Budget Realism Needed For 2014

Credit-Rmb-per-GDP-unit-UBS

By John Richardson

SOME people might prefer that the central banks spigots in the US and China are kept open indefinitely – or at least until they have retired. It would then be left to the next generation of chemicals and other industry employees to confront the mess that has been left behind.

Many more kicks of the can down the road are a possibility, sure, but they are a remote possibility, we feel, because:

  • The Fed has given every indication that it is still on course to reduce bond purchases, possibly by as early as end-October or if not, at some point next year.
  • We are heading towards the crucial November plenum meeting during which further tightening measures, particularly aimed at the shadow banking system’s “black box”, seem likely to be announced.

We will deal with why it would be dangerous for the Fed to continue kicking its particular can the road in a later post.

And we will also continue with our series on the effects of central bank action on Asia ex-China over the next few days and weeks.

Here, though, we will look at China.

Many chemicals companies are, of course, preparing their budgets for 2014 and so it is important that they are realistic over China.

Growth this year in some chemicals and polymers, including polyethylene (PE), has surprised on the upside. But this is largely because of the excess liquidity now sloshing around the financial system.

We think that one scenario for 2014 has to be much-tighter credit conditions and thus a moderation of growth rates.

It is not the only scenario, of course, but one that we think would be the best outcome for China if it is avoid an increasing risk of  economic implosion.

“You have a credit system gone crazy there. New debt has been running anywhere from 30 to 40% of GDP a year,” said the famous investor Jim Chanos in this interview with Bloomberg TV. Chanos first warned about overheating in certain areas of the Chinese economy three years ago.

“Think about that for a second. Their economy is going 10% nominally, 7.5% real and 2.5% inflation,” he added.

“If you are growing your debt at 35% and your economy is growing 10% a year, that means that new debt is growing 25 percentage points greater than your economy.

“And using the old rule of 72, that means you double your debt to GDP every three years. So when we started looking at China, total debt in China to GDP is about 100% of GDP. It’s now about 200%.”

He warned that 2013 has seen a repeat of the same old story in China of “stick a shovel in the ground, put up another building, another stadium, another railroad…at this point, the returns are minimal.”

Over the next few weeks and months we will be studying the comments of chemical company CEOS very carefully to see whether they are putting this year’s growth recovery in China into what we think is the proper context.

The CEOS have no real reasons to be surprised on the downside in 2014, as most of the evidence required to build a solid “worst case” scenario is already out there.