (behind Germany and France) and the 22nd-largest in the world.

ReviewThe U.K. was downgraded by Fitch from AAA to AA+ during Q2 and they also re-vised downward future economic growth projections for both 2013 and 2014.

The U.K. is faced with a dilemma of the combination of continuing weak growth and high debt, where further fiscal consolidation will weaken output, with the risk of a permanent loss to productivity capacity, while the debt will accumulate unless there is consolidation. The U.K. is by no means the only nation which finds itself with this dilemma.

Fitch forecasted that the general government gross debt will peak at 101% of GDP in 2015/16 and will only gradually decline from 2017/18. They go on to say that “de-spite the U.K.’s strong fiscal financing flexibility underpinned by its own currency and the long average maturity of its public debt, the fiscal space to absorb further adverse economic and financial shocks in no longer consistent with a ‘AAA’ rating.”

A wider range of data points indicated a failure for a broader recovery to take hold with manufacturing still struggling and with large geographical differences be-tween the London area and the rest. The sluggish Eurozone put downward pres-sure on exports even if homegrown consumption ticked up slightly during Q2.



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The UKAn uneven recoveryWhen the coalition government came to power in 2010, it stated that it hoped to build an economic model that no longer depended on the spendthrift habits of a few hun-dred thousand impossibly wealthy bankers and resident Russian oli-garchs. Instead, they pledged to lead a “march of makers”, rebalancing Britain’s growth model away from debt-fuelled spending towards in-dustry. In turn that was supposed to help spread the benefits of growth beyond the capital. Anyone visiting London and Glasgow in the last cou-ple of years can only come to the con-clusion that this has not taken place if anything the split has become more pronounced.

The large spending cuts of the last 3 years has made an already difficult economic situation in the north and other regions even worse. Historically recoveries have tended to be unbal-anced and favoring the south as it tends to be consumer and housing market led, which is where mone-tary policies of low interest rates and monetary expansion first takes hold. Real poverty has taken hold even amongst working families who in-creasingly have to settle for part time work.

According to a survey carried out in April by Which? Says that one in five U.K. households borrowed money or used savings to cover food costs. It suggests that the equivalent of five million households used credit cards overdrafts or savings to buy food. Ac-cording to the same survey nearly 6 out of 10 said they found it difficult to cope on their current income and a third stated that they had borrowed money from friends and family in the last month for basic necessities. The executive director of Which? stated

that; “Our tracker shows that many households are stretched to their fi-nancial breaking point, with rising food prices one of the top worries.”

An FT article states that a 170% surge in demand for food handouts will fuel debate over the impact of govern-ment austerity on poorer households, amid concerns about the effect on demand as consumers are forced to cut back on everyday spending. This is not going to keep the fire burning in the traditional F.I.R.E. (Financials, Insurance and Real Estate) driven economy of the U.K.

According to the Economist household lending is just 0.3% be-low its 2008 peak. But lending to businesses is 22% lower and accounting for inflation the drop is more like 32% and the de-cline is accelerating. Some of the credit cutbacks are a natural response to companies’ past excesses. Commercial property firms borrowed on a whim in the mid-2000s. But while the par-ty was in one sector, the hangover has been widespread.

Credit to the manufacturing sector has been cut sharply, with lending to firms that make chemicals and electronics 30% low-er than the peak. In fashion and food the crunch has culled 39% and 47% of loans. None of these was a particularly bubbly sector. Loans let firms bridge the gap between buying inputs and making sales, they finance outlays on machines that must be made before revenues can rise.

The crunch explains why Britain’s rate of new-firm creation is oddly low and why business investment has fallen 34% in five years. Britain’s investment-to-GDP ratio was a dreadful 159th in the world in 2012. Its R&D spending puts is towards the bot-tom of the developed world table.

Britain’s house prices are rising again and household debt is starting to swell. This is only sustainable if workers’ future wag-es justify the mortgages granted against them. They will not if Britain stays on a path of low investment, poor productivity and weak wage growth.

An unsustainable model



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JapanOverviewThe Gross Domestic Product (GDP) in Japan was worth 5960 billion US dollars in 2012. The GDP value of Japan represents 9.61 percent of the world economy.The economy of Japan is the third largest in the world by nominal GDP, the fourth largest by Purchasing Power Parity and is the world’s second largest developed economy. According to the International Monetary Fund, the country’s per capita GDP (PPP) was at $35,855 or the 22nd highest in 2012.

Japan is a member of the Group of Eight and a is closely allied with the U.S through the 1952 Treaty of Mutual Cooperation and Security between the two nations, fur-thermore the two nations are currently discussing the inclusion of Japan to the U.S. led Trans-Pacific Partnership (TPP) which aims to enlarge free trade from NAFTA across the Pacific.

The population estimate was 127,650,000 as of March 2012, making it the world’s tenth most populated country.

ReviewJapan was the subject of our Spotlight Segment in our Q1 report and for good reason which has continued to play out during Q2. Getting an exact overview of GDP growth for Q1 and Q2 has been somewhat difficult as there has been a series of subsequent revisions to official data for both Q1 and Q2.

Which is perhaps to be expected when one considers the unprecedented meas-ures employed by the government and the BOJ. According to data released by the Cabinet Office in mid August the economy grew at an annual rate of 2.6% in Q2 and they revised downwards the growth for Q1 from 4.1% to 3.8%. Disregard-ing the accuracy of these numbers one can draw the conclusion that some above trend growth has occurred in the first half of the year.

