“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.

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Why everyone ignored my warnings ahead of the financial crisis

It’s 10 years since my forecast of a global financial crisis came true, as Lehman Brothers collapsed.  I had warned of this consistently here in the blog, and in the Letters column of the Financial Times. But, of course, nobody wanted to listen whilst the party was going strong.  As the FT’s world trade editor wrote at the time, commenting on the Queen’s question “Why did nobody see this coming”:

“Why didn’t people see it coming? Some did, Ma’am. Some did. But it doesn’t mean they were listened to. And there is a long history of people in authority running up vast debts without public accountability and eventually losing their heads. Let’s just try and get through this one without a civil war, shall we?”

That rationale, I understood.  I was the “party pooper” warning of crisis for nearly 2 years.  But people didn’t want warnings.  And, of course, until we got to March 2008 and Bear Stearns collapsed, I couldn’t answer their all-important question, “When is this going to happen?”.

If you take the 4 great questions of life – Why, What, How and When – the ‘When’ question is really the least important:

  • If you know ‘Why’ something is going to happen, ‘What’ it involves and ‘How’ it will impact, then ‘When’ is simply the detail that confirms the analysis was right
  • But if you don’t want to know about a problem, its the easiest thing in the world to dismiss it by arguing “your comment is no use to me, unless you can tell me when its going to happen”

But I admit that what did surprise me, after John Richardson and I had written Boom, Gloom and the New Normal: how the Western BabyBoomers are Changing Demand Patterns, Again, was that people really liked our analysis of the impact of demographic change on the economy – but still ignored its implications for their business and the economy.

The above chart is a good example, showing the latest data from the US Consumer Expenditure Survey.  It confirms what common sense tells us:

  • Household spending is closely linked to age
  • Housing expenditure is the biggest single expense for most people, and peaks between the ages of 35-54
  • Transport and food & drink are the next largest spend, and peak at the same ages
  • Health expenditure, on the other hand, peaks as one gets older

This is critical information for central bankers, companies and investors, given that consumer spending is 60%-70% of GDP in most developed countries.

Yet the only central banker who took it seriously, Masaaki Shirikawa, Governor of the Bank of Japan, was promptly sacked after premier Abe came to power.   Printing money seemed so much easier than having difficult but essential discussions with voters about the impact of an ageing population, but as Shirikawa noted:

“The main problem in the Japanese economy is not deflation, it’s demographics. The issue is whether monetary policy is effective in restoring economic recovery. My observation is, it is quite limited.”

Equally, the second chart confirms that the US is also a rapidly ageing society, with 20m households having moved into the 55+ age range since 2000.  And whilst the 55+ group’s spending has increased over the period, this is only because many of the younger BabyBooomers are still in their 50s or early 60s.  So whilst their spend is declining, it hasn’t yet suffered the 43% fall that occurs after the age of 75 (by comparison with the peak spending 45-54 period).

Yet policymakers still insist that the 2008 crisis was all about liquidity, and had nothing to do with the impact of today’s ageing populations on spending and economic growth.  And most companies also still plan for “business as usual”.

SO WHAT HAPPENS NEXT, AS THE DEBT BURDEN GROWS?
For obvious reasons, I disagree with these views.  Of course, it would be lovely to find that today’s record levels of debt – created in the vain attempt to stimulate growth – could be made to simply disappear.  I have read analyses by learned commentators arguing that central banks can simply “write off” their debt, and it will magically disappear.

But I have never yet found a bank or credit card company prepared to “write off” any debt that I owe them in this way.  (If you know of one, please let me know, and I will pass on the details).  And most of us know from personal experience that interest costs soon mount up, if you can’t pay the debt at once and have to finance it for a while.

So its quite clear that today’s record levels of debt create massive headwinds for future growth. At $247tn, it now amounts to 318% of global GDP.  In reality, only two choices lie ahead:

  • The past decade’s borrowing brought forward consumption from the future, so repaying the debt means growth will slow very dramatically – adding to the demand deficit created by today’s globally ageing populations
  • Failing to pay back the debt risks creating chaos in financial markets, as we are starting to see with the crises in Argentina and Turkey, as lenders suddenly realise their loans cannot be repaid

But, of course, I can’t yet say exactly ‘When?’ this simple fact will finally impact the economy and markets.  For the moment, as between 2006 – March 2008, I can only tell you:

‘Why?’ it is going to happen, ‘What?’ it involves and ‘How?’ you can recognise the warning signs.

