By John Mauldin, By Neil Howe,
I’ve been a bit slow in bringing good friend Neil Howe’s predictions for 2016 to your attention, but over the last couple weeks I have turned back to them more than once as Neil’s take on the year ahead has begun to look very prescient indeed.
In this New Year’s interview that Neil did with his firm, Saeculum Research, he wastes no time in telling us that he thinks expectations of several more Fed rate raises this year are “delusional,” because “The global economy is in no condition to take this medicine. My very safe prediction is that the Fed will either stall or back down.”
Bingo: after scaring the pants off everybody in the world last year with their hawkish talk of a persistently isolationist monetary policy, the Big Dogs of the FOMC have been yapping like toy fox terriers the past couple weeks, making sure everybody hears the message that “… we are closely monitoring global economic and financial developments and assessing their implications for the labor market and inflation, and for the balance of risks to the outlook” (Board of Governors Vice-Chairman Stanley Fischer, Feb. 1, 2016).
Neil doesn’t stop there. He reminds us that the world geopolitical situation is deteriorating, particularly in the Middle East, and that the US presidential race is a complete crapshoot. At this point, the interviewer chirps in with “You sound a bit more downbeat than most.” Well, says Neil,
If I’m coming in beneath the consensus forecast, it’s because – over the last decade – reality has been coming in beneath the consensus forecast….
[T]here do arise periods lasting ten years or more when the consensus forecast can veer consistently too high or too low. And over the last decade, it has veered too high. Each year since about 2005, forecasters have been predicting a rise in corporate earnings, in GDP, in inflation, in interest rates—in basically all of the vital growth metrics – that is substantially higher than what subsequently occurred. And I’m talking about every forecaster: the IMF, World Bank, Fed, ECB, OECD, and CBO, along with surveys of business economists….
Systematic overshooting by international institutions is leading some observers to talk about “an in-built ‘optimism bias.’”
Which leads the interviewer to quip, “I guess we can’t call it the dismal science anymore,” and to wonder at the reasons for the chronic boosterism.
“Oh, I know why it’s happening, says Neil,
The world has fundamentally shifted over the last decade, especially since we’ve emerged from the Great Recession. We are seeing slower demographic growth, overleveraging, a productivity slowdown, institutional distrust, policy gridlock, and geopolitical drift. But the professional class has been very slow to understand what is going on, not just quantitatively but qualitatively in a new generational configuration that I call the Fourth Turning. They don’t accept the new normal. They keep insisting, just two or three years out there on the horizon, that the old normal will return – in GDP growth, in housing starts, in global trade.
But it doesn’t return.
And with that, I think I’d better turn you over to Neil for the straight scoop on what is shaping up to be a watershed year. His message here is a very fundamental, very important one. I should also mention that in addition to his newsletters and research at his website, he is now available on the larger services at Hedgeye.com. He recently joined them as managing director to lead the investing research firm’s work in the demography sector. If you’d like to know how to access Neil and Hedgeye’s institutional research, you can email them at sales@hedgeye.com.
Oh, and for those of you who have registered for the upcoming Strategic Investment Conference, don’t forget that Neil will be with us. For the first time ever, he’ll be previewing his upcoming work, The First Turning. His book The Fourth Turning, published back in 1997, is familiar to many of my readers as one of the most significant books written in the past 25 years.
I was actually somewhat surprised that the conference sold out almost four months before it opens. I’ve never had that happen before. For those who didn’t jump on the registration bandwagon in time, we may possibly have a few slots open up, as there are always a few people who have to cancel at the last minute. You can go to the SIC 2016 website and register to be placed on our waiting list.)
Now, let’s take a look at Neil’s “Big Picture.”
Your thinking about fundamental shifts analyst,
John Mauldin, Editor
Outside the Box
JohnMauldin@2000wave.com
The Big Picture
January 2016 Report
All signs point to 2016 being a momentous year on every front, from the shuddering global economy to the stormy upcoming election season. How will the world look by year’s end? BP interviewed Saeculum Research Founder and President Neil Howe to get his take on what’s ahead. (This is an expanded version of the interview we published as a Social Intelligence report on January 6, 2016.)
