Until recently, the job description for a UK (and most Western) politician has been fairly simple – look good on television, and only say something when it has been approved by a focus group. The reward was the ability to jet off to important sounding meetings of the G7 and G20, and have agreeable dinners at Summit meetings.
There was no sense that, as was the case before the economic SuperCycle, that politicians needed to have a clear view about economic policy, and what they wanted to achieve. Instead, this “detail” was the responsibility of the central banks, with their seemingly magical powers to guide a global economy of 7.3bn people by printing money and reducing interest rates. Most senior politicians in Europe, the USA and Japan clearly still believe in this presumed ability of their central banks to implement NICE policies that create Non-Inflationary Constant Expansion.
One case study for this behaviour has been the UK Conservative Party, where schoolboy politics has instead come to dominate. Historians will focus on the Brexit debate as the great example. Neither David Cameron for Remain, or Boris Johnson and Michael Gove for Leave, had any understanding of the dark forces around the immigration issue that they unleashed during the campaign. They all assumed a Remain vote was inevitable, and saw the vote itself as simply a proxy for the really interesting battle (for them at least) to be prime minister.
This meant that neither side bothered to prepare a Plan to handle a UK vote to leave the European Union. As a result, Cameron was forced to tell his 27 fellow EU leaders last week that he had no plan at all for dealing with a Brexit vote. Similarly, Johnson simply ducked the issue and went off to play cricket after the result, whilst Gove’s wife has revealed he went to bed whilst the votes were being counted.
Tragedy is always close to farce, and we can see that in the events of the past week, since the Brexit vote. Gove’s comment, “Gosh, I suppose I had better get up!” summarises the shallowness of the preparation for an event which could completely change the course of British history, as well as Europe and the world.
The writing is now on the wall for this wishful thinking. The world’s demographic deficit means the global economy has a demand deficit. Even central bankers are starting to realise they cannot possibly deliver on the expectations they have created. As the Governor of the Bank of England, Mark Carney, clearly stated last week:
“The future potential of this economy and its implications for jobs, real wages and wealth are not the gifts of monetary policymakers.”
Unfortunately, the Brexit vote means that the UK is effectively going to be a test-bed for what happens next, now that the “cult of the central banks” is drawing to a close. And who therefore knows whether Dutch premier Mark Rutte (a long-time UK friend) over-stated the risks with his warning last week:
“England has collapsed politically, monetarily, constitutionally and economically.”
However, although it may be too late, some change does finally seem to be underway, as the photos illustrate:
- We appear to be seeing the end of the schoolboy politics that has dominated for too long
- Instead, it appears that Teresa May, currently Home Secretary, is favourite to become UK prime minister
- Nicola Sturgeon is already First Minister of Scotland, and Arlene Foster of N Ireland
These women appear to be more prepared to take responsibility for the impact of their actions.
May’s first campaign promise was that she would not trigger the start of negotiations to leave the EU “until next year at the earliest“. She clearly understands that nobody on either side has any idea of how to conduct these discussions, let alone what they should cover. This wise decision immediately sets her apart from her schoolboy predecessors, who thought 43 years of economic and legal union could be replaced more or less overnight.
Will May be successful in returning the UK to the world of grown-up politics? Will she get ambushed on the way, as Michael Gove ambushed his supposed friend and colleague Boris Johnson on Thursday? Or will the crisis now facing the UK and EU economies make it impossible for rational debate to take place?
We cannot know the answer.
But we can hope that the events of the past 10 days have begun to change the nature of political debate, at least in the UK. It even seems possible that the schoolboy socialist, Jeremy Corbyn, could soon be replaced as leader of the opposition Labour Party – in which case, the government might also start to be properly held to account for its actions.
But whatever happens now, difficult times still lie ahead for the UK and the world economy:
- As The Telegraph confirms, the UK has hardly anyone with experience of global trade negotiations – nor, indeed, the lawyers to turn their agreements into law. Even the job of assessing what to do about the 12,295 EU Regulations now part of UK law will take years rather than months to resolve
- Similarly, nobody in the world has any experience of a situation where its 5th largest economy suddenly decides to tear up its past 43 years of history, and start again with a clean sheet of paper – as the UK did 2 weeks ago
No adult politician would ever have risked putting their country into such a absurd and potentially risky situation.
