More signs the deflationary spiral is upon us

11 11 2015

I’m feeling poorly this morning, the victim of some bug apparently doing the rounds in my neck of the woods. Ute I is having minor repairs done to pass the safety certificate it needs to have its new shiny Tassie plates screwed to its bumper bars, so I’m taking the time to do a bit more blogging.

This scary item from Zerohedge turned up in my inbox the other day, and it really rattled my cage…….  All the ducks are lining up on the wall… I better start spending the proceeds from selling Mon Abri quick smart.

It’s no secret that Beijing has an excess capacity problem.

Indeed, the idea that a yearslong industrial buildup intended to support

i) the expansion of the smokestack economy,

ii) a real estate boom, and

iii) robust worldwide demand ultimately served to create a supply glut in China is one of the key narratives when it comes to analyzing the global macro picture.

That, combined with ZIRP’s uncanny ability to keep uneconomic producers in business, has served to drive down commodity prices the world over, imperiling many an emerging market and driving a bevy of drillers, diggers, and pumpers to the brink of insolvency.

As we noted late last month, if you want to get a read on just how acute the situation truly is, look no further than China’s “ghost cities”…

Here’s the simple, straightforward assessment from the deputy head of the China Iron & Steel Association:

“Production cuts are slower than the contraction in demand, therefore oversupply is worsening. Although China has cut interest rates many times recently, steel mills said their funding costs have actually gone up.”

To which we said, “meet the deflationary commodity cycle in all its glory”:

China’s mills — which produce about half of worldwide output — are battling against oversupply and sinking prices as local consumption shrinks for the first time in a generation amid a property-led slowdown. The fallout from the steelmakers’ struggles is hurting iron ore prices and boosting trade tensions as mills seek to sell their surplus overseas.Shanghai Baosteel Group Corp. forecast last week that China’s steel production may eventually shrink 20 percent, matching the experience seen in the U.S. and elsewhere.

“China’s steel demand evaporated at unprecedented speed as the nation’s economic growth slowed,” Zhu said. “As demand quickly contracted, steel mills are lowering prices in competition to get contracts.”

Right. Well actually there’s that, and the fact that they can’t get loans despite multiple RRR cuts and attempts on Beijing’s part to boost China’s credit impulse. In fact, over half the debtors in China’s commodity space are generating so little cash, they can’t even cover their interest payments.

So, considering all of the above, the obvious implication is that China will simply export its deflation…

Given that, it shouldn’t come as any surprise that on Friday, the world’s biggest steelmaker suspended its dividend and cut its outlook.

Here’s more from Bloomberg:

The world’s biggest steelmaker on Friday cut its full-year profit target and suspended its dividend, putting the blame on the flood of cheap steel from China’s loss-making mills. The market is being overwhelmed with material coming from the nation’s state-owned and state-supported producers, a collection of industry associations said Thursday.

“It is obvious that we are operating in a very challenging market,” Chief Financial Officer Aditya Mittal said on a call with reporters. “This is essentially the result of very low export prices out of China that are impacting prices worldwide.”

The steel industry has been roiled by the slowest economic growth in two decades in China, the biggest consumer.

The flood of cheap exports from the nation has drawn complaints from Europe and the U.S. that the shipments are unfair. Bloomberg Intelligence estimates Chinese steel shipments overseas will exceed 100 million metric tons this year, more than the combined output of Europe’s top four producing countries.

While demand for steel in the company’s largest markets of the U.S. and Europe is recovering, producers’ profits are being hit by slumping prices because China has been pushing excess supply onto the world market as its economy slows.

So again, we’re seeing disinflation (the exact opposite of what DM central bankers intended when they decided to expand their balance sheets into the trillions) as global growth and trade enters a new era, characterized by a systemic slump in demand. Here’s the damage in terms of the Arcelor’s equity:

And here’s more from The New York Times on the impact of Chinese “dumping:

“The Chinese are dumping in our core markets,” Mr. Mittal said. “The question is how long the Chinese will continue to export below their cost.”

The company’s loss for the period compared with a $22 million profit for last year’s third quarter.

ArcelorMittal, which is based in Luxembourg, also sharply cut its projection for 2015 earnings before interest, taxes, depreciation and amortization — the main measure of a steel company’s finances. The new estimate is $5.2 billion to $5.4 billion, down from the previous projection of $6 billion to $7 billion.

On a call with reporters, Aditya Mittal, Mr. Mittal’s son and the company’s chief financial officer, said that a flood of low-price Chinese exports was the biggest challenge for ArcelorMittal in the European and North American markets.

The company estimates that Chinese steel exports this year will reach 110 million metric tons, compared with 94 million tons last year and 63 million tons in 2013. ArcelorMittal produced 93 million metric tons of steel in 2014.

Of course when the standing government policy is to roll over bad debt and avoid SOE defaults at all costs, uneconomic producers can and will continue to produce. This means the deflationary impulse ArcelorMittal cites isn’t likely to dissipate anytime soon, and on that note we close with what we said just a week ago:

The cherry on top is that China itself is now trapped: it simply can’t afford to let anyone default, as one bankruptcy would cascade across the entire bond market and wipe out countless corporations leaving millions of angry Chinese workers unemployed, and is therefore forced to keep bailing out insolvent companies over and over. By doing so, it is adding even more deflationary capacity and even more production into the market, which leads to even lower prices, and even greater bailouts! In short: this is a deflationary toxic spiral.

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6 responses

11 11 2015
davekimble3

And since China produces half of the world’s steel, the impact on other steel producers is horrendous. Major British steel producer Caparo Industries went into administration last month, and yesterday the CEO and major partner of Caparo Group, billionaire Angad Paul, fell to his death off a tall building.

US billionaires are repatriating their money out of foreign-based industries and converting it back to Dollars, pushing the Dollar Index to 99.19 from 80 in mid-2014. This makes US exports more expensive and imports cheaper, which does nothing for US industry. US corporations can’t see how to make a profit, so they borrow more cheap money and spend it on share buybacks and mergers.

Those trying to make money by shorting the stock market and suffered 3 “epic short squeezes” in the last 3 weeks – sudden plunges in bonds, gold, silver and oil, coupled with a massive buying splurge on shares, presumably organised by the Fed. And the Fed still pretends that they are going to RAISE interest rates in the face of all this.

11 11 2015
MargfromTassie

Mike, how long do you think it will be before your house is built? Yes, the ducks may be lining up, but I personally don’t think another major crisis will occur until at least the end of next year or in early 2017.

11 11 2015
Mike

I can’t see it happening before 12 months to be honest…….

11 11 2015
John Doyle

I think that money is not going to be the major issue with the economy. It will be resources. Money and debt allow us to consume today what otherwise would be tomorrow. This shortens the time to resource depletion. It will only take one resource that is essential for Liebig’s Law to show that we are stuffed.

The Chinese government is monetary sovereign. It has, as Philip Lawn says,a “bottomless pit” from which to draw money. So it could, more than theoretically, just pull down all the empty cities, and rebuild them again, new.
It’s aim is to keep people in work, so they can and likely will just repeat jobs over and over. Eventually resource scarcity will stop it but not before.

11 11 2015
Mike

I would not be so sure. As Nicole Foss reminds us, during the last depression, the world had virgin continents’ worth of resources, but not the money to make the most of them. When you break the operating system and the money lubricant disappears, everything grinds to a halt.

15 11 2015
kika

and china has now dropped its ‘one child’ policy, so even more unemployed people will be emerging – if they have any chance of growing to adulthood.

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