Last week, the UK’s Foreign Secretary, its chief Brexit negotiator and several junior ministers, resigned. President Trump gave an interview attacking the UK prime minister, Theresa May, and suggesting her policies would “kill” any future trade deal with the US. And the EU 27’s main negotiator on the critical Brexit issue, Michel Barnier, warned:
“On both sides of the Channel, businesses… should analyse their exposure to the other side and be ready, when necessary, to adapt their logistical channels, supply chains and existing contracts. They should also prepare for the worst case scenario of a “no deal”, which would result in the return of tariffs under WTO rules.” (My emphasis)
It was quite a week. None of us know what may happen next, as I warned when Ready for Brexit launched last month.
WHAT ARE WTO RULES?
It is now less than 9 months until the UK officially leaves the EU on 29 March. Yet according to a ReadyforBrexit poll:
- Only around a quarter of businesses have begun to plan for what happens next
- Nearly three-quarters have so far done nothing
They could have a considerable shock ahead of them, as the Brexplainer video above explains.
Currently, the UK trades with the world on the basis of around 750 agreements negotiated by the EU. Trade between the current 28 EU members is covered by the Single Market and Customs Union. But as Barnier warns, if there is no deal agreed by 29 March, then WTO rules will apply:
- WTO rules would mean that a tax, called “Tariffs”, would be reintroduced for trade in goods between the UK and the EU27. Services, including financial services, could also be impacted by restrictions on market access
- Border controls and customs checks could add time to shipments and impact supply chains. This could be particularly important for highly regulated sectors such as chemicals
- Documentation and paperwork will increase, as businesses will need to be able to prove the nature and origin of their goods, especially if they use parts or components from several different countries
HAS YOUR BUSINESS PLANNED AHEAD FOR A ‘NO DEAL’ BREXIT?
Most major businesses have been planning for a ‘no deal’ scenario for some time:
- They are increasing warehouse space, in case deliveries are delayed
- They are checking their cash flow, as VAT could be payable up-front under WTO rules
- They are working out the possible ‘no deal’ impact in key areas such Customs & Tariffs, Finance, Legal, Services & Employment and their Supply Chain
Most smaller businesses have assumed they don’t need to do anything. Yet 29 March is now only 257 days away.
SURELY ITS CERTAIN THAT WITHDRAWAL AND TRANSITION AGREEMENTS WILL BE SIGNED?
After the Brexit vote in June 2016, the chief Brexit negotiator, David Davis, was confident that all the major trade deals would be finalised by July 2018:
“Be under no doubt, we can do deals with our trading partners, and we can do them quickly… So within two years, before the negotiation with the EU is likely to be complete, and therefore before anything material has changed, we can negotiate a free trade area massively larger than the EU.”
But by September last year, he had changed his mind and was instead warning as the Telegraph noted:
“Nobody ever pretended this would be simple or easy.”
And now, of course, Davis has resigned along with his fellow Leave campaigner, Boris Johnson.
NOBODY KNOWS WHAT WILL HAPPEN NEXT
The truth is that nobody knows what will happen next. After last week, any UK business that trades with the EU, or any EU business that trades with the UK, would be wise to start planning ahead for a ‘no deal’ WTO rules scenario:
- Have you asked your suppliers about their plans for a ‘no deal’ scenario?
- Have you asked your customers about their plans for one?
- Have you checked if your ‘just in time’ deliveries will still arrive?
- Have you checked if your insurance policies will still be valid?
As the UK’s main business organisation, the CBI, warned on Friday “It will be a make or break summer:
‘With three months left to go, it is now a race against time. The EU must now engage constructively and flexibly, as must politicians from all UK parties. This is a matter of national interest. There’s not a day to lose.’
We can all hope that negotiations are successful. But hope is not a strategy. And after the events of the last week, prudent managers now need to start start planning for ‘no deal’. Please click here to watch the Brexplainer video.
