Tags
Australia, Black Swan, China, Chinese Exports, Chinese Government, Chinese Imports, coal imports, Cooking Oil, Cost Push Inflation, expectations of inflation, food crisis, Grey Swan, Inflation
The Chinese economy is heading toward an economic hard landing; it will overshoot to the downside and become the economic Black Swan event of 2011-2012. Inflation, yes both types, will be the story in China in the coming months.
The steps necessary for an economic black swan landing have all happened, what is next is just the crash landing. The rains in Australia have cemented China’s economic slowdown. The rains will have longer lasting implications for both economies.
- China is about to have its steel mills shut down due to a lack of available high BTU coal. This has always been the weak link in the Chinese export model. A reliance on imported raw commodities.
- China is about to have its electrical grid under perform during the peak winter months as it uses Australian high-grade coal to “sweeten” local Chinese sourced low-grade low BTU coal for their power plants. While these plants will work using the local coal, they will not produce the same Megawatt load they did.
- China will have to import emergency supplies of Diesel to help the local factories to continue to run on their own independently powered generators.
- China will end up paying at least 100% increase in high-grade coal prices, year over year. This will have to be pushed into their cost structure, it is too large to absorb.
The Chinese are going to be shopping the worlds markets for any available coal with BTU content higher than their own average domestic coal. They have no choices. They are going to be buying coal from the US east coast terminals in size before this is over.
The need to import high-grade coal ore & iron ore are the two Achilles heel of their export based economy. China is going to be pushing up coal prices around the world, making locally sourced steel profitable again in the US.
The Chinese are also looking at an increase in iron ore, the primary input for steel mills. Vale has raised rates by 8.8% for the 1st Quarter of 2011. BHP is reported to have raised rates by 40% this year. In the future, BHP is now negotiating quarterly rates. The inflation in iron ore for the 1st Q of 2011 is reported to be 7% higher than last Q2010.
The last time that Australian coal fields were flooded, the price of high grade coal reached $300 per ton. The price for Australian coal for 1st quarter 2011 was $225 per ton, and this was before Force Majeure was declared. It was an increase of 75% over the price negotiated in March 2010.
The new flooding is going to push prices of high-grade coal to $300+ this time. The flooding is more extensive, with the damage to the local Australian infrastructure worse this time. This is not going to be a quick or easy repair job in Queensland. This is going to be a longer lasting event than the main stream media is giving it.
In simple terms, there are two types of inflation.
- There is cost push inflation where a producer is able to increase prices, because of an increase in raw costs.
- There is the expectation of inflation type. This is the source of all past hyperinflationary events!
The second type is the dangerous type. Expectations of inflation infected the US economy when Paul Volcker took charge of the US Federal Reserve. He raised interest rates in the US, until he killed the expectation that there would inflation. It was a gutsy call at the time, and is what provided the fuel for the historic bull market of 1982 -2000 to grow.
Today, the media pundits are talking about a slowdown to the mid-single digits because of Chinese government attempts to slow down inflation, or said better the expectations of inflation. It is the second type of inflation that the Chinese leaders fear.
Once it’s infected a nation’s population, it does not go silently away. It takes Volcker type actions to stop it dead in its tracks. To do that, China would have to put their economy into a negative growth period, something they can’t afford to do.
The Chinese manufacturing base is not going to able to absorb the inflation, and will have to use cost push inflation at this point. This should boost the nations with steel export capacity, and locally sourced coal. The US steel industry, with locally sourced iron ore and coal, is going to be competitive again.
This is going to push expectations of inflation into the China economy as hard import costs continue to rise in a slow global economy. Their ability to continue to raise the Yuan against the US Dollar will be further stressed. Let the Yuan rise, and watch all competitive edge bleed away, or stay fixed and watch inflation rage internally through their economy.
The ongoing economic war between the US & China is driving up the cost of food for the average Chinese citizen. This will hit the Chinese hard, as they import a food staples for a growing middle class. There are already reports that basic food staples are more expensive on an equal basis in the US, compared to US food supermarkets.