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Financial crises and the five stages of loss

The Financial Times has kindly printed my letter as their lead letter, arguing that the rise of the populists emphasises the risk of continuing to deny the impact of today’s ageing populations on the economy.

Sir,  Martin Wolf’s sobering analysis of policymakers’ post-crisis decision to “go back to the past”, ( “Why so little has changed since the financial crash”, September 5), brings to mind the celebrated “Paradigm of Loss” model developed by Elizabeth Kübler-Ross. Originally designed to describe how people come to terms with loss and death, it has since been more widely applied, including to economic and financial market developments.

His description of the post-1918 period appears to be a classic example of the paradigm’s denial stage, with policymakers ignoring the economic impact of the earlier carnage. Young people are the prime source of future demand as they enter the wealth creator 25-54 age group, when people typically settle down, have children and develop their careers. The war cruelly destroyed the lives of millions of young men before they could realise this potential.

As the paradigm would suggest, this denial then led to anger, and the rise of fascism and communism. This proved so intense that the next stage, bargaining, was delayed until 1945, when the adoption of Keynes’s new thinking finally allowed the cycle to complete.

Today, we are again seeing a demand deficit created by demographic change. Thankfully, it is not due to war, but to the post-1945 increase in life expectancy and collapse in fertility rates. Inevitably, therefore, consumer spending — the motor of developed economies — is now slowing as we have an ageing population for the first time in history. Older people already own most of what they need, and their incomes decline as they retire.

Just as in 1918, this means we need new policies to create “a better future”, as Mr Wolf notes. In their absence, the rise of the populists suggests that we instead risk moving into a new anger phase. It is not yet too late for new thinking to emerge, but time is starting to run out.

Paul Hodges

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Political and economic risks rise as US mid-term elections near

This is the Labor Day weekend in the USA – the traditional start of the mid-term election campaign.  And just as in September 2016, the Real Clear Politics poll shows that most voters feel their country is going in the wrong direction.  The demographic influences that I highlighted then are also becoming ever-more important with time:

Demographics, as in 1960 and 1980, are therefore likely to be a critical influence in November’s election:

  • Median age in 1960 was just 30, and 29 in 1964. Young people are by nature optimistic about the future, believing anything can be achieved – and their support was critical for the Great Society project
  • Median age was still only 30 years in 1980. The Boomers were joining the Wealth Creator 25 – 54 generation in large numbers. They were keen to join the Reagan revolution and eliminate barriers
  • Today, however, median age is nearly 50% higher at 38 years, and the average Boomer is aged 61.. The candidates are not mirroring Kennedy/Johnson and Reagan/Bush in focusing on the need to remove barriers. Indeed, Trump’s signature policy is to build a wall”

2 years later, the median age is still increasing, and the average Boomer is aged 63.

But there is one major change from 2 years ago.  Then, President Obama had a positive approval rating at 50.7%.  But today, President Trump has a negative approval rate of 53.9%.

This has clear consequences for the likely outcome of the mid-terms, with the latest FiveThirtyEight poll suggesting the Democrats have a 3 in 4 chance of winning control of the House.  In turn, of course, this increases the risk of impeachment for Trump and makes it even more difficult for him to stop the Mueller investigation.  We therefore have to assume that Trump will do everything he can to reduce this risk over the next few weeks.

