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Exports: Europe is not the only show in town

Felicity Burch November 09, 2011 16:39

Earlier today Andrew blogged about the potential fallout from the Eurozone crisis on our other export markets, such as China.

Europe buys about one fifth of Chinese exports, so it is a key market for China. As Andrew explained, this means that problems in the Eurozone could reduce growth and confidence in China, and have a knock-on impact on demand for UK exports.

But, the crisis in the Eurozone is only one of many factors influencing Chinese growth. The Chinese economy is in a state of flux, and undergoing massive structural change. There is significant potential for Chinese domestic demand to grow, especially if they move forward in the way agreed at the recent G20 summit:

Emerging market economies commit to adopting macroeconomic policies to enhance the resilience of their economies and those in surplus will adopt macroeconomic policies to move towards more domestic-led growth, thus supporting the global recovery and financial stability.

China will rebalance demand towards domestic consumption by implementing measures to strengthen social safety nets, increase household income and transform the economic growth pattern. These actions will be reinforced by ongoing measures to promote greater exchange rate flexibility to better reflect underlying economic fundamentals, and gradually reduce the pace of accumulation of foreign reserves.

The latter paragraph mentions allowing greater exchange rate flexibility, this could provide a significant boost to exports.

As I mentioned earlier today, emerging economies (and non-EU markets) offer great potential for UK exporters. Many of these economies are growing rapidly, and have large, increasingly affluent populations. China is only one example.

There are real challenges ahead, as the potential downsides of the Eurozone crisis make only too clear, but there are plenty of opportunities to grow exports too.

Confidence spillover

Andrew Johnson November 09, 2011 11:27

Last week’s disappointing PMI numbers said a lot about confidence at the start of 2011q4. Confidence is going down; not just in the UK but in the global economy.

How is falling confidence impacting on real activity for manufacturers?

The first place confidence spills over is into firms’ business decisions that have longer time horizons – investment and recruitment.

Manufacturers have longstanding issues finding the skilled employees they need. But it is also fair to say that the sector has not been a source of long-term employment growth for the economy overall. Neither of those things looks likely to change in the short term.

So focusing on investment, lower confidence means manufacturers see the future demand for their products as less bright – or at least more uncertain.

That goes against potential investment decisions for three reasons:

- potential for lower cashflow making it harder to service any external finance used to help finance investment;
- lower demand weakens the case for creating extra capacity;
- The value of retaining cash to help firms to cope during a downturn goes up;

On the last point we have an additional piece of evidence – earlier this year George Osborne claimed UK companies were sitting on cash worth 5% of GDP.

But last week’s data suggested falling confidence may be spilling over into more than just investment. Customer orders seem to be pulling back too – including those from outside of Europe.
How might that work?

Take China as an example. This is a country that relies on export demand to drive growth. Europe is a major market for the Chinese – in 2010 the EU accounted for 20.1% of China’s total exports.

The trade balance with the EU increased by a massive 39.5% in 2010 to return close to 2008 levels with a surplus of €108 billion.

If demand from Europe is lower, Chinese growth prospects are lower – unless they can find offsetting demand elsewhere to compensate.

So thinking about what all this means for Chinese companies that buy UK exports, it’s important to think about what kinds of goods we export to China.

One of our major exports is electrical machinery for example power generation equipment. Now some of this such as motors and variable speed drives go in to equipping Chinese factories, which for the same reasons as the UK, might be thinking now is the time to hold off on investments.

Vehicles, particularly luxury cars, are a growing export to China. If luxury cars are a purchase item of the wealthy, and the wealthy derive a relatively higher proportion of their income from capital (including owning Chinese factories) – then this is the sort of item that could suffer if Chinese export markets look weaker. This is my speculation only.

But despite all this there are reasons there’s still cause for optimism. These confidence impacts are not likely to be as severe in China as they are for the UK. China’s export exposure to the EU at 20% is still a way off the UK’s 50%+.

Later today Felicity’s going to talk more about these causes for optimism.

Getting real about manufacturing

Andrew Johnson July 13, 2011 14:44

Anthony Hilton’s Evening Standard article, Let’s get real about manufacturing, suggests politicians – and the public – need to realise manufacturing cannot deliver the rebalancing the economy so desperately needs. Hilton claims the real rebalancing we need is a shift away from debt-fuelled consumption towards savings and investment.

