…..AND WHY YOU NOW NEED MULTIPLE SCENARIOS
By John Richardson
FOR many, many years a small group of men who run China were viewed as uniquely competent because of the “economic miracle” that they had achieved. China’s 
approach to government was thus seen as much better than the chaotic mess that is usually democracy in the West, especially in the immediate aftermath of the Global Financial Crisis.
Far too many people stubbornly clung-on to this belief, right up until as late as July of this year, and in so doing delayed essential new thinking within their chemicals companies. “There is now a different group of men in charge who have changed direction, but they will still be successful. This means that we don’t have to change our forecasts for growth. All we instead have to do is accept that our numbers will be right for reasons different from from what we had expected,” was a common argument right up until July.
Next came the first wave of panic, which occurred after China’s early July stock market rout. People saw the failed government attempts to prop up the market as the first evidence of Chinese political incompetence that they had ever encountered. This was accompanied by the fear that the new “wealth effect” of rising equities had failed, and so this meant GDP growth would be lower than many people had expected.
But I think this analysis was wrong as a.) The failed attempt to prop-up the market was good news as it discredited the anti-reformers within the government and b.) There was simply never any way that equities could possibly represent a new broad-enough based “wealth effect” because of the small percentage of Chinese people who play in stocks. This was just mathematically impossible.
There was another wave of panic after the 11 August decision by China to change the Yuan’s trading band against the US dollar. “Oh my goodness, they are going for a competitive devaluation because GDP growth is collapsing,” was the form that this new panic took. This left some if not all Chinese officials scratching their heads, as they had long been told by Washington and the IMF to liberalise the way that the Yuan trades, and this is exactly what they had done.
This has been followed by a return to complacency amongst some people. They assume that because the Yuan is so far only down by around 2% against the US dollar since 11 August, this means that there will be no major competitive devaluation, meaning no big rise in China’s export and no global trade war. This is a wrong “single scenario” assumption for two reasons.
- China doesn’t need a big Yuan devaluation to hugely boost its export volumes if it so wants to. This is because it has vast supply chain advantages as a result of becoming the “workshop of the world”. Even though labour costs are going up, these supply chain advantages haven’t suddenly disappeared. Plus, it has big oversupply in many manufactured goods and in some chemicals and polymers that it could choose to export rather than shut down or merely run at low operating rates. Purified terephthalic acid is a great example of this as China has new, world scale capacities that it could choose to run harder than anticipated. So far this year, as the above chart indicates, we have seen a big increase in PTA exports with imports also substantially down. Further big increases in PTA exports may not happen, but it is a scenario you must consider – along with your “base case” assumptions. (And, indeed, it is important to stress that the ICIS Consulting base case assumptions for PTA is that local production and demand will pretty much balance out from now until 2025. Up until 2022, for instance, we see local operating rates as averaging below 80%. This is a very solid, carefully thought-through assumption. But you still must have different scenarios, which we can help build for you)
- Even if all Chinese officials are determined to avoid a major devaluation, they may lose control of events – and could thus be forced into a Yuan devaluation of 10% or more. In such an event, we could of course end up with a global trade and currency war. Unlikely? Perhaps, but you would be simply wrong not to also consider this as a scenario given recent events.
What all of this tells us is that China’s last generation of senior leaders got it very badly wrong because of course, surprise, surprise they were human. Human beings often make mistakes.
Now let’s not swing to the other extreme and assume that because economic reforms appear to have stumbled of late, China’s new leaders are uniquely incompetent – maybe almost as bad as some politicians in the West. Instead, they will also make mistakes and will sometimes take one step forward only to take two steps back.
The new “stimulus package” of more spending on railways should, for example. not be interpreted as two steps back, as I shall discuss in detail in my post tomorrow. This package is instead very positive news and gives us a pointer to what the New China will look like in the long term, and the new opportunities that this will create for the global chemicals business.