Governmen t vs Hum an Nature

The Quest for Revenue

Since the dawn of time man-kind has been doing battle

with the greedy ruling class be it amonarchy, democracy, dictator-ship, tribal leader or communisticauthority. History is merely a sagaof the trials, tribulations and injus-tices that have always been carriedout by those in power against thosewho inevitably become their sub-jects. This timeless pursuit of reve-nue has littered the journals of his-tory with countless tax revolts, civiluprisings and outright revolutionsthroughout both ancient times aswell as present 20th centuryevents.

Sometimes government has lis-tened to the people and tax revoltshave taken the form of enlightenedwisdom. Figure #1 is an illustrationof a Roman sesterius issued in theyear 119 AD by the EmperorHadrian. The reverse side of Ro-man coinage served a function ofgeneral newspaper. Coins wereoften used to inform the populationof some great victory or new socialprogram and even the opening of apublic works project such as theCol ise um. In thi s ca se, theSesterius depicts Hadrian re-sponding to the frustration of thepeople concerning high taxation.Hadrian gathered all the back taxrecords of the people and took

them to Trajan’s Forum in Romeand burned every last one. This taxrelief wiped out over 900 millionsesteri owed by the people in backtaxes to the previous administra-tion. As a result, Hadrian was oneof the first emperors of Rome toenact a tax amnesty program.

Government’s endless pursuit ofpower and revenue has alwaysgone too far. The climax of thisendless battle has always con-cluded with the abolishment of gov-ernment and its replacement by itsbenevolent reincarnation that ulti-mately becomes the very thing itonce promised to replace. EvenAdam Smith wrote about this prob-

lem in his Wealth of Nations backin 1776.

" It is the highest impertinenceof k ings and ministers to pretendto watch over the economy ofprivate people and to restraintheir expense, e ither by su mptu-ary laws, or by p rohibiting theimportation of foreign luxuries.They are themselves a lways, andwithout excep tion, the greatestspend thrifts in the society. Letthem look well after their ownexpense, and they may safelytrust private peop le with theirs. Iftheir own extravagance does notruin the state, that of their sub-jects never will."

Issue #10 November 1995 Copyright Princeton Economic Institue all rights reserved214 Carnegie Center,Princeton NJ 08540 609-987-9522 Annual Subscription US$49.95

No matter how much we studythe recorded past, somehow,someway government always ig-nores sound advice and deter-mines that it is, in some magicalway, different from all previous in-carnations of authority. At times,government will argue that the pastis totally irrelevant simply becausewe have modern technology in theage of lunar landings. But this argu-ment is merely a smoke screen toallow the self-interest of those inpower to ignore common sense.Nowhere in the debate to they rec-ognize that human nature has notchanged over time. Mothers stillmourn for the death of a son inbattle and the average man on thestreet still resents high levels oftaxation as much today as he did inthe time of Constantine the Great.

Government always fails to seehow it has grown from its own pur-suit of power and revenue trans-forming itself into the very thing itonce pledged to replace. Even theAmerican Revolution sought tooverthrow the greedy monarchy ofBritain through its slogans of "notaxation without representation."Today, the American dream hasbeen transformed into the worstnightmare of our Founding Fathers.Where once a greedy monarchy

tried to extort taxes of 10%, theaverage American now pays morethan 40% in taxes. Americans suc-ceeded in overthrowing a king onlyto replace him with politicians.

This seemingly endless cycle ofbenevolence, corruption, suppres-sion, persecution and revolutionappears to be linked to the darkside of human nature. This is why itis wisely said that while power cor-rupts, supreme power corrupts su-premely. Government has alwayssought to restrain and control thenature of mankind for its personalgain. Even when government hasattempted to control the social be-havior of man, it still fails to suc-ceed. Figure #2 is a Roman Pros-titute token issued around the timeof Tiberius (14-37AD). At the time,Tiberius sought to eliminate prosti-tution by declaring it to be illegal topay a prostitute with money thatbore the image of the Emperor.Since all official coinage displayedthe image of the Emperor, the solu-tion to the problem was clear. Thebrothels issued tokens denomi-nated in units of the Roman As. Theclient merely purchased his tokensand used them to finally pay theprostitute thereby committing no of-fense. The prostitute in turn re-deemed her tokens at the end of

the day with the brothel. Such to-kens were issued for nearly 100years until the law was finallydeemed to be a failure and re-scinded following the Civil War of68-69 AD.

Modern day government stillfails to display any better sense ofcontrolling the masses. When Con-gress decided they wanted to raisetaxes in 1986, one item that theyattacked was interest deductibilityfor car purchases. Instead of col-lecting the intended revenue, thenet result gave birth to the leasingindustry. In business, tax lawssought to require companies to de-preciate assets over greater peri-ods of time even though all theirupfront costs might be paid in thecurrent year. Leasing helped solvethat problem since it eliminated theextended depreciation period byavoiding legal title of ownership.Consequently, the company couldtake the full deduction for its ex-penses in the current year ratherthan over a 3 to 5 year period.These schemes are nothing differ-ent than those employed in count-less recorded situations throughouttime. Like the prostitutes of Rome,we merely transform a transactioninto something else and commercecontinues to go on its merry way.

Sometimes, government reactsquite violently or passes even moresevere laws seeking to get itspound of flesh. While Congresswould certainly disagree, theyplayed a very key role in creatingthe entire S&L crisis. In the 1986tax reform, many deductions forreal estate were eliminated as gov-ernment pursued greater revenue.Suddenly, real estate no longer be-came tax effective and investorsbegan to bail out. Congress cre-ated a one way market where themajority wanted to cash in. Unfor-tunately, since the issue was taxdriven and not economic driven,there were no buyers. Default afterdefault began to unfold as propertyvalues crashed and lenders foundthemselves holding the bag. Con-gress responded by focusing onthe small percentage of fraudcases and tried to blame the privatesector and ultimately tax dollars

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were then spent to bailout the sav-ers.