However this was to be expected considering the dramatic actions undertaken in terms of expanding the monetary base to a degree where the aim is to double it within two years as part of the so called ‘Abenomics’ strategy.

Japan has a long history of crafting economic reform packages full of bold pre-scriptions and good intentions, many of which has ended up as empty promises. This time the government is under some internal as well as international pressure to follow up hyper-easy monetary policy, which so far has escaped serious criticism despite the yen’s dive, with reforms to ensure sustainable growth.

Prime Minister Abe has promised to make structural reform and deregulation a key component of his growth strategy, the third tranche of his ‘Abenomics’ prescription after hyper-easy monetary policy and big government spending. This third area is obviously also the most difficult to implement and it is where past governments have failed during the last two decades of ongoing malaise. In essence the third ar-row of ‘Abenomics’ is a growth strategy based on structural reform. The challenge here will be to raise growth even though the working age population will be falling by up to 1% per year over the next 10 years.



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Japan

Review continued

The government has identified several priorities, including deregulation with a fo-cus on the labor market, energy sector and healthcare, reforming the corporate tax regime and trade liberalization - notably by seeking to join the Trans-Pacific Partnership headed by the US. However the jury is still out on whether this admin-istration will be any more successful in raising Japan’s productivity than its prede-cessors. Announcing yet another fiscal stimulus for 2013 and persuading the BOJ to further loosen its monetary policy were relatively easy wins.

In short, the Japanese government has embarked upon an economic experiment in Keynesian theory that is breathtaking in its promised scope. They are betting that they can gear up enough growth to overcome deflation and demographics, allow the country to balance its budget, find an inflation level that will allow the Japanese debt to shrink relative to GDP, make Japan even more of an export pow-erhouse and increase productivity on a scale never before seen in a developed country. They will attempt to do all this while hoping that the rest of the world sits idly by and watches Japan take export market share through devaluing their currency. All of this in a slowing global economic environment and with several regional geopolitical challenges rising on horizon – it would be nothing short of a miracle if all of this plays out to plan.

The signs, besides the relatively meaningless short term GDP growth and positive official CPI announcements, are not good so far. If you look at the CPI components you come to the conclusion that it has nothing to do with the demand-pull broad “benign” inflation driven by rising wages and everything to do with the cost-push of a plunging yen forcing food and energy prices higher. With income flat at best, in order to accommodate soaring food and energy prices the local population has to cut their spending for all other products which leads to deflation in real terms as the energy and food is largely imported and the consumer goods which can not be purchased as a result are the exact goods which Japan Inc. produces. The upcom-ing plans for increases to the sales tax rate will only exasperate this trend. It would appear as if Japan has employed hope as a strategy, which rarely ends well.



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South Korea

OverviewSouth Korea has a market economy which ranks 15th in the world with a nominal 2012 GDP of USD1.6 trillion and 12th by purchasing power parity (PPP), identifying it as one of the G-20 major economies. It is a high-income developed country, with a developed market, and is a member of OECD. It is Asia’s fourth largest economy and the world’s 15th (nominal) or 12th (purchasing power parity) largest economy.

The economy is export-driven, with production focusing on electronics, automo-biles, ships, machinery, petrochemicals and robotics. South Korea is a member of the United Nations, WTO, and OECD, and a founding member of APEC and the East Asia Summit. South Korea has a close relationship with the U.S. through the 1953 Mutual Defense Treaty and several economic treaties.

The total population in South Korea was last recorded at 50.0 million people in 2012 up from 25.0 million in 1960, changing 100 percent during the last 50 years. South Korea faces the problem of a rapidly aging population. In fact, the speed of aging in Korea is unprecedented in human history, overtaking even Japan accord-ing to the IMF.

ReviewSouth Korea’s economy grew the most in two years in the first quarter, during quar-ter two improvements continued but clouds are appearing on the horizon with China’s slowing economy and Japan’s continued currency devaluation, the first being South Korea’s largest trading partner and the latter being its major direct competitor.

It is also worth noting that the newly elected government frontloaded 72% of its 2013 spending budget to the first half of the year and President Park Geun Hye un-veiled a further extra budget and property stimulus package worth USD 15 billion.

All these measures are meant to offset the headwinds on Asia’s fourth largest econ-omy, namely below trend growth in developed markets, slowing economic growth in developing economies, a declining yen which provides a competitive advantage to Japan’s exporters, risks associated with North Korea, record levels of household debt and a stagnant housing market.

The problems do appear to be structural and long term in nature and the relatively modest ‘sugar-high’ which these measures have provided will not provide a perma-nent fix to the problems facing South Korea.




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China

OverviewThe socialist market economy of China is the world’s second largest economy by nominal GDP and by purchasing power parity after the United States. It is the world’s fastest-growing major economy, with growth rates averaging 10% over the past 30 years. China is also the largest exporter and second largest importer of goods in the world. China is the largest manufacturing economy in the world, out-pacing its world rival in this category, the service-driven economy of the United States of America.

On a per capita income basis, China ranked 87th by nominal GDP and 92nd by GDP (PPP) in 2012, according to the International Monetary Fund (IMF). The provinces in the coastal regions of China tend to be more industrialized, while regions in the hinterland are less developed.

