US-China trade war confirms political risk is now a key factor for companies and the economy

There are few real surprises in life, and President Trump’s decision to launch a full-scale trade war with China wasn’t one of them.  He had virtually promised to do this in his election campaign, as I noted here back in September 2015:

“The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat.  People no longer needed to argue over “who got what” as there seemed to be plenty for everyone.  But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels.

“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.”

Of course, I received major push-back for this view at the time, just as I did in 2007-8 when warning of a likely US subprime crisis.  Most people found it very hard to believe that politics could trump economic logic, as one American commentator wrote in response to my analysis:

“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”.

But, sadly or not, depending on your political persuasion, my conclusion after the election result was known seems to have stood the test of time:

“You may, or may not, approve of President-elect Trump’s policies. You may, or may not, think that these policies are destined to fail. But they do confirm that the world is moving into a New Normal, which will inevitably create Winners and Losers.

“The Winners are likely to come from those who accept that President Trump will at least try to introduce the policies proposed by Candidate Trump. And the Losers will almost inevitably include those who continue to believe he represents “business as usual”.

Now, of course, we will start to see these Winners and Losers appear, as there is little the Western central banks can do to counteract the economic cost for the global economy of a US-China trade war.

One sign of this was Uber’s miserable performance on its stock market debut – despite having been priced at the low end of the planned range, it still fell further on its opening, in line with my suggestion last month that Uber’s $91bn IPO marks the top for today’s debt-fuelled stock markets.

But there will be many more serious casualties over the next few months and years:

  • NE Asian countries such as Japan and S Korea are part of global supply chains which send a wide range of components to China, where they are incorporated into finished goods for sale to the USA
  • Germany and the major European countries have relied on sales to China to boost economic growth, as domestic demand has stagnated, and clearly this support is now going to weaken
  • The mining industry and other suppliers of commodities will also be hit – Rio Tinto, for example, depends on China for 45% of its revenue, and on the USA for 15%
  • The petrochemicals industry has been dependent on China for its growth since the 2008 financial crisis, as I noted last summer, US-China tariffs could lead to global Polyethylene price war

Back in 2011-12, John Richardson and I wrote ‘Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’ to give our view of the likely consequences of the major demographic changes underway in the global economy.

Unfortunately, the politicians of the time took the seemingly easy route out of the crisis. They decided that printing money was so much easier than having a dialogue with the electorate about the implications of ageing populations, or the fact that Western fertility rates have been below replacement levels for the past 45 years.  Our warning is now coming true:

“The transition to the New Normal will be a difficult time. The world will be less comfortable and less assured for many millions of Westerners. The wider population will find itself following the model of the ageing boomers, consuming less and saving more. Rather than expecting their assets to grow magically in value every year, they may find themselves struggling to pay-down debt left over from the credit binge.

“Companies will need to refocus their creativity and resources on real needs. This will require a renewed focus on basic research. Industry and public service, rather than finance, will need to become the destination of choice for talented people, if the challenges posed by the megatrends are to be solved. Politicians with real vision will need to explain to voters that they can no longer expect all their wants to be met via endless ‘fixes’ of increased debt.

“We could instead decide to ignore all of this potential unpleasantness.

“But doing nothing is not a solution. It will mean we miss the opportunity to create a new wave of global growth from the megatrends. And we will instead end up with even more uncomfortable outcomes.

Don’t get carried away by Beijing’s stimulus

Residential construction work in Qingdao, China. Government stimulus is unlikely to deliver the economic boost of previous years © Bloomberg

China’s falling producer price index suggests it could soon be exporting deflation, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog
On the surface, this year’s jump in China’s total social financing (TSF) seems to support the bullish argument. TSF was Rmb5.3tn ($800bn) in January-February, a 26 per cent rise on 2018’s level.By comparison, it rose 61 per cent in 2009 as the government panicked over the impact of the 2008 financial crisis, and 23 per cent in 2016, when the government wanted to consolidate public support ahead of 2017’s five-yearly Party Congress session, which reappointed the top leadership for their second five-year term.

The markets were certainly right to view both these increases positively, as we discussed here two years ago. But we also added a cautionary note, suggesting that 2017’s Congress might well be followed by a “new clampdown”, as Xi’s leadership style was likely to “move away from consensus-building towards autocracy”. This analysis seems to have proved prescient, and it makes us cautious about assuming that Xi has decided to reverse course in 2019.

