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"...public opinion deserves to be respected as well as despised" G.W.F. Hegel, 'Philosophy of Right'

the party is over « Previous | |Next »
November 26, 2008

So BHP has walked away from its takeover bid of Rio Tinto. That sends a very clear signal about the economic downturn, commodity prices (aluminium, copper, nickel, iron ore and coal) going lower, and the unlikeliness of China's economic growth continuing to power a long-term seller's market for all the major commodities. It's contraction all round these days.

Moirdeficit.jpg Moir

This has implications for the global balance of payments system, which has been dominated in the last decade by the trade and investment relationship between China and the US. This relationship where excess US demand and excess Chinese supply were in a temporarily stable balance and as part of running a trade surplus, China necessarily accumulated dollars, which were exported to (invested in) the US. is now undergoing a major shift. Domestic consumption is falling in the US and that gives rise to overproduction in China.

In Can China Adjust to the US Adjustment? Michael Pettis says:

But since the balance of payments must balance, something else must happen to equilibrate this decline in US household consumption. Either consumption in other sectors of the US economy (i.e. the government) must expand by that amount, or consumption by China (by which we mean all foreign countries, with China bearing the brunt) must expand by that amount, and as it does so its savings must decline. To the extent that neither happens, global overproduction – which consists mainly of Chinese overproduction – must decline by that amount. This is just a way of saying that if net American consumption (the excess of consumption over production) declines, either consumption must rise somewhere else, or production must fall.

Everybody ---including BHP---has been banking on the first scenario--that consumption will rise somewhere else, namely China to prevent a global slowdown. China was the world's insurance policy. But, as Pettis points out, this is unlikely:
In the best possible world Chinese consumption would rise by exactly the same amount as US consumption drops, and a new stable balance would quickly be achieved with one major difference: the US trade deficit would decline, and the amount of capital exported by China to the US would decline by exactly the same amount ..... But if it doesn’t, total global consumption must decline, and the world economy slow – in fact as it slows global income will decline with it, so that both savings and consumption could decline, trapping the world in a downward spiral.

By how much must Chinese consumption rise to prevent a global slowdown? Given that the US economy is about 3.3 times the size of China’s, and consumption accounts for less than 50% of China’s income, Chinese consumption will have to rise by nearly 40% in order to accommodate a 5% increase in US savings. This is clearly unlikely.

Since domestic demand in China is not rising fast enough there is massive overproduction.The option of relying on net exports to protect itself from its overcapacity--- ie., trying to export their way out of a slowdown---is not there. So there is going to be a global slowdown.

All that Australia, like the US a current-account deficit countries, can do is expand moderately so as to slow down the adjustment period. China, as the central current account surplus country, needs to force domestic demand up. Since expecting private consumption to rise quickly enough is unrealistic, it has to be public consumption – and that means large fiscal deficits. The other option is for both current account deficit and surplus countries to work to expand global trade.

| Posted by Gary Sauer-Thompson at 5:15 AM | | Comments (10)


I see that Citigroup has had to be bailed out by the US Government---by investing $20 billion in the group. It is socialism US style to contain the fallout from the housing slump and credit crunch.

And President Bush continues to defend free markets in the light of massive market failure.

it is pretty clear that the US Treasury and Federal Reserve have been badly wrong footed by the credit crunch. They got it wrong ----remember they said that the subprime crisis could be contained and they played down the impact of the subprime crisis on the broader economy.

They don't understand the financial/economic system they are governing.

The AFR is reporting that layoffs and production cuts are happening across South-East Asia---eg., Malaysia, Singapore, Indonesia, Thailand. Same situation in China. Lack of economic growth means social instability.

The miners were the big economic boosters in Australia--the eternal boom cos China would grow for ever. They had dollar signs in their eyes, thats all they saw, and they reckoned that capitalism expanding forever was cold hard reality. Those who thought otherwise were gloom merchants.

Well the sharp slump in commodity prices and falling demand from Chinese steel makers have seen them come back to earth. Rio Tinto's big expansion plans at its Cape Lambert iron ore port facility in the Pilbara have been put on hold. It is struggling to repay its massive $42 billion debt (from its acquisition of Alcan, the Canadian aluminium producer) with falling cash flow.