Today China’s population is over 1344 million, the largest of any country in the world. In 2012, for the first time, according to statistics released by China’s National Bureau of Statistics in January, 2013, the number of people theoretically able to en-ter the Chinese labor force (individuals aged 15 to 59), shrank slightly to 937.27 mil-lion people, a decrease of 3.45 million from 2011. This trend, resulting from China’s successful one-child policy of population control, is anticipated to continue for at least the next 20 years, to 2030.

ReviewPlease see our Spotlight Section for a broad review of China’s realities as we per-ceive them.




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India

OverviewThe economy of India is the tenth-largest in the world by nominal GDP and the third-largest by purchasing power parity (PPP). The country is one of the G-20 ma-jor economies.

The demographics of India are inclusive of the second most populous country in the world, with over 1.21 billion people (2011 census), more than a sixth of the world’s population. Already containing 17.5% of the world’s population, India is projected to be the world’s most populous country by 2025, surpassing China, its population reaching 1.6 billion by 2050.

ReviewIndia, Asia’s third-largest economy, is more vulnerable than most. Economic news has disappointed for two years, with growth falling to 4 – 5%, half the rate seen dur-ing the 2003-08 boom. It may fall further. Consumer price inflation remains stub-born at 10%. A drive by Mr. Chidambaram, the finance minister, to push through a package of reforms and free big industrial projects from red tape has not yielded any positive results.

An election is due by May 2014 which is adding increased uncertainty. India’s de-pendence on foreign capital is also high and has risen sharply. The current-account deficit soared to almost 7% of GDP at the end of 2012.

India has historically been a capital-starved economy, with imports and foreign debt servicing bills that far exceed revenues. Capricious governments have done little to ensure a steady stream of foreign investment flows, and India remains one of the most difficult countries in which to do business.

After nearly a decade of reporting 9% average growth annually, India’s econom-ic output has slowed to around 5%. Such a downward adjustment for a country like India, which lacks strong institutions and an industrial base to weather the slowdown is perilous. While millions of Indians remain in absolute poverty, India’s much-vaunted middle class, numbering between 150 to 300 million depending on how you define the term, is not inclined to tolerate cuts in subsidies or tax hikes when infrastructure remains decrepit across the country, power blackouts are a way of life and corruption scandals across party, state and national lines continue to disillusion the electorate.

Complicating this picture, the Indian rupee has been on a downward spiral for the past six weeks as short-term portfolio investments have left the country over fears about the country’s burgeoning current account deficit. India faces no good, feasi-ble short-term solutions to its structural problems and with elections on the hori-zon it is hard to imagine much political will to make the tough calls on limitations to the government subsidized food and energy entitlement programs.




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India

A Stalling or Falling outlook?Populist pressures and India’s fractious political environment virtually guarantee that the government will not deliver on its 2012 budget promise to reduce total subsidy spending to 2% of GDP. Continued profligacy heightens the looming risk of a sovereign ratings downgrade to “junk” status, though the government will seek to accomplish just enough on the reform and fiscal fronts to forestall a down-grade, which heightens India’s fiscal troubles by raising the government’s borrow-ing costs. It would also precipitate a fall-off in FDI inflows and a likely outflow of foreign portfolio inflows, which in turn will put a continued downward pressure on the rupee. In the best of circumstances, the political context for economic reform might improve following the elections.

However at this point, the more likely outcome is that India’s policymaking en-vironment becomes even more difficult as the poll is expected to return a more fractious and divided parliament, generating a weak ruling coalition without the political support for a strong reformist push.



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Brazil

OverviewBrazil has the sixth largest economy by nominal GDP in the world, and seventh larg-est by purchasing power parity. The Brazilian economy is characterized by moder-ately free markets and an inward-oriented economy. Brazil’s economy is the largest of the Latin American nations and the second largest in the western hemisphere. The Brazilian economy is dominated by commodity exports with heavy reliance on exports to China.

As of the latest (2010) census, the Brazilian government estimates its population at 190.8 million.

ReviewIt has been said that Brazil is a country that has been dealt a fantastic hand, and has played it very poorly. Between 1991 and 2011 it appeared that they had put this statement to shame as the liberalization of the economy coincided with the open-ing up of the Chinese economy.

Beginning in the early 2000s, China became a major consumer of Brazilian soy-beans and iron ore. Between 2002 and 2012, Brazilian iron ore exports to China increased from 34.6 million tons to 169.9 million tons, while soybean exports in-creased from 4.1 million tons to 22.9 million tons.

High demand gave Brazilian producers an incentive to rapidly expand output even without sufficient infrastructure to make that production particularly profitable. Higher volume compensated for slimmer profit margins despite the considerably greater expense of exporting commodities produced in the interior.

As Chinese demand stagnates, Brazil can no longer rely solely on volume and it could be viewed as a lost opportunity that the government has made little process with developing this infrastructure during the boom time. As we mentioned in an earlier report it costs more to ship soybeans from source to the port than the cost of shipping it halfway around the world to China.

As mentioned in our China focused Spotlight Segment, Brazil and all other raw material exporters are faced with a deflating boom in demand for their produce. At the same time Brazilian consumers are more burdened by debt than at any time since the central bank began measuring household credit. Growing defaults last year led banks to cut back lending.




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Brazil

Review continued

After average yearly economic growth of more than 4% during president Lula’s two terms, average growth through the end of current president Rousseff’s term isn’t expected to exceed much more than 2%. Inflation a longtime concern has crept back up to an annual pace of 6.5%. Fiscal discipline has also deteriorated under Rousseff, with primary budget surplus in 12 months through May falling to 1.95% of GDP from 2.77% at the end of Lula’s last year in office. In April the government posted the biggest budget deficit in almost 4 years of close to USD 60 billion. Bra-zil’s unemployment rate jumped to 6% in June, the highest in more than a year and job creation during the first half of 2013 was the lowest in four years according to Bloomberg.