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 53%
Naphtha Europe, down 52%. “The European naphtha market is seen as fairly weak, balanced to long, with demand of light virgin naphtha said to be low.”
Benzene Europe, down 55%. “Higher US pricing supports Europe”
PTA China, down 39%. “Buying sentiment was thin in the week, as buyers took into account the volatile upstream energy prices and stayed on the sidelines”
HDPE US export, down 33%. “Increased supply across most other grades caused prices to slip by a few pennies”
US$ Index, up 17%
S&P 500 stock market index, up 8%
The UK’s Brexit referendum is fast becoming a bitter battle for the Conservative Party leadership. It is hard to believe that Boris Johnson, who leads the Leave campaign, really cares either way about the issue of leaving Europe:
- He told Germany’s Der Spiegel only last year: ‘We can’t leave Europe. We’re part of the European Continent. What is the English Channel? It’s a primeval river that got slightly too big … We’re always going to be a part of Europe psychologically.”
- And he told friends earlier this year, before choosing to fight on the Leave side, that he was “Veering all over the place like a shopping trolley”
All the evidence suggests that instead, his real motive for deciding to lead the Leave campaign was that – win or lose – this would make him the likely successor to David Cameron as premier.
The problem for UK voters is that this jockeying for power means that basic principles of debate, such as “Comment is free, but facts are sacred” have been abandoned. Instead, facts are being treated as mere opinions:
- The core Brexit argument is “We send the EU £350 million a week – let’s fund our NHS (health service) instead“
- Yet this figure does not include the automatic rebate from the EU to the UK or other automatic flows
- As the Head of the UK Statistics Authority warned, “Without further explanation, I consider these statements to be potentially misleading“
But Johnson refused to change the slogan, saying:
“If you take out the abatement and the money that comes back via Brussels, the figure is obviously lower. We think it’s relevant to keep people focused on the global figure, because that is the figure over which we have no control.”
Sadly, Cameron was similarly focused on internal Conservative Party politics when he called the referendum. As Martin Wolf has recently argued in the Financial Times:
“This referendum is, arguably, the most irresponsible act by a British government in my lifetime….Right now one can only hope that the country does not soon learn what it means to divorce in haste and repent at leisure”
IMMIGRATION NOW A KEY ISSUE IN THE BREXIT DEBATE
Immigration is another key issue where assertion is being used to whip up anti-EU emotions. But as the chart above shows, based on official data from the UK’s Office of National Statistics:
- Most migrants are non-EU citizens – even with the recent rise, EU citizens have never been in the majority
- The Conservatives could have easily reduced net migration ”below 100k”, as they promised in the 2010 election
- EU migration in 2010 – 2012 was only around 80k/year, and there were no treaties requiring the UK to admit any non-EU migrants, as the BBC notes:
“The UK isn’t bound to accept them (non-EU migrants) by any international treaties, but nevertheless let 277,000 of them move over last year alone.”
One is therefore forced to conclude that the new Conservative government, containing many of the Leave leaders, simply decided to ignore the pledge once they were in power.
This behaviour also raises doubts over the new Leave pledge to reduce EU immigration. It is hard to see how anything will be changed by basing EU migration on the “points-based system” used for non-EU migrants, as this has failed to have a major impact on their overall numbers.
LEAVING THE EU WOULD BE A COMPLEX AND DIFFICULT PROCESS
Most of the UK population have only ever known life within the EU. And those of us who remember the pre-1973 period, know that today’s world is very different. Yet Leave have failed to give us any clear picture of what they would do, if the UK votes for Brexit on 23 June. Instead, as former Conservative premier Sir John Major has warned:
“Vote Leave’s campaign is an unforgivable fraud on British people.”
Critically, the key issue of how Leave would implement Brexit has been dominated by assertion rather than fact:
- It is easy for Leave to assert that other countries will rush to sign new trade treaties with the UK
- But anyone who have ever bought a house knows how difficult and detailed contract negotiations can become
- Trade deals are far more difficult and complex to negotiate, and take years rather than months to conclude
Equally important is the fact that the UK has had no direct experience of negotiating trade deals for the past 43 years. These have all been done via the EU, with the backing of other major G7 nations such as France, Germany and Italy. Almost inevitably, therefore, this lack of experience would lead to us being out-negotiated – particularly as we could find ourselves having to finalise 80 deals in just 2 years, to replace current EU arrangements.
