G7 Summit shows leaders are forgetting the lesson of the 1930s

G7 May17G7 Summits began in the crisis years of the mid-1970s, bringing Western leaders together to tackle the big issues of the day – oil price crises, the Cold War with the Soviet Union and many others.  Then, as stability returned in the 1980s with the BabyBoomer-led economic SuperCycle, they became forward-looking.  The agenda moved to boosting trade and globalisation, supporting the rise of China and India, and the IT revolution.

This weekend’s 43rd Summit in Italy suggested we may be going back to earlier days.  As the picture confirms, the leaders did all meet in the Italian city of Taormina in Sicily.  But they clearly found it difficult to meet the challenge set by their hosts of “Building the Foundations of Renewed Trust”.  One very worrying sign was that both the USA and the UK seem to have become semi-detached from the process. :

□  UK premier Theresa May left early, to “hold urgent talks with her election campaign chiefs” after new polls showed her lead dropping to single figure levels
□  President Trump refused to endorse the Paris Agreement, causing German Chancellor, Angela Merkel, to comment:
“The entire discussion about climate was very difficult, if not to say very dissatisfying. There are no indications whether the United States will stay in the Paris Agreement or not.”

There was some good news, with a compromise seemingly being agreed with US President Trump over his desire to dismantle the world’s open trading system, as the final statement noted:

“We reiterate our commitment to keep our markets open and to fight protectionism, while standing firm against all unfair trade practices. At the same time, we acknowledge trade has not always worked to the benefit of everyone.”

But it was a relatively weak statement, and nothing was said about the President’s withdrawal from the Trans-Pacific Partnership, or his decision to demand a formal review of the North American Free Trade Agreement. The change is even clearer by contrast with last year’s Summit in Japan, when the leaders committed:

To fight all forms of protectionism ….(and) encourage trade liberalization efforts through regional trade agreements including the Trans-Pacific Partnership, the Japan-EU Economic Partnership Agreement, the Transatlantic Trade and Investment Partnership and the Comprehensive Economic and Trade Agreement.”

Sadly, the same lack of unity had been seen just before the Summit, when President Trump failed to endorse Article 5 (the fundamental principle of the NATO Alliance), which declares that an attack on one member state is an attack on all, and requires a mutual response.  As the Financial Times noted:

This was particularly galling given that he was attending a memorial for the September 11 terror attacks — the only time Article 5 has been triggered. It remains unclear why he equivocated.”

Even the Summit dinner saw a lack of unity, with US National Economic Council director Gary Cohn suggesting:

There was a lot of what I would call pushing and prodding.”

This lack of a common purpose amongst Western leaders is deeply worrying.  Of course, they were able to agree on strong words about terrorism and the role of social media.  But their key role is to be pro-active, not reactive.

Collectively, their countries are responsible for nearly two-thirds of the global economy.  Individually, none of them – not even the USA – can hope to successfully tackle today’s challenges.  This was the rationale for the formation of the G7 in 1975, and it has since played a critical role in helping to spread peace and prosperity around the world.

Today’s G7 leaders seem to be in danger of forgetting their core purpose.  They need to re-open their history books and focus on the lesson of the 1930′s, when “beggar-my neighbour” trade policies led directly to World War II.

 

The global economy’s best leading indicator forecasts a downturn

NewIf you want to know what is happening to the global economy, the chemical industry will provide the answers. It has an excellent correlation with IMF data, and also benefits from the fact it has no “political bias”.  It simply tells us what is happening in real-time in the world’s 3rd largest industry.  The chart above confirms the extremely high correlation:

   It shows annual GDP % growth figures from the IMF on the vertical axis from 2000, including the 2016 forecast
   The  horizontal axis shows the annual change in Capacity Utilisation % data for the global chemical industry

The correlation is remarkable at 88%.  Nothing that I have ever seen comes anywhere close to this level of accuracy.

The logic behind the correlation is partly because of the industry’s size.  But it also benefits from its global and application reach. Every country in the world uses relatively large volumes of chemicals, and their applications cover virtually all sectors of the economy, from plastics, energy and agriculture to pharmaceuticals, detergents and textiles.

ACC all Jan17

We can also use the data to look forward, given its timeliness, as the ACC also produce detailed reports on the major Regions and countries.  And as the second chart shows, the outlook is unfortunately not good:

   N America’s recovery since 2014 has faded away, and is at -1%; Latin America is very weak at -3.9%
   W Europe has also slowed to 1.6%; Asia has collapsed from 7.5% in 2014 to just 1.4%
   The Middle East/Africa has halved from 5.3% to 2.7%; only Central/Eastern Europe has grown, from 1.9% to 4.4%

This rather negative picture is in complete contrast with the official views of forecasters such as the IMF.   They currently suggest that global growth will rebound from 3.1% in 2016 to 3.4% in 2017, and then move higher.  But sadly, their optimism has been wrong for the past few years, as I noted in my Budget Outlook in October.