While there is certainly truth in the need for a reappraisal of our debt-fuelled model of growth of the past decade, Hilton misses some important elements where manufacturing is very important.

Firstly exports. It is true that the UK, along with many other developed economies is going through a painful but necessary retrenchment in private consumption and government spending as people and governments learn to live within their means.

But this is not true for the world as a whole. Indeed there are parts of the world where consumption looks set to boom as aspiring and increasingly affluent middle classes emerge in developing economies like China and India.

This is a real opportunity for the UK. If we can export more goods and services to parts of the world that are looking to consume more, we can help drive our own economic growth. This is a key part of the rebalancing story.

So who does the exporting in the UK economy? Manufacturers punch way above their weight. 48% of total UK exports in 2010 came from the manufacturing sector. And we are seeing growth. Goods exports to China in 2011q1 were up 26% over 2010q1. This is admittedly off a small base but shows there is large potential.

Over a longer timeframe what drives an economy’s long run growth potential? Expansion of its technological frontier through investment in innovation.

How does manufacturing look here? Well manufacturing accounted for 71% of UK business R&D in 2008.

Finally what about Hilton’s warning to politicians not to devote ‘too much time to the pursuit of the impossible’?

Well our competitors are showing us what’s possible. Germany is booming on the back of its exports to China where it has a stronger foothold than the UK.

Our competitors take seriously the need to create the right business environment for manufacturing to succeed. It isn’t about ‘perversely damag[ing] those areas where we are competitive’.

It’s about our tax system reflecting the realities of modern capital investment to allow our manufacturers to keep reinvesting in modern technology.

It’s about making sure our world class financial sector actually supports the real economy as well as the inter-bank trade so that SMEs aren’t citing access to finance as a barrier to growth.

And it’s about having a demand-led skills system that delivers what the economy needs and produces a consistent pipeline of skilled young people.

Even if you support Hilton’s premise, it’s hard to see how addressing these areas would distort the economy. But it would mean getting real about manufacturing.

FT Alphaville on housing market woes

Jeegar Kakkad June 01, 2011 09:52

It's worth checking out a few blog posts from FT Alphaville on the state of the UK and Chinese housing markets.

The first flags up UK house price gloom, citing a Morgan Stanley report that forecasts a 10% fall in house prices by the end of 2012.

The second set looks at the Chinese housing market. An FT Alphaville post flags up the rising housing inventories in China, citing one forecast for 15 months of inventory by the end of this year. The analysis points out that some cities have a 7-year inventory of unsold property.

The kicker comes from an FT article on the importance of the Chinese real estate market to the global economy. According to the article, China accounts for 50% of global commodity consumption. But two-thirds of China's steel demand, for example, comes from the real estate market.

If construction slows in response to rising inventories and official concerns for inflation, then commodity price rises could ease. But as the article points out:

"Whether China’s real estate market is a bubble that could pop, knocking out Chinese growth and shaking the world’s economy, is a question that is being asked by everyone from Brazilian iron ore traders to hedge fund managers in the City of London.

And while there is no consensus among economists and analysts over whether rapid price rises and a big construction boom do constitute a bubble, there is serious concern among some Chinese officials and recognition from almost everybody that the current levels of growth are unsustainable over the long term."

 

Were the seeds of the crisis sown in mid-2001?

Jeegar Kakkad May 16, 2011 09:08

Last Friday, FT Alphaville wrote up a Kevin Gaynor (from Nomura) comment that pinpointed mid-2001 as the starting point for the recent crisis.

As Gaynor states:

"Looking back it now seems that a fundamental shift happened in mid 2001 to the commodity and currency world, a shift which has been ongoing since and that has affected the global supply side inflation picture around dramatically.

This shift has not been analyzed before as far as I’m aware, but in fact, it appears to have dominated asset returns over the period. The US Dollar measured against its broad index shifted from being in a quasi permanent appreciation since the breakup of Bretton Woods, into a depreciating phase which is still going on today.

