By John Richardson
JANET Yellen has firmly signalled that US interest rates will be raised later this month for the first time since 2006.
There will be collateral damage, sure, as I discussed in September, most importantly because of the private-sector debt binge in emerging markets resulting from such a long period of record-low US borrowing costs. Fitch issued another warning about the unwinding of this debt earlier this week.
But the main event remains China, as the chart above underlines. Nearly half of the $35 trillion of stimulus that has been pumped into the global economy since 2009 has come from China, compared with just $4 trillion from the Fed. So policy decisions in China still matter far, far more than anything the Fed does or does not do in December.
On those Chinese policy decisions, we know that the domestic credit squeeze will continue. It simply has to continue. So in 2016 we will see a further contraction of the Chinese economy as the credit bubble further deflates. Real GDP growth will once again be way below the official numbers.
China’s policy shift will thus continue to drag the global economy into a deep deflationary down-spiral.
A good example of the link between China and the rest of the world is the chart below. It shows producer price deflation in China, Germany – and also, crucially, the US a well. So much for the Yellen’s theory that the US economy is poised for “lift off”. US labour participation rates also tell us that this is simply not true.
The chart you have just seen underlines my long-held belief that China will export more and more deflation as it makes use of its vast manufacturing surpluses to ease the pain of economic reforms.
Jobs will have to go, and are indeed going, sure, in provinces dominated by the old, unwanted heavy industries, such as in Hebei province. But for reasons of social stability, those job losses have to be staggered and very carefully measured. You will also see local governments fighting tooth and nail to keep aluminium, steel and chemicals plants open because these factories are important sources of tax revenue.
And of course it is also the global fall in input, or raw material costs, that’s behind what will be a prolonged and very deep period of global deflation. Oil is the best example of this. Vast oversupply in crude was built up on completely false assumptions about Chinese demand growth. The same applies to polyethylene.
How do you therefore plan for next year?
- Assuming that the Fed does raise interest rates, prepare for collateral damage. This will include credit issues amongst some of the buyers of your chemicals and polymers in emerging markets.
- And higher US interest rates will obviously mean more dollar strength and so more downward pressure on crude.
- Meanwhile, counter-intuitive as it may seem, your 2016 budget must include more spending on sales and marketing and on research and development. The route to success is to take a much more granular, on the ground approach to selling into different regions and end-use markets. And ride the deflation wave to your advantage. For example, what are the opportunities to make use of long-lasting oversupply in propylene and its derivatives?