Suddenly, manufacturing and protectionism have become political issues across the Western world. President Trump has already formed a Manufacturing Council with the aim of “reshoring jobs” from outside the USA, and is threatening to introduce import duties of up to 45%.
The problem, however, as the chart shows, is that this will not help the people who voted for him. Manufacturing is not the key to future success for a High Income economy like the US. Its real importance has always been as the mechanism for Low Income economies to become Middle Income:
The US moved from being Low to Middle Income long ago and is now a High Income economy based on Services
High Income economies are 74% based on Services – Industry is just 25% of GDP (World Bank 2014 data)
By contrast, GDP in Middle Income economies is 35% based on Industry, with Services at just 56%
GDP in Low Income countries is only 48% based on Services, Agriculture is well ahead of Industry at 31%
The real problem facing the US and other developed societies is two-fold:
One is that the the wealthy developed world has moved into the fourth stage of the Demographic Transition. As the IMF noted 10 years ago:
“Industrial countries have largely completed what is called the “demographic transition”—the transition from a largely rural agrarian society with high fertility and mortality rates to a predominantly urban industrial society with low fertility and mortality rates”.
But this has never been explained to voters. Western political leaders didn’t want to have difficult debates about the the key issue raised by collapsing fertility rates and increasing life expectancy – how do we retrain people in their 50s and 60s to ensure they continue to contribute to economic growth? Instead, they preferred to hope that central bank stimulus could somehow replace the loss of babies.
Today, the voters’ patience is starting to wear out. They see little evidence of growth returning to the earlier SuperCycle levels, when most of the population were in the Wealth Creation 25 – 54 generation. And so they are looking for new leaders, who will do a better job of protecting their living standards.
This is where the second problem becomes critical. Unfortunately, Western education systems have not provided every voter with the Basic Skills they need to work successfully in a Services-based economy, as the second chart (from the new UK government Industrial strategy) highlights:
Sadly, 30% of US adults aged 16 – 65 lack basic numeracy and literacy skills to OECD Level 2 standard
Other major economies – Germany, UK, Poland, France, Spain, Italy – are also above the OECD average of 22%
It is therefore no great surprise that large numbers of adults, who have not voted regularly in previous elections, are now becoming more active. Populist policies have an obvious attraction for them, as they feel their country is heading in the wrong direction.
The third chart highlights an even more serious side of this issue, namely the very low levels of computer skills across the OECD. These are critical for an increasing number of jobs, but the OECD reported last year that nearly three-quarters of adults have poor (or lower levels) of computer skills. As they also noted:
“There is a strong positive relationship between problem-solving proficiency (in technology-related areas) on the one hand and literacy, and numeracy proficiency on the other.”
Education policy is not something that can be changed overnight. It will take years, if not decades, to replace today’s failing systems and to provide adults with the Basic Skills they have been denied.
Protectionism, on the other hand, appears to offer almost immediate prospect of change. Only later will it become apparent that its main role has been to turn back the clock on incomes and the economy.
This is Budget week, when the blog prepares to present its Budget Outlook for 2014-16. On Saturday, it reviewed its 2012 forecast. And starting tomorrow, it will analyse auto markets – as these are the largest single driver of demand – before issuing its 2014 Outlook next Saturday.
The chart above presents the dilemma facing companies, as they try to map out the future. It shows two key prices:
- The S&P 500 (purple), the world’s most important financial market
- Benzene (green), historically the most reliable leading indicator for future economic growth
Clearly, they are telling completely different stories.
Long-standing readers will remember benzene’s unique performance in 2008, when it successfully called both the top of the market in March, and then the bottom in November*. So it would be tempting fate to simply ignore its performance this year, when its price has already fallen 22%.
On the other hand, the S&P 500 has delivered an equally stunning performance, and is up 19% since January. This is particularly impressive given it has been delivered against a backdrop of weak/weakening growth in all the major economies and regions.
So what are we to believe about the future outlook?
Financial markets always claim predictive powers, and so most analysts suggest the S&P 500 is ‘looking through’ today’s problems to a sunlit future ahead. They believe the genius of the central banks with their stimulus programmes has created a firm foundation for strong future growth. And they dismiss suggestions that the stimulus has in fact just had a circular impact, supporting asset prices through the availability of cheap finance.
