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The great ‘Deflation Shock’ is coming closer

Economic growth
By Paul Hodges on 19-Jan-2015

RingofFire Jan15


The world is about to be hit by a demand shock equivalent to 1973’s supply shock.  Yet, astonishingly, most commentators remain so focused on central bank activity, that they have completely missed what is happening.  Here’s how it is playing out.

You may remember the ‘The pH Report‘ forecast in early December that:

Oil prices are likely to continue falling to $50/bbl and probably lower in H1 2015, in the absence of OPEC cutbacks or other supply disruption.  Critically, China’s slowdown under President Xi’s New Normal economic policy means its demand growth will be a fraction of that seen in the past.

“This will create a demand shock equivalent to the supply shock seen in 1973 during the Arab oil boycott.  Then the strength of BabyBoomer demand, at a time of weak supply growth, led to a dramatic increase in inflation.  By contrast, today’s ageing Boomers mean that demand is weakening at a time when the world faces an energy supply glut.  This will effectively reverse the 1973 position and lead to the arrival of a deflationary mindset.” 

The reason is that central banks have created a debt-fuelled ‘Ring of Fire’, and as the map shows, major fault lines are now opening up across the world – and creating warning tremors of the earthquakes ahead.

These are unlikely to lead to a repeat of 2008’s financial collapse.  But their effect will be magnified by the fact they are all linked to debt burdens that can probably never be repaid.

China’s New Normal policies were the starting point for the opening of the fault lines:

  • June saw the first impact as Beijing house prices fell; now property tax revenue is down a third nationally
  • Oil demand then weakened, as the Great Unwinding of China’s stimulus policies continued
  • The US$ also began to strengthen, as the US Federal Reserve tapered its money-printing activity
  • These moves were mutually supportive, as financial players then saw no need to buy oil as a ‘store of value’
  • The first fault lines thus opened between China and Russia/Middle East as oil prices collapsed

Last week, a new set of fault lines opened to Australia and South Africa, as copper prices and mining company shares began to collapse due to major selling in China.

Copper has an importance beyond its own markets.  It is widely seen as Dr Copper – an important indicator for the entire global economy.  Its price decline, along with that of most other commodities, will add to deflationary pressure:

  • China’s slowing economy is exporting deflation around the world – its producer prices fell 3.3% last month
  • The Eurozone went into deflation last month, with consumer prices down 0.2%
  • Japan’s return to deflation is now just a matter of time, despite premier Abe’s money-printing
  • Switzerland’s sudden removal of its currency cap means its deflation will become entrenched
  • And US inflation has already fallen to just 0.8%, making deflation very likely there before too long

Even more significant was that the tremors from Switzerland ‘s revaluation opened the fault lines across the Atlantic to New York.  Currency brokers around the world suffered major losses, as the franc initially soared 40% in 2 minutes versus the euro.

Of course, the same people who missed the start of the Great Unwinding are still arguing that “everything is for the best, in this best of all possible worlds“.

But chemical markets remain the best leading indicator we have for the global economy.  They told us in April that a downturn had begun.  And today I am hearing reports of some major bankruptcies underway in China.  There will be many more globally, as companies find themselves with high-priced inventory whilst demand remains weak.

In 1973, the inflation shock was led by oil, as Boomer demand created massive supply shortages.  Now, 40 years later, oil is taking us into deflation.  The reason is simple – the ageing Boomers no longer need, or can afford, to maintain their previous levels of demand.


The weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:

Benzene Europe, down 59%. “Weakening oil and energy prices and slow derivative demand are weighing on the market”
Brent crude oil, down 54%
Naphtha Europe, down 52%. “Downstream ethylene volumes are being purchased on a strict hand-to-mouth basis, whilst the propylene market is long”
PTA China, down 45%. ”Sentiment was largely weaker during the week as buyers were trying to maintain low inventories amid an uncertain market outlook”
¥:$, down 15%
HDPE US export, down 19%. “Export prices tumbled across the board in response to lower ethylene and energy market values. But prices still can fall much lower.  Traders reported INEOS auctioned off 8-10 rail-cars at prices 15% below published market prices”
S&P 500 stock market index, up 3%