The litmus test for the global economy

The world has wasted 3 months – there is little time now left to avoid a Covid-19 catastrophe

It is now 3 months since China’s state television broadcast the first news of the Wuhan virus, now known as Covid-19. And it is almost 3 months since China released the first genetic sequence for the virus on 9 January.

But with certain notable exceptions, governments since then have mostly failed to properly activate their pandemic contingency plans. Some have even refused to make the hard choices necessary to protect the public. And as we are now learning the hard way, avoiding painful decisions doesn’t make them go away. Instead, the available options narrow.

We will never now know, for example, whether prompt action by governments could have reduced the total impact of the virus. But, we do know that the delay has helped to create a global economic crisis to add to the health crisis, as the IMF’s head warned on Friday:

Never in the history of the IMF have we witnessed the world economy coming to a standstill. It is way worse than the financial crisis”.

So was this a so-called ‘Black Swan’ that nobody could have forecast? You might think so, reading consensus commentary.

These are the same people who failed to spot the problem in the first place, just as they failed to spot the 2008 crisis when it was building.

In reality, the path to today’s disaster – for that is what it has now become – was very clear from early February, as I have highlighted here each week:

9 February: Coronavirus disruptions make global recession almost certain
16 February: Financial markets head for (another) train crash as coronavirus starts to impact
23 February: China’s lockdown makes global debt crisis now almost certain
1 March: Oil markets hit perfect storm as coronavirus cuts demand
8 March: China’s smartphone and auto sales tumble as coronavirus hits demand
15 March: “They may ring their bells now, before long they will be wringing their hands”
22 March: A new recession era to emerge
29 March: China’s property sector is at the epicentre of the crisis

The problem, even today, is that people who shout loudest get the media attention. There is no analysis of what they have said before, or whether it made sense. This is quite different from the past, when people like Henry Kissinger were US Secretary of State.

Kissinger actually took tough decisions that upset people, because his rigorous analysis told him they had to be made.  And this is what he wrote on Saturday, under the heading “The Coronavirus Pandemic Will Forever Alter the World Order“:

“The coronavirus has struck with unprecedented scale and ferocity. Its spread is exponential: U.S. cases are doubling every fifth day. At this writing, there is no cure. Medical supplies are insufficient to cope with the widening waves of cases. Intensive-care units are on the verge, and beyond, of being overwhelmed. Testing is inadequate to the task of identifying the extent of infection, much less reversing its spread. A successful vaccine could be 12 to 18 months away.”

Please read this statement again, and tell your friends about it. The USA is the world’s wealthiest economy,and its senior statesman is warning that it is currently powerless in the face of the virus. And please then read this statement, and ponder what it means for the outlook for the global economy:

“The contraction unleashed by the coronavirus is, in its speed and global scale, unlike anything ever known in history. And necessary public-health measures such as social distancing and closing schools and businesses are contributing to the economic pain. Programs should also seek to ameliorate the effects of impending chaos on the world’s most vulnerable populations.”

We are already close to the point where the pandemic will kill hundreds of thousands of people, possibly millions. And we are also close to the point where today’s lockdowns will create a global depression on a scale not seen since the 1930’s.

This is now not just my opinion, but that of the IMF and of thoughtful, highly experienced public servants such as Henry Kissinger. We all need to act now, in whatever way we can, to avert this potential catastrophe. Otherwise, as Kissinger warns:

“The historic challenge for leaders is to manage the crisis while building the future. Failure could set the world on fire.”

A new recession era to emerge

Contingency planning has become mission-critical. The longer the coronavirus pandemic continues, the more it will expose the underlying fragility of today’s debt-laden global economy.

Companies therefore have to move into crisis management mode, with a number of key areas requiring immediate attention:

• Employee health and safety is the top priority. Governments are slowly waking up to the risks and are starting to provide expert advice. In the meantime, of course, many companies have already taken steps to reduce all unnecessary travel and to encourage home-working wherever possible. It would be prudent to assume their measures will last for longer than initially expected, as nobody will want to take the risk of problems emerging as a result of precautions being relaxed – especially in litigious countries such as the USA
Value chain risks are clearly a key area of concern for the business itself. Upstream, the oil price collapse means that the new US shale gas expansions have lost their hoped-for feedstock advantage versus European and Asian producers. Downstream, China’s auto sales fell 80% in February, whilst smartphone sales were down 55%. We must assume that other affected countries will also see major declines, even if hopefully not on the same scale
Supply chain risks are another major area for review. Anyone who has tried to map a modern supply chain knows that the exercise quickly reveals a number of ‘black holes’ where nobody really understands all the inter-dependencies. For example, although it might seem obvious in hindsight, did anyone really expect freight volumes in Los Angeles to fall 25% last month – even given its role as the largest gateway for seaborne China imports? And even if China does now return to normal, it will still take weeks for new shipments to arrive given the disruption that has occurred to freight and logistic operations
Credit risks also have the potential to surprise the unwary. The lure of cheap money from the central banks, and investor pressure to maximise earnings, has unfortunately led many companies to over-leverage their balance sheets. Even a relatively small profit downturn will therefore put their financial viability at risk. And as we know, whilst banks are happy to lend when the outlook is sunny, they are very quick to withdraw when storms appear on the horizon
Paradigm shifts add to the complexity that we now face. Today’s population growth is largely due to a major post-War rise in life expectancy, rather than a new babyboom. But older people already own most of what they need, creating a ‘demographic deficit’ in terms of demand growth. As a result, sustainability is now replacing globalisation as a key driver for our business. Used car sales, for example, are already cannibalising new car sales in China and elsewhere. Similarly, analysts see the used smartphone market growing by 50% over the next 3 years from the current 207 million sales.

Every business will have its own priority list of key risks. And, of course, I understand the feeling that ‘one can’t plan until one knows what is happening’. But whilst this was entirely logical in a world of ‘business as usual’, we now face the necessity of learning how to plan for uncertainty.

Reasonable people can disagree about whether the risks I have identified are a 10%, 50% or a 90% probability. But even if you assume they are just a 10% probability, their potential downside impact is so large that they cannot be ignored.

Contingency planning has therefore become mission-critical. One key uncertainty is that nobody can know how long the virus pandemic will last. But we can be sure that the longer it continues, the more it will expose the underlying fragility of today’s debt-laden global economy.

This crisis means it has therefore become mission-critical for businesses to build scenarios covering different timescales.

The aim is to understand what can be done today to mitigate the consequences of the epidemic extending beyond the end of this quarter, or into the second half of the year, in key markets? It will also provide a framework for assessing how recession might impact prices and margins for your products, as well as accelerating the trend towards buying second-hand products?

As the saying goes – “to fail to plan, is to plan for failure.”

Please click here (no registration required) if you would like to read my full analysis in this week’s ICIS Chemical Business.

Chain’s smartphone and auto sales tumble as coronavirus hits demand

China is the world’s largest market for smartphones and autos – responsible for c30% of global sales for both.  Yet as Reuters notes:

“Most western policymakers and journalists view the world economy through a framework that is 10-15 years out of date, failing to account fully for the enormous shift in activity towards China and the rest of Asia.”

The critical fact is that both markets are now about to go into a severe downturn as a result of the coronavirus epidemic. This is already having a major impact on domestic sales in China, and is starting to create major disruption to today’s globalised supply chains.


As the chart shows, global smartphone sales were down again in Q4.  2019 sales were 1.4bn, versus their 2017 peak of 1.5bn. And, of course, Q1 is going to be a terrible period for sales, given the coronavirus impacts.

China has been the world’s largest market since 2012, but sales were down 37% in January as consumers began to worry about the risks from the virus.  February will clearly be much worse, as a result of the major lockdowns in place.  As Strategy Analytics warn:

“The smartphone market will be adversely impacted by the slowing GDP growth and the plunging consumer spending. It will also impact global smartphone supply and manufacturing, because China makes 70% of all smartphones sold on the planet.”

Research firms IDC and Canalys are already forecasting that China’s market will be down 40% in Q1. But this is likely an under-estimate, given the impact of the lockdowns.  Most retail stores, including Apple’s, have been shut during February, after all. And as Chinese business paper Caixin reported:

“China’s capital might be officially back to work, but it would be hard to tell from walking around the normally congested city. Tourist sites and other popular destinations remain unusually free of sightseers, customers or pedestrians.”