The slowdown muddles the message for a government accustomed to telling its citizens – indeed, the entire world – that Brazil has finally made it.

More than a million Brazilians took to the streets in the largest mass demonstrations since the impeachment of President Fernanco Collor De Mello in 1992. It began as a modest protest movement in Sao Paulo against a seemingly routine 20% bus fare increase, but quickly transformed into a broader and more diffuse protest against a range of grievances, political corruption, the dismal performance of public ser-vices such as transportation, health and education and even excessive spending in preparation for the World Cup and Olympics. The mostly peaceful protests spread to dozens of cities across the country while capturing the world’s attention.

These social disturbances had a further negative effect on the economy and as for-eign investors reassessed their perceptions and the Brazilian Real was seen trading at its lowest level in four years in June. However Brazil is not about to go belly up. The protests have been largely non-violent and in contrast to Prime Minister Erdog-an of Turkey’s reaction, Rousseff while blindsided by the protests moved quickly to recognize and to some extent deal with their concerns. Brazil do have some serious internal challenges – the before mentioned infrastructure deficiencies, crime, cor-ruption and low government investment levels* - which when taken in combina-tion with the broader slowdown in demand for its key exports signals challenging times ahead for South Americas largest economy.

*When democracy followed a two-decade military dictatorship, Brazil’s 1988 consti-tution enshrined European-style pensions and other social benefits despite the limi-tations of Brazil’s developing economy. This model transfers a lot of public wealth to individuals and leaves very little for public investments. So even though it taxes the populace at levels similar to Switzerland, Canada and Australia, with a tax burden equal to about 34% of the economy, Brazil spends most of its resources on personnel costs and entitlements. Instead of improving roads, rail systems or schools, revenues go toward pensions, public-sector salaries and transfers to state and municipal govern-ments who use the funds for their own high expenditures of a similar sort. Less than 5% of the government’s expenditures in 2012 went toward investments according to a recent study by Credit Suisse.



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Russia

OverviewThe economy of Russia is the eighth largest economy in the world with a nomi-nal value of USD 2 trillion and the sixth/ fifth largest by purchasing power parity (PPP). The Russian economy is currently labeled a developing one by the Inter-national Monetary Fund and the World Bank. The country has an abundance of natural resources, including timber, precious metals, and particularly fossil fuels (oil, natural gas, and coal) that can be developed without the constraint of OPEC production quotas and other rules. Russia’s oil and gas production and pipeline projects have been not only a primary source of Russia’s economic growth, but also a geostrategic lever in the country’s relationship with Europe and Asia.

According to an official estimate for 1 October 2013, the population of Russia is 143,600,000.The population hit a historic peak at 148,689,000 in 1991, just before the breakup of the Soviet Union, but then began a decade-long decline, falling at a rate of about 0.5% per year due to declining birth rates, rising death rates and emigration.

Russia is major military power with significant nuclear weapons arsenal and has a comprehensive sphere of influence in its near-abroad.

ReviewRussia’s economy unexpectedly slowed in the sec-ond quarter to extend a slide that’s stoking con-cern that the world’s largest energy exporter may be entering a recession. GDP expanded 1.2% from a year earlier according to the Federal Statistics Service in Moscow.

Sagging investment and household spending, once a mainstay of the fragile economic recovery, are dragging the nation to the brink of a reces-sion, compounding the challenges Russia faces from weaker global demand for its commodities. Economic growth has slowed every quarter since the final three months of 2011 as invest slumped and the government slowed spending increases following president Vladimir Putin’s re-election in March 2012.

In recent years the employment levels have been stable and comparatively strong but during the last three months we have seen unemployment move to an upward trajectory, this is noteworthy as it is politically sensitive in any country and it is especially sensitive in a closed political system like Russia’s. It is also important because it shows just how broad-based Russia’s current spate of eco-nomic weakness is.

Throughout 2012 the Russian authorities could point to the robust labor market and validate their actions as the economy slowed but still created jobs. This year there is no such fallback, everything – investment, foreign trade, industrial production, the labor market – are simultaneously moving in the wrong direction. That might not be a fatal crisis but it has led to increased protests and question-ing of the authorities right to govern which may have long term implications.

The political fallout from the hardening of the fi-nancial climate have been largely discouraging as Putin has retrenched from his earlier attempts to liberalize the economy and promote more re-form minded members of his inner circle. In recent months he has turned the clock back and thrown several of these reform minded individual under the proverbial bus and a return of the so called “siloviki”, or men of power, mostly veterans from the spy and security agencies who now appear to dominate the shaping of Putin’s thinking are be-hind what the opposition sees as a Soviet-style clampdown on dissent.




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Russia

Quis custodiet ipsos custodes? Or Who watches the watchmen? History tells us that no bureaucracy can police itself effectively. That’s why interna-tional conventions clearly state that graft can be reduced only if whistle-blowers and non-state actors play an active role. Yet Putin is sending a message, with his actions and words, that he is Russia’s only anti-corruption champion and that ex-posing dishonest officials is at the sole discretion of the Kremlin.