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Suddenly, businesses across Europe are waking up to the realisation that the UK is currently on course to leave the European Union (EU) on 29 March next year, without a deal on trade and customs. As Katherine Bennett, the UK boss of aerospace giant, Airbus, warned on Friday:
“This is not project fear, this is dawning reality.”
As the BBC reported on Friday: “Airbus has warned it could leave the UK if it exits the European Union single market and customs union without a transition deal…It also said the current planned transition period, due to end in December 2020, was too short for it to make changes to its supply chain. As a result, it would “refrain from extending” its UK supplier base. It said it currently had more than 4,000 suppliers in the UK.”
BMW, which makes the iconic Mini and Rolls Royce, added:
“Clarity is needed by the end of the summer.”
Similarly Tom Crotty, group director at INEOS, the giant petrochemicals group, said several companies were putting investment decisions on hold because of Brexit uncertainty:
“The government is relatively paralysed … it is not good for the country.”
THE RANGE OF TOPICS COVERED BY THE BREXIT NEGOTIATIONS IS VERY LARGE
This is why my IeC colleagues and I have now launched Ready for Brexit on the 2nd anniversary of the UK’s referendum to leave the EU. We are particularly concerned that many small and medium-sized businesses (SMEs) – the backbone of the European economy – are failing to plan ahead for Brexit’s potential impact.
As our Brexit Directory above shows, Brexit creates a wide range of challenges and opportunities:
- Customs & Tariffs: Export/Import Registration, Labelling, Testing, VAT
- Finance: Payment Terms, Tax & VAT, Transfer Pricing
- Legal: Contracts, Free Trade Agreements, Intellectual Property
- Services & Employment: Banking, Insurance, Investment, Property
- Supply Chain: Documentation, Regulation, Transport
And yet, today, nobody knows on what terms the UK might be trading with the other EU 27 countries after 29 March. Or indeed, all the other countries where UK trade is currently ruled by EU agreements.
The EU is a rules-based organisation, and the legal position is very clear:
- The UK has notified the EU of its intention to leave by 29 March
- Negotiations are underway over a possible Withdrawal Agreement, which would set new terms for UK trade with the EU 27 after this date
- The proposed Transition Agreement, which would extend the deadline for leaving until 31 December 2020, will only apply if this Withdrawal Agreement is finalised in the next few months
Ready for Brexit will keep its subscribers updated on developments as they occur, as well as providing news and insight on key areas of business concern.
A NUMBER OF VERY DIFFERENT OPTIONS EXIST FOR FUTURE UK-EU TRADE ARRANGEMENTS
The UK has been in the EU for 45 years. Unsurprisingly, as the slide above confirms, the negotiations are proving extremely complex. Both sides have their own objectives and “red lines”, and compromise is proving difficult.
The negotiators not only have to deal with all the trade issues covered in the Ready for Brexit Directory, but also critical political questions such as the trading relationship between N Ireland and Ireland after Brexit. That, in turn, is complicated by the fact that the UK government depends on Democratic Unionist Party (DUP) votes for its majority, and the DUP is opposed to any “special deal” on customs for the Irish border.
BUSINESSES NEED TO RECOGNISE THERE MAY BE “NO DEAL” AFTER 29 MARCH
I have taken part in trade negotiations, and negotiated major contracts around the world. So I entirely understand why Brexit secretary David Davis has insisted:
“The best option is leaving with a good deal but you’ve got to be able to walk away from the table.”
Similarly, International Trade Secretary Liam Fox is right to warn that:
“The prime minister has always said no deal is better than a bad deal. It is essential as we enter the next phase of the negotiations that the EU understands that and believes it… I think our negotiating partners would not be wise if they thought our PM was bluffing.”
The issue is simply that many businesses, and particularly SMEs, have so far ignored all these warnings.
According to a poll on the Ready for Brexit website, only a quarter have so far begun to plan for Brexit. Half are thinking about it, and almost a quarter don’t believe it is necessary. This is why we have produced our easy-to-use Brexlist checklist, highlighting key areas for focus.
