Nov 192015
 November 19, 2015  Posted by at 11:28 am Finance Tagged with: , , , , , , , , ,

Robert Capa Anti-fascist militia women at Barcelona street barricade 1936

Looking through a bunch of numbers and graphs dealing with China recently, it occurred to us that perhaps we, and most others with us, may need to recalibrate our focus on what to emphasize amongst everything we read and hear, if we’re looking to interpret what’s happening in and with the country’s economy.

It was only fair -perhaps even inevitable- that oil would be the first major commodity to dive off a cliff, because oil drives the entire global economy, both as a source of fuel -energy- and as raw material. Oil makes the world go round.

But still, the price of oil was merely a lagging indicator of underlying trends and events. Oil prices didn‘t start their plunge until sometime in 2014. On June 19, 2014, Brent was $115. Less than seven months later, on January 9, it was $50.

Severe as that was, China’s troubles started much earlier. Which lends credence to the idea that it was those troubles that brought down the price of oil in the first place, and people were slow to catch up. And it’s only now other commodities are plummeting that they, albeit very reluctantly, start to see a shimmer of ‘the light’.

Here are Brent oil prices (WTI follows the trend closely):

They happen to coincide quite strongly with the fall in Chinese imports, which perhaps makes it tempting to correlate the two one-on-one:

But this correlation doesn’t hold up. And that we can see when we look at a number everyone seems to largely overlook, at their own peril, producer prices:

About which Bloomberg had this to say:

China Deflation Pressures Persist As Producer Prices Fall 44th Month

China’s consumer inflation waned in October while factory-gate deflation extended a record streak of negative readings [..] The producer-price index fell 5.9%, its 44th straight monthly decline. [..] Overseas shipments dropped 6.9% in October in dollar terms while weaker demand for coal, iron and other commodities from declining heavy industries helped push imports down 18.8%, leaving a record trade surplus of $61.6 billion.

44 months is a long time. And March 2012 is a long time ago. Oil was about at its highest since right before the 2008 crisis took the bottom out. And if you look closer, you can see that producer prices started ‘losing it’ even earlier, around July 2011.

Something was happening there that should have warranted more scrutiny. That it didn’t might have a lot to do with this:

China’s debt-to-GDP ratio has risen by nearly 50% in the past four years.

The producer price index seems to indicate that trouble started over 4 years ago. China dug itself way deeper into debt since then. It already did that before as well (especially since 2008), but the additional debt apparently couldn’t be made productive anymore. And that’s an understatement.

Now, if you want to talk correlation, compare the producer price graph above with Bloomberg’s global commodities index:

World commodities markets, like the entire global economy, were propped up by China overinvestment ever since 2008. Commodities have been falling since early 2011, after rising some 60% in the wake of the crisis. And after the 2011 peak, they’ve dropped all the way down to levels not seen since 1999. And they keep on falling: steel, zinc, copper, aluminum, you name it, they’re all setting new lows almost at a daily basis.

Moreover, if we look at how fast China imports are falling, and we realize how much of those imports involve (raw material) commodities, we can’t escape the conclusion that here we’re looking at not a lagging, but a predictive indicator. What China doesn’t purchase in raw materials today, it can’t churn out as finished products tomorrow.

Not as exports, and not as products to be used domestically. Neither spell good news for the Chinese economy; indeed, the rot seems to come from both sides, inside and out. And no matter how much Beijing points to the ‘service’ economy it claims to be switching towards, with all the debt that is now deflating, and the plummeting marginal productivity of new debt, most of it looks like wishful thinking.

And that is not the whole story either. Closely linked to the sinking marginal productivity, there is overleveraged overcapacity and oversupply. It’s like the proverbial huge ocean liner that’s hard to turn around.

There are for instance lots of new coal plants in the pipeline:

China Coal Bubble: 155 Coal-Fired Power Plants To Be Added To Overcapacity

China has given the green light to more than 150 coal power plants so far this year despite falling coal consumption, flatlining production and existing overcapacity. [..] in the first nine months of 2015 China’s central and provincial governments issued environmental approvals to 155 coal-fired power plants — that’s 4 per week. The numbers associated with this prospective new fleet of plants are suitably astronomical. Should they all go ahead they would have a capacity of 123GW, more than twice Germany’s entire coal fleet; their carbon emissions would be around 560 million tonnes a year, roughly equal to the annual energy emissions of Brazil; they would produce more particle pollution than all the cars in Beijing, Shanghai, Tianjin and Chongqing put together [..]