Outside China, parts arriving in the West today came from factories that were still open before Lunar New Year.  But now, supply chain problems are about to become evident:

  • Port calls in China fell 30% last month, as ships worried about crews being quarantined
  • Los Angeles – the largest US gateway for seaborne China imports – saw volumes drop 25%
  • Things will now get worse, as shipping times of 4 – 6 weeks mean new supplies are reducing
  • And back in China, it seems workers are often frightened to return – Apple’s main supplier, Foxconn, is having to offer $1k bonuses to persuade new workers to join

And, of course, the recession is also seeing major paradigm shifts take place.

For example, used smartphones are now becoming a viable market in their own right for the first time.  207m were sold last year, up 18% from 2018, and IDC see the market growing to over 300m phones by 2023. As they note:

“In contrast to the recent declines in the new smartphone market, as well as the forecast for minimal growth in new shipments over the next few years, the used market for smartphones shows no signs of slowing down across all parts of the globe. Refurbished and used devices continue to provide cost-effective alternatives to both consumers and businesses that are looking to save money when purchasing a smartphone.”


China’s auto market also matters. It is easily the largest in the world, with peak sales in 2017 of 24.7m, versus 17.9m in the USA and 15.3m in Europe.  And without China’s four-fold stimulus-powered sales increase since 2008, the global market would have seen no growth at all.

But today, the used market has become key to auto sales growth, as the chart confirms.  Consensus opinion still believes that its new car sales would continue to grow until at least the end of the decade. But this conclusion fails to reflect the unique nature of China’s market:

  • Back in 2000, there were just 16m cars on the road – and the quality was so bad, they mostly fell apart within a few years. There were still only 65m cars in 2008, before stimulus began
  • As a result, used car sales hardly existed. Instead, as in most poor countries, local mechanics would strip out parts from abandoned cars and reuse them to keep others on the road
  • It was only when China’s “subprime on steroids” stimulus programme began in 2009, with shadow banks funding speculative house purchases, that Western companies introduced their technology
  • Even then, it took until 2014 for used sales to start motoring, and they have still not reached a 50:50 ratio with new cars. And the direction of travel is clear, as used sales are normally 2x-3x new in most countries

China’s used sales rose 8% in 2019, whilst new sales fell 9%. They may well equal new sales this year for the first time, given the collapse underway in new sales.

Thus the virtuous circle of the last decade is turning vicious.  China’s new car sales fell by 90% in February, and salary losses during the lockdowns make it unlikely that the crisis has left a backlog of pent-up demand to create a V-shaped recovery.

Similarly, used car sales are set to cannibalise new car sales in all the major markets. Lending standards are already tightening, making new cars simply unaffordable.


People sometimes say they ‘can’t plan until they know what is happening’. But in reality, what they mean is that they have become used to doing tactical planning, based on the idea of ‘business as usual’.  Today, however, we all have to relearn how to plan for uncertainty.

The question now for investors and companies is to start contingency planning for what may happen next.  We have to ask the question – how quickly will used smartphones and cars cannibalise new sales over the next year? Will they take 10%, 20% or more?  And what will happen to prices and margins as a result?

As the saying goes – “to fail to plan, is to plan for failure.”

China’s lockdown makes global debt crisis now almost certain

Beijing has a population of 21.5 million, but you wouldn’t know it from this BBC video from last Thursday.  Normally busy streets and transport systems are eerily empty, with food deliveries often the main traffic on the roads.

It’s the same picture in industry, with the Baidu Migration Index reporting only 26% of migrant workers had returned to work across 19 sample cities by 19 February, compared with 101% a year earlier.

The position is even worse in Hubei province, the most important industrial manufacturing province in the country, as this South China Morning Post video, also from last Thursday, confirms.

China is clearly nowhere near getting “back to normal”, as the SCMP reports:

“Choked off from suppliers, workers, and logistics networks, China’s manufacturing base is facing a multitude of unprecedented challenges, as coronavirus containment efforts hamper factories’ efforts to reopen. 

“Many of those that have been granted permission to resume operations face critical shortages of staff, with huge swathes of China still under lockdown and some local workers afraid to leave their homes. Others cannot access the materials needed to make their products, and even if they could, the shutdown of shops and marketplaces around China means demand has been sapped. 

“Those who manage to assail the challenges, meanwhile, have found that trucking, shipping and freight services are thin on the ground, as China’s famed logistical machine also struggles to find workers and navigate provincial border checkpoints that have popped up across the country.”

