A Perfect World? If Only It Were So

Business, China, Company Strategy, Economics, Oil & Gas

ChinadebtMcKinsey

By John Richardson

IN A perfect world everything always turns out for the best in the end.

And so quite a few people who argued that high oil prices were good for the global economy, as they said that expensive crude pointed to robust consumption growth well ahead of demand, are now arguing the exact opposite: That cheap oil is an unambiguous overall benefit to the global economy.

Here is the basis of their argument.

  • The ‘multiplier” effect on consumers of cheaper oil as transportation and other costs plummet.
  •  Lower inflation for big oil importing countries will provide more monetary policy flexibility, according to Moody’s Investors Service.
  • The International Monetary Fund has said that a prolonged oil-price drop could boost global growth by up to 0.7% in 2015 and 0.8% next year.
  • Cheaper crude seems, on the surface, unarguably good for some countries. It has, for example, enabled Indonesia and India to cut wasteful fuel subsidies. The money saved can be now spent infrastructure that will, hopefully, lift hundreds of millions more people out of poverty.

I agree with this last point in the long term. This is where the future for the chemicals industry lies.

But we should not be talking at all about the benefits of lower inflation over  the next few years. Chemicals companies should instead be planning for the consequences of deeply entrenched global deflation.

I am convinced that we are in a deflationary world where, of course, consumers and companies will be focused on paying-down debt. As the value of money falls, servicing debt becomes more in real terms – hence, the focus switches to getting rid of liabilities as quickly as possible.

I also believe that a great deal of debt will have to be written off. It shouldn’t have been acquired in the first place, but the past is the past. There is no point in dragging this process out and further by pretending that this debt is serviceable.

And has been the case in Japan for many years, and is becoming the case in the EU and China, deflation makes consumers delay their purchases. Why buy something today when it might well be cheaper tomorrow?

Overinvestment in oil, leading to today’s huge overcapacities, is just one driver of deflation.

We have seen the same pattern in chemicals and real estate in China and in iron ore in Australia. Capacity across many regions and many industries has bene built on totally false assumptions of global economic strength.

The good news for anybody who has listened is that I have been making this case for a couple of years now. I have been consistently warning that China would become the epicentre of this debt and deflation crisis.

On 2 February 2014, for example, I wrote:

HISTORIANS will end up concluding that falling emerging market currencies and stock markets – the prelude to what could be a full-blown crisis – is really about China and not about the US Federal Reserve.  The Fed is just a sideshow to the main event of what is going to drive not just emerging markets, but also the global economy, over the next few years.

Why? Because China has spent far more on stimulating its economy since 2009 than the Fed – in fact, crunching the data  a little further, when you add shadow lending, it has raised total credit from $1 trillion in that year to $10 trillion in 2013. This compares with Fed spending since 2009 of $2 trillion on Treasury Bonds and $1.5 trillion on Mortgage Bonds.

The great news is that more and more consultants and analysts are falling into line. Only by recognising the problem can we start to fix it.

A great example is this Bloomberg article, which was published yesterday, on a new McKinsey & Co study:

Thanks to real estate and shadow banking, debt in the world’s second-largest economy [China} has quadrupled from $7 trillion in 2007 to $28 trillion in the middle of last year. At 282 percent of GDP, the debt burden is now larger than that of the U.S. or Germany. Especially worrisome to McKinsey is that half the loans are linked to the cooling property sector. 

Bloomberg also detailed how McKinsey has put the debt crisis into an extremely valuable global context, when the wire service wrote in the same article:

The world economy is still built on debt.

That’s the warning today from McKinsey’s research division which estimates that since 2007, the IOUs of governments, companies, households and financial firms in 47 countries has grown by $57 trillion to $199 trillion, a rise equivalent to 17 percentage points of gross domestic product.

While not as big a gain as the 23 point surge in debt witnessed in the seven years before the financial crisis, the new data make a mockery of the hope that the turmoil and subsequent global recession would put the globe on a more sustainable path. Government debt alone has swelled by $25 trillion over the past seven years and developing economies are responsible for almost half of the overall gain.

McKinsey sees little reason to think the trajectory of rising leverage will change any time soon.

This is proof that we do not live in a perfect world. If we did, we would have learnt our lessons from the 2008 Global Financial Crisis.

PREVIOUS POST

China's Damage Limitation: The Reserve Requirement Cut

05/02/2015

By John Richardson DAMAGE limitation is the motive behind China’s decision cut...

Learn more
NEXT POST

Australia: This Is No Way To Run A Country

09/02/2015

By John Richardson TONY Abbott has survived an attempt to remove him as Australi...

Learn more
More posts
Global polyethylene oversupply, the highest in 19 years, hasn’t gone away
03/07/2020

By John Richardson BRENT crude futures surged by 80% during the second quarter and enjoyed their bes...

Read
China could be in complete polypropylene self-sufficiency by 2022
28/06/2020

By John Richardson SORRY to labour the point but this comes from a genuine concern for the readers o...

Read
Asian polyethylene price recovery faces multiple challenges
25/06/2020

By John Richardson THERE are reports of significant cuts in Middle East polyethylene (PE) operating ...

Read
China’s long-term ambition for paraxylene self-sufficiency seems close to being realised
21/06/2020

On Friday, I examined how China’s paraxylene (PX) net imports could fall to as little 8m tonne...

Read
China’s big declines in 2020 PX and PP imports: the impact on its major trading partners
18/06/2020

By John Richardson CHINA’S refineries and petrochemicals plants came roaring back to almost fu...

Read
Paraxylene demand collapses as higher China production threatens 6m tonne fall in imports
15/06/2020

By John Richardson DON’T SAY I didn’t tell you that a decline in stock markets would happen. The...

Read
Coronavirus will severely damage the developing world unless we take the right steps
12/06/2020

By John Richardson IT IS a fantastic achievement. “Over the last 25 years, more than a billion peo...

Read
Main Street versus Wall Street and the crisis in the developing world
10/06/2020

By John Richardson RISING equity and oil markets do not necessarily point to a V-shaped recovery. I ...

Read

Market Intelligence

ICIS provides market intelligence that help businesses in the energy, petrochemical and fertilizer industries.

Learn more

Analytics

Across the globe, ICIS consultants provide detailed analysis and forecasting for the petrochemical, energy and fertilizer markets.

Learn more

Specialist Services

Find out more about how our specialist consulting services, events, conferences and training courses can help your teams.

Learn more

ICIS Insight

From our news service to our thought-leadership content, ICIS experts bring you the latest news and insight, when you need it.

Learn more
X

Uncover exclusive industry upates from ICIS

Interested to uncover more articles related to this topic? Explore additional news, insights and intelligence, tailored to the markets you are interested in by accessing exclusive content from ICIS.com

DISCOVER MORE