“NOTHING IS AGREED UNTIL EVERYTHING IS AGREED”
As the UK and EU negotiators have said many times over the past 2 years, “nothing is agreed until everything is agreed“. These 7 words should be written above every business’s boardroom table:
- They remind us that it may prove impossible to agree a Withdrawal Agreement between the UK and EU27
- And without a Withdrawal Agreement, there will be no Transition Agreement
Instead, the UK would then simply leave the EU in 278 days time on World Trade Organisation terms.
If you don’t know what WTO terms would mean for your business, you might want to visit Ready for Brexit and begin to use its Brexlist checklist *.
* Ready for Brexit offers users a free one-month trial including access to the Brexlist. After this there is an annual fee of £195 to access the platform. Discounts are available for companies who want to help SMEs in their supply chains to prepare for Brexit, and for trade associations who would like to offer the service to their members.
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It is almost a year since Donald Trump became President. And whilst he has not followed through on many of his promises, he has indeed introduced the major policy changes that I began to discuss in September 2015, when I first suggested he could win the election and that the Republicans could control Congress:
“In the USA, the establishment candidacies of Hillary Clinton for the Democrats and Jeb Bush for the Republicans are being upstaged by the two populist candidates – Bernie Sanders and Donald Trump….Companies and investors have had little experience of how such debates can impact them in recent decades. They now need to move quickly up the learning curve. Political risk is becoming a major issue, as it was before the 1990s.”
Many people have therefore had to go up a steep learning curve over the past year, given that their starting point was essentially disbelief, as one commentator noted when my analysis first appeared:
“I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors.”
Yet this, of course, is exactly what has happened.
It is true that many of the promises in candidate Trump’s Contract with America have been ignored:
- Of his 174 promises, 13 have been achieved, 18 are in process, 37 have been broken, 3 have been partially achieved and 103 have not started
- His top priority of a Constitutional amendment on term limits for members of Congress has not moved forward
Yet on areas that impact companies and investors, such as trade and corporate tax, the President has moved forward:
- On trade, he has not (yet?) labelled China a currency manipulator or moved forward to fix water and environmental infrastructure
- But he has announced the renegotiation of NAFTA, the withdrawal from the Trans-Pacific Partnership, his intention to withdraw from the UN Climate Change programme and lifted restrictions on fossil fuel production
These are complete game-changers in terms of America’s position in the world and its trading relationships.
Over the decades following World War 2, Republican and Democrat Presidents alike saw trade as the key to avoiding further wars by building global prosperity. Presidents Reagan, Bush and Clinton all actively supported the growth of global trade and the creation of the World Trade Organisation (WTO).
The US also led the world in environmental protection following publication of Rachel Carson’s ‘Silent Spring‘ in 1962, with its attack on the over-use of pesticides.
Clearly, today, these priorities no longer matter to President Trump. And already, US companies are starting to lose out as politics, rather than economics, once again begins to dominate global trade. We are returning to the trading models that operated before WTO:
- Until the 1990s, trade largely took place within trading blocs rather than globally – in Europe, for example, the West was organised in the Common Market and the East operated within the Soviet Union
- It is therefore very significant that one of the President’s first attacks has been on the WTO, where he has disrupted its work by blocking the appointment of new judges
Trump’s policy is instead based on the idea of bilateral trade agreements with individual countries, with the US dominating the relationship. Understandably, many countries dislike this prospect and are instead preferring to work with China’s Belt & Road Initiative (BRI, formerly known as One Belt, One Road).
US POLYETHYLENE PRODUCERS WILL BE A CASE STUDY FOR THE IMPACT OF THE NEW POLICIES
US polyethylene (PE) producers are likely to provide a case study of the problems created by the new policies.