And new car plants too:

China’s Demand For Cars Has Slowed. Overcapacity Is The New Normal.

For much of the past decade, China’s auto industry seemed to be a perpetual growth machine. Annual vehicle sales on the mainland surged to 23 million units in 2014 from about 5 million in 2004. [..] No more. Automakers in China have gone from adding extra factory shifts six years ago to running some plants at half-pace today—even as they continue to spend billions of dollars to bring online even more plants that were started during the good times.

The construction spree has added about 17 million units of annual production capacity since 2009, compared with an increase of 10.6 million units in annual sales [..] New Chinese factories are forecast to add a further 10% in capacity in 2016—despite projections that sales will continue to be challenged. [..] “The players tend to build more capacity in hopes of maintaining, or hopefully, gain market share. Overcapacity is here to stay.”

These are mere examples. Similar developments are undoubtedly taking place in many other sectors of the Chinese economy (how about construction?!). China has for example started dumping its overproduction of steel and aluminum on world markets, which makes the rest of the world, let’s say, skittish. The US is levying a 236% import tax on -some- China steel. The UK sees its remaining steel industry vanish. All US aluminum smelters are at risk of closure in 2016.

The flipside, the inevitable hangover, that China will wake up to sooner rather than later, is the debt that its real growth, and then it’s fantasy growth, has been based on. We already dealt extensively with the difference between ‘official’ and real growth numbers, let’s leave that topic alone this time around.

Though we can throw this in. Goldman Sachs recently said that even if the official Beijing growth numbers were right -which nobody believes anymore- ”Chinese credit growth is still running at roughly double the rate of GDP growth”. And even if credit growth may appear to be slowing a little, though we’d have to know the shadow banking numbers to gauge that (and we don’t), that hangover is still looming large:

China Bad Loans Estimated At 20% Or Higher vs Official 1.5%

[..] While the analysts interviewed for this story differ in their approaches to calculating likely levels of soured credit, their conclusion is the same: The official 1.5% bad-loan estimate is way too low.

Charlene Chu [..] and her colleagues at Autonomous Research in Hong Kong take a top-down approach. They estimate how much money is being wasted after the nation began getting smaller and smaller economic returns on its credit from 2008. Their assessment is informed by data from economies such as Japan that have gone though similar debt explosions. While traditional bank loans are not Chu’s prime focus – she looks at the wider picture, including shadow banking – she says her work suggests that nonperforming loans may be at 20% to 21%, or even higher.

The Bank for International Settlements cautioned in September that China’s credit to gross domestic product ratio indicates an increasing risk of a banking crisis in coming years. “A financial crisis is by no means preordained, but if losses don’t manifest in financial sector losses, they will do so via slowing growth and deflation, as they did in Japan,” said Chu. “China is confronting a massive debt problem, the scale of which the world has never seen.”

Looking at the producer price graph, we see that the downfall started at least 44 months ago, and that 52 months is just as good an assumption. And we know that debt rose 50% or more since the downfall started. That does put things in a different perspective, doesn’t it? (Probably) the majority of pundits and experts will still insist on a soft landing at worst.

But for those who don’t, please consider the overwhelming amount of deflationary forces that is being unleashed on the world as all that debt goes sour. As the part of that debt that was leveraged vanishes into thin air.

It’s ironic to see that it’s at this very point in time that the IMF (Christine Lagarde seems eager to take responsibility) seeks to include the yuan in its SDR basket. Xi Jinping’s power over the exchange rate can only be diminished by such a move, and we’re not at all sure he realizes to what extent that is true. Chinese politics are built on hubris, and that goes only so far when you free float but don’t deliver.

To summarize, do you remember what you were doing -and thinking- in mid-2011 and/or early 2012? Because that’s when this whole process started. Not this year, and not last year.

China’s producers couldn’t get the prices they wanted anymore, as early as 4 years ago, and that’s where deflationary forces came in. No matter how much extra credit/debt was injected into the money supply, the spending side started to stutter. It never recovered.

