US-China trade war confirms political risk is now a key factor for companies and the economy

There are few real surprises in life, and President Trump’s decision to launch a full-scale trade war with China wasn’t one of them.  He had virtually promised to do this in his election campaign, as I noted here back in September 2015:

“The economic success of the BabyBoomer-led SuperCycle meant that politics as such took a back seat.  People no longer needed to argue over “who got what” as there seemed to be plenty for everyone.  But today, those happy days are receding into history – hence the growing arguments over inequality and relative income levels.

“Companies and investors have had little experience of how such debates can impact them in recent decades.  They now need to move quickly up the learning curve.  Political risk is becoming a major issue, as it was before the 1990s.”

Of course, I received major push-back for this view at the time, just as I did in 2007-8 when warning of a likely US subprime crisis.  Most people found it very hard to believe that politics could trump economic logic, as one American commentator wrote in response to my analysis:

“I have a very, very, very difficult time imagining that populist movements could have significant traction in the U.S. Congress in passing legislation that would seriously affect companies and investors”.

But, sadly or not, depending on your political persuasion, my conclusion after the election result was known seems to have stood the test of time:

“You may, or may not, approve of President-elect Trump’s policies. You may, or may not, think that these policies are destined to fail. But they do confirm that the world is moving into a New Normal, which will inevitably create Winners and Losers.

“The Winners are likely to come from those who accept that President Trump will at least try to introduce the policies proposed by Candidate Trump. And the Losers will almost inevitably include those who continue to believe he represents “business as usual”.

Now, of course, we will start to see these Winners and Losers appear, as there is little the Western central banks can do to counteract the economic cost for the global economy of a US-China trade war.

One sign of this was Uber’s miserable performance on its stock market debut – despite having been priced at the low end of the planned range, it still fell further on its opening, in line with my suggestion last month that Uber’s $91bn IPO marks the top for today’s debt-fuelled stock markets.

But there will be many more serious casualties over the next few months and years:

  • NE Asian countries such as Japan and S Korea are part of global supply chains which send a wide range of components to China, where they are incorporated into finished goods for sale to the USA
  • Germany and the major European countries have relied on sales to China to boost economic growth, as domestic demand has stagnated, and clearly this support is now going to weaken
  • The mining industry and other suppliers of commodities will also be hit – Rio Tinto, for example, depends on China for 45% of its revenue, and on the USA for 15%
  • The petrochemicals industry has been dependent on China for its growth since the 2008 financial crisis, as I noted last summer, US-China tariffs could lead to global Polyethylene price war

Back in 2011-12, John Richardson and I wrote ‘Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again’ to give our view of the likely consequences of the major demographic changes underway in the global economy.

Unfortunately, the politicians of the time took the seemingly easy route out of the crisis. They decided that printing money was so much easier than having a dialogue with the electorate about the implications of ageing populations, or the fact that Western fertility rates have been below replacement levels for the past 45 years.  Our warning is now coming true:

“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.

IKEA heads into the circular world with furniture subscription trial

“Once upon a time, Granny and Grandad used to go to a large shop on the motorway to buy their furniture. They used to stagger around carrying Billy bookshelves and Dombas wardrobes, before treating themselves to Swedish meatballs in the canteen. And then Grandad would spend the rest of the weekend trying to assemble the furniture, whilst Granny turned up the volume on her radio to drown out his swearing.

“What, Granny, you actually bought furniture?  But why did you buy when you could just rent it, and change it when you wanted something different?

That future isn’t very far away. In fact, if you live in Switzerland, you’ll be able to rent furniture from IKEA stores this month on a trial basis.  As the boss of Inter IKEA told the Financial Times last week:

“We will work together with partners so you can actually lease your furniture. When that leasing period is over, you hand it back and you might lease something else. And instead of throwing those away, we refurbish them a little and we could sell them, prolonging the lifecycle of the products. The trial is the first in a series of tests that IKEA hopes could lead to “scalable subscription services” for different types of furniture.”

Of course, IKEA aren’t the first company to be moving in the direction of subscribing rather than selling.  Not many people buy CDs or videos these days, after all, but instead subscribe to streaming services that enable them to download what they want, when they want it.

But what is new, as the chart from Prof Michael Wade of IMD shows, is that it illustrates a growing move by consumer product groups and manufacturers to follow this lead.  And behind the move is an early effort to put the principles of the circular economy into practice, as IKEA describe:

“You could say leasing is another way of financing a kitchen. When this circular model is up and running, we have a much bigger interest in not just selling a product but seeing what happens with it and that the consumer takes care of it.  He added that Ikea now designed kitchens so that it was possible to change the cupboard doors without needing to rip out the whole set-up.  “It’s interesting if you as a consumer say ‘I can change and adapt and modernise my kitchen if that’s a subscription model’”.”

