Concerns about China’s slowdown

July 22nd, 2010

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Back in April, when economic ?experts? were expecting further growth in the Chinese economy, we wrote in this article that

Contrarian investors like Marc Faber believes that the Chinese economy will ?slow down regardless? any time from now on. Whether this slowdown will be a nice soft-landing or a gut-wrenching crash is another matter.

Marc Faber was on record for saying that there?s a possibility that China may ?even crash.? How could the pundits missed the signs that something is really wrong with the Chinese growth in 2009? As we wrote back then, there were plenty of signs:

? there are massive excess productive capacities in the Chinese economy. As we wrote in Is China going to dump their excess metal stockpiles?, there are eye-witnesses? reports of ghost cities, vacant office blocks and apartments in China. It had been reported that China?s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined. All these points to a massive mis-allocation of resources in China, which according to the Austrian School of economic thought, a pre-cursor to a bust (see our free report, What causes economic booms and busts?).

That?s why, as we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap, the Chinese government will have to rein in their runaway economy sooner or later (e.g. through administrative means, revaluation of the yuan). The longer they delay, the bigger the inevitable bust will be.

Today, the financial markets are finally noticing that China is slowing down more than expected. For example,

  1. Rate of decline for Chinese industrial production is more than expected.
  2. And if Chinese government statistics can be believed, even the inflation numbers were below expectation.
  3. Spot iron ore prices have been in free-fall since May.
  4. Steel production has now fallen to its lowest rate of growth since 2001.
  5. The Baltic Dry Index has lost more than 50% in one month.

Back in January, when we wrote Chinese government cornered by inflation, bubbles & rich-poor gap, we were wondering when the Chinese government will bite the bullet and rein in the runaway economy. We didn?t have to wait long to see it happening.

The question that the pundits and the financial markets will be wondering is this: will this unexpected rate of slowdown continue for rest of the year? Will it continue on to 2011? If they get it wrong (again), it goes to show that they have underestimated the resolve of the Chinese government to cool down the economy.

The risk is that the Chinese government may accidentally let the slowdown turn into a crash. We shall see.

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  • DavidL

    Well, how long can a system last that is set up the way the global trade system was set up? The longer structural imbalances exist, whether that means the US importing more than exporting or China doing the opposite, the bigger the problem will be when its time to correct it. I admit I didn't pay much attention to any of this till 2006, but once I started to look a the system it became pretty obvious it was set up to fail. The kick the can down the road fallacy has been there since the beginning, the whole globalization mantra was just a way to get a few more years out of capitalism and it is amazing that it has worked so long–I'm impressed enough to think they can pull off another cycle of this, although it looks like they are failing. We will see, the cycles have gotten shorter and shorter and more and more expensive….

  • Paul in Beijing

    sorry, but your post reminds me again that you don't live here. I guess from the outside, it's easy to watch for key signals and indicators, and to stake a position based on those.

    But you yourself also warn us of black swans, and I ask you to be careful not to put yourself at risk of a black swan attack.

    It takes years to understand the Chinese psyche, and it's virtually impossible to get even close from outside the country. Yes, there's a correction going on, but it's controlled at the core. Outcomes and reactions will of course be wild and woolly, such as the steel production slowdown. Conversely, aluminium production in June was at an all-time high, just when the Government was asking for energy reductions. One needs to separate the cause factors from the effects factors.

    Same with inflation. Why do you think the Government opened the Yuan to a touch more flexibility? Because inflation was a touch higher than they wanted. Reduce the cost of inputs a tad, and hey presto.

    But you aught to know that the next phase of the program is already being put into train. What you seem to forget is that we are now in the final six months of the 11th 5-year plan. In order for Hu and Wen to retain power and to retire with authority in 2012 (as Jiang Zemin did previously in 2006), they need their legacy etched in stone.

    As for ghost cities, well of course, if you don't understand how the chinese work, you will think they are ghost cities. But that's how they do things here – they build the whole damn thing, then move the people in. As I said, you have to understand the Chinese way of thinking.

    Put this in your diary. The restrictions will last until November. By December this year, production of key items such as steel and cement will be returning to full pelt.

    By the way, I can still only get to your site via my VPN. You are still blocked in China.

  • mrgalak

    And how to benefit from these observations ?

  • Hi Paul!

    Thanks for your feedback. China is really an enigma and that's why we rely on our readers like you to be our eyes and ears.

    our suspicion is that thanks to China, economic and political text-books will have to be rewritten over the years to come.
    For example, economic orthodoxy dictate that central planning command economy will ultimately fail because no government bureaucrat/authority looking from the top will have sufficient information to make allocation decisions. The fall of Communism in the Soviet Union greatly support this theory. Several decades ago, Ludwig Von Mises, one of the thought leaders of the Austrian School of economic thought predicted that Communism will ultimately fail and he was right (although he died before he could see it).