“On a recent Friday, the balding 33-year-old, who runs a breakfast stand with his wife, wheeled a shopping cart into the aisle of a C.P. Lotus Corp. superstore in northern Shanghai, eying only prices. In seconds, his wife emptied the shelves of its 11 remaining bottles of Cofco Ltd. “Five Lakes” soybean oil, the discount choice at 47.90 yuan, or about $7.20, for five liters (1.32 gallons).
At the checkout, Mr. Liu separated their $79 purchase into three batches to sidestep the store’s four-bottle maximum and government bans on hoarding. To transport the provisions to their food stand, Mr. Liu placed two bottles into the basket of his blue electric scooter and balanced nine more on the running board. His wife plopped on back.
Mr. Liu’s livelihood is now just as precariously balanced. He reckons his cooking-oil costs shot up 27% in 2010.”
WSJ
The Chinese have exported deflation to the US for the last decade. The US for the last few years using Q.E. has exported inflation to China. This two-way exchange is now hitting the Chinese consumer in the wallet. It is affecting their ability to put expected food staples on the table at dinner time. This is also about the only way you can destabilize the Chinese government. The implications of that are farther reaching then this article…
Jack, your writings have tremendous value to me. Whether or not you are right, it is unbelievable eye-opening to read how you connect the dots, macro with micro, theory with practice etc.
I was wondering if you had any suggestions for a beginner who aspires to take this kind of approach? I mean what books should I read, what kind of news, which blogs shall I follow?
Many thanks and keep up the fantastic work!
Andras,
Thank you for the kind words. I would read global macro news as much as you can stand, for years. Once you can see nations as nothing more than large corporations, things become easier to put into context.
For blogs to follow, I would suggest places like http://www.Zerohedge.org. International news is a great source for a view unlike what we normally are feed by American media sources. You want to do everything you can, to escape from media bias.
Edward Hugh is a great source of original thought… It is always nice to find an independent economist willing to share their original research. He is one.
Pingback: Viral Stash Financial News » Calling the need to import high-grade coal and iron ore China’s achilles heel, Jack Barnes sees a Black Swan in the Aussie floods … the restriction in coal supply creating an even greater wave of inflation, p
Thanks, Jack, for the great article! Echoing what the previous commenter said, you did a great job of tying together the US and Chinese monetary policies, inflation, and the tipping point, in your view, of Australian flooding and energy prices.
For me, the question is what the outcome of this increased inflation and run-up in input prices will be — if China decides to let the yuan float (which I don’t see happening, but I’m certainly no expert) would the higher prices on US imports from China put the US into another recession? And if try to curb inflation domestically by raising rates etc, what kinds of effects do you predict will arise? Do you see the current events as a precursor to another global recession?
Thanks again for your insight.
Eric,
I would expect that by 2012 we are hearing stories about factories being relocated. Contract production facilities have no loyalty. That works too ways. I would expect that as the cost of core commodities rise, from rare earths used in technology to basic raw coal and iron ore, China will find it is competition with Vietnam, India, and soon Africa.
The US does not rely on Chinese imports of our products, so I see China being hurt from all sides. They have been pouring funds into propping up European bonds lately. These bonds are going to blow up in their face. At some point, China is going to find themselves financially hurting in ways people dont expect. Here is an example… China sent its 4 largest banks on an international road trip to raise capital. Each bank was trying to raise between 5-20 Billion in fresh western capital. WHY? The implications to me is that Chinese banks are still as bad as they were 5-8 years ago, but now China can’t hide the bad leveraged debts.
Pingback: Delusional Economics: Death of manufacturing and the beer economy, Qld floods and China, | manubiz
Helpful tips! I have been browsing for things similar to this for some time these days. Thank you!