Americans are not alone in feeling that their country is heading in the wrong direction, as the latest survey (above) for IPSOS Mori confirms.  And they have been feeling this for a long time – as I noted back in November 2016:

  • China, Saudi Arabia, India, Argentina, Peru, Canada and Russia are the only countries to record a positive feeling
  • The other 18 are increasingly desperate for change

Today Malaysia, S Korea, Serbia and Chile have moved into the positive camp.  But Argentina, Peru and Russia have gone negative.  And if we narrow down to the world’s ‘Top 10’ economies:

  • 7 of them are negative – 53% of Italians, 59% of Americans, 63% of Japanese, 66% of Germans, 67% of British, 73% of French and 85% of Brazilians
  • Only 3 are positive – 91% of Chinese, 67% of Indians and 52% of Canadians

There is a clear message here, as the median ages of the ‘Unhappy 7’ are also continuing to rise:

  • Median Japanese age is 47.3 years; Italy is 45.5; Germany is 43.8; France is 41.4, Britain is 40.5; US is 38.1, (Brazil is unhappy because of economic/political chaos, and is the exception that proves the rule at 32 years)
  • By contrast, China’s media age is 37.4 years, India is 27.9 (Canada is the exception at 42.2 years)

The key issue is summarised in the 3rd slide from a BBC poll, which shows that 3 out of 4 people in the world believe their country has become divided.  More than half believe it is more divided than 10 years ago.

There is also a clear correlation with the demographic data:

  • 35% of Japanese, 67% of Italians, 66% of Germans, 54% of French, 65% of British, 57% of Americans and 46% of Brazilians see their country as more divided than 10 years ago
  • Only 10% of Chinese, 13% of Indians and 35% of Canadians feel this way

POLITICIANS ARE INCREASINGLY FOCUSED ON ‘DIVIDE AND RULE’
One might have expected that politicians would be working to remove these barriers.  But the trend since 2016 has been in the opposite direction.  Older people have historically always been less optimistic about the future than the young.  And the Populists from both the left and right have been ruthless in exploiting this fact.

This trend has major implications for companies and investors. As long-standing readers will remember, very few people agreed with my suggestion in September 2015 that Trump could win the US Presidency and that political risk was moving up the agenda.  As one normally friendly commentator wrote:

“Hodges’ predictions are relevant to companies, he says, because of the likelihood of political change leading to political risk:

  • 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 a prediction skeptic like me would say this, but 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.” (my emphasis)

Yet 3 years later, this has now happened on a major scale – impacting a growing range of industries and countries.

As the mid-term campaigning moves into its final weeks, we must therefore assume that Trump will focus on further consolidating his base vote.  Further tariffs on China, and the completion of the pull-out from the Iran nuclear deal are almost certain as a result.  Canada is being threatened in the NAFTA talks, and it would be no surprise if he increases the economic pressure against the US’s other key allies in the G7 countries, given the major row at June’s G7 Summit.

Anyone who still hope that Trump might be bluffing, and that the world will soon return to “business as usual”, is likely to have an unpleasant shock in the weeks ahead.

 

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Trump’s trade war should set warning bells ringing for every company and investor

There should be no surprise that President Trump has launched his trade war with China.  The real surprise is that financial markets, and business leaders, are so surprised it is happening.  He was, after all, elected on a platform that called for a trade war, as I noted originally back in November 2016 – and many times since, even just last month.

Nor is it a surprise that China has chosen to target chemicals in its proposed list of products for retaliation. As my colleague John Richardson has noted:

“On Tuesday, China’s reaction to that first round of $50bn US tariffs included proposed tariffs of 25% on US exports of low and linear-low density polyethylene.  The same tariffs could also be levied on US polycarbonate, polyvinyl chloride, plastic products in general, acrylonitrile, catalysts, lubricants, epoxy resin, acrylic polymers, vinyl polymers, polyamides (nylon) and surfactants.”

China, unlike almost everyone else it seems, has used the past 15 months to prepare for Trump’s trade war.  So they are naturally targeting the chemicals industry – which was a great supporter of Trump in the early days, and has also come to depend on China for much of its growth.

They will have seen this December 2016 photo of Dow Chemicals CEO, Andrew Liveris, joining Trump at a victory rally in Michigan.

They will also have read Liveris’ tribute to the new President, when announcing the opening of a new R&D centre in Michigan:

“This decision is because of this man and these policies,” Mr. Liveris said from the stage of the 6,000-seat Deltaplex Arena here, adding, “I tingle with pride listening to you.”

