Overcapacity in steel production and surging demand for iron in China?

January 12th, 2010

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Currently, economists in general are at a consensus regarding China. As this news article reported,

As the Great Recession wanes, there?s no better example of the Great Consensus than China. The overwhelming view is that it can grow 10 per cent indefinitely, its potential is boundless and it?s run by omnipotent geniuses who can?t lose. China is today?s New Economy and anyone who disagrees just doesn?t get it.

When the herd is all crowding at one side of the story, it is time to check out the other side. As you can read from our previous articles at Chinese government cornered by inflation, bubbles & rich-poor gap and Hazard ahead for Australia- interim crash in China, we have made our case for being sceptical on China’s post-GFC recent growth. While Western nations are mired in the ghosts of post-GFC deflation, China is the only major economy that managed to engineer a crack-up boom (see What is a crack-up boom?).

Unfortunately, many economists believe that this crack-up boom is a sign of ‘prosperity.’ The trouble with a crack-up boom is that there are only two possible outcomes:

  1. If the government wakes up to their mistake and decide to rein in the crack-up boom, the result will be deflation (falling asset prices, rising unemployment, bankruptcies).
  2. If the government have no guts to allow deflation to happen, hyperinflation will be the end result.

China is now at a critical junction- should they rein in the crack-up boom or should they let it continue?

From what we observe, they seem to be trying to walk the middle-ground. So far, they’re taking half-baked measures in an attempt to cool things down. That is, they’re trying to engineer a soft-landing. Although the former Chinese premier Zhu Rongji was successful in achieving that in the 1990s, there’s no guarantee that they will succeed again this time. In fact, there’s always a risk that they will tinkle with the balance too much and make a mistake that result in tipping the economy into a crash. Or a pin will appear from outside (e.g. trade war) and pop the bubble. Or they will do too little and let the economy overheat. Either way, it will be disastrous.

It is in this backdrop that the infamous short-seller, Jim Chanos is looking to short China. Since November last year, we first heard that this shark was on the prowl, examining China’s books (see Is the Chinese economy a house of cards?).

Indeed, there’s one aspect of China’s ‘books’ that we find a contradiction. Here, we turn to our readers to reconcile this contradiction:

  1. Take a read at Spot market for iron ore may sink contracts. From that article, it seems that China is trying to resist another round of price hikes for iron ore. As this article said,

    As senior executives from BHP and the two other iron giants, … , prepare to face down increasingly aggressive Chinese steel mills, prices are soaring again for the red dirt that it is essential for China’s massive urbanisation and infrastructure programs.

    So, this fit in with economists’ consensus that Chinese demand for Australian iron ore will continue to surge as their economy roar ahead.

  2. Next, take a read at China Trims Steel Capacity Amid Glut, Minister Says (Update1),

    China, also the world?s biggest producer of iron, cement and aluminum, is facing a severe oversupply of steel as mills expand faster than outdated plants are closed. The government is studying a ?more feasible? plan to tackle steel overcapacity, Li?s ministry said on Dec. 3.

Dear readers, why should there be another surge in Chinese demand for iron ore in 2010 when they are looking into closing steel mills to address the severe overcapacity problems? Does anyone have any idea on how to reconcile this contradiction?

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