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Chasing Inflation: When Something Doesn’t Work, Stop Doing It

Business, China, Company Strategy, Economics, Europe, US

By John Richardson

sisyphusIn Greek mythology Sisyphus was punished for chronic deceitfulness by being compelled to roll an immense boulder up a hill, only to watch it roll back down, repeating this action forever.

There is a good comparison here with what the Fed and the European Central Bank have been trying to do with inflation. Time and time again over the last few years, just when they have become convinced that healthy inflation has taken hold as a result of their stimulus programmes, inflation has fallen. As long as they continue their misguided policies, the same pattern will be repeated over and over again.

Why? Because too much supply is chasing too little demand. Tomorrow, I shall examine the faultiness in Western economies that explain why too much supply is chasing too much demand, and I shall argue that central bank policies have actually made oversupply and global debt much, much worse.

But here, I am going to look at the role of China in all of this. I have long argued that China’s vast oversupply in manufacturing, the result of its own misguided stimulus policies during 2008-2013, would make healthy global inflation impossible. In fact, the very opposite is resulting from these vast manufacturing surpluses, as China has become the principal driver of a prolonged spell of global deflation.

More evidence of this is emerging week by week. For example, in this quite shocking Wall Street Journal article, from last week, we hear that:

  • The price of natural-rubber latex has fallen by 60% over the last four years. This was the result of too much planting of rubber trees back in 2007, when too many people thought that China’s economy would carry on growing at more than 10% a year. It is also the result of huge expansion in tyre capacity in China. And because tyres are made from synthetic as well as natural rubber, global prices for butadiene have collapse. Butadiene  is, of course, the petrochemicals raw material used to make synthetic rubber (see the chart below).Butadiene3
  • Tyre capacity in China trebled between 2000 and 2013 to 800 million tyres a year, with much of many of these expansions occurring in the 2008-2013, during China’s huge economic stimulus programme. Not surprisingly, exports have risen tenfold between 2000 and 2013 again and global prices for tyres have collapsed –for example, the US, the price of tyres has fallen in 23 of the past 32 months. Six countries have imposed antidumping duties on Chinese tyre imports.
  • Last year, China exported 94 million tonnes of steel, more than the total output of the US, India and South Korea combined. The price of hot-rolled coiled steel has, as a result, fallen by 44% since March 2012. Prices of iron ore and coking coal have, of course, also collapsed.
  • Prices of all goods exported to the US directly from China have fallen in 20 of the past 28 months. This amounts to overall deflation  in these goods of 2.2%. This was a major factor behind  US consumer price inflation being just 0.1% in April.
  • More deflation will be exported by China as it tries to preserve jobs during the most difficult and risky set of economic reforms for at least the past two decades. Which of China’s industries might end up exporting further deflation? Back in 2013, China identified 19 sectors severely affected by oversupply, including chemical fibres (including purified terephthalica acid), aluminium, cement and solar panels.

How do we deal with this? First of all, we must stop trying to roll the rock up the hill. The great news is that, unlike poor old Sisyphus, we don’t have to carry on doing the same useless thing over and over again.

The next step is to come up with monetary and fiscal policies that make sense. There is, of course, a limited amount that chemicals company CEOs can do to reshape the policy agenda. But the CEOs can develop new sources of sustainable growth for their companies, as I discussed yesterday when I used the example of Africa.