Yuan Devaluation Needs To Be Considered

Deflation2.pngBy John Richardson

The “beggar my neighbour” trade wars that many economists feared would erupt after the global financial crisis were delayed thanks to fiscal stimulus.

But now politicians will be under increasing pressure to erect trade barriers.

“We are seeing a rise in antidumping cases involving chemicals,” a trade lawyer who specialises in the chemicals industry told the blog last week. More details later.

The chart above, from Comstock Partners, was first used by our fellow blogger Paul Hodges.

It begins on the left hand side of the chart with the world before 2007. As China funnelled its savings from export earnings into industrial capacity, debt levels in the West rose.

China was left with overcapacity in industry and the West with overcapacity in financial services, leading to harmful innovations such as sub-prime mortgages.

As we said, fiscal stimulus delayed the shift to excess capacity and the weakness in pricing power phases.

Quantitative easing (QE) in the US created positive sentiment but did nothing to address the country’s underlying problem of weak employment prospects for the middle classes. Financial services have been the main beneficiary of QE.

US unemployment has declined by just one percentage point over the last two years, commented Janet Yellen, vice chairman of the Fed recently.

Private sector employment remains more than 6 million below the record levels of early 2008, she added.

In Europe, sovereign imbalances that date back to the formation of the Euro threaten the break-up of the Eurozone. Any deal reached this week is unlikely to resolve the underlying problems.

China helped to delay the shift to excess capacity and weakness in pricing power. Its enormous economic stimulus of late 2008 enabled chemicals companies to export their surpluses as China sucked-in every spare molecule.

But as we have discussed before, this stimulus merely brought demand forward. It also led to socially disruptive inflation and a property bubble that now threatens the stability of its banking system.

China, despite an easing in inflation, cannot afford a stimulus programme anywhere close to the scale of late 2008. The risks are further pumping-up the property bubble, higher overall inflation and, as a result, widening the gap between the rich and poor – not to mention making the bad-debt crisis worse.

It might introduce further limited measures to ease credit conditions – for example, more support for its struggling small and medium-sized enterprises.

But nobody can realistically expect a return to the easy credit of 2009-2010.

We are therefore set to enter the “excess capacity” phase in 2012 when the less-competitive chemicals companies will lose pricing power. The Middle East will be OK, of course, because of its feedstock advantage with Sinopec continuing to run plants hard for “social” reasons rather than economics. Everyone else is likely to struggle.

Down many production chains from chemicals to finished goods there will be pressure on politicians for more protectionism.

A clear indication of this shift in mood was the bleak view that the US-China Economic and Security Review Commission took of China’s adherence to World Trade Organisations practices since its admission in 2001.

The blog continues to be disappointed, a little like Wile E Coyote who of course never catches Road Runner, about how people just don’t get the fundamental changes to the world economy that we outline in our e-book, Bloom Gloom & the New Normal

An example of this lack of understanding was analysis we heard last week that the Yuan was inevitably going to appreciate further against the US dollar in 2012.

Why not include in your scenarios the possibility of a competitive depreciation, as “beggar my neighbour” trade wars develop?

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