US-China tariffs could lead to global Polyethylene price war

I was interviewed on Friday about the likely impact of President Trump’s trade wars on the global chemical industry by Will Beacham, deputy editor of ICIS Chemical Business. His interview is below.

The introduction on Friday of trade tariffs by China and the US is the first step in a trade war that could turn into a global polyethylene (PE) price war as the wave of new US production is sent to new markets, likely Europe.

Paul Hodges, chairman at London-based International eChem, said that around 6m tonnes/year of new US PE capacity has to find a home and, with China largely out of reach, the obvious destination would be Europe, where the surplus production will put downward pressure on prices there and around the world.

“The main hit from a trade war is going to be the US PE expansions – clearly it is being targeted so the opportunity to export to China is sharply reduced,” said Hodges.  “But this won’t just be a US problem because they will still want to move their product – it has got to come to Europe as there is no surplus demand in Asia, the Middle East or Latin America.”

He added that this first wave of tariffs were a wake-up call to those who thought globalisation was going to continue as it did in the past.  “We have reached a tipping point where we have to expect that trade wars are more rather than less likely”, he said.

“If you assume the US production will come onstream, then where will those 6m tonnes of product go? It can’t go to China, it can’t go to Latin America as that is too small a market, the Middle East is in surplus, Africa is too small – so Europe is the only place,” said Hodges.

US PE producers that are integrated up to the wellhead need to extract ethane in order to monetise their gas production:

  • These producers will continue to export happily at whatever price because essentially the ethane is a distressed product and has to be sold
  • However, non-integrated players’ margins could come under pressure.

In Europe, there is a parallel to the US, said Hodges, as regional production is generally tied into refineries.

Naphtha is a relatively small part of the product flow from a refinery, so prices can go down quite a long way before you start to think about cutting back on refinery operating rates.

“The risk for the second half of this year and 2019 is that you have two heavyweights in the boxing ring – one integrated back to the gas wellhead in the US and the other refinery-integrated in Europe – and people get squeezed in between,” he added.

EUROPE VALUE CHAINS
Hodges pointed out that if cracker operating rates decline in Europe it will hit all the other product streams such as propylene, butadiene (BD) and pygas. There are tremendous knock-on risks across all the value chains, not just ethylene.

“This won’t happen this year, but if it continues and gets worse over the next 12-18 months, do you start to look at cracker shutdowns in Europe? What will the implications be for people relying on those crackers for feedstocks?” said Hodges.  “It’s a hornet’s nest of unintended consequences: people don’t send a ship load of PE to Europe expecting it to shut down a PP plant.”

Hodges urged the industry to make contingency plans now to manage these future risks.  European producers will have to think about how they protect feedstock supplies for value chains on a Europe-wide and country basis so that pipelines are not shut down.

“You’d have to focus on a number of core hubs and reinvest in those to give the infrastructure you need for the future. You need to do it now – while there is time to take action,” he said.  “You might end up spending money you don’t need to spend, but that’s much better than waking up and realising you don’t have a feedstock supply,” he said.

According to ICIS data, the US is forecast to export a total of 1.37m tonnes of low density polyethylene (LDPE), high density polyethylene (HDPE) and low linear density polyethylene (LLDPE) to China (see LLDPE map above).  Although HDPE is not included in the current tariffs, it could be added later, according to Hodges.

He added that a price war in PE would impact other polymers because of inter-polymer competition.  It may only be 5-10% that is substituted, but to lose that amount of volume at the margin would be quite significant.

He described the trade war as a paradigm shift for the whole global industry as the era of globalisation switches to regional and nationalism.  “I’m worried that a lot of people in this industry have grown up with globalisation and they assume that is how it is,” he said.

Trade policy and geopolitics are like a chess game with lots of moving pieces and the approach is that you give up something in order to gain more, he added. This has been a very successful approach by the US since the Second World War, when it implemented the Marshall Plan or ‘European Recovery Plan’.  Almost the equivalent of $110bn in today’s money was invested to rebuild the continent.