If one focuses on the facts, rather than on the assertions, it therefore seems clear that a Brexit vote would mean taking a complete leap in the dark. Nobody can know where we would end up, or the damage that would be caused.
Most importantly, as I noted last month, it would put at risk the ”peace and prosperity” that my generation have enjoyed since the EU was founded. This is why it will be the most critical vote that many of us will ever cast. I will be voting to Remain, and I hope that my country does too.
Iron ore prices on China’s futures market were at 5-year lows yesterday. Copper prices also weakened in Australia. This adds to the blog’s concern that China’s ‘collateral trade’ market is getting closer and closer to its ‘moment of truth’.
This will come as an awful shock to most outside observers, who have been led to believe China’s vast imports of key raw materials such as copper and iron ore have been used for economic development. It has been, for example, importing 2/3rds of internationally traded iron ore.
Mining companies have dramatically over-expanded capacity as they, and their investors, wanted to believe that China’s demand was somehow real. And all this new capacity is now starting come online, just as the problems with the ‘collateral trade’ are becoming more widely known.
As the chart shows, price moves since China’s stimulus programme began in late 2008 have been mind-bending:
- Iron ore prices peaked at 1250% above their January 2003 level (blue)
- Copper prices peaked at 500% of their January 2003 level (black)
- Both have since been weakening, particularly since the new government began to burst the housing bubble
- But the return to historical levels has been delayed by their use in the ‘collateral trade’
This is potentially about to change. Last week the government announced they had uncovered nearly $10bn of trade deal fraud. Banks have been ordered to tighten rules for issuing Letters of Credit, and there are growing fears that China’s vast stockpiles may soon be released back onto the open market.
In turn, this would impact metals markets around the world, and open the fault lines of the debt-fuelled ‘ring of fire’ created by the world’s central banks.
THE COLLATERAL TRADE HAS BLINDED COMPANIES TO REAL DEMAND LEVELS
The blog’s ‘Your Compass on China’ Research Note highlighted the key issues and risks back in June. Published in association with leading Hong Kong-based financial advisory firm Polarwide, the blog warned then:
“Titled ‘Here today and gone tomorrow – a simple guide to China’s world of trade finance’, it is probably the single most important paper it will publish all year – please click here to download a free copy.
“The bottom line – China’s vast imports of commodities such as iron and copper have, in reality, often been used to finance today’s property bubble.”
Confirmation of the blog’s analysis came from Chinese authorities last week, as Bloomberg reported:
“China uncovered almost $10 billion in fraudulent trade nationwide as part of an investigation begun in April last year, including many irregularities in the port of Qingdao, the country’s currency regulator said today.
“Companies “faked, forged and illegally re-used” documents for exports and imports, Wu Ruilin, a deputy head of the State Administration of Foreign Exchange’s inspection department, said at a briefing in Beijing. The trades have “increased pressure from hot money inflows and provided an illegal channel for criminals to move funds,” Wu said, adding that those involved in such fraud would be severely punished.”
The ‘collateral trade’ itself is not illegal in China. But as the new leadership’s credit squeeze has tightened, it seems property developers may have become more desperate to raise funds and turned to fraud. They also seem to have begun to use other commodities such as polyethylene in the ‘collateral trade’, as the blog noted last month:
“More recently, it seems large amounts of polyethylene (PE), ethylene glycol (MEG) and probably other chemicals have also started to be used for the trade. None of this used to matter when the Chinese economy was booming. Why ask too many questions, when the profits are rising? But now China’s economy is slowing fast under the new leadership.
“So now people are asking questions about why, for example, polyethylene imports appear to have risen 20% in H1 versus 2013″.
THE GREAT UNWINDING OF THE COLLATERAL TRADE MAY NOW BE VERY CLOSE
The government’s moves to investigate the potential fraud add a new dimension to the issue, and could have major ’second-order effects’.
Until recently, prices appeared to have stabilised in metals markets outside China. But this was a false calm, caused by the fact that official investigations meant that the vast stocks of copper and iron ore in Qingdao could not be moved.
After last week’s official announcement, there is a clear risk that this calm may be replaced by panic:
- Imports of new volumes of copper and iron ore (and other commodities) has become much more difficult
- Banks have been told to check all requests for future Letters of Credit (LCs) very carefully indeed
- This on its own is leading to delays of several weeks
- And at the same time, rollovers of existing LCs have effectively been stopped, as they can no longer be issued against warehouse receipts
This means that all the new capacity coming online outside China is struggling to find a home.
