Policy makers reach the fork in the road, again
on January 28, 2013

D'turn 26Jan13.png

“Two roads diverged in a yellow wood,
And sorry I could not travel both”

These lines by famous American poet Robert Frost provide a good description of the critical cross-roads now being approached for the 3rd time since June 2008, as the impact of the QE3 stimulus reduces. Each time previously, policy makers have simply refused to accept that the world is now at a ‘demographic cliff’, where people live longer and spend less:

• Yet demographics mean that all the major economies have gone ex-growth. Large and increasing numbers of people are now at the age when they only need to buy replacement items. And they also have less money to spend because they are approaching retirement
• Refusing to accept this obvious fact is like trying to make water run uphill. Central banks and governments have had to massively increase debt levels to fund their stimulus programmes and/or tax cuts. Thus the US Federal Reserve now has $3tn debt compared to $900bn in 2008

The chart shows how markets have moved since the June 2008 peak:

• China has been the biggest “winner”. PTA prices (red line) have benefited from two major rounds of stimulus (November 2008-December 2010, May-October 2012). But “winning” has meant creating a ‘wealth effect’ by boosting home prices to record levels versus earnings. As the US subprime boom showed, such credit bubbles are fun at first but unpleasant afterwards
• US financial markets have also done well. The S&P 500 index (brown) is back at the 1500 level which capped previous advances in 2000 and 2007. Oil prices have also boomed as the Fed’s efforts to reduce the value of the US$ led pension funds to see oil as a ‘store of value’. But high oil prices end up destroying demand and negating the stimulus impact

Sadly, policy makers’ efforts are doomed to fail in the end. As the Boston Consulting Group reported recently, each new dollar of debt created today adds just 18 cents of extra GDP growth. By comparison, a new dollar of debt added 59 cents of new GDP growth in the 1960s, when populations were younger and consuming more.

In addition, the need to repay the borrowed money creates even greater headwinds for the wider economy. Comments on key product markets by senior ICIS pricing editors highlight the poor state of demand in the major economies:

• In China, Becky Zhang notes “Given the weak polyester demand, a number of Chinese polyester makers have planned plant shutdowns in January and February to relieve inventory pressure. A total of 4.6m tonne/year polyester capacity will be offline during the holiday. Operating rates on polyester staple fell sharply by 10% to 56% capacity
• In the US, Michelle Klump reports “Higher ethylene prices are based on tight supply caused by several planned and unplanned cracker outages after “a weak fourth quarter (for PE demand)”
• In Europe, Linda Naylor confirms “It is clear to all that increases are due to high feedstock costs and production cutbacks rather than any fundamental strength in the PE market”

What happens next is anyone’s guess. Will this be the time that policy markers decide to recognise reality, and give up on the myth of being able to create ‘non-inflationary constant expansion” in the global economy? Or will they, as in Q2 2012, try yet another even-larger round of co-ordinated stimulus and tax cuts?

Benchmark price movements since the IeC Downturn Monitor’s 29 April 2011 launch, and latest ICIS pricing comments are below:
Naphtha Europe, dark brown, down 14%. “Much of the recent surplus has been offloaded as a result of an open arbitrage to Asia”
PTA China, red, down 12%. “Majority of textile factories in China are to be closed from early February to end-February”
HDPE USA export, purple, down 11%. “Continued to firm as tight supplies helped boost prices”
Brent crude oil, blue, down 10%
Benzene NWE, green, up 8%. “Lukewarm derivative demand and global price volatility keep activity subdued”
S&P 500 stock market index, brown, up 10%

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