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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I was interviewed on Friday about the likely impact of President Trump’s trade wars on the global chemical industry by Will Beacham, deputy editor of ICIS Chemical Business. His interview is below.
The introduction on Friday of trade tariffs by China and the US is the first step in a trade war that could turn into a global polyethylene (PE) price war as the wave of new US production is sent to new markets, likely Europe.
Paul Hodges, chairman at London-based International eChem, said that around 6m tonnes/year of new US PE capacity has to find a home and, with China largely out of reach, the obvious destination would be Europe, where the surplus production will put downward pressure on prices there and around the world.
“The main hit from a trade war is going to be the US PE expansions – clearly it is being targeted so the opportunity to export to China is sharply reduced,” said Hodges. “But this won’t just be a US problem because they will still want to move their product – it has got to come to Europe as there is no surplus demand in Asia, the Middle East or Latin America.”
He added that this first wave of tariffs were a wake-up call to those who thought globalisation was going to continue as it did in the past. “We have reached a tipping point where we have to expect that trade wars are more rather than less likely”, he said.
“If you assume the US production will come onstream, then where will those 6m tonnes of product go? It can’t go to China, it can’t go to Latin America as that is too small a market, the Middle East is in surplus, Africa is too small – so Europe is the only place,” said Hodges.
US PE producers that are integrated up to the wellhead need to extract ethane in order to monetise their gas production:
- These producers will continue to export happily at whatever price because essentially the ethane is a distressed product and has to be sold
- However, non-integrated players’ margins could come under pressure.
In Europe, there is a parallel to the US, said Hodges, as regional production is generally tied into refineries.
Naphtha is a relatively small part of the product flow from a refinery, so prices can go down quite a long way before you start to think about cutting back on refinery operating rates.
“The risk for the second half of this year and 2019 is that you have two heavyweights in the boxing ring – one integrated back to the gas wellhead in the US and the other refinery-integrated in Europe – and people get squeezed in between,” he added.
EUROPE VALUE CHAINS
Hodges pointed out that if cracker operating rates decline in Europe it will hit all the other product streams such as propylene, butadiene (BD) and pygas. There are tremendous knock-on risks across all the value chains, not just ethylene.
“This won’t happen this year, but if it continues and gets worse over the next 12-18 months, do you start to look at cracker shutdowns in Europe? What will the implications be for people relying on those crackers for feedstocks?” said Hodges. “It’s a hornet’s nest of unintended consequences: people don’t send a ship load of PE to Europe expecting it to shut down a PP plant.”
Hodges urged the industry to make contingency plans now to manage these future risks. European producers will have to think about how they protect feedstock supplies for value chains on a Europe-wide and country basis so that pipelines are not shut down.
“You’d have to focus on a number of core hubs and reinvest in those to give the infrastructure you need for the future. You need to do it now – while there is time to take action,” he said. “You might end up spending money you don’t need to spend, but that’s much better than waking up and realising you don’t have a feedstock supply,” he said.
According to ICIS data, the US is forecast to export a total of 1.37m tonnes of low density polyethylene (LDPE), high density polyethylene (HDPE) and low linear density polyethylene (LLDPE) to China (see LLDPE map above). Although HDPE is not included in the current tariffs, it could be added later, according to Hodges.
He added that a price war in PE would impact other polymers because of inter-polymer competition. It may only be 5-10% that is substituted, but to lose that amount of volume at the margin would be quite significant.
He described the trade war as a paradigm shift for the whole global industry as the era of globalisation switches to regional and nationalism. “I’m worried that a lot of people in this industry have grown up with globalisation and they assume that is how it is,” he said.
Trade policy and geopolitics are like a chess game with lots of moving pieces and the approach is that you give up something in order to gain more, he added. This has been a very successful approach by the US since the Second World War, when it implemented the Marshall Plan or ‘European Recovery Plan’. Almost the equivalent of $110bn in today’s money was invested to rebuild the continent.
“This boosted the European economy in order to make it a bigger import market for US exports. Trade expands opportunities and the overall economy. There may be some short-term successes going into a trade war but ultimately the US economy will lose,” Hodges conclude.
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The blog has now been running for 11 years since the first post was written from Thailand at the end of June 2007. And quite a lot has happened since then:
Sadly, although central banks and commentators have since begun to reference the impact of demographics on the economy, they have not changed their basic belief that the right combination of tax and spending policies can always create growth.
As a result, the world has become a much more complex and confusing place. None of us can be sure what will happen over the next 12 months, given today’s rising geo-political tensions.
In times of short-term uncertainly, it can be useful to take a longer-term view. It is therefore perhaps helpful to look back at Chapter 4 of Boom, Gloom, which gave “Our 10 predictions for how the world would look from 2021:
- “A major shake-out will have occurred in Western consumer markets.
- Consumers will look for value-for-money and sustainable solutions.
- Young and old will focus on ‘needs’ rather than ‘wants’.
- Housing will no longer be seen as an investment.
- Investors will focus on ‘return of capital’ rather than ‘return on capital’.
- The term ‘middle-class’ when used in emerging economies will be recognised as having no relevance to Western income levels.
- Trade patterns and markets will have become more regional.
- Western countries will have increased the retirement age beyond 65 to reduce unsustainable pension liabilities.
- Taxation will have been increased to tackle the public debt issue.