Oh, and the Australian Bureau of Agricultural and Resource Economics has screwed up again. They had been predicting a huge jump in exports underpinned by massive price increases. The reality is price decreases and big cuts in production.

And with RIO shares falling 40% with the announcement, somebody must hve made a fat killing in the weeks leading up to the announcement.
Re Gary's response to Nan's first post, the US government has been utterly deplorable with its scorched earth/avoidance of responsibilities policy for its racketeer mates; for the incoming government left with the mess, the ordinary people and the rest of the world.
Even the Brits have demanded some accountability from the big organisations, but you get the impression with the US, that it's only ever been, "wink, wink; nudge, nudge".

if BHP is right about falling commodity prices, then Rio must deal with falling cash flows from operations, and an impossible environment in which to sell assets and too much debt.

The core problem is Rio’s recent acquisition of Alcan. In Business Spectator Stephen Bartholomeusz says that the $US42 billion of debt Rio Tinto is carrying as a consequence of its debt-financed acquisition of Alcan for $US38 billion last year. Rio has failed to make major inroads into that debt by selling non-core assets and Alcan’s packaging businesses in particular. Bartholomeusz adds:

The current state of both equity and debt markets means that both the value of assets targeted for sale and the ability to find buyers for them has diminished. Rio Tinto faces significant write-downs on the Alcan assets it was holding for re-sale. It also confronts the need to refinance about $US9 billion of the Alcan acquisition debt next October....Rio Tinto may have to contemplate a major equity raising in circumstances where the floor under its share price provided by the terms of the proposed offer has been withdrawn.

Rio do not look to be in a good position. Enter the Chinese---Aluminum Corp of China (Chinalco) to lift its stake in Rio Tinto to at least 14.99%? That would create problems for Rudd + Co wouldn't it.

Peter S Stock, thanks for that, mate.
So, all the birds have to do is keep riding the thermals for a bit longer and the corpse might fall apart like an overcooked chook, obviating even the need for a bit of elbow-grease in separating the various tasty bits.

re your comments on Citibank--Robert Reich has some interesting comments in an early post before the bail out. He says:

Citi is about to be bailed out while GM is allowed to languish. That's because Wall Street's self-serving view of the unique role of financial institutions is mirrored in the two agencies that run the American economy -- the Treasury and the Fed. Their job, as they see it, is to keep the financial economy "sound," by which they mean keeping Wall Street's own investors and creditors happy.

In a latter post on Citibank he says:
If you had any doubt at all about the primacy of Wall Street over Main Street; the utter lack of transparency behind the biggest government giveaway in history to financial executives, and their shareholders, directors, and creditors; and the intimate connections the lie between Administrations -- both Republican and Democratic -- and the heavyweights on Wall Street, your doubts should be laid to rest. Today it was decided the government will guarantee more than $300 billion of troubled mortgages and other assets of Citigroup under a federal plan to stabilize the lender after its stock fell 60 percent last week. The company will also will get a $20 billion cash infusion from the Treasury Department, adding to the $25 billion the bank received last month under the Troubled Asset Relief Program.

Meanwhile, more than a million workers in the automobile industry, along with six million homeowners in danger of losing their homes, and a millions of Americans who depend on small businesses and retailers for paychecks, are getting nothing at all.

I've started reading Paul Krugman in the New York Times. I can understand him as he talks in a language that I can follow. There is little of that awful economic speak.

On the US he says that the good news is that:

the long era of Republican political dominance in the US has came to an end in the face of an economic and financial crisis that, in voters’ minds, both discredited the G.O.P.’s free-market ideology and undermined its claims of competence.

The bad news is that there will be two months of policy drift until Obama comes to power in January. At minimum, the next two months will inflict serious pain on hundreds of thousands of Americans, who will lose their jobs, their homes, or both. He adds that there is nothing happening on the policy front that is remotely commensurate with the scale of the economic crisis.

So Rudd now talks in terms of the deficit. Big deal The sky hasn't fallen in.