History warns that days wherepolitical unrest begin to rise to thesurface are directly linked to peri-ods of excessive taxation. In 1381,Wat Tyler was the leader of theKentish peasantry who marchedupon London to petition King Rich-ard I to provide some tax relief. Toa large extent, the rising tax burdenhad been accelerated by the BlackDeath which had killed up to 50%of the laborers over a 50 year pe-riod. The feudal system collapsedand landlords for the first time bidfor workers and paid them in coinrather than in crops. The Kingmerely needed revenue and taxesrose drastically on a per capita ba-sis as he quickly saw a new sourceof revenue - wages. As the peas-antry protested in London, theMayor called out the troops andWat Tyler was slain. The Crownpromised relief from the poll-tax butnever provided it in the end.

Government’s resorting to use offorce to collect taxation still goes ontoday. In Germany, the tax authori-ties surrounded Merril Lynch andtwo other banks earlier this year.The tax authorities were looking forGerman citizens who have placedtheir funds offshore. The tele-phones were blocked, including allcellular phones as the police sur-rounded and cut off all access tothe offices. Brokers were escortedback to their homes where a searchfor any customer files was thenconducted. This single incidenthas had the net opposite effect thatthe German government intended.Instead of frightening the peopleinto paying higher taxes, hugeamounts of capital have been flee-ing to Switzerland. This net capitaloutflow has been so significant,that the cross- rate between the DMand Swiss caused the DM to de-cline and the Swiss to rally. Whatthe German tax authorities don’trealize is that once that capitalleaves due to such police state ac-tion, it is unlikely to return in thenear future. The people have sim-ply lost all confidence in Germanyand can no longer trust it to protectthe basic freedom of privacy.

In Japan the same issue hasaffected the FX markets for theJapanese yen. The sharp massivedecline in the yen in a single monthof over 10% was also due to therising concern that the Japanesegovernment is about to assign taxID numbers to all its citizens. Manyhigh networth individuals from Ja-pan have been flying to the Carib-bean and stopping by our officesalong the way. If this rumor be-comes reality, as it is most likely willnext year, this factor alone couldhelp create a 2 year dollar bull mar-ket going into 1998.

Whenever a government be-comes desperate for revenue, it al-ways burns down the barn to get atthe rat. Even when the US installedthe income tax, it realized thatgiven the Constitution and the safe-guards it contained for the peopleagainst the silent encroachment ofgovernment, it needed to removethose basic rights of freedom. Un-like all other forms of law where youare innocent until proven guilty,when it comes to taxes, you areassumed to be guilty and it is thetaxpayer who must prove his inno-cence. In effect, the IRS can simplyclaim that you owe $1 million dol-lars and you must prove that theyare wrong. If you cannot, well theycan confiscate all your assets.Clearly, there is not much differ-ence between the IRS and the king.

The single greatest lesson thatgovernment needs to learn, regard-less of its political constitution, isthat the people will pay only thosetaxes that they deem to be fair andreasonable. Once government’sdemands exceed such levels offairness, as defined by its own peo-ple, then the battle begins.

While history is littered withcountless episodes of violent con-frontation over taxation, there arealso interesting accounts of totalavoidance of taxation on the part ofthe people. Even today, if we lookat Italy, the economic statisticsshow that the nation is on the brinkof defaulting on its national debt.Yet when you travel to Italy, onecannot help but notice the vibrant

underground economy all conduct-ing business in a world floating withcash. Eventually, a violent clashwill emerge because the peoplehave created a world in which theysimply ignore government. The fi-nancial pressure is then placedupon government, then it will ulti-mately force it to act severely toprevent its own demise. In the end,a national default becomes inevita-ble.

In the United States, the currentflat tax movement is none otherthan government pursuing its en-chanted dream. The idea behindthe flat tax is to ELIMINATE all theloopholes. The flat tax proposalsare NOT tax relief but instead rep-resent tax increases for some, re-ductions for others and merely areshuffling of the tax burden. In re-ality, the flat tax will prove to be thesingle easiest form of taxation toavoid and will open far more loop-holes than it will close. If enacted,the flat tax could result in creatingthe next real big recession.

If you look at a car dealer whomight have several hundred carson his lot, the amount of capital tiedup in inventory is usually far greaterthan the net worth of the dealer.Consequently, his inventory is typi-cally financed by a bank who in turnhas a lien upon the inventory ascollateral. This means that interestmust be a deductible item for busi-ness - particularly those involved indurable goods. Once interest is al-lowed to be deductible for businessbut not on a personal level, thepossibilities become endless. Youcan form a corporation and sellyour home to it thereby enjoyingcapital gains. Then you can rentyour home from the corporationwhich would then be able to deductthe mortgage interest expenditure.Any profits you might wish to shiftinto your corporation could then bepaid back to yourself in the form ofa dividend which would render it taxfree.

The possibilities for reclassifying"earned" income into "unearned"tax free income are endless. Evencompanies can setup an offshoresubsidiary, shift the bulk of its

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manufacture to these offshore ven-tures, import its goods at the high-est possible cost and repay its prof-its back in the form of interest ordividends from the subsidiary com-pletely tax free. The net losers willnot only be the treasury, but alsothe American people who will seetheir jobs migrate to other parts ofthe world.

