Aurelia Butler

China’s industrial groups posted their worst decline in profits in two years in April, in the latest sign of the economic and corporate pain stemming from a wave of coronavirus lockdowns.Industrial profits dropped 8.5 per cent in April compared with the same period a year earlier, the measure’s worst fall since March 2020, when China was also gripped by restrictions to combat the initial outbreak of the virus.The contraction piles greater pressure on the government, which has insisted on maintaining its zero-Covid policies that seek to eliminate infections through mass testing, lockdowns and quarantine. The strategy is a priority for President Xi Jinping this year as he bids for an unprecedented third term in power, but its mounting economic costs pose a grave threat to the country’s growth target of 5.5 per cent for 2022.Official data last week showed a fall in overall activity in April at a time when Shanghai, China’s financial hub, was closed off and residents were confined to their homes. Retail sales, an important gauge of consumption, collapsed 11 per cent while industrial production also fell. Unemployment hit 6.1 per cent, its highest level in two years. Lockdowns are estimated to have affected dozens of cities and hundreds of millions of people. Restrictions are also being imposed in Beijing, which is reporting dozens of daily cases.

Premier Li Keqiang this week issued a stark warning over the state of the economy and called for “reasonable growth” in a speech to more than 100,000 officials that did not explicitly address the zero-Covid strategy but mentioned virus prevention. He added that corporate liquidation was up 23 per cent in April.China’s latest outbreak has been centred mainly around Shanghai, which has reported about 63,000 infections, and where many residents are still confined to their homes. Officials have emphasised the need for quick citywide responses to the highly infectious Omicron variant.Zhu Hong, a senior statistician at the National Bureau of Statistics, said that in April the outbreak “had a large impact on the production and operation of industrial firms”, and added that for manufacturing companies specifically, profits fell 22 per cent.Authorities, who were already easing monetary policy in response to a liquidity crisis in the real estate sector that erupted last year, have taken other steps to support the economy. Last week, China’s rate underpinning mortgage lending was cut for the second time this year.Analysts at Goldman Sachs pointed to the effect of “high raw material costs” on industrial profits, in addition to the supply chain disruptions arising from Covid lockdowns in manufacturing centres.“We expect policies to ease further on the fiscal front to boost demand, given downward pressures on growth and the uncertainty of the recovery pace from Covid disruptions,” they noted. More

Good morning. A nice little micro-rally in stocks yesterday, as good results from Dollar Tree, Dollar General, and Macy’s suggested that not every retailer was going to fall into the traps that Walmart and Target did. But there may be more traps laid elsewhere, as I discuss below. Email us your thoughts: [email protected] and [email protected]. And, if you are in the US, enjoy the first long weekend of summer. Inventories crack that whipWay back in December I wrote about the bullwhip effect. It works like this: in response to a drop in supply or pop in demand, companies in a supply chain over-order or hoard inventory to protect themselves. The over-ordering amplifies as it moves up the chain from retailer to wholesaler to manufacturer to supplier. The whip cracks when suddenly demand weakens and there is too much inventory in the chain, leading to a glut. I wrote:The question is whether bullwhip effects might go into reverse next year [2022], leading to oversupply at just the same time as rabid end demand for goods is cooling anyway because (please, please) Covid is subsiding. This could lead to supply gluts or even deflation. I would hate to attach a probability to this, but it seems possible but not likelyRegular Unhedged readers will now be thinking about Target and Walmart. The shares of the two big-box retailers were recently clobbered after they ordered a lot of the wrong stuff and ended up with billions in extra inventory they have had to mark down, at a cost to margins. This does indeed sound rather bull-whippy.Albert Edwards of Société Générale thinks the Target and Walmart situation could be part of a global bullwhip phenomenon. In a recent note to investors (in which he kindly mentioned Unhedged) he argued that “unanticipated excess inventory build-ups, especially during a Fed tightening cycle, can help to trigger a recession”. He points out that in the fourth and first quarters, US business inventories grew by $212bn and $185bn, respectively, or roughly a per cent of GDP in each quarter.If we have built up too much inventory, then it will have to be wound down, which will not only creates the possibility of price deflation (as in the Walmart/Target case) but of less orders for suppliers and manufacturers. Who will this hurt most? Probably China:If we accept there is an inventory issue at the retail level in the US, producers are clearly going to see orders cut . . . China is likely to be especially hard hit — just at a time when the authorities there are desperately trying to revive growth. While I think it is only a matter of time before the Fed capitulates, maybe it will actually be China that is forced to (re-) open the liquidity floodgates first.But is there an excess inventory problem? Overall inventory-to-sales ratios do not look very high. But, Edwards argues, if you look at certain sectors, the story is not so pretty. Here is his chart:

