Monday, May 7, 2007

Sarkozy v. Gasoline

What does the election of Nicolas Sarkozy as President of France and the record high price of gasoline at US pumps ($3.07/gal) have in common? Directly, nothing... but digging a little deeper, they are both manifestations of the same problem: there are too many of us humans on this planet and our growing consumption is straining national, social and natural boundaries.

Sarkozy got elected - in large measure - because of his anti-immigration policy, i.e. shutting the doors of France to large numbers of poor North African economic immigrants and deporting all those already in France illegally back to their countries. He is also completely against the entry of Turkey into the EU. Some may think him racist, but it is probably just his way of preserving the wealth and comfortable lifestyles of the French from the masses of poor foreigners straining against the walls of Europe.

And it is not just France: the US is also involved in a thorny immigration issue, the "Polish plumber" is raising competitive fears within the EU itself and hundreds of thousands of Iraqis have already abandoned their country. In fact, Iraqi medical schools have been ordered to stop issuing paper diplomas and transcripts in an effort to stop their graduates from fleeing to practice abroad. Everyone wants a better lifestyle - who can blame them? Globalization may have allowed for cheap Chinese imports, but it also raised everyone's awareness of the wide divide between rich and poor. When your neighbour is eating prime rib and you are starving, those leftovers look mighty inviting.

Now, if the election of Sarkozy points to mounting social pressures, record prices for gasoline are a sure sign of resource demand reaching supply limits. I do not know if those limits are "hard" (i.e. constrained by nature) or "soft" (i.e. added supply will soon kick in), but price action is not reassuring: Since 2002-03 the price of copper has increased 5x, nickel 6x and aluminum 2x. Corn, soybeans, wheat and oats have doubled and even rice has gone up by 150%. Hog prices are also up 150% from their lows and feeder cattle 60%.

If it weren't for all those cheap goods from China flooding western markets and offsetting rising material input prices with cheap manufacturing labor, even officially calculated headline inflation indexes would be zooming by now. Things get further complicated when we consider that the cheapness of chinese imports is dependent on the yuan being pegged against the US dollar. Right now, a factory in Guangzhou is effectively using the same currency as a factory in Ohio, only with 1/50th the labor cost plus next to zero environmental, safety and health regulation costs. In other words, those cheap prices we all enjoy so much during our trips to the mall - be it in Peoria or Poitiers - are hanging by a very thin thread, indeed: the thread of a currency peg. If it snaps, we may be left with an emasculated manufacturing base in the US (and increasingly, in Europe, too) and rapidly rising import prices. It's no wonder that Hank Paulson, the US Treasury Secretary, is constantly flying back and forth to China.

One final anecdote: Yesterday I had lunch with a friend who imports and trades chinese goods and I asked him what would be the effect to his business of a 7-8% rise in prices from a potential yuan revaluation. None, was his answer, explaining that there is simply no one left domestically that makes any of the stuff he imports. Left unsaid, but fully understood, was that his domestic prices would simply go up by the same percentage and the consumer would have to pay them, want it or not.


  1. The gutting of manufacturing capacity has been of concern to me. I just hope that either equipment is mothballed here in the US, waiting for the time when it's economically viable to use again, or that equipment is owned by American interests even though it's in China, and can be crated and brought back.

    The booming economies, debt fueled, have led to higher consumption which increases commodity prices. Also, petro-chemical inputs have risen because we have hit the apex of peak oil.

    Too many people. We cant regulate our own population, so we will be subject to an environmentally induced population reduction. All economic activity has its distant roots in the environment.

    Jason B

  2. Once manufacturing goes, it goes. There is much more involved than just machinery: it takes technology, skilled production workers and engineers, a robust supply/delivery chain. It's all gone to China now and it's not coming back.

    For historical perspective, think what happened to the UK after the US exploded onto the global scene right after the Civil War... industrial implosion and eventually bye bye Empire.

    I hate to sound populist, but the US is selling the Chinese its Empire for the price of cheap sneakers.

    But isn't that the way all empires go? They first get fat and lazy on cheap goods and when the "barbarians appear at the gates" they have no ability or will to fight them back.

    Population of ANYTHING, humans included, is directly correlated to energy (fuel/food) availability. The Petroleum Era has made our lifestyle possible, not some superior intellect. As someone said, what separates us from the Middle Ages is but the flip of an electrical switch...


  3. I came upon this link on the ocean shipping rates and the near vertical rise. Another forcing for import price increases?

  4. The "Dry" indeces refer to bulk carrier transport of raw commodities such as grain, sugar, iron ore, coal.. i.e. the inputs to the Great Factory of China. Shipping is almost always a tiny fraction of the final commodity prices and that's why they can go up so much without the buyer being too concerned. It is also why bulk carrier shipowners can become filthy rich if they time the market right - or go bust if they don't.