If government tried to close thisloophole of not allowing corpora-tions to deduct interest as part of itscost of production, then the flat taxwill severely reduce economic ac-tivity rather than enhance it. Busi-ness inventories will need to bereduced drastically in turn reducingmanufacture quite sharply in thenear-term. Eventually, the glut ofinventory will be disposed of butbusiness will need to operate withless inventory in the system. Suchan error would immediately causea recession that might last 2 to 3years before any return to normalactivity unfolds.

The other problem that a flat taxpresents is quite interesting. Whileit is widely recognized that the dis-crimination against capital gainshas resulted in long-term invest-ment moving offshore, the flat taxdoes nothing to restore this trend.If company A offers a 8% dividendand company B offers a 4% divi-dend, investors will flow to the high-est yield. Nevertheless, company Bmight be paying a lower dividendbecause it is spending more capitalon R&D while company A is enjoy-ing short-term gains. Under theDemocrats, capital has beentaught that short-term investment isthe best and punishment will beassociated with long-term invest-ment. After 40 years of such socialengineering, it is highly doubtfulthat we can expect capital to sud-denly change its philosophy with-out some prodding with reversediscrimination of a higher short-term tax rate with a much lowerlong-term tax rate where businessis concerned. But here too, gov-ernment just cannot admit thatmuch of modern technology mayhave been designed in the US, itwas manufactured overseas whereshort-term taxes are high and long-

term investment enjoys almost atax free status.

Taxation is becoming a very ma-jor issue globally. As we move into1996, this issue will singlehandedlybecome perhaps the most impor-tant. Political elections are comingdue everywhere from Russia andIsrael to the UK, Australia and Ja-pan. Of course the US elections willbe a big issue and tax reform willplay an important role as well. Therisk of massive swings in capitalflows globally next year are clearlyrising as tax issues rise to the sur-face in Germany and Japan not tomention Canada and the UnitedStates. Just how this will play out isdifficult to say but the one clear bull

market to emerge will be noneother than volatility.

The flat tax issue in the US ismost likely going to fall flat on itsface as the wealth of loopholes be-gin to emerge. To add spice to theconfusing brew for 1996, we expectthe elections in Russia to turn verynationalistic. By the end of 1996,the old cold war will begin to re-emerge once again. And then thereis Hong Kong due to be handedover in 1997. So welcome to thenew age of volatility, confusion andat times pandemonium. 1996 looksto be the year from Political Hell.

1996 Global Capital Market Conference

April 18-19th Princeton, New Jersey

Keynote Speaker Lady ThatcherCome join us for one of the most important conferences

ever held. Our list of guest speakers will include some ofthe most important political leaders that will help shed somelight upon what we see as the driving forces behind capitaland the geopolitical future that lies ahead for all of us goinginto the next century.

Thursday, April 18th will be a solid day of reviewing ourforecasts for the future as we approach the next turningpoint on our Economic Confidence Model. Friday, we willhave special technical training sessions for those whowould like to continue their education process of under-standing market behaviour. Friday night, we will have abanquet with Lady Thatcher delivering her view of ourgeopolitical future. Other guests will include William Kristol,former Chief of Staff and driving force behind the ContractWith America, Steve Moore of the Cato Institute and more.

Seats are $295.00reservations mandatory

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UNITED STATES

ECONOMIC GROWTH: The USeconomy rebounded vigorously inthe July- September quarter, grow-ing at an annualized rate of 4.2% inreal terms. The third quarter re-bound partly reflected special fac-tors such as a surge in residentialconstruction and heavy purchasesof consumer durables following asharp decline in long-term interestrates. Companies also failed to cutthe rate at which they accumulatedstocks of unsold goods. A stocksoverhang could depress growth inthe fourth quarter.

Consumer spending increasedat an annualized rate of 2.9%,down from 3.4% in the secondquarter. Business capital spendinggrew at an annualized 8.3%against 11.3% in the second quar-ter.

The low inflation component wasas striking as the rapid growth. TheGDP "deflator" - a broad measureof inflation - rose at an annual rateof 0.6%, down from 1.6% in thesecond quarter. A "fixed-weight" in-dex showed inflation at 1.8 downfrom 3.2%.

INDUSTRIAL PRODUCTION:US industrial production fell in Sep-tember for the first time in fivemonths, indicating that economicgrowth is likely to remain moderate.The Federal Reserve said manu-facturing output rose 0.2% in Sep-tember but the increase was notsufficient to offset a large drop inelectricity usage following the re-turn of cooler weather.

Production as a whole fell 0.2%following an erratic 1.1% gain inAugust. The rate of capacity utiliza-tion declined to 83.8% against84.2% in August, a further sign thatinflationary pressures are reced-ing.

Industrial production grew at anannual rate of 3.5% over the thirdquarter, following a decline of 2.3%in the previous three months.

EMPLOYMENT: US payroll em-ployment grew modestly in Sep-tember, providing further evidencethat the economy is returning to astable growth path after weaknessearlier this year. The Labor Depart-ment said non-farm payroll rose121,000 in September.

The employment gain was suffi-cient to hold the jobless rate stableat 5.6%, but not large enough to putupward pressure on inflation. Whilegenerally encouraging, the figuresshowed that job growth remainsconcentrated in the service sector.Employment in services rose106,000 in September, with solidgains in retailing and health care.Construction added 16,000 jobs.

Employment in manufacturing,however, fell 32,000, bringing thetotal job losses since March to200,000. The sector was forced tocut production earlier this year fol-lowing an unexpected rise in inven-tories of unsold goods.

