G7 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.
“We should not forget the historic nature of what is at stake.
“Its about whether a country can leave the euro zone and what that means for the future of an incomplete and flawed European Monetary Union.
“Its about whether there may soon be a failed state in southeastern Europe with all the geopolitical consequences that could entail in a fragile region.
“Its about whether the EU’s 58-year-old project of “ever closer union” goes into reverse, and whether the objective forces of economic divergence finally overwhelm the political will on which the euro was founded.
“The United States, China and Japan understand what’s at issue and all have expressed concern that Europeans should find a solution to keep Greece in the euro. Yet at this point, that does not appear the most likely outcome…..
“If European leaders effectively abandon a defiant Greece to its fate, neither the euro zone nor the European Union will be the same again. Some, notably among the growing ranks of Eurosceptics around the continent, will think that is for the better. The glee with which Nigel Farage, Marine Le Pen and Geert Wilders greeted the prospect of the unravelling of European integration may give euro zone leaders pause.”
This summary from Reuters’ vastly-experienced European Affairs editor, Paul Taylor, expertly sums up the real issues at stake in Sunday’s final Eurozone summit on Greece.
These have been largely ignored in the on-going arguments about Greece’s debt. Debate has instead focused, understandably enough, on the fact that the Greeks have managed to borrow large amounts of money, at least €322bn ($365bn), and cannot possibly ever repay it. Even worse, the various Greek governments appear to have done nothing to reduce their future spending, or indeed, even to raise a more sensible amount of tax.
It is no wonder that only 10% of Germans want to handover more money to the Greeks, given the history of previous loans. The word for debt in German, “Schuld“, also means “guilt” – and it is understandable that Germans and others across Europe now see Greece as a morality play, where the guilty need to be punished for their crimes.
Yet, with all apologies to my many German friends, this is not the real issue on Sunday:
- Last Saturday, 1600 Syrian refugees landed on the Greek island of Lesbos. Many more thousands are on their way. If Greece leaves the Eurozone on Monday, who will run the reception camps where these migrants now live? Nobody, is the likely answer. The Greek government will be unable to feed and protect their own population, so why should they devote precious resources to these people? Inevitably, therefore, Greece will become an open door for increasing numbers of Syrian/Libyan and other migrants into the European Union
- Equally important is the future of the Eurozone itself if Greece is to be abandoned to its fate. It will then be clear to everyone that it is no longer a currency union, bound together by treaty obligations. Instead, it will have become just another exchange rate mechanism, like its ill-fated predecessor the Exchange Rate Mechanism (ERM). Its fragility was summed up by the UK’s finance minister, who boasted that he went home that evening after leaving the ERM and “was singing in his bath”.
- The third reason why the Eurozone should pause is that Greece in many ways is just the ‘canary in the coalmine’, warning of the flawed construction of the Eurozone itself. As I have long argued, Eurozone leaders should never have set up economic and monetary union without political union. They knew this at the time, but they ducked the issue. Now it has come back to bite them, hard. And if Greece goes, we can be sure that others will follow them, if this fundamental flaw in the design is not now fixed.
Of course it will be difficult for resolve all the long-standing issues created by the Greek crisis on Sunday. But as the Chinese proverb says, “a journey starts with a single step”. And the facts are at least clear:
- Everyone knows that Greece will never pay its bills
- Everyone also knows that Greece will immediately default on its debt if it is forced to leave the Eurozone
- And everyone also knows that taxpayers in the richer Eurozone countries will end up paying the bill as a result – Germany will end up paying at least €86bn, and probably much more
So why take this pain for no gain? Why not instead deal with the cause of the problem – the lack of political union. Why not admit, as Paul Taylor argues, that the Eurozone is “incomplete and flawed”? And having recognised reality, then use the crisis to make a fresh start by agreeing a more sustainable basis for the Eurozone itself?
“Summit fatigue” is a real issue in long-running sagas like Greece. It can easily lead people to sleepwalk into a situation they had never dreamed could happen.
In this case, the risk is very clear and immediate. It is that large numbers of migrants start to pour into N Europe via the relatively safe route from Turkey to Greece. (The United Nations estimates there are now 4 million Syrian refugees, and report that total migrant crossings rose 80% in H1 versus 2015 to 137k). And in turn, their arrival leads within a short while to the triumph of nationalist parties in France, the Netherlands and elsewhere, all determined to exit not just the Eurozone but the European Union itself.
Sunday will be a critical day for all of us who live in Europe. And for the underlying stability of the political structures that have underpinned the world since World War 2.
My 4 May post was titled “‘Sell in May and go away?’ as US, German bond yields jump“. Since then, US interest rates have continued to soar and the US stock market is starting to wobble, as I discussed last week. Now emerging markets are in the line of fire. $9.3bn was withdrawn last week – the highest figure since the financial crisis began.
