The chemical industry is the best leading indicator for the global economy. And my visit to Singapore last week confirmed that the downturn underway in the Asian market creates major risks for developed and emerging economies alike.
The problem is focused on China’s likely move into recession, now its stimulus policies are finally being unwound. And the result is shown in the above chart from The pH Report, updated to Friday:
- It confirms that the downturn began before oil prices peaked at the beginning of October, confirming that companies were responding to a downturn in end-user demand
- Since then, of course, the oil price has – rather dramatically – entered a bear market, with prices down by nearly a third
The question now is whether finance directors will choose to aggressively destock ahead of year-end results, to mitigate the volume decline with a decline in working capital. This would be a bold move given continuing geo-political uncertainty in the Middle East, and would also conflict with the more upbeat guidance that was given earlier with Q3 results.
But a review of ICIS news headlines over the past few days suggests they may have little choice. Inventories are described as “piling up” in a wide range of major products, including polyethylene – the biggest volume polymer. Indian producers are even offering “price protection” packages on polypropylene, to safeguard customers from losses if prices fall further.
Asian countries and their major partners (eg Argentina, S Africa, Turkey) were, of course, the first to be hit by China’s downturn. But Q3’s fall in German GDP shows the downturn has now spread to the Western economy that most benefited from China’s post-2008 stimulus bubble. As The Guardian noted:
“Goods exports make up 40% of German GDP – a much bigger proportion than for the next two biggest eurozone economies, France and Italy.”
OIL MARKETS CONFIRM THE RECESSION RISK
Of course, consensus opinion still believes that the US economy is sailing along, regardless of any problems elsewhere. But the chart of oil prices relative to recession tells a different story:
- The problem is that oil prices have been rising since 2016, with the summer proving the final blow-off peak. As always, this meant consumers had to cut back on discretionary spending as costs of transport and heating rose
- The cost of oil as a percentage of GDP reached 3.1% in Q3 – a level which has always led to recession in the past, with the exception of the post-2008 stimulus period when governments and central banks were pouring $tns of stimulus money into the global economy
- In turn, this means a downturn is now beginning in US end-user demand in critical areas such as housing, autos and electronics
Oil markets have therefore provided a classic example of the trading maxim for weak markets – “Buy on the rumour, sell on the news”.
- Prices had risen by 75% since June on supply shortage fears, following President Trump’s decision to exit the Iran nuclear deal on November 4
- As always, this created “apparent demand” as buyers in the US and around the world bought ahead to minimise the impact of higher prices
- But the higher prices also negated the benefit of the earlier tax cuts for his core supporters just ahead of the mid-term elections, causing Trump to undertake a policy u-turn
- He is now pushing Saudi Arabia and Russia to maintain production, and has announced 180-day exemptions for Iran’s 8 largest customers – China, India, S Korea, Japan, Italy, Greece, Taiwan and Turkey.
Understandably, oil traders have now decided that his “bark is worse than his bite“. And with the downturn spreading from Asia to the West, markets are now refocusing on supply/demand balances, with the International Energy Agency suggesting stocks will build by 2mb/d in H1 2019. In response, OPEC are reportedly discussing potential cuts of up to 1.4mb/d from December.
CHINA’S SHADOW BANKING COLLAPSE IS CREATING A NEW FINANCIAL CRISIS
Unfortunately, as in 2008, the collapse in oil prices is coinciding with the end of stimulus policies, particularly in China, as the chart of its shadow bank lending confirms. This has hit demand in two ways, as I discussed earlier this month in the Financial Times:
- Just 3 years ago, it was pumping out an average $140bn/month in mainly property-related lending *
- This created enormous demand for EM commodity exports
- It also boosted global property prices as wealthy Chinese rushed to get their money out of the country
- But during 2018, lending has collapsed by more than 80% to average just $23bn in October
China’s post-2008 stimulus programme was the growth engine for the global economy – with the efforts of the Western central banks very much a sideshow in comparison. It was more than half of the total $33tn lending to date. But now it is unwinding, prompting the Minsky Moment forecast a year ago by China’s central bank governor:
“China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous.”