“This boosted the European economy in order to make it a bigger import market for US exports. Trade expands opportunities and the overall economy. There may be some short-term successes going into a trade war but ultimately the US economy will lose,” Hodges conclude.

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Time to recognise the economic impact of ageing populations

Is global economic growth really controlled by monetary policy and interest rates?  Can you create constant growth simply by adjusting government tax and spending policy?  Do we know enough about how the economy operates to be able to do this?  Or has something more fundamental been at work in recent decades, to create the extraordinary growth that we have seen until recently?

  • As the chart shows for US GDP, regular downturns used to occur every 4 or 5 years
  • Then something changed in the early 1980s, and recessions seemed to become a thing of the past
  • Inflation, which had been rampant, also began to slow with interest rates dropping from peaks of 15%+
  • For around 25 years, with just the exception of the 1st Gulf War, growth became almost constant

Why was this?  Was it because we became much cleverer and suddenly able to “do away with boom and bust” as one UK Finance Minister claimed?  Was it luck, that nothing much happened to upset the global economy?  Was it because the Chairman of the US Federal Reserve from 1986 – 2006, Alan Greenspan, was a towering genius?  Perhaps.

THE AVERAGE BABYBOOMER IS NOW 60 YEARS OLD 

Or was it because of the massive demographic change that took place in the Western world after World War 2, shown in the second chart?

  • 1921 – 1945.  Births in the G7 countries (US, Japan, Germany, France, UK, Italy, Canada) averaged 8.8m/year
  • 1946 – 1970.  Births averaged 10.1m/year, a 15% increase over 25 years
  • 1970 – 2016.  Births averaged only 8.5m/year, a 16% fall, with 2016 seeing just 8.13m born

Babies, as we all know, are important for many reasons.

Economically, these babies were born in the wealthy developed countries, responsible for 60% of global GDP.  So right from their birth, they were set to have an outsize impact on the economy:

  • Their first impact came as they moved into adulthood in the 1970s, causing Western inflation to soar
  • The economy simply couldn’t provide enough “stuff”, quickly enough, to satisfy their growing demand
  • US interest rates jumped by 75% in the 1970s to 7.3%, and doubled to average 10.6% in the 1980s
  • But then they began a sustained fall to today’s record low levels as supply/demand rebalanced

BOOMERS TURBOCHARGED GROWTH, BUT ARE NOW JOINING THE LOWER-SPENDING 55-PLUS COHORT

The key development was the arrival of the Boomers in the Wealth Creator 25-54 age group that drives economic growth.  Consumer spending is 60% – 70% of GDP in most developed economies.  And so both supply and demand began to increase exponentially.  In fact, the Boomers actually turbocharged supply and demand.

Breaking with all historical patterns, women stopped having large numbers of children and instead often returned to the workforce after having 1 or 2 children.  US fertility rates, for example, fell from 3.3 babies/woman in 1950 to just 2.0/babies/women in 1970 – below replacement level.    On average, US women have just 1.9 babies today.

It is hard to imagine today the extraordinary change that this created:

  • Until the 1970s, most women would routinely lose their jobs on getting married
  • As Wikipedia notes, this was “normal” in Western countries from the 19th century till the 1970s
  • But since 1950, life expectancy has increased by around 10 years to average over 75 years today
  • In turn, this meant that women no longer needed to stay at home having babies.
  • Instead, they fought for, and began to gain Equal Pay and Equal Opportunity at work

This turbocharged the economy by creating the phenomenon of the two-income family for the first time in history.

