First, the good news. It has long been recognised that the UK economy is over-dependent on financial services, and that its housing market – particularly in London – is wildly over-priced in relation to earnings. The Brexit vote should ensure that both these problems are solved:
- Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
- There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
- This will also undermine the London housing market by removing the support provided by these high-earners
- In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven”
This is probably not the result that most Leave voters expected when they voted on Thursday. These voters will also soon find out that Thursday was not the Independence Day they were promised. It is already obvious that Leave campaigners have no clear idea of what to do next. They are even divided about whether to immediately trigger the 2-year departure period under Article 50 of the Lisbon Treaty.
Leave voters have more shocks ahead of them, of course:
- Most believed that the UK would immediately be able to “take control of its borders” and dramatically reduce immigration. But as I noted during the campaign, the majority of immigration has always been from outside the EU – and could already have been stopped, had the current or previous governments chosen to do this
- Nor will the National Health Service suddenly benefit from the promised £350m/week ($475m) by stopping UK contributions to the EU. For a start, more than half of this money already came back to the UK from the EU, and so can’t be spent a second time
- Even more importantly, nothing is going to happen for at least 2 years whilst the Leave negotiations take place
This, of course, is where the bad news starts. What will be the reaction of Leave voters as they discover they have been fed half-truths on these and other critical issues? And what will happen as house prices begin to fall, and jobs in financial services – as well as manufacturing – begin to disappear as companies relocate elsewhere within the EU?
BREXIT VOTE WILL HIT EUROPE AND THE GLOBAL ECONOMY
The bad news is, unfortunately, not restricted to the UK. Already, alarm has begun to spread across the rest of the EU. There are strong calls for referendums to take place in 3 of the EU’s 6 founding members – France, Italy and The Netherlands. It is hard to see how the EU could survive if even one of these votes resulted in a Leave decision.
In turn, of course, this is bound to draw attention once more to the unsolved Eurozone debt crisis. Can anyone now really continue to believe the European Central Bank’s 2012 promise to do “whatever it takes” to preserve the euro, as set out by its President, Mario Draghi?
The simple fact is that the Brexit vote is the canary in the coalmine. It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis. And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.
THE BREXIT VOTE, LIKE THE 2008 CRISIS, WAS NOT A ‘BLACK SWAN’ EVENT
I am used, by now, to my forecasts being ignored by conventional wisdom. The Brexit vote saw a repeat of the complacency that greeted my warnings in the Financial Times and here before the 2008 financial crisis. Thus my March warning was again mostly ignored, namely that:
“A UK vote to leave the European Union is becoming more likely”.
Instead, like the 2008 crisis, the Brexit vote is already being described as a ‘black swan’ event – impossible to forecast. This attitude merely supports the status quo, as it means consensus wisdom does not have to challenge its core assumptions. Instead, it takes comfort in the view that “nobody could have foreseen this happening”.
Critically, this means that the failure of the post-2008 stimulus programmes is still widely ignored. Yet these have caused global debt levels to climb to more than 3x total GDP, according to McKinsey. As the map above shows, they have created a debt-fuelled ‘ring of fire’, which now threatens to collapse the entire global economy:
- China’s reversal of stimulus policies has led to major downturns in the economies of all its commodity suppliers
- Latin America, Africa, Russia and the Middle East can no longer rely on exports to China to support their growth
- Japan’s unwise efforts at stimulus via Abenomics have also proved a complete failure
- Now Brexit will almost inevitably cause a major collapse in London house prices
- And it will focus attention on the vast debts created by the Eurozone debt crisis
- It will also unsettle US investors, who have taken margin debt to record levels in the belief that the US Federal Reserve will never let stock market prices fall
TIME FOR STRAIGHT TALKING ON THE IMPACT OF AGEING POPULATIONS ON ECONOMIC GROWTH
It is therefore vital that policymakers now make a new start, whilst there is still time to avoid total financial collapse. Once people begin to realise that all this debt can never be repaid, then interest rates will soar and many currencies collapse. This is not being alarmist – this is just stating obvious facts.
The critical need is to recognise that demographics, not monetary policy, drive economies. A world with lots of young BabyBoomers in the Wealth Creating 25-54 age group will inevitably see strong growth. And if more and more women return to the workforce after childbirth, this will turbo-charge an economic SuperCycle.
This is what happened between 1983 – 2007, when the world saw almost constant growth. The US recorded just 16 months of recession in 25 years. But last year saw global GDP decline by a record amount in current dollars, more than in 2009 – a clear warning sign of major trouble ahead.