The fact that Liveris stepped down last year as head of Trump’s manufacturing council will also have been noticed in Beijing, but clearly did not change their strategy.

FINANCIAL MARKETS EXPECT THE  FED TO BE A FAIRY GODMOTHER
Industry now has a few weeks left to plan for the inevitable.  But if history is any guide, many business people will fail to take advantage of this narrowing window of opportunity.  Instead, like most investors, they will continue with “business as usual”.  The problem is simple:

  • A whole generation has grown up expecting the central banks to act as a fairy godmother
  • Whenever markets have moved downwards, Fed Chairmen and others have showered them with cash
  • Therefore the winning strategy for the past 20 years and more has been to “buy on the dips”
  • Similarly, industry no longer bothers with genuine scenario analysis, where bad things can and do happen

Another key factor in this developing drama is that not all the actors are equally important.  China seems to have been initially wrong-footed, for example, by placing its trust in Treasury Secretary, Steve Mnuchin, and US Ambassador to China, Terry Branstad, to argue its case.  They might appear on paper to be the right people to lobby, but at the end of the day, they are simply messengers – not the ones deciding policy.

The key people are the US Trade Representative, Robert Lighthizer, and his aide, Peter Navarro.  They are now being joined by arch-hawk John Bolton, who in his role as National Security Advisor can be expected to play a key role – along with newly appointed Secretary of State, Mike Pompeo.   Like everything in the Trump White House, Lighthizer’s power comes from his relationship with the President, as the Wall Street Journal describes:

“To Mr. Trump, Mr. Lighthizer was a kindred spirit on trade—and one who shuns the limelight. The two men, who have a similar chip-on-the-shoulder sense of humor, bonded. Mr. Lighthizer caught rides to his Florida home on Air Force One. Mr. Trump summons Mr. Lighthizer regularly to the Oval Office to discuss trade matters, administration officials say.

THE NEXT 6 MONTHS WILL BE A WAKE-UP CALL FOR MANY
The past 18 months have in many ways been a repeat of the 2007-8 period, when I was told my warnings of a subprime crisis were simply alarmist.  This complacency even lasted into October 2008, after the Lehman collapse, when senior executives were still telling me the problems were “only financial” and wouldn’t impact “the real world”.

Similarly, I have been told since September 2015, when I first began warning of the dangers posed by populism in the US and Europe, that I “didn’t understand”. It was clear, I was told, that Trump could “never” become the Republican candidate and could “never ever” become President – and if he did, then Congress would “never ever ever” allow him to take charge of trade policy.  Similarly, I was being told in March 2016 that the UK would “never” vote for Brexit.

I also understand why so many friends and colleagues have been blindsided by these developments, as I discussed in the same September 2015 post:

“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.”

TIME TO DEVELOP PROPER SCENARIOS ANALYSIS
Nobody can forecast everything in detail over the next 6 months, let alone the next few years.  And it is very easy to mock if one detail of the scenario analysis turns out to be wrong.  But the point of scenario analysis is not to try and forecast every detail.  It is instead to give you time to prepare, and to think of alternative strategies.

Just imagine, for example, if you had taken seriously my September 2015 warning about the rise of populism:

  • Think about all the decisions you wouldn’t have made, if you had really believed that Trump could become President and Brexit could happen in the UK?
  • Think of all the decisions you would have made instead, to create options in case these developments occurred?

I understand that you may worry about being mocked for being “stupid” and “alarmist”.  But you should simply remind the mockers of the lesson learnt by insurer Aetna’s CEO, from his failure to undertake proper scenario analysis, as he described in November 2016:

“When Aetna ran through post-election expectations, the idea that Donald J. Trump would win the presidency and that Republicans would control both chambers of Congress seemed so implausible that it was not even in play.  We started with a fresh piece of paper yesterday — we had no idea how to approach it. What we would have spent months doing if we thought it was even remotely possible, we had to do in a day.” 

There is no doubt that he was the one feeling stupid, then.