INFLATION: The Labor Depart-ment said consumer prices rose aless than expected 0.1% in Sep-tember. The rate of inflat iondropped to 2.5% a year, from 2.6%in August. The consumer price in-dex was held down by a large de-cline in energy prices and by mod-est declines in clothing and trans-port costs.

RETAIL SALES: The Com-merce Department said retail salesrose 0.3% between August andSeptember, slightly more than ex-pected. That comes after August’sdownward-revised gain of 0.5%,and a July decline of 0.4%. Exclud-ing cars, sales rose a robust 0.7%.The figures showed strength innearly all sectors except cars,which saw a setback after excep-tional strength in August.

INVENTORIES: Inve ntor iesheld by US businesses grew for the17th consecutive month in August,according to the Commerce De-partment, despite the biggest in-crease in total business sales in ayear. Stocks of unsold goods grew0.4% in August to a seasonally ad-justed $969.12 billion following a

revised 0.5% increase in July - withmost of the August rise occurring atthe retail level. Previously, the de-partment said inventories had risenby a smaller 0.3% in July.

Total business sales were up1.5% in August to a seasonally ad-justed $686.09 billion, the biggestincrease since a 3.1% rise in Au-gust 1994.

PURCHASING MANAGERS’INDEX: The purchasing managers’index - a guide to the health of themanufacturing industry - rose to48.3% in September against 46.9%in August. However, it remainedbelow the 50% level predicted bymany economists - the level widelyregarded as marking the thresholdfor growth in the sector.

The figures indicated that the USeconomy is rebounding but growthis unlikely to be rapid enough to putupward pressure on inflation. Thepurchasing survey indicated thatmanufacturing industry has not yetrecovered fully from its troublesearlier this year when excessivelevels of inventories prompted cutsin production and employment. Theindex has been below the 50%threshold for growth in four of thepast five months.

INDUSTRIAL PRODUCTION:US industrial production fell in Sep-tember for the first time in fivemonths, indicating that economicgrowth is likely to remain moderate.The Federal Reserve said manu-facturing output rose 0.2% in Sep-tember, but the increase was notsufficient to offset a sharp drop inelectricity usage following the re-turn of cooler weather, causing util-ity output to drop 5.4%.

Production as a whole fell 0.2%following an erratic 1.1% gain inAugust. The rate of industrial ca-pacity utilization declined to 83.8%against 84.2% in August, a furthersign that inflationary pressures arereceding

DURABLE GOODS: New or-ders for US durable goods rose ahigher- than-expected 3% in Sep-tember, and 8.5% in the year to

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September, signalling solid busi-ness investment growth in spite ofan earlier manufacturing shakeout.

The September increase, whichfollowed a revised 5.1% gain in Au-gust, reflected an erratic 10.8% risein orders for aircraft and othertransport equipment. Electrical ma-chinery orders - including commu-nications equipment - were up5.2%.

HIGH TECH TRADE GAP: Areport published by the AmericanElectronics Association said theUS trade deficit in high technologyproducts and services rose to$11.7 billion in the first half of thisyear, a 56% increase over the firsthalf of 1994. Total exports in-creased 20% to $60 billion, but im-ports rose 25% to $71.7 billion.Much of the increased deficit, ac-cording to the AEA, came from in-creased imports of products fromthe Asia-Pacific region, excludingJapan.

The negative trade balance ofthese countries with the US rose to$15.7 billion, a 27% increase ver-sus the first half of last year. The UShad a positive high technologytrade balance with Europe of $7.6billion, up 15% from $6.6 billion.Trade with Japan showed a deficitof $15.7 billion, up 27%. The AEAsaid that part of the reason for theincreased trade deficit is that somecountries restrict imports of Ameri-can products.

TRADE DEF ICIT: Stronggrowth in exports prompted a sharpand unexpected decline in the UStrade deficit in August according tothe Commerce Department. Thedeficit fell from $11.2 billion in Julyto $8.8 billion in August, its lowestlevel since December. The drop re-flected a 3.7% increase in importsfrom July to $65.7 billion, a recordin cash terms. Strength of exportswas concentrated in capital goodsand cars. Imports were unchangedat $74.6 billion, reflecting the slug-gish growth of US consumer de-mand.

The sharpest improvement re-gionally was in trade with westernEurope. The bilateral deficit with

the European Union dropped to$494 million against $2.7 billion inJuly. The deficit with Mexico fell to$1.1 billion, the lowest since Janu-ary. The deficit wit Japan fell onlyslightly to $5.1 billion.

There is some evidence thatgrowth of exports is overtaking thatof imports. In the first eight monthsof the year, exports of goods grew15.7% relative to the same periodlast year. Imports of goods rose15.4%. The deficit for the year todate was $82.1 bill ion against$70.1 billion in the same period lastyear.

UNITED KINGDOM

TRADE DEFICIT: The CentralStatistical Office reported that theUK’s trade deficit was 1.1 billionSterling in July, up from 868 millionSterling in June, and 772 millionSterling in July 1994. Although theUK recorded larger deficits in Aprilthis year and December 1994,these months were affected by er-ratic imports of cruiser ships andartwork. July’s deficit was also ad-versely affected by lower levels ofoil sales and swings in the diamondtrade. Meanwhile, currency swingsleft export prices rising faster thanimport prices, improving the bal-ance slightly.

The data fueled fears that theimprovement in trade seen earlierin the recovery may now be comingto an end. With growth in importsnow outstripping underlying exportgrowth, the CSO admitted "the lat-est estimate of the trend suggeststhat the UK whole world deficit iswidening".

