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By HaleStewart November 14, 2014 12:17 pm
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International Economic Week In Review: Potential Problems in Brazil, Russia and China Highlighted

Earlier this week an economic consultant stated that the world has a higher than 50% probability of having a world-wide recession in 2015.  Earlier today, Bloomberg released a survey of money managers showing 38% thought the overall world economic situation would worsen next year:

The world economy is in its worst shape in two years, with the euro area and emerging markets deteriorating and the danger of deflation rising, according to a Bloomberg Global Poll of international investors.

A plurality of 38 percent of those surveyed this week described the global economy as worsening, more than double the number who said that in the last poll in July and the most since September 2012, when Europe was mired in a recession.

Earlier this week, I noted that the calls for a world-wide recession were not far-fetched.  In the article, I argued the combination of weak EU and Japanese growth combined with the slowing situation in Brazil, Russia and China all made the prediction of a global slowdown a possibility.  In this article, I’ll focus on China, Russia and Brazil to highlight exactly what the underlying problems of each economy are.

Let’s start by looking at a chart of the real and ruble (because the Chinese manipulate their currency, there’s little reason to discuss its level).  The real (blue line) has been moving lower since 2Q11.  Its level has steadied somewhat over the last year, but overall it’s value has clearly declined.  In contrast is the ruble, which didn’t start dropping until the end of 1Q13, but has obviously moved lower since. 


In the latest World Economic Outlook, the IMF described the Brazilian economy in very concerning terms:

In Brazil, output contracted during the first half of the year. Full-year growth in 2014 is now projected at 0.3 percent. Weak competitiveness, low business confidence, and tighter financial conditions (with interest rate hikes through April 2014) have constrained investment, and the ongoing moderation in employment and credit growth has been weighing on consumption.

Let’s start by observing the economy is in a technical recession, which is loosely defined as two consecutive quarters of negative GDP growth.  And in the last four quarters, there has only been one quarter with positive growth.  The total macroeconomic picture presented by the GDP figures is of an economy in trouble.

And business confidence is clearly dropping.  The above graphs are from the central bank’s most recent presentation on interest rate policies.  Construction’s confidence (right chart, red line) has been declining for the better part of 4 years.  Service confidence has been dropping since 3Q11 while industry’s has been moving lower since 2Q13.  And commerce – which was negative for most of 2013 – has been moving lower since 1Q14.  In broad terms, there isn’t a Brazilian business sector that has a positive view of the economy.

The year over year percentage change in industrial production has been negative for the better part of this year as well.

To make matters worse, inflation has been creeping higher:

To combat this price rise, the central bank has been slowly raising interest rates.

In general terms, Brazil is experiencing classic stagflation: slow to negative GDP growth combined with high inflation.  This places the central bank in a terrible policy bind: they can lower rates to stimulate growth, which would have the extremely negative effect of increasing inflation.  Or, they could raise rates to lower inflationary pressures, which would lead to slower growth.  Given Brazil’s negative inflation history, they have clearly opted for the latter. 


Russia faces problems similar to Brazil’s: slow growth and high inflation.  However, they have the added problem of being an aggressor and therefore having the added burden of sanctions.

Let’s begin by looking at overall GDP, which has been declining since mid-2011 and now stands below 2%.  And growth components are narrowing, with consumption and exports being the primary drivers in the first part of the year.  Notice there has been no net capital formation in the last 5 quarters, largely because of declining business sentiment:

Business confidence peaked a few years ago, and has been heading lower ever since.

And retail sales – a very good coincident economic indicator – have also been heading lower since the end of 2011.

Overall, the HSBC manufacturing PMI is slightly positive (and has been for the last 4 months) at 50.3.  However, inflationary pressures are starting to build:

“What singles out the most from the previous month’s PMI report is the marked acceleration of inflation pressures. Both input inflation and output inflation got stronger momentum. Observing similar dynamics of PMI inflation indexes in March this year, we believe that fast currency depreciation was the main inflation driver both in March and October. This promises another wave of fast price rises due a pass-through effect from weaker RUB

And the service sector is already in a contraction:

And then there is inflation, which is clearly rising:

And, like Brazil’s central bank, the Russian central bank is faced with the impossible policy choice no central bank wants: either lower rates to stimulate growth or raise rates to halt inflation.  And like Brazil, the RCB has raised rates.

Like Brazil, Russia is dealing with stagflation.  But, in addition to the problems associated with this very troublesome economic situation, they are also an international aggressor dealing with the negative implications of sanctions imposed against them.  This combination of events could prove to be extremely debilitating in the long run.


When talking about China, it’s first important to note the country is still growing at a solid clip.  However, that pace of annual growth has clearly slowed from around 10% to the current rate of a bit over 7%:

And the reasons for the slowdown have international ramifications.  First, the manufacturing sector is clearly not the driver of growth it once was:

Before the recession, the manufacturing PMI reading was routinely above 50.  While this index did reach its previous level after the recession as a result of the mammoth stimulus the government injected into the economy, the sector has been growing at a slower pace for the last year, with the PMI fluctuating around the 50 level.  This indicates the sector has been moving between expansion and contraction.  This lowered demand is a prime reason for the current weak state of commodity prices, especially industrial metals:   

     But here is a bigger problem lurking underneath the surface of the Chinese economy: the potential for a balance sheet recession.  This occurs when economic participants are more focused on paying down high debt levels rather than taking out loans to take advantage of lower rates.  Currently, China has an incredibly high debt to GDP ratio of 251%.  The debt service burden for all of this debt has reached 17% of GDP .  And real estate – the asset tied to the some of those loans – is having problems.  Prices of newly constructed houses are declining year over year and the pace of residential real estate sales are slowing significantly.  The month to month rate of decline has now extended to 5 straight months.  And the commercial real estate market has been in a contraction for the entire year.

But real estate isn’t the only problem as capital investment is also declining:

Granted these paces of investment are still at high rates.  But, they are also slowing.

The biggest concern regarding China is the debt/real estate problem.  Balance sheet recession by definition and experience lead to far slower recoveries.  Just look at the US economy since the end of the Great Recession.


These economies are the 3rd, 8th and 9th largest in the world.  Two are experiencing stagflation while a third is building up an extremely large amount of debt relative to GDP.  People have been predicting a Chinese fall for some time as a result of its debt/real estate situation.  The lack of a negative development does not make these predictions less salient.  And the combination of all three countries having serious problems is a very concerning development for other developed economies.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer







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