But developments in German markets have been most extraordinary, as the above charts from ThomsonReuters show. Germany is the world’s 4th largest economy, and had been seen as a beacon of stability in an uncertain world:
- Just 2 months ago, on 10 April, its DAX Index of leading shares hit an all-time high of 12374 (top chart)
- On 17 April, the German 10 Year bond yield hit an all-time low of just 0.049% (bottom chart)
- Last Friday, the DAX closed down 10% versus its high at 11196
- And the yield on the 10 year bond was 17x higher than its low, at 0.85%
Even more worrying is that the consensus view of major analysts completely failed to forecast these developments. Instead, they all believed that German interest rates would continue to fall and its stock market would rise. Thus on 16 April, Bloomberg quoted one leading interest rate analyst as forecasting:
“There’s room for them to fall further given the ECB’s policy. There are willing buyers and not many willing sellers because they can make capital gains if yields keep falling.”
Whilst on 10 April, the Financial Times reported that “the Xetra Dax in Frankfurt and London’s FTSE 100 both ended at record peaks.”
The problem is that most analysts have only ever known a world where central banks kept pumping markets higher, and interest rates lower, via their liquidity programmes. These began as long ago as Q4 1999 with the Y2K liquidity injection, and then continued through the subprime mania to the post-2008 QE programmes.
The result is that very few people in the markets remember a period when the fundamentals of supply/demand set prices, and markets themselves were a vehicle for price discovery. This is why I fear we will see massive volatility as Stage 2 of the Great Unwinding of policymaker stimulus gets underway.
The debt mountains around the world are each frightening enough in themselves. But together they represent a ‘Ring of Fire‘. Greece is moving closer to crisis, and Reuters last week confirmed my argument that European governments fear major domestic upset if Greece defaults on its debt, and thereby destroys their ‘pretend and extend’ policy:
“IMF chief Christine Lagarde is hinting that European governments need to give Greece debt relief to make the numbers add up, but since this is politically unacceptable in Germany, she has had to talk in code in public…Behind closed doors, IMF officials are telling the Europeans that Greece will not survive without a third bailout program, which will require debt restructuring by European governments.”
And if it is not Greece, then it could easily be house prices in markets such as China, Singapore, London or New York. These are all held aloft, as the saying goes, “on a wing and a prayer”: they long ago lost contact with the borrower’s ability to repay out of their income. And if not house prices, then energy markets, where vast investment ($1.2tn in the US alone) has created major surpluses, at a time when demand growth is slowing sharply.
The issue is that the market’s obsession with US interest rate policy has blinded it to the reality of today’s New Normal world. We urgently need our political leaders to begin sensible conversations with the voters about the hard choices that need to be made. They cannot continue to hide behind the figleaf of monetary policy forever.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 41%. “The recent spate of cracker outages seen in Europe was also potentially having a tightening effect on benzene availability.”
Brent crude oil, down 39%
Naphtha Europe, down 36%. “Strong gasoline demand in the US and Asia continues, with the July naphtha crack spread staying strong in line with the exceptionally high gasoline refining margins.”
PTA China, down 29%. “export orders for their products were also slow, resulting in strong resistance for feedstock prices..”
HDPE US export, down 17%. “Domestic export prices held steady”
¥:$, down 21%
S&P 500 stock market index, up 7%
The blog’s 6-monthly review of global stock markets highlights the narrow nature of the advance since September 2008, when the blog first began analysing developments. It shows their performance since the pre-Crisis peak for each market, and the performance of the US 30-year Treasury bond.
Remarkably, only the US, India, Germany and the UK stock markets are in positive territory, along with the 30-year bond. Japan, Brazil, Russia and China remain well below their previous peaks:
- The 30-year bond remains the best performer, as investors fear that a sustained economic recovery remains as far away as ever (purple line)
- The US had been the best stock market performer till now, driven by the US Federal Reserve’s belief that a strong stock market would spur economic recovery (green)
- India has now become the best performer, due to hopes for broad economic reform from the new Modi government (black)
- Germany is next, supported by hopes the European Central Bank will continue to follow the Fed’s low-cost money approach (orange)
- The UK has just slipped into positive territory, also supported by Bank of England stimulus (pink)
A number of major markets remain in negative territory:
- Japan strengthened in 2012 as the Abe government followed the Fed’s policy, but has recently seen a slowdown as GDP fell in Q2 (blue)
- Brazil had weakened, despite the World Cup and 2016 Olympics stimulus, but recent polls lead investors to hope for a change of government next month (brown)
- Russia’s recovery also ended rather early, despite the boost from high oil and commodity prices, and Ukraine developments have caused it to move sideways (red)
- China’s market has never seen a recovery, as investors have preferred to speculate in the housing bubble, where prices have been doubling every 2 – 3 years (blue)
All-in-all it is hard with the benefit of hindsight to argue with September 2008′s conclusion, as the storm began to break:
“This pattern seems to confirm the blog’s long-standing concern that we may now be facing a multi-year global slowdown, as the financial excesses of the 2003-7 boom are unwound.”
