Macroeconomics

The triangle of war, inflation and the situation in China with zero-covid policies there continues to be the defining theme for economics and politics. Of course, there are many other things that matter, but somehow they are all just a derivative of these three factors.

On the subject of the war, as gruesome as it continues to be, there is not much new to report, except that it is unlikely to end any time soon and its effects in terms of food and raw material supplies worldwide will not be fully known until next year perhaps. We must not give up hope that, aside from the military conflict, which is unlikely to end quickly, it may be possible to reach agreements that could at least alleviate the difficulties of producing exports of products from Ukraine.

There is not much news to report regarding inflation. The European Central Bank (ECB) is suddenly beginning to publish figures frantically and suggest options for quick action on rising consumer goods prices. Whatever comes will not be able to compensate for the mistakes of the past. It is a mistake when things other than competence play the decisive role in filling exceptionally important posts. Unfortunately, it is always others who have to pay the bill.

Developments in China are taking up more and more space in the economic and political discussion. The Economist analyses many facets of this topic very thoroughly and correctly, in our opinion.

The Chinese leadership has led the country further and further into technocracy in recent years. China has had years of growth and success. It looked as though this would continue even in the early stages of the pandemic. This is now beginning to crack in many areas of Chinese society and more and more surveillance and repression appear to be needed to ensure that this does not become a threat to the current leadership and system.

It could now be that we are heading towards a tipping-point that cannot be in anyone’s interest. On the one hand, an unstable China would be a disaster politically; on the other hand, it would be particularly dramatic for foreign policy with regard to the Taiwan question and for the world economy. The focus of the current political leadership has been on controlling the development of the Chinese economy, especially in technology, while at the same time rigidly applying a zero-covid doctrine. But the economic damage caused by the pandemic is now obvious to everyone.

Unemployment is rising in China, the real estate market is showing serious problems and, internationally, supply chains and sales markets are seriously threatened. Growth in China this year will be far below expectations and it does not matter what statisticians report from Beijing. When the Chinese economy will return to a certain normality and what traces this will leave in production and consumption can probably only be known in the second half of this year.

In particular, one should not be misled by the one-sided concentration of reporting on the two big centres Beijing and Shanghai. Covid outbreaks are also occurring in other provinces and the heavy hand of the central government demands an extremely restrictive policy from the local authorities. For now, the majority of Chinese provinces are affected by the restrictive policies. There are not many alternatives to restricting public life at the moment owing to the insufficient vaccination of the elderly population in particular, and as long as Beijing is not willing to buy the appropriate vaccines abroad or produce them under licence in China, it will probably not be possible to achieve a quick turnaround. 

Much will now depend on whether pragmatists or technocrats prevail in China. There are already strong forces in the Chinese government that want to counter the problems nationwide in the short term with massive government aid and a relaxation of the covid policies. Whether this is acceptable to President Xi in view of his expected re-election at 20th National Congress of the Chinese Communist Party in Beijing in the second half of 2022. A further spread of the pandemic outside Shanghai and the current measures associated with it would certainly be an extremely big problem for the global economy, but political instability and possible conflicts inside the Chinese government would probably have an even worse impact in the medium and longer term.

International stock markets continue to play yo-yo. Days of sharp declines are met with equally sharp and rapid recoveries. The technology sector cannot make up for its massive losses in the markets. More defensive stocks and the old-value chips, on the other hand, are standing up much better.

The oil price has recovered significantly and at the end of last week seemed to have set its sights on the level of $120 per barrel again. The price of natural gas, on the other hand, has corrected significantly and in some cases is even back at levels below those before the war in Ukraine.

Gold remains relatively unmoved at values between $1800 and $1900 per ounce.

The US dollar weakened somewhat in the last two weeks as the ECB’s new stance begins to take effect. The parity that many were expecting has moved further away again.