The issue is very simple. Common sense tells us that the combination of a 50% increase in global life expectancy since 1950, and a 50% fall in fertility rates, means that the world has now reached the “demographic cliff“:
- 1bn ageing Boomers are joining the low-spending, low-earning New Old 55+ generation for the first time in history
- They will be more than 1 in 5 of the global population by 2030, twice the percentage in 1950
This is good news, not bad. Who amongst us, after all, would not choose to have 20 years of life expectancy at age 65 instead of dying? That is today’s position in the Western world. And people in the emerging economies are catching up fast. They can already now expect to live another 15 years at age 65.
The trade-off is lower, or negative growth. People in this New Old 55+ age group already own most of what they need, and their incomes decline dramatically as they approach retirement.
But this simple fact of life has never been explained to voters. Instead they have been told since 2008 that policymakers are confident of returning the economy to SuperCycle levels of growth. No wonder they are growing restless, and starting to mistrust everything they are being told by the supposed experts.
CONCLUSION – TIME TO RESTORE TRUST WITH PLAIN SPEAKING
Policymakers and the media now have a grave responsibility, as do do all of us.
It is critically important that policymakers now recognise they must immediately reverse course on stimulus policies, and come clean with voters about the real economic situation.
Of course this will result in very painful conversations. But the alternative, of ignoring the warning provided by the Brexit vote, is simply too awful to contemplate.
The world’s central bankers would have been sacked long ago if they were CEOs running companies. They would also have been voted out, if they were elected officials. Not only have they failed to achieve their promised objectives – constant growth and 2% inflation – they have kept failing to achieve them since the Crisis began in 2008.
But they are neither, So instead, they cling on to office, becoming more discredited with every year that passes. Even the IMF is now warning that:
“Advanced economies are facing the triple threat of low growth, low inflation, and high public debt. This combination of factors could create downward spirals where economic activity and prices decline—leading to increases in the ratio of debt to GDP—and further, self-defeating attempts to reduce debt.”
Much of the IMF’s analysis could easily have come from the blog – with just one exception. It, like central bankers themselves, is still too proud to admit that demographics drive the world’s economies – not central bankers:
- Central banks revelled in the idea they were geniuses during the Boomer-led SuperCycle
- Like UK Finance Minister, Gordon Brown, they claimed to have conquered the cycle of “boom and bust”
- But their economic models were so out of date, they couldn’t even forecast the subprime crash
- Yet its inevitability was obvious even to the blog, long before it happened, as documented in “The Crystal Blog“
Finally, however, 8 years later, the voice of common sense is starting to be heard. As the World Bank’s country director for Indonesia told the Financial Times:
“No country becomes rich after it gets old. The rate at which you grow [with] a whole bunch of old people on your back is much lower than the rate of growth at which you can grow when people are active, are educated, are healthy.”
Nobel Prize-winner, Prof Joseph Stiglitz has also argued the need for change:
“It should have been apparent that most central banks’ pre-crisis models – both the formal models and the mental models that guide policymakers’ thinking – were badly wrong. None predicted the crisis; and in very few of these economies has a semblance of full employment been restored. The ECB famously raised interest rates twice in 2011, just as the euro crisis was worsening and unemployment was increasing to double-digit levels, bringing deflation ever closer.
“They continue to use the old discredited models, perhaps slightly modified. In these models, the interest rate is the key policy tool, to be dialled up and down to ensure good economic performance. If a positive interest rate doesn’t suffice, then a negative interest rate should do the trick….If central banks continue to use the wrong models, they will continue to do the wrong thing.”
But central bankers can’t be sacked by shareholders or voted out by the electorate. And now they are starting to cover up for their own mistakes by blaming each other. Thus as the Wall Street Journal headlined over the weekend:
“U.S. chides five economic powers over policies
“U.S. officials are increasingly concerned other countries aren’t doing enough to boost demand at home, relying too heavily on exports to bolster growth. “Counting on cheap currencies as a shortcut to boosting exports can create risks across the global economy, as nations fight to stay ahead of their competitors”.
This would be sound advice, if it wasn’t for the awkward fact that the US Federal Reserve is currently relying on a devaluation of the US$ to support the US economy. Just as in Japan and Europe, the Fed’s optimism about its policies creating the magical 2% inflation and a return to SuperCycle growth have just been proved wrong again:
But still, they refuse to recognise the economic impact of demographic change. Instead central bankers are now starting to fight amongst themselves. Each wants a lower value for their currency – even though common sense says this is impossible – and is also irrelevant to meeting the challenge of ageing populations.
