Saturday, 14 July 2012

The Good News Is . . . China's Slowing

“And now China's slowing, I don't see any spark for growth anywhere in the world,” lamented a friend last night. My friend is right to be worried, because he runs a string of listed mining companies. Which puts him in the same situation as Australians, Middle Eastern oil-producers and . . . virtually nobody else. For the rest of us, the fact that China is slowing is almost unreservedly good news. Unfortunately, our imaginations are so locked-in to the model that emerging markets growth is the only hope for the world, we cannot see what is plainly obvious.

China is the marginal buyer – the price setter – for every major commodity in the world. When China slows, commodity prices fall. When commodity prices fall:
  • households everywhere in the world (with the exceptions noted above) get an immediate boost to real incomes,
  • non-commodity producing countries get a lift in their terms of trade, and
  • corporates in those countries get some immediate relief from margin pressure.

All this is obvious, and is already showing up in the data.

In a global economy suffering from stagnant demand in over-leveraged developed economies, there could be no better news. Falling commodity prices are identical to an unexpected one-off bonus, or an income tax refund. Nominal incomes may be rising very slowly, if at all, but as gasoline prices fall, real incomes are boosted. That means either non-gasoline consumption can rise, or household balance sheets can be fixed faster without cutting into non-gasoline consumption.

But there's more. Don't imagine this works only for the West: these dynamics work as well inside China as elsewhere. Falling commodity prices, if passed on to the consumer, boost real household incomes there too. When China slows, the headline numbers tell us that China's imports growth slows sharply. And if China's import growth slows, doesn't that mean that Western hopes of exporting to China slow with it? Not at all: it means commodity-producers' hopes of exporting to China slow. If you are exporting goods or services to China's household sector, it's probably either a wash, or a modest positive (as Chinese household incomes, and corporate margins improve).

Now let's see how this is playing out in the data. The big shock of the week, and the one which unlocks the key to most of the rest of the week's data, was China's imports for June: they fell 8.6% mom – a fall 1.3SDs below seasonal historic trends which was sufficiently bad fully to reverse May's gains. China's imports fell because of collapsing commodities buying: in volume terms crude oil fell 14.8% mom (lowest volume since Dec); refined products fell 15.6% mom (lowest since Sept); iron ore fell 8.7% (lowest since April); copper fell 17.5% mom (lowest since Aug). By country, the biggest loser was Australia, down 17.5% mom.

(Withdrawal on this scale by the marginal buyer, if sustained, is most unlikely to be properly reflected in prices yet. We have yet to discover just how much untracked and undisclosed commodity inventories are meandering aimlessly around the world's oceans, sitting it out and waiting for an upturn before docking.)

But now let's look at the data outside China. First of all, let's look at terms of trade, where the story is unambiguous: 
  • US import prices fell 2.7% mom in June, whilst export prices fell 1.7% mom, so terms of trade rose 1% mom. Over the last three months US terms of trade have gained 2.2%.
  • Korean import prices fell 3.6% mom in June, whilst export prices fell 3.6%, so terms of trade rose 2% during June. In the three months to June they improved by 5.3%.
  • Taiwan import prices fell 2.2% mom in June, whilst export prices fell 0.7%, so Taiwan's terms of trade improved 1.6% mom. That takes the improvement over the last three months to 3.6%.
  • In Europe, the latest data we have is Germany's data for May: they show import prices down 0.7%, whilst export prices fell only 0.1%, so terms of trade rose 0.6%. Since March, however, they have now risen 1.3%, and we should expect a similar trajectory in June.
Improvement in the terms of trade in the short term (ie, before the change in relative prices affects other economic choices) a boost to trade balances, which in turn implies greater liquidity in the economy, and improved cashflows into the banking system (which turned up, for example, in China's June money data).

The same transfer in relative pricing power is also showing up in the change in producers and wholesalers prices, in a way which demonstrates the potential relief to operating margins:
  • In Japan, the Domestic Corporate Goods Price Index showed raw materials down 3.7% mom, but intermediates by 0.8%, and final goods down only 0.5%.
  • In S Korea, the PPI fell 1.4% mom, led by agricultural products. Outside those, however, chemical, petroluem and petrochemicals and basic metals fell most steeply, whilst electronics rose 0.5% mom and vehicles 0.4%.
  • In Taiwan, the WPI fell 1.2% mom, but with raw materials down 6.2%, intermediates up 0.1% and finished goods up 0.6%.
  • In Germany, the WPI fell 1.1% mom in June, and although the full data-set is not available, it is clear from what data is available that the fall was led by fuel costs.
  • In France, May's PPI fell 1.1%, mainly because of a 5.3% fall in coke and refined products, but prices of manufacturing products fell only 0.7%.
  • Even in inflation-prone Turkey, the PPI fell 1.5% mom in June, as crude petroleum /gas fell 8.6% mom and agriculturals fell 6.1%, whilst manufacturing goods prices fell only 0.75%.
  • In the US, the story is slightly different, in that most unexpectedly, the PPI did not deflate in June, but rather rose 0.1% mom. But even here the margins story is the same: crude goods fell 3.6% mom, intermediates fell 0.5%, and finished goods rose 0.1%.

So margins, cashflows and financial systems are getting relief from the falling commodity prices which the Chinese slowdown is precipitating.

But will this boost to the corporate and financial sectors also, crucially, be passed on to the household sector? By the end of 2011, gasoline and energy spending accounted for 4% of US household consumption, and almost certainly more in a Europe where – inexplicably, irresponsibly and regressively - government policies assume and usually encourage ever-rising real fuel prices. Rather than worry about the slowdown in China, Western economists should worry about Western governments not allowing the pricing benefits of that slowdown to pass to their household sectors. 

On current showing, such stupidity must class as the default setting.

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