The CRB index, which had been in a broad cycle since the 1960s, shifted into a turbo charged increase phase. Not surprisingly, the basic materials and oil and gas components of the global equity index shifted into a major bull phase at the same time and have together been the two best performing sectors over the period."

But if he's right, the question is why did dollar and commodity markets experienced a structural shift in mid-2001?

Commenting on the FT Alphaville post, my answer was that the Bush tax cuts and the September 11 attacks resulted in a massive fiscal earthquake:

"Two fundamental global economic pivot points in mid-2001 were the US passing the first Bush tax cuts and the September 11 attacks.

It's why the US fiscal position shifted from the 2001 projection of $889 billion annual surplus in 2011 to a $1,480 billion deficit forecast this year by the CBO for 2011. A $2.3 trillion swing in the deficit for 2011.

The impact on net indebtedness? Instead of a surplus of $2.3 trillion, it has a net debt of $10.4 trillion - a $12.7 trillion swing in a decade."

The rest of the FT Alphaville post and the comments are worth reading because they flag up the rather stark implications for global rebalancing.

 

Can export strength compensate for domestic weakness in 2011q2?

Andrew Johnson May 13, 2011 15:22

The UK economy has stuttered along since the end of 2010.

2011q1 growth was weaker than many expected, including the OBR and the Bank of England, at 0.5%. Taking into account the 2010q4 contraction, the economy has been flat for six months.

Prospects for the second quarter look moderate, with modest growth set to continue.

Consumer spending weakness in the UK in 2011 so far, received a boost in April from the bank holidays and warm weather. This impact however is likely to be temporary. UK households are continuing to feel the squeeze on their disposable incomes from the VAT rise in January and strong food price inflation.

Investment intentions continue to be clouded by uncertainties. Demand uncertainties have been further complicated by volatile and (until very recently) increasing commodity prices - for many firms this makes sitting on cash the smart option right now.

While 2011q1 overall showed an improvement in the UK trade position relative to 2010q4, this appeared to have weakened at the end with ONS stats showing the deficit widening in March compared with February.

This was driven by a contraction in goods exports to countries outside the EU, with falls notably heavy in intermediate and capital goods exports. Some analysts fear that recent softness in commodity prices might indicate weaker activity in emerging markets.

This is particularly important for manufacturers as emerging markets are where they have seen strength in the recovery.

But on the flipside, more traditional UK markets in Europe, notably France and Germany, are powering ahead, with the Germans in particular showing strengthening domestic demand (and in impressive 1.5% q/q growth figure for 2011q1).

However, there are reasons to think the recovery in trade will revert to type in 2011q2. EU countries, with the possible exception of Germany, are unlikely to be able to sustain strong domestic demand recorded in q1.

And strength still remains in emerging markets. China beat expectations for retail sales growth in 2011q1 and with inflation also beating forecasts, pressure continues to build for an appreciation of the renminbi – a benefit to UK exporters.

For Asia more generally, BBVA (for example), sees continued strong growth in 2011, albeit moderated by high oil prices and supply disruption from Japan’s earthquake and tsunami.

In fact this supply disruption made it to the UK too, with UK outlets of Japanese-owned carmakers having some production restrictions.

This was perhaps part of the picture in April’s manufacturing PMI, which declined to a seventh month low, following January’s peak (though still very much in expansion territory).

How serious the Japanese impacts are remains to be seen, with some tentative indications that it may not be as serious as initially thought. What impacts we do see may be confined to the automotive sector in 2011q2.

The orders reading for the PMI underlined the contrast in strength between domestic and export markets. While this was already the case previously the difference, export market strength v domestic market weakness is becoming much more stark.

Export orders continue to be strong, particularly from emerging markets but also the U.S. and EU. But the domestic market appears to be weak and getting weaker.

Manufacturing powered through another strong quarter in 2011q1 and as my colleague Jeegar has noted is responsible for a larger share of the UK’s recovery than its share of the overall economy i.e. manufacturing punches above its weight.

We’ll be having a further think over the next few weeks about conditions for 2011q2 and coming to a view as to whether export strength will continue to deliver positive results for manufacturing and the wider economy.

Keep an eye out for our views early next month in the next edition of EEF’s Manufacturing Outlook.

