Boom, Gloom and the New Normal

Long-standing readers will remember that then-UK Finance Minister Alastair Darling was the first Western politician to recognise in August 2008 the disaster that was about to hit financial markets.

Now out of office, his warning today therefore deserves the widest possible discussion around the world:

“I despair of the way in which EU leaders are constantly behind events. I do not think enough people realise how serious this crisis is, and how hard it is going to hit us.

“I know of no one in private who thinks the solution proposed for Greece will work. Any solution that will leave Greece with debts of 120% of GDP in 2020 is simply not credible. Everyone knows there is going to have to be a larger cut than the 50% write-off”.He termed last week’s G20 Cannes summit last week a “disaster” and added that the EFSF (European Financial Stability Fund) “‘rescue fund’ does not exist.

“The ECB has been buying Italian bonds in the markets for months, and now they have to recognise they have to be the lenders of the last resort, and they must say they will do everything possible to protect the euro. Unless they do that, the markets will continue to have a go at any weak economy.”

Darling described bank recapitalisation as being “like a fire that starts under the floorboards – before you know where you are, the whole building is in flames and burnt down”.

“We are seeing government after government introducing austerity programmes to protect themselves from the markets, but if there is no growth there is no way that the austerity can be enough. That is why the G20 should have been focusing on how to achieve growth – but it did not, and we may now pay a very heavy price.”

Darling has no need to exaggerate for effect. And his track record is excellent. The blog therefore takes his warnings very seriously indeed.

The blog will publish its fifth annual Budget Outlook next weekend. As usual, it is therefore time to review last year’s Outlook. Past performance may not be a perfect guide to future outcomes. But it is one of the best that we have.

The blog’s 2008 Outlook ‘Budgeting for a Downturn’, and its 2009 ‘Budgeting for Survival’, meant it was one of the few to forecast the Great Recession.

2010′s ‘Budgeting for a New Normal’ was then more positive than most forecasts, suggesting “2010 should be a better year for the chemical industry, as demand grows in line with a recovery in global GDP”.

The 2011 Outlook was titled ‘Budgeting for Uncertainty’. This argued “Scenario planning will give businesses the chance to adopt the wisdom of the Scouting movement. Its motto, ‘Be Prepared’, seems the best possible approach in today’s increasingly uncertain New Normal environment.”

It described its Base Case as being “the classic ‘muddle through’ Scenario”. This suggested we might see 3% global GDP growth, oil in the $60-$80/bbl range and continued financial market volatility. It was broadly similar to the consensus chemical company forecast.

But the blog then suggested that companies should also consider an Upside Scenario based on global GDP growth of >3.5%, “causing oil prices to rise above $80/bbl” and inflation to become a major issue.

It also suggested that plans should be tested against a Downside Scenario, where countries instead “put their own interests first and adopted beggar-my-neighbour policies”. It suggested this could cause “the banking system to come under major strain”.

It looks as though 2011 will see all 3 Scenarios occur at different times.

Equally, the blog’s concern in the Outlook about the potential for ‘currency wars’ has proved well-founded:

• The US QE2 stimulus programme did force China and the other BRICs to allow their currencies to rise, and supported US export growth
• But as the blog warned, “when elephants fight, those around them need to be cautious”. And we have seen increasingly violent swings in major currency values in recent months

The blog’s aim is to ‘share ideas about the influences that may shape the chemical industry over the next 12 – 18 months’. It hopes that its 2011 Outlook again helped readers to better prepare for today’s increasingly difficult economy.

Its underlying viewpoint remains the same as in 2010′s ‘Budgeting for a New Normal’ when it forecast that:

“We will start to see a rebalancing of the global economy. The West will see lower consumption, as people rebuild their savings, and borrow less. In turn, this will mean lower export demand for the emerging economies. The outcome will be a more sustainable world economy, but it will be a difficult journey.”

China was understandably a key item on most people’s minds at this week’s annual EPCA (European Petrochemical Association) meeting in Berlin. It has been the motor of global chemical demand growth over the past 3 years.

The blog’s discussions identified a number of signs that this support may be disappearing:

• Many companies worry about the level of inventories being held down the value chain. Some fear these could be up to twice normal levels.
• Credit has become much tighter, as the authorities try to reduce inflation. Interest rates of 2%-3% a month seem to be quite common.
• Considerable inventory is controlled by property developers, who are using it to replace bank credit lines that have been cut off.
• The risk of bankruptcies is seen to be rising. At today’s prices, this represents considerable credit risk for petchem suppliers.

Thus there are good reasons for companies to take a more cautious approach. In turn, of course, this further reduces potential growth levels.

At the same time, the latest data confirms major changes are underway in China’s trade patterns. The chart above shows net polyethylene imports – eg imports less exports – using GTIS data for January-August:

• China’s total net imports have fallen 11% in 2011 versus 2009
• Meanwhile, its net imports from the Middle East have risen 60%
• Its net imports from SEA have risen 17%
• But net imports from NEA have fallen 40%
• Net imports from NAFTA have fallen 51%

This trade data is key to understanding future demand patterns.

It shows China is refocusing its imports on strategic oil partners in the ME, and within the ASEAN Free Trade area. At the same time, it continues to increase its own production ahead of demand growth.

In turn, of course, this strategy intensifies competition in other regions, as traditional exporters to China are forced to seek new markets. This competition can only intensify, if fears of a China slowdown prove real.