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Page added on January 14, 2016
China, Oil Show Peril of Faulty Assumptions
National home prices never go down.
Eurozone countries don’t default.
Saudi Arabia won’t let the price of oil crash.
China’s demand for raw materials is infinite.
These are some of the most cherished assumptions of investors and policy makers in the past decade, assumptions that have underpinned trillions of dollars of investment and debt. The U.S. housing bust and eurozone debt crisis demonstrated the havoc that comes when such assumptions are proven wrong.
Something similar may be happening now. A pronounced slowing in China’s industrial sector and a steep drop in oil prices have taken investors, business and policy makers by surprise. That doesn’t mean a crisis or recession are in the cards. But it could mean the U.S. economy and markets will take a bigger hit than the relative importance of either China or oil can explain.
Exports to China constitute less than 1% of U.S. annual gross domestic product. The U.S. is also a net importer of oil, so a fall in oil prices should be positive.
Yet, some economists estimate, in the fourth quarter of 2015 the U.S. economy grew only about 0.5% at an annual rate. Manufacturing may already be in recession: For two months the Institute for Supply Management’s index of factory purchasing managers has been below 50, the line between expansion and contraction.
At Tuesday’s close, the overall U.S. stock market is down nearly 10% from its high, while the Dow Jones Transportation Average and the Russell 2000 index of small company shares, both of which are sensitive to economic momentum, are down 24% and 19%, respectively.
Blame this on how dramatically sentiment has changed.
China is the world’s biggest consumer of many commodities; through October 2015 it accounted for around half of the world’s consumption of aluminum, copper, nickel and zinc, according to BCA Research, an investment advisory firm. As recently as 2012, the International Monetary Fund predicted China would grow an average of 8.6% a year from 2015 through 2017. That outlook led many suppliers to invest in added capacity, assuming China’s appetite would grow indefinitely.
What they didn’t appreciate was that China’s own leaders had concluded that that growth, driven by excessive borrowing, was unsustainable. China grew an estimated 7% last year, and the government’s informal target is just 6.5% this year, a figure many private economists consider too high. Moreover, the economy’s most commodity-hungry sectors—heavy industry and construction—have led the slowdown.
“Resource development spending was based on a linear extrapolation of demand from China, which has just proven far too optimistic,” says Jason Thomas, director of research at Carlyle Group, a private-equity firm.
ENLARGE The U.S. didn’t sell many commodities directly to China, but it sold things to countries that did. Their growth has slumped along with commodity prices, and capital has fled, driving down their currencies and pushing up the dollar, creating headwinds to U.S. exports.
The reversal of sentiment on oil has been even more dramatic. From 2011 through early 2014, Brent oil was almost always above $100 per barrel. “You had the illusion that it was sustainable because volatility was very low,” says Paul Cheng, an analyst at Barclays. “In early 2014, the general assumption by industry was that it can’t drop below $90 because Saudi Arabia would defend it.”
That fueled a boom in projects premised on oil between $80 to $100, and in loans and bond issues that valued the companies’ reserves at $80 to $100 per barrel. Mr. Thomas estimates that energy accounted for two-thirds of the rise in total U.S. industrial capacity between 2009 and 2014.
But in late 2014, Saudi Arabia stopped defending that price and ramped up production to claw back market share from the U.S. Shale production in the U.S. has been slow to decline but investment has collapsed.
Indeed, while U.S. auto production rose last year to meet consumer demand for gas-guzzling light trucks, Mr. Thomas notes that was more than offset by a collapse in orders for machined parts, precision tools, engines, transmissions, pumps and other “intermediate” goods for the global commodity production chain. Many companies earlier in the chain didn’t realize how exposed they were to the commodity bust.
The selloff has spilled into the financial system. Yields on bonds of energy companies have shot up and smaller banks are announcing significant reserves against lending to energy companies. The stress has spread to other borrowers: Yields on bonds issued by nonenergy companies have risen to 7.7% from 5.3% in mid-2014.
“Credit-market shocks of the sort triggered by the commodity-price collapse can prove quite damaging to broader economic conditions,” Mr. Thomas says.
How bad will it get? Because output per worker is much higher in manufacturing and mining than in services, the pullback in those sectors affects GDP more than employment. Indeed, overall job growth and demand for services so far remain buoyant.
China’s growth appears to have steadied. So absent even more contagion, the U.S. seems likely to escape a recession. Even so, this year will likely provide another object lesson in taking trends for granted.
72 Comments on "China, Oil Show Peril of Faulty Assumptions"
Davy on Fri, 15th Jan 2016 10:43 am
Greg, who are you to judge who has a message and who doesn’t. Get a life and grow up.
GregT on Fri, 15th Jan 2016 10:45 am
“Do something of use instead of name calling. Go volunteer for the senior citizens. Be a good citizen. You are always a big talker maybe practicing what you preach would be good for you.”