EXPORTS: British exports tothe US fell a seasonally adjusted11.1% in the three months to July,compared with the previous threemonths, according to the CSO.However, exports to Germany rose9.5% in this period while sales toBelgium, Holland and the Nether-lands grew by 10.6%.

The data suggests that tradersare seeing a growing divergence

between different regions as worldgrowth patterns shift. The CSOsaid volume of UK exports, meas-ured overall, was 12.7 billion Ster-ling ($20.1 billion) in July, un-changed from the previous month.On a three-monthly basis, exportswere 2.6% higher in the threemonths to July, compared with theprevious three months. Becauseexport prices rose 3.2% in this pe-riod, the actual rise in export vol-umes was only 0.7%.

CAR EXPORTS: The CSO saidexports of cars from the UK to therest of the world were a seasonallyadjusted 18% higher in the threemonths to July than a year before.However, in a shift that suggeststhe trend is turning, exports fell11% between the three months toApril and the three months to Julyof this year.

Exports to the EU accounted formuch of the fall, dropping by 13%in the period. Exports to non-EUcountries - which account for about30% of overseas sales - also fell by5% in the same period.

ECONOMIC GROWTH: Th eCentral Statistics Office said grossdomestic product in the threemonths to September was 0.5%higher than in the previous threemonths. This was the same rate ofexpansion as in the previous quar-ter and the fourteenth successivequarter of growth.

The annual rate, however,slipped back in the year to the thirdquarter to 2.4% from 2.8% in theyear to the previous quarter. Thiswas the slowest annual rate ofgrowth for more than two years andin line with rates which have beensustainable in the past withoutpushing up inflation.

While the manufacturing sectorcontinued to display signs of weak-ness, the service sector remainedrobust, notwithstanding recentweakness in retail sales. The CSOsaid service sector output grew by0.7% between the second and thirdquarters and was 3.2% higher inthe latest quarter compared withthe same quarter a year earlier.

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MANUFACTURERS OUTPUT:Manufacturers stepped up theirproduction in August, reversing thedrop in output seen in July. Butwhile car manufacturers, comput-ing and soft drinks raised produc-tion, other sectors such as machinetools and pharmaceuticals re-ported declining activity. Althoughmanufacturing expanded stronglylast year, it slowed earlier this yearamid slower export growth.

CAR OUTPUT: Car productionfell in September for the first time in15 months as manufacturers re-acted to sales in August that disap-pointed hopes of a strong recoveryin Mainland European markets.Car output for the first three quar-ters of the year nevertheless re-mained 7% higher than in the sameperiod of 194 and is still on courseto reach the highest yearly total fortwo decades.

The Society of Motor Manufac-turers and Traders said the figuresfrom the CSO were disappointing.Total UK car output in Septemberwas 111,182, down 11.2% fromSeptember 1994. Output for ex-port, at 54,423, was 2.3% lowerthan a year before.

PURCHASING MANAGER’SINDEX: The purchasing managerindex, which surveys business ac-tivity, fell in September to its lowestlevel for three years. The data fu-elled suspicions that manufactur-ing output has eased in recentmonths.

Measured overall, the purchas-ing manager’s index, which con-sists of data on stocks, output, de-mand, delivery times and employ-ment, fell to a seasonally adjusted50.5% in September. Since any fig-ure above 50% indicates month-on-month growth, the data sug-gested that manufacturing activityhad expanded slightly between Au-gust and September. However, therate of expansion was the slowestseen for three years, and a break-down of the data suggested thatthis easing in growth had been as-sociated with company destocking.

The level of purchases by com-panies from other companieseased. The level of new orders re-ported by companies fell back be-tween August and September.Overall output was reported tohave risen slightly between Augustand September.

The survey of some 300 manag-ers suggested that a lower level ofdemand and orders is promptingmany companies to sell off stock.Although the survey suggested thatsome price pressures in industryare easing, this did not entirely allaythe City of London fears that infla-tionary pressures could reappearnext year if demand recovers.

MANUFACTURING GROWTHRATE EASING: Two business sur-veys reported that orders were nowrising at a slower rate. The BritishChambers of Commerce said theproportion of companies reportingincreased levels of sales had fallenin the last quarter. The BCC surveyof some 7000 companies, con-ducted in September, found thatthe proportion of manufacturingcompanies reporting higher exportsales, compared to those reportinglower ones, was a positive balanceof 29%. This was down from theprevious quarter’s level of 35%,with a similar slowdown reported inthe growth of export orders.

Dun and Bradstreet, the busi-ness information group, said thatbusinesses were now considerablyless optimistic about the outlook forprofits, sales, new orders and ex-ports.

SKILLS SHORTAGES - PAYRISES STEADY: According to asurvey by DHL, the express deliv-ery group, almost half of all Britishexporters are experiencing skillsshortages. However, the surveynotes that with shortages concen-trated in a few specific areas ofmanufacturing, they are having lim-ited pressure on overall wage lev-els.

Surveys from the Confederationof British Industry, the UK’s largestemployer’s organization and In-come Data Service also report that

pay settlements show little sign ofsignificant acceleration, with thelow level of public-sector settle-ments keeping the average rate ofwages growth below the level ofinflation.

The CBI reported that manufac-turing pay awards averaged 3.5%in the three months to September,fractionally up from 3.4% recordedin the three months to June, andhigher than the 3% seen in thesame period last year. Service sec-tor awards averaged 3.4% in thethree months to September, downfrom 3.9% a year before.

