China polys Feb15More and more commentators are beginning to recognise that deflation is becoming inevitable in many major economies:

  • China’s producer prices fell -4.3% last month, and its consumer prices rose just 0.8%
  • Eurozone consumer prices fell in December to -0.2%, and are likely to have fallen further in January
  • US prices rose just 0.8% in December and are also likely to have fallen further in January
  • Japan’s prices have already fallen by a third from their 3.7% peak in May, after last year’s VAT increase to 8%

This is hardly a surprise to anyone but the central banks.  The world has an ageing population, and there is a growing shortage of people in the peak spending age range of 25 – 54 years, due to the halving of global fertility rates to just 2.5 babies/woman since 1950.

My concern is not about deflation.  It is about the enormous debt created by the central banks since 2007, in their vain attempt to compensate for the lack of babies by printing money.

They had assumed that they could create a ‘wealth effect’ by boosting stock prices.  But fewer people own stocks than houses.  So the US subprime housing bubble should have been a warning that they were doomed to fail.

And as McKinsey’s report highlighted yesterday, they have instead only succeeded in raising global debt to 3x GDP.

Debt, of course, becomes more expensive with deflation.  So unfortunately, the central banks have done exactly the wrong thing by adding debt.  Major defaults are now becoming almost inevitable, as we move through the Cycle of Deflation.

CHINA’S CHANGING MARKET FOR PLASTICS HIGHLIGHTS KEY ISSUES
As so often, developments in chemical markets are a leading indicator of what lies ahead.  The chart shows the changes taking place in China’s demand for the 3 main plastics – polyethylene (PE), polypropylene (PP) and PVC between 2012 – 2014:

  • All 3 markets show demand growth slowing, whilst China’s own production increases at the expense of imports
  • The reason is the adoption by the new government of its New Normal policies which reverse previous stimulus
  • It had realised the stimulus had “wasted $6.8tn” – around the size of its own economy
  • PVC shows this development very clearly, as its growth was based on the development of the property bubble
  • The new policies means China is now a net exporter, when it had been the world’s largest importer in 2012

Of course, this reverse-course is creating major problems for countries which had built vast new complexes to supply ever-increasing amounts of plastic to China.  Instead, these producers find themselves in an over-supplied market.

They are thus forced to cut prices to gain orders, creating yet more deflation.  As the charts also show:

  • The big losers are NE Asia (NEA) and North America (NAFTA), whose exports have fallen sharply
  • NAFTA has done particularly badly, despite its temporary cost advantage with shale gas versus oil
  • China clearly prefers to buy its limited import needs from the Middle East (ME) and SE Asia (SEA)

And so the plastics market highlights how deflation is set to continue, particularly as oil prices return to more normal levels below $50/bbl.

As China has discovered, central banks are essentially pushing on the proverbial piece of string.  Adding more stimulus only creates more over-capacity.