BP: Neil, 2016 sure began with some big headlines, didn’t it?
NH: Yes, the year began with a bang—and not in a good way. Both the Dow and the S&P 500 suffered their worst 5-day and 10-day start to a year in history. With the market down roughly 8%, we are suddenly back to the “correction” lows of late last summer. China’s Shanghai market entered free fall, with circuit breakers stopping trading on January 6 after only 29 minutes. Beijing had to intervene massively to keep the CNY from following suit. Meanwhile, most of the Sunni Arab nations abruptly broke off diplomatic relations with Iran. And North Korea successfully tested an H bomb, which—Dear Leader Kim Jong Un helpfully, if not quite accurately, reminded the media—“is capable of wiping out the whole territory of the U.S. all at once.”
BP: Wow. “Bang” may be just the right word. Neil, could you give us a sense of what everybody is going to be talking about in 2016?
NH: In January, analysts always predict how the economy will perform over the coming year. Now is no different, especially with the big December announcement that the Federal Reserve is raising short-term interest rates by 25 basis points to between 0.25 and 0.5%. The Fed boldly suggests that interest rates may close in on 1.4% by the end of 2016 and 2.4% by the end of 2017. Spoiler alert: I think this is delusional. The global economy is in no condition to take this medicine. My very safe prediction is that the Fed will either stall or back down. And the risk of U.S. recession by the end of the year? It’s higher than most are estimating: I’d say roughly 50-50.
Abroad, there are signs of progress in international relations, but the overall geopolitical outlook is dangerous. The Middle East has become a maelstrom. Europeans are voting for leaders who want to dismantle Europe. Putin seems to enjoy doing whatever he damn well wants to—while boasting off-the-chart popularity ratings at home. Meanwhile, Americans are left wondering why their country no longer plays a leadership role in world affairs.
These issues only raise the stakes for the upcoming elections. Not that Americans needed more reason to pay attention: Ever since the first slate of primary debates last summer, we haven’t been able to take our eyeballs off this race. We have the prospect of seeing another Clinton in the White House, a highly polarized presidential campaign season, and—oh yeah—Donald Trump endlessly in the headlines.
BP: OK, let’s focus on the economy. You sound a bit more downbeat than most.
NH: If I’m coming in beneath the consensus forecast, it’s because—over the last decade—reality has been coming in beneath the consensus forecast. And this is a new development. Much has been written about the abysmal track record of expert forecasters, whose performance is hard to distinguish statistically from a “blind” forecaster who simply chooses the historical average growth for each indicator. As the late economist Ezra Solomon once remarked, “The only function of economic forecasting is to make astrology look respectable.” But even if most forecasts are pretty random, they are generally unbiased, meaning that they do not systematically err too high or too low over a long time span. The CBO recently confirmed this for its own forecasts going back to the 1970s.
That being said, there do arise periods lasting ten years or more when the consensus forecast can veer consistently too high to too low. And over the last decade, it has veered too high. Each year since about 2005, forecasters have been predicting a rise in corporate earnings, in GDP, in inflation, in interest rates—in basically all of the vital growth metrics—that is substantially higher than what subsequently occurred. And I’m talking about every forecaster: the IMF, World Bank, Fed, ECB, OECD, and CBO, along with surveys of business economists.
Does anyone recall that the IMF’s first estimate (in 2010) for global growth by 2015 (+4.6%) was roughly double the likely final print for 2015. Or that the initial look-ahead Fed forecasts for U.S. GDP growth in 2011, 2012, and 2013 were at or over +4.0%? 4.0%! The actual average value over those years for the U.S. was +1.8%. For the EU and Japan, it was +0.6%. I mean, how wrong can you be?
Even if you look at GDP growth predictions made in January of the year in question, the Fed has been too high on average by well over one percentage point since 2005. The Wall Street Journal’s survey of economists has erred in the same direction by exactly one percent. In 10 of the last 12 years, they overestimated, sometimes wildly. In 2 of the 10, they nailed it. In no year did they significantly underestimate.