The IDS data noted that mostpublic sector settlements were be-tween 2% and 3%, while of the 95private-sector settlements moni-tored only half were more than3.5%

VISITOR SPENDING: T heamount spent by tourists at UK visi-tor attractions last year exceededBP1 billion ($1.5 billion) for the firsttime and represented a 5% in-crease on the previous year, ac-cording to the English TouristBoard. The number of visits to bothadmission charging and free attrac-tions increased by 2% to 387 mil-lion last year, with overseas visitorsaccounting for 19%.

GERMANY

TRADE BALANCE: Germany’strade in July continued to shrug offthe effects of the strong D-Markearlier this year, with exports risingby 3.6% compared with July 1994to DM 56 billion ($38 billion). TheFederal Statistics Office said im-ports declined over the same pe-riod by 0.8% to DM50.1 billion,leaving a visible trade surplus forthe month of DM5.9 billion com-pared with DM3.6 billion in July lastyear. According to provisional Bun-desbank calculations, Germany’scurrent account balance of pay-ments was DM5.9 billion in deficitin July because net paymentsabroad for services and transferswere double the visible trade sur-plus. In July 1994, Germany’s cur-

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rent account showed a DM11.2 bil-lion deficit. The visible trade sur-plus rose to DM51.7 in the firstseven months from DM41.9 billion.The statistics office also reportedthat German wholesale turnover inAugust fell by 1% in real, season-ally adjusted terms from July. How-ever, it was 3% higher in real termsthan in August last year.

EMPLOYMENT CONCERNS:Growing unemployment prompteda worried government to declarejob creation as its "central task".The number of unemployed grew inSeptember a seasonally adjusted48,000 to about 3.5 million, or 9.2%of the workforce. Since February,the jobless total has increased100,000, despite an estimated2.5% increase in gross domesticproduct. High labor costs have ledmanufacturers and other industriesto slash jobs and boost productivityby operating with fewer workers.

In west Germany, unemploy-ment increased by 14,000 and inthe east by 34,000, according to theFederal Labor Office. The joblessrate in eastern Germany was un-changed from a year ago at 13.8%.

INDUSTRIAL ORDERS: Neworders for German industry in Au-gust fell following a strong rise amonth earlier, but the governmentand analysts warned that the fig-ures should be treated with cautionbecause of a recent changeover inthe way they are calculated. TheAugust figures may also be un-representative because they wereaffected by the summer holidays,the ministry said.

August new orders fell 2.4%compared with July and slipped0.2% compared with the same pe-riod a year earlier. A more repre-sentative measurement - the com-bined figures for July and Augustcompared with the same period lastyear - showed that foreign ordershad risen 4.7% while domestic or-ders had fallen 1.3%.

WHOLESALE PRICES ANDINFLATION: West German whole-sale prices rose by 0.4% month-on-month in September after falling

0.5% in August. The year-on-yearrise was 1.3%, compared to 1.0%last month.

West German inflation fell a pro-visional 0.1% in October on the pre-vious month for the second monthrunning and remained stable at a nannual 1.6%.

REVISED F ACTORY OR-DERS: Germany said growth innew orders received by manufac-turers in the first half was muchlower than previously estimated.The Economics Ministry slashedits estimate of order growth in the6-month period to 3%, down from apreviously estimated 3.8%.

WEST GERMAN OUTPUT:Manufacturers in Western Ger-many expect a marked slowdownin output next year, according tosurvey from the Munich-based Ifoeconomic research institute.

A poll of 350 companies employ-ing more than a quarter of the re-gions manufacturing labor force

TAX REVENUE SHORTFALL:According to the government’s taxforecast committee, slower eco-nomic growth and higher demandfor investment subsidies in easternGermany will cause a shortfall ofDM11.4 billion ($7.7 billion) in 196tax revenues.

The DM11.4 billion shortfall fromthe committee’s last estimate inMay is higher than the DM10 billionprojected in September by Mr.Theo Waigel, the finance minister,and is likely to make it difficult forthe government to keep within theplanned 1996 budget deficit ofDM60 billion.

The tax committee, which meetstwice a year said all levels of gov-ernment would be missing a com-bined DM26.1 billion this year anda total of DM29.4 billion next yearbecause of lower revenues. Antici-pating the shortfalls, Mr. Waigelhas ordered spending restrictionsat all ministries, demanding a thatany expenditure over DM1 millionhad to be cleared by the financeministry.

TAX PROBE: German ta xauthorities have stepped up theirinvestigations into people sus-pected of evading tax by sendingmoney abroad, prompting sharpcomplaints from two of the coun-try’s leading banks. Tax investiga-tors said up to 2,000 clients of Com-merzbank were being investigatedfor possible offences.

The cases, like those at severalother German and foreign bankswhich have been visited by tax offi-cials, center on the 30% withhold-ing tax levied by the German gov-ernment on investment income andattempts by private investors toavoid paying this. It is not illegal toinvest money abroad, but the earn-ings on such investment must bedeclared for tax.

GERMAN GROWTH FORE-CAST: German consumer spend-ing will recover next year but eco-nomic growth will be a modest2.5% because of the building boomthat followed unification in 190 willcome to an end, according thecountry’s main economic institutes.

The institutes warned that theslowing of demand in the construc-tion industry, especially in easternGermany, meant unemploymentwas likely to remain above 9%, butthey are expecting stronger eco-nomic growth in the second half ofthe year. They also warned thegovernment would find it difficult tokeep the budget under its DM60billion ($43 billion) target next year.Slower-than-expected economicgrowth this year will contribute to ashortfall in tax revenue that the gov-ernment estimates at DM20 billionover this year and next.