 

 

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Budgeting for the Great Unknown in 2018 – 2020

“There isn’t anybody who knows what is going to happen in the next 12 months.  We’ve never been here before.  Things are out of control.  I have never seen a situation like it.

This comment from former UK Finance Minister, Ken Clarke, aptly summarises the uncertainty facing companies, investors and individuals as we look ahead to the 2018 – 2020 Budget period.  None of us have ever seen a situation like today’s.  Even worse, is the fact that risks are not just focused on the economy, or politics, or social issues.  They are a varying mix of all of these.  And because of today’s globalised world, they potentially affect every country, no matter how stable it might appear from inside its own borders.

This is why my Budget Outlook for 2018 – 2020 is titled ‘Budgeting for the Great Unknown’.  We cannot know what will happen next.  But this doesn’t mean we can’t try to identify the key risks and decide how best to try and manage them.  The alternative, of doing nothing, would leave us at the mercy of the unknown, which is never a good place to be.

RISING INTEREST RATES COULD SPARK A DEBT CRISIS

Central banks assumed after 2008 that stimulus policies would quickly return the economy to the BabyBoomer-led economic SuperCycle of the previous 25 years.  And when the first round of stimulus failed to produce the expected results, as was inevitable, they simply did more…and more…and more.  The man who bought the first $1.25tn of mortgage debt for the US Federal Reserve (Fed) later described this failure under the heading “I’m sorry, America“:

You’d think the Fed would have finally stopped to question the wisdom of QE. Think again. Only a few months later—after a 14% drop in the U.S. stock market and renewed weakening in the banking sector—the Fed announced a new round of bond buying: QE2

• And the Fed was not alone, as the chart shows.  Today, the world is burdened by over $30tn of central bank debt
• The Fed, European Central Bank, Bank of Japan and the Bank of England now appear to “own a fifth of their governments’ total debt
• There also seems little chance that this debt can ever be repaid.  The demand deficit caused by today’s ageing populations means that growth and inflation remain weak, as I discussed in the Financial Times last month

China is, of course, most at risk – as it was responsible for more than half of the lending bubble.  This means the health of its banking sector is now tied to the property sector, just as happened with US subprime. Around one in five of all Chinese apartments have been bought for speculation, not to be lived in, and are unoccupied.

China’s central bank chief, Zhou Xiaochuan, has warned that China risks a “Minsky Moment“, where lenders and investors suddenly realise they have overpaid for their assets, and all rush together for the exits – as in 2008.  Similar risks face the main developed countries as they finally have to end their stimulus programmes:

• Who is now going to replace them as buyers of government debt?
• And who is going to buy these bonds at today’s prices, as the banks back away?
$8tn of government and corporate bonds now have negative interest rates, which guarantee the buyer will lose money unless major deflation takes place – and major deflation would make it very difficult to repay the capital invested

There is only one strategy to manage this risk, and that is to avoid debt.  Companies or individuals with too much debt will go bankrupt very quickly if and when a Minsky Moment takes place.

THE CHINA SLOWDOWN RISK IS LINKED TO THE PROPERTY LENDING BUBBLE

After 2008, it seemed everyone wanted to believe that China had suddenly become middle class by Western standards. And so they chose to ignore the mounting evidence of a housing bubble, as shown in the chart above.

Yet official data shows average incomes in China are still below Western poverty levels (US poverty level = $12060):

•  In H1, disposable income for urban residents averaged just $5389/capita
•  In the rural half of the country, disposable income averaged just $1930
•  The difference between income and expenditure was based on the lending bubble

As a result, average house price/earnings ratios in cities such as Beijing and Shanghai are now more than 3x the ratios in cities such as New York – which are themselves wildly overpriced by historical standards.

Having now been reappointed for a further 5 years, it is clear that President Xi Jinping is focused on tackling this risk.  The only way this can be done is to take the pain of an economic slowdown, whilst keeping a very close eye on default risks in the banking sector.  As Xi said once again in his opening address to last week’s National Congress:

“Houses are built to be inhabited, not for speculation. China will accelerate establishing a system with supply from multiple parties, affordability from different channels, and make rental housing as important as home purchasing.

