The global economy has been collapsing for the last 2 years.
Demand for “stuff” has shrunk 10% since 2014, down to levels not seen since the recession. Just look at cargo shipments from two of the world’s largest ports.
The roots of the current global trade slowdown go back to China.
China’s emergence on the world stage precipitated a massive super-cycle of infrastructure building.
It spurred a global rush to supply the raw materials like steel and copper. Then suddenly the boom times stopped.
First came a halt to the infrastructure demand. In late 2013, the Chinese government announced a fiscal budget that held infrastructure spending flat. Still big spending (enormous actually), but not larger than the previous year. Almost immediately iron ore imports flattened.
Next, the People’s Bank of China (PBOC) attacked the credit bubble.
Easy money was inflating a real estate bubble. And commodities like iron were interwoven with real estate.
On the one hand, slower real estate development slowed demand for iron. On the other hand, iron ore was being used as collateral for real estate loans. Expecting a never-ending demand for iron and rising prices, companies were taking out loans and using the money to buy and stockpile iron. Then they turned around and used the iron as collateral for more loans.
This was very similar to a Ponzi scheme.
Then it fell apart – like they all do.
The gap between real demand and the artificially inflated demand was exposed. Worse, as the chart shows, factories were expanding production capacity based on expectations of future demand rising.
Demand was flat while new supply was coming online. So the Chinese factories began to dump the excess.
So the background of 2014-2016 has been excess supply caused by falling demand and rising supply. (Some pundits refer to it as Chinese exporting deflation.) The result has been falling prices for raw materials and a global industrial recession.
In China, pandemonium ensued. Companies began to default on loans. It was a Lehman moment unfolding. So the PBOC reversed gears and flooded the market with loans: in just 1 year, from June 2015 to June 2016, China’s M1 money supply was pumped up 35%. Nearly trillion added to the economy.
And it worked: the bubble was immediately re-inflated. Housing prices and iron ore imports have surged again.
Industrial Production has accelerated again. The game is back on.
Following the massive liquidity injection, the real-estate market came back to life. Like dominoes falling, the renewed demand has boosted prices. Suddenly iron and coal and copper prices are moving up.
The key point is that China is single-handedly responsible for the moves in commodity prices.
And the enabling factor is the PBOC version of QE.
It also means that there is an illusion of a bottom in the industrial recession. Thanks to the artificial stimulus, over the next 6 months, the industrial sector will look a little livelier. Higher prices will lead to more production and equipment orders and all that follows. But then the pattern will repeat again: excess supply followed by price deflation.
Desperate Times Ahead
Like China, the US economy is also slowing down. But unlike China, it lacks fiscal and monetary solutions.
Like China & the EU, US exports have collapsed to 2011 levels. Imports have fallen to 2014 levels.
But monetary ammunition has run out. And because the US lacks a coherent industrial policy, fiscal stimulus is difficult to enact in the best of times and practically impossible in an election year.
KEY POINT: Added together, we have a slowing global and US economy. Along the way, we can expect to see a slight bump in industrial activity thanks to targeted Chinese stimulus – aka M1 Supply. The only engine of growth is China. To know when the party ends, watch their M1 supply.