The controversial "solidarity" in-come tax surcharge re-introducedthat year to finance the soaringcosts of unification was unlikely tobe lifted soon because easternGermany was still dependent onassistance. Transfers to the east,according to the institutes, will totalDM194 billion. The Federation ofGerman Chambers of Industry andCommerce said the report con-firmed that " the blockade of growth

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forces through excessive taxes andlevies is continuing" The federationwared that the solidarity tax andhigher social insurance costswould dampen investment andwork against growth.

INDUSTRIAL PRODUCTION:German industrial production inAugust was weaker than expected.Seasonally adjusted industrial pro-duction fell 3.4% compared withJuly, and was down by 0.9% com-pared with a year earlier. At thesame time the economics ministryrevised its July industrial produc-tion figures downwards to 1.7%,from a provisional 3.3%.

WEST GERMAN OUTPUT EX-PECTATIONS: According to a sur-vey from the Munich-based Ifo eco-nomic research institute, manufac-tures in western Germany expect amarked slowdown in output. A pollof 350 companies, employing morethan a quarter of the region’s manu-facturing labor force, indicated thatoutput would grow by an average of2% next year after nearly 5.5% in1995. However, during 1996 pro-duction should exceed the previousrecord level reached in early 1992before the recession of 1993.

Ifo said the investment goodssector was expected to show thefastest output growth this year, forthe first time this decade. It shouldcontinue to lead production growthnext year, but at a slower rate. Out-put of the raw material and produc-tion goods sector would continue togrow until late 1996, when a declineis expected to set in. Output of con-sumer goods and consumer dur-ables was expected to stagnate un-til the middle of next year, with pro-duction in labor intensive sectorssuch as clothing and shoes suffer-ing from plant closures and transferof production to low-cost areasabroad.

MONEY GROWTH: The Bun-desbank said M3 rose at an annual-ized rate of 1.5% in Septemberover the fourth quarter of 1994,compared with 0.8% the previousmonth and only 0.3% in July.

JAPAN

IMPORTED VEHICLE SALES:September sales of imported cars,trucks and buses in Japan surged20% to 35,966 from a year earlier.Of the total, 33,715 foreign-madeautos were sold, up 23%, whiletruck sales fell 8.7% o 2,250. Im-ports increased for the 23rd straightmonth because of lower prices re-sulting from a stronger yen and for-eign producers’ expanded Japa-nese sales networks, while overallvehicle demand has stalled. Thisyear through September, importedvehicle sales c limbed 28% to284,706.

MACHINE ORDERS: Privatemachinery orders in Japan fell inAugust for the second month run-ning, according to the EconomicPlanning Agency. Private sectormachinery orders, excluding thosein the shipbuilding and electricpower industries, dropped 3.9%month- on-month because of a8.3% fall in demand from the manu-facturing sector.

The fall follows a 6.3% decline inJuly. Compared with machinery or-ders in the same month a year ago,August showed a 2.4% growth. Ifgovernment orders and orders fromabroad are included, the Augusttotal was 5.9% up from the previousmonth, and 5.5% up from a yearago.

ECONOMIC GROWTH: Mr.Isamu Miyazaki, director general ofthe Economic Planning Agencysaid Japan’s economy is expectedto recover early next year in re-sponse to record low interest rates,a weaker yen, and increased publicspending.

The government’s chief eco-nomic forecaster’s comments ac-companied the EPA’s l atestmonthly report, which gave a bleakpicture of the present state of theeconomy. The report said the econ-omy still shows "signs of weak-ness". It cited as evidence a contin-ued rise in stocks of unsold goodsand materials in the steel andchemicals industry, record unem-

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ployment, slower export growthand slower growth in housingstarts. Steel and chemicals inven-tories both rose in response toweaker demand from the car andhousing industries.

A report on bankruptcies under-lined the grim situation. The num-ber of corporate collapses in thefirst half of the fiscal year rose by9.3% to 7,549, the worst s ixmonthly toll for nine years. Theyinclude 21 subsidiaries of HyogoBank and Kizo Shinyo Kumai,which collapsed in August.

However, Mr. Miyazaki was en-couraged by growing investment innew plant in the electronics andmachinery industries. The EPA re-port said that September’s Y14,220billion pump priming package andrecord low official discount rate of0.5% would "combine well" tostimulate activity.

MONEY SUPPLY: Japanesemoney supply grew at an annual2.8% in September, from a revised2.9% in August, according to pre-liminary report by the Bank of Ja-pan. The sedate growth in bench-mark money supply, M2 plus certifi-cates of deposit, came in spite of aradical easing of monetary condi-tions in September. The Bank ofJapan cut the official discount rateon September 8 to 0.5%, the lowestof any leading economy in post-waryears and drove money marketrates even lower. However, a BOJofficial said it was too early to judgethe impact of the rate cuts.

A broader measure of liquidity,also including postal savings andgovernment bonds, grew at 3.8% inSeptember, compared with 3.6% inAugust.

TRADE SURPLUS: Japan’strade surplus fell 5.1% in the sixmonths to September, as slowerexport growth to the US was partlyoffset by a sharp rise in trade withthe rest of Asia. The third succes-sive year-on-year fall, to $56.18 bil-lion, was driven by a rise in imports,up nearly a quarter in the first halfof the fiscal year, and helped by thestrength of the yen, which has

made foreign goods cheaper thandomestic products.

A decline in car exports was themain factor in the first six- monthlyfall in four years in Japan’s tradesurplus with the US. The bilateraltrade gap fell by 13.9% to $23.3billion during the six months.

The trade surplus with the rest ofAsia, Japan’s fastest growing in-vestment and export market, rose21.4% for the 11th half-year run-ning, to $38.07 billion, nearly two-thirds more than the surplus withthe US.