Systematic overshooting by international institutions is leading some observers to talk about “an inbuilt ‘optimism bias.’” The OECD, chastened by its overcarbonated numbers, is soul-searching for solutions. The Fed’s new chronic boosterism is also coming under intense fire, with critics charging (accurately, I think) that the Fed is wagering its credibility on a high-risk expectation game: Forecast it, and they will come. Look, I get that a few institutions—corporations fore casting earnings or the White House forecasting employment, for example—will always initially overshoot. We all understand their incentives. But the economics profession as a whole?
BP: I guess we can’t call it the dismal science anymore. Why do you think this is happening?
NH: Oh, I know why it’s happening. The world has fundamentally shifted over the last decade, especially since we’ve emerged from the Great Recession. We are seeing slower demographic growth, overleveraging, a productivity slowdown, institutional distrust, policy gridlock, and geopolitical drift. But the professional class has been very slow to understand what is going on, not just quantitatively but qualitatively in a new generational configuration that I call the Fourth Turning. They don’t accept the new normal. They keep insisting, just two or three years out there on the horizon, that the old normal will return—in GDP growth, in housing starts, in global trade.
But it doesn’t return. So even while they grudgingly downgrade their near-term forecasts, they keep reassuring us that a better future is still out there if we just wait another year. Like a receding mirage, the good news always keeps glimmering on the horizon.
BP: It’s been a decade now. Are these guys finally waking up?
NH: Interesting you asked. For the most part, I see most forecasters trying to stay on script. Once again, both here and abroad, they are predicting a “rebound” from 2015: Faster real growth, rising inflation, higher interest rates, and so on. Both Kiplinger and the IMF, for example, predict U.S. GDP growth will hit 2.8% in 2016—up from perhaps only 2.4% in the year that just ended.
But I also notice that the mood is a lot less giddy than it was at the end of 2013 and 2014. There’s a new sobriety. Fewer forecasters are entering 2016 expecting any robust acceleration. Indeed, many have been busy downgrading their estimates. Most remarkable are the increasingly gloomy—indeed, dirge-like—2016 market forecasts issued by big banks like GS and by big asset managers like Morgan Stanley both before and after the holidays. Citibank has downgraded the U.S. stock market to “underweight.” Credit Suisse says “rotate out of stocks.” JP Morgan has shifted from b uy on the dips to sell on the rallies. RBS is bluntly telling clients to “sell everything.” We haven’t witnessed this degree of institutional bearishness since the Crash of ’08-09.
Now you could say these are signs that forecasters are waking up. Or that the forecasters are still too sanguine and that you should continue to discount accordingly. Which is a scary thought. But it seems to resonate well in a scary January.
BP: OK, so much for the other forecasters. I’d like you to explain why you think 2016 will be a dangerous year for the economy.
NH: It’s because of what I would call a “quadruple whammy” of economic bad news.
Let me start with whammy number one: the clear deceleration over CY2015 in U.S. economic growth. We see this in GDP. Over the last three quarters, GDP growth has slowed from a healthy 3.9% in the spring, to 2.0% in the summer, to perhaps a mere 0.7% in the fall. This last estimate (from the Atlanta Fed’s GDPNow, a cutting-edge Big Data algorithm whose star is clearly rising) itself shows a stunning deterioration in forward-looking evidence. On November 5, the GDPNow estimate for Q4 was +2.9%—and ever since, with almost all the new information negative, that estimate has been declining at about 3 bps per day.
We also see the deceleration in consumer spending. According to GDPNow, Q4 PCE spending grew at only 1.8%, slower (even) than it did in the “frozen” Q1. Just look at nominal retail sales, which barely budged (0.6% CAGR) over the last five months of 2015. For the entire year, they grew at the lowest rate (2.1%) since 2009. These figures combine both brick-and-mortar (which continues to struggle mightily, showing its embarrassment on Black Friday) with on-line (which continues to grow strongly and above trend).
