Macroeconomics

In the last two weeks, as expected, the war in Ukraine continued to dominate the political news and the COP 27 meeting in Egypt was the second major event to receive widespread media attention. In addition, the world is currently preoccupied with the development of the pandemic in China.

The zero-covid policy there seemed to be successful for a long time, but question-marks are now increasing as to how things will continue. In other countries that have had to deal with covid-19 for years, the realisation has prevailed that only vaccinations can mollify the course of the disease and that any attempt to completely contain the spread of the virus has little or no success.

Since China was reluctant to accept Western vaccines and at the same time opted for isolation and thus propagated health through isolation, the door is now open for the spread of the virus. The official figures, which are currently around 30,000 new infections per day, seem very low. Talking to people directly in China, there is considerable doubt that the numbers are so low. Whatever the truth may be, unrest in China and criticism of the political leadership continue to grow.

Especially when you watch the World Cup in Qatar on television, where tens of thousands of people cheer in the stadiums without masks and life goes on relatively normally. This has not gone unnoticed in China and has triggered renewed criticism of China going it alone. The big problem for the government now, of course, is to make appropriate policy corrections without losing face, which is so important in that part of the world.

Whatever may be right or wrong, the decisions not only burden people in their private lives, but also in their economic activity. At the moment, it is calculated that one-fifth of China’s economic output has already been affected by lockdowns again. This means that the impact is roughly back to the point reached by the lockdown in Shanghai in the spring. In this case, however, the situation is much more complicated because the virus is spreading in all parts of the country and can therefore no longer be contained regionally.

This development must be observed very closely in the coming weeks because further and longer closures would again put extreme strain on supply chains. In addition to the international supply chains, the situation is of course also putting a strain on local consumption in China, and with a population of over 1 billion, who are also very keen shoppers, this is a not inconsiderable threat to the economy. All major institutes are currently reducing their forecasts for economic growth in China significantly.

The COP 27 meeting, which started with great expectations of decisions on combatting climate change, must be seen as a failure. Serious, far-reaching decisions from the global community acting together to save the planet failed to emerge. It seems that the economy and prosperity in the immediate term are more important to people. The current geopolitical problems also severely limit many countries’ options for action.

Whether global meat production is worse than the effects of the war in Ukraine, or the 300+ new coal-fired power plants being built in China, or the increase in the use of coal in India, may be an ideological issue, but it doesn’t really help us or the climate. Ultimately, the takeaway from this event is that climate and the broader human interest must continue to be subordinated to wealth inequality.

The war in Ukraine is now entering a particularly hard phase for people. Winter is approaching and temperatures are falling steadily. Russia is attacking the energy and water supply infrastructure in Ukraine, with the death and suffering of civilians following as a result. 

The equity markets are showing amazing resilience to any threats one might see to corporate developments. In most markets one can see a year-end rally that may indeed last until the end of the year, but could also turn out to be a bear-market rally.

At the same time, the negative expectations for economic development are weighing on energy prices. On the one hand, this may be a negative indicator, but on the other hand it will have a positive impact on the inflation trend. Oil fell back to levels around $80 per barrel and prices on the spot market for natural gas in Europe also continued to weaken. Also international transport is getting constantly cheaper.

The price of gold continued to move relatively little and was able to remain reasonably stable, above the level of $1,700.

Leather Pipeline

Although this year the Christmas holidays would allow almost two full, normal production weeks in Europe, most companies have decided to take two full weeks off. This would only ever be done if the order situation allowed it, so, the decision says a lot about the business outlook; energy savings are being taken into account as well.  If the order situation and production were normal, no one would stop production for so long.

This is not only a problem in Europe, but also in China where there are already very active discussions about when to close and reopen factories for the Chinese New Year holidays, which fall around January 22. There are quite a few rumours that there are businesses that are already thinking about closing and only want to reopen after the holidays in February.

On the one hand, this is hard to imagine, but on the other hand, from a business owner’s point of view, it is perhaps understandable. The constant uncertainty about lockdowns, transport of raw material and of finished products, questions over employees being able to show up for work, combine to mean a new lottery every day. Under such circumstances, who wants to plan production, manage their business and bear the risks involved.

The extent to which the Chinese state and the provinces can and want to help the companies is also unclear. Most of the provinces are already suffering financially from the expenses they have to bear on an ongoing basis for mass covid-19 tests. Whether sufficient funds will still be available to support the economy without the help of the central government is probably only known by those responsible in Beijing. It is only understandable that under these conditions many entrepreneurs are increasingly considering simply shutting down their businesses for a while and only reopening them when there is clarity regarding the pandemic and the government’s policy.

Of course, one must also consider the consequences of this. If people stop working, they lack income and as much as the central government cares about the welfare of workers, there is no functioning security for a large part of the working class. At the same time, this means that consumption in China would suffer further and this would also mean lower sales in the domestic market for the leather industry. 