The chart does not look too bad to me — it seems to show inventory-to-sales ratios only a little above pre-pandemic levels. But the increase was enough to make me think. Where besides the balance sheets of big retailers may excessive inventories be hiding? So I had a poke around the companies in the S&P 500. While, again, there is not an obvious pattern cutting across industries, at a number of large companies inventories are moving up remarkably quickly. A couple of examples. Stanley Black & Decker is a big company that makes hand tools, which were in great demand with bored do-it-yourselfers during the pandemic. Here is what its inventory to sales ratio looks like over the past five years: Intel is a big company that makes computer chips, which there was not enough of during the pandemic. Here is it’s inventory to sales ratio over five years:These two companies stuck out to me because they are large and important, in disparate sectors, and suddenly have a lot of inventory. But they are not alone. Within the S&P 500, similar patterns were also visible not just at Target and Walmart but also companies such as Garmin, Cisco, Monster Beverage, Ross Stores, and others. I’m not jumping to any conclusions here. It may be that the growth in inventories at these companies reflects tactical choices in response to pandemic conditions, and can be managed down smoothly. What do the companies say? Here is Stanley’s CFO Donald Allan on the company’s first-quarter call:As a reminder, last year, we made significant investments in inventory to help meet the outsized demand in the tools business. Our 2022 cash flow guidance assumes that we can modestly reduce inventory versus 2021 levels, and we expect much of that improvement to occur in the second half of the year…Our inventory at the end of Q1 was up approximately $850mn versus the year-end ‘21 balance. The increase in our first-quarter inventory was primarily due to working capital seasonality to support the peak outdoor buying season, spring merchandising and the Father’s day selling season.That all sounds sensible, if demand comes in as expected. Here’s Intel’s CEO Patrick P. Gelsinger, responding to a question about high inventory levels:We are building 10-nanometer [chip] inventory. We have new products that we’re ramping into the marketplace. And we do see some of those will be reversals as we go into the latter part of the year as that inventory will start flowing through the product area. So we would say this is very typical management of new product ramps…as we’ve indicated, we did see our customers’ inventory burn down in Q1. We expect some of that to be in Q2 as well. But by the second half, we expect those adjustments and obviously the strength of second half outlook, we do expect much of that inventory burn to have finished in the first half and a strong second half as we’re ramping our new products.Again, there is nothing unreasonable about this. It is hard to see from the outside who if anyone is going to get into a Target-style mess. But there is clearly a lot of inventory at big companies right now. I don’t know if Edwards is right and that is likely to contribute to a global recession. But it is clearly an important thing to keep an eye on. One good readA global economy whistle-stop tour with Matt Klein and Cardiff Garcia. More

