Posts Tagged ‘exports’

Is the Chinese export surge really good news?

Monday, June 14th, 2010

Last week, the mainstream financial news media was cheering on the news that China’s exports surged on a year-on-year basis. This led to the belief that China’s economic recovery is on track, which implies that the recovery in commodity demand will be sustained, which will then flow on to the Australian economy. As a result, according to media narrative, the stock market rose on that ‘good’ news.

But before we get carried away with this bout of optimism, let us put on our thinking caps and consider the bigger picture. Firstly, is the surge in Chinese exports and imports really a good news for Australian mining companies? To answer this question, consider this news article,

But rising textiles and electronics exports will do little to offset the slump in Chinese demand for Australian commodities that will come with an expected construction slowdown.

Construction starts for government infrastructure projects have slowed sharply and private sector transactions have been bludgeoned by government measures.

Private sector measures show real estate transactions fell by as much as 70 per cent from April to May in Beijing, Shanghai and Shenzhen, where policy restrictions have been most severe.

To put it simply, China’s demand for Australian commodities post-GFC is mainly influenced by China’s construction ‘boom’ in 2009. It is open knowledge that there’s overcapacity in China’s steel and cement industries. As we wrote in Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle),

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.

A rise in Chinese exports will not be likely to offset the slump in construction.

Next, when you look at the big picture in mind, an export surge is the last thing the world needs. In the this post-GFC world, where growth is anaemic and unemployment is stubbornly high, countries are covertly engaging in competitive currency devaluation in order to prop up their exports in order to prop their economies. The Americans wants to re-balance their? economy with more exports, which implies other countries have to import more from America. Yet, on the other side of the Atlantic ocean, as Niall Ferguson said in this recent interview, the Germans are shedding crocodile tears over the falling Euro because that would boost their exports, which in turn is good boost for their economy. As Marc Faber said in this interview, a falling Euro (i.e. rising US dollar) will give the Americans the excuse to print money to give their economy another adrenaline boost.

Unfortunately, growth-via-exports is a zero-sum game because a for every export, there is an import on the counter-party. If every country wants to increase their exports to boost economic growth, who’s the one doing the importing? Thus, China’s export surge is one step in the wrong direction. The world needs a rebalancing of exports and imports, not more of the same unsustainable imbalance.

Already, the Americans are murmuring about this ‘good’ news. As? China export surge stirs U.S. anger reported,

A surge in Chinese exports and rising anger in the US Congress will put renewed pressure on China to allow its currency to rise against the US dollar.Chinese trade figures showed exports leaping by 48.5 per cent in May over the year before, way ahead of analysts’ forecasts. Data released in the US showed America’s trade deficit widening slightly in April, with some economists arguing that the improvement in net trade and its contribution to US growth appeared to have stalled.

The data gave more ammunition to China’s critics in the US Congress, who have said they will proceed with legislation to restrict Chinese imports to correct the perceived misalignment of the country’s currency. The US Treasury has been pursuing quiet diplomacy with Beijing to allow the renminbi to rise, but lawmakers said they were losing patience.

In the bigger picture, rising trade tensions between the US and China is moving them towards trade war. This can hardly be good news.

Hazard ahead for Australia- interim crash in China

Sunday, January 3rd, 2010

This is the first major post of 2010 (the previous post was more for our readers’ entertainment). Today, we will look ahead at a likely hazard facing Australia in 2010 and beyond- an interim crash in China.

First, you may wonder why we used the word “interim” before the word “crash?” To answer this question, you may recall what we wrote in June 2007 at Will the China boom go in a straight line?,

… one of the common stories we hear is this: since China is an ascendant superpower, its demand for commodities will increase in the decades to come, and hence, the commodities super-cycle will have a lot more room to go for a very long time.

However, the market always latches on to the generalities of a story and takes a simplistic projection of the story too far into the indefinite future. What do we mean by that? Put it simply, we do not believe that the rise of China will take on the path of a straight line. Instead, there will be ups and downs, booms and bust and progress and setbacks. Anytime when the path does not look like a straight line upwards and take a temporary dive, the market will flip to the other extreme of this story and project extreme pessimism into the indefinite future.

In other words, when we say that a “crash” is coming in China, we do not mean that China will collapse into a heap of total anarchy, civil war, foreign invasions, internal divisions by warlords, etc as in the first half of the 20th century. Instead, as we wrote before, such a “crash” will be a major setback in the bigger scheme of things.