Walmart just announced it is closing 269 stores globally (154 in the United States) to adjust to this shift and focus more resources on online retailing.
What’s still hot in retail? Travel and hotels (thanks, king dollar!); low-budget “experiences” like games and media; furnishings and home remodeling (a big bull trend we spotlighted two years ago); and health services, full stop. What’s suffering in retail? Everything else, including autos, which has been on a great run but is now exhausted.
The problem is not that households don’t have income to spend. They do. Slowing inflation plus unchanged pay growth has translated into a nice real income boost in 2015. The problem is that households are taking that extra income, due largely to falling energy prices, and they are saving it. Maybe they feel the bonanza will be short-lived. Maybe they are uncertain about the future. If Larry Summers were our economic czar (well, he nearly became our monetary czar), no doubt he would implement negative interest rates and try prying those extra dollars out of people’s pockets. But he’s not, and so here we are.
The cooling consumer would not be worrisome if industry and agriculture were picking up the slack. But that’s clearly not happening. The Industrial Production Index has fallen 2% over the last 12 months, with especially steep drops in November and December. Energy has been hit the hardest: The same oil price decline that delights commuters in New York has slammed drillers in North Dakota and Texas. If the price stays in the $30 neighborhood, we can count on a dramatic growth in energy bankruptcies. Keep in mind: Many of these companies will see their forward hedge contracts expire in the spring.
Since the global crash in raw materials prices is across the board, U.S. revenue from all forms of mining has shrunk to about two-thirds of what it was 18 months ago. Falling prices are also hitting U.S. farmers: 2015 net income is down 50% from the glorious bounty harvests of 2013 and 2011. In 2016, we can expect a further drop. There’s lots of hardship here.
Meanwhile, the U.S. manufacturing sector is wheezing. Its biggest single complaint is the high dollar, which chokes exports and devalues income from foreign subsidiaries. It’s also suffering from a decline, both at home and abroad, in capex spending. According to the ISM PMI, U.S. manufacturers’ new orders and production stopped growing since July and have been contracting since October. Census reports and Fed regional indexes tell basically the same story.
In short, the U.S. economy has experienced a dramatic deceleration since last spring. While it is still growing—and is in no immediate danger of recession—it may not be moving much above stall speed. More than all of its current growth is now fueled by modest growth in U.S. consumer spending. If personal savings rates fall and if no other dangers arise (a big “if,” which I hope to come back to in a bit), GDP growth may pick up speed and the economy may have another mediocre year in 2016. If savings rates go up, perhaps in the presence of other dangers, my outlook is a lot less happy.
BP: What are the odds that oil could rebound to say $50 in 2016 and at least take the heat off U.S. producers?
NH: I see very low odds that will happen. As I explained in my Big Picture essay last year (see BP: “January 2015 Report”), the global demand and supply shifts that triggered the recent price decline cannot easily be reversed in a year or two. They will take many years to reverse, which is why we often talk about a long “supercycle” in energy prices. In 2016, the consumer behaviors leading to lower demand will be reinforced by dismal growth in global GDP. On the supply side, most producing nations (I’ll throw in Texas here) have no choice but to max out on output even at basement prices—to pay creditors, quell political unrest, or shore up FX rates and FX reserves. Those who do have a choice (like Saudi Arabia and its Persian Gulf allies) have chosen for long-term strategic reasons to turn the valves all the way up and weld them there. T hen there are the massive deep-water production sites in the Gulf of Mexico and Brazil just now coming on line for which the capex is already a sunk cost. And I haven’t even mentioned the new supply from Iran or the Caspian Sea.
Let me cut to the chase: I don’t think we’ll see a reprieve. More likely, we may see oil coming down to $20 or lower for a while—which may actually help in the long run by forcing some producers to close down.
BP: You talk about faltering growth in farms and factories. But don’t services now constitute the vast majority of U.S. value added? So long as services are strong, do we really need to worry about the thing-producers?
