Posts Tagged ‘de-couple’

Does the major Chinese economic slowdown signify the end of the commodities boom?

Monday, November 17th, 2008

Even as late as the end of last year, when the credit crisis was only a few months old, there was a popular de-coupling theory that believes that Chinese economic growth will run independently from any malaise in the US economy. As we recalled what we wrote at Is Chinese growth ?de-coupled? from the US economy? in November last year,

According to this new theory, China should continue to grow and power the global economy regardless of what happens to the US economy. This is the ?de-coupling? theory. Proponents of this theory sees that so far, China had ?de-coupled? (both in real and financial terms) the most from the US.

Today, this theory is very much discredited. As this news article from the Sydney Morning Herld (SMH) says,

China’s domestic economy is slowing, but no-one really knows how much.

IT IS NOW eight weeks since Beijing waved goodbye to the Olympic Games and yet the sky remains an eerie, brilliant blue. The world is waiting for China’s smokestack economy to roar back to life.

Only weeks ago it seemed China might provide an island of growth that would keep Australia afloat while the rest of the world fell apart.

How could a Wall Street credit crisis knock over a country with closed capital accounts, where shops do not take credit cards and where people buy apartments with suitcases of cash?

There is no doubt that the Chinese economy is slowing much more than expected. The latest data reported that China’s 3rd quarter GDP slowed to a less than expected single digit of 9% (see China’s third quarter GDP growth slows to 9%). There are reports that tens of thousands of factories in China’s manufacturing province, Guandong, have already gone bust.

Is China falling into a recession along with the rest of the world? Our long time readers should not be surprised at this development, as we warned at Can China really ?de-couple? from a US recession? in January this year,

So, do you see China being caught in between? On one hand, a slowdown in US consumption will ultimately result in far greater proportion of contraction in investment spending in China, which accounts for the majority of Chinese economic activity.

Now, we will ask a very interesting question that has never been brought up by the mainstream media: Is this slowdown of the Chinese economy within the design of the Chinese government? Please note that we are not suggesting this slowdown is deliberately engineered by the Chinese government. Rather, we are suggesting that this slowdown could be part of the longer-term big picture plan.

Why do we say that?

Remember that we wrote at China to pull the plug? in March last year (2007)

… the Chinese leadership is highly concerned about the social and environmental impact of breakneck economic growth over the past few decades. There is worry that the status quo is ?unstable, unbalanced, uncoordinated and unsustainable.?

Assuming that this news is true, we can expect significant policy changes in China that will shift focus from the economy to the environment and social stability. This means the Chinese government will take steps to slow economic growth significantly in order for the non-economic aspects of the nation to catch up and for the economy to catch a breather. Indeed, China, for all her impressive economic growth, has a host of other serious problems as side effects.

Whatever the specific actions that the Chinese government take, we can be sure that there will be a great impact on the global economy and financial markets.

If you are a frequent watcher of the Chinese news media, you will notice that in recent times, the government showed its intention to develop the inner provinces. There are some snippets of images showing government initiatives in the agricultural heartlands of the peasant countryside (in Chinese lingo, that’s called “scientific farming”).

Thus, in the bigger scheme of things, this slowdown of the Chinese economy is still consistent with the Chinese government’s long-term plans. As we wrote in Can China really ?de-couple? from a US recession?,

The needs of the Chinese consumption economy is different from the US consumption economy. Some Chinese are rich. But some other parts of China are unbelievably poor. Wealth distribution in China is rather uneven and there are still many pressing social and environmental issues to be solved. Currently, the Chinese export economy is tooled towards US consumption. To re-tool and re-configure the Chinese economy towards its domestic needs requires a period of adjustment in which capitals are destroyed and built.