They are now bringing online around 6 million tonnes of new shale gas-based production. It had been assumed a large part of this volume could be exported to China. But the chart above suggests this now looks unlikely:
- China’s PE market has indeed seen major growth since 2015, up 18% on a January – November basis. Part of this is one-off demand growth, as China moved to ban imports of scrap product in 2017. Its own production has also grown in line with total demand at 17%
- But at the same time, its net imports rose by 1.8 million tonnes, 19%, with the main surge in 2017. This was a perfect opportunity for US producers to increase their exports as their new capacity began to come online
- Yet, actual US exports only rose 194kt – within NAFTA, Mexico actually outperformed with its exports up 197kt
- The big winner was the Middle East, a key part of the BRI, which saw its volume jump 29% by 1.36 million tonnes
Sadly, it seems likely that 2018 will see further development of such trading blocs:
- The President’s comments last week, when he reportedly called Africa and Haiti “shitholes” will clearly make it more difficult to build long-term relationships based on trust with these countries
- They also caused anguish in traditionally pro-American countries such as the UK – adding to concerns that he has lost his early interest in the promised post-Brexit “very big and exciting” trade deal.
US companies were already facing an uphill task in selling all their new shale gas-based PE output. The President’s new trade policies will make this task even more difficult, given that most of it will have to be exported.
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We are living in a strange world. As in 2007 – 2008, financial news continues to be euphoric, yet the general news is increasingly gloomy. As Nobel Prizewinner Richard Thaler, has warned, “We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.” Both views can’t continue to exist alongside each other for ever. Whichever scenario comes out on top in 2018 will have major implications for investors and companies.
It therefore seems prudent to start building scenarios around some of the key risk areas – increased volatility in oil and interest rates, protectionism and the threat to free trade (including Brexit), and political disorder. One key issue is that the range of potential outcomes is widening.
Last year, for example, it was reasonable to use $50/bbl as a Base case forecast for oil prices, and then develop Upside and Downside cases using a $5/bbl swing either way. But today’s rising levels of uncertainty suggests such narrow ranges should instead be regarded as sensitivities rather than scenarios. In 2018, the risks to a $50/bbl Base case appear much larger:
- On the Downside, US output is now rising very fast given today’s higher prices. The key issue with fracking is that the capital cost is paid up-front, and once the money has been spent, the focus is on variable cost – where most published data suggests actual operating cost is less than $10/bbl. US oil and product exports have already reached 7mbd, so it is not hard to see a situation where over-supplied energy markets cause prices to crash below $40/bbl at some point in 2018
- On the Upside, instability is clearly rising in the Middle East. Saudi Arabia’s young Crown Prince, Mohammad bin Salman is already engaged in proxy wars with Iran in Yemen, Syria, Iraq and Lebanon. He has also arrested hundreds of leading Saudis, and fined them hundreds of billions of dollars in exchange for their release. If he proves to have over-extended himself, the resulting political confusion could impact the whole Middle East, and easily take prices above $75/bbl
Unfortunately, oil price volatility is not the only risk facing us in 2018. As the chart shows, the potential for a debt crisis triggered by rising interest rates cannot be ignored, given that the current $34tn total of central bank debt is approaching half of global GDP. Most media attention has been on the US Federal Reserve, which is finally moving to raise rates and “normalise” monetary policy. But the real action has been taking place in the emerging markets. 10-year benchmark bond rates have risen by a third in China over the past year to 4%, whilst rates are now at 6% in India, 7.5% in Russia and 10% in Brazil.
An “inflation surprise” could well prove the catalyst for such a reappraisal of market fundamentals. In the past, I have argued that deflation is the likely default outcome for the global economy, given its long-term demographic and demand deficits. But markets tend not to move in straight lines, and 2018 may well bring a temporary inflation spike, as China’s President Xi has clearly decided to tackle the country’s endemic pollution early in his second term. He has already shutdown thousands of polluting companies in many key industries such as steel, metal smelting, cement and coke.
His roadmap is the landmark ‘China 2030’ joint report from the World Bank and China’s National Development and Reform Commission. This argued that China needed to transition: “From policies that served it so well in the past to ones that address the very different challenges of a very different future”.
