The cracks appearing in an already vulnerable European banking system and the apparently greater than anticipated slowing of China’s economy is impacting commodity markets and prices. Unless the Europeans act quickly, and China acts to stimulate its domestic economy, it could get significantly worse.
The slowly accelerating bank runs in the weaker European economies are adding a new dimension to the already severe tensions within Europe and inflating concerns around the globe about the potential for another global financial crisis.
If the Europeans aren’t able to patch together a response to the crisis created by Greece’s rejection of the austerity-for-funding deal it had negotiated to remain within the eurozone, the exodus of savings from Greece, Spain and Italy has the potential to completely destabilise the region’s banking system and already recessed economies.
The uncertainty being generated by Europe has already frozen Europe’s wholesale funding markets, which inevitably means less credit available elsewhere in the world. After what occurred in 2008, moreover, bankers around the world will be tightening their already modest new lending and sitting on whatever liquidity they have accumulated.
Their nervousness about lending to miners, in particular, will be exaggerated by China’s April economic statistics, which showed an economy slowing more quickly than expected. Industrial production, retail sales, investment, imports, exports and bank lending all slowed sharply.
The combination of the weak world economy and markets for its exports, and its own attempts to deflate the inflationary property bubble of activity last year, are biting.
Commodity prices have slipped back, and the big miners like BHP Billiton and Rio Tinto clearly don’t believe they are going to bounce back quickly given the levels of anxiety and risk aversion now flowing through the global economy.
Both have scaled back their previously aggressive capital expenditure plans. It doesn’t help that Australian capital and operating costs have been soaring even as commodity prices have been softening.
A reduced supply of funding, lower prices and rocketing costs is an issue for the level of profitability of the major miners but, given the strength of their post-crisis balance sheets and cash flows, not an existential one.
That’s not necessarily the case for lesser miners with projects under development. Traditionally second tier miners use borrowings to fund their developments and almost inevitably their projects will be higher up the cost curve than the majors.
There is some potential for a new credit crisis to combine with the slowdown in China, sliding prices and rising costs to do some real damage to the smaller resource companies, as well as to cause the deferral of the myriad of projects in the pipeline but not yet fully underway. The position for thermal coal miners in particular is unpleasant, with US coal displaced by the emergence of the shale gas sector now being added to the supply into Asia, forcing prices down further.
Weekend UK newspaper reports of Chinese traders reneging on coal and iron ore contracts and deferring cargos rather than pay above-market prices for the commodities provide a disturbing echo of what occurred in 2008-09.
In Europe, this looms as a critical week, with the region’s leaders trying to devise a framework for either keeping Greece within the eurozone or ushering it out in a controlled fashion and without generating the contagion in other vulnerable economies that would cause a European banking system and economic implosion. There are no easy or painless solutions available to the Europeans.
China’s in a very different position. It has the capacity, through fiscal stimulus and regulatory easing, to blunt the impact of a eurozone-led global economic slowdown or another bout of crisis – as well as to reverse the effects of its own deflationary measures.
Premier Wen Jiabao promised today to place more emphasis on, indeed to prioritise, stabilising China’s growth, saying the country should be able to maintain stable and relatively fast growth while adjusting its economic structure and managing inflationary expectations.
That’s a pretty clear signal that the Chinese authorities have been taken aback by the extent of the slowdown they engineered and are prepared to do what it takes to protect their growth rate. There has already been some relaxation of controls on bank lending but they do have the capacity to move to more directly stimulatory tactics.
Unless and until Europe can be stabilised, however, it is likely that global economic growth will be relatively weak, that commodity prices will reflect that weakness and new credit for resource developments will be scarce and expensive.
The really big projects already underway – like the raft of $20 billion-plus LNG projects – are already committed and in any event have sponsors powerful enough to underwrite their funding. The outlook may not be as sanguine for the myriad of smaller iron ore, coal and base metal projects that are also in the pipeline.