In this new year, this is the theme that investors (especially the highly leveraged property speculators in Australia) should be watching out for. Australia is highly leveraged to the Chinese growth story, both in terms of financial leveraged (look at Australia’s debt level) and population leverage. The word “population leverage” will sound alien to you because this is a phrase that we invented in this article. To understand this phrase, consider this: the entire population of Australia can fit into population of just one major Chinese city (Shanghai) if you include the ‘unofficial’ migrant workers. Because of the colossal size of China, if every Chinese reduce their consumption by 1%, then its effect will be much more than 1% reduction in income on Australia. Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

The Panic of 2008 should be the year whereby a major correction in the Chinese economy could have occurred. Indeed, in late 2008, one newspaper headline in the Sydney Morning Herald was screaming of a great “stall” in the Chinese economy. Indeed, it seemed at that time that what we wrote in January 2008 at Can China really ?de-couple? from a US recession? was coming into fruition.

However, what stopped the major correction in the Chinese economy in its track was a massive government stimulus and ultra-loose monetary policy. The former is concentrated on fixed asset and infrastructure investments (e.g. construction boom, bridge building, etc), while the latter is basically force feeding loans into the economy (see How big is the credit bubble in China? and Is China setting itself up for a credit bust?).

The problem with these government policies is that, while it may have averted a major correction, the structural imbalances in the Chinese economy are being exacebated. To understand the gravity of this situation, consider this simplified line of thought:

  1. Prior to the GFC, the Chinese economy was highly geared towards capital investments in the form of productive capacity for exports.
  2. A contraction in demand in the US/Europe led to a disproportionate contraction in Chinese economic activity (see Can China really ?de-couple? from a US recession? to understand the theory behind this reasoning).
  3. Chinese economic activities that are related to exports suffered the worst of this contraction.
  4. Chinese government stimulus and ultra-loose monetary policies led to increased economic activity in the Chinese economy mostly in the area of capital investments for infrastructure.
  5. Overall the economy ‘grew’, but a lot of them are wasted and ‘leaked’ into mal-investments, asset market bubbles, corruption (see Will China succeed in navigating its way out of the Global Financial Crisis (GFC)? for a juicy story about corruption in China) and trophy projects.

You see the problem here?

Chinese government policies are accentuating the gap between investments in future productive capacity and current consumption of the Chinese people. To further complicate the picture, infrastructure investments produces capital goods (e.g. bridges, roads, highways) that cannot be exported. If Chinese consumption cannot grow fast enough to catch up with huge expansion in productive capacity and American consumption cannot recover enough to fill the gap, then what will happen to those investments?

Obviously, these investments will, at best result in a dismal return and at worst, result in bad debts. And we know bad debts are the roots of a credit crisis.

We believe consumption growth cannot catch up fast enough. As we wrote in Can China really ?de-couple? from a US recession?,

  1. 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. As we said before in Overproduction or mis-configuration of production?, the issue is not a simple case of overproduction. Rather, it is the mis-configuration of production that is the issue.

Because of the structural imbalance between consumption and investments, a lot of these forced investments are leaked into asset speculation (e.g. look at the massive property bubble in Shanghai alone). To understand this point, consider what we wrote in Connecting monetary inflation with speculation,

Thus, by further inflating the supply of money and credit in the financial system at such a time, there comes a situation whereby there are excess liquidity without adequate avenues for appropriate investments.

The ultra-loose monetary policies in China resulted in too much money and credit sloshing around in the financial system. The structurally weak and mis-configured domestic consumption market means that there’s not enough avenue for appropriate investments. Hence, a lot of money and credit ended up as speculations in the asset market.

To structurally streghthen the Chinese domestic consumption market, the gap between the rich and poor has to be narrowed. Anecdotal indications suggest that the opposite is happening, thanks to inflation (see Does monetary inflation increase the rich-poor divide?). The bubble in the asset markets is worsening the situation.

By now, you should be able to appreciate the gravity of the situation. The ‘success’ of the Chinese government seems to have averted a major economic correction. But in reality, they are just postponing it for a greater bust in the future.

What is the implication of this in the financial markets? Keep in tune!

Falling currency and inflation

Monday, September 1st, 2008

Back in February this year, while the US dollar was still in a downward trend, Jimmy Rogers made a scathing remark about Ben Bernanke here:

We know now he doesn?t even know about economics. I mean, he?s got a PhD in economics and he was a professor of economics, but he doesn?t have a clue about economics.

I will quote you – I hate to quote you, but one more time – I was watching him testify before congress and I almost fell out of my chair. He said under oath, so we presume he wasn?t lying, that he was just a fool, he said if an American only buys American products, it does not matter to him if the value of the U.S. dollar goes down. He will not be affected. I was looking at the man to see if he was lying, giving government propaganda, but then I could see he didn?t even really understand.

He didn?t understand if, you know, even if say I?m an American, Lindsay, and I only buy American tires. Well if the price of foreign tires goes up, obviously the price of American tires are going to go up too. Plus, if the dollar goes down, the price of rubber?s going to go higher, etcetera, etcetera, etcetera.