Consumer markets are also indicating a cautious response. Passenger car sales, for example, were down 18 per cent in January-February compared with the same period last year, after having fallen in 2018 for the first time since 1990. Smartphone sales were also down 14 per cent over the same period. In the important housing market, state-owned China Daily reported that sales by industry leader Evergrande fell by 43 per cent.

There is little evidence on the ground to suggest that Xi has decided to return to stimulus to revive economic growth. Last month’s government Work Report to the National People’s Congress said it would “refrain from using a deluge of stimulus policies”.

Instead, it seems likely that this year’s record level of lending was used to bail out local government financing vehicles (LGFVs) and other casualties of China’s post-2008 debt bubble. The second chart illustrates the potential problem, with TSF suddenly taking off into the stratosphere after 2008, when stimulus began, while GDP growth hardly changed its trajectory.

The stimulus programme thus dramatically inflated the amount of debt needed to create a unit of GDP. And given the doubts over the reliability of China’s GDP data, it may well be that the real debt-to-GDP ratio is even higher. These data therefore support the argument that debt servicing is now becoming a major issue for China after a decade of stimulus policies.


One example comes from the FT’s analyses of the debt problems affecting China Rail and China’s vast network of city subways. The FT reported that China has 25,000km of high-speed rail tracks, two-thirds of the world’s total, and that China Rail’s debt burden had reached Rmb5tn — of which around 80 per cent related to high-speed rail construction. Its interest payments have also exceeded its operating profits since at least 2015.

Unsurprisingly, given China’s relative poverty (average disposable income was just $4,266 in 2018), income from ticket sales has been too low even to cover interest payments since 2015. And yet the company is planning to expand capacity to 30,000km of track by 2030, with budgets increased by 10 per cent in 2018 as a result of the decision to boost infrastructure.

The same problem can be seen in city subway construction, where China accounted for 30 per cent of global city rail at the end of last year by track length, but only 25 per cent of ridership, which suggests that some lines may be massively underused and economically unviable.

The issue is not whether this level of investment is justifiable over the longer term in creating the infrastructure required to support growth. Nor is it whether the debt incurred can be repaid over time. Instead, the real question is whether the need to support economic expansion has led to a financially-risky acceleration of the infrastructure programme and whether, in turn, Beijing is now being forced to cover potential losses in order to avoid a series of credit-damaging defaults.


So where does this alternative narrative lead us? It suggests that far from supporting consumer spending, the TSF increase is flagging a growing risk in Asian debt markets — where western investors have rushed to invest in recent years, attracted by the relatively high interest rates compared with those enforced by central banks in their home markets. In 2017, for example, Chinese borrowers raised $211bn in dollar-denominated issuance, at a time when corporate debt levels had already reached 190 per cent of GDP.

This risk is emphasised if we revisit our suggestion here at the end of last year, that data for chemicals output — the best leading indicator for the global economy — was suggesting “that we may now be headed into recession”. More recent data give us no reason to change this conclusion, and therefore highlight the risk that some Chinese debts may prove more equal than others in terms of the degree of state support that they can command. Missed interest and capital repayments are now becoming common among the weaker borrowers.

The performance of China’s producer price index provides additional support for our analysis. As the third chart shows, this is now flirting with a negative reading, suggesting that a decade of over-investment means that China now has a major problem of surplus capacity. This problem will, of course, be exacerbated if demand continues to slow in key areas. In turn, this suggests that the implications of our analysis go beyond Asian markets.

China still remains, after all, the manufacturing capital of the world, and its falling PPI implies that 2019 could see it exporting deflation. This would be exactly the opposite conclusion to that assumed by today’s rallying equity markets, although it would chime with the increasingly downbeat messages coming from global bond markets. Investors may therefore want to revisit their recent euphoria over the level of lending in China, and their new confidence that the so-called “Powell put” can really protect them from today’s global market risks.

Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.

Stock markets risk Wile E. Coyote fall despite Powell’s rush to support the S&P 500

How can companies and investors avoid losing money as the global economy goes into a China-led recession?  That’s the key question as we enter 2019.  We have reached a fork in the road:

The central banks’ aim was set out in November 2010 by US Federal Reserve Chairman, Ben Bernanke:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

And the current Chairman, Jay Powell, rushed to calm investors on Friday by confirming this policy:

“We will be prepared to adjust policy quickly and flexibly and use all of our tools to support the economy should that be appropriate.”