Corruption costs Russia about USD 300 billion a year, a severe 16% of GDP. And that doesn’t capture the distorted incentives and lost investment that are side effects. Russia placed last in Transparency International’s most recent Bribe Payers Index, which ranks countries according to their companies’ propensity to offer bribes.

Unfortunately, corruption would appear to be an integral part of the state-based economic system. In the oil and gas sector, for example, the government controls 45% of production, compared with 10% in 1998-1999, according to research by BNP Paribas. Managers of state-owned oil and gas companies are usually former government officials, and their companies are routinely tapped to fund unrelated projects such as the 2014 Sochi Winter Olympics.

The natural gas monopoly OAO Gazprom’s budget for such activities in 2011-2014 is USD 14.3 billion, according to BNP. In 2011 Gazprom lost USD 40 billion to cor-ruption and inefficiency according to a recent report by the Peterson Institute. From an investors perspective this is the kind of opacity and outright fraudulent behavior which makes it hard to consider deploying funds in Russia and which has lead to an alarming level of capital flight by unsettled local businessmen.

It also has serious long term consequences for Russia, as a lack of investment in this crucial sector will lead to less government revenue in the future. In recent years, Gazprom has paid 7 to 11% of total stare revenue and the oil sector has contributed about 40%, this may be what ultimately forces the Kremlin to reconsider its policies or it will a spectacular example of the “killing of the goose that lay the golden eggs”.



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Turkey

OverviewTurkey has the world’s 17th largest nominal GDP of USD 789 billion and 15th largest GDP by PPP. The country is a founding member of the OECD (1961) and the G-20 major economies (1999). Since December 31, 1995, Turkey is also a part of the EU Customs Union.

The economy of Turkey is defined as an emerging market economy by the IMF and is largely developed, making Turkey one of the world’s newly industrialized countries. The country is among the world’s leading producers of agricultural products; textiles; motor vehicles, ships and other transportation equipment; construction materials; consumer electronics and home appliances. In recent years, Turkey had a rapidly growing private sector, yet the state still plays a major role in industry, banking, transport, and communications.

The country’s population was 74.7 million people in 2011, nearly three-quarters of whom lived in towns and cities.

ReviewTurkey, with an USD 800 billion economy that has consistently expanded since 2009, has weathered the EU financial crisis better than its neighbors. The country’s history of poor tax compliance has been an obstacle to its development. About 40% of workers are part of an informal economy that pays no taxes according to the World Bank. Only about 4% of the population pays income tax. To meet the growing middle classes demands for better services they have in-creased the government revenue base through consumption taxes, like the fuel tax, that are relatively easy to enforce but which leads to higher inflationary pressures and prohibits overall consumption and damages business competitiveness. This in turn has led to higher unemployment levels and forcing the government into a budget balance deficit.

These factors combined by an increasingly overreaching government led by long-term incumbent Prime Minister, Recep Tayyip Er-dogan, have led to increasing social unrest and division which have manifested them-selves in wide ranging protests during this quarter. Erdogan’s response has been de-fiant and aggressive both in rhetorical as well as actual terms. This has lead to an in-creasingly fraught situation where the more

liberal middle classes increasingly finds themselves marginalized while the Erdogan government increasingly plays to its more conservative base.

As a result questions have increasingly been asked of the reality behind the generally ac-cepted façade of Turkey as a model for its neighbors as a balanced democratic Islamic society. The government is still strong and broadly supported but cracks are appear-ing and long term the business community which has been cautious during the recent challenges along with the growing liberal urban middle classes may seek alternatives.

Even with these challenges Turkey has been comparatively stable considering the con-tinued unraveling on its borders and in the broader MENA region. Serious attempts to find an amicable solution for the long standing Kurdish conflict which may in turn lead to better ties with the Iraqi Kurdish re-gion and the benefit of access to one of the regions major oil producing areas. However the escalating conflict in Syria may unravel this process as their Kurdish population seeks to establish an independent Kurdish state.




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MENA & AP

OverviewThe MENA countries may be divided into two groups from an economic perspec-tive, one group the oil-exporters which include the six GCC countries (Bahrain, Ku-wait, Qatar, Oman, Saudi Arabia and the UAE), Algeria, Libya, Iraq and Iran and a second group, the net oil-importers which include Egypt, Jordan, Lebanon, Mo-rocco, Syria and Tunisia. For a wider geopolitical context we have chosen to add Afghanistan and Pakistan to this broader group.

The MENA countries had a combined GDP of about USD 2.9 trillion and a popula-tion of about 321 million in 2012 according to the IMF. Afghanistan has an approxi-mate GDP of USD 29 billion and a population of 31.1 million while Pakistan have a GDP of USD 240 billion and a population of around 180 million. This gives the combined broader area a collective economy of over USD 3 trillion with a collective population of 532 billion people. This puts the combined group at a GDP level just below that of Germany and in terms of population it would be above the US as the third most populated if it was one country.

Endowed with about 70% of the world’s proven oil reserves and 50% of proven gas reserves, MENA oil-exporters play a critical role in the world energy market. Earn-ings from oil and gas accounted for about 73% of total exports and 78% of budget revenues in 2012 according to the IMF.

ReviewSeveral countries in the region are still navigating a protracted process of politi-cal change which has delayed important economic policy decisions. The political transitions in Egypt, Tunisia and Libya are proceeding in fits and starts while Syria has entered a full-blown, destructive civil war that could leave the country in a shambles. Libya has made significant progress, but there remain serious concerns about the security situation.