Cash-flow is also drying up at thousands of companies, large and small.  It is now a month since the emergency began. Bloomberg reports, for example, that the Hainan provincial government is in talks to takeover HNA’s $143bn airline to property development business empire.

It would be nice to believe that the epidemic will have no impact on China’s economy. But common sense tells us this can’t be true. We just have to ask ourselves 5 obvious questions.  What would happen to:

  1. Our own country’s economy, if our capital and a major manufacturing base shutdown for a month?
  2. Businesses, large and small, if orders stopped and transport was severely disrupted?
  3. Imports and exports, if critical shipping schedules and flights were cancelled?
  4. Cash-flow, if the above happened and we still had to pay interest bills on debt?
  5. Supply chains, if workers at one or more partners couldn’t get to work for a month?

South Korea’s president Moon-Jae has given the obvious answer as the Financial Times reports:

“We should take all possible measures we can think of” to support the economy, Mr Moon told a cabinet meeting on Tuesday. “The current situation is more serious than we thought . . . we need to take emergency steps in this time of emergency.”

Of course, ‘this time may be different’. But common sense tells us that China’s economy is under enormous pressure today. The charts above highlight the range of areas that are affected:

  • Property sales are down 79%, with Evergrande offering 22% discounts through March
  • Construction is 25% of GDP, with Fitch identifying 6 developers with high risk of default
  • Ports are often at a standstill – and many shippers have simply stopped calling at Chinese ports
  • Car sales collapsed by 92% in the world’s largest auto market in the first two weeks of February

1. Domestic sales.  Thousands of stores have been shut since the epidemic began, and people are understandably too scared to venture out – even if this was allowed. So we must assume most areas of domestic consumption are being hit.

2. Imports for manufacturing. Chemicals are an excellent guide to the overall position, as the charts show based on Trade Data Monitor data. Given the shipping problems, large volumes of cancelled imports must now be sitting in suppliers’ tanks and warehouses, waiting to find a new market

3. Exports as part of supply chains. Apple’s profit warning highlights how even major companies have been caught out, as they cannot obtain the component supplies on which their global sales depend. Car and electronics companies are probably most at risk, and we will no doubt see more profit warnings as companies realise inventory is running short

4. Domestic suppliers. There is little data available about the virus’ impact on smaller Chinese companies. But presumably many have already gone bust, especially if they were unlucky enough to be in the centre of the downturn, such as those in Hubei and Wuhan

5. Oil and currency markets.  Caixin reports that Chinese refinery runs are at just 10mbd, compared to an average 13mbd in 2019:

“The deepening run cuts belie optimism that the impact of the epidemic may have peaked, a sentiment that’s helped spur a recovery in oil prices over the last week and a half. Many people are still trapped in their homes and unable to go to work, while curbs on travel have pummeled demand for transport fuels.”

Currency markets are also realising the worst may yet be to come.  Companies such as HNA have been major borrowers in the offshore dollar market – hoping to take advantage of low US interest rates. But as we have seen many times before, when the currency starts to fall, those debts quickly become impossible to service.

Observers such as myself have warned about this problem for years.  Earlier this month, an international G20 task force of currency experts warned:

“Central banks have lost control of global liquidity. The dollarised international financial system has become treacherously unstable and vulnerable to a sudden reversal in capital flows.  A decade of ultra-low interest rates and quantitative easing has flooded the globe with highly unstable forms of funding denominated in dollars, with no guarantor standing behind them. Glaring currency and maturity mismatches have accumulated.

“This structure is prone to an abrupt “dollar crunch” should borrowers in China, east Asia, emerging markets, or even parts of Europe suddenly start scrambling for scarce US currency to repay bonds and loans in a crisis.”

Central banks and governments either didn’t realise the risks or, more likely, simply hoped the problem would only hit once they had left the job.  But today, this “dollar crunch” may well be about to arrive:

  • After a brief rally, the Rmb has gone back below Rmb 7: US$ 1
  • This will make it even more impossible for many companies to repay their dollar loans

Many western pension funds felt forced to rush into the offshore dollar market in a ‘search for yield’. Zero rate interest policies meant they couldn’t get the level of yield they needed to fund future pensions in ‘safer’ markets at home. And employers weren’t willing to fill the gap, as this would have hit their earnings and share prices.