China will therefore no longer be powering global growth, as it has done since 2008.  Prudent companies and investors will therefore want to review their business models and portfolios to identify where these are dependent on China.

This may not be easy, as the link to end-user demand in China might well be further down the supply chain, or external via a second-order impact.  For example, Company A may have no business with China and feel it is secure.  But it may suddenly wake up one morning to find its own sales under attack, if company B loses business in China and crashes prices elsewhere to replace its lost volume.

PROTECTIONISM IS ON THE RISE AROUND THE WORLD

Trade policy is the third key risk, as the chart of harmful interventions from Global Trade Alert confirms.

These are now running at 3x the level of liberalising interventions since 2008, as Populist politicians convince their voters that the country is losing jobs due to “unfair” trade policies.

China has been hit most times, as its economy became “the manufacturing capital of the world” after it joined the World Trade Organisation in 2001.  At the time, this was seen as being good news for consumers, as its low labour costs led to lower prices.

But today, the benefits of global trade are being forgotten – even though jobless levels are relatively low.  What will happen if the global economy now moves into recession?

The UK’s Brexit decision highlights the danger of rising protectionism. Leading Brexiteer and former cabinet minister John Redwood writes an online diary which even campaigns against buying food from the rest of the European Union:

There are many great English cheese (sic), so you don’t need to buy French.

No family tries to grow all its own food, or to manufacture all the other items that it needs.  And it used to be well understood that countries also benefited from specialising in areas where they were strong, and trading with those who were strong in other areas.  But Populism ignores these obvious truths.

•  President Trump has left the Trans-Pacific Partnership, which would have linked major Pacific Ocean economies
•  He has also said he will probably pull out of the Paris Climate Change Agreement
•  Now he has turned his attention to NAFTA, causing the head of the US Chamber of Commerce to warn:

“There are several poison pill proposals still on the table that could doom the entire deal,” Donohue said at an event hosted by the American Chamber of Commerce of Mexico, where he said the “existential threat” to NAFTA threatened regional security.

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.

POLITICAL CHAOS IS GROWING AS PEOPLE LOSE FAITH IN THE ELITES
The key issue underlying these risks is that voters no longer believe that the political elites are operating with their best interests at heart.  The elites have failed to deliver on their promises, and many families now worry that their children’s lives will be more difficult than their own.  This breaks a century of constant progress in Western countries, where each generation had better living standards and incomes.  As the chart from ipsos mori confirms:

•  Most people in the major economies feel their country is going in the wrong direction
•  Adults in only 3 of the 10 major economies – China, India and Canada – feel things are going in the right direction
•  Adults in the other 7 major economies feel they are going in the wrong direction, sometimes by large margins
•  59% of Americans, 62% of Japanese, 63% of Germans, 71% of French, 72% of British, 84% of Brazilians and 85% of Italians are unhappy

This suggests there is major potential for social unrest and political chaos if the elites don’t change direction.  Fear of immigrants is rising in many countries, and causing a rise in Populism even in countries such as Germany.

CONCLUSION
“Business as usual” is always the most popular strategy, as it means companies and investors don’t have to face the need to make major changes.  But we all know that change is inevitable over time.  And at a certain moment, time can seem to literally “stand still” whilst sudden and sometimes traumatic change erupts.

At such moments, as in 2008, commentators rush to argue that “nobody could have seen this coming“.  But, of course, this is nonsense.  What they actually mean is that “nobody wanted to see this coming“.  The threat from subprime was perfectly obvious from 2006 onwards, as I warned in the Financial Times and in ICIS Chemical Business, as was 2014’s oil price collapse. Today’s risks are similarly obvious, as the “Ring of Fire” map describes.

You may well have your own concerns about other potential major business risks. Nobel Prizewinner Richard Thaler, for example, worries that:

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping.”

We can all hope that none of these scenarios will actually create major problems over the 2018 – 2020 period. But hope is not a strategy, and it is time to develop contingency plans.  Time spent on these today could well be the best investment you will make. As always, please do contact me at phodges@iec.eu.com if I can help in any way.

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