NH: Good question. I’d say first that the data are often misconstrued. According to the BEA, “goods production” (agriculture and industry) today comprise only 21% of GDP value added. But if we look only at the private sector, that share rises to 24%. What’s more, a rising share of the other 76%—“services”—in effect comprise intermediate inputs to industrial companies. Just think of all the professional functions, from IT to legal to finance to PR, which used to be handled in-house by the industrials but are now outsourced. Estimates vary, but some believe a full adjustment for this “contracting-out” could push goods production up to about 33% of GDP value added.
And that’s not all. These goods-producing industrials comprise an even greater share of large-scale marketplace transactions. They make up the majority of exports and imports between nations. They make up roughly half of the market cap of the DJIA or S&P 500, which means they dominate fixed-income and equity markets. And because so much of their output goes into capital goods, their health is a superb forward-looking indicator of where the economy is going. Five of the Conference Board’s ten leading economic indicators specifically refer to manufacturing or construction.
A lot of services, especially personal services like cleaning and home care, are just this side of informal “household production,” which has never been included in GDP. Largescale goods production stands at the other extreme. Its performance can make or break nations.
So let’s lighten up here and give the industrials a little love.
BP: They certainly have my love. I’m thrilled I can buy gas extracted from preCambrian shale for the same price as bottled water. So you expect them to rebound quickly?
NH: Well, not exactly. I just wanted to stress that the industrials’ current size and importance is larger than many seem to think. Over the long run, there’s no question that their share in GDP is declining over time—and that they are now entering what could be a very difficult decade or two. Keep in mind that the bust in commodity prices, mining, energy, and manufacturing are not just U.S. trends. They are global trends; they’re hurting Manchuria and Malaysia as much as Manitoba and Michigan. Many thing-making industries are going to require a serious structural reduction in global capacity in the years to come.
We recently published a report (see SI: “The Immaterial World”) outlining the drivers behind this trend. They include the rise of the “sharing economy”—everything from Uber to Rent the Runway—which enables durables to be used much more intensively. There’s the spread of urban living, which requires less personal housing and transportation per person. Ditto for the spread of extended family living (rising in both America and Europe). And then think about the ubiquitous presence of social media, enabling Millennials to define their social status by purchasing and showing off experiences rather than things. We’re seeing a lot of changes, many of them generational.
Finally, don’t forget demography. Aging societies with slow-growing workforces no longer require much capital-widening investment. After all, the existing plant and equipment can already handle all the new workers and the existing homes can already house all the new families. Getting local permits to build a new home is Italy is tough—but that’s OK because Italy really doesn’t need any new homes. Over time, the impact on durable goods and construction is massive. Consider further that in most high-income aging societies, working adults are taxed to support the consumption of the retired elderly, who in every society are the least likely to spend on things and the most likely to spend on services (starting with health care and personal care).
Let me stop there. Suffice it to say that increasingly we’re all living in an immaterial world. And our economy will have to adjust.
BP: Fascinating. But let’s return to 2016. What’s the next whammy?
NH: The second bad sign is on the financial side. For the first time since the Great Recession, we are experiencing a substantial “earnings recession.” We’ve had two consecutive quarters, Q2 and Q3, in which S&P 500 earnings have declined year over year. Q4 growth will almost certainly be negative as well—and, according to FactSet, company guidance suggests that even Q1 of 2016 will be negative. The BEA data for all corporate earnings show the same narrowing trend.
Profit margins are shrinking in part because of the high dollar and in part because of rising real worker compensation. CEOs would love to raise prices to keep their margins fat, but in today’s deflationary environment they cannot. Naturally energy is showing the biggest profit squeeze, but over half of the other S&P 500 sectors are also showing negatives.
Earnings recessions are a classic late-stage indicator of an “aging” recovery. They are often (though not always) a prequel to the next full-blown recession. Their impact on the real economy is very direct. As a rule, companies handle declining profits by cutting back—on hiring, on R&D, on capex—anything at the margin no longer expected to add value. This pullback ultimately feeds forward into declining consumer demand. Arguably, we’ve already seen this dynamic underway during the second half of 2015.