So we continue to move through the Cycle of Deflation, as the chart shows. We are heading, if nothing changes, towards major currency wars. And it is no surprise that populist politicians such as likely Republican Presidential candidate, Donald Trump, are now starting to argue for trade protectionism to preserve jobs.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 58%
Naphtha Europe, down 53%. “Naphtha prices rise to fresh 2016 highs on Brent crude”
Benzene Europe, down 53%. “Both benzene and oil initially moved lower due to uncertainty deriving from the decisions expected from the Bank of Japan and the US Federal Reserve”
PTA China, down 39%. “Buyers could book PTA cargoes earlier in the May/June period due to the upcoming preparations for the G20 meetings in China from July onwards, when producers in the entire polyester chain are expected to reduce operating rates.”
HDPE US export, down 27%. “Continuous weak buying interest weighed on the market sentiment in China.”
¥:$, down 4%
S&P 500 stock market index, up 5%
A paradigm shift is underway in global petrochemical and polymer markets, as I discuss in a new article for ICIS Chemical Business.
Previously successful business models, based on the supply-driven principle, no longer work. As our new study, “Demand – the New Direction for Profit”, explains, companies now need to adopt demand-led strategies if they want to maintain revenue and profit growth.
The infographic above highlights the key issues:
- During the 1980s/1990s, the BabyBoomers – the largest and wealthiest generation that the world has ever seen – entered the Wealth Creator generation (those aged 25 – 54), when income and spending peak
- They powered an Economic SuperCycle
- The world’s largest economy, the USA, suffered just 18 months of recession in 25 years between 1983 – 2007
- The demand surge created the phenomenon of globalisation, integrating Eastern Europe, then China and India, into the global economy
- It peaked between 1995 – 2000, when all the BabyBoomers (born 1946-70) were in the Wealth Creator generation
But then the oldest Boomers began to join the New Old generation of those aged 55+. In the past, they would have died very quickly – life expectancy, even just a century ago, was only 46 years in the West, and 26 years in emerging economies. But major advances in healthcare, food/water safety, and personal lifestyles meant that the average 65-year old could instead hope to live another 15 – 20 years.
Demand growth began to decline. The New Old already own most of what they need, and their incomes decline as they enter retirement.
Policymakers refused to accept this obvious fact. Instead, they claimed to be able to produce constant growth by boosting financial markets. First they created the subprime bubble in the USA, and then today’s stimulus bubble. This had created $57tn of debt by 2014, nearly the size of the global economy. Clearly, this could not continue:
- China was the first to change economic course, when President Xi Jinping took office in 2013
- The Great Unwinding of policymaker stimulus began in August 2014
China had been responsible for more than half of the stimulus spending under the previous leadership. So its New Normal policies had a major impact on the global credit bubble.
Since then, oil and commodity prices have collapsed, and economies dependent on exports to China have gone into recession. Global GDP fell by a record $3.8tn in 2015 in current dollars. Inflation is turning into deflation.
But still, policymakers in the developed world refuse to accept that demographic changes are driving the global economy. Instead, they are creating even more debt – which can probably never be repaid.
What are companies and investors to do? As the infographic below describes, they have a clear choice ahead:
- They can either hope that somehow these new stimulus policies will succeed despite past failure
- Or, they can join the Winners who are now starting to develop new revenue and profit growth by adopting demand-led strategies
Please click here if you would like to download a copy of the feature article, and click here to download a copy of the Study brochure.
3 years of massive stimulus spending in Japan has had no impact on the problem it was supposed to solve. This is highlighted by new government data on household spending for 2015, as the charts above confirm – they compare 2015 data with that for 2012, before Abenomics began:
- Spending was almost exactly the same at every age group in 2015 versus 2012, when premier Abe took office
- Spending in the peak age range of 50 – 59 was just ¥250/year higher, and ¥7900 lower in the 40 -49 age group
- It still declines 31% once people reach the age of 70 – critically important with Japan’s ageing population
- In US$ terms, of course, the numbers are lower due to Abe’s focus on devaluing the yen since he took office
- US$ spending in the two peak age groups of 40 – 49, and 50 – 59, has fallen by $15k/year to $29k/year
This matters, because consumer spending is 60% of Japanese GDP.
