Thursday, July 16, 2015

"China's economic troubles start to spread"

That's the title of an article at Bloomberg View.  It confirms what I've been saying for some time:  that economic problems in one part of the world can rapidly spread to others, because the world economy is now so interlinked that one area can't be isolated or insulated from another.

Singapore is the closest thing Asia has to an economic barometer. Its highly open, trade-reliant economy usually signals when trouble is approaching the global stage. And at the moment, Singapore is flashing clear warning signs.

The city-state's gross domestic product plunged 4.6 percent last quarter, a downturn almost certainly triggered by China. Singapore's plight may mark a dangerous inflection point not just for Asia, but for the entire global economy.

After the 2008 global crisis, China's 9-percent-plus growth picked up the slack from a West licking its financial wounds. But as Asia's biggest economy cools, officials from Seoul to Brasilia are finding themselves without a reliable growth engine. Uneven recoveries in the U.S. and Europe have already slowed the exports that power most Asian economies, including Japan. China's downturn could now throw Asian manufacturing into reverse.

Morgan Stanley's Ruchir Sharma warns that "the next global recession will be made by China."

. . .

Beijing's troubles are now the world's. In 2010, it accounted for roughly 23 percent of global growth. By the end of 2014, that share had surged to at least 38 percent. China punches even further above its weight in the commodity markets that countries from Indonesia to South Africa rely on for growth. "Over the next couple of years," Sharma told Bloomberg News, "China is likely to be the biggest source of vulnerability for the global economy."

There's more at the link.

Let's try to put this in simple terms.  China's economy expands, leading to demand from its industries for raw materials (e.g. iron ore to make steel;  crude oil to refine into fuels, plastics and other products;  food to supplement what its own farms produce;  etc.).  Nations around the world, ranging from First World economies such as Australia's to Third World countries such as Zambia or Tanzania, ramp up production in order to respond to Chinese demand and earn valuable foreign exchange for their own economies.  In the process, governments and corporations spend billions (and often incur billions in debt) to open new facilities and/or expand existing ones (e.g. factories, mines, etc.), and extend their infrastructure (e.g. railways, roads and harbors) to be able to get their newly-produced goods to the Chinese market.

Now, as Chinese demand contracts in line with that country's economic downturn, suddenly its need for raw materials also contracts.  In fact, the latter contracts more than the former, because China has already built up huge stockpiles of raw materials and strategic commodities.  When money is tight, companies aren't going to spend it on bringing in yet more supplies - they're going to consume what they've already bought and paid for, and replace their stockpiles with just enough to keep production running at its now-reduced levels.  That means an even further reduced demand.  Countries that had ramped up production and invested billions in expanded infrastructure now suddenly find that they can't sell enough to pay off the debts incurred in the process - but the international banks and financiers who lent that money aren't interested in excuses.  They're hard-nosed businessmen.  They want their money on time, in full.

That also impacts national governments.  In many cases budgets and infrastructure expenditure were pegged to the rising taxation income generated by the export boom.  As exports collapse, so does the income they used to generate - but the projects being built on the strength of that income are still there, and in many cases haven't yet been completed.  If a bridge is half-built, you can't just abandon it.  What's already been built will deteriorate over time, and may have to be torn out and replaced by the time money's available to restart the project, adding to its cost.  On the other hand, if the government decides to complete it so as not to waste what's already been spent, where's the rest of the construction budget to come from?  Is it worth taking out more loans to finance the project?  If so, where's the money to come from to repay those loans?

We saw above how the contraction in Chinese demand is affecting Singapore.  Here's how that boom-and-bust cycle has affected Australia.

Australia is the world’s 13th largest economy this year and is home to only 0.3% of the world’s population, according to the Australian Trade Commission’s latest Benchmark Report.

However, the nation’s economic growth has been inextricably linked to China’s resources demand for nearly 20 years, creating the longest boom in history of Australia’s terms of trade – a measure of the value of iron ore, coal and other exports.

“Australia’s terms of trade got to levels we hadn’t seen for 140 or 150 years, and that’s one of the reasons why the GFC barely touched the sides here,” said Steve Miller, BlackRock investment strategist, of Australia’s economic resilience during the global financial crisis.

He said the reversal of Australia’s trade fortunes has been much sharper than expected and the swift pace of declines was expected to continue into 2016.

China’s reduced demand for iron ore amid a glut of supply has driven the market price of high-quality iron ore more than 60% lower since the beginning of 2014.

The glut was the result of lower cost miners ... increasing production to ratchet up the pressure on smaller, high-cost producers.