But today, the average G7 Boomer (born between 1946 – 1970) is now 60 years old, as the 3rd chart shows.  Since 2001, the oldest Boomers have been leaving the Wealth Creator generation:

  • In 2000, there were 65m US households headed by someone in the Wealth Creator 25-54 cohort, who spent an average of $62k ($2017).  There were only 36m households headed by someone in the lower-spending 55-plus cohort, who spent an average of $45k
  • In 2017, low fertility rates meant there were only 66m Wealth Creator households spending $64k each.  But increasing life expectancy meant the number in the 55-plus cohort had risen by 55%.  However, their average spend had only risen to $51k – even though many had only just left the Wealth Creators

CONCLUSION – THE CHOICE BETWEEN ‘DEBT JUBILEES’ AND DISORDERLY DEFAULT IS COMING CLOSE
Policymakers ignored the growing “demographic deficit” as growth slowed after 2000.  But their stimulus policies were instead essentially trying to achieve the impossible, by “printing babies”.  The result has been today’s record levels of global debt, as each new round of stimulus and tax cuts failed to recreate the Boomer-led economic SuperCycle.

As I warned back in January 2016 using the words of the OECD’s William White:

“It will become obvious in the next recession that many of these debts will never be serviced or repaid, and this will be uncomfortable for a lot of people who think they own assets that are worth something. The only question is whether we are able to look reality in the eye and face what is coming in an orderly fashion, or whether it will be disorderly. Debt jubilees have been going on for 5,000 years, as far back as the Sumerians.”

That recession is now coming close.  There is very little time left to recognise the impact of demographic changes, and to adopt policies that will minimise the risk of disorderly global defaults.

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Financial markets party as global trade wars begin

More people left poverty in the past 70 years than in the whole of history, thanks to the BabyBoomer-led economic SuperCycle.  World Bank and OECD data show that less than 10% of the world’s population now live below the extreme poverty line of $1.90/day, compared to 55% in 1950.

Globalisation has been a key element in enabling this progress, as countries and regions began to trade with each other.  But now global trade is starting to decline, as the chart from the authoritative Dutch World Trade Monitor shows:

  • After a good start to 2018, February saw trade fall 0.7% in February and 1.2% in March
  • The major slowdown was in Asia, particularly China, as its lending began to slow

And then on Friday, President Trump confirmed the opening of his long-planned trade wars:

  • He imposed 25% import tariffs on steel and 10% on aluminium from Canada, Mexico and the European Union
  • Similar tariffs were already in place on imports from China, Russia and other countries
  • America’s longest standing allies have since imposed their own sanctions in retaliation
  • The stage is now set for a developing global trade war as more countries join in

PRESIDENT TRUMP IS IMPLEMENTING THE POLICIES ON WHICH HE WAS ELECTED
None of this should have been a surprise, as it simply follows the agenda that President Trump set out in his Gettysburg speech just before the election.  His policy proposals then, which I featured here in depth in January 2017, were crystal clear about his objectives, as the slide shows:

  • Those policies marked in red are now being introduced
  • Only 2 of them – around China being a currency manipulator, and infrastructure – are still to be delivered
  • Yet companies, commentators and analysts have preferred to ignore the obvious

It was clear then, and is even clearer today, that Trump intends to abandon the policies followed by all post-War Republican and Democratic presidents including Eisenhower, Reagan and Clinton, and summarised in President Kennedy’s 1961 Inauguration Speech:

“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”

As I noted after Trump’s own Inauguration Speech in January last year, he broke very explicitly with these policies:

“We assembled here today are issuing a new decree to be heard in every city in every foreign capital and in every hall of power. From this day forward, a new vision will govern our land. From this day forward, it’s going to be only America first, America first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families.”

BAD NEWS HAS ALWAYS LED TO MORE STIMULUS IN THE PAST

Unsurprisingly, financial markets have chosen to ignore this rise in protectionism.  For them, bad news is always good news, as they expect the central banks to provide more stimulus via their money-printing policies.  As the left-hand chart shows of Prof Robert Shiller’s CAPE Index (Cyclically Adjusted Price/Earnings ratio) since 1881:

  • When Trump took office, the ratio was already at 28.5 – above the 1901 and 1966 peaks
  • Since then it has peaked at 33.3, above the 1929 peak
  • Only 2000 was higher at 44, when the end of the SuperCycle coincided with the Fed’s first liquidity programme to prevent any problems with the Y2K issue

The right-hand chart confirms the bubble nature of the rally:

  • It compares S&P 500 developments with the level of margin debt in the New York Stock Exchange
  • Until 1985, the Fed operated on the principle of “taking away the punchbowl as the party gets going
  • Since then, it has increasingly believed, as then Fed Chairman Ben Bernanke said in November 2010

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

As a result, the S&P 500 has risen along with margin debt, which peaked at $659bn in January ($2018).