His words confirm he equates “the economy” with the stock market, as the chart shows:

  • The Fed no longer sees its core mandate on jobs and prices as defining its role
  • Instead it has become focused on making sure the S&P 500 moves steadily upwards
  • Every time the S&P 500t flirts with breaking the lower “tramline”, the Fed rushes to its rescue

Like Wile E Coyote in the Road Runner cartoons, the Fed has used more and more absurdly complex strategies to try and keep the market going upwards.  But now it is very close to finding itself over the cliff edge.

CORPORATE DEBT IS THE KEY RISK FOR 2019

The Fed should have realised long ago that markets cannot keep climbing forever.  Instead, by printing $4tn of free cash, it has temporarily destroyed their key role of price discovery.  As a result:

  • Investors now have no idea if are paying too much for their purchases
  • Companies don’t know if their new investments will actually make money

We are heading almost inevitably to another  ‘Minsky Moment’ as I described in September 2008,:

“Earnings from the new investments prove too low to pay the interest due on the debt. Confidence in the ‘new paradigm’ disappears and, with it, market liquidity. Investors find themselves unable to sell the under-performing asset, and suddenly realise they have over-paid. In turn, this prompts a rush for the exits. Prices then begin to drop quite sharply, as ‘distress sales’ take place.

This time, however, the risk is in corporate debt, not US subprime lending.  As the charts above show:

  • The ratio of US corporate debt to GDP has reached an eye-watering 46%, higher than ever before
  • Lending standards have collapsed with most investment debt in the lowest “Triple B” grade

Investors’ obviously loved Powell’s confirmation on Friday that he is determined to cover their backs. But they may start to remember over the weekend that the cause of Thursday’s collapse was Apple’s problems in China – about which, the Fed can actually do very little.

And whilst Apple won’t go bankrupt any time soon, weaker companies in its supply chain certainly face this risk – as do other companies dependent on sales in China.  And as their sales volumes and profits start to fall, investors similarly risk finding that large numbers of companies with “Triple B” ratings have suddenly been re-rated as “Junk”:

  • Bianco Research suggest that 14% of companies in the S&P 1500 are zombies, with their earnings unable to cover interest expenses
  • The Bank of International Settlements has already warned that Western central banks stimulus lending means that  >10% of US/EU firms currently “rely on rolling over loans as their interest bill exceeds their EBIT. They are most likely to fail as liquidity starts to dry up”.

CHINA’S CORPORATE DEBT IS THE EPICENTRE OF THE RISK

As the chart shows, China’s corporate debt is now the highest in the world.  Yet it hardly existed before 2008, when China’s leadership panicked and began the largest stimulus programme in history.

The “good news” is that China’s new leadership recognise the problem, as I discussed in November 2017,  China’s central bank governor warns of ‘Minsky Moment’ risk.  The “bad news” – for the Fed’s desire to support the stock market, and for companies dependent on Chinese demand – is that they are determined to tackle the risk, having warned:

“China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous. The structural unbalance is salient; law-breaking and disorders are rampant; latent risks are accumulating; [and the financial system’s] vulnerability is obviously increasing.”

Companies and investors need to take great care in 2019.  China’s downturn means that markets are starting to rediscover their role of price discovery, despite the Fed’s efforts to keep waving its magic wand:

  • Companies with too much debt will go bankrupt, leading to the Minsky Moment
  • The domino effect of price wars and lower volumes will quickly hit other supply chains
  • Time spent today in understanding this risk will prove time very well spent later this year

Once the tramline is broken, the Fed and the S&P 500 will find themselves in Wile E Coyote’s position in the famous Road Runner cartoons – with nowhere to go, but down. 

BASF’s second profit warning highlights scale of the downturn now underway

The chemical industry is easily the best leading indicator for the global economy.  And thanks to Kevin Swift and his team at the American Chemistry Council, we already have data showing developments up to October, as the chart shows.

It confirms that consensus hopes for a “synchronised global recovery” at the beginning of the year have again proved wide of the mark.  Instead, just as I warned in April (Chemicals flag rising risk of synchronised global slowdown), the key  indicator – global chemical industry Capacity Utilisation % – has provided fair warning of the dangers ahead.

It peaked at 86.2%, in November 2017, and has fallen steadily since then. October’s data shows it back to June 2014 levels at 83.6%. And even more worryingly, it has now been falling every month since June. The last time we saw a sustained H2 decline was back in 2012, when the Fed felt forced to announce its QE3 stimulus programme in September.  And it can’t do that again this time.