They have forecast a similar recovery every year since 2011, but growth has continued to slow.

The problem is that their models ignore the influence of demographics, and today’s ageing populations, on demand. The result, as the deputy chairman of the US Federal Reserve, Stanley Fischer, observed in 2014 is that:

Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back.”

Clearly, it is encouraging that economists such as Andy Haldane at the Bank of England now recognise that demographics “have been under-emphasised for too long“.  We can certainly hope that future forecasts may start to take account of the fact that older people do not consume as much as when they were young.

But in the meantime, it seems wise to take the chemical industry data very seriously.

It is clearly suggesting that the global economy is moving into a downturn. And whilst we must all hope this turns out to be wrong, hope is not a strategy.  We also cannot ignore the major upheavals now underway in economic policy in both the USA and the UK, with President Trump taking office and the UK starting to leave the European Union.

These developments may well produce good results in the longer term.  But in the short-term, they create major uncertainty.  And if we look across the G20 countries – such as China, Russia, Brazil, India, S Africa, Saudi Arabia and Turkey – many are experiencing from similar political and economic uncertainty.

Uncertainty usually makes everyone – companies and consumers – more cautious in their spending. And lower spending inevitably means less growth.

The blog in 2016

Blog Dec162016 saw the Great Reckoning for the failure of stimulus policies begin to impact companies and markets.

The blog’s readership has increased significantly as a a result, as shown in the chart above, with its visits now totaling nearly 500k.  Its readership includes 197 countries and over 11k cities.  Readers also remain very loyal, with one in two reading it every week, and one in four reading it every day.

The key issue is that consensus wisdom has clearly failed – once again – to provide a reliable guide to the outlook. By contrast, the blog was one of the first to explore the attractions of Populist policies, and to suggest that the UK government would lose the Brexit vote, and that Donald Trump would likely become President.

Even today, however, most “expert commentary” continues to ignore these developments, and the later Italian referendum, and instead believes we will see “business as usual” in 2017.  Yet developments in the world’s 2 most important economies, the USA and China, suggest that in reality, this is the least likely option:

In the USA, President-elect Trump continues to focus on the need to reshore jobs from overseas, particularly China, in order to “make America great again”.  As Peter Navarro, head of Trump’s new White House National Trade Council, told the New York Times:

“Imposing steep tariffs on China was an essential step to begin to address the American trade deficit with China, which reached $365bn last year. He blamed Chinese trade practices for “destroying entire industries, hollowing out entire communities” and “putting millions out of work.”  His colleague, Prof Greg Auty added:

“The Trump camp was dead serious about its threats to impose tariffs on China. The goal is to force manufacturers to come back to the United States as a condition of selling into the American market.  A full-on trade war between the world’s two largest economies would cost American jobs in the immediate term, but eventually millions of new ones would be created as the United States again hummed with factory work.

“We moved our supply chain to Asia in about two decades,” he said. “You certainly can do it in the U.S. a whole lot faster. It’s going to take a few years, but it’s going to be a much better America.” (my emphasis)

In China, as Xinhua reports, bursting the property bubble has become the key target of government policy:

President Xi Jinping highlighted curbing property bubbles at a meeting of the Central Leading Group on Finance and Economic Affairs on Wednesday, the fourth time asset bubbles were mentioned by Chinese leaders in the second half of the year.

“China will take a varied approach to regulating the property market, adopting financial, fiscal, tax, land and regulation measures to build a long-term housing mechanism that provides housing for all people, according to Xi.  Thanks to policies introduced by local authorities in October, the property market in big cities continued to stabilize in the last month, gradually retreating from sky-high prices.

“Houses are built for living, not for speculation,” policymakers have agreed.

In addition, of course, a number of major challenges exist in other parts of the global economy:

  The recent Italian referendum means the collapse of the Eurozone has become a real possibility
  The future of the European Union itself is also under threat given the Brexit votes and upcoming elections in The Netherlands, France and Germany
  Oil markets will likely see further volatility as the inevitable cracks appear in the recent OPEC output cuts deal
 India’s currency reforms pose a further threat to the outlook for the world’s 6th largest economy, as premier Modi’s 50-day deadline for resolving all the problems ends today

I will do my best to follow these and other critical developments in 2017.  Thank you for your continued support.