It also marks a further departure from the concept of globalisation, which has dominated business for a generation. Globalisation was essential for the world of the BabyBoomers, where the world’s population went from 2.5bn in 1950 to 6.1bn by 2000. There just wasn’t enough “stuff” to go round in the rich Western countries, and so companies were forced to develop global supply chains to satisfy demand.

But today, as the chart describes, smart companies like IKEA are starting to plan for a world where services rather than products will be the main driver for revenue and profit growth.  Rather than building in obsolescence, so that the consumer was forced to make repeat purchases, the new business model is based on providing a solution that can evolve with the consumer’s needs.

It will also, necessarily, operate on a local scale. It will make no sense, for example, for IKEA to be continually shipping kitchen doors across the world, because the customer doesn’t want a pink colour any more.

The same principle is being applied by the Circular Plastics Alliance in Europe, which is focused on 5 key areas to turn 10 million tonnes/year of recycled plastics into new products within the next 6 years – Collection and sorting; Product design for recycling; Recycled plastic content in products; Monitoring systems; R&D and investments, including chemical recycling.

The days of Granny and Grandad choosing to actually “own” their furniture may well be coming to an end. And for companies, the challenge of developing new business models is no longer something they can put off till the future.  Those that recognise the opportunity created by the growing demand for products that are more sustainable, affordable and sustainable will be the Winners in this New Normal world.

CEOs need new business models amid downturn

Many indicators are now pointing towards a global downturn in the economy, along with paradigm shifts in demand patterns. CEOs need to urgently build resilient business models to survive and prosper in this New Normal world, as I discuss in my 2019 Outlook and video interview with ICIS.

Global recession is the obvious risk as we start 2019.  Last year’s hopes for a synchronised global recovery now seem just a distant memory.  Instead, they have been replaced by fears of a synchronised global downturn.

Capacity Utilisation in the global chemical industry is the best leading indicator that we have for the global economy.  And latest data from the American Chemistry Council confirms that the downtrend is now well-established.  It is also clear that key areas for chemical demand and the global economy such as autos, housing and electronics moved into decline during the second half of 2018.

In addition, however, it seems likely that we are now seeing a generational change take place in demand patterns:

  • From the 1980s onwards, the demand surge caused by the arrival of the BabyBoomers into the Wealth Creating 25 – 54 cohort led to the rise of globalisation, as companies focused on creating new sources of supply to meet their needs
  • At the same time the collapse of fertility rates after 1970 led to the emergence of 2-income families for the first time, as women often chose to go back into the workforce after childbirth. In turn, this helped to create a new and highly profitable mid-market for “affordable luxury”
  • Today, however, only the youngest Boomers are still in this critical generation for demand growth. Older Boomers have already moved into the lower-spending, lower-earning 55+ age group, whilst the younger millennials prefer to focus on “experiences” and don’t share their parents’ love of accumulating “stuff”

The real winners over the next few years will therefore be companies who not only survive the coming economic downturn, but also reposition themselves to meet these changing demand patterns.  A more service-based chemical industry is likely to emerge as a result, with sustainability and affordability replacing globalisation and affordable luxury as the key drivers for revenue and profit growth.

Please click here to download the 2019 Outlook (no registration necessary) and click here to view the video interview.

“What could possibly go wrong?”

I well remember the questions a year ago, after I published my annual Budget Outlook, ‘Budgeting for the Great Unknown in 2018 – 2020‘.  Many readers found it difficult to believe that global interest rates could rise significantly, or that China’s economy would slow and that protectionism would rise under the influence of Populist politicians.

MY ANNUAL BUDGET OUTLOOK WILL BE PUBLISHED NEXT WEEK
Next week, I will publish my annual Budget Outlook, covering the 2019-2021 period. The aim, as always, will be to challenge conventional wisdom when this seems to be heading in the wrong direction.

Before publishing the new Outlook each year, I always like to review my previous forecast. Past performance may not be a perfect guide to the future, but it is the best we have:

The 2007 Outlook ‘Budgeting for a Downturn‘, and 2008′s ‘Budgeting for Survival’ meant I was one of the few to forecast the 2008 Crisis.  2009′s ‘Budgeting for a New Normal’ was then more positive than the consensus, suggesting “2010 should be a better year, as demand grows in line with a recovery in global GDP“.  Please click here if you would like to download a free copy of all the Budget Outlooks.