Yet this time around, there’s another reason to regard this earnings recession as especially dangerous. For the last few years, we have been looking at very high valuations in U.S. equity markets. I don’t want to go into all the different measures people use to measure equity valuations— like Shiller’s CAPE, Tobin’s Q, and so on. I just want to point out that most of them focus on three overlapping concepts: a smoothed ratio of price to earnings; a smoothed ratio of earnings to GDP; and the expected future of growth rate of GDP. Now here’s my point. The two ratios are both far above their historical averages, and the low expected GDP growth rate (due to demographics) suggests, if anything, that the ratios should be beneath their historical averages. It’s a sobering triad, pointing to nothing pleasant.
I don’t want to get wonky or wade beyond my depth here. Let me just mention two analysts whose work on valuations I greatly admire, John Hussman and Ed Easterling. Their reports give me cover by allowing me to come across as an optimist.
So what do all these measures have to do with the earnings recession? It’s this. Just knowing that the market is overvalued is of limited practical significance if the market can sometimes stay overvalued for years on end. What you really want is a leading indicator that tells when the market will break to the downside and correct. I think profit margins are such an indicator—not 100% foolproof, but highly suggestive. In every major postwar bear market, profit margins have declined together with P/E ratios and have typically shown a clear declining trend before it became apparent in the noisy P/E ups and downs.
BP: So does the current market downdraft marks the beginning of secular valuation correction?
NH: It may. Look, for example, at the ratio of S&P market cap to GDP, a very familiar valuation indicator. You can see that it plateaued at a lofty level throughout 2014 and started falling swiftly after Q1 of 2015. Today, I reckon it has already dropped by around 20% from its peak. The problem is it still has to drop another 30% just to reach its recent historical average. And of course it may in time overshoot.
Warren Buffett once described this indicator as “the best single measure of where valuations stand at any given moment.” But there are obviously many others, and most of these are situated at roughly the same distance above their historical average.
BP: What’s your prognosis for the market in 2016? And what impact will the market have on the real economy?
NH: I think 2016 will be a very dangerous year for equities. And I think the big banks already suspect as much, which is why they are doing something they hardly ever do: Warning their investors to cut their exposure. For several years, analysts have been puzzling over what Mohamed El-Erian calls the “decoupling” of market returns (which have been splendid) from real economic growth (which has repeatedly stumbled). In 2015, market returns ran out of steam. In 2016 and beyond, there is a growing fear that decoupling may turn around and rush back toward “recoupling”—implying large negative market returns.
In retrospect, we may put the turning point at the brief S&P 500 swoon of last August. Though prices recovered late in the year, other indicators showed the market turning steadily against risk—with the bond spread widening, the VIX rising, and the IPO count falling. By year’s end, tech startups were struggling with downrounds and new “unicorns” were deemed an endangered species.
The forward link to the real economy is harder to assess. Though it is said that market crashes often do not cause recessions—those that don’t are often fast crashes (like 1987) with no triggers in business income statements. What concerns me in 2016 is something a lot bigger than a flash crash. So yes, I think it could participate in a negative feedback loop with an economy that is already starting out the year in low gear.
BP: With so much up for grabs in our domestic economy, I guess the deciding factor may be what happens abroad.
NH: Wonderful segue. You’ve taken me straight to my third whammy, the global economy, which is slowing down on a massive scale.
If you look at 2016 from a comprehensive geographic perspective (“from China to Peru,” to borrow from Samuel Johnson), you see a clear separation. There are few dire threats in the high-income world. None of the major affluent players are growing very fast, but then again neither are they expected to slow down much. Let’s say Japan continues to eke along at 0.75%, the EU at 1.5%, and the U.S. at 2.5%. That’s a good status quo ante for roughly half of global GDP. But now let’s look at the other half, the developing half. Here we see ongoing deceleration. In 2015, the IMF estimates that the developing economies grew at 4.0%—the slowest since the Great Recession year of 2009 and less than half the rate they enjoyed in 2007, just before that downturn. In 2016, I think their performance will deteriorate further.