 

Italy’s referendum is next test for Eurozone stability

ItalyItaly was one of the 6 founding members of the European Union (EU) in 1957, along with France, the Netherlands, W Germany, Belgium and Luxembourg.  Its referendum next month will therefore be a critical test of whether the Eurozone and EU can survive the pressure from the Populists.

If the Populists win, then the future of the Eurozone and the EU itself will be in doubt.

As often happens at critical moments, the subject of the referendum is of relatively minor importance.  It was called by Premier Matteo Renzi to amend the constitution by approving a reform of Italy’s Parliament.  The problem is that he then made himself the key issue in the referendum, by promising to resign if he lost, as he confirmed to Italian media last week:

If the citizens vote no and want a decrepit system that does not work, I will not be the one to deal with other parties for a caretaker government”

Italy is now in a 2 week blackout period for polling before the vote on 4 December.  But the final polls showed the “No vote” with a comfortable lead.  There is therefore a major risk that Renzi will soon be following UK premier Cameron out of office.  3 quite different Scenarios could then develop:

Another premier takes over.  Italian premiers have historically not lasted long.  Before Renzi took over in 2014, there had been over 50 different premierships since Italy’s first post-War premier, Alcide de Gasperi, resigned in 1954. So maybe, the revolving door revolves again, and a new premier is appointed by the President
New elections are held, and another premier takes over.  Renzi was the 3rd Italian premier in a row to take office without have a personal mandate from an election (neither Mario Monti or Enrico Lette had this).  An election may therefore take place, after which perhaps the revolving door revolves again
New elections are held and an anti-euro coalition takes office.  This would seem to be the base case Scenario, with a probability of at least 50%.  It would likely means that Beppe Grillo’s anti-euro 5 Star Movement would take office with Berlusconi’s Forza Italia and the Northern League, and would then hold a referendum on leaving the euro – with the aim of capping Italian debts and nationalising its banks, as Grillo has promised

Given that around €360bn ($400bn) of all Italian loans are classed as “troubled”, and amount to around one-fifth of total loans, capping the debts would cause major disruption to the Eurozone and global financial systems.  Leaving the euro would also mean, that foreign holders of Italian debt would be paid in Italian lira, not euros.  And presumably this would be after a devaluation of the lira.  So as the Financial Times warned on Monday:

“Since banks do not have to hold capital against their holdings of government bonds, the losses would force many continental banks into immediate bankruptcy. Germany would then realise a massive current account surplus also has its downsides. There is a lot of German wealth waiting to be defaulted on.”

DEMOGRAPHIC REALITY IS NOW CONFRONTING STIMULUS FANTASY
Italy’s real problem is not its Parliament, but that its economic policies haven’t adjusted to the New Normal world. Like most developed countries, politicians of all parties have failed since the end of the BabyBoomer-led SuperCycle, to understand the trade-off that has taken place between increased life expectancy and economic growth.  Italy has a median age of 45 years, and as the chart above shows:

 It now has only 24m in the Wealth Creating 25 – 54 cohort, versus 22m New Olders in the 55+ cohort
 By 2030, it will have just 20m Wealth Creators and 26m New Olders
 This is completely different from the 1950 position, when there were 18m Wealth Creators and only 8m New Olders

In addition, of course, Italy has become the main route for migrants and refugees following the EU’s deal with Turkey. 168k people have already arrived this year, compared to 154k in the whole of 2015 and 170k in 2014. Resources have been further strained by the sequence of earthquakes, which are made worse by the lack of anti-seismic regulations for its buildings.

It is small wonder, therefore, that the 5 Star Movement is building support, having won Rome in this year’s elections, whilst the Lega Nord (Northern League) won the Veneto and Lombardy regions.

Nor is it surprising that investors are starting to panic.  As I discussed on Monday, Italy’s 10 year interest rate has doubled to 2% since the summer.  It could go very much higher if Renzi loses, as the prospect of a vote to leave the eurozone and cap Italy’s debts comes closer.

This is the Great Reckoning in action, and there is probably little that the European Central Bank (ECB) can do to mitigate the position.  In a few weeks’ time, investors may well wonder how they allowed Italian interest rates to trade below US rates for much of the past few years.  And in a few months’ time, it may well seem equally incredible that anyone ever believed ECB’s President Mario Draghi’s 2012 boast that:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. 

It could be a very difficult H1 in 2017.  Next month’s Italian referendum is followed in March by Dutch elections and in May by France’s Presidential election.  Both may well be won by parties committed to leaving the EU itself.

It is therefore hard to ignore the possibility that by June, the EU could have effectively ceased to exist in its current form.  Developing a contingency plan, in case this develops, could well be the wisest move you make in 2016.