But, of course, transitions can be a dangerous time, as China’s central bank chief, Zhou Xiaochuan, highlighted at the 5-yearly Party Congress in October, when warning that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008 in the west.
“Business as usual” is always the most popular strategy, as it means companies and investors don’t face a need to make major changes. But we all know that change is inevitable over time. And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.
At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“. But, of course, this is nonsense. What they actually mean is that “nobody wanted to see this coming“. Nobody wanted to be focusing on contingency plans when everybody else seemed to be laughing all the way to the bank.
I discuss these issues in more detail in my annual Outlook for 2018. Please click here to download this, and click here to watch the video interview with ICB deputy editor, Will Beacham.
The post The return of volatility is the key market risk for 2018 appeared first on Chemicals & The Economy.
“There isn’t anybody who knows what is going to happen in the next 12 months. We’ve never been here before. Things are out of control. I have never seen a situation like it.“
This comment from former UK Finance Minister, Ken Clarke, aptly summarises the uncertainty facing companies, investors and individuals as we look ahead to the 2018 – 2020 Budget period. None of us have ever seen a situation like today’s. Even worse, is the fact that risks are not just focused on the economy, or politics, or social issues. They are a varying mix of all of these. And because of today’s globalised world, they potentially affect every country, no matter how stable it might appear from inside its own borders.
This is why my Budget Outlook for 2018 – 2020 is titled ‘Budgeting for the Great Unknown’. We cannot know what will happen next. But this doesn’t mean we can’t try to identify the key risks and decide how best to try and manage them. The alternative, of doing nothing, would leave us at the mercy of the unknown, which is never a good place to be.
RISING INTEREST RATES COULD SPARK A DEBT CRISIS
Central banks assumed after 2008 that stimulus policies would quickly return the economy to the BabyBoomer-led economic SuperCycle of the previous 25 years. And when the first round of stimulus failed to produce the expected results, as was inevitable, they simply did more…and more…and more. The man who bought the first $1.25tn of mortgage debt for the US Federal Reserve (Fed) later described this failure under the heading “I’m sorry, America“:
“You’d think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2”
• And the Fed was not alone, as the chart shows. Today, the world is burdened by over $30tn of central bank debt
• The Fed, European Central Bank, Bank of Japan and the Bank of England now appear to “own a fifth of their governments’ total debt”
• There also seems little chance that this debt can ever be repaid. The demand deficit caused by today’s ageing populations means that growth and inflation remain weak, as I discussed in the Financial Times last month
China is, of course, most at risk – as it was responsible for more than half of the lending bubble. This means the health of its banking sector is now tied to the property sector, just as happened with US subprime. Around one in five of all Chinese apartments have been bought for speculation, not to be lived in, and are unoccupied.
China’s central bank chief, Zhou Xiaochuan, has warned that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008. Similar risks face the main developed countries as they finally have to end their stimulus programmes:
• Who is now going to replace them as buyers of government debt?
• And who is going to buy these bonds at today’s prices, as the banks back away?
• $8tn of government and corporate bonds now have negative interest rates, which guarantee the buyer will lose money unless major deflation takes place – and major deflation would make it very difficult to repay the capital invested
There is only one strategy to manage this risk, and that is to avoid debt. Companies or individuals with too much debt will go bankrupt very quickly if and when a Minsky Moment takes place.
THE CHINA SLOWDOWN RISK IS LINKED TO THE PROPERTY LENDING BUBBLE
After 2008, it seemed everyone wanted to believe that China had suddenly become middle class by Western standards. And so they chose to ignore the mounting evidence of a housing bubble, as shown in the chart above.
Yet official data shows average incomes in China are still below Western poverty levels (US poverty level = $12060):
• In H1, disposable income for urban residents averaged just $5389/capita
• In the rural half of the country, disposable income averaged just $1930
• The difference between income and expenditure was based on the lending bubble
As a result, average house price/earnings ratios in cities such as Beijing and Shanghai are now more than 3x the ratios in cities such as New York – which are themselves wildly overpriced by historical standards.