Our guess is that this is the adjustment period that China re-tooling its economy whereby capitals will be destroyed and built. The slowdown may still be significant, but that does not mean that the long-term commodity boom is over. As we said in What the commodities super-cycle is and isn?t?,

The point we are trying to bring across is that this secular commodity trend is a very long-term trend that will take decades to unfold. Within this secular trend, there will be cycles of bad years. But do not mistake these cycles of bad years as a permanent decline that will stretch on forever and ever.

What will be first sign of an impending Chinese economic correction?

Wednesday, April 30th, 2008

In our previous article, Can China really ?de-couple? from a US recession?, we mentioned our theory that China’s economy

may be an epic boom waiting to be a bust.

In that article, there are three major reasons why we have reservations (which may turn out to be unfounded, hopefully) on China’s economy:

  1. “A severe recession in the US economy will crimp US consumption significantly. This will translate into a disproportionate contraction in the higher stages of production, which is China?s job. This in turn will result in yet another disproportionate contraction in yet another higher stage of production- for example, Australian resource production.”
  2. “Does China have enough capital goods, labour and raw materials to continue the current trajectory of capital investment growth in China?”
  3. “To re-tool and re-configure the Chinese economy towards its domestic needs [and away from declining export market] requires a period of adjustment in which capitals are destroyed and built.”

Indeed, Marc Faber did wrote that

Let us assume that the unthinkable happens: China?s economy slows down sharply, or even contracts – and there are reasons why it could.

So, if this unthinkable happens, what will be the warning signs?  Today, we will attempt to answer this question.

Let’s take the above-mentioned reason (2) as an example. Suppose the Chinese economy cannot be supplied with enough raw materials and skilled labour fast enough to maintain the trajectory of economic growth. How will this situation be manifested in real life? Rising and persistent price inflation is a sign that the Chinese economy is running low on ‘fuel’ to keep the economy running at the current speed. During inflationary times, input cost of production rises. For producers of consumer goods, this may mean that their profit margins get squeezed. Some may even go out of business. For major capital projects, rising costs may render them into mal-investments. For example, for the builder of a skyscraper, cost overruns may result in the project being unprofitable. Banks may not be willing to extend further credit for such projects.

For reasons (1) and (3), it is obvious that a lot of businesses will fail.

So, imagine what will happen if all these business and project failures happen en masse? A lot of bad debts will build up in the economy. If there are enough of them, the banking system will be severely threatened. Then the economy will go into a slump.

Therefore, rising levels of bad debts will precede an impending Chinese economic correction. This does not mean that such a correction is imminent. It may possible take a while for that stage to arrive, but we believe that if such breakneck economic growth continues, it is only a matter of time for a bust to arrive.

Can Australia’s resource boom end sooner than expected?

Wednesday, April 9th, 2008

Our long time readers will be very familiar with our frequent warnings not to take Australia’s resource boom for granted. Today, we will repeat this warning again, albeit briefly.

Back in September last year, in this news article, Post-Olympics hangover may be risky business, it said

A LEADING global manufacturing expert has warned that China could be heading for a post-Olympics hangover with the potential to disrupt the resources boom on which Australia depends.

In particular, domestic consumption in China still accounts for a relatively small 39 per cent of the economy, with the remaining 61 per cent soaked up by infrastructure investment and net exports.

“Over time, this will shift and domestic consumption is going to become a bigger and bigger piece of the economy,” Mr Gromley told BusinessDay. “But, while that transition happens, there is a risk that over-investment in infrastructure will cause a bubble effect, particularly after the Beijing Olympics.”

What Mr Gromley calls over-investment is what we call mal-investment (see our guide, What causes economic booms and busts? for the concept of mal-investments).

In January this year, we wrote about our scepticism about the Chinese de-coupling theory at Can China really ?de-couple? from a US recession?. If our theory is right, this will have grave implication for Australia’s resource boom. If this boom peters out, Australia, with such high debt levels, will fall into severe recession (if not already in recession) led by debt deflation. When that day comes, a lot of ‘rich’ people will suddenly find the value of their asset worth far less than their expectation (see Aussie household debt not as bad as it seems?).