You have absolutely no idea what I am involved in Davy. A personal attack that has no bearing on reality. Your anger management issues on the other hand, are crystal clear.
twocats on Fri, 15th Jan 2016 10:46 am
Davy, yeah Boat is pretty much useless. Every now and again he has almost a good thought, but almost always misses the mark. I can’t tell whether he’s just a kid, maybe 14, a paid troll by energy companies (or maybe an unpaid intern), or a kept houseboy.
GregT on Fri, 15th Jan 2016 10:48 am
“Greg, who are you to judge who has a message and who doesn’t. Get a life and grow up.”
Boat is delusional Davy, and is in an extreme state of denial. You haven’t been able to figure that out yet?
twocats on Fri, 15th Jan 2016 10:58 am
http://www.zerohedge.com/news/2016-01-15/worlds-largest-miner-books-massive-72-billion-writedown-us-shale-assets
Dudley just floated today that the Fed is considering a rate cut. That was fast. Yes, we are in the middle of the swamp, there’s really no reason to even entertain the notion that things are going well (basically anything Boat says), now is the time to survey the horror. enjoy!
GregT on Fri, 15th Jan 2016 11:02 am
twocats,
Boat, like several others here, believes that he is arguing against the ‘doomers’. He doesn’t appear to understand that none of us are particularly stoked about what is occurring, or why. He has even said that he believes that the ‘doomers’ are looking forward to the end of modern industrial society. Which is of course, completely ridiculous. The way I see it there are three distinctly different groups of people in this world. Optimists, pessimists, and realists. Often times optimists are really pessimists in denial, thus the reason for lashing out against the realists. Some people cannot get out of the way of their own emotions, and fear is a very powerful human emotional response.
twocats on Fri, 15th Jan 2016 11:05 am
from the article:
“Tokyo Gas Co said on Friday it expects to book 10.6 billion yen ($90 million) in impairment losses on its Texas shale gas development project in the October-December quarter, reflecting the recent steep declines in oil and gas prices. The company, Japan’s biggest city gas supplier, said it was reassessing earnings projections for the business year ending March and would announce them as soon as that becomes available.”
This is a great example of how contagion spreads. What the fuck is a public utility in Japan doing investing in Texas shale? But you don’t need to tell Japan how important it is to secure plentiful oil & gas supplies.
Davy on Fri, 15th Jan 2016 11:09 am
That’s fine Greg, you can show some manners and a code of conduct with a message. You treat people constantly with a “holier than thou” BS. It gets old hearing your same old labels and attacks. Say something constructive and show some respect.
twocats on Fri, 15th Jan 2016 11:15 am
Hey GregT,
It doesn’t really matter to me what Boat’s personal motives or projections are. Like you’ve said many times facts are the important thing (but even facts need to be interpreted into a context of understanding). His ability to gauge and register events is extremely poor. This whole “end of modern industrial society” is work for those that are see risk before reward, who consider the negative potential outcomes. It’s not a left/right, it’s a down/up. Whether recognizing these types of events triggers your dopamine or anxiety centers is irrelevant. It’s like magic-eye, you can either see it or you can’t. He’s talking an entirely different language, the language of most people on the planet by the way.
GregT on Fri, 15th Jan 2016 11:18 am
“You treat people constantly with a “holier than thou” BS.”
My shit stinks just as much as anybody else’s Davy. I don’t believe for one second that I am holier than anybody else. I’m only interested in the truth, nothing more, nothing less.
GregT on Fri, 15th Jan 2016 11:25 am
“He’s talking an entirely different language, the language of most people on the planet by the way.”
Completely agree twocats. Boat is among the vast majority. Denial is also a very powerful human emotional response. Anybody that has gotten this far to acceptance has experienced denial, I know myself, that I still do from time to time. It’s really difficult to accept what I see unfolding in front of me, but painfully obvious at the same time.
Revi on Fri, 15th Jan 2016 12:19 pm
I went through the denial phase a long time ago. I bought a big truck and pretended that it didn’t matter. Then I got through that phase and moved into the bargaining, where I thought that doing things like installing solar panels and building electric cars was going to save us. Eventually after a lot of depression I have arrived at acceptance. I think…
GregT on Fri, 15th Jan 2016 1:46 pm
Different people go through the stages differently Revi. I experienced bouts of depression first, then I got pissed off, and after that I entered into the bargaining stage. While I have now reached acceptance, I still have days where I find myself in disbelief. Those days are becoming further apart though, as this shit storm gathers strength and continues to grow nearer.
onlooker on Fri, 15th Jan 2016 4:37 pm
I reached acceptance though the road was rocky to get there. Nothing like taking a deep breadth and knowing someday it will be your last. Father died recently and it bought this sense of the inevitable to a clearer starker focus.
BC on Fri, 15th Jan 2016 5:14 pm
https://research.stlouisfed.org/fred2/graph/fredgraph.png?g=39wo
https://www.youtube.com/watch?v=Fo4746XZgw8
https://www.youtube.com/watch?v=20Ov0cDPZy8
It won’t be reported for a while, but the US economy likely entered recession in Q2 2015.