Currency wars debate: some conclusions

Felicity Burch November 16, 2010 10:23

A currency war is on hold – though it depends on the performance of the US Economy

 “The prospect of a full blown trade war is unlikely; it benefits nobody” … “it is not in China's interest to provoke the US”
World_First

Additionally, currency intervention… “May go off US agenda if QE2 works/economy grows” … “I suspect that a war will be averted”
JeffreyPeel

“The G20 is split - Washington consensus is dead. But sanity may prevail. No-one really wants no-win #cwars or #fx wars”
JeffreyPeel


Chinese currency depreciation is not win-win

JohnPullin asked “What will be effects on scarcity of raw materials including strategic metals?”

“that is defintely one of the aces up China's sleeve and should we see supply concerns come to the fore then the pressure will rise”
World_First

“If the West achieves its objectives re. Chinese revaluation may mean more expensive input costs”… “may be good for US steel and other traded goods though - China hasn't all aces”
JeffreyPeel

For UK manufacturers the largest impact of currency wars is likely to be price volatility

We asked whether the UK would “be collateral damage from fx volatility?”

“you have a point. To an extent it depends how much the Chinese are prepared to pump-prime and how much US resists”
JeffreyPeel

“we are advising manufacturing clients to hedge at these GBP levels to negate volatility and lock in profit”
World_First

 

Or, as we put it on twitter: "currency war is on hold as QE2 gets going & eurozone distracts markets. But..." "QE2 could go down like the Titanic if it hits China's raw materials iceberg." "So for now, UK manufacturers have little to worry about, except maybe protecting themselves from #fx volatility."

Currency wars: what does it mean for manufacturers? #fx #cwars

Jeegar Kakkad November 15, 2010 11:30

Although we've blogged on how global demand - especially from emerging economies - is helping drive the recovery in manufacturing, today's news out of Ireland is a pretty stark reminder of the risks posed by the global economy.

The G-20 meeting in Seoul managed only loose commitments to resolve the economic imbalances behind the currency war.

China is signalling it’s concern about inflation (which is code for their going to let the reminbi appreciate), which has knocked 5% off the Shanghai markets. This could have been typical pre-G-20 posturing, or it could reflect significant concern about rampant credit.

And now rumours are swirling of Ireland requiring, but shunning a bailout.

Where does this leave UK manufacturers? Many UK businesses I’ve talked to are concerned about the impact on three key points: demand, costs and profits, with further Sterling volatility being the worrying wildcard.

The concern about demand

If goods exports to China have risen by 44% since the start of the year, a trade war involving China and other developing economies, such as Brazil, could undermine the demand that is helping to drive growth in the UK. Most manufacturers worry that, if the currency battles slip into protectionism, then developing economy demand may dry up, profits could get hit or materials costs could rise (e.g. China produces 97% of global rare earth mineral supply).  

So far, so good. But what will happen to UK exports if the UK doesn't try to competitively devalue its currency? Would that help mitigate the damage from a trade war? Would the UK be viewed by China, Brazil and others as a benign trading partner, and so avoid the worst of the restrictions? Or would UK exports become collateral damage, caught in the crossfire between the US, China and others?

With the bulk of exports still headed for the EU, UK firms will have a decent buffer against such global headwinds. But the longer a trade war between the US and China persisted, the more likely the global economy - and UK exports with it - will suffer.

Profitibility could be hit 

Over the past decade, many firms protected themselves against a strong pound by buying and selling in dollars and eruos rather than pounds. This is standard practice for firms operating out of small, open economies and with exports making a big contribution to turnover. This way, if sterling moves, then firms take the hit on profits rather than on orders. This is why, as sterling fell during the recession, EEF's Business Trends survey showed improving profit margins on exports, even as world trade fell.

What's this mean for a currency war?

If the UK doesn't try to devaule it's currency, sterling will probably rise, for example, relative to the dollar. As discussed above, this will hit profitability, while potentially protecting orders. The knock to profits could eventually feed through to greater caution on investment and employment intentions.

If the UK tries to devalue the pounds, for example, through further QE, then profitibility could be temporarily protected, but at the cost of demand if protectionist measures begin to bite.