As the global elite gathered for the World Economic Forum this week, various multilateral organisations and governments have warned of what could become the worst food emergency in decades.The war in Ukraine has ground agricultural commodity exports from the country to a virtual halt, and has come on top of deteriorating food security caused by droughts and the pandemic. Since the invasion, wheat and corn prices have increased 41 per cent and 28 cent respectively, as Russia and Ukraine combined represent about 30 per cent of global wheat exports, with both countries having a large share of corn and sunflower oil export markets.The conflict has also caused a sharp rise in energy prices, which has increased some countries’ reliance on biofuels, made from grains and oilseeds, to limit price increases in petrol and diesel. In Europe and elsewhere, skyrocketing prices of natural gas, a key ingredient for fertiliser, has further added to price pressures in agricultural markets.But the energy crisis must not be allowed to cause hunger catastrophe and the ties between energy and agricultural markets need to be weakened.The production of biofuels uses about 4 per cent of arable land worldwide, corresponding to 32 per cent of world sugar production, 12 per cent of corn, and 15 per cent of vegetable oils. There is significant interchangeability between crops grown for biofuels, animal feed, and food, even though these are not perfect substitutes for each other. A 50 per cent reduction in the amount of grain used for biofuels in Europe and the US, two leading biofuel producers, would compensate for all the lost exports of Ukrainian wheat, corn, barley and rye, according to the World Resources Institute.Greater demand for biofuels was a main driver of the 2007-2008 food crisis, along with trade shocks in the food market and rising oil prices that led to increased costs of cereal production. These conditions are also prevalent in the current crisis. If high food prices persist, alternative sources of food supplies could be freed up by easing biofuel mandates.While cuts to biofuel production would have a large impact on food supply and prices, the impact on fuel supply would be limited. The maths are simple. Whereas humans need about 2,000 calories a day to survive, a single litre of bioethanol contains 7,000 calories, enough to feed a human for 3.5 days. The US, a leading ethanol producer, uses 30-40 per cent of its corn supply for biofuel, to produce only 5 per cent of domestic fuel for transport.On the fertiliser front, prices have increased 250 per cent since the end of January, and has led some producers to reduce output. The principal cause is the surging price of natural gas, a main input for nitrogen fertilisers such as ammonia and urea. Russia and Belarus are big exporters of potash, another key crop nutrient. Record fertiliser prices could result in global agricultural output falling by tens of millions of tonnes, according to IDFC, an agriculture non-profit, and the International Rice Research Institute, enough to feed hundreds of millions of people. To mitigate the risk of catastrophe, multilateral organisations have issued calls for countries to avoid export bans on food and fertiliser. While such moves are important but unlikely to be sufficient in curbing price rises, a temporary limit on biofuels, and safeguarding natural gas supplies for fertiliser production, could go a long way towards mitigating the risk of food scarcity and famine. Nevertheless energy and agricultural policies of many developed countries work against such solutions. Those hit hardest by the food crisis will be low-income food-importing countries, including many African countries, and middle-income food-importing countries with large low-income populations.In food exporting countries, however, policymakers, farming and biofuel lobby groups, and voters may be more concerned about rising fuel prices, and the revenues that biofuels bring. Similarly, policymakers in Europe and elsewhere have so far been more concerned with replacing Russian gas used for energy generation than with making natural gas supplies available for fertiliser.Whereas during the 2007-2008 food crisis there were high-level calls for a five-year biofuel moratorium, this time reactions have been muted. Only a few countries have taken steps to reduce the production of crop-based biofuels. There are also no international mechanisms to ensure prioritisation of natural gas supplies for urgently needed fertiliser. If Covid-19 taught us anything, it is that government policy matters. As does international co-operation. Governments and international organisations must ensure that measures to mitigate energy price growth do not imperil the food security of the millions already struggling to feed themselves and their children.Håvard Halland, Rüya Perincek, and Jan Rieländer are executives at the OECDThe Commodities Note is an online commentary on the industry from the Financial Times More