As I warned then:
“Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy. China’s lending bubble – particularly in property – is likely coming to an end. In turn, this will lead to a bumpy ride for the global economy.”
The bumps are getting bigger and bigger as we head into recession. Asia’s downturn is now spreading to the rest of the world, and is a major wake-up call for anyone still planning for “business as usual”.
* Lending has major seasonal peaks in Q1, so I use rolling 12 month averages to avoid distortions
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.
China’s housing bubble is not just about Shenzhen. It is the most obvious sign of problems ahead, as I noted last month. But as the chart above shows from the Wall Street Journal, total lending to the property sector has rocketed in recent months:
More than one-third of all loans went to the sector in H1 2016
This was double the average percentage between 2010 – 2015
10 cities saw annual house price gains of more than 20% in August
Total home loans are expected to be around 30% of GDP this year, versus 20% in 2014
The bubble highlights the growing split between the 2 main factions in China’s Communist Party – the Princelings, led by President Xi, and the Populists led by Premier Li.
The split is set to intensify as the factions prepare for next year’s critical Party meeting in November. This will decide Politburo membership for the next 5 years – and hence, China’s leadership. Critically, 5 of the current 7 members of the top Standing Committee are due to retire, leaving only Xi and Li as eligible for reappointment.
The issue is not just about politics, of course. Underlying the manoeuvring is an increasingly critical debate over the outlook for China’s economy. As the second chart shows from the Bank for International Settlements (the central bankers’ bank), China’s debt levels have exploded since 2008.
This was when former President Hu and Premier Wen (both Populists) unleashed the biggest stimulus programme in history, in response to the loss of exports after the start of the Financial Crisis:
China’s debt was then around 150% of GDP – high, but probably tolerable as most borrowing was going into longer-term projects which would underpin future economic growth
Today, it is nearly 250%, due to the Populists’ stimulus programmes, which have focused on maintaining employment in the short-term via the creation of a property bubble
The main focus of the debt build-up has been the property sector, where residential buyers have never seen a downturn since the urban market was opened up to private buyers in 1998. Many suppliers are now increasingly worried that it is being driven by speculative demand. One told me recently of apartments being built with only minimal insulation, despite local temperatures dropping below zero in the winter.
This is the background to President Xi’s decision to take charge, by telling the government to “control asset bubbles”. He knows that he has to “take the short-term pain” of restructuring the economy away from property speculation and asset bubbles. The longer he leaves the Populists in charge, the greater the danger for the economy.
A successful rebalancing of the economy would also bring major benefits for the future, as the IMF noted last week:
“China’s transition has a direct negative impact on global demand through trade, an indirect impact through commodity prices, and an effect on asset prices. However, a well-managed transition will benefit the global economy in the long term, with more sustainable growth in China and a reduction of risks of a disruptive adjustment.”
The question, of course, is whether Xi will succeed, given the entrenched opposition of the Populists and all those who have benefited from the post-2008 mania? The next 12 months are likely to provide a very bumpy ride – not only for China, but also for the global economy.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 51%
Naphtha Europe, down 48%.“The European naphtha market has been enjoying exceptionally good demand on the back of high gasoline exports”
Benzene Europe, down 53%. “The market has been inching up and down with crude oil movements recently”
PTA China, down 41%. “Market closed for Golden Week holiday in China”
HDPE US export, down 27%. “Domestic prices for export held steady during the week.”
S&P 500 stock market index, up 10%
Its not a good time to be selling new cars in China. As the chart shows:
- Sales fell 2% in Q2 (red line) versus 2014 (green), with June down 3.4%
- This is the first time sales have fallen in a quarter since Q1 2011 (pink)
- China’s auto dealer association said customer visits to dealers “dropped sharply in H1″
- Inventories continue to grow and are at 50 days of sales, even though operating rates are below 70%
- Inventories for imported cars are at 143 days, compared to normal levels around 30 days
Contrary to many media reports, this is nothing to do with the stock market crash – which only began in mid-June. The sales downturn has been going on for months, as part of China’s switch to its New Normal economic policy direction. Thus BMW’s Chinese partner, Brilliance, yesterday forecast a 40% drop in H1 profit.