So the man doesn?t even understand economics. He?s going to print money. He?s going to throw money out the window. The dollar?s going to go down further and further and further. Inflation?s going to get worse and worse and worse throughout the world – the world, not just America – and we?re going to have a worse recession in the end.

What happened was that Ben Bernanke swore under oath that a falling US dollar would not hurt Americans as long as they buy only American products. But as we explained before in Is the falling dollar good for the economy?, a falling domestic currency will result in a

… divergence between the internal and external value of the dollar. Since in the short term, the domestic economy cannot increase its production, effect (1) will be the result.

Since the American economy is very much dependent on imports, a fall in the US dollar will result in an increase in demand for American-produced goods. Without increased capacity in the short-term, this will almost certainly result in price inflation.

Now, we will look at the context of Australia, which is another import-dependent country. A rapid depreciation of the Aussie dollar will result in rising price inflation for the same reasons stated above. To make matters worse, the Australian economy is already at full productive capacity, due to reasons that include full (or almost full) employment, inadequate infrastructure, skills shortage and so on. Therefore, in order to take advantage of the increased demands for Australia’s commodities in the longer term, there will be a need for a restructuring of the Australian economy. As we explained in Is the falling dollar good for the economy?,

This means a restructuring of the economy whereby some industries will have to decline in order for the export industry to expand. This is effect (2).

The restructuring process is where the pain lies. It is a time where certain industries decline, unemployment rises and people returning to university and TAFE to retool and retrain on other skills and professions. The problem with Australia is that with far too many people and businesses filled with too much debt, such restructuring process can be too painful to be contemplated.

Is the falling dollar good for the economy?

Thursday, August 28th, 2008

In the financial news media, we often hear reports that give the impression that the fall of the dollar (whether US dollar or the Australian dollar) is good for the economy because it benefits exporters. In reality, this is only half-true- exporters may benefit, but it may not be necessarily be good for the economy as a whole.

To see why, take a read at Chapter 6 (The Depreciation of the Mark and Germany’s Foreign Trade) of this book, The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany written by Costantino Bresciani – Turroni, an economist who lived through the German Hyperinflation of the 1920s:

The relations between exports and production deserve to be considered in greater detail. Three principal cases may be considered:

  1. The increase of exports of a given article, which is the consequence of the divergence between the internal and external values of the national money, is not followed by an increase in the production of that article. The rise in exports signified in this case a corresponding fall in the quantity formerly consumed at home.
  2. The possibility of increasing the exports of a given article provoked an increase in the production of it, but at the expense of other articles, the export of which is less attractive. On the whole, the production of the country is not increased; only the direction of economic activity is changed.
  3. The rise in exports is accompanied by an increase in the total production of the country with a depreciated currency.

Before we continue, we must first explain the concept of internal and external value of a currency. Basically, the internal value of a currency is its purchasing power domestically. Let’s say an apple cost 1 dollar domestically. This is the internal value of the dollar. Let’s say an apple cost 2 marks in a foreign country and the exchange rate is 1.5 mark for 1 dollar. Therefore, the cost of an apple overseas is 1.33 dollar. This is the external value of the dollar. In this example, the internal value of the dollar is greater than its external value.

Let’s say the dollar depreciate in value. As a result, there is a divergence between the internal and external value of the dollar. Since in the short term, the domestic economy cannot increase its production, effect (1) will be the result. In other words, using the example above, domestic apples will be exported, resulting in less apples domestically. The outcome is price rise for domestic apples. As Costantino explained,

The first case appears when a divergence between the internal and external values of money occurs suddenly and after a short time stops. The influence of that divergence is shown only in the sale of goods already in the warehouses; given the brief duration of the phenomenon, production in general does not feel it.

In the longer term, either effect (2) or effect (3) will be the outcome. That will depend on the situation of the domestic economy. Let’s say the economy has plenty of spare capacity. Perhaps there are far too many unemployed apple growers and land laying idle. In that case, all these idle resources will be put to work to produce more apples, which will raise national income. The nation becomes wealthier as a result. This is effect (3). As Costantino explained,

On the other hand, in a country where only a part of the machinery is occupied and where there is a considerable number of unemployed, a depreciation of the exchange, by stimulating foreign demand, can really provoke an increase in the total production.

What if the economy’s productive capacity is completely used up and can no longer increase its production of apples? In that case, the economy has to free up resources in order to produce more apples. This may mean that for example, clock makers may have to change their professions into growing apples. This means a restructuring of the economy whereby some industries will have to decline in order for the export industry to expand. This is effect (2). As Costantino explained,

But in a country where plant is already fully occupied, where unemployment does not exist, and where available resources are scarce, the effects on total production cannot be very considerable. If the divergence continues, a displacement of production is slowly produced: capital and labour move towards the production of those goods for which the divergence [in the internal and external value of the domestic currency] is most conspicuous.

In the next article, we will apply these insights into the study of real-life economies.