Olympic fever is gripping Britain and the FTSE 100 is climbing. So it’s easier to forget the perilous state of the world economy. Yet the news here isn’t good. And one of the biggest worries is China, says John Stepek in Tuesday’s Money Morning.
“It’s been clear for a while that China is slowing down quite sharply”, says John. “Results from the latest manufacturing survey were worse than analysts expected. But for the really grim news you have to look at Chinese companies.”
“The giant state-owned enterprises have posted their worst figures since 2008. First-half profits were down 11.6% on the year. The main casualties so far have been commodity-related companies. Steelmakers have seen profits dive by 96%. The authorities are clearly getting worried. They have cut interest rates and are encouraging the banks to start lending more once again.”
China bulls will say that if the economy continues to struggle, authorities will take more stimulus measures to turn things around. “It’s certainly possible”, says John. “We always say that politicians take the path of least resistance. And while the central government might be talking a big game, the regional governments are keen to boost their growth again.”
But in the long run, that still won’t be good for China. “Any big stimulus measures will just boost inflation and increase the bad debt load across the Chinese economy. That would set up China for an even harder landing in the future.”
What should investors do?
John has an answer for this one. “To profit from China’s decline, the most obvious play to us is a speculative one – to go short the Australian dollar.”
“As we’ve explained before, the Australian economy is highly geared towards China’s success. Australia sells commodities, China buys them. If China’s demand for commodities falls – which it has – then Australia’s economy loses one of its key drivers. Throw in a bursting house price bubble, and you have a recipe for falling interest rates and a weakening currency.”
To find out a great way to do this, one of the biggest worries is China. And as he explains, you could also use spread betting. As we always point out, this is very risky and you can easily lose a lot more than your initial stake. If you want to learn more about how to do it, sign up for our free email MoneyWeek Trader, which has various tips and tactics for successful spread betting.
Why Europe’s crisis will get worse
Of course, the other big worry is Europe. On Wednesday, Matthew Partridge explained why the eurozone crisis will get worse before it gets better.
Mario Draghi, head of the European Central Bank, is making investors nervous, says Matthew. He had promised to do “whatever it takes” to save the euro. But this week he did nothing much at all. Investors want him to turn on the printing presses, but while he hinted he may do so in the future, there’s no sign he will do it now.
“Given that the bond market had priced in immediate, extravagant action, following Draghi’s rash promise last week, you can see why the markets were unhappy. It also raises the question of whether the intervention will come quickly enough to prevent a crisis.”
In the end the ECB will have to print, says Matthew. “It is the only way to get monetary growth up to rates consistent with any kind of recovery. However, it looks like Brussels wants Spain to formally seek a bail-out before there can be any action. This would give the ECB a lot more leverage in any negotiations with the Germans.”
Neither the Italians nor the Spanish are in a rush to do that, so it looks like the situation will drag on, says Matthew. In other words, the situation will need to get a lot worse to force the European leaders to hammer out a deal.
But this still presents good opportunities for investors. “Shares in the more troubled parts of Europe already look to be pricing in a pretty awful outcome. That’s why we’d suggest drip-feeding some of your money into the region”, says Matthew.
How to get rid of Britain’s shadow economy
Closer to home, Merryn has been blogging about Britain’s shadow economy.
This has become a hot topic recently as various tax avoidance schemes have been put under the spotlight. In particular, government minister David Gauke’s comments that paying ‘cash-in-hand’ is ‘morally wrong’ have stirred things up.
“Is paying for goods in cash morally wrong?” asks Merryn. “Clearly not. Is paying for goods in cash in order to avoid paying VAT morally wrong? I suppose so.”
Merryn explains: “Any tax you avoid paying has to be made up somewhere. So if you don’t pay it, someone else will – or you’ll end up paying it anyway via higher income tax or some such.”
However, Merryn reckons a lot of the controversy seems to “miss the point. The real villains of the piece are not so much the ones paying in cash, as the ones receiving in cash, and the ones who created the system that encouraged them to do so.”
There are “huge numbers of people who operate almost entirely outside the tax system”, says Merryn. “The painter you pay in cash? Most likely everyone else pays him in cash too. So not only is no VAT paid, but no income tax is paid. And no National Insurance is paid either. That’s not tax avoidance – it is tax evasion.”
This isn’t just a point of principle, says Merryn. It has a huge impact on our national finances. “The tax gap in the UK (the difference between the amount we should get in tax revenues and the amount we actually do get) is estimated to be somewhere in the region of £35bn. That’s the kind of money that could more or less make our fiscal problems go away”.
In Europe the lost tax is estimated to be worth €1trn – a significant sum that would help the region’s debt problem.
So what’s Merryn’s solution? “Lower taxes overall and better enforcement of those lower taxes.” We don’t have to look far for an example of this, says Merryn. “In the Isle of Man (no capital gains tax, inheritance tax or stamp duty; and income tax at 20%) there is no such thing as a tax avoidance scheme.”
And here’s what you think…
Tax is a controversial topic. So it’s no wonder your comments came flying in thick and fast.
‘Barkingmad’ says the least favourite tax is employers’ National Insurance. “It just makes employment more expensive – costs jobs / encourages jobs to be moved overseas. [It] would be simpler to roll income tax and NI together and would actually close a significant (legal) loophole – the benefit of directors being paid the vast majority of their ‘salary’ as dividends which do not attract NI.”
For ‘Chris’, corporation tax is the problem. “Abolish Corporation Tax altogether and you abolish the need for big business to find ways to avoid paying it as well as instantly making the UK a business friendly country and possibly the business capital of the world.”
‘Lupulco’ has a whole range of suggestions ranging from a flat tax on income to 22.5% VAT, to a 1% company asset tax.
It’s a great debate and one that affects us all. So if you haven’t read the piece yet, Merryn has been blogging about Britain’s shadow economy.
A rare agreement with Ed Miliband
Here’s a turn up! On Tuesday Tom Bulford, author of the Penny Sleuth newsletter, found himself in rare agreement with Labour leader Ed Miliband.
Miliband has complained about the convoluted world of pensions’ hidden charges. And Tom couldn’t agree more.
Sure, say Tom, “somebody has got to make the investments, keep the records, ensure that the assets are secure, provide the reports etc. Not everybody wants to be bothered with these tiresome administrative matters.”
What annoys Tom is how much reward these people are taking for their efforts. “Whether it is the fund accountant or lawyer, custodian or fund manager, we all know that these people are doing very nicely for themselves out of our money.”
Indeed, “fund management charges are a scandal. They have been for years. When markets were rising nobody minded too much. But if the annual investment return is only 5%, you don’t want the managers to take half of it. And with many managers falling a long way short of that kind of return, it becomes especially annoying.”
If fund management fees could be cut by just around 0.2% a year, notes Tom, “compounded over time this would be worth thousands to investors.” If you’re interested in hearing more from Tom, you can sign up to his FREE Penny Sleuth email here.
The market’s fear gauge
Finally, here’s a quick mention about the latest video tutorial from my colleague Tim Bennett. These videos are one of the most popular items on our website. And this week Tim takes a look at the Vix – the market’s so-called ‘fear gauge’. What’s more, don’t worry if you’ve missed any of Tim’s earlier videos: you can access the archive here.
• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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Have a great weekend!
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