The problem, as I found when warning of subprime risks in 2007-8 (The “Crystal Blog” foresaw the global financial crisis), is that many investors and executives prefer to adopt rose-tinted glasses when the data turns out to be too downbeat for their taste.  Whilst understandable, this is an incredibly dangerous attitude to take as it allows external risks to multiply, when timely action would allow them to be managed and mitigated.

It is thus critical that everyone in the industry, and those dependent on the global economy, take urgent action in response to BASF’s second profit warning, released late on Friday, given its forecast of a “considerable decrease of income” in 2018 of “15% – 20%”, after having previously warned of a “slight decline of up to 10%”.

I have long had enormous respect for BASF and its management. It is therefore deeply worrying that the company has had to issue an Adjustment of outlook for the fiscal year 2018 so late in the year, and less than 3 weeks after holding an upbeat Capital Markets Day at which it announced ambitious targets for improved earnings in the next few years.

The company statement also confirmed that whilst some problems were temporary, most of the issues are structural:

  • The impact of low water on the Rhine has proved greater than could have been earlier expected
  • But the continuing downturn in isocyanate margins has been ongoing for TDI since European contract prices peaked at €3450/t in May — since when they had fallen to €2400/t in October and €2050/t in November according to ICIS, who also reported on Friday that
    “Supply is still lengthy at year end in spite of difficulties at German sellers BASF and Covestro following low Rhine water levels”
  • The decline is therefore a very worrying insight into the state of consumer demand, given that TDI’s main applications are in furniture, bedding and carpet underlay as well as packaging applications.
  • Even more worrying is the statement that:
    “BASF’s business with the automotive industry has continued to decline since the third quarter of 2018; in particular, demand from customers in China slowed significantly. The trade conflict between the United States and China contributed to this slowdown.”

This confirms the warnings that I have been giving here since August when reviewing H1 auto sales (Trump’s auto trade war adds to US demographic and debt headwinds).

I noted then that President Trump’s auto trade tariffs were bad news for the US and global auto industry, given that markets had become dangerously dependent on China for their continued growth:

  • H1 sales in China had risen nearly 4x since 2007 from 3.1m to 11.8m this year
  • Sales in the other 6 major markets were almost unchanged at 23m versus 22.1m in 2007

Next year may well prove even more challenging if the current “truce” over German car exports to the USA breaks down,

INVESTORS HAVE WANTED TO BELIEVE THAT INTEREST RATES CAN DOMINATE DEMOGRAPHICS

The recent storms in financial markets are a clear sign that investors are finally waking up to reality, as Friday night’s chart from the Wall Street Journal confirms:

“In a sign of the breadth of the global selloff in stocks, Germany’s main stock index fell into a bear market Thursday, the latest benchmark to have tumbled 20% or more from its recent peak….Other markets already in bear territory are home to companies exposed to recent trade fights between the U.S. and China.

The problem, as I have argued since publishing ‘Boom, Gloom and the New Normal: how the Ageing Boomers are Changing Demand Patterns, again“, in 2011 with John Richardson, is that the economic SuperCycle created by the dramatic rise in the number of post-War BabyBoomers is now over.

I highlighted the key risks is my annual Budget Outlook in October, Budgeting for the end of “Business as Usual”.  I argued then that 2019 – 2021 Budgets needed to focus on the key risks to the business, and not simply assume that the external environment would continue to be stable.  Since then, others have made the same point, including the president of the Council on Foreign Relations, Richard Haas, who warned on Friday:

“In an instant Europe has gone from being the most stable region in the world to anything but. Paris is burning, the Merkel era is ending, Italy is playing a dangerous game of chicken with the EU, Russia is carving up Ukraine, and the UK is consumed by Brexit. History is resuming.

It is not too late to change course, and focus on the risks that are emerging.  Please at least read my Budget Outlook and consider how it might apply to your business or investments. And please, do it now.

 

You can also click here to download and review a copy of all my Budget Outlooks 2007 – 2018.

Asian downturn worsens, bringing global recession nearer

The chemical industry is the best leading indicator for the global economy.  And my visit to Singapore last week confirmed that the downturn underway in the Asian market creates major risks for developed and emerging economies alike.