At the moment, the leather industry in China is particularly burdened by the uncertainty in the transport sector. Even though the Chinese government has decided to relax certain regulations, it is still a gamble for truck drivers and transport companies to try to drive around safely. The risk of being isolated or falling victim to a lockdown is and remains very high. The same applies to the delivery of raw materials and financial administration (banking), which is also putting a strain on production at the moment. How the government will react to the usual winter environmental problems under these conditions is not yet known. Some people may remember that there were always interruptions to production, especially in the north of China, when air pollution increased in winter. This season, this may be resolved on its own, if the companies significantly reduce or even completely stop production in the coming months for the reasons mentioned above.

In any case, one must at least assume that without a significant improvement in infection figures, a radical reversal of Chinese policy or a sudden improvement in the order situation, production in the Chinese leather industry will be significantly reduced during the most active time of the year. 

Despite all the difficulties, stresses and problems already experienced in Chinese leather production in recent months, a deterioration would be an additional strain on the whole leather pipeline simply because of the size of the industry in China.

Now, leather is also being produced in other countries and regions outside China. Even if the statistical data do not point to a positive development in India at the moment, many of our contacts nevertheless report increasing activity from the Indian subcontinent. This seems to be especially true for dress-shoes, which are obviously experiencing a renaissance after the covid-19 restrictions. More parties, more weddings, more formal gatherings have led to a renewed interest in formal wear after the casual times of working from home.

The news from the furniture sector remains negative almost everywhere at the moment. This is a particular burden on the upholstery leather tanners in big centres in China and, of course, in northern Italy. After two very good seasons, this can probably still be borne if it does not last too long. If you look at the situation in the real estate markets, however, you would have to be full of optimism to see a turnaround in the near future.

Many continue to talk about the automobile industry. Here, from our point of view, things are relatively complicated. On the one hand, the European premium manufacturers are sticking to their anti-leather strategy. The decisions have been made and even if there are arguments in favour of an increased use of leather in their models, it seems that this is not being considered at any of the company headquarters. This remains a very European strategy. Buyers of expensive cars outside Europe continue to be happy about an attractive leather interior. In clear terms, this means the continued use of leather where it is desired, where one would have to reckon with a loss in sales if one were to do without it, and the further abandonment of leather in markets where one does not expect any sales losses for the brand as a result, especially among younger buyers.

At the same time, however, this also means in Europe that the demand for the better hide assortments remains high. At the same time the balance between the high-quality hides and the lower assortments that always arise is permanently disturbed. On the one hand, this is a problem for hides already in stock, but on the other hand, of course, it is also a problem for tanners’ ongoing calculations. At the moment, we cannot see that this problem can really be taken care of without cooperation from the automotive industry; it will be very difficult to find a solution. The products and the manufacturing processes for use in cars are simply too specific to allow alternatives. There are some conceivable solutions, but even that would mean that other sales opportunities would have to be developed for the resulting product, and this would require a growing demand for leather in other sectors. This too is not really discernible at the moment.

In the medium term, however, we remain positive about the use of leather in cars in other regions of the world. Just as the combustion engine will not die for a long time outside Europe, leather in interiors will remain an exclusive and desirable material in many regions. This will lead to changes in the production structure, but after the crisis also to an increase in demand again.

Somewhat surprising to many are the public declarations of co-operation between leather manufacturers and the developers of alternative materials. If the new materials are explicitly against plastic and presented as a complement to leather, this would be very welcome, but if the manufacturers of the alternative materials nevertheless present themselves as leather substitutes or even as visionaries who can bring about the end of leather, then one should certainly reconsider the matter.

The raw material markets are still reacting very hesitantly to the current, difficult situation in the leather pipeline. The biggest problem, however, is that the officially published prices are moving further and further away from the market reality. The so-called ‘private-deals’ between the dominant suppliers and the large producers are becoming stronger and stronger, and as attractive as it may be for large meat producers to make deals with financially strong, reliable customers, it must also be clear that this is forcing smaller and medium-sized producers out of the market. Small players have to buy raw materials at prices that are too expensive, their production costs are correspondingly higher and at the same time not everyone can secure higher prices for their products in a shrinking market. In our opinion, the monoculture between large and large is not a sustainable concept for the leather industry in the long term.

The situation in the split market is calming down. Despite lower production and availability of lime splits, the heat in the market situation has cooled. Whether this is a temporary phenomenon and also has to do with the interruptions for holidays we cannot really say yet. However, there are a number of experts who predicted this some time ago. The increasing production of directly from cattle hides in new factories, especially on the American continent, is bringing more and more finished products onto the market and the growth potential in this sector is by far not so great that significant supply expansions can be absorbed easily.

We have not seen any major new developments in sheepskins in the past two weeks. Speciality items remain in demand, but even in this sector we are beginning to think about how consumers will behave in the coming months. Again, like everywhere else, luxury items are not part of this picture, at least for the time being.

At the moment we really have no idea what could change in the current market situation along the leather pipeline in the next few weeks. The results of consumer purchases in the coming weeks will certainly be of great importance: first of all the Christmas business in the Western world and then the consumption for the Chinese New Year in China. It remains to be seen which products consumers will want to spend their money on. Even if Christmas spending were statistically satisfactory, this would not mean that leather products would benefit particularly.

If the situation along the leather pipeline does not improve significantly before the beginning of the new year, questions about financing in the value chain and reducing unused production capacities will probably come to the fore again.

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