At the epicenter of this slowdown is China, whose high growth rate only a few years ago (running over 10% per year) enabled it to generate, singlehandedly, perhaps a quarter of the annual growth in global production. Everyone agrees that China’s growth rate is now falling, but no one can agree on how much. While the official numbers put Chinese GDP growth last year at just under 7%, most outside analysts are frustrated by the regime’s irregular accounting methods and figure it’s doctoring the numbers to hit official targets.
Leland Miller at China Beige Book says the real growth rate may be around 4.5%. Citigroup chief economist Willem Buiter suggests the true growth rate is probably closer to 4.0% and could be as low as 2.2%. Imports and exports (in USD) declined every month last year. The Caixin Manufacturing PMI shows contraction in 6 of the last 7 months, while producer prices have been tumbling for over three years.
There are many reasons why China is now in trouble. Its industrial and real estate sectors racked up vast amounts of debt over the past decade, leading to excess production and capacity that is hard to unwind. Its overvalued currency is squeezing its export businesses, but any deliberate attempt to devalue would be like disarming a bomb, incurring the risk of sudden capital flight. Meanwhile, just as rural areas are running dry on new young adults to send to the cities, China is undergoing rapid demographic aging. Just this year and next, its working-age population has stopped growing and has now started a gradual decline. Basically, China has outgrown one growth paradigm and hasn’t yet figured out how to move to another.
So much for the causes of China’s woes. Let’s look at the effects. Most importantly, China’s slowdown shrinks an important source of rising demand that has helped keep global economies running over the past decade. Europe, for example, exports furs, fashions, and sport cars to feed China’s insatiable demand for brand-name luxuries. That is taking a hit. The U.S. and South Korea export films and smartphones to feed China’s mania for media and cool IT. That is also taking a hit.
The collapse of China’s infrastructure boom is a significant driver of falling global energy demand and a huge driver of falling global commodities demand. In 2014, incredibly, China constituted roughly half of the global demand for most major metals, from iron, copper, and nickel to all those once-treasured “rare earth metals” whose prices have since tanked.
China has been an economic juggernaut over the past quarter century. It has lifted more people out of utter destitution into at least modest affluence than any nation in history. But now its boom is coming to an end, after producing “ghost cities” without residents and “ghost bullet trains” without riders. As China changes its course, so must much of the rest of the world.
BP: Which countries are getting hit hardest?
NH: Here’s how to think of it: If your country is dependent on exporting oil or commodities, or if you are close to China (which presumably means you trade a lot with China), it is likely you are feeling pain. Sadly, this rule of thumb covers the great majority of the developing economies.
The energy price collapse has obviously slashed income to most of the Middle East and to Russia and its Central Asian CIS allies. The energy and commodity declines together are dragging down nearly every nation in sub-Saharan Africa, many of which export little other than oil, gems, precious metals, and base metal ores. Ironically, most of the vast mining operations in Angola, Zambia, and the Congo were originally funded by China. The price declines are also a hardship for Latin America, a region already reeling from a catastrophic failure of political leadership (in Venezuela, Brazil, and Argentina). The IMF estimates the Latin American GDP, as a whole, actually shrank last year.
Among the regional Asian economies suffering from falling trade with China, let me mention Indonesia, Malaysia, and Mongolia. There are even some regional high-income economies who are struggling to adjust: Taiwan, Singapore, South Korea, and (to a lesser degree) Australia and New Zealand.
BP: This sounds uniformly bleak. There must be some blue sky out there.
NH: Yes, there are important exceptions. Look for economies that aren’t blessed with energy and commodities and aren’t hugely dependent on China. Check out India and the Philippines, two large economies which (using unbiased national accounting) are probably growing faster than China right now. They hardly skipped a beat last year. Vietnam and Thailand are also doing well, largely because they are not affluent enough to have been swept into China’s indust