By John Richardson
THERE are 2.8bn people – 40% of the world’s population – who live on $2-10 a day.
These people are “the fragile middle”, according to the Financial Times, as they are constantly in danger of falling back into poverty.
And those risks have been greatly escalated by the policies of the US Federal Reserve. Here is why:
- The Fed’s Quantitative Easing (QE) programme has forced an enormous amount of money to move out of the US and into the emerging world, as investors have chased higher yields.
- What the Fed was trying to do was buy time for the US economy, as a 27 October issue of the John Maudlin financial newsletter points out. But this was “at the expense of rampant misallocation across the rest of the world. Major developed economies can adjust their policies to offset the effects, but the emerging markets find themselves in a far more vulnerable position as easy money masks the urgent need for reforms,” says the newsletter. The Fed has therefore failed. It will argue that its mandate doesn’t include emerging markets, but what on earth is the point of US monetary policy that doesn’t take into account the global context?
- Last year’s Fed taper panic in emerging markets gave us a taste of what is about to happen. Economists suddenly became concerned about how countries such as Malaysia had leveraged-up on consumer debt, thanks to all the cheap overseas money.
- What developing countries in general have done is use debt to compensate for lost global trade, which remains below its 2008 level (see chart below).
- Now that QE is over, “hot money” is flowing back to the US in pursuit of a booming local stock markets, a strengthening dollar and eventually, perhaps, higher interest rates.
History tells us what happens next.
“The experience of the 1990s shows how, against the backdrop of a relatively strong US economy and policy divergence between major central banks, extreme stress in the emerging markets can lead to elevated US dollar strength, which in turn can trigger additional crises and push the world’s reserve currency to even greater heights,” continues the same newsletter.
“For example, the Mexican ‘Tequila Crisis’ of 1994 played a role in pushing the US dollar higher and, along with Bank of Japan easing, helped trigger the Asian Financial Crisis in 1997.
“The Asian crisis, in turn, set off a sharp jump in US dollar strength and an equally sharp fall in oil demand, which, along with an oversupply of oil, contributed to a crash in oil prices in 1998 and threw Russia into crisis.”
But this is likely to be a lot worse than 1994 or 1998, according to the latest Geneva Report on the World Economy. It says that there has been a “strong increase in the ratio of total debt (ex financials) to GDP for emerging economies, by a staggering 36% since 2008.”
The chart below shows the big increase in emerging market financial assets since 2008.
One outcome for the global petrochemicals industry could well be that hundreds of millions of people in this “fragile middle” slip back into extreme poverty as they lose their jobs. Extreme poverty is when you have to try and live on $1-2. One billion people already fall into this category.
When you live on $2-10 a day, and, of course, even less, you barely have enough money to get by, never mind invest in frothy local equity markets or real estate. And so these people have had no opportunity “to get in at the bottom and get out at the top”. The Fed’s policies, and the response of their own governments have, thus, in the long term been of no value to these people.
The extreme poor and the fragile middle are also the most-exposed to lack of enough investment in public healthcare, education, sanitation and infrastructure. Where will some emerging countries now find the money to make these investments?
So much for the story sold to investors in petrochemicals companies of the “relentless rise of the developing world’s middle class” that has been used to justify major capacity expansions in the US.
I think there is another very probable outcome as well: Politicians in the developing world, desperate, of course, to keep their jobs by preserving local employment, will throw up trade barriers.
Why on earth would they want to, in effect, outsource jobs to the US by importing lots of its surplus polyethylene?
They will instead protect existing producers, and new investments, with trade barriers. Local petrochemicals production creates many millions of direct and indirect jobs.
We mustn’t forget China in all of this, of course. China has to some extent benefited from Fed hot money, but the main issue here is the harmful impact of the policies of its own central bank.
Now that these policies are being reversed, and its economy undergoes a painful rebalancing, China will also want to preserve jobs by protecting its own petrochemicals business through subsidies and, possibly even, trade barriers.
I worry that you can, thus, entirely forget about the idea that there will be enough global room for as many as 12 new crackers in the US. In fact, I think that there will not be anywhere near enough room for the six new crackers in the US that are already being built.
But, as we discussed on Tuesday, there is a way forward for US petrochemicals – and for the global industry.
The opportunities are nothing short of fantastic in helping people escape poverty. This will not only make money, but it is also the right thing to do.