And the truly frightening fact is that global output from the world’s 5 largest producers of iron ore is about to grow 40% by 2017 to 1.5bn tonnes.
Thus we are coming close to entering Phase 1 of the ‘Worst Case Scenario‘ described by the blog back in June:
“First to be hit would likely be the global commodity markets, if they wake up one morning to find that China’s vast ‘collateral trade’ is starting to unwind, perhaps rather suddenly:
- The prices for those metals and other commodities caught up in the trade would be hit first
- Mining company shares would also be hit, as people worried their vast capacity expansions were wishful thinking
“Investors may begin to put 2 and 2 together and start to worry, as the BBC described in February, that “China Fooled the World”.”
The blog’s recent Research Note on the likely impact of China’s economic reforms has attracted enormous interest.
As a result, it will hold 2 free webinars on Wednesday to discuss the outlook in more detail.
The webinars will be co-hosted with John Richardson, author of the Asian Chemical Connections blog – and co-author with the blog of Boom, Gloom and the New Normal. They will focus on 4 key issues:
- China’s lending bubble and its impact on chemical demand
- Today’s problems of over-capacity and pollution
- The demographic drivers
- 7 key changes for the future
The webinars will be held live at
- 15:00 Singapore time for Asian and Middle East audiences and then again at
- 15:00 UK time (10:00 EST) for European and American audiences
Kindly sponsored by ICIS, they are free to join. Please click here to register for the time that suits you best.
German Chancellor Merkel’s recent comment that “I don’t see anything which signals a recession in Germany” is just one sign of the current complacency about the global economy within the Western political elite.
Long-standing readers will remember Profs Eichengreen and O’Rourke 2009-10 work comparing today’s Great Recession with the Depression of the 1930s. Worryingly, the parallels seem to be increasing again, as the chart above shows from new research by Prof Nouriel Roubini:
“World trade (dark grey line) has stalled since the onset of the year and is falling in line with lower growth in the developed world. While global industrial production increased slightly in June, it is still down on the quarter. July data, coupled with leading indicators such as PMIs (Purchase Manager Indices), points to Q3 weakness. Chinese commodity demand began to weaken in Q2 and continued to fall in July.”
JACKSON HOLE MEETING OF ECONOMIC POLICYMAKERS
There was less complacency amongst economic policymakers at the US Federal Reserve’s annual Jackson Hole meeting last week. There was no mention of a new QE3 programme to try and boost stock and commodity prices. Instead, as the OECD’s head noted, policymakers are now realising that “this consolidation effort is going to take a generation.”
Fed Chairman Ben Bernanke warned that “The quality of economic policy-making in the United States will heavily influence the nation’s long-term prospects”. Whilst Christine Lagarde, new IMF head, said economic risks “have been aggravated further by a deterioration in confidence and a growing sense that policymakers do not have the conviction, or simply are not willing, to take the decisions that are needed.”
Policymakers, if not yet the politicans, may therefore be finallly realising that we face a solvency crisis, not one of liquidity:
• Solvency is whether one is able to pay one’s total debts
• Liquidity is simply whether one can pay today’s bills
The risk is, of course, that 2 years of implementing the wrong policies have left them dangerously short of time, and money. With actual US GDP growth just 0.33% ($40bn) in H1, there is surely a strong risk that the US is now entering a new recession. Europe cannot be in much better shape, despite the politicians’ denials, given Q2 data.
IeC DOWNTURN ALERT UPDATE
Hopefully the blog’s April launch of its IeC Downturn Alert launch has enabled chemical companies to prepare robust contingency plans for what may lie ahead. Price movements since April, and ICIS pricing comments this week are below:
S&P 500 Index (pink dot), down 14%.
Naphtha Europe (brown dash), down 13%. “Most sources still believe an oversupply threatens in September “.
Brent crude oil, down 12%.
HDPE USA export (purple), down 13%. “Latin America has now turned its attention to Asian offers”.
Benzene NWE (green), down 11%. “Shutdowns downstream are expected to soften demand next month.”
PTA China (red), down 5%. “Expected to be underpinned by rising PX prices caused by limited supply”.