As always, slowing sales have led to price cuts. These began over the peak holiday season, according to the official CCTV station. Analysts JATO Dynamics report average prices are now 40% below official selling prices at Rmb170k ($27k). Even German brands are offering 15% discounts, whilst GM has cut prices by up to 20% to maintain volume.
Auto market developments highlight a wider trend in the economy. This will not be reflected later this week when China reports its official GDP level for Q2. But as the former head of the UK’s secret service, MI6, told the Euromoney conference last month, China’s real level of GDP growth today is probably only 3% – and falling. As Premier Li said long ago, the official number is “man-made and therefore unreliable“:
- How could China possibly collect all the data and process it in just 2 weeks from the end of the quarter?
- It takes developed countries such as the US at least 4 weeks to publish a first estimate
- Even more revealing is that China’s data is never revised – yet other countries take years to finalise the figure
Common sense suggests that the bursting of the property and stock market bubbles is bound to hit markets such as new cars and luxury items, that have depended on a wealth effect for their sales. Instead the government is focused on promoting the services sector via its mobile internet strategy.
As I discussed recently in the Financial Times, this change of direction is another reason why the new car market is struggling. For the first time in China’s history, buyers have an option to buy a cheaper used car. And those manufacturers and dealers who have adapted their business models to China’s New Normal will now profit instead from used car sales and servicing revenue.
Everyone seems sure that China’s government is about to undertake major new stimulus. Thus Reuters reported:
“Economists said it was a matter of when, not if, China eased policy again after economic growth in Q1 cooled to 7%, a level not seen since the depths of the 2008/09 global financial crisis. Indeed, some analysts have even said recently that the PBOC had fallen behind the curve by not responding aggressively enough to deteriorating conditions.”
The only people who seem to have failed to get the message seem to be the government itself. As I discussed yesterday, they instead seem more worried about the likely problems associated with the Great Unwinding of stimulus policies. And they seem in no mood to take any step in the direction of further stimulus themselves.
This is creating a most bizarre situation in world markets. News media and analysts seem to have stopped talking about the obvious slowdown underway in China’s economy – presumably on the basis that this is already ‘old news’ as vast stimulus is just about to happen. Yet the slowdown is real, and growing in momentum:
- Fixed-asset investment rose only 12% in January-April versus 2013, the slowest pace since December 2000
- Government and private sector spending growth slowed, mining saw a sharp drop, new project spend stalled
- Property investment growth slowed to 6% in January to April, the weakest level since 2009
- Housing inventories are very high outside the Tier 1 cities, at up to 3 years
- New property starts fell 17%, hitting demand for cement, steel, polymers, furniture and appliances
- Car sales actually fell in April, despite price cuts of up to 25%; some dealers now have 6 months inventory
It has also been clear, as we argued in The pH Report more than a year ago, that China’s new leadership are determined to slow the economy in order to bring the lending bubble they inherited under control. And the chart above shows they are succeeding:
- Total Social Financing (TSF eg official and shadow bank lending), was down 18% at the end of April versus 2014
- Shadow banking was down an astonishing 55%, highlighting the property bubble squeeze (red area)
- Official lending, necessary to maintain liquidity in the banking system, was up just a minimal 14% (green)
- And this is the continuation of a trend, as shadow banking fell 21% in 2014, and TSF fell 5%
One day, perhaps not too far away, we will all have to take off our rose-tinted glasses and recognise the reality of the policy shift underway in China. Its New Normal is the reverse of the previous policies of the ‘lost decade’, when $6,8tn was “wasted“. It is not a continuation by another name.