“Between 2010 and 2013, the iron ore price averaged US$140 per tonne. Now it’s US$50,” Miller said.

“The income shock [for Australia] implied by that is pretty severe,” he said.

Worrying signs have emerged across the market. S&P recently lowered its iron ore price forecasts and said it was monitoring eight of the world’s largest iron ore producers for possible credit downgrades, including BHP, Rio and Fortescue Metals Group (ASX: FMG).

Australia’s number four producer Atlas Iron Group (ASX: AGO) announced a suspension of all mining activities, prompting several mining services companies to make announcements of their own.

Meanwhile, Treasurer Joe Hockey has said the upcoming federal budget forecast could contain an iron ore price as low as US$35 a tonne, which would lead the government to write off $25bn in revenue over four years.

. . .

It’s hard not to long for the halcyon days when Australia was one of only about four countries in the world that had what a rapidly expanding China needed.

“We lived through a once-in-100-year boom where one-seventh of the world’s population went from being impoverished to having purchasing power,” Slater said.

Asked whether Australia’s adjustment to life after the mining boom would bring some short-term pain, Slater said, “No no. I think it’s medium-term pain.”

Again, more at the link.

Nor do the problems affect only nations.  The transport infrastructure built up to service global trade is also feeling the pinch, from ships to aircraft to railways to trucks.

According to the Wall Street Journal, the container-freight rates on the Asia-to-Europe route have sunk like rocks and are now below the cost of fuel. And that doesn’t even include all the other fixed and variable costs.

The Shanghai Containerized Freight Index—the cost of shipping a container from Shanghai to Rotterdam—fell to $243 per TEU (twenty foot equivalent unit), a new all-time low and below the cost of fuel, estimated to be $300 per TEU.

That’s right: For every container an Asia-to-Europe ship transports, it will lose $57. Ouch!

There are a lot more costs to operating a ship than just fuel, which is estimated to account for 40% of operating costs. Drewry Maritime Research estimates that the break-even rate for most container ships is $800 per TEU on that route.

Global demand is weak, but the real culprit is a massive increase in the number of container ships that have come online, mostly ULCSs (Ultra Large Container Ships).

. . .

“Unless by a miracle demand grows, we are up for heavy losses in the next quarter and maybe the rest of 2015,” moaned one industry executive.

. . .

Truck and rail are the dominant forms for moving freight in the United States and are crucial parts of the US economy. Billions of dollars of freight is transported across our nation’s highways and railroads every day. In fact, roughly 90% of the value of all goods moved in the US is transported by trucks and trains.

Especially by trucks. In 2014, trucks hauled just under 10 billion tons of freight and collected $700.4 billion, or 80% of total revenue earned by all transport modes.

That’s why I pay close attention to what the American Trucking Associations (ATA) has to say about the state of its industry, and according to the ATA, business isn’t very good.

The association reported that its For-Hire Truck Tonnage Index, which represents the actual tonnage hauled by trucks, fell 3% in April (most recent reporting period) and is definitely trending down.

“Like most economic indicators, truck tonnage was soft in April,” said ATA Chief Economist Bob Costello. Yes, the April numbers were down, but the above chart clearly shows that truck shipments have been down all of 2015.

More at the link.

All these problems around the world end up affecting the US economy, too.  Don't forget that many of the world's leading financial institutions are either American, or are heavily invested in the US market.  As they're put under pressure by under-performing loans, made to countries and companies suddenly impacted by the Chinese economic slowdown, their problems are reflected into the US economy as well.  Such banks' operations cross national boundaries.  If a major debtor nation or company defaults on payment, it's not only the bank's operations in that country that suffer - it affects that bank in every country where it operates.  If one major debtor defaults or must renegotiate terms, the money that would have come from them is no longer available to help the bank's customers in other areas.  Furthermore, banks often join together in consortia to finance big projects, or make loans to nation states.  If one bank in a consortium finds itself in difficulties, the others can usually be expected to 'pick up the slack' - but what happens if more than one bank runs into problems?  What if it's half of them, or - heaven forbid - all of them?  What happens to the consortium then, and to the loans it's granted or the investments it's made?

China's stock market woes are no more than a reflection of pressures and problems in its national economy.  Those issues have not yet been satisfactorily addressed;  in fact, given the structural problems affecting China, it may not be possible to satisfactorily address them.  The future is far from clear.  As noted above, at the end of last year it was estimated that China had been generating almost two-fifths of all growth in the world economy.  If that two-fifths of world growth is cut back or removed entirely, we're all going to be hurting very badly.


1 comment:

Don RN said...

Excellent essay. Much food for thought and reason for concern.