Cost of commodities

Over the past couple of years, a weaker dollar has meant rising commodity prices. Allowing sterling to appreciate could insulate UK firms from rising costs, while also helping to dampen down inflationary pressures in the UK (as import costs reduce).

But as we said before, getting caught up in competitive devaluations could mean getting caught out on access to China's supply of rare earth minerals.

A spanner in the works

The one issue that could through all this analysis - and firms' best laid plans - out the window is further exchange rate volatility.

Stirling volatility over the past year or so made planning for the recovery difficult, and another bout of it could keep cash-rich companies' on the sidelines of the economy until the G-20 manages to either resolve the currency crisis or settle the Doha trade round.

TWITTER DEBATE: Do UK companies have anything to fear from currency wars? #fx #cwars

Felicity Burch November 15, 2010 11:02

Do UK companies have anything to fear from currency wars?

Join the debate!
(Monday, 15 November 2010, 15.00 - 15.45)

On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars.

 Time:  3.00pm - 3.45pm 
 Hashtags:          #fx #cwars
 Participants:

@EEF_Economists (Moderator)
@World_First (panellist)
@JeffreyPeel (panellist)

 Key questions:      1. What is a currency war and should we be worried?
2. How would a currency war impact Sterling?
3. What, if anything, should UK manufacturers be worried about?
4. How should the government and the Bank of England respond?

Pre-debate, we've put together some background information: 

Currency wars: the story so far

Currency wars: the best of the press

Currency wars: the view from manufacturing

--

16/11/2010 Update

Here is a summary of the discussion -

Currency wars debate: some conclusions

 

Currency wars: the best of the press

Felicity Burch November 11, 2010 15:43

In the G20 meeting in Seoul last week one of the key issues was how to avoid the currency wars which threatening global economic recovery. Although some agreement was made over continuing discussions, tensions have not dissapated. On Monday 15th November at 3pm EEF is hosting a twitter debate on the impact of currency wars on the UK, and UK companies. 

 

As a background to this, here are some key articles and blogs that have been written on currency wars in the last couple of months:

 

What is a currency war?

The BBC’s animated guide: http://ow.ly/388kiOr, if you’d prefer something to read, Stephanie Flanders’ summary is here: http://ow.ly/38bb7

When did this one start?

The first rumblings of currency hostility started in March 2010 when 130 bipartisan US Congressmen sent a letter last week to US Secretary of Commerce Gary Locke, calling for the government to identify China as a currency manipulator. However, it was Guido Mantega, Brazil’s finance minister, whose announcement on September the 28th branded competitive depreciations as “currency wars”. Reported by the FT: http://ow.ly/38bp8

Who is fighting whom?

The BBC’s Andrew Walker sets out the key players and the main battlegrounds: http://ow.ly/388oq What impact could currency wars have on the global economy?Competitive depreciation could represent a very serious risk to the global recovery. In particular, the global rebalancing which debtor countries are relying on to boost growth could be hindered by surplus countries accumulating excess reserves to boost their own exports. The FT reported here: http://ow.ly/38bOK

What has happened with currency wars in the past?

Douglas Irwin at the Wall Street Journal summarises how high tariffs and currency wars caused problems in the 1930s: http://ow.ly/38bxy

What happened at the G20?

According to the Guardian "the summit set vague "indicative guidelines" to measure imbalances" however "the leaders were unable to agree on how to identify when global imbalances pose a threat to economic stability, merely committing themselves to a discussion of a range of indicators in first half of 2011": http://ow.ly/39MMK  

 

Therefore, questions remain: What would trade wars mean for the UK? Crucially, how will UK companies be affected if exchange rates become increasingly volatile, or if currency tensions lead to increased protectionism?

 

Join the debate! On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars. The debate will start at 3pm and last for 45 minutes. 

Disclaimer
This is an informal blog about manufacturing and the economy written by EEF's policy and representation staff. While it is written from an EEF perspective, contributions should not be taken as formal statements of EEF policy, unless stated otherwise. Nor does it cover all the issues on which we campaign - you can check these out in more detail at our main site.

We welcome and encourage comments, but we reserve the right to remove any that are offensive or irrelevant. We are not responsible for the content of external internet sites.

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