- Social unrest will have become a more regular part of the landscape.
“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.”
Most of these forecasts are now well on the way to becoming reality, and the pace of change is accelerating all the time. It may therefore be helpful to include them in your planning processes for the 2019 – 2021 period, to test how your business (and your personal life) might be impacted if they become real.
THANK YOU FOR YOUR SUPPORT OVER THE PAST 11 YEARS
It is a great privilege to write the blog, and to be able to meet many readers at speaking events and conferences around the world. Thank you for all your support.
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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There will be no shortage of important topics to discuss on Thursday, at my regular Chemistry and the Economy: 2018 Mid-Year Update webinar for the American Chemical Society.
Please join me on Thursday @ 2pm – 3pm Eastern US Time for the webinar, which will be moderated as usual by Bill Carroll, former ACS Chair.
Free registration is at Chemistry and the Economy: 2018 Mid-Year Update.
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Is global economic growth really controlled by monetary policy and interest rates? Can you create constant growth simply by adjusting government tax and spending policy? Do we know enough about how the economy operates to be able to do this? Or has something more fundamental been at work in recent decades, to create the extraordinary growth that we have seen until recently?
- As the chart shows for US GDP, regular downturns used to occur every 4 or 5 years
- Then something changed in the early 1980s, and recessions seemed to become a thing of the past
- Inflation, which had been rampant, also began to slow with interest rates dropping from peaks of 15%+
- For around 25 years, with just the exception of the 1st Gulf War, growth became almost constant
Why was this? Was it because we became much cleverer and suddenly able to “do away with boom and bust” as one UK Finance Minister claimed? Was it luck, that nothing much happened to upset the global economy? Was it because the Chairman of the US Federal Reserve from 1986 – 2006, Alan Greenspan, was a towering genius? Perhaps.
THE AVERAGE BABYBOOMER IS NOW 60 YEARS OLD
Or was it because of the massive demographic change that took place in the Western world after World War 2, shown in the second chart?
- 1921 – 1945. Births in the G7 countries (US, Japan, Germany, France, UK, Italy, Canada) averaged 8.8m/year
- 1946 – 1970. Births averaged 10.1m/year, a 15% increase over 25 years
- 1970 – 2016. Births averaged only 8.5m/year, a 16% fall, with 2016 seeing just 8.13m born
Babies, as we all know, are important for many reasons.
Economically, these babies were born in the wealthy developed countries, responsible for 60% of global GDP. So right from their birth, they were set to have an outsize impact on the economy:
- Their first impact came as they moved into adulthood in the 1970s, causing Western inflation to soar
- The economy simply couldn’t provide enough “stuff”, quickly enough, to satisfy their growing demand
- US interest rates jumped by 75% in the 1970s to 7.3%, and doubled to average 10.6% in the 1980s
- But then they began a sustained fall to today’s record low levels as supply/demand rebalanced
BOOMERS TURBOCHARGED GROWTH, BUT ARE NOW JOINING THE LOWER-SPENDING 55-PLUS COHORT
The key development was the arrival of the Boomers in the Wealth Creator 25-54 age group that drives economic growth. Consumer spending is 60% – 70% of GDP in most developed economies. And so both supply and demand began to increase exponentially. In fact, the Boomers actually turbocharged supply and demand.
Breaking with all historical patterns, women stopped having large numbers of children and instead often returned to the workforce after having 1 or 2 children. US fertility rates, for example, fell from 3.3 babies/woman in 1950 to just 2.0/babies/women in 1970 – below replacement level. On average, US women have just 1.9 babies today.
It is hard to imagine today the extraordinary change that this created:
- Until the 1970s, most women would routinely lose their jobs on getting married
- As Wikipedia notes, this was “normal” in Western countries from the 19th century till the 1970s
- But since 1950, life expectancy has increased by around 10 years to average over 75 years today
- In turn, this meant that women no longer needed to stay at home having babies.
- Instead, they fought for, and began to gain Equal Pay and Equal Opportunity at work
This turbocharged the economy by creating the phenomenon of the two-income family for the first time in history.
But today, the average G7 Boomer (born between 1946 – 1970) is now 60 years old, as the 3rd chart shows. Since 2001, the oldest Boomers have been leaving the Wealth Creator generation:
- In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, who spent an average of $62k ($2017). There were only 36m households headed by someone in the lower-spending 55-plus cohort, who spent an average of $45k
- In 2017, low fertility rates meant there were only 66m Wealth Creator households spending $64k each. But increasing life expectancy meant the number in the 55-plus cohort had risen by 55%. However, their average spend had only risen to $51k – even though many had only just left the Wealth Creators
CONCLUSION – THE CHOICE BETWEEN ‘DEBT JUBILEES’ AND DISORDERLY DEFAULT IS COMING CLOSE
Policymakers ignored the growing “demographic deficit” as growth slowed after 2000. But their stimulus policies were instead essentially trying to achieve the impossible, by “printing babies”. The result has been today’s record levels of global debt, as each new round of stimulus and tax cuts failed to recreate the Boomer-led economic SuperCycle.
As I warned back in January 2016 using the words of the OECD’s William White:
“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.”
That recession is now coming close. There is very little time left to recognise the impact of demographic changes, and to adopt policies that will minimise the risk of disorderly global defaults.
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