Having now been reappointed for a further 5 years, it is clear that President Xi Jinping is focused on tackling this risk. The only way this can be done is to take the pain of an economic slowdown, whilst keeping a very close eye on default risks in the banking sector. As Xi said once again in his opening address to last week’s National Congress:
“Houses are built to be inhabited, not for speculation. China will accelerate establishing a system with supply from multiple parties, affordability from different channels, and make rental housing as important as home purchasing.”
China will therefore no longer be powering global growth, as it has done since 2008. Prudent companies and investors will therefore want to review their business models and portfolios to identify where these are dependent on China.
This may not be easy, as the link to end-user demand in China might well be further down the supply chain, or external via a second-order impact. For example, Company A may have no business with China and feel it is secure. But it may suddenly wake up one morning to find its own sales under attack, if company B loses business in China and crashes prices elsewhere to replace its lost volume.
PROTECTIONISM IS ON THE RISE AROUND THE WORLD
Trade policy is the third key risk, as the chart of harmful interventions from Global Trade Alert confirms.
These are now running at 3x the level of liberalising interventions since 2008, as Populist politicians convince their voters that the country is losing jobs due to “unfair” trade policies.
China has been hit most times, as its economy became “the manufacturing capital of the world” after it joined the World Trade Organisation in 2001. At the time, this was seen as being good news for consumers, as its low labour costs led to lower prices.
But today, the benefits of global trade are being forgotten – even though jobless levels are relatively low. What will happen if the global economy now moves into recession?
The UK’s Brexit decision highlights the danger of rising protectionism. Leading Brexiteer and former cabinet minister John Redwood writes an online diary which even campaigns against buying food from the rest of the European Union:
“There are many great English cheese (sic), so you don’t need to buy French.”
No family tries to grow all its own food, or to manufacture all the other items that it needs. And it used to be well understood that countries also benefited from specialising in areas where they were strong, and trading with those who were strong in other areas. But Populism ignores these obvious truths.
• President Trump has left the Trans-Pacific Partnership, which would have linked major Pacific Ocean economies
• He has also said he will probably pull out of the Paris Climate Change Agreement
• Now he has turned his attention to NAFTA, causing the head of the US Chamber of Commerce to warn:
“There are several poison pill proposals still on the table that could doom the entire deal,” Donohue said at an event hosted by the American Chamber of Commerce of Mexico, where he said the “existential threat” to NAFTA threatened regional security.
At the moment, most companies and investors seem to be ignoring these developments, assuming that in the end, sense will prevail. But what if they are wrong? It seems highly likely, for example, that the UK will end up with a “hard Brexit” in March 2019 with no EU trade deal and no transition period to enable businesses to adjust.
Today’s Populist politicians don’t seem to care about these risks. For them, the allure of arguing for “no deal”, if they can’t get exactly what they want, is very powerful. So it would seem sensible for executives to spend time understanding exactly how their business might be impacted if today’s global supply chains came to an end.
POLITICAL CHAOS IS GROWING AS PEOPLE LOSE FAITH IN THE ELITES
The key issue underlying these risks is that voters no longer believe that the political elites are operating with their best interests at heart. The elites have failed to deliver on their promises, and many families now worry that their children’s lives will be more difficult than their own. This breaks a century of constant progress in Western countries, where each generation had better living standards and incomes. As the chart from ipsos mori confirms:
• Most people in the major economies feel their country is going in the wrong direction
• Adults in only 3 of the 10 major economies – China, India and Canada – feel things are going in the right direction
• Adults in the other 7 major economies feel they are going in the wrong direction, sometimes by large margins
• 59% of Americans, 62% of Japanese, 63% of Germans, 71% of French, 72% of British, 84% of Brazilians and 85% of Italians are unhappy
This suggests there is major potential for social unrest and political chaos if the elites don’t change direction. Fear of immigrants is rising in many countries, and causing a rise in Populism even in countries such as Germany.