FINANCIAL MARKETS HAVE AN UNPLEASANT “SURPRISE” AHEAD AS CHINA SLOWS
It is therefore no great surprise that financial markets have continued to ignore developments in the real world.

Yet a decline in world trade, and the rise in protectionism, will inevitably produce Winners and Losers.  This will be quite different from the SuperCycle, when the rise of globalisation created “win-win opportunities” for countries and regions:

  • Essentially the deal was that consumers in richer countries got cheaper, well-made, products
  • People in poorer countries gained paid employment for the first time in history by making these products

History also suggests President Trump will be proved wrong with his March suggestion that:  “Trade wars are good and easy to win”.  Like all wars, they are easy to start and increasingly difficult to end.

So far, financial markets have ignored these uncomfortable facts.  They still believe that any bad news will lead to even more central bank stimulus, and a further rise in margin debt.

But as I noted last week, China – not the Fed – was in fact the major source of stimulus lending.  Now its lending bubble is history, the party in financial markets is inevitably entering its end-game.

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US PE exports on front line as Trump changes trade policies

It is almost a year since Donald Trump became President.  And whilst he has not followed through on many of his promises, he has indeed introduced the major policy changes that I began to discuss in September 2015, when I first suggested he could win the election and that the Republicans could control Congress:

“In the USA, the establishment candidacies of Hillary Clinton for the Democrats and Jeb Bush for the Republicans are being upstaged by the two populist candidates – Bernie Sanders and Donald Trump….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.

Many people have therefore had to go up a steep learning curve over the past year, given that their starting point was essentially disbelief, as one commentator noted when my analysis first appeared:

“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.

Yet this, of course, is exactly what has happened.

It is true that many of the promises in candidate Trump’s Contract with America have been ignored:

  • Of his 174 promises, 13 have been achieved, 18 are in process, 37 have been broken, 3 have been partially achieved and 103 have not started
  • His top priority of a Constitutional amendment on term limits for members of Congress has not moved forward

Yet on areas that impact companies and investors, such as trade and corporate tax, the President has moved forward:

  • On trade, he has not (yet?) labelled China a currency manipulator or moved forward to fix water and environmental infrastructure
  • But he has announced the renegotiation of NAFTA, the withdrawal from the Trans-Pacific Partnership, his intention to withdraw from the UN Climate Change programme and lifted restrictions on fossil fuel production

These are complete game-changers in terms of America’s position in the world and its trading relationships.

Over the decades following World War 2, Republican and Democrat Presidents alike saw trade as the key to avoiding further wars by building global prosperity.  Presidents Reagan, Bush and Clinton all actively supported the growth of global trade and the creation of the World Trade Organisation (WTO).

The US also led the world in environmental protection following publication of Rachel Carson’s ‘Silent Spring‘ in 1962, with its attack on the over-use of pesticides.

Clearly, today, these priorities no longer matter to President Trump.  And already, US companies are starting to lose out as politics, rather than economics, once again begins to dominate global trade.  We are returning to the trading models that operated before WTO:

  • Until the 1990s, trade largely took place within trading blocs rather than globally – in Europe, for example, the West was organised in the Common Market and the East operated within the Soviet Union
  • It is therefore very significant that one of the President’s first attacks has been on the WTO, where he has disrupted its work by blocking the appointment of new judges

Trump’s policy is instead based on the idea of bilateral trade agreements with individual countries, with the US dominating the relationship.  Understandably, many countries dislike this prospect and are instead preferring to work with China’s Belt & Road Initiative (BRI, formerly known as One Belt, One Road).