Unfortunately, as I noted 18 months ago, Ernest Hemingway’s The Sun also Rises probably describes the end-game we have entered:

“How did you go bankrupt?” Bill asked.

“Two ways,” Mike said. “Gradually and then suddenly.”

Financial markets head for (another) train crash as coronavirus starts to impact

China’s industrial heartland of Hubei (pop 59m) and its capital Wuhan (pop 11m) have now been locked down for nearly a month as a result of the coronavirus COVID-2019 epidemic.  In total, more than half of the population (760m) are subject to some form of residential lock down. Yet as with the subprime crisis in 2008, financial markets are in denial –  just a 0.1% decline in global GDP, says Goldman Sachs.

Yet China is the manufacturing capital of the world, its second largest economy, and the key player in global trade. And within China, some areas of the economy seem to be in freefall as Capital Economics charts – construction is 25% of GDP, but property sales are virtually zero, for example.

Nobody yet knows when the return to work after the Lunar New Year holiday will be complete. Last Wednesday, for example, national passenger traffic was down by 85% compared with the same day in 2019, according to Morgan Stanley. Understandably, the government is focused on avoiding a second outbreak, caused by infection carried by people returning home after the holiday.

Auto industry. Global auto sales have been in decline since 2018.  Without China, there would have been no growth in world auto sales since 2007. Now. China’s auto association reported last week:

“Massive short-term impact from COVID-2019 outbreak, Q1 output and sales to fall significantly, short-term consumption spurt expected once outbreak subsides, but full-year outlook remains pessimistic. Auto sales expected to fall more than 10% in H1.”

The impact is across the market. Only 9% of China’s dealerships are currently open, due to contagion fears. Traffic jams in major cities such as Beijing are non-existent.  And coming round the corner is a major impact on China’s auto supply chains, which supply components all around the world as NBC note:

“The growing concern is what the epidemic might mean for the industry outside China. While China ships relatively few vehicles abroad, it exports about $70bn worth of car parts and accessories globally, with roughly 20% going to the U.S. The list covers everything from steering wheels to shock absorbers, d:own to literal nuts and bolts, washers, springs and copper rivets. Most of that comes in the form of aftermarket parts and accessories”.

Global supply chains. Japan’s Fukushima disaster in March 2011 provides an example of the potential risks

  • One of its key impacts was to close the Renesas Electronics factory in Naka, which made 40% of the microcontrollers used in cars. Most cars use at least 50 of these, with luxury models using up to 100 to power windows, move seats etc.
  • On a one-off basis, global automakers were able to urgently develop a new source of supply, and avoid shutting down auto production lines around the world.
  • We cannot yet know the wider impact from China’s lockdown, but the FT’s chart shows the scale of the issue
  • Every global supply chain linked to China is potentially now being impacted as auto factories are retooled to supply masks, and trucks are diverted to supply food to the quarantined population.

A wide range of indicators confirms that the ripples are already spreading outwards from China to the global economy.

Energy markets.  Shipping rates are the lowest ever seen on the Capesize Index, as trade flows to/from China seize up.  LNG prices have similarly collapsed, in some case below freight costs as producers have to offload cargoes at any price. Reuters reports that China’s oil storage is near all-time highs, with “numerous VLCCs capable of holding more than 2mb of crude each, unable to unload at China’s top crude import terminal of Qingdao”.

Travel. Most western airlines have cancelled China flights for the moment, and outbound travel bookings from China for March/April are down by 50% – bad news also for the luxury industry as Chinese tourists disappear.

Chemical markets are telling a similar story.  China is more than a third of global polyethylene demand, and its downstream factories are currently only at 40% of normal operating rates (OR%).  China is also the largest market for polypropylene and its downstream OR% are currently at 30%-60%. This is leading some producers to export to reduce inventory – adding to the pain for Asian producers who normally export to China. PVC demand is expected to reduce by 30%-50%, whilst polyester production in the key provinces of Jiangsu and Zhejiang remains shut.

Debt levels. Our August Special Report, China’s devaluation risks opening the world’s debt-fuelled ‘Ring of Fire‘ highlighted the risk that many major companies would start to default on their debts once the global economy went into recession.

