The Chemicals Party Is Over

By John Richardson

IT has been a fantastic party. Nobody expected that the drinks would last for so long, thanks to Wen Jiabao and Ben Bernanke working overtime to man the 24/7 off-licence (it is called “liquor store” in the States and a ”bottle shop” in Australia).

But now the market has clearly reached the top with China facing the unenviable task of tackling deep-rooted, systemic inflation that has placed Beijing in an exceptionally difficult situation.

It will have to clampdown much harder on the cost and availability of money if it wants to bring food prices under control. The risk of failing to do so is major social unrest. As my fellow blogger Paul Hodges said the other day “how can any government expect to survive food inflation at 11.7%?” (its level in March).

But crackdown too hard on the extraordinary growth in liquidity post-2009 and the risk is a severe correction in house prices. All the millions of Chinese who would then find themselves in negative equity could then instead exert pressure on the government.

S&P’s decision to put the US’s AAA debt review on reviews is, as Hodges says in this post, a potential game changer.

“It means that policymakers can no longer pretend the $5trn they have spent over the past 2 years on stimulus measures somehow “doesn’t count” in terms of needing to be repaid. Oil markets will be first in the line of fire.

“The S&P move makes it much less likely that the US Federal Reserve will be able to follow QE2 with QE3. And QE2 has been the prime reason why oil prices have risen from $75/bbl to $125/bbl since August, when it was first announced.”

Even Barack Obama has said that he believes the rise in oil prices has been driven by speculation and not supply shortages.

Chemicals prices rose following the announcement last August that QE2 was going to take place with confidence further bolstered by the continuing boom in China.

But since the Chinese New Year, the world’s most-important chemicals market has stalled as the realisation has sunk-in that there is something deeply wrong with China’s economy.

It has happened before as Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management in Beijing, says in this blog post we also linked to on Tuesday. He quoted a book called Red Capitalism, where the authors – Carl Walter and Fraser Howie – write of how there was a surge in bank lending and inflation ahead of the Tiananmen Square crisis in 1989.

In an attempt to confirm what we fear, the blog spoke to four chemicals and polymers traders yesterday to assess the current mood in China. They said that while some markets had seen slight rallies early last week on mild recoveries in confidence, volumes remained exceptionally subdued.

“All the end-users are buying hand-to-mouth. There is no visibility anymore over the economic outlook. We have done incredibly well since Q1 2009, but it is now time to reduce our exposure,” said a polyolefins and polyvinyl chloride (PVC) trader.

This repeats what we heard from another trader on our recent trip to Singapore  

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