US POLYETHYLENE PRODUCERS WILL BE A CASE STUDY FOR THE IMPACT OF THE NEW POLICIES
US polyethylene (PE) producers are likely to provide a case study of the problems created by the new policies.

They are now bringing online around 6 million tonnes of new shale gas-based production.  It had been assumed a large part of this volume could be exported to China.  But the chart above suggests this now looks unlikely:

  • China’s PE market has indeed seen major growth since 2015, up 18% on a January – November basis.  Part of this is one-off demand growth, as China moved to ban imports of scrap product in 2017.  Its own production has also grown in line with total demand at 17%
  • But at the same time, its net imports rose by 1.8 million tonnes, 19%, with the main surge in 2017.  This was a perfect opportunity for US producers to increase their exports as their new capacity began to come online
  • Yet, actual US exports only rose 194kt – within NAFTA, Mexico actually outperformed with its exports up 197kt
  • The big winner was the Middle East, a key part of the BRI, which saw its volume jump 29% by 1.36 million tonnes

Sadly, it seems likely that 2018 will see further development of such trading blocs:

  • The President’s comments last week, when he reportedly called Africa and Haiti “shitholes” will clearly make it more difficult to build long-term relationships based on trust with these countries
  • They also caused anguish in traditionally pro-American countries such as the UK – adding to concerns that he has lost his early interest in the promised post-Brexit “very big and exciting” trade deal.

US companies were already facing an uphill task in selling all their new shale gas-based PE output.  The President’s new trade policies will make this task even more difficult, given that most of it will have to be exported.

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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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Brexit disaster looms as UK government power struggle erupts

UK voters were never very bothered about membership of the European Union (EU) before the Brexit vote last year.  Opinion polls instead showed they shared the general feeling of voters everywhere – that their country was heading in the wrong direction, and it was time for a change.  Now, last week’s Conservative Party conference showed that the government itself, and the prime minister, have also lost all sense of direction.

The problem is that nobody has any idea of a what a post-Brexit world would look like for the UK.  The Leave campaigners famously told the voters it would be a land where the UK would no longer “give” £350m/week ($455m) to Brussels, and could instead spend this money on improving health care and other worthy objectives.  This, of course, was a lie, as the head of the National Statistics Agency has since confirmed.  But then-premier Cameron failed to call out the lie at the time – fearing it would split his Conservative Party if he did.

15 months later, this lie has again come centre stage as the Foreign Secretary, Boris Johnson, revived it before the Conference as part of his bid to replace premier May:

“Once we have settled our accounts, we will take back control of roughly £350 million per week.  It would be a fine thing, as many of us have pointed out, if a lot of that money went on the NHS.”

As a result, the splits in the Conservative Party are out in the open, with its former chairman now calling for a leadership election and claiming at least 30 law-makers already support the move.  Bookmakers now expect May to leave office this year (offering odds of just evens), and suggest the UK will have a new election next year (odds of 2/1), despite the fact that Parliament has nearly 5 years to run.

May’s problem is two-fold:

 As the photo shows, she was humiliated in her main speech to the Conference by a prankster handing her a P45 form (the UK’s legal dismissal notice), and claiming Johnson had asked him to do it
 Her previous set-piece speech in Florence on negotiations with Brussels over the UK’s exit arrangements had also rebounded, as it made clear the Cabinet was divided on the terms that should be negotiated

Voters don’t like being lied to, and they don’t like governments that are unable to govern because of internal splits – particularly when the splits are over such a critical issue as the UK’s economic future.  Unsurprisingly, therefore, the opposition Labour party are now favorites to win the next election, and their leader, Jeremy Corbyn, is favourite to become the next prime minister.  This, of course, would confirm my suggestion 2 years ago:

“My local MP, Jeremy Corbyn, won the UK Labour Party leadership election on Saturday with a 60% majority. An anti-NATO socialist, he has represented the constituency for 32 years, and has never held even a junior ministerial post. Now, he could possibly become the UK’s next Prime Minister.