    But what about China? Is it a command economy? Hmmm…. not really because it is certainly not the same economy as during the Mao Zedong era. Is it a market economy? Hmm…. yes, because there're elements of free-market capitalism in it.

    We agree that currently, a controlled correction is happening. But we really wonder whether it is possible to control the 'temperature' and general resource allocation of the economy in the long-run without any stuff ups? If China can pull it off successfully without serious mis-steps, certainly many economic text-books will have to be re-written.

    As for ghost cities, well of course, if you don't understand how the chinese work, you will think they are ghost cities. But that's how they do things here – they build the whole damn thing, then move the people in.

    We watched a YouTube video made by a Westerner in one of these ghost cities. His implication is that it is a ghost city because there's no 'demand' by the people to live there. That is, no one wants to choose to live there. But as you say, the Chinese government will “move the people in.” But we wonder how this will happen in China? In Western countries, no government can just “move the people in.”

    … just when the Government was asking for energy reductions.

    We also wonder about the level of control and authority that the Chinese central government has. When the Chinese Government 'asks' for energy reductions, was it in the form of an edict (as in ancient times when the Emperor send an edict that has to be obeyed on pain of death)? Do the provincial/local governments have the ability to nibble and water down (or worse still, defy) those 'edicts,' thus undermining the authority of the central government? If so, does it mean that it don't have full absolute control? What role does corruption play in undermining central government control?

    What about the side-effects and unintended consequences of government policies? Is the government receiving feedback about the results of their policies in time? With the government intervening very much in the economy, is it possible for them to stuff up, resulting in a crash?

    We have more questions than answers on China.

  • DavidL

    My recommendation is to work on build community resilience in the necessities of life so that as a very complex system begins to simplify itself there are not disruptions in the basics that your community needs. I live in a small town in the US so for me this has meant helping to rebuild local agricultural capacity–I got involved in a group that is helping new farms get started, I buy food from local producers even if it seems more expensive because I want them there in the future. I got involved in the community more and have a deeper network and know more like-minded people. We turned our backyard into a garden, built a root cellar, switched to heating with wood and have started our education in living more simply. We have a lot to learn and a long way to go in what I suspect is a short amount of time. Most importantly I've broadened my idea of what wealth is from something that is measured in dollars to something that is measured by the strength of my community (I'd also like to buy some farmland). So on the individual and community level it was relatively straight forward, on the governmental levels it is less clear. It doesn't look like the US has the will or capacity to face the facts of life and the US will try to do whatever it can to keep a doomed way of life going and will probably create a lot of damage and suffering in the world along the way. As far as making money in this situation, that can be tricky. We are definately shifting from a mindset of making money work for us to a time when we work to make our money. The new normal for most people isn't actually that different, except for the shift in types of work, and the current unemployment is the beginning of that shift. Obviously finding investment that keep or increase their value during a shift of this kind is not easy and may depend on where you live and what is possible for you. Gold is a good bet, but like anything else it depends what the government does. Gold can go up but your government may cut the little people out of that trade. This is potentially true of any idea you come up with. The middle class or upper middle class will be hit the hardest, they have the most to lose and the least power to protect it. Finding/making a resilient community is the surest thing in a very unsure world. Good luck.

  • DavidL

    Modern China is a very interesting case. It has to been seen in the global context that made it possible. While the production side of the economy has capitalistic elements, the command elements can easily dominate. The consumption side of the equation happens mostly abroad, so Chinese command economy leaders don't have to manage both supply and demand. Industrial demand is largely from abroad so only production needs to be helped by government, which is much more easily done in a context where democracy is weak and the central authority can dictate lots of outcomes. The main problem for China (among a lot of problems) is that demand in the West that relies on credit and inflating home prices is over and does not seem like it is coming back. How China manages this is the big question I have and maybe Paul can shed some light on this. It seems like the capacity in China is as miss-allocated as the demand was in places like the US. Until most countries most of the time sell about the same amount as they buy unstable imbalances will develop. Globalism may be taken care of by the end of cheap oil as the increasing cost of shipping goods around the world will make relative advantages in labor or locale insufficient to balance out the increased cost of transport. What will China do when demand has to be developed domestically from 35% of the economy where it is today to a much higher number? The time horizon on these views may be longer than I can image and shorter term issues may become the more relevant ones-labor unrest and pollution come to mind. We certainly live in interesting times.