Those markets where there has been little direct central bank stimulus have found it very hard to recover. This is quite contrary to the pre-2008 experience, when ‘a rising tide lifted all ships’.
The blog will look in more detail at the US equity market next week, as it concludes its mini-series on the Great Unwinding of stimulus policy now underway.
The blog, like most people, doesn’t like change. Change creates uncertainty, and makes us all nervous. Therefore in recent years, it has secretly hoped that its forecasts about the inevitability of the subprime crisis, and the arrival of the New Normal, would prove wrong. Life would be so much easier if everything could simply continue as it was.
Thus it is distressed to see developments at Lanxess, one of its favourite chemical companies. Lanxess has achieved a great deal over the past decade since it became independent from Bayer, even gaining a place in Germany’s blue-chip Dax stock market index in 2012.
But now Lanxess is struggling, and its CEO, Axel Heitmann, is departing “by mutual agreement” with the Board. As the Financial Times reported:
“About 40% of the company’s sales remain linked to the automotive and tyre industries which have suffered in the depressed state of the European car market.”
Lanxess’ problems are thus a case study on the need for companies to carefully consider how the dramatic demographic changes now underway across the world will impact their future business and profits:
- Germany is, of course, a classic case, as the blog discussed in detail in December
- Its median age is 45.7 years, and German women are having an average of just 1.2 babies
And as the above chart based on a study from Germany’s IMFO institute shows, older people drive much less. 70 year-olds, for example, drive only half the distance of 30 year-olds (blue line). Thus we are seeing the end of a long period where Germans were driving more each year:
- Even driving amongst 30-39 year-olds is no longer increasing
- They were driving 34km/day (21 miles/day in 1976 (green), and this distance rose around 9% by 1997 (red)
- But it has now stabilised at this level
Equally important is a separate finding from IFMO, discussed in the blog a year ago, that car ownership has decreased in the core 30-39 age group in Germany and most Western countries.
A later report takes this study a stage further, showing that fewer young men in Germany and elsewhere now bother to take a driving test. By definition, of course, someone without a driving licence will not own a car.
IFMO is the research establishment of BMW, and so its work is really ‘a must-read’ for any company selling to the auto industry. It suggests, for example, there is :
“A strong indication of profound changes in the travel behaviour of young adults in industrialised countries with signs of decreasing car orientation and reduced overall travel” .
In fact, they go so far as to speculate that we could now be seeing a “peak car” phenomenon develop. This is being caused by older people driving less than when they were younger, whilst younger people use other modes of transport, or substitute social media instead.
The blog fears that profound change is thus inevitable in many key industries as we move into the New Normal. In turn, this conclusion suggests that Lanxess’ current problems are a powerful example of how this will impact even companies which have been highly successful in the past.
Germany is the world’s 4th largest economy ($3.4tn), and so is the next to be studied in the blog’s series on the impact of demographics. Its population is almost as old as Japan’s: Germany’s median age is 45.7 years, compared with Japan at 45.8 years. The reason is shown in the chart above:
- German women have almost given up having babies – there are currently only 1.2 being born per woman, half 1960′s already low 2.5 level, and well below replacement level of 2.1
- At the same time, life expectancy has increased nearly 25% to around 80 years today
Germany is therefore heading in the same direction as Japan in terms of the proportion of its adult population who are in the New Old 55+ generation. 1 in 3 people used to be in this group during the SuperCycle, but already today the figure has jumped to 40%, and will rise to 1 in 2 adults within the next 10 years.
This means that, like Japan, it has historically seemed hard to persuade people to increase their spending. They already have most of what they need in terms of basic products, and so the country’s economy has instead become focused on exports. These are an astonishing 52% of GDP, compared to 15% in the USA.
Data from the OECD Pension Book continues the parallel with Japan:
- Average earnings are $59k ($55k in Japan)
- Until 1995, two-thirds of its adult population were in the Wealth Creator 25-54 age group
- But since then, the number of Wealth Creators has been in a slow decline from a peak of 36m
- By 2030 their number will have fallen to just 28m
- Already today, one in three Germans are at retirement age of 65 or older
The parallels with Japan end at this point, as Germany has an extremely generous pension scheme. Although too complex to summarise here, the OECD calculate it equates to 52% of median earnings. In addition a ‘safety net’ system provides generous means-tested benefits from social assistance.
But they are not spending it at the moment. This may be partly due to understandable concerns over their future income levels. But it probably also reflects the fact that companies have made very little effort to focus on the needs of this rapidly expanding sector.
It seems highly likely, to the blog at least, that Germany’s New Olders would be happy to spend more if companies started to develop products and services aimed at meeting their needs. But for the moment, youth-obsessed marketing professionals continue to chase after the wrong market.
It made some sense for German companies to focus on export opportunities when there were still plenty of Wealth-Creators outside Germany. But now the New Old are starting to dominate these markets as well, an export-led strategy is going to prove very hard to sustain.