“Business as usual” is always the most popular strategy, as it means companies and investors don’t have to face the need to make major changes. But we all know that change is inevitable over time. And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.
At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“. But, of course, this is nonsense. What they actually mean is that “nobody wanted to see this coming“. The threat from subprime was perfectly obvious from 2006 onwards, as I warned in the Financial Times and in ICIS Chemical Business, as was 2014’s oil price collapse. Today’s risks are similarly obvious, as the “Ring of Fire” map describes.
You may well have your own concerns about other potential major business risks. Nobel Prizewinner Richard Thaler, for example, worries that:
“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.”
We can all hope that none of these scenarios will actually create major problems over the 2018 – 2020 period. But hope is not a strategy, and it is time to develop contingency plans. Time spent on these today could well be the best investment you will make. As always, please do contact me at firstname.lastname@example.org if I can help in any way.
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Next week, I will publish my annual Budget Outlook, covering the 2018-2020 period. The aim, as always, will be to challenge conventional wisdom when this seems to be heading in the wrong direction. Before publishing the new Outlook each year, I always like to review my previous forecast. Past performance may not be a perfect guide to the future, but it is the best we have:
The 2007 Outlook ‘Budgeting for a Downturn‘, and 2008′s ‘Budgeting for Survival’ meant I was one of the few to forecast the 2008 Crisis
2009′s ‘Budgeting for a New Normal’ was then more positive than the consensus, suggesting “2010 should be a better year, as demand grows in line with a recovery in global GDP“
The 2010 Outlook was ‘Budgeting for Uncertainty’. This introduced the concept of Scenario planning, to help deal with “today’s increasingly uncertain New Normal environment.”
2011 was ‘Budgeting for Austerity’. It anticipated weak growth across Europe as a result of the austerity measures being introduced, and disappointing global growth, whilst arguing that major new opportunities were opening up as a result of changing demographic trends
2012 was ‘Budgeting for an L-shaped recovery’, arguing that recovery was unlikely to meet expectations
2013 was ‘Budgeting for a VUCA world‘ where Volatility, Uncertainty, Complexity and Ambiguity would dominate
2014 was ‘Budgeting for the Cycle of Deflation‘, 2015 was ’Budgeting for the Great Unwinding of policymaker stimulus’, 2016 was ‘Budgeting for the Great Reckoning’
Please click here if you would like to download a free copy of all the Budget Outlooks.
My argument last year was that companies and investors would begin to run up against the reality of the impact of today’s “demographic deficit”. They would find demand had fallen far short of policymakers’ promises. As the chart shows, the IMF had forecast in 2011 that 2016 growth would be 4.7%, but in reality it was a third lower at just 3.2%. I therefore argued:
“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.”
Oil markets are just one example of what has happened. A year ago, OPEC had forecast its new quotas would “rebalance the oil market” in H1 this year. When this proved over-optimistic, they had to be extended for a further 9 months into March 2018. Now, it expects to have to extend them through the whole of 2018. And even today’s fragile supply/demand balance is only due to China’s massive purchases to fill its Strategic Reserve.
Policymakers’ unrealistic view of the world has also had political and social consequences, as I noted in the Outlook:
“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.”
As the second chart confirms from Ipsos MORI, most people in the world’s major countries feel things are going in the wrong direction. Voters have lost confidence in the political elite’s ability to deliver on its promises. Almost everywhere one looks today, one now sees potential “accidents waiting to happen”.
Understandably, Populism gains support in such circumstances as people feel they and their children are losing out.
The last 10 years have proved that stimulus programmes cannot substitute for a lack of babies. They generate debt mountains instead of sustainable demand, and so make the problems worse, not better.
Next week, I will look at what may happen in the 2018 – 2020 period, and the key risks that have developed as a result of the policy failures of the past decade.
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