    Finished goods are shipped in container ships and that's a wholly different type of operation. Because of standardization, automation, port expansion and vessel-size increases, rates there have not risen nearly as much as in bulk carriers. In fact 2006 was downright awful, with significant declines.


  5. Hellasious,

    I agree with much of what you said about American manufacturing goods being replaced by imports from overseas. And that related manufacturing jobs are most likely gone forever.

    However, I think its important to understand China in the proper context as just one of many links in the global supply chain. As Stephen Roach recently discussed, the value add of China to the finished products it exports to the US is estimated to be around 20%.

    The remainder of the value add comes from sources outside China including Japan, Taiwan, Korea, Australia, SE Asia etc.

    While prices will certainly rise to some degree in the event of a revaluation of the yuan, the reality is that many of the products that the US imports from China can also be supplied by other developing countries albeit at a slightly higher price point. Furthermore, Chinese workers will come under massive pressure to accept even lower wages as the 200 million+ migration from rural areas to the cities over the next decade continues unabated.

    In fact with the Yuan devaluing further against most developing countries' currencies (think Mexico, Brazil, SE Asia, Korea), the devaluation of the Yuan actually acts as a deflationary force overall in the global marketplace placing pressures on other developing countries to reduce costs further.

    Certainly, as you have noted, the price of a wide range of commodities has risen dramatically but the pressure to reduce wages in both developed and developing nations has been far more dramatic. That is why workers and governments in both developed and developing nations must take on so much debt to maintain the high levels of global demand necessary to prevent massive deflationary forces from being unleashed.

    China will suffer to a far greater degree than the US from a massive revaluation of the Yuan. That is why it will never happen voluntarily on the part of the Chinese. Remember China has a tradition of keeping hundreds of millions of workers in non-productive jobs for the sake of social cohesion. What will happen if the Yuan revalues? Simple. The wages of Chinese workers will be reduced but you can bet that the price of goods imported from China will remain competitive.

    My own belief is that the US and other developed countries' consumers will choke on their own debt burdens before the Chinese and other developing countries are willing to stop exporting cheap goods to them. My best guess is that it will be the bursting of the debt bubble globally, which you have so brilliantly mapped out, and the debt liquidation that comes with it that finally brings the current party to an end.

    Until such time as I start to read articles about strengthening unions and widespread labor strikes in Europe, US and Japan demanding better wages and benefits, I believe the ultimate outcome will be widespread global deflation regardless of any exchange rate fluctuations. Exchange rate fluctuations just determine who will bear the brunt of deflationary pressures at the present moment.

  6. Dear Anon.,

    Excellent points.

    If things keep going as they are, at some point the wage pressures against developing (and developed) nation workers will become so unbearable that social cohesion will be torn apart. Substituting debt and asset inflation for income growth has kept living standards up for a while, but this is illusory and unsustainable. Crunch time is already here for the US (negative saving rate) and won't be far behind for the EU, either.

    For example, Esthonians (and many others) are already borrowing in SFR and JPY for their mortgages, to "take advantage" of low rates. When JQ Public has to assume FX risk to afford housing, the world is in trouble.

    The global low-wage deflationary pressures that you so astutely describe are creating a race to the bottom, one that is setting up the "debt choking": stagnant income and rising debt service. If, or when, we also get lower asset prices, then the trapdoor will swing open.

    By the way, I don't think the Chinese will easily accept lower wages now, but this is not based on hard data. It's more of a social observation - from afar.


  7. reference crude oils' prices are not so much a result of demand/supply for the physical but, rather, speculation in 'paper barrels'.

    too often, but understandably, this price formation is thought of as, at least in theory, it used to be, but even then, in reality, crude oils' price regime had most to do with the combination of cartel and oligopoly rather than 'free' and 'efficient' market.

    See, e.g. The International Oil Price Regime Origins, Rationale and Assessment Published in The Journal of Energy Literature, Volume XI, No1, June 2005, pp3-20 By Robert Mabro


    The conclusion is that, given the structure of the market, and the features of the oil price regime the correct [OPEC] policy is unsustainable. Clearly, the flaw is in a system which has vested too much power into the hands of speculators. The shift of the price determination regime in the mid-1980s away from OPEC and into the market turned out to be a transfer of power from OPEC to speculators. This is neither a desirable nor a comfortable state of affairs. (p21)

  8. I certainly agree that financial markets for commodities amplify price moves and volatility in the short to medium term and allow for manipulation.

    However, I am not so sure when it comes to the longer-term, i.e. more than a couple of years.