china and iron ore

Below is a summary of what the new book, The World is Curved, has to say about China. Quite long even as a summary but perhaps key to companies such as UMC. I personally opt for the outlook being that they will go for the status quo and maintain growth at 9% pa. I 10 years time, maybe 5, there may be some issues but for now the China machine will plough ahead imo. I am flying over the next 24 hours so will not be on air so to speak - just i air

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From “The World is Curved”

A summary of the section on China

For the global economy, China represents an enormous paradox, which I will begin to describe in a nutshell. On one hand, China has no choice but to try and expand an unheard-of rathe of growth …… China as it expands rapidly also risks becoming a menacing economic and financial bubble to the world.

When the Chinese bubble bursts (and bubbles always do, in one fashion or another), China could instantly become a deflationary threat to the world.

Upon such a scenario, commodity prices upon hitting the tipping point would decline viciously, because some of the price increase pressure has been the result of speculators’ betting on higher prices.

… it requires annual economic growth rates to remain close to 10 percent. It requires unprecedented high rates of investment and increasing rates of consumption. Maintaining those rates while controlling inflation will be extraordinarily difficult, if not impossible.

The greatest danger id that China is becoming the latest economic and financial bubble …..

When the Chinese bubble bursts – and it is likely will burst, slow slowly deflate – the consequences for the rest of the world could be catastrophic ….

Whatever the doom and gloom scenario, most the world would likely retaliate against China by setting up protectionist barriers, which would produce immediate retaliation by the Chinese against foreign firms based in China.

In the final analysis, we really don’t know what is about to unfold in China, and a single jolt could be all that’s needed to topple the whole structure.

With Hong Kong included, China now represents Americas third largest export market, behind Mexico and Canada.

The world fixates on what China could be. But as of now, the economy is roughly three times the size of the Netherlands, as measured using World Bank dollar exchange rates (ten times if measured on a purchasing power parity basis).

The World Bank observes that sixteen of the world’s twenty most polluted cities are Chinese. Over 70% of the water in China’s seven major rivers in already considered undrinkable.

IPO of one of China’s largest banks ….. Chinese hired as the bank’s senior risk officer a Westerner who had worked before at a well-known American investment bank. That all sounds prudent except for one small detail: The new risk manager did not speak Chinese….. he eventually quit ….

Compared to the Chinse banks, today’s troubled, large American and European financial institutions look like paragons of financial purity.

In the event the economy slows and inflation continues to soar, China could see an astounding increase in instability in a kind of reverse eruption of pent-up emotion in coming years.

Peter Martin of the Financial Times said “China has a tiger by the tail: that tiger, of course, is China itself”

China’s economic situation is suspiciously reminiscent of the Japanese experience in the late 1980s and early 1990s.

…. Commodity stockpiling out of control?

When an economy experiences negative real interest rates, investors borrow as much as possible and buy as much as possible. For a while, they buy stocks as well as physical assets such as commodities and real estate with reckless abandon. That is why the Chinese in recent years have roamed the developed world, including Africa, locking in long-term contracts for the purchase of commodities.

… by mid-2008 wage inflation had jumped to a rate of 20% a year. Yet real wages, after accounting for inflation, were at best flat.

Chinese consumer spending strangely has plummeted from nearly 50% of GDP in 1992 to 36% in 2006.

By mid-2008 wage inflation had jumped to a rate of 20% a year. Yet real wages (after accounting for inflation) were at best flat.

From mid-2006 to mid-2008, the Chinese money supply grew at 16%. Inflation during this period jumped from 2% to 8%. The real money supply (after adjusting for inflation) was rapidly decelerating.

China had tried to corner the world market in iron ore with little regard to world demand for steel or for the fact that the world already produces ample amounts of steel to meet global needs. China’s planned steel-producing capacity at one point was large enough tom meet not only its own needs, but also those of the world’s two giant economies, Japan and the United States.

The Chinese have embarked on this ambitious steel-production venture despite having an economy still only three times the size of the economy of the Netherlands. The danger of such an approach is the creation of large stockpiles of commodities, which at first lends to artificial price rises, but at the risk of a swift and brutal price collapse once the global commodities market reaches a tipping point of uncertainty about sustaining the new price levels.

…. If the numbers can be believed they are astounding. In 2006, Chinese domestic car-producing capacity amounted to roughly six million units. The Beijing planners decree that by 2012, automobile production capacity should reach twenty million units, a more than 300% increase. Chinese domestic demand is estimated to be, at best, only nine million units. So where will the remaining eleven million units be sent?

China today is highly reminiscent of Japan in the 1960s. During that period, the Japanese economy grew at 10%, led by massive steel production. Once Japan reached a level of overcapacity such that the steel bubble began to deflate, Japanese annual growth rates dropped form 10% to the 4% range.

China, whose one-child policy of the 1970s and 1980s has created no less than a demographic monster (thought some analysts argue Japan’s demographic problem will be just as difficult),

By 2045, one in every three Chinese will be of retirement age.

We suspect they’ll use that liquidity to modernise and enhance the military, not solely or even primarily for external purposes, but like the Saudi military mostly to maintain domestic order.