Fiji will join the US-led Indo-Pacific Economic Framework just days before China’s foreign minister lands in the country, giving the Biden administration a victory in its competition with Beijing over influence in the Pacific.Jake Sullivan, US national security adviser, welcomed the move by Fiji to become the first Pacific Island nation and 14th member of IPEF, a trade initiative designed to deepen economic ties, which President Joe Biden launched in Japan on Monday.“IPEF now reflects the full regional diversity of the Indo-Pacific, with members from north-east and south-east Asia, South Asia, Oceania and the Pacific Islands,” Sullivan said. The decision provided the US with some relief in its rapidly-escalating battle with Beijing over sway in the Pacific Island nations.The US, Australia, New Zealand and Japan were alarmed when China signed a security pact with Solomon Islands this year. Some security experts believe the deal could pave the way for Beijing to build a naval base that would allow it to project its power further into the Pacific.The Financial Times reported last week that China was negotiating a security pact with Kiribati, another Pacific island nation 3,000km from Hawaii. Reuters has reported that Beijing has proposed an even broader security and economic arrangement called the “China-Pacific Island Countries Common Development Vision” to 10 Pacific Island nations. Chinese foreign secretary Wang Yi was expected to discuss the proposal with Pacific Island nations in Fiji on Monday. But Suva’s decision to join the IPEF has undercut Beijing’s drive to reach a comprehensive political, economic and security deal.Fiji has been central to China’s push for influence in the Pacific. After Frank Bainimarama, now prime minister, became president through a military coup in 2006, western governments suspended contacts with the country. China stepped in to build ties, offering its backing to Bainimarama’s government and boosting aid from $1mn to $161mn within two years.Fiji has since helped China promote partnerships with other countries in the region outside the Pacific Island Forum, a grouping that includes US allies Australia and New Zealand. But analysts said Suva has been much more sophisticated in managing its relationship with China than other small nations in the region.“They have learned how the Chinese government functions, which agencies do what, and so have acquired capacity to look out for their own interests,” said Tarcisius Kabutaulaka, an associate professor at the University of Hawaii. “For example, they say no to Chinese loans when they think it is not beneficial to them.”The US push to get Fiji to join IPEF is part of a broader strategy to woo some countries back from China’s sphere of influence. The IPEF is designed to fill part of the vacuum created when then-president Donald Trump withdrew the US from the 12-nation Trans-Pacific Partnership trade deal in 2017.

Penny Wong, Australia’s new foreign minister, has also made a clear commitment to the region in an effort to win back support ahead of Wang’s visit. Speaking to the Pacific Islands Forum in Suva this week, she said Canberra would boost aid to the Pacific by about A$500mn (US$356mn) over the next four years and that it “won’t come with strings attached, nor impose unsustainable financial burdens”.Sullivan said Fiji would add “vital value” to the IPEF, particularly in efforts to tackle climate change. Fiji and the other Pacific Nations face dire threats from increasing temperatures and rising sea levels.Follow Demetri Sevastopulo, Kathrin Hille and Nic Fildes on Twitter  More

TOKYO (Reuters) – Bank of Japan (BOJ) Governor Haruhiko Kuroda said on Friday the country’s core consumer inflation will likely remain around the central bank’s 2% target for 12 months unless energy prices drop sharply.But he told parliament that prices likely would not rise “sustainably and stably” unless accompanied by wage hikes, suggesting the recent increase in inflation alone would not lead to an immediate withdrawal of monetary stimulus. More