The quite scary result is that the Bank of Japan has spent ¥200tn ($1.84tn) since Abe came to power on its quantitative easing programme. Yet the Abenomics policy has completely failed to achieve its major objectives of boosting GDP and inflation:
As a result, Japan now has the world’s highest level of government debt as a percentage of GDP at 226%.
Yet premier Abe and Bank of Japan Governor Kuroda refuse to accept that their policies have failed. Instead, just like the European Central Bank yesterday, they have decided to implement their policies on a greater scale. Thus Japan introduced negative interest rates in January, meaning that the Bank now charges you to deposit money with it.
Clearly these are increasingly desperate measures, which have a vanishingly small chance of being successful. Past performance is no guarantee of future results, but it is usually the best guide that we have. And understandably, Japan’s Diet (its parliament) is becoming very concerned – Governor Kuroda has been summoned for questioning a record 25 times so far this year.
One major concern is that Japan’s value proposition for foreign investors is looking increasingly unattractive:
- Foreigners have to pay the government to lend it money (and so are guaranteed to get back less than they lend)
- They also know devaluation remains a key policy, meaning that the return in their currency will probably be lower
- And GDP growth is almost impossible with Japan’s median age now 47 years and its population will decline 600k/year by 2020
Premier Abe initially promised that he would restore the country to growth within 2 years, and push inflation to at least 2%. Today, 3 years later, his Abenomics policies have entered the end-game. Some investors will no doubt continue to maintain positions in Japan, as it is still the world’s 3rd largest economy.
But they will no doubt be keeping a close eye on their exit opportunities. When the rush starts, nobody will want to be left behind.
The chemical industry remains the best leading indicator for the global economy. That much is clear from the warnings it has delivered over the past year:
It really is a clear and consistent track record. And it is far superior to the performance of financial markets, who find themselves at the mercy of central bank manipulation – with vast amounts of electronic money being forced on investors, who have to then bid up prices in response – as happened again, yesterday.
So what do latest company statements tell us about the outlook in detail?
- US companies are no longer confident of riding out the storm due to the collapse of their feedstock cost advantage and the rise of the US$
- European companies see no recovery in end-user markets, but have been supported by lower oil prices and currency values
- The Middle East has seen margins hit by lower oil prices, whilst Asia has been in the eye of the storm as China slows
The key issue is that we are moving into the New Normal world, as we discuss in our major new Study, Demand – the New Direction for Profit. China’s slowdown and the collapse of oil prices highlight that we are seeing a paradigm shift in demand patterns. Companies, as the chart highlights, can no longer rely on previously successful supply-driven business models.
Instead, as I will discuss on Monday, we all have to relearn how to operate demand-led models again.
The summary of 2015 company results is as follows:
Air Products. “Unfavourable currency and lower energy pass-through of 5% each more than offset volume and pricing increases of 1%”
Air Liquide. “Improved margins and revenue”
Akzo Nobel. ““We expect 2016 to be a challenging year. Difficult market conditions continue in Brazil, China and Russia. No significant improvement is anticipated in Europe, particularly in the Buildings and Infrastructure segment. Deflationary pressures continue and currency tailwinds are moderating”
Ashland. “Income down 11% due to a drop in sales”
BASF. “In the chemicals segment, the good earnings of the first three quarters of 2015 will not be matched and a significantly lower contribution is expected”
Axiall.”Sales fell because of lower values for chlorine and caustic soda”
BP. “Improved operational performance and benefits from our simplification and efficiency programmes leading to lower costs”
Braskem. “Brazil’s petrochemical industry should face a challenging year similar to the one in 2015, when domestic sales contracted 5.4% and domestic demand for chemicals fell 6.8%”
Celanese. “We took a number of steps to improve our competitive position”
CP Chem. “Reduced margins, as well as decreased equity earnings”
Covestro. “All three regions in which the company operates recorded comparable volume growth last year”
Dow. “Global economy continues to be volatile with consistent demand being driven by the consumer”
Clariant. “Have been able to offset the negative impact of the stronger Swiss franc”
DSM.”Intends to reduce costs and control its capital expenditure”
DuPont. “Lower ethylene prices and volumes, together with a negative currency impact of $19m, could not offset cost reductions, continued productivity improvements and increased demand in the auto sector”
Eastman. “Attributed the decline to propane hedges and lower sales volumes from acetate tow”
Enterprise. “2015 was very rough for our industry, and 2016 appears to be even more difficult given the low pricing environment”