The September surplus fell5.8%, year-on-year, to $11.3 billionlast month. The surplus with the USdeclined 23.9% to $4.4 billion. Asharp slowdown in export growth,to 6.9% last month, from 12.6% inAugust, was the main surprise toeconomic analysts.

VEHICLE EXPORTS: Japan’smotor-vehicle exports for the sixmonths ended Sept. 30 fell 16%from a year earlier to 1.8 millionunits, the lowest level since 1975.Of the total, auto shipments fell14% to 1.4 million vehicles, andexports to the US slumped 27% to614,557. Spurred by the strongeryen, Japanese auto makers havemoved more production abroad.

YEN POLICY COST: The Bankof Japan spent the best part of$13.7 billion in September in itsattempt to revive the stagnanteconomy by driving down the yenagainst the US dollar. That figurerepresents the increase in the cen-tral bank’s foreign exchange re-serves in September, to set a worldrecord, for the eighth month run-ning, of $179.86 billion, accordingto the finance ministry. The bulk ofthe increase, an estimated $11 bil-lion, came from market interven-tion, with the remainder from profitson managing the banks own funds.

FRANCE

TRADE SURPLUS: France hada FFr9.06 billion ($1.8 billion) tradesurplus in August, a sharp rise overthe previous month’s FFr4.47 bil-lion. The official figures, which tookthe surplus for the first eight monthsof the year to FFr72.5 bil lion,against FFr47.7 billion in the sameperiod in 1994, demonstrated theresilience of French exports. Ex-ports rose from FFr113.2 billion inJuly to FF118.6 billion, includingabout FFr2.5 billion from Airbussales. The trade surplus with Euro-pean Union partners rose fromFFr1.7 billion in July to Fr3 billion.Deficits with Japan, Germany andthe US, all shrank. In terms of prod-ucts, agricultural goods expandedtheir surplus, as did industrial andmilitary equipment.

INDUSTRIAL PRODUCTION:French industrial production inJuly/August rose 0.2%, after a fallof 0.3% in June.

MONEY SUPPLY: French M3money supply rose 0.9% in August,after the July figure was revised to0.9% from a provisional 1.0% rise.

SOCIAL SECURITY SYSTEMDEFICIT: According to an officialaudit committee, the deficit in theFrench social security system is ex-pected to reach FFr64.5 billion($13.24 billion) this year, which ishigher than previously forecast.

According to the Commision desComptes, the combined deficit inthe three main branches of the wel-fare system - Healthcare, pensionsand family allowances - will beabout FFr2.5 billion higher thanforecast in the July report. The ex-pected total shortfall of Fr64.5 bil-lion compares with a deficit ofFFr55 billion last year.

The report by the Commisiondes Comptes confirmed the gravityof the french financial problems. Itcomes at a time that prime ministerAlain Juppe is preparing reformsaimed at eliminating the deficit by1997. The issue is regarded as oneof the most important challenges

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facing his administration as a re-duction in France’s deficits isneeded to enable lower interestrates and to satisfy the conditionsfor European monetary union.

Mr Juppe has said he aims to cutthe deficit to FFr30 billion next yearand to zero in 1997. Measures areexpected to include an increase inthe rate or scope of the CSG, a taxon most forms of income, in-

creased contributions from welfarerecipients and spending curbs inhospitals.

Although all the branches of thewelfare system are in deficit, it isthe health insurance system whichaccounts for most of the shortfall.The gap between receipts and ex-penditure in the national health in-surance scheme is expected toreach FFr36.5 billion this year,

about FFr1 billion more than pre-dicted in July. The increase partlyreflects a continued rise in healthexpenditure, despite governmentpressure for restraint in prescrip-tions by general practitioners.

BASE LENDING RATES RISE:France’s biggest commercialbanks announced they were rais-ing their base lending rates from7.9% to 8.2% - a move which will

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add to fears about a slowdown inthe French economy. The move fol-lowed an increase in French mar-ket interest rates and a key officialinterest rate as investors have ex-pressed concern about Frencheconomic policy, and about thegovernment’s ability to achieve itsdeficit reduction targets.

DEFICIT REDUCTION PRIOR-ITY: President Jaques CHIRAC setthe reduction of France’s publicdeficits as a precondition for all hisgoals for the country, including join-ing Germany

AUSTRALIA

CURRENT ACCOUNT DEFI-CIT: Mr. Kim Beazley, Australia’sfinance minister, said the federalgovernment would revise down-ward its current account deficitforecast for 1995/96 in Januarynext year. In the May budget, thegovernment indicated that it ex-pected a current account deficit ofA$27 billion ($20.6 billion) in thecurrent f inancial year - l ittlechanged from the 1994/95 figureand about 5.5% of the gross do-mestic product. However, the slow-down in the economy, coupled withimprovement in prices for commod-ity exports and the ending of theeastern states’ drought has lead toan improvement in the trade posi-tion. Most analysts expect a1995/96 trade deficit of aroundA$22 billion.

INFLATION WARNING: Aus-tralia’s Reserve Bank, the country’scentral monetary authority reiter-ated a warning that annual inflationwas expected to increase in theyear ahead and, even on an "un-derlying" basis, exceed 3%. But itis said this would not be "inconsis-tent with the bank’s inflation objec-tive, provided inflation returns tothe 2-3% range within a reasonabletime". The bank, in its October bul-letin, added that the slowdown inAustralia’s economic growth rate,coupled with the recent recovery inthe Australian dollar, should be"more conducive to price stability".

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