China’s changed priorities signal end to stimulus

China’s ‘One Belt, One Road’ project and the need to reduce pollution have replaced “growth at any price” as key government priorities, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

OBOR demographics May17

Companies and investors are assuming it is “business as usual” in China ahead of the important 19th National Communist Party Congress in October. They look back to the 2012 Congress, and imagine the Party’s leaders are again focused on ensuring economic stability. But in reality, 2012 was the exception not the rule, as it featured two potentially very destabilising events for Communist Party rule:

□  The arrest and subsequent trial of Bo Xilai for corruption. Bo was a very senior Party figure (a so-called Princeling whose father was one of the Party’s “Eight Immortals”), and had been expected to join the Politburo Standing Committee at the 2012 Congress. His wife was separately convicted of murdering British businessman Neil Heywood.
□   The intervention of former president Jiang Zemin in the final preparations for the leadership change. This became essential after President Hu’s top aide was involved in a scandal where he endeavoured to cover up the death of his son — who crashed while driving a Ferrari at high speed through Beijing, accompanied by a woman who also died of her injuries.

No such dramas have occurred this year. And as the chart shows, there has been no need to boost the economy via a repeat of the 50 per cent increase in monthly stimulus lending seen in 2012. Instead, growth in total social financing has actually been slowing.

TSF May17

Companies and investors need instead to focus on the two new areas being promoted by President Xi ahead of his nomination for a second five-year term.

The first is his signature “One Belt, One Road” (OBOR) project. Many have assumed this is simply a mechanism for tackling China’s over-capacity in steel and cement. A measure of its real importance can be seen from the fact that the recent OBOR Summit in Beijing was attended by 20 national leaders and more than 100 countries. It connects 64 countries accounting for 62 per cent of global GDP and has two critical elements:

□  It positions China to resume its geopolitical role as the Middle Kingdom, with the One Belt creating a land link from China to Europe, while the One Road creates a maritime link between the South China Sea, the South Pacific Ocean and the Indian Ocean.
□   Economically, as the map shows, it connects China’s ageing population (its median age will be 43 years by 2030) with the much younger countries along the Belt and Road. Most of them have median ages between 17 and 30 years. The OBOR project enables China to benefit from the demographic dividend potentially available to its neighbours.

OBOR is thus critically important for China as it seeks to avoid becoming old before it becomes rich.

The second new policy is Xi’s decision to move away from the “growth at any price” policies of his predecessors. He knows that reducing pollution, rather than maintaining economic growth, has become key to continued Communist Party rule.

As Alan Clark noted in beyondbrics, “environmental sustainability is rapidly moving up the agenda . . . (as) heavy palls of industrial smog have almost become the norm in some Chinese cities”.

The recent rapid elevation of Beijing’s mayor, Cai Qi, to become party chief for the city is further confirmation of the high priority now being given to tackling air pollution and stabilising house prices.

Taken together, these policies represent a paradigm shift from those put in place 40 years ago by Deng Xiaoping after Mao’s death in 1976. This shift has critically important implications, as it means growth is no longer the main priority of China’s leadership. In turn, this means that stimulus programmes of the type unleashed in 2012, and on a more limited basis by Premier Li last year, are a thing of the past.

Xi’s new priorities have already led to renewed weakness in commodity markets. Their full-scale implementation will probably reconfirm Napoleon’s famous warning that “China is a sleeping giant. Let her sleep, for when she wakes she will move the world.” 

The global economy’s best leading indicator forecasts a downturn

NewIf you want to know what is happening to the global economy, the chemical industry will provide the answers. It has an excellent correlation with IMF data, and also benefits from the fact it has no “political bias”.  It simply tells us what is happening in real-time in the world’s 3rd largest industry.  The chart above confirms the extremely high correlation:

   It shows annual GDP % growth figures from the IMF on the vertical axis from 2000, including the 2016 forecast
   The  horizontal axis shows the annual change in Capacity Utilisation % data for the global chemical industry

The correlation is remarkable at 88%.  Nothing that I have ever seen comes anywhere close to this level of accuracy.

The logic behind the correlation is partly because of the industry’s size.  But it also benefits from its global and application reach. Every country in the world uses relatively large volumes of chemicals, and their applications cover virtually all sectors of the economy, from plastics, energy and agriculture to pharmaceuticals, detergents and textiles.

ACC all Jan17

We can also use the data to look forward, given its timeliness, as the ACC also produce detailed reports on the major Regions and countries.  And as the second chart shows, the outlook is unfortunately not good:

   N America’s recovery since 2014 has faded away, and is at -1%; Latin America is very weak at -3.9%
   W Europe has also slowed to 1.6%; Asia has collapsed from 7.5% in 2014 to just 1.4%
   The Middle East/Africa has halved from 5.3% to 2.7%; only Central/Eastern Europe has grown, from 1.9% to 4.4%

This rather negative picture is in complete contrast with the official views of forecasters such as the IMF.   They currently suggest that global growth will rebound from 3.1% in 2016 to 3.4% in 2017, and then move higher.  But sadly, their optimism has been wrong for the past few years, as I noted in my Budget Outlook in October.

