The World Bank issued its latest health check on the state of the global economy on January 14th. The results were – surprisingly – somewhat encouraging. In the report, the World Bank states that it expects global Gross Domestic Product (GDP) to expand by 3%. The projection represents global GDP growth to go up from the 2.6% experienced in 2014.
Some of the rosy outlook is based on the impact of falling oil prices and low interest rates. There is a catch however as the report also included this caveat, “Risks to this slow-moving global recovery are significant and tilted to the downside.”
That remark is akin to the weatherman stating that it will be sunny, but that we should not be surprised if it rains. Still, the optimistic outlook is a positive sign that we haven’t seen in a while.
Another interesting takeaway from the report is that low interest rates are here to stay… except in the United States.
The bigger issue for the pallet industry – especially in the West – is what the report had to say about China. China’s manufacturing index – which is seasonally adjusted – revealed a decline in China’s manufacturing sector in December.
Now, at press time, HSBC/Markit Services Purchasing Managers’ Index (PMI) for January was at a six month low. The weaker PMI readings were reportedly due to a continued fall in new business volumes placed at Chinese manufacturers in December. The reduction in new orders – though slight – was the first drop since April. The PMI registered a larger drop from December to January, clocking in at 51.8 on a scale where 50 is zero growth.
Slowing Domestic Demand Drives China’s Contraction
A more concerning, larger issue for world’s second-largest economy is that the decline was not due to a drop in global demand but rather driven largely by softer domestic demand. Available data showed new export work continued to climb, supporting the reports that suggest China’s economic slowdown is at home.
This leads to concerns that China’s manufacturing sector is contracting. There is talk within the financial community that this isn’t just a slowing, but a true contraction. That wouldn’t only be a problem for China but likely would signal trouble for the global economy.
The World Bank report termed the current slowdown in China a “managed slowdown.” In measuring the global impact, the World Bank estimated that a 1% slowdown in the Chinese growth would hamper global growth by 0.5 %.
It wasn’t too long ago that China was boasting close to an 11% growth rate. That is now right around – or slightly below 7% and projections for 2015 are pointing to 6.5% which would be a 40% decline in growth.
Economists at UBS and Charles Schwab have reported that they expect that number to drop to 5% and below over the coming decade. There are some financial projections pointing to horizon numbers of China leveling at 3.5%.
That is a drastic drop overall, but even a 3.5% growth isn’t alarming in the grand scheme of things. The issue for the government is that the number could become problematic in respect to handling previously established expectations.
China’s Economic Transition
Beijing has done a masterful job of pushing China’s economy from an agrarian-based economy towards a consumer-driven economy thus far. Guiding this sort of changeover within a single generation is more than a little difficult. China is now hitting a spot where some countries (Brazil) have faltered and not completed the transition.
China is now encountering some of the same issues that have dramatically slowed the economic transition in Brazil.
One of the issues is Beijing’s over-investment in infrastructure as this area accounts for 50% of China’s GDP. While this allowed China’s economy to cruise through years of global economic stagnation, it also was bought at a considerable price. China took on considerable debt that economists say is unsustainable.
Another issue is that China has too much manufacturing capacity for its own benefit. The county’s manufacturing capacity has the ability to outstrip global demand in an upbeat economy, so activity from the continuing slow global recovery presents its own separate issues.
Possibly the trickiest issue for the government to maneuver around occurs as the transition gets further along. As larger portions of the citizenry approaches middle-class status, wages begin to be driven higher. The trend is good for the citizenry, but the rising labor costs erode the country’s competitive advantage.
The country is already feeling the impact. Some of China’s older, industrial sectors, manufacturers are looking to other markets such as Indonesia or Vietnam to drive down costs. This factor was a primary issue for Brazil.
Internally, China is dealing with a deteriorating housing market. Managing the declining housing market is another balancing act for Beijing because the housing market accounts for the largest portion of savings/wealth accumulation for the middle class.
Tumbling housing markets have been the undoing of solid, more established economies in the past, with Japan and the United States being recent examples. China’s property market – which was red-hot not too long ago – is easily one of the biggest threats to the country’s economy.
China’s property market accounts for about 15% of GDP on its own, and like the United States, it directly affects other sectors such as banking and construction.
Beijing is telling anyone who will listen that the bubble has deflated and will not pop. The Chinese government reportedly will be removing restrictions on second-home purchases to help encourage the sinking housing market. The problem with the “deflated, non-popping” housing market is that home prices have dropped. Although this creates an excellent opportunity for wealthy Chinese to invest again, it will only carry them so far, especially with home prices expected to decline further, according to the Chinese Academy of Social Sciences.
Where Does that Leave Us?
North America’s problem with a slowdown in Chinese growth is the impact on raw material demand. This will be felt in forest products markets.
China has continued and will continue to be to be a steady player in the lumber market, but signs point to the volumes being at levels that have less dramatic impacts on our lumber markets in the short-term.
Fortunately for North American lumber suppliers, the U.S. housing market finally appears to be returning to some semblance of health. Typical projections for the year are around 1.3 million starts. This would be a very healthy market. It would offset the decline in offshore demand. It would fuel more than just framing lumber production at export friendly mills.
Projected U.S. housing growth also could drive hardwood production. It would impact the derived demand products that go along with a strong housing market. It would be good for the entire forest products industry, including the pallet sector.
Editor’s Note: Jeff McBee is an analyst who researches and writes about the pallet industry and its raw material markets for Pallet Profile Weekly and the Recycle Record, the only newsletters dedicated to serving the pallet industry. For information on subscribing to Pallet Profile Weekly or the Recycle Record, call 800-805-0263 and ask for Jeff.