Bahrain, Jordan and Morocco, longstanding monarchies, appear to have succeed-ed in avoiding major disruptions through a combination of political reforms, ad-ditional government spending and tighter security. Financial support from GCC countries has underpinned the monarchies’ political stability and eased economic strains.

The future political landscape in the region remains unclear, as the ascendant Is-lamists struggle to govern in highly volatile and unpredictable political environ-ment. This has sharply reduced economic activity and undermined the authori-ties’ capacity to reestablish security and the rule of law and undertake the urgently needed structural reforms to reignite growth and reduce unemployment.




33

MENA & AP

Review continued

Without a clean path to political stabil-ity, the economic recovery will remain halting at best. At the same time, in-creased government spending on fuel and food subsidies, combined with pressures to raise public wages, has further strained public finances. Con-cessional external financing has been promised and some has been forth-coming, but disbursements will remain slow and contingent upon increasingly challenging reforms linked to IMF pro-grams. The sharp contraction of the Syrian economy will continue this year. Among the MENA oil importers only the Moroccan economy has been oper-ating at near-trend growth.

Most of the region’s oil exporters con-tinue to post relatively strong non-hydrocarbon growth even if it is from a low base, and fiscal and current ac-count surpluses have been buoyed by higher oil prices in recent years. Over the medium term, stronger growth will be contingent on building diversified capacities with reduced dependence on hydrocarbons through sustained structural reforms.

For the oil importers, the economic toll from the unrest, political uncertainty and weak external demand have led to weak real GDP growth of around 1% in 2011 and 2012, as compared with an average of 5% in 2001-2010.

Tourism and foreign direct investment (FDI) remain weak and are still far be-low pre-revolution levels.

Most businesses have retrenched. The Euro Area recession and sporadic vio-lence have depressed economic activ-ity in Egypt and Tunisia while Jordan and Lebanon have been severely im-pacted by the spillover from the civil war in Syria.

The economic prospects in the coming years remain challenging throughout the wider region at a crucial time when the regions large young populations seek opportunity to access economic opportunities and better their life. The region finds itself at a tipping point and it faces a wide gamut of possibilities from fragile growth to chronic instabil-ity and regional conflict.

In summary, two years after the “Arab Spring” commenced, many countries of the Middle East and North Africa re-gion are still undergoing complex po-litical, social and economic transitions. Economic performance was mixed in 2012, although most of the region’s oil-exporting countries grew at healthy rates, economic growth remained slug-gish in the oil importers. Many coun-tries face the immediate challenge of re-establishing or maintaining mac-roeconomic stability amid political uncertainty and social unrest, but the region must not lose sight of the me-dium-term challenge of diversifying its economies, creating jobs and generat-ing more inclusive growth.



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South Africa

OverviewThe economy of South Africa is the largest in Africa, accounts for 24% of its gross domestic product in terms of purchasing power parity, and is ranked as an upper-middle income economy by the World Bank; this makes the country one of only four countries in Africa in this category.

The demographics of South Africa encompasses about 52 million people of diverse origins, cultures, languages, and religions. According to official estimates, a quarter of the population is unemployed, however unofficial estimates put the real unem-ployment rate as high as 40%. A quarter of South Africans live on less than US $1.25 a day. South Africa is home to an estimated five million illegal immigrants, includ-ing some three million Zimbabweans.

ReviewSouth Africa, Africa’s largest economy and a major commodity producer saw it’s manufacturing based sectors severely damaged in the years prior to the global financial crisis by a strong currency and China’s global export “attack” based on cheap labor. It has since reverted to a more or less pure commodity producer and exporter model with little value added locally and the general ailments associated with the “resource curse” - high unemployment, lack of diversification and a rising wealth gap.

The sharp recent drop in the currency is not likely to reverse these trends as the global economy continues its slide into a low-growth environment that has re-sulted in significantly less global demand for South Africa’s raw materials. This has been exasperated by increasing demands from labor for increases in wage levels and South Africa’s lack of energy sources which leaves it with very high energy in-put pricing and inflationary pressures. Furthermore these wage demands have led to increasing social volatility especially around the large mining operators and the long suffering auto manufacturing sector.

The unfortunate reality, as former president Nelson Mandela enters his 96th year while recovering in a Pretoria hospital, is that his dream of widely distributing the country’s riches has faded. Discontent is mounting 19 years after his election over how a tiny minority still holds the lions share of the wealth and large swaths of the population is increasingly disenfranchised from the economy and the political process which appears to be fraught with the complete control exhibited by what in reality is a one-party system.

According to recent census data almost 14% of South Africa’s 53 million people live on less than USD1.25 a day and black citizens on average earn a sixth of what their white counterparts do and 1.9 million households have no income. Unemploy-ment stands at over 25% officially with much higher numbers in certain regions.




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Chaos is sweeping the Arab world. Tunisia is in political disarray and can barely con-trol its borders. Libya hardly exists as Tripoli is not the capital of a country but the weak point of arbitration for tribes and militias in far-flung desert reaches. Egypt wallows in a political stasis in which the government has trouble functioning, ideo-logical divisions between the military and Islamists split the country and guns and vigilantism abound. The government of Yemen may on a good day control half of its territory. Syria is in full-fledged civil war with over 100,00 dead. Iraq, too, barely exists as a state and low-intensity violence there is a feature of life. Bahrain and Jor-dan are much weakened states compared to previous decades. Significantly, none of this anywhere will be solved anytime soon.