They have forecast a similar recovery every year since 2011, but growth has continued to slow.

The problem is that their models ignore the influence of demographics, and today’s ageing populations, on demand. The result, as the deputy chairman of the US Federal Reserve, Stanley Fischer, observed in 2014 is that:

Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back.”

Clearly, it is encouraging that economists such as Andy Haldane at the Bank of England now recognise that demographics “have been under-emphasised for too long“.  We can certainly hope that future forecasts may start to take account of the fact that older people do not consume as much as when they were young.

But in the meantime, it seems wise to take the chemical industry data very seriously.

It is clearly suggesting that the global economy is moving into a downturn. And whilst we must all hope this turns out to be wrong, hope is not a strategy.  We also cannot ignore the major upheavals now underway in economic policy in both the USA and the UK, with President Trump taking office and the UK starting to leave the European Union.

These developments may well produce good results in the longer term.  But in the short-term, they create major uncertainty.  And if we look across the G20 countries – such as China, Russia, Brazil, India, S Africa, Saudi Arabia and Turkey – many are experiencing from similar political and economic uncertainty.

Uncertainty usually makes everyone – companies and consumers – more cautious in their spending. And lower spending inevitably means less growth.

S&P 500 volatility close to 43-year lows as uncertainty rises

Something very strange is happening in US stock markets, as the above chart highlights:

  It shows weekly (blue line) and average quarterly (red line) volatility in the US S&P 500 Index since 1928
  Both are very close to 43-year lows, going back to September 1973, at 1.7% and 1.6% respectively

This seems quite extraordinary, given the volatility seen in other financial markets, and rising political uncertainty:

  Interest rates have been rising rapidly: the US 10 year Treasury rate is up by a third since July to 1.8%
  The US Presidential election is clearly one of the most bitterly fought in decades
  Globalisation appears to have stalled: the EU-Canada deal only just managed to gain approval last week
  And, of course, there are growing concerns about what will happen when the UK triggers Brexit negotiations in Q1

There are a number of potential explanations for the lack of volatility.

One is that traders have become used to taking direction from the US Federal Reserve.  As the Fed is clearly on hold at the moment, waiting for the outcome of the Presidential election, traders have nothing to guide them and so are unwilling to take a position.  If the market moves up a few points, they therefore sell off – and vice versa.

A second is that markets are perfectly priced, with all possible uncertainties balancing each other out, and there is no justification for anyone to try and push the market higher or lower.

A third could be that markets are moving back to the lower volatility levels that were common before 1973.  Certainly, financial flows have been reducing.  Regulators have demanded that the banks hold much higher levels of reserves to back their trading activity – making this less attractive for them, by reducing their ability to leverage their bets.

A fourth could be that traders are simply terrified of making a mistake this close to the end of the year.  Players have nothing much to gain, and a lot to lose, given that they are only weeks away from receiving their annual bonus.

Probably all of these explanations contain some element of truth.  And it is also true that it is generally more profitable to follow the trend, rather than to be a “hero” or “heroine” by placing large bets on an essentially unknowable outcome.

The latest IeC Boom/gloom Index above confirms the sense of uncertainty.

The Index is trading within the 4 – 6 band, where the Fed has previously moved in to support prices with new stimulus. It therefore suggests a fifth possibility, that markets could be very vulnerable if such support does not appear.  The start of the Great Reckoning may perhaps not be very far away.

Budgeting for the Great Reckoning

imf-2016One thing is certain about the 2017 – 2019 Budget period. ”Business as usual” is the least likely Scenario to occur. The IMF chart above highlights the key issue: for the past 5 years, all its forecasts of a return to “normal” levels of growth have proved over-optimistic:

 Back in 2011, the IMF was forecasting growth of almost 5% in 2016
 It was still forecasting 4% growth as recently as 2013
 Today, however, it is forecasting just 3.1% as the actual out-turn for 2016

This false optimism has now created some very negative consequences:

 Companies committed to major capacity expansions during the 2011 – 2013 period, assuming demand growth would return to “normal” levels
 Policymakers committed to vast stimulus programmes, assuming that the debt would be paid off by a mixture of “normal” growth and rising inflation
 Today, this means that companies are losing pricing power as this new capacity comes online, whilst governments have found their debt is still rising in real terms

This is the Great Reckoning that now faces investors and companies as they plan their Budgets for 2017 – 2019.

Even more worrying is that most people began work after the start of the BabyBoomer-led economic SuperCycle in 1983. They have no experience of living through today’s more uncertain economic, political and social times:

Economics. Many major countries have already seen growth disappear (Brazil and Russia of the BRIC nations)
Politics. Populists are gaining support everywhere, as people feel failed by current political leaders
Social. Tolerance is breaking down, particularly with regard to immigration


The second chart explains why the IMF have been wrong. It shows the change that has taken place in the population of the Most Developed Regions (Northern America, Europe, Australia/New Zealand and Japan) since 1950. The Regions dominate the global economy with 57% of total global GDP in 2016 ($43tn out of $75tn).