THE 2017 OUTLOOK WARNED OF 4 KEY RISKS
My argument last year was essentially that confidence had given way to complacency, and in some cases to arrogance, when it came to planning for the future.  “What could possibly go wrong?” seemed to be the prevailing mantra.  I therefore suggested that, on the contrary, we were moving into a Great Unknown and highlighted 4 key risks:

  • Rising interest rates would start to spark a debt crisis
  • China would slow as President Xi moved to tackle the lending bubble
  • Protectionism was on the rise around the world
  • Populist appeal was increasing as people lost faith in the elites

A year later, these are now well on the way to becoming consensus views.

  • Debt crises have erupted around the world in G20 countries such as Turkey and Argentina, and are “bubbling under” in a large number of other major economies such as China, Italy, Japan, UK and USA.  Nobody knows how all the debt created over the past 10 years can be repaid.  But the IMF reported earlier this year that total world debt has now reached $164tn – more than twice the size of global GDP
  • China’s economy in Q3 saw its slowest level of GDP growth since Q1 2009 with shadow bank lending down by $557bn in the year to September versus 2017.  Within China, the property bubble has begun to burst, with new home loans in Shanghai down 77% in H1.  And this was before the trade war has really begun, so further slowdown seems inevitable
  • Protectionism is on the rise in countries such as the USA, where it would would have seemed impossible only a few years ago.  Nobody even mentions the Doha trade round any more, and President Trump’s trade deal with Canada and Mexico specifically targets so-called ‘non-market economies’ such as China, with the threat of losing access to US markets if they do deals with China
  • Brexit is worth a separate heading, as it marks the area where consensus thinking has reversed most dramatically over the past year, just as I had forecast in the Outlook:

“At the moment, most companies and investors seem to be ignoring these developments, assuming that in the end, sense will prevail. But what if they are wrong? It seems highly likely, for example, that the UK will end up with a “hard Brexit” in March 2019 with no EU trade deal and no transition period to enable businesses to adjust.

“Today’s Populist politicians don’t seem to care about these risks. For them, the allure of arguing for “no deal”, if they can’t get exactly what they want, is very powerful. So it would seem sensible for executives to spend time understanding exactly how their business might be impacted if today’s global supply chains came to an end.”

  • Populism is starting to dominate the agenda in an increasing number of countries.  A year ago, many assumed that “wiser heads” would restrain President Trump’s Populist agenda, but instead he has surrounded himself with like-minded advisers; Italy now has a Populist government; Germany’s Alternativ für Deutschland made major gains in last year’s election, and in Bavaria last week.

The last 10 years have proved that stimulus programmes cannot substitute for a lack of babies. They generate debt mountains instead of sustainable demand, and so make the problems worse, not better.  As a result, voters start to listen to Populists, who offer seemingly simple solutions to the problems which have been ignored by the elites.

Next week, I will look at what may happen in the 2019 – 2021 period, as we enter the endgame for the policy failures of the past decade.

The post “What could possibly go wrong?” appeared first on Chemicals & The Economy.

The blog’s 11th birthday – and a look forward to 2021

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.

The post The blog’s 11th birthday – and a look forward to 2021 appeared first on Chemicals & The Economy.

President Xi focuses on pollution, not growth, as key Party Congress nears

Beijing pollution Feb14

Imagine living in the capital city of a major country, and suffering the level of pollution shown in the above photo on a regular basis.  We used the photo in chapter 6 of Boom, Gloom and the New Normal when we highlighted how pollution was inevitably going to move up the political agenda in China. Controversial at the time, it warned:

Recent growth in China and India has come at a price: Poor air quality, chronic water shortages and deforestation.”

By February 2014, the pressure to act was becoming almost overwhelming as:

“The problems have worsened, to the point where almost everyone now agrees that they are creating a major political problem. The new leadership simply has to solve this, if it wants to remain in office. Beijing and the 6 northern provinces have now been shrouded in smog for 6 days, and on Wednesday the US embassy reported that the levels of PM2.5, the small particles that pose the greatest risk to human health, were “beyond index” at 512.

Guangdong province, close to Hong Kong, had already moved to clean up.  But other provinces did little or nothing, as officials worried about the likely impact on jobs. A major part of the problem was that the economy is the Premier’s responsibility, and Premier Li has been more worried about maintaining growth via stimulus programmes.