LONDON/WASHINGTON (Reuters) – Britain will sign its first state-level trade agreement with the U.S. corn belt state of Indiana on Friday, with more to come as London eyes ways to expand commercial ties despite Washington’s decision to halt talks on a national-level free trade deal.Britain is working with about 20 states to secure individual trade deals, in the absence of a broader deal with Washington, with the first eight alone accounting for about 20% of the U.S. economy, trade policy Penny Mordaunt has said.International Trade Minister Ranil Jayawardena will sign a memorandum of understanding (MoU) with the Indiana Governor Eric Holcomb on Friday and more deals would follow.”We are ready to progress negotiations on a United States free trade agreement whenever the U.S. is ready to do so. But we don’t want to wait for that, which is why we’re doing these trade and economic agreements with the states,” Jayawardena told Reuters.He declined to provide details until the MoU was signed but said it would help lower market access barriers for British firms, potentially boosting jobs and wages in areas such as advanced manufacturing, pharmaceuticals and renewable energy.The agreement would also streamline procurement processes, enable academics to collaborate more easily, and ensure that professional qualifications were recognized on both sides.Britain currently buys more than $1.5 billion worth of goods and services from Indiana annually, about 1% of total U.S. exports to the UK.U.S. trade agreements are usually negotiated and signed on the national level, but foreign governments have long sought to develop stronger ties with individual states and cities.London once viewed a free trade deal with the United States as the one of the biggest prizes for leaving the European Union. But hopes of a quick agreement were dashed when the incoming Biden administration put all free trade talks on ice.For now, they have settled for a strategic dialogue on expanding the $260 billion bilateral trade relationship, with a third round of those talks scheduled in Boston in June.Britain has been advancing post-Brexit trade negotiations, starting talks with Canada and Mexico as part of a foreign policy tilt towards the Pacific.Officials in London still hope talks with Washington can ultimately produce an overarching free trade agreement. Some U.S. lawmakers, who must approve trade agreements, have said there can be no trade deal with Britain if it proceeds with plans to unilaterally scrap some of the rules governing trade with Northern Ireland that had been agreed with the European Union under the deal to leave the bloc. More

Beijing could not have made its displeasure with Joe Biden any clearer. As the US president met leaders of the Quad security grouping in Tokyo, Chinese and Russian nuclear bombers flew over the Sea of Japan.But China is also employing less crude tactics to counter the US in the form of a diplomatic drive. Just as Biden embarked on his Asian trip, Beijing began promoting its Global Security Initiative (GSI), a proposal for an alternative security order.Floated by President Xi Jinping in April, the initiative is a collection of policy principles such as non-interference and grudges against US “hegemonism”.Now Beijing is trying to entice other countries on board. In a video address to foreign ministers from the Brics grouping of big emerging economies on May 19, the Chinese president spoke of the myriad virtues of GSI. Xi urged fellow Brics members Brazil, Russia, India and South Africa to “strengthen political mutual trust and security co-operation, . . . accommodate each other’s core interests and major concerns, respect each other’s sovereignty, security and development interests, oppose hegemonism and power politics, reject cold war mentality and bloc confrontation and work together to build a global community of security for all”.Over the following days, Wang Yi, China’s foreign minister, extracted declarations of support for GSI from Uruguay, Nicaragua, Cuba and Pakistan. Indonesia and Syria have endorsed it, too.The initiative is part of Beijing’s increasingly frantic efforts to oppose US-led blocs, which it blames for global conflict and tension.Chinese and Russian bombers fly over the Sea of Japan during Joe Biden’s trip to Tokyo © Joint Staff Office of the Defense Ministry of Japan/ReutersTian Wenlin, a professor for international relations at Renmin University in Beijing, described the western-led world order as “barbaric and bloody” and accused the US of dragging other nations into wars.“Countries . . . are urgently clamouring for a new global security paradigm based on equality and mutual trust in the face of the rapid changes in the international landscape,” he wrote in a recent article. “As a result, the Global Security Initiative was designed to protect the security interests of a broader spectrum of people around the world.”Beijing’s focus on security marks a departure from its traditional approach to international relations.“Previously, when Chinese officials spoke about how the conflicts and security issues in the world would be resolved, the front foot was development. The answer was to provide prosperity to those troubled regions. But now there is a reprioritisation,” said Bates Gill, professor of Asia-Pacific security studies at Macquarie University. This greater role played by security is evident in the Pacific, where China is rapidly expanding its influence at the expense of the western powers that have dominated the region.On a tour of eight Pacific island nations over the coming week, Wang is proposing a co-operation deal covering everything from customs to fishing. But the first of the draft agreement’s eight articles focuses on security, including joint law enforcement and cyber security.M Taylor Fravel, director of the Security Studies programme at MIT, said the initiative was part of China’s attempts to delegitimise the global role of the US. “I think their focus would be mainly on states from the developing world,” he said. “This is clearly a huge priority for China, especially in the light of its alienation of most of Europe.”Chinese diplomats have been promoting the GSI in developing countries including India, the Philippines, Uganda, Somalia and Kenya through articles in local media and on its embassy websites.Security experts said planning for the GSI predated the Ukraine war. “It is the next step in Xi’s efforts to steer the global security order away from cold war thinking, which he has been making since 2014,” said a Chinese scholar who advises the government. But Russia’s invasion has made that endeavour both more urgent and difficult. “Since the war in Ukraine started, China has gone to some lengths to defend Russia’s ‘legitimate security interests’,” said Paul Haenle, director of the Carnegie-Tsinghua Center in Beijing. “The Global Security Initiative, similarly, borrows from Russian concepts of ‘indivisible security’.”