As for chaos threatening the march toward democracy, well, what did the propo-nents of democratic change in the Middle East actually expect? It took Europe, by some measures, the better part of a millennium to make the transition from absolute autocracies to stable and liberal democracies. In between there was a series of wars and insurrections. Russia in the 1990s tried to make an overnight transition from communist dictatorship to Western-style democracy and the re-sult was near-anarchy. Meanwhile, Asian countries carefully went through many years of authoritarianism combined with market-orientated reforms as part of a slow transition to democracy. In post-Communist Central and Eastern Europe the transition was quicker, but that was because those countries had a background of democratic practices and bourgeois culture prior to World War II, to a degree that many Arab states simply do not. Moreover, Central and Eastern Europe had the advantage – for geographical and cultural reasons – of being more easily absorbed into the NATO and EU. In short, chaos of some degree is what one should expect for years to come in the Middle East.

Rapid social and political transformation historically leads to violence. According to Henry Kissinger’s thinking as represented in his excellent book, first published in 1957, titled ‘A world restored: Metternich, Castlereagh and the problems of peace 1812-1822.’: Disorder is worse than injustice. Injustice merely means the world is imperfect, but disorder implies that there is no justice for anyone, since it makes even the mundane details of daily existence risky.

Geopolitical Focus

MENA & AP = High Risk Region



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MENA & AP = High Risk RegionObviously great injustice is worse than a little disorder and there certainly has been many examples of great injustice across the MENA&AP region in the last couple of decades however the current level of disorder which has followed the initial eu-phoria surrounding the so called ‘Arab Spring’ must be considered to be signifi-cantly affecting the average person across the region and the initial aspirations appear to have given way to anarchy and a downward societal and economic spiral in many places with Syria, Egypt and Libya being the most extreme cases.

In the thought provoking book ‘The coming anarchy’ the talented Mr. Robert D. Kaplan writes the following; “While the minority of the human population will be as Francis Fukuyama would put it, sufficiently sheltered so as to enter a “post-historical” realm, living in cities and suburbs in which the environment has been mastered and ethnic animosities have been quelled by bourgeois prosperity, an increasingly large number of people will be stuck in history, living in shanty-towns where attempts to rise above poverty, cultural dysfunction, and ethnic strife will be doomed by a lack of water to drink, soil to till, and space to survive in. “

The fast growing populations of the MENA&AP region along with the people of Sub-Saharan Africa would appear to be the ones most at risk to be left behind and as these nations are also the ones with the youngest and highest population growth numbers it would appear that if one reaps the lessons of history these areas will be increasingly volatile and potentially caught in a destructive reality. This will have potentially large and unpredictable consequences for the world and as global investors we hope that our pessimism can be seen as a foundation for prudence.



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During Q2 we have largely seen events unfold as to the high probability paths which we have outlined in past reports. The NAFTA nations have shown fundamen-tal strengths driven by the U.S. basic strengths and advantageous global position. The EU/ECB has managed to disrupt a dramatic deterioration of the unions global position, if only on a temporary basis while Germany held its awaited elections. The broad fragility exhibited amongst the so-called emerging nations has become more pronounced with significant social unrest in many places.

Our Spotlight Section was focused on China, as the dynamics and the changing paradigms warrant significant consideration at this juncture. China is faced with a classic historic battle between the regions and the central leadership which has been a recurrent part of China’s long history. In the face of dropping demand for the nations exports of manufactured goods combined with troublesome regional debt levels and a fragile banking system which has been build around the real es-tate sector to the usual adverse effects. China’s search for ‘weiwen’ (Chinese for sta-bility preservation) goes on and has taken the first steps down a new path which will, for better or for worse, have long lasting effects for Asia and beyond.

In the NAFTA region, the fundamental strengths of the U.S. has become more pro-nounced. With falling energy prices and relatively competitive labor costs taken in combination with inherent geographic, geopolitical and institutional strengths, it is set to continue to emerge as the most solid pillar of the global economy. Mexico is benefitting from this and the new government appears to be on the path to real changes which may unlock its potential in the coming decade as it is further incor-porated into the U.S. economy.

The EU was largely suspended in a frozen reality during Q2, while the ECB bought some time while German elections took place. Will it be a case of ‘fast-forward’ in 2014? The grim realities are still there and the eternal conundrum of governance via central committee, a committee inhabited by diverging players. We will contin-ue to watch France, Spain and Italy closely for continued economic deterioration and social unrest. In the longer run it would appear that the destruction of the illu-sion of the EU being a path to a better future for all involved may be the undoing of the project with individual voters pulling back from further integration via national and EU parliamentary elections.

Our Conclusions



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Our Conclusions

The UK is experiencing an uneven recovery with London increasingly taking on the role of a wealthy city-state while its grim up north. The UK followed the US with aggressive QE which has brought some relief while the government has been attempting to rein in expenses and restructure the economy. As we mentioned in our Q1 report, where the UK was a part of our Spotlight Section, the progress has been limited in real terms especially on the restructuring of the economy which is still heavily focused on the financial industry and real estate sector. As could be expected the QE has led to increased financial fragility and it will be interesting to see how the UK is affected by a continued troubled EU and whether the UK will chose to further integrate itself into the US sphere via the proposed Transatlantic Free Trade Area.