This year, however, Xi finally lost patience ahead of next month’s 5-yearly People’s Congress – at which he will be renominated for another 5-year term.  Having signed China up to the Paris Agreement on climate change in December 2015, he seized control of the economic agenda, as I noted in the Financial Times:

Xi knows that reducing pollution, rather than maintaining economic growth, has become key to continued Communist Party rule.  The recent rapid elevation of Beijing’s mayor, Cai Qi, to become party chief for the city is further confirmation of the high priority now being given to tackling air pollution and stabilising house prices.

“Taken together, these policies represent a paradigm shift from those put in place 40 years ago by Deng Xiaoping after Mao’s death in 1976. This shift has critically important implications, as it means growth is no longer the main priority of China’s leadership. In turn, this means that stimulus programmes of the type unleashed in 2012, and on a more limited basis by Premier Li last year, are a thing of the past.”

Since then, the Beijing area, and surrounding provinces such as Hebei and Henan, have become a centre of the battle against pollution.  One key development has been the use of thousands of drones to spot, and measure air and water pollution, and then identify and photograph the culprits. As state-controlled Xinhua reported last week:

“A total of 599 companies, mainly construction materials, furniture, chemicals, packaging and printing, were relocated out of the capital, said the Beijing municipal commission of development and reform.  Beijing also closed 2,543 firms and ordered 2,315 firms to make changes. About 73% had pollution issues.

Similarly, a senior chemical industry executive told me last week:

“I was in/near Cangzhou the other day (another city on the list) where the government have created a large National Level Economic Zone including a dedicated chemical “park” to accommodate the companies that are being cleared out of Beijing and surrounds. This was an otherwise nondescript flatland whose only previous claim to fame was a Mao era collaboration with then Czechoslovakia to make tractors.

China lend Sept17

The war on pollution has another side to it, of course, as it marks the end of the “growth at any cost” economic model.

As a result, realism is finally returning to discussion about China’s real growth potential.  As last month’s IMF Report on China noted, GDP growth had only averaged 7.3% over the 5 years to 2016 because of stimulus: without this, growth would have been just 5.3%.  As a result, the IMF also highlighted an increasing risk of “a possible sharp decline in growth in the medium term”, as well as a need to boost domestic consumption by reducing savings.

This is a welcome development. Too many companies and analysts have indulged in wishful thinking, wanting to believe China had suddenly become middle-class by Western standards.  In reality, as the second chart shows, the growth surge was due to $20tn of stimulus lending via official and shadow banking channels.

At its peak, between 2009 – 2013, this lending reached 3.2x official GDP.  And GDP itself was probably also over-stated for internal political reasons, as Communist Party officials were routinely judged for promotion on their success in generating GDP growth.  Now the pendulum has swung the other way, as the Caixin business magazine has reported:

In a document jointly released by the Ministry of Environmental Protection and nine other ministry-level bodies, if a city does not achieve 60% of the emission reduction target, the city’s vice mayor will be held responsible.  If the city achieves less than 30% of its target, the mayor will be held responsible; and if the PM2.5 level ends up increasing instead of falling over the winter, the party secretary of the city will be held responsible.

“Possible punishment includes party disciplinary or administrative punishments, the document says.”

Large economies are like super-tankers, they take a long time to change course.  As I noted nearly 2 years ago, China is now attempting to move in a radically new direction, away from export-driven growth and infrastructure spending – and towards a New Normal economy based on the mobile internet:

“The winners are developing services-led businesses focused on China’s New Normal markets – such as those aimed at boosting living standards in the poverty-stricken rural areas, or for environmental clean-up. The losers will be those who cling to the hope that more stimulus is just around the corner, and that China’s Old Normal will somehow return.”

Those who have done well under the old regime, like the Party heads focused on job-creation and the opportunities that it created for large-scale corruption, will inevitably fight hard to preserve their way of life.  Next month’s Congress will therefore be critical in assessing just how much power Xi will have to pursue his reform policies in his second term.

As I noted a year ago, this Congress will settle key questions.  Will Premier Li gain a second term, and continue to be able to obstruct reform? Will anti-corruption tsar Wang maintain his position on the all-powerful Politburo Standing Committee, despite being over the nominal age limit?

The Congress is therefore likely to the most important meeting since 1997, when Jiang Zemin gained re-appointment for his second term as President and led China out of poverty via membership of the World Trade Organisation.  Now, as set out in the China 2030 Report (published when Xi became President), Xi has to led China in a new direction.

Otherwise, he will be unable to achieve his twin goals of

□   Making China a “moderately prosperous society” by 2021 (the centenary of the Chinese Communist Party)
□   Making it a “fully developed, rich and powerful nation” by 2049 (the centenary of the People’s Republic), and returned to its historical status as the Middle Kingdom via his ‘One Belt, One Road’ project.