Interesting and insightful article Jack. Well, what do you think about the chances and potential success of the gov’t instituting income policies to help curb inflation? In theory, it should work given the presence of monopolies, oligopolies and nationalized industries correct?
The US tried price quota’s in the early 70′s and that helped to fuel some of the issues later in the decade. I am not a fan of government instituted policies to correct social ills. They tend to have repercussions worse than the ill.
I’m glad to hear you are optimistic for other emerging markets / the US even in the event of a large crash in China. I would hate to see a second, China-triggered global recession just as we emerge from the first (and as I graduate from college & enter the workforce!)
Interesting note about Chinese banks — do you foresee a credit collapse / general ‘failure’ (for lack of a better word) of the chinese financial sector along the lines of what happened in the US when banks were over-leveraged?
Eric,
Markets move in multi -year cycles. Check into the average life of a bull market, or bear market in real estate. They tend to be 7 year moves give or take. Commodity bull & bear markets are usually around 16-18 years each, which is realistically a generation.
A second way to view things, is that there is almost always some place where money is fleeing, some place where it is starting to arrive, and some place where it is already too HOT. You almost never have multi-regions in the world HOT at the same time.
There will always be some place where money is arriving at globally. The idea is to find the place where the party is just getting started, instead of being the last guy to the party.
Jack,
Thanks for the reply and comment on income policies in China. As to your last post, I agree, money moves (and moves really fast for the most part) and the key is to find where it’s headed before main stream media publicizes it. In the past, I’ve used ETFs and of course currency pairs as my guides. But nowadays, there’s an ETF for almost anything and everything which has created “noise” and my past strategy hasn’t been as good as it was before. I mean it’s still quite accurate but definitely not the success I’ve had in months/years past.
Would you have any advice as to better methods for a retail trader like myself?
I would trade less, and look for the pure trades. You can have an amazing year with only three trades, if that is all you needed. I would be looking for obvious future trends, before they become quit so obvious.
Since China coal is the topic, who is the largest exporter of coking coal via seaborne methods, that is not from Australia?
Pingback: Australia’s flooding to jam China’s steel industries? — Keith Fitz-Gerald's Blog
Jack,
Not my style to trade that less. I tried it before and I just wasn’t comfortable with it. I’d rather have the brokers take their commissions and me have lots of smaller positions.
As for coal, I believe it’s the US. And we have seen the jump on the coal names even prior to the Aussie floods. As a derivative, maybe look into the dry bulk shippers and rails (if those shipped to China are mined from the east coast).
Jeff,
I understand what you are saying, I can also say my personal best was during period of holding a small basket of stocks as they performed well.
The coal answer is a Canadian company.
It’s got to be TECK?
So much for a confident answer…LOL
Pingback: Reading List 1.6.2011–Bill Gross Vigilante–Bernake the Trader–Interbank Stress in China
“Heavy rains have delayed trains, interrupting deliveries of coal from mines operated by Xstrata Plc, the biggest thermal coal exporter, and BHP Billiton Ltd. to South Africa’s Richards Bay Coal Terminal. About 20,000 hectares (49,200 acres) of agricultural land have been swamped, the Johannesburg-based South African Press Association cited Agriculture Minister Tina Joemat-Pettersson as saying.
The government is due to hold a press briefing at 1:30 p.m. local time, when it will probably declare some of the flood- affected areas disaster zones.
The floods have hit the Gauteng region, which includes Johannesburg and the capital, Pretoria, the Northern Province, KwaZulu-Natal, the Limpopo province. In December, most of the country had more than double the normal volume of rain for the month, according to data on the South African Weather Service website.”
http://www.businessweek.com/news/2011-01-17/south-africa-says-flood-death-toll-rises-to-40.html
Clara,
Thank you for this, I had missed the news about South Africa being affected by the rains. I should be be surprised since Brazil and Australia both are being impacted. This appears to suggest that both Coking and now Thermal Coal supplies for export are being constrained, at the same time that the Southern Bread Basket is being flooded.