In Japan we have seen the launch of the first and easiest parts of the ‘Abenomic’ economic policy to mixed effect and with real implications for other nations in Asia. We have seen plenty of rhetoric and ‘easy money’ policy but not much concrete in terms of restructuring the economy or delivering a viable long term solution to Japans inherent energy problems. In our Q1 Spotlight Section we covered Japan and our view that Japan is closest to the flames amongst the developed nations still stand. A worrying tendency towards military build up and a confrontational attitude to regional matters is likely to continue.

In South Korea we have seen an already injured economy attempt to come to terms with its regional competitors lax monetary policies. The answer so far has been fur-ther government spending and business friendly rhetoric but no concrete plans nor action to begin to rectify structural problems or to develop a plan for how to overcome the significant changes in the global trade patterns.

India has suffered as the global storm swept across the emerging economies, all its inherent weaknesses have been exposed and the fragility has led to real deterio-ration at an economic level. With elections due in the spring of 2014 and the rise of Mr. Modi who could be a force for change, good or bad, it will be an interesting time ahead for the nation with potential for real paradigm change nationally and regionally.

In Brazil, China’s slowdown has led to real economic trouble, which when taken in combination with the inherent structural weaknesses presented by poor infra-structure, sup-optimal government services and rising inequality, has led to seri-ous social distress and significant social unrest. With the worlds eyes focusing on the nation in 2014 and beyond, as the nation hosts several high profile events, it will be crucial that the government acts to begin to rectify these errors and put the country on a path to reach its full potential as opposed to reverting to a historic pattern of economic volatility and dysfunctional governance.

Russia has real economic trouble with an economy heavily focused on its energy sector and a tax system which has made the government increasingly dependent on its funding from this sector. The economy is faced with geographical and struc-tural inefficiencies along with worsening demographics and high levels of corrup-tion.



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Our ConclusionsThe Combination these pressures and rising inequality has led to rising levels of confrontations amongst the nations different power bases and the general population. On the international front we have seen increasingly confronta-tional rhetoric and policies. Russia is faced with some real headwinds and the next couple of years holds a lot of uncertainty especially if we see lower energy prices.

Turkey was faced with the realities of having come far in the last decade but still having real work to do in terms of building social and economic institu-tions to ensure the gains are protected and can act as a basis for the future. The fundamental problems of a ‘troubled neighborhood’, high energy costs and reliance on Russia for this important economic input as well as unresolved problems from the past with the Kurd-ish question still going unanswered. During Q2 we also saw the question of personal freedom within a state which requires high levels of central control coming to the forefront. This resulted in significant unrest as protests spread and the government was caught off guard and reactive. Turkey is well posi-tioned but it will require a nimble and proactive approach to realize its poten-tial in the years ahead.

In the MENA&AP region we still have several countries that are still navigat-ing a protracted process of political change to reflect new geopolitical re-alities and events on the ground. The region finds itself without a clear path to political stability that the economic recovery will require.

South Africa’s economy has continued to suffer from the changes in global trade patterns. Its economy has strug-gled and the nation is looking to find answers to difficult questions such as rising inequality, a narrow economy, limited infrastructure, corruption and

high energy costs. Again we have seen an increase in protests and unrest. The path for Africa’s biggest economy is still unclear and political direction has not been forthcoming in facing these chal-lenges and providing a route forward.

At the halfway point of the year 2013 we find ourselves with a slightly surreal calm with flashes of real world realities coming to the forefront at increasing frequency, especially if you look at the so-called emerging nations. The story has only just begun and there are many different paths ahead, representing choices for individuals, nations and re-gions which may lead to real paradigm changes away from the status quo of the last three decades.

As long as the world remains stuck in this stagnant economic state, the pos-sibility of further social unrest and paradigm change increases. Which in-cidentally, introduces the increasing importance of geopolitics and how it affects your investment portfolio. We recommend that you keep an eye on the horizon.



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About LibrariumLibrarium Associates Ltd. is an independent research company focusing on global macro and geopolitical monitoring and analysis. We are committed to delivering distinctive insights on global trends enabling our partners and clients to make in-formed decisions in a changeable world.

We offer global accredited investors such as asset managers, family offices and institutional investors with quarterly and annual publications providing an inde-pendent overview of global macro economic and geopolitical events and their im-plications on the world of investing.

We also provide intra-monthly event driven insights as a part of our constant hori-zon scanning services.

Our services can also be employed on a retained basis, providing the client direct & always confidential access to our team on an on-going basis allowing us to act as an independent sounding board for our clients ventures.

Furthermore, we can also produce exclusive client commissioned stand-alone re-ports across a number of broad areas.

We prefer to work with a relatively small and select group of active clients allowing us to provide them and their projects with our full attention and as such we oper-ate a limited amount of such partnerships.



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Librarium AssociatesDisclaimerThe views expressed are opinions or our team through the period ending April 2013 and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and/or invest-ment. The report includes forward looking statements. There can be no guarantee that any forward looking statements will be realized. Librarium Associates Ltd. un-dertakes no obligation to publicly update forward looking statements, whether as a result of new information, future events or otherwise. Statements concerning fi-nancial market trends are based on current market conditions, which will fluctuate. There is no guarantee that the investment strategies mentioned will work under all market conditions and each investor should evaluate the suitability of their invest-ments for the long term and the compatibility of the ideas mentioned in this report with their existing investments and their investor profile.

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librarium associates horizonscanning 2013 q2

Documents

eu overview

brazil overview

turkey overview

overview review20

review24 china overview

librarium annual report

continued29 russia overview

review25 india overview