We are releasing the Report for open access.  Just click here to download it (no registration needed).

Where will we be in 6 months time?  Wall Street clearly believes all this is just a ‘9-day wonder’. But it is hard to see how this can be right.

By the autumn, US politics may also be impacted.  President Trump’s advisers have confidently forecast that the Dow Jones Index will be at least 32,000 by year-end, allowing the President to walk to victory in the election.   But markets are fickle friends. As many commentators have noted, they are currently priced for perfection. And perfection is emphatically not the current start of the world economy.

Coronavirus disruptions make global recession almost certain

Last month, our Hong Kong-based pH Report colleague, Daniël de Blocq van Scheltinga, warned of the “Possible development (epidemic?) of the Wuhan SARS like illness, and economic impact?”  His current view of developments, and their likely impact, is as follows:

Hubei, the epicentre of the corona virus epidemic, is a province in central China, where the famous Three Gorges Dam is located. It has a 59m population (around the same as the UK) and is known as the birthplace of modern industry in China. Today, it is the most important industrial manufacturing province in the country.

Wuhan is the capital, with 11m population. Its central location means it is also the largest comprehensive transport and logistics hub in China, with rail and road connections to all surrounding provinces.  430 high speed trains arrive in Wuhan every day, the airport has 3m passengers a month, and the port on the Yangtze River handles a large part of the 3bn tonnes of cargo that passes down the river each year.

Hubei’s GDP is $595bn, equal to Poland and Taiwan. Automotive, chemicals, steel, textile and machinery are all major local industries. Honda, Nissan, PSA, Renault, Dongfeng all have their most important production facilities in Hubei, as do companies such as Siemens, GE, Corning, Beiersdorf, and more recently Xiaomi. Their supply chains include thousands of Chinese companies – who are often supplying both domestic and international markets.

Financial markets are ignoring the economic impact for the moment. But they will wake up with a bump very soon:

  • The ’best case scenario from a leading Shanghai expert is that: “Treatment of all patients will be completed in two to four weeks, and the national epidemic will be brought under control in two to three months
  • The second order impacts are spreading fast.  Oil demand is expected to be down by 3.2mbd in February, and LNG prices are already at all-time lows due to Chinese force majeures, Auto factories in China have postponed their restart and some are being retooled to make masks. Major factories outside Hubei, including Boeing in Zhoushan have stopped production. Trucking fleets have been taken away from normal duties to maintain food supplies. Asian manufacturing is already slowing as China’s demand slows and supply chains are disrupted. China is the world’s largest market for petrochemicals and the virus has already reduced demand for most products – polyethylene demand will be down by at least 1.5Mt
  • Domestic demand is being badly hit – cinemas are shut and holiday spending over Lunar New Year holiday collapsed as people were told to keep indoors. Car-buying and property (the latter is 25% of GDP) are now likely to be badly hit. Thousands of Starbucks, Nike, Yum (which owns KFC and Pizza Hut), and Apple stores are shut, with others on shorter opening hours
  • Services inside and outside China are also impacted.  180m Chinese went abroad in 2018, spending $277bn. These visits have almost completely disappeared as have inbound visits to China. The airline, hotel, car rental, and luxury industries are all already suffering. Employees returning to Shanghai’s vast Pudong business district have been told to remain in quarantine for 14 days, as have many millions returning to other cities

The IMF had again reduced its global growth forecasts last month, before the corona virus epidemic.  China is over 15% of global GDP and has been central to global GDP growth since 2008. No other country can replace it. As the Wall Street Journal warned:

“The world is now more dependent than ever on China for key goods and services, increasing the virus’s impact on the global economy.”

The US trade war had already weakened its economy. The corona virus impact will take growth well below the forecast 6% in H1. The virus also presents a political challenge to President Xi Jinping, which could lead to a scaling back of his reform programme.

Overall, therefore, it is clear that the economic impact will be severe, both inside China and across the outside.

At best, therefore, companies and investors should develop their contingency plans on the basis that China will effectively be out of the global economy till the end of Q1, and that the total impact will not be fully unwound until the middle of Q2.  And they should recognise that this relatively optimistic outlook depends on the assumption that warm weather from April/May will effectively kill off the virus, as it did with SARS in 2003.

As Daniel advises, “Fasten your seatbelts!”