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Halloween And The Ghost Economy

Economics / US Economy Oct 19, 2012 - 10:56 AM GMT

By: Andrew_McKillop


Best Financial Markets Analysis ArticleGhost cities in China, ghost racetracks in Greece, ghost jobs and growth in America: Halloween is coming right on time. However, in the now intensely mythologized Euro Crisis, even the ghost of terminal crisis seems to be dying. Today, the Eurozone is running a bigger and bigger capital surplus simply because the economy collapsed. With it, there are impressive falls in imports of Donald Duck flashlights and other stuff from China. Even black oil imports from friendly Russia and Arab countries are declining: most recent YOY data for motor fuel demand in the Eurozone-17 group shows about 6.5% decline. Trade deficits can only decline - as in the USA.

The Ghost crisis has problems staying credible, at least in the daytime. Even nighttime sessions may soon also become difficult, and then impossible after the coming crash of commodity prices.

How can we have a nightmare economic crisis and runaway inflation without extreme and dangerous commodity prices? That's as bad as deflation happening instead of hyperinflation. Ben Bernanke is one believer even if you are not.

During the last decade, or longer, commodity producers were caught by (pleasant) surprise: surging demand. Their belated response was to ramp up production dramatically, but the well-known cycle lag and lead-time between investor intentions and new supply firstly prevented not enough new stuff being available, and then - for the next several years as the economy sags and crumbles - we will experience rapid growth in supply. What could be more liberal? The waste will be awesome, and end-of-chain suppliers, the last and biggest expanders of useless supply, will be the worst hit. The 1980s and 1990s version of this was called the Third World Debt Crisis: investment loans to massively expand hard commodity exports were impossible to repay.

Now called "China rebalancing" this even threatens world supply of non-strategic flashlights and carbon fiber bicycles (to strap on those 4WDs, demand for which is falling). For everybody, but starting with commodity producers, the length of time getting to understand what the "rebalancing" codeword means is another telltale sign of the sleepwalking mindset of corporate and political elites: great for ghost watching, but nothing else.

 Chinese rebalancing mostly and firstly threatens overpriced commodities and everything that goes with them. Understanding rebalancing first needs our acceptance that global demand growth of everything was phenomenal in the past twenty years, but in practice most of this surge occurred in the last decade, and was focused not exclusively but especially on China. Its economy and growth process was therefore incredibly unbalanced. Even the most exuberant of China bulls now recognize, China’s economic growth is slowing - and changing.

As China’s economy rebalances towards a more sustainable form of growth, this will automatically make Chinese growth much less commodity intensive. No matter if China was miraculously able to regain growth rates of 10-11% annually, its rebalanced economy will demand much less in the way of hard commodities. Energy amd materials intensity will decline, rapidly.

Very comparable with the microcosm of oil traders mulling crude stocks and product inventories,  surging Chinese hard commodity purchases, in the past few years, have not only supplied growing domestic industry needs but also rapidly growing inventory. The result is that inventory levels in China are now much too high to support real demand growth over the next few years: Chinese firms can in some cases be net sellers, not net buyers, of a "surprising" number of commodities.

This combination of factors – rising supply, shrinking demand, rising inventory overhang – all but guarantee that prices of hard commodities will collapse, that is suffer "severe correction". Certain key commodities, like oil, iron ore, rubber, copper will drop by 33% to 50% in the next 24 - 36 months.

Not everyone agrees. There is no problem finding what we can call "the orthodox view". Possibly Jim Rogers and Marc Faber still believe world demand for hard commodities can hold up right to the last bitter moment. Books are still being written which say the world is facing a "structural" commodity shortage crisis and prices will go on surging. However, this is being wise before the event: after the price correction event, commodity prices will stay low for several years thereafter.

Several key supplier countries are more than slightly committed to the past but not present, fast and furious China Growth Model. Countries like Australia, Peru and Brazil and commodity producer corporations operating in these countries, as three examples, have significantly overestimated the sustainability of the previous Chinese growth model. Until very recently, meaning past months, large-scale investment to expand production was the only game to play. Increasing numbers of producers have started acknowledging recent price declines, but they prefer to believe these can be short-lived and prices will rebound - - when Chinese demand returns.

We could take the example of iron ore price correction. Prices which were set at near $150 per ton in April 2012 slumped about 20% since July to around $104 per ton in Sept-Oct 2012, with major falls in a few days trading. Herd Analysts, counting exclusively on China, however still forecast that iron ore prices can rebound as high as $150. An example of the China-based thinking is the following Reuters report datelined 16 October:  "Rio Tinto, the world's No.2 iron ore miner, backed plans to lift production this year, saying its operations were running strong despite a volatile market caused by China's uncertain economic outlook. The output of iron ore from Australia, the world's biggest exporter, is being closely watched for clues on how weaker consumption of steel in China is hitting demand for industrial commodities".

At one and the same time a cause and result of previously surging commodity price growth on the back of surging demand growth, the very important role of overpriced oil - oil prices must be kept high - in maintaining Herd Faith in high commodity prices is itself now threatened. The threats are notably but in no way exclusively caused by decling demand growth in China and India - and simply because oil is so massively overpriced relative to any other source of energy.

As we know, and the World Bank/IMF knows, Chinese growth is declining. In fact China’s real GDP growth may very well be lower than claimed by the official numbers from its National Bureau of Statistics, which are for the least "party faithful". This is certainly what national electricity consumption numbers imply, oil import numbers imply, and a swath of so-called "anecdotal evidence" implies. Taking the surprise zero growth in YOY electricity demand: if China's real GDP, corrected for purchasing power parity is growing at the World Bank-IMF-National Bureau of Statistics rate of about 7.2% - 7.6% on an annual basis, zero growth of electricity consumption is a little hard to attribute only to "improving energy efficiency". The collapse of car sales growth from an annual rate of 32% in 2010, to 2.5% in 2011 and probably zero growth in 2012 is another indicator of what is really happening.

For outsiders, China rebalancing is presented as both magical and win-win for everybody, a painless process where China will go on sucking in commodities, turning them into industrial products and exporting them. Inside China rebalancing primarly means raising the consumption share of growth. Doing this needs household income growth from its present unprecedentedly low share of GDP, and this means China must increase wages, revalue the yuan - and raise interest rates to remunerate household savers, among others, instead of forcing households to pay borrowers to take their savings in the form of artificially low interest rates and deliberately under-reported and underestimated inflation.

To be sure and again from the outside, China seems to be doing the opposite, with relatively regular cuts in interest rates, twice in 2012, but this ignores the sharp and continuing decline of inflation - followed by declining prices for an increasing number of products. The real cost of borrowing is rising in China, and with it the real rate of investment growth will decline, a lot.

A major reason why many western or Japanese observers tend to view rebalancing as a good thing is they believe that in the short term, overall, rebalancing can increase the amount of global demand absorbed by China, through rising imports of goods and services, more than counterbalancing the hit to commodity prices caused by falling Chinese imports. The problem is firstly the timescale and duration of this "beneficial phase", and the end result of rebalancing which will be a fall in world demand - for everything - for some length of time. Rebalancing will inevitably and first result in falling prices for hard commodities, even if this will mostly hurt countries like Australia, South Africa, Peru or Brazil. The problems comes in the following phase of global decline of demand, before a probably long term but large "cyclic recovery".

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2012 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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