What’s wrong with having official reserves – an official slush fund – of over a trillion dollars, 90% of which is held in relatively safe US Assets, while holding 15% of the US debt? Having more than a trillion dollars in reserve, while administratively controlling the exchange rate, represents a heck of an insurance policy in the event of a global meltdown. What’s not to like? The answer is that artificial undervalued currencies and the massive build up of reserves represents a giant distortion to the global financial system. This distortion not only creates financial bubbles, but for the Chinese officials themselves, it makes the job of controlling inflation and of managing the economic system during the catastrophic bursting of those bubbles extraordinarily difficult.

None of this is to deny that China’s economic performance has been impressive.

…more than half of China’s imports come from outside-funded companies, meaning that they are for re-export as finished products. More than half of China’s product exports are made from components imported from elsewhere in Asia.

In the process of spearheading this growing manufacturing giant, China consumes or stockpiles one-third of the world’s annual supply of tin, coal, zinc and iron ore.

At last one hundred million workers today already earn more than $5,000 a year.
….. the new Chinese middle class not only equals about two-thirds of the total American workforce, but their standard of living already resembles in many ways the average American living standard ….

In the next decade, economic strategists expect an additional two hundred million Chinese to also participate in this middle-class lifestyle.

What’s more, there is no denying that China’s economic impact on the rest of the world, to date at last, has been largely positive …… the problem from here on, however, is that the rising oil and commodity prices, including food prices, which are fuelled by Chinese and other developing-world countries’ demand, are beginning to uncap inflationary expectations throughout the industrialized world.

China’s surplus saving is continuing to swell …. this savings bonanza is coming from corporations in the form of undistributed profits.

The implications of what is happening in China are huge. But the issue is not whether China is growing; the issue is whether China is growing too much.

Here’s the dilemma: Chinese officials stress that a 9% plus growth level is the bare minimum need to avoid serious political disruption.

Most Western experts suggest that if the Chinese growth rate drops below 7.5%, serious unemployment would set in, furthering political unrest and threatening the stability of the entire system.

In America, for example, almost 50% of clothing purchases and 85% of toy and footwear purchases now come from China.

Europeans believe the Chinese have four possible approaches (for a soft landing): (1) quantitative intervention (administratively guiding the system such as by issuing government edicts calling for less consumption: (2) interest rate hikes; (3) allowing the currency to strengthen; and (4) administrative efforts to promote economic and financial outflows and to hinder inflows.

In the European view, only one of these choices would be an effective option – allowing the currency to float and thus strengthen.

They have also argued that dramatic currency appreciation is likely to be the only effective means of controlling inflation.

By allowing the yuan to further strengthen, China’s inefficient, uncompetitive
State-owned enterprises would risk collapse, creating mass unemployment.

The politically powerful but highly inefficient domestic (often state-run) enterprises fear negative effects of a dramatically stronger currency. Today, foreign-funded companies in China employ a mere 3% of the workforce (25 million workers) but are responsible for 55% of exports, 80% of export growth, 22% of GDP, and 41% of GDP growth.

For the foreign-funded sector, labour productivity may be as much as none times higher than it is in the domestic funded sector.

…something that is unlikely to take place any time soon - independent monetary policy requiring a complete modernisation of the financial system. This would have to include an immediate dismantling of the corrupt state-run banks.

Chinese companies are actually experiencing labour shortages, a development that will tend to put a floor under wages.

As inflation continues to creep up in China, particularly effecting food and clothing, the outcome will produce even greater social tensions. In the end, Chinese leadership could be forced to confront a nasty choice between protecting the domestic and state-run enterprises while accepting the politically and socially destabilizing effects of higher inflation, or accepting a stronger currency, which will throttle back the economy a bit and potentially control inflation, but jeopardize, at lest in the minds of officials, the survival of many state-run enterprises. The crucial choice, when made, could effect the entire global economy.

The PC (personal computer) is incompatible with the CP (Communist party).

Will the predictions that China will run the world someday have more accuracy than earlier predictions about Japan, France, the Soviet Union, and Argentina coming out top?

… don’t count out India, the dark horse candidate. … Of its roughly one billion people, fewer than five million work in manufacturing. If anything, India represents not so much a threat to the world as a threat to China.

Clearly, the Indian economy, with its huge, well-educated, English- speaking middle class, is in a takeoff phase. If China is the world’s factory, India is the world’s back office.

Nonetheless, the larger point is that China, which opened its economy in 1979, benefits from a twelve-year head start over India, which did so in 1991. Yet India may be in a better position than China at this stage of development. India’s direct foreign investment, today over $50 billion, is roughly the same as China’s at the fifteen year mark after reform.

So the issue is not what India has done, but what it could do inn the decades ahead if infrastructure needs, restrictive labour laws, and other impediments to growth are corrected quickly, as the government has promised.

Together the new “G2,” the United States and China, in the last five years was responsible for more than 60% of the cumulative growth of the world’s total GDP.

With China, we have little concept of what is around the bend, yet here is no turning back. We desperately need to coordinate efforts to try to guide this impressive yet dangerous beast that has the capacity to lift the world to a new era of prosperity – or drag us all down into chaos.

ENDS