Leather Pipeline

In the leather industry, the selling price of leather does not play a particularly important role in terms of cyclical developments. For the leather manufacturer, all that matters is whether the sum of the costs is covered by the sales price for leather, whether it is still possible to achieve a sufficient profit margin to secure a future and whether it is possible to sell quantities that will occupy all the production capacity and allow the raw material that accumulates worldwide to be consumed. 

In our opinion, however, there is a fundamental problem currently occupying us in the leather pipeline. Is there sufficient market demand to justify processing all of the available raw material into leather?

At the moment, so many discussions focus solely on price. The leather industry justifiably complains about the massively increased cost of production and claims it is necessary to lower raw material prices. On reflection, however, questions arise about whether a low price for leather would stimulate demand for finished products made from leather. It would be presumptuous to suggest that a reliable answer can be given to this question.

We have already published several times our confidence that a falling price for leather and a simultaneously rising price for plastic alternatives should significantly increase the competitiveness of leather again and, for cost reasons alone, and in our estimation this is the really decisive factor, make leather more attractive and interesting again as a material for many brands and manufacturers. We are by no means giving up this hope. We may be accused of stubbornness, but one thing is clear: these developments never happen quickly. It always takes at least one season, usually more like two, before the basic parameters in production can really change. The facts are right and so are the economic factors, but in many marketing and design departments a move away from leather had already become so deeply entrenched that a quick return is not possible.

It may well be that people from the Fridays-for-Future generation will not be so easily persuaded when they attain senior positions in big companies, but neither can the arguments in favour of leather be ignored.

One may lament the fact that the general world situation has once again pushed the climate discussion very much into the background for the moment, but it also remains true that this has no connection with the use of leather. Whether we like it or not, we will continue to have a lot of raw material from meat production in the coming years and we all know it would be absolutely reprehensible if this available raw material were not used to make leather. 

It is becoming clearer than ever that overproduction in the clothing industry in general - and this of course includes plastic shoes - should be a very significant factor in the climate debate. All the greenwashing and gobbledygook about recycling doesn’t help either. At the end of the day, durability and quality, and the lifecycle that this allows, remain one, if not the only decisive criterion for climate impact. This will remain the case as long as meat is produced.

Let us forget this topic and turn more to the economic component, which we honestly believe is always the decisive one in the end. Today, a shoe made of leather costs little more than a plastic shoe that is then forced on the consumer at great marketing expense (big brands show a marketing budget of 30% of the retail revenue, which means that for a shoe costing $100 per pair, $30 has gone into advertising or into the pockets of sport stars or celebrities who endorse the brand). If the price increases for food and energy continue in the coming years, the disposable income for other products will be significantly lower for many people than they have been used to in the past decades when you got more and more for your money every year. We do not want to talk about additional economic crises at this point. In times of scarce resources, the good use of scarce resources (money) is becoming increasingly important. The best way to counteract this problem is to realise that goods that do not have to be quickly discarded and replaced are ultimately the best value for money because we are not forced to replace them frequently when we may not have the means to do so.

What particularly disturbs us in this topic is that this component is almost never thrown into the discussion by the leather industry. It may well be that luxury, fashion and design are hip and durability and longevity are not, but that could change. The times are definitely ripe for such a change. What seemed impossible and improbable just a few months ago has, from our point of view, become very possible again today owing to the changed economic conditions.

We notice that the situation in the markets has clouded over at rapid speed. Of course, there are also seasonal reasons, because the end of spring traditionally marks the beginning of the period in which leather production falls and discussions begin about future developments. The changed general conditions, which we have actually known about for several months, are only now beginning to come to the fore. Falling disposable incomes, the difficulties in production and consumption in China and, of course, a general uncertainty among people about what will happen in the near future do not create a particularly positive environment for production or consumption. Even though the supply of chemicals and their prices are a problem for many leather producers, leather does not have to deal with the same supply problems as many other products do. Other industries have production constraints as an additional major problem.