President Xi was being very serious when he told China’s economic policy-making policy conference that “The good meat is all gone; all that is left are hard bones to chew”.
China’s interest bill this year is around $1.7tn, according to ratings agency Fitch. And no, the “tn” isn’t a typo. China’s interest bill is indeed around the total size of India’s economy, and larger than the economies of S Korea ($1.3tn), Spain ($1.4tn) or Mexico ($1.3tn).
Common sense tells us that no economy can afford to pay out 17% of GDP in interest bills. But this was the position inherited by President Xi and Premier Li when they took office, two years ago:
- In 2007, each dollar of credit added 83 cents to GDP
- By 2012, each dollar was only adding 29 cents; in 2013, a dollar added only 17 cents
- Estimates suggest the figure for 2014 was as low as 10 cents
This is the problem with stimulus programmes in the New Normal of ageing populations and collapsing fertility rates. China’s demographic dividend has turned to a demographic deficit. So stimulus spending merely creates a mountain of debt, rather that the expected rocket-fuelled growth.
Reducing this debt is thus a key priority for the leadership, as The pH Report noted a year ago in “China bank lending: From $1tn to $10tn and back again”. The chart above highlights the change in direction now underway:
- It shows Total Social Financing (TSF) segmented by Official (green area) and Shadow Bank lending (red)
- TSF peaked in Q2 2013 at $250bn/month, versus just $90bn/month in Q1 2009
- Q1 2015 data showed it had fallen 14% to average $210bn/month – still far too high, of course
The chart also highlights the government’s strategy for reducing the debt:
- The first priority was to bring shadow banking (unregulated lending) under control
- These were the loans that had financed the “collateral trade” and China’s property bubble.
- They had more than doubled from $60bn/month to $135bn/month between Q2 2013 and Q2 2014
Stopping this shadow lending outright would have crashed the economy. Instead, the tactic was to move the lending back into the official sector, where it could then be properly controlled. Q1 data shows that the tactic has worked, with shadow lending reduced to $77bn/month – and March was just $41bn/month
In turn, this has led to bankruptcies in the property sector. First to go was Peach Blossom Palace a year ago for $563m, and since then the sums involved have risen – thus Kaisa Group defaulted last week on $2.5bn of debt. As the Wall Street Journal warned last week:
“More than 2/3rds of the liabilities owed by China’s publicly-listed real-estate and construction companies is owed by those with dangerous levels of leverage, defined as liabilities exceeding 3x common equity”
LOCAL GOVERNMENT DEBT IS NOW BEING REDUCED
This highlights a bigger problem.
China’s private sector debt is now twice the size of the total economy, its ratio having almost doubled since the 2009 stimulus began.
And at the same time, the debt owed by China’s provincial governments has soared to Rmb 17.9tn ($2.89tn), as the chart from the Financial Times shows. Much of it also related to property development.
In the past, this debt was hidden via the use of LGFVs (Local Government Financing Vehicles). But China’s parliament blocked this loophole last year, forcing the loans to become public. Now the provincial governments are being forced to try and refinance under a $161bn bond auction plan.
Unsurprisingly, the auctions are having mixed success, just as the Politburo intended. Both Jiangsu province on the coast, and inland Anhui province failed to sell their debt in auctions last week.
THE SLOWDOWN HAS GLOBAL IMPLICATIONS
Earlier this month, Premier Li made the leadership’s position very clear on a visit to the North-East:
“Intentional neglect of duty has added up to an ill-structured economy. … I felt upset when I saw industrial equipment standing idle along the roads when I traveled through Changchun.
“Why was it there? Was it waiting for the next project? Land has been wasted without being developed, and officials have to be held accountable.”
Of course, the main effect of this major restructuring will be felt in China. But investors have loaned vast sums to China’s property developers, without asking too many questions as to how it would be used.
Large amounts have almost certainly found their way into overseas property markets such as New York, London, Sydney/Melbourne, Singapore and other major cities. They are therefore also at risk as China’s lending bubble cools.