The problem is focused on China’s likely move into recession, now its stimulus policies are finally being unwound.  And the result is shown in the above chart from The pH Report, updated to Friday:

  • It confirms that the downturn began before oil prices peaked at the beginning of October, confirming that companies were responding to a downturn in end-user demand
  • Since then, of course, the oil price has – rather dramatically – entered a bear market, with prices down by nearly a third

The question now is whether finance directors will choose to aggressively destock ahead of year-end results, to mitigate the volume decline with a decline in working capital. This would be a bold move given continuing geo-political uncertainty in the Middle East, and would also conflict with the more upbeat guidance that was given earlier with Q3 results.

But a review of ICIS news headlines over the past few days suggests they may have little choice.  Inventories are described as “piling up” in a wide range of major products, including polyethylene – the biggest volume polymer.  Indian producers are even offering “price protection” packages on polypropylene, to safeguard customers from losses if prices fall further.

Asian countries and their major partners (eg Argentina, S Africa, Turkey) were, of course, the first to be hit by China’s downturn.  But Q3’s fall in German GDP shows the downturn has now spread to the Western economy that most benefited from China’s post-2008 stimulus bubble.  As The Guardian noted:

“Goods exports make up 40% of German GDP – a much bigger proportion than for the next two biggest eurozone economies, France and Italy.”

OIL MARKETS CONFIRM THE RECESSION RISK

Of course, consensus opinion still believes that the US economy is sailing along, regardless of any problems elsewhere.  But the chart of oil prices relative to recession tells a different story:

  • The problem is that oil prices have been rising since 2016, with the summer proving the final blow-off peak.  As always, this meant consumers had to cut back on discretionary spending as costs of transport and heating rose
  • The cost of oil as a percentage of GDP reached 3.1% in Q3 – a level which has always led to recession in the past, with the exception of the post-2008 stimulus period when governments and central banks were pouring $tns of stimulus money into the global economy
  • In turn, this means a downturn is now beginning in US end-user demand in critical areas such as housing, autos and electronics

Oil markets have therefore provided a classic example of the trading maxim for weak markets – “Buy on the rumour, sell on the news”.

  • Prices had risen by 75% since June on supply shortage fears, following President Trump’s decision to exit the Iran nuclear deal on November 4
  • As always, this created “apparent demand” as buyers in the US and around the world bought ahead to minimise the impact of higher prices
  • But the higher prices also negated the benefit of the earlier tax cuts for his core supporters just ahead of the mid-term elections, causing Trump to undertake a policy u-turn
  • He is now pushing Saudi Arabia and Russia to maintain production, and has announced 180-day exemptions for Iran’s 8 largest customers – China, India, S Korea, Japan, Italy, Greece, Taiwan and Turkey.

Understandably, oil traders have now decided that his “bark is worse than his bite“.  And with the downturn spreading from Asia to the West, markets are now refocusing on supply/demand balances, with the International Energy Agency suggesting stocks will build by 2mb/d in H1 2019. In response, OPEC are reportedly discussing potential cuts of up to 1.4mb/d from December.

CHINA’S SHADOW BANKING COLLAPSE IS CREATING A NEW FINANCIAL CRISIS

Unfortunately, as in 2008, the collapse in oil prices is coinciding with the end of stimulus policies, particularly in China, as the chart of its shadow bank lending confirms.  This has hit demand in two ways, as I discussed earlier this month in the Financial Times:

  • Just 3 years ago, it was pumping out an average $140bn/month in mainly property-related lending *
  • This created enormous demand for EM commodity exports
  • It also boosted global property prices as wealthy Chinese rushed to get their money out of the country
  • But during 2018, lending has collapsed by more than 80% to average just $23bn in October

China’s post-2008 stimulus programme was the growth engine for the global economy – with the efforts of the Western central banks very much a sideshow in comparison.  It was more than half of the total $33tn lending to date.  But now it is unwinding, prompting the Minsky Moment forecast a year ago by China’s central bank governor:

China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous.”

As I warned then:

“Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy. China’s lending bubble – particularly in property – is likely coming to an end. In turn, this will lead to a bumpy ride for the global economy.

The bumps are getting bigger and bigger as we head into recession.  Asia’s downturn is now spreading to the rest of the world, and is a major wake-up call for anyone still planning for “business as usual”.