ExxonMobil. “Lower margins, as well as unfavourable foreign exchange, tax and inventory effects”
Honeywell. “Favourable impact of raw materials pass-through pricing in its Resins & Chemicals business”
Huntsman. “We expect continued EBITDA pressure on our cyclical businesses”
INEOS. “Weakening markets in Asia, particularly China”
LG Chem. ““Overall sales have decreased due to slow recovery of the global economy and oil price plunge”
Lonza. ““Healthy market demand, combined with significantly better operational performance bolstered the strong results”
LyondellBasell. “Record performance from our olefins and polyolefins – Europe, Asia and International, intermediates and derivatives, and technology segments”
MOL. “Downstream general environment will be still supportive for our industry”
OMV. “Higher refining margin and petrochemical results”
Oxiteno. “Sharp slowdown in Brazil”
PPG. ““Results improved despite the persistent, unfavorable impact of weaker foreign currencies”
Petronas. “We expect the market to continue to be challenging moving forward”
PetroRabigh. “Petrochemical margins were low last year because of the slump in crude prices”
Praxair. ““The macro-economic headwinds faced in 2015 from negative currency translation and the slowdown in global industrial activity have not yet abated”
Reliance. “Falling feedstock costs have allowed for margin expansion”
Repsol. “Improved margins at the chemicals business”
SABIC. “Average selling prices of its products, particularly in the metals segment, slumped”
Sasol. “Negatively impacted by challenging and highly volatile global markets, marked by a steep decline in global oil and commodity chemical prices, partly offset by a weaker rand exchange rate”
Saudi Kayan. “Higher sales volumes were offset by declines in average selling prices of products”
Shell. “Contributions from the chemicals business fell mainly as a result of weaker base chemicals and intermediates industry conditions”
Sipchem. “Selling prices of its products declined”
Solvay. “Sales were mainly supported by a favourable impact of favourable exchange rates of 7%”
Synthos. “Weakening market conditions and the problems related to Litvinov”
Tasnee. “Steep decline in selling prices and higher expenses”
TOTAL. ““Petrochemical margins in Europe increased in 2015 due to strong demand for polymers and the decrease in raw material costs”
Unipetrol. “significant decline in petrochemical production and sales volumes of petrochemical products due to Litvinov outage”
Univar. “Sales fell across all regions it operates in during the fourth quarter”
Vopak. ““Looking ahead, we expect 2016 occupancy rates of our global terminal network to exceed 90%”
Westlake, “Higher sales volumes could not offset lower selling prices”
Only one central banker spotted the subprime crisis before it occurred – William White. Now he is warning that the world will have to revive the Old Testament concept of “debt jubilees“, with much of today’s debt being written off:
“Debts have continued to build up over the last eight years and they have reached such levels in every part of the world that they have become a potent cause for mischief. Emerging markets were part of the solution after the Lehman crisis. Now they are part of the problem, too.
“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”
Long-standing readers will remember that White was one of my guides in 2007-8, when forecasting the subprime crisis. He was then Chief Economist for the central bankers’ bank (the Bank for International Settlements). I summarised his July 2007 Report in ‘4 risks to the world economy’, and the July 2008 Report as ‘The difficult task of damage control’. Unfortunately, I was one of the few to take him seriously.
Today, he is Chairman of the OECD Review committee and continues to speak his mind. His analysis parallels my own concept of the ‘Ring of Fire’ created by central bank stimulus policies, set out in the map above:
- It focuses on the massive changes underway in China, where President Xi has cut back dramatically on stimulus lending since taking office
- Xi has particularly squeezed the shadow banking sector, responsible for most of the speculative property lending that has done such damage to China’s economy
- As a result, commodity-based companies around the world, and countries, are in crisis
- Mining company shares have been in freefall for months, as investors wake up to the fact that stimulus has created vast surpluses in key products
- Even worse is that China’s slowdown is creating major recessions in countries in a wide arc from Brazil through South Africa, Asia, Australia, the Middle East and Russia
I will look at the potential implications of White’s analysis in more detail on Wednesday.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 72%
Naphtha Europe, down 64%. “European petrochemical producers are maximising propane cracking because of the co-products derived from it”
Benzene Europe, down 58%. “Prices have risen sharply this week, with players now seeing product short for January and early February.”
PTA China, down 47%. “Overall buying appetite continued to be thin in the market”
HDPE US export, down 42%. “Chinese end-users still showed strong resistance to the relatively firm-priced cargoes”
¥:$, down 16%
S&P 500 stock market index, down 3%