Employment growth is being overstated by as much as 1% or more. Were payrolls to be actually growing at 1.9% against reported wage and salary disbursements, US real GDP would be growing 3.25-3.5% instead of the Q4 4-qtr. rate of ~1.7%, implying little or no growth of employment YoY.
https://www.youtube.com/watch?v=IrOqnZdvI6M
https://www.youtube.com/watch?v=Rag_9J1ZC2g
GregT and onlooker, thanks for sharing. I’ve been in a Gandalf- and Zen-like “natural state” of “no-mind” acceptance/resignation for half my adult life by now; but it doesn’t take half a life, just now . . . and then now . . . and now. 🙂
And so it goes . . .
Davy on Fri, 15th Jan 2016 5:29 pm
I have been a freak since I was in college. I have been telling people the awakening is coming for 30 years now. In 2003 I left the status quo world I was living in because I knew huge changes were coming. I could no longer live in a world I did not believe in and one that caused me spiritual pain. I have been a doomer ever since.
I am in complete acceptance now but with a surreal subconscious feeling from living in the status quo and out of it. Every day I think about what it will be like without things that we all take for granted. I came in from working on the farm just now and took my boots off. I thought to myself “self what are you going to do when your 3 different types of specialty boots are no longer replaceable? Little things like a good pair of boots makes life so much easier.
These and so many other little things will be gone. I think about my health and how in a matter of a few years if I have heart disease I may not be able to get a stint or pacemaker. These high tech items could be unavailable very quickly. The hardest acceptance has to be the thought that my kids may not have the opportunity to live out their full life or have a family. These are some of the many things I reflect on daily, weekly, and yearly.
BC on Fri, 15th Jan 2016 6:24 pm
Davy, yes, I’m sure most of us of “a certain age” and older can fully empathize. Thanks for sharing.
makati1 on Fri, 15th Jan 2016 7:09 pm
Onlooker, my dad passed a year after he visited me here in Manila. He was 88. But I listened to my grandfather plead to be allowed to die when he was in pain and bedridden due to two heart attacks in his 60s (WW1 Mustard gas destroyed a lung, putting extra stress on his heart). I was in my teens at the time. He was in pain most of seven years before he finally passed.
I learned early on that death is at any moment in our lives and accepted that fact. I am thankful for my 71 years and hope for many more, but if this is my last day, so be it. I will not know it happened. I am at peace with death.
As for modern world conditions, I went thru the stages of denial, etc, about five years ago and never looked back. Accepting reality is the best way to live and be happy. Stressing out about it or worrying what tomorrow will bring is what drives some to suicide. Others to drinking/drugs.
Most of America is on drugs/alcohol which is why I see the pain there being much worse than here. I see many still vocally and financially supporting the very system that is killing them. Is it stupidity? Brainwashing? Greed? Or all three?
Do I wish that things were truly as they are portrayed in the news? Upbeat with a shining future. Yes! I have had a very happy life and wish it would have continued for my kids and grands. Reality dictates differently. Much different and much worse, I suspect. Too bad.
Stevo on Sat, 16th Jan 2016 9:31 am
Greg is just a douche bag…..he thinks he knows everything and has it all figured out…but in the back of his mind he is really too old to make it very far as we sink in collapse and that makes him angry….His disconnect from reality showed when he crowed several months ago about how brilliant his kids are for going into the “engineering” field and making money and having “good paying jobs”!
It reminds me of the people on the oil drum who used to say when the collapse happens I am just going to sit back and watch…..”I have my pension”
Thinking that everything will be just fine for them….similiar to someone in Paris just before the Nazi invasion thinking that they can just watch the “movie” unfold…Greg I don’t give a sh45 how many fish you can catch! I live in your neighborhood and I know what it takes to survive in this environment and It ain’t going to be easy for a 60+ year old man!
Kenz300 on Sat, 16th Jan 2016 9:32 am
China is finally dealing with its pollution problems…… transitioning to wind and solar power production and electric vehicles
China to Increase Wind, Solar Power Capacity by 21 Percent in 2016 –
http://www.renewableenergyworld.com/articles/2016/01/china-to-increase-wind-solar-power-capacity-by-21-percent-in-2016.html
Apneaman on Sat, 16th Jan 2016 10:22 am
How is Asia doing on the plastic, Kenz?
5 countries spew more plastic into the oceans than the rest of the world together
http://www.globalpost.com/article/6718373/2016/01/11/asia-plastic-trash-ocean
Dead ocean = dead apes.
makati1 on Sat, 16th Jan 2016 6:20 pm
Ap, Certain parts of the Ps has passed laws banning plastic bags and extra plastic wrapping, Most things here that have plastic are Western brands of stuff and most of that is in the cities. Also, foam take-out boxes are no longer allowed, which made the fast food places like McDonalds, Wendys, KFC, Burger King, etc, upset. They had to switch to eco friendly cardboard.
Not to say that we don’t contribute to the plastic island in the Pacific, but I would say that the article is slanted toward a few places and does not include China where much of the plastics are made, in US owned factories, I bet.
I will say that plastics that can be recycled, are. You can see men carrying large bags of plastic bottles that they have salvaged from the trash along the street. It is an income for many here. But then, this IS the 3rd world. ^_^