 

* Lending has major seasonal peaks in Q1, so I use rolling 12 month averages to avoid distortions 

Chemical output signals trouble for global economy

A petrochemical plant on the outskirts of Shanghai. Chinese chemical industry production has been negative on a year-to-date basis since February

Falling output in China and slowing growth globally suggest difficult years ahead, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Chemicals are the best leading indicator for the global economy. Data for both Chinese and global chemical production, shown in the first chart, are warning that we may now be headed into recession.

China’s stimulus programme has been the key driver for the world’s post-2008 recovery, as we discussed here in May (“China’s lending bubble is history”).

It accounted for about half of the global $33tn in stimulus programmes and its decline is currently having a dual impact, as it reduces both demand for EM commodities and the availability of global credit.

In turn, this reversal is impacting the global economy — already battling headwinds from trade tariffs and higher oil prices.

Initially the impact was most noticeable in emerging markets but the scale of the downturn is now starting to hit the wider economy:

  • China’s demand has been the growth engine for the global economy since 2008, and its scale has been such that this lost demand cannot be compensated elsewhere
  • China’s shadow banking bubble has been a major source of speculative lending, helping to finance property bubbles in China and many global cities
  • It also financed a domestic construction boom in China on a scale never seen before, creating excess demand for a wide range of commodities

But now the lending bubble is bursting. The second chart shows the extent of the downturn this year. Shadow banking is down 84%  ($557bn) in the year to September, according to official People’s Bank of China data. Total Social Financing is down 12% ($188bn), despite an increase in official bank lending to support strategic companies.

It seems highly likely that the property bubble has begun to burst, with China Daily reporting that new home loans in Shanghai were down 77% in the first half. In turn, auto sales fell in each month during the third quarter, as buyers can no longer count on windfall gains from property speculation to finance their purchases.

The absence of speculative Chinese buyers, anxious to move their cash offshore, is also having a significant impact on demand outside China in former property hotspots in New York, London and elsewhere.

The chemical industry has been flagging this decline with increasing urgency since February, when Chinese production went negative on a year-to-date basis. The initial decline was certainly linked to the government’s campaign to reduce pollution by shutting down many older and more polluting factories.

But there has been no recovery over the summer, with both August and September showing 3.1% declines according to American Chemistry Council data. Inevitably, Asian production has also now started to decline, due to its dependence on exports to China. In turn, like a stone thrown into a pond, the wider ripples are starting to reach western economies.

President Trump’s trade wars aren’t helping, of course, as they have already begun to increase prices for US consumers. Ford, for example, has reported that its costs have increased by $1bn as a result of steel and aluminium tariffs. Trump’s withdrawal from the Iran nuclear deal has also caused oil prices as a percentage of GDP to rise to levels typically associated with recession in the past.

The rationale is simply that consumers only have so much cash to spend, and money they spend on rising gasoline and heating costs can’t be spent on the discretionary items that drive GDP growth.

It seems unlikely, however, that Trump’s trade war with China will lead to his expected “quick win”. China has faced far more severe hardships in recent decades, and there are few signs that it is preparing to change core policies. The trade war will inevitably have at least a short-term negative economic impact but, paradoxically, it also supports the government’s strategy to escape the “middle income trap” by ending China’s role as the “low-skilled factory of the world”, and moving up the ladder to more value-added operations and services.

The trade war therefore offers an opportunity to accelerate the Belt and Road Initiative (BRI), initially by moving unsophisticated and often polluting factories offshore. It also emphasises the priority given to the services sector:

  • Already companies, both private and state-owned, are focusing their international acquisitions in BRI countries. According to EY, 12 per cent of overall Chinese (non-financial) outbound investment was in BRI countries in 2017, versus 9 per cent in 2016, and 2018 is likely to be considerably higher. Apart from south-east Asia, we expect eastern and central Europe to be beneficiaries, given the new BRI infrastructure links, as the map highlights
  • Data from the Caixin/Markit services purchasing managers’ index for September suggests the sector remains in growth mode. And government statistics suggest the services sector was slightly over half of the economy in the first half, with its official growth reported at 7.6 per cent versus overall GDP growth of 6.8 per cent

We expect China to come through the pain caused by the unwinding of the stimulus bubbles, and ultimately be strengthened by the need to refocus on sustainable rather than speculative growth. But it will not be an easy few years for China and the global economy.

The rising tide of stimulus has led many investors and chief executives to look like geniuses. Now the downturn will probably lead to the appearance of winners and losers, with the latter likely to be in the majority.

Paul Hodges and Daniël de Blocq van Scheltinga publish The pH Report.