By John Richardson
I CONTINUE to worry that people are only paying attention to when the Fed will raise interest rates. As a result, they are missing the far bigger story, which is the slowdown in both developing and developed economies resulting from events in China.
The good news is that this view is gaining more and more traction. For example, Bhanu Baweja, global head of emerging markets strategy at UBS, told the Financial Times: “In obsessing about the Fed, people are missing the fact that we will see much less trade, which will lead to much lower emerging markets growth.”
China was at the epicentre of the 2008-2013 global economic boom because of its stimulus programme. But now it is withdrawing that stimulus – hence, the weaker growth prospects for both the developing world and the West.
How this boom worked was that China sucked-in vast quantities of iron ore, coal and other commodities from countries such as Brazil and Indonesia during its 2008-2013 stimulus programme.
Any common sense analysis of that stimulus programme would at that the time have told you that it was unsustainable. And yet companies such as Vale, the Brazilian mining company, saw things very differently. In 2010, it took delivery of 35 huge dry-bulk ships, each of which could carry iron ore sufficient to build three copies of San Francisco’s Golden Gate Bridge. In Q1 of this year, the company reported its worst financial performance in six years.
Australia was also a beneficiary of this China-driven commodities boom. This led to wage inflation that has left the economy uncompetitive. So you ended up with people who operated hand-held “Stop and Go” sites at iron ore and other types of mines in Australia earning $100,000 a year.
But in every downturn there are many silver linings. For example, I was chatting to a Perth taxi driver the other month. I suggested that someone should set up a business buying luxury four-wheel drive vehicles and jet skis etc. from redundant mineworkers at knockdown prices for export markets. “Funny you should say that, as this is exactly what my brother is already doing,” he said.
The recent data that further confirms the above argument is staring everyone in the face. For example:
- In aggregate, the 17 largest developing economies reduced world trade values by 0.9% in Q1. This compares to the 2.5 percentage points they added to trade growth annually between 2000 and 2014.
- When you strip out China, the average GDP growth of emerging markets in US dollar terms could end up being close to zero for the full year 2015.
- The latest Australian government has made an awful mess of its budget projections because it simply doesn’t get China. It has thus decided to cut foreign aid to the lowest proportion of national income since the 1960s (this is incredibly short sighted, but more of this in a later post).
- As China tries to compensate for weaker growth at home, it is exporting deflation. And when prices start to fall, consumer spending slows down. For example, the 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%.
What the Fed is doing is, of course, also important. It has inflicted a mountainous amount of damage on the global economy thanks to its own equally misguided stimulus policies.
And now, as it prepares to raise interest rates, it is inflicting even more damage. In the three quarters to the end of March, for instance, emerging markets suffered a bigger net capital outflow than during the Global Financial Crisis. This is largely because investors are moving money back to US dollars in anticipation of higher borrowing costs.
But, as I said, do not lose sight of China as you plan for lower global growth as you look for the silver linings in today’s dark clouds – and, crucially, also, as you build a new long term strategy for your chemicals companies. The long term opportunities are nothing short of fantastic, but they require a whole new way of thinking.