1950. There were 320m in the Wealth Creator 25 – 54 cohort that drives economic growth, and they were 39% of the population. By comparison, there were only 130m in the over-55 cohort (16%), where spending declines as older people already own most of what their need, and their incomes reduce as they enter retirement
2016. Today, there are 515m in the Wealth Creator cohort (41%). But the number of over-55s (the New Old 55+ segment) has trebled to 390m, and they are nearly a third of the population
2030. The UN forecasts there will be 475m in the Wealth Creator segment (37%), almost exactly the same as the 460m New Olders (36%)

The key issue is changing demographics:

Fertility rates. These have been below the replacement level of 2.1 babies/woman for the past 45 years
Life expectancy. Someone aged 65 can now expect to live for another 20 years

As I noted in my Financial Times letter on Friday:

“It is good to see that the US Federal Reserve is finally beginning to address the impact of demographics on the economy, after years of denying its relevance. But its continued focus on supply-side issues means it is looking down the wrong end of the telescope… Policymakers need to urgently refocus on the demand-side implications of ageing, if they want to craft suitable policies for this New Normal world.”

The problem, of course, is that it will take years to undo the damage that has been done. Stimulus policies have created highly dangerous bubbles in many financial markets, which may well burst before too long. They have also meant it is most unlikely that governments will be able to keep their pension promises, as I warned a year ago.

Of course, it is still possible to hope that “something may turn up” to support “business as usual” Budgets. But hope is not a strategy. Today’s economic problems are already creating political and social unrest. And unfortunately, the outlook for 2017 – 2019 is that the economic, political and social landscape will become ever more uncertain.

I always prefer to be optimistic. But I fear that this is one of those occasions when it is better to plan for the worst, even whilst hoping that it might not happen. Those who took this advice in October 2007, when I suggested Budgeting for a Downturn, will not need reminding of its potential value.

Chemical industry is the best indicator of EM outlook – and the outlook is not good

Policymakers would be better off following the fortunes of the chemical industry, if they wanted to forecast the global economy, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Capacity utilisation (CU%) in the chemical industry has long been the best leading indicator for the global economy. The IMF’s recent downward revision of its global GDP forecast is further confirmation of the CU%’s predictive power. As the first chart shows, the CU% went into a renewed decline last October, negating hopes that output might have stabilised. March shows it at a new low for the cycle at just 80.1 per cent, according to American Chemistry Council (ACC) data.

By comparison, the CU% averaged 91.3 per cent during the baby boomer-led economic supercycle from 1987 to 2008. This ability to outperform conventional economic models is based on the industry’s long history and wide variety of end-uses. It touches almost every part of the global economy, enabling it to provide invaluable insight on an almost real-time basis along all the key value chains – covering upstream markets such as energy and commodities through to downstream end-users in the auto, housing and electronics sectors. Chemical industry production growth provides similar real-time insight into the major economies, using a year-on-year comparison. Current data for the Bric economies is particularly revealing, as the second chart highlights.

China’s post -2008 stimulus programme had provided critical support for all four countries. But as discussed on beyondbrics last year, China’s adoption of its New Normal economic policies during 2013 initiated a Great Unwinding. Chemical industry production growth has nearly halved since 2014 to just 5.7 per cent a year today. And as discussed last month, much of this output is now aimed at boosting exports (to preserve jobs) rather than to supply domestic demand. There are an increasing number of key products where China has moved from being the world’s major importer to a net exporter – with a consequent negative effect on margins.

Brazil was the early loser from China’s change of economic direction. Its monthly output declined very sharply in early 2014 as China’s stimulus-related infrastructure and construction demand slowed, and growth turned negative in June 2014. Output then staged a minor recovery in the middle of 2015, but has since fallen back to -4.6 per cent again. Brazil now no longer needs to import major polymers such as polyethylene, and has instead become a net exporter.

Russia was similarly impacted by China’s policy reversal, and its monthly output went negative in mid-2014. The collapse of the rouble then temporarily mitigated the downturn, by supporting exports and increasing the attractions of local production versus more expensive imports. But output growth has since staged a precipitate decline since last summer, falling by more than two-thirds from September’s peak of 14.9 per cent to just 4.2 per cent in March.

India has seen similar volatility. Output growth turned negative during 2014, but then staged a mild recovery in 2015 before a renewed decline took place, leaving March output barely positive at 0.4 per cent. In principle, India’s domestically oriented economy should make it more resilient to China’s slowdown, but it is still impacted by the second-order effects of increased competition in Asian markets. Not only is China ramping up its own exports of key products, but companies that had formerly relied on exporting to China are now having to find new homes for their product.

These developments in capacity utilisation and output confirm that major changes are taking place in the global economy and the formerly high-flying Bric economies. Policymakers would perhaps do better with their forecasts if they looked beyond their theoretical models – and focused instead on the chemical industry’s proven ability to provide real-time insight into the underlying transformation taking place in global demand patterns.