It seems logical that the general conditions for the sale of leather should be better than for many other products. However, this is not the case, because demand is stuttering. At least for the moment, we can exclude the luxury sector, but in all other areas this is the current reality. It could be argued that the production possibilities are not really unlimited, if you look at the situation in China. For the leather industry, however, we would not share this view, because in China the policy has rather less impact on the leather production sector than on logistics and processing. One could also say that if one is very optimistic about the demand at the end of the restrictions, one should be prepared to produce stock for the expected wave of demand afterwards. However, there is very little, if any, sign of this in China.

If you look at the destinations of raw material shipments, you can already see that the restriction in China is partly offset by greater activity in other countries in Asia, Central America and Europe. However, all this is not enough to process the available raw material in its entirety at the moment. The conclusion: there is simply not enough demand for leather.

At the end of the 1990s, during the 2008 financial crisis and at the beginning of the covid-19 pandemic there was one thing in common. Cheap prices were an invitation for manufacturers and consumers in China to take advantage of the opportunities. In other words, despite all the fears and impairments in China, the optimism and interest of consumers was always so great that there was no real fear of a worldwide collapse in demand. Chinese industry always saw these crises as an opportunity and that is what is missing at the moment. It is certainly far too early to make a final judgement at this stage, but the feedback we are getting presently from China makes the time windows quite narrow in which a real reversal could lead to a significant improvement.

As a consequence, prices for cattle hides are falling and it is obvious to see that although suppliers are still trying to resist this trend, that the risk of prolonged sales problems is not diminishing at the moment. It is clearly noticeable that secure sales to financially strong customers are much more important than the price. Thus, the price trend and the corresponding difficulties have continued to point downwards in recent weeks.

The market for split, as crazy as it sounds, is still benefiting from the overall situation. On the one hand, there is not enough split, on the other hand, there are still ongoing orders for split leather that need to be covered. Plus, the collagen industry is also playing an important role in this market at the moment. It, too, has noticed that the supply is insufficient owing to reduced production and therefore the competition for raw material has become more and more intense in the last few months with the usual consequence: higher prices. Here, too, the usual economic laws are now taking effect. With the sharp drop in prices for cattle hides, many types are already primarily attractive for the production of collagen, with possible additional use in making leather secondary. The situation is similar to that of the summer of 2020 and the result will probably be the same. As long as prices for cattle hides are low enough, with relatively high split prices at the same time, more raw material will flow into these channels and will very quickly rebalance supply and demand and price differentials.

For lamb and sheepskins, there is not much change in the market. The niche areas are still relatively stable and doing well at the moment, but in mass production sheepskins continue to play no role, although they are extremely cheap. Here, low prices have not triggered any extra stimulus for years. Only fashion can really save us here, and to be honest, in the clothing sector, markets like Russia already played an important role and they will at least partially cease to exist in the foreseeable future. In any case, they are not a predictable sales markets for the coming months and perhaps even years.

All in all, the situation for the leather industry is not very pleasant at the moment. Some luxury brands continue to defend themselves very successfully, but that means very little or perhaps nothing for the overall situation. The situation is particularly difficult because we are at the beginning of the summer season and one cannot really expect any positive change in the coming months. 

It is true that in the automotive industry, for example, we are facing a considerable backlog of orders. One day this will certainly be reflected in a short-term surge in demand. However, it does not improve the fundamental issues. Again, China plays a weighty role, and the production and sales declines in April and May are leaving deep scars. In addition, consumer confidence is falling steadily worldwide. If people cut back on consumer spending for a variety of reasons and perhaps put last year’s savings into a holiday this summer, there would be less disposable income left for general consumption.

Without a significant return to embracing the quality of leather as a material, there are almost no arguments for hoping for a sustainable increase in demand for leather in the near future.

We readily admit that our optimism has taken a hit in recent weeks. We hope that the leather industry shifts from the defensive strategy into an offensive one.

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