“His path to power depends on two developments taking place, neither of which are impossible to imagine. First, he needs to win back the 40 seats that Labour lost to the Scottish Nationalists in May. And then he has to hope the ruling Conservative Party tears itself apart during the up-coming Europe Referendum.”

Unfortunately, Corbyn would be unlikely to resolve the mess over Brexit.  In the past, before becoming leader, he took the Trotskyist view that the EU is a capitalist club, set up to defraud the workers.  He has since refused to confirm or deny his views on the subject, but he did take very little part in the Referendum campaign last year.  Had he been more active in arguing the official Labour Party position of Remain, it is unlikely that Leave would have won.

Today, he is far more concerned over the likely result of a Labour Party win on financial markets, with his shadow Finance Minister admitting recently they were “war-gaming” in advance of an expected currency crisis.  UK interest rates are already rising, as foreign buyers wonder whether they should continue to hold their current 28% share of the UK government bond market.  Clearly, it is highly likely that a Labour government would need to return to capital controls after a 40-year break, to protect their finances.

A VERY HARD BREXIT IS BECOMING ALMOST CERTAIN
The confusion and growing chaos in the political world means that the detail of Brexit negotiations has taken a back seat.  The UK has still to make detailed proposals on the 3 critical issues that need to be settled before any trade talks can begin – rights of EU/UK citizens post-Brexit; status of the N Ireland/Ireland border; UK debts to Brussels for previously agreed spending.  And most European governments are now far more focused on domestic concerns:

  As I warned a year ago, the Populist Alternative für Deutschland did indeed “gain enough seats to make a continuation of the current “Grand Coalition” between the CDU/CSU/SDP impossible” in Germany
  Spain has to somehow resolve the Catalan crisis, following last week’s violence over the independence referendum
  Italy has autonomy referenda taking place in the wealthy Lombardy and Venice regions in 2 weeks, and then faces a difficult national election where the populist 5 Star movement leads most opinion polls. The scope for political chaos is clear, as the wealthy Northern regions want to reduce their tax payments to the south – whilst southern-based 5 Star want more money to go in their direction

President Trump has also undermined the Brexit position.  He initially promised a “very big and exciting” US-UK trade deal post Brexit.  But since then the US has supported a protectionist move by Boeing to effectively shut-down the vital Bombardier aircraft factory in Belfast, N Ireland, despite May’s personal appeals to him. And last week, it joined Australia, New Zealand, Argentina and Brazil in objecting to the EU-UK agreement on agricultural quotas post-Brexit.

I have taken part in trade talks and have also negotiated major contracts around the world.  So I know from experience the UK could never have achieved new deals within the 2 years promised by leading Brexiteers.

Today, it is also increasingly clear that May’s government doesn’t have the votes in Parliament to agree any financial deal that would be acceptable in Brussels.  So whilst large parts of UK industry still assume Brexit will mean “business as usual”, European companies are being more realistic.    In a most unusual move, the head of the Federation of German Industries spelt out the likely end result last week:

“The British government is lacking a clear concept despite talking a lot. German companies with a presence in Britain and Northern Ireland must now make provisions for the serious case of a very hard exit. Anything else would be naive…The unbundling of one of Germany’s closest allies is unavoidably connected with high economic losses. A disorderly exit by the British from the EU without any follow up controls would bring with it considerable upheaval for all participants. (German companies feel) not only that the sword of Damocles of insecurity is hovering over them, but even more so that they are exposed to the danger of massive devaluation.”

UK, European and global companies are already drawing up their budgets for 2018 – 2020. They cannot wait until Brexit day on 29 March 2019 before making their plans. And so, as it becomes increasingly obvious that the UK-EU talks are headed for stalemate, and that ideas of a lengthy transition period are simply a dream, they will make their own plans on the assumption that the UK will head over the Brexit cliff in 18 months time.

Nobody knows what will happen next.  But prudent companies, investors and individuals have to face the fact that Brexit, as I warned after the vote, is likely to be “a disaster for the UK, Europe and the world“.

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