The initiative also seeks to counter the fallout from China’s support for Russia. “GSI is also a corrective for China’s Ukraine response, which has left states questioning China’s espoused commitment to multilateralism and international order,” said Courtney Fung, an associate professor at Macquarie University.Analysts believed Beijing could eventually institutionalise the programme, as it has done with its Belt and Road Initiative. But that could take years. The BRI was announced in 2013 but many nations did not join until 2016. “They want to consolidate a large ‘third camp’ of countries that do not want to take sides in what they see as a polarised world,” said Yun Sun, director of the China programme at the Stimson Center think-tank.“But it will be impossible to implement such a broad and vaguely defined strategy on a global scale.” Additional reporting by Maiqi Ding in Beijing More

(Reuters) – The world is moving rapidly toward increasing use of digital payments and an official digital version of the U.S. dollar could help safeguard its global dominance as other countries issue their own, Federal Reserve Vice Chair Lael Brainard said on Thursday.”I don’t think we should be taking the global status of the dollar for granted and in a world where other major jurisdictions move to the issuance of their own digital currencies it is important to think about whether the United States would continue have the same type of dominance without also issuing one,” she told lawmakers in Congress.Fed policymakers remain divided on the need for a central bank digital currency (CBDC) and have just finished a four-month public consultation period soliciting feedback on the idea.Brainard has emerged as a supporter of the idea while some other Fed policymakers, including Fed Governor Christopher Waller, are more skeptical and point out that many dollar transactions are already digital, and have also raised privacy concerns. The Fed as a whole has indicated it would not launch one without clear support from the White House and lawmakers.She reiterated that no decision has been made, and acknowledged the risks of both sides, but noted that in a world that is rapidly digitalizing creating a digital currency could help ensure financial system stability as crypo-assets and digital currencies developed by other countries become increasingly popular. “We recognize there are risks of not acting, just as there are risks of acting,” Brainard said during a hearing on the issue before the U.S. House of Representatives Financial Services Committee, noting that even if it was agreed to set up one it would take perhaps five years to put a U.S. digital dollar in place.That puts it behind its other major global central bank peers, including the ECB, Bank of Japan and Bank of England, on the process of possible adoption. China is currently piloting its own CBDC and in total nine countries have launched one and another 87 countries are exploring the option, according to the Atlantic Council think tank.CRYPTO MARKETS NEED MORE REGULATIONThe risks of loosely-regulated cryptocurrencies and stablecoins, which exploded in value during the COVID-19 pandemic, have come into sharp focus with the crypto market slumping sharply this month after the downfall of major “stablecoin” terraUSD. Leading cryptocurrency Bitcoin has dropped more than 50% since November.”These events underscore the need for clear regulatory guardrails to provide consumer and investor protection, protect financial stability, and ensure a level playing field for competition and innovation across the financial system,” Brainard told the committee.Unlike cryptocurrencies, which are typically run by private actors, a CBDC would be issued and backed by the central bank. If the United States goes ahead with creating one, Brainard said the Fed should mitigate the risk of “disintermediating banks,” given their centrality to the financial system, by, for instance, limiting the amount an individual could hold or transfer.Brainard also said her preference would be for a U.S. digital dollar not to be interest bearing in order to prevent a reduction of deposits elsewhere in the banking system. More