By John Richardson
HERE is a reminder of some key facts about the Chinese economy:
- Investment, in the form of local real estate, infrastructure and industrial capacity accounts for around 50% of the country’s GDP.
- China’s total investment levels are 10-15% of GDP higher than comparable countries, such as Japan and South Korea, when they were at similar stages of economic development.
And then consider this data, from China’s National Bureau of Statistics:
- At the end of 2013, the number of employed people in the country was 769.77 million.
- The total number of migrant workers was 268.94 million, 2.4% higher than the previous year.
We also know that hundreds of millions of these employees work in export-focused factories in China’s eastern and southern coastal provinces – and that exports of goods and services account for 30% of GDP.
So how on earth can anyone expect that China will, in effect, roll over and die economically by allowing thousands of uncompetitive factories to shut down overnight as it rebalances its economy?
It cannot, should not and fortunately, for all of us, will not allow this to happen – as the end-result would be economic, social and political chaos with major global implications.
We must accept that at least for the next few year –perhaps longer – China has no choice but to export deflation in the form of its huge manufacturing surpluses. We saw evidence of this in China’s steel exports in September, which, year on year, surged by 73% to an all-time record high volume of 8.52m tonnes.
And we are seeing a lot of evidence of this in petrochemicals markets – for example, in purified terephthalic acid where it has become an exporter for the first time ever.
Also see our above slide.
Here are some important numbers on polyvinyl chloride (PVC):
- As recently as 2009, China’s PVC net imports totalled 1.5m tonnes, mainly from Asia and the US.
- By 2012, the country’s domestic output had jumped 70% from 9m tonnes to 15.25m tonnes As a result of this, and the start of the housing market slowdown, its imports had halved to 665,000.
- in January-September of this year, China stopped being a net importer of PVC as imports during that period were just 608,000 tonnes compared with exports of 949,000 tonnes.
You then need to think about last week’s hopelessly wrong decision by Japan to expand is quantitative easing (QE) programme, as bankers and politicians panicked over their failure to solve domestic deflation.
What is this decision going to do?
The decision is going to add to global deflation as it has already driven the value of the Yen lower, with a further deprecation very likely . This will boost the export competitiveness of Japan’s manufacturers.
Again, you need to ask yourself the question of whether China will roll over, die, and accept the loss of manufacturing jobs as its exports become less competitive versus those of Japan. Of course not.
And there are reports today that Mario Draghi, the chairman of the European Central Bank (ECB), has won the necessary consensus from the ECB’s Governing Council to expand the Eurozone’s monetary stimulus.
If this is true, and stimulus is increased, then the value of the Euro will, of course, go lower.
We don’t have to repeat the question again, just the answer: There is no way, in the event of a weaker Euro, that China will allow its export trade with the Eurozone to suffer as a weaker Euro would, potentially, make Chinese imports more expensive.
Equally, it will not allow a weaker Euro because this would also give Eurozone’s manufacturers an edge in the export markets in which they compete with China’s manufacturers.
Hence, I agree with the analysts who are now raising this as a possibility: A competitive devaluation of the Yuan.
On a trade-weighted basis, the Yuan has already risen in value by 15% against the Yen and the Euro since the start of 2013, according to JP Morgan.
The rise in the value of the Yuan is a result of Abenomics, Eurozone stimulus and the fact the Yuan trades in a range of values against the US dollar. The US dollar has, of course, strengthened recently on the end of the Fed’s own equally misguided QE programme.
Whatever the biggest cause, the Yuan is now 15-25% overvalued, according to Charles Dumas of Lombard Street Research.
He quite rightly points out that whilst Beijing’s clearly stated objective is to boost domestic consumption to offset a fall in investment, the “only palliative” during this very difficult transformation phase is exports.
China’s exports will, as a result, increase rather than fall, he thinks. I agree.
The current value of the Yuan may thus prove to be unsustainable for Beijing, added Dumas.
“The pressure on the People’s Bank of China [China’s central bank] to engineer another short and sharp mini-devaluation, and once again shock expectations, will rapidly escalate,” said BNP Paribas economist, Richard Iley.
They could be wrong about the Yuan, but Dumas is not wrong about exports being the “only palliative” for China.
And so, even if the Yuan is not devalued, you can expect other measures to boost the competitiveness of exporters, including maybe cheap loans and tax breaks.
A case in point was the announcement, made by China’s State Council earlier this week, that financial institutions would be urged to step up lending to companies that import high-tech equipment and components. These imports will end up us as re-exports of ever-more competitive higher-value products, such as smartphones.
The essential point here is that, to borrow a phrase from Mario Draghi, China will do whatever it takes” to boost its export volumes.
What does this mean for petrochemicals companies outside China?
It means that:
- Given the hopelessness of central bank policy in general, we are now in a “race to the bottom” in the price of just about everything, which will be led by China.
- This will last until major trade barriers are erected, reversing many years of increasing globalisation of petrochemicals markets.
How should petrochemicals companies outside China respond?
1.) Minimise raw material purchases, as, of course, the costs of raw materials will constantly be lower tomorrow compared with today.
2.) Pay down debt as the real value of debt will rise as deflation gets worse.
3.) And do not even think about taking on any new debt because its real value, too, will obviously increase – and crucially, also, there will be insufficient demand to justify any new debt.
4.) Focus on improving local integration and feedstock advantage. Work with governments to this effect.
5.) Concentrate on keeping local customers happy. The reason is that as markets become more regional, petrochemicals sales will increasingly be “local for local” – e.g. polyethylene sold to a local converter, who then sells his finished products in your home market. If companies don’t look after their local customers, they will lose market share to your domestic petrochemicals competitors.