Fans of benzene, however, counter that it has a much sounder basis for prediction, as the blog summarised in the Financial Times in March 2012. It is noteworthy that PTA prices, also cited in the FT as an indicator for China’s economy, are also down 14% this year. This suggests that whilst central banks are keeping asset prices strong, it has become increasingly difficult to pass on today’s higher energy/food prices as consumers are forced to cut back.
It is hard to imagine two more contradictory views. One suggests that central banks have rescued the global economy. The other, that they have unintentionally made an already bad situation much worse.
Readers will, of course, make up their own minds. But the blog’s money is, as always, on benzene. And there is certainly support for this position from Coca-Cola, one of the world’s most successful consumer products companies. Last week it reported revenues down 2% in 2012, with Q3 down 3%, whilst its CEO told investors:
“As we have all noted, emerging markets have become increasingly more volatile, further exacerbating a challenging global landscape. Hence, disposable income and consumer spending have become challenged and consequently have impacted the overall growth of the non-alcohol ready-to-drink industry”
Latest benchmark price movements since January with ICIS pricing comments this week are below:
Benzene Europe, down 22%. ”Prices dipped to fresh yearly lows this week, alongside losses in both the US and Asia, as well as low domestic derivative offtake so far this month”
PTA China, down 14%. “Prices fell for the fifth consecutive week because of a supply glut.”
Naphtha Europe, down 2%. “Fundamentals are weak as oversupply and flat demand persist”
Brent crude oil, down 2%.
HDPE USA export, up 16%. “Globally, demand is weak. Availability of product for export remains very limited, and prices are too high for most markets”
US$: yen, up 11%
S&P 500 index, up 19%
* For those interested, prices fell 32% in 8 weeks, after the ‘market top’ call in August 2009
German Chancellor Merkel’s recent comment that “I don’t see anything which signals a recession in Germany” is just one sign of the current complacency about the global economy within the Western political elite.
Long-standing readers will remember Profs Eichengreen and O’Rourke 2009-10 work comparing today’s Great Recession with the Depression of the 1930s. Worryingly, the parallels seem to be increasing again, as the chart above shows from new research by Prof Nouriel Roubini:
“World trade (dark grey line) has stalled since the onset of the year and is falling in line with lower growth in the developed world. While global industrial production increased slightly in June, it is still down on the quarter. July data, coupled with leading indicators such as PMIs (Purchase Manager Indices), points to Q3 weakness. Chinese commodity demand began to weaken in Q2 and continued to fall in July.”
JACKSON HOLE MEETING OF ECONOMIC POLICYMAKERS
There was less complacency amongst economic policymakers at the US Federal Reserve’s annual Jackson Hole meeting last week. There was no mention of a new QE3 programme to try and boost stock and commodity prices. Instead, as the OECD’s head noted, policymakers are now realising that “this consolidation effort is going to take a generation.”
Fed Chairman Ben Bernanke warned that “The quality of economic policy-making in the United States will heavily influence the nation’s long-term prospects”. Whilst Christine Lagarde, new IMF head, said economic risks “have been aggravated further by a deterioration in confidence and a growing sense that policymakers do not have the conviction, or simply are not willing, to take the decisions that are needed.”
Policymakers, if not yet the politicans, may therefore be finallly realising that we face a solvency crisis, not one of liquidity:
• Solvency is whether one is able to pay one’s total debts
• Liquidity is simply whether one can pay today’s bills
The risk is, of course, that 2 years of implementing the wrong policies have left them dangerously short of time, and money. With actual US GDP growth just 0.33% ($40bn) in H1, there is surely a strong risk that the US is now entering a new recession. Europe cannot be in much better shape, despite the politicians’ denials, given Q2 data.
IeC DOWNTURN ALERT UPDATE
Hopefully the blog’s April launch of its IeC Downturn Alert launch has enabled chemical companies to prepare robust contingency plans for what may lie ahead. Price movements since April, and ICIS pricing comments this week are below:
S&P 500 Index (pink dot), down 14%.
Naphtha Europe (brown dash), down 13%. “Most sources still believe an oversupply threatens in September “.
Brent crude oil, down 12%.
HDPE USA export (purple), down 13%. “Latin America has now turned its attention to Asian offers”.
Benzene NWE (green), down 11%. “Shutdowns downstream are expected to soften demand next month.”
PTA China (red), down 5%. “Expected to be underpinned by rising PX prices caused by limited supply”.