Home Forums The Great Fall Of China Started At Least 4 Years Ago

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    Robert Capa Anti-fascist militia women at Barcelona street barricade 1936 Looking through a bunch of numbers and graphs dealing with China recently, i
    [See the full post at: The Great Fall Of China Started At Least 4 Years Ago]

    Dr. Diablo

    Cool stuff. One thing that you touched on a little, is that China’s slowdown is really a slowdown of their customers, the U.S. and E.U. Virtually everything China imports, they export again as the factory of the world. I heard this same thing on NPR yesterday, that the U.S. economy is only “responding” to the slowdown in China: i.e. “It’s their fault!! We were just fine before China broke our economy!!” –Your typical political blame-game. (PS, Let’s bomb them) In fact, the way China is built, it can only slow down or did only slow down because their factories stalled from a lack of orders, due to a lack of buyers, due to an overwhelming debt + falling wages + credit crisis in the West. No doubt China was itching for overcapacity and this would have happened soon anyway–you can’t double your concrete and steel capacity every 5 years forever–but the actual tipping point was the West’s credit crisis throwing the kill switch. In my opinion. These things are complicated, of course.

    Second item, yes China is in debt, and that’s always a problem, first that unrestrained debt leads to overcapacity and boom/bust, but also that it can’t be paid and must be liquidated. But the liquidation doesn’t destroy assets(mostly): it transfers ownership of them. The social stress comes when someone who owned an asset gets it taken away from them, and they cry, throw a tantrum, and plan revenge. The new owner now is pals with whoever transferred somebody else’s stuff to them–a potential example of political payoffs. But for the most part, the assets, factories, warehouses, mines, continue to exist, however less valuable for the moment, and however many unimportant people are out of work.

    My point about debt not being paid, and ownership being transferred in weakness and bankruptcy, however, is WHO does China owe their debt to? WHO is not going to get paid? If the debt is internal, all minted up by the Chinese central bank, then the problems and social stresses of taking assets and redistributing them are all internal. And this is something China has very, very familiar with. China isn’t run like the west, and never has been. The Government, the Party, the Emperor, the Confucian bureaucracy going back 1,000 years, they own everything inside the borders of China without dispute. They always have. If the Emperor wants to take your land, your province, your title, your manor house, your factory, and hand it to someone else, he can. You can be upset and get him back, but they’re very experienced in this problem of power and dissent. China, the Chinese people, will consider this normal.

    So if China wants to call a time-out on all internal debt, cancel the Yuan, go through the books, and clear the ledger, and reboot with Yuan2, they can. And all the extreme, overwhelming debt (internally) can vanish in a weekend. –Of course, so can we, and we probably will, but the American people especially will find this unjust, high-handed, and unacceptable. We believe WE own our property. Inside China, the Emperor, the Party, the Nation, the bureaucracy owns the property.

    Just a thought. They don’t run by our rules. If the debt is internal, it doesn’t mean there what it means here. If the debt is external, owed to the Western US/EU nations and banks, then look out all the more, because it’s that much easier not to get paid.

    John Day

    I sent a 0.25 Troy oz. Mexican gold bullion coin by registered international mail to Pireas Solidarity Clinic yesterday, after purchasing it at $1170/oz + 8% at a local dealer, here in Austin. The tracking number supplied doesn’t work on this perfectly legal form of asset transfer, but the software tells me it can’t track my package to Greece, so it recognizes it.
    Financial geurrilla charity? I worked a lot last month, and still have kids in college and that $15,000 of credit card debt. I can’t buy things for myself until that is paid off, but I have a little wiggle room to do this, with the same charity we helped together this summer.
    (I know it has been 5+ years since I contributed to Automatic Earth and Nicole’s trip to Austin, but I have excuses.)


    I’ll go seen them again soon, John, should remember to ask them about the gold coin.


    For an alternative view (translated from French) on the background to recent events in Paris, I suggest this article:

    “The French Republic taken hostage
    by Thierry Meyssan

    The war which has now spread to Paris is incomprehensible for those French citizens who are ignorant of practically all the secret activities of their government in the Arab world, of its unnatural alliances with the Gulf dictators, and its active participation in international terrorism. These policies have never been discussed in Parliament, and the major media have rarely dared to take an interest in them.”


    ” If the debt is external, owed to the Western US/EU nations and banks, then look out all the more, because it’s that much easier not to get paid.”
    Seems like selective sovereign (internal vs external) debt repayment is likely to be an important phase in the upcoming debt default game, followed by selective internal debt repayment, as the process grinds on.


    “China has given the green light to more than 150 coal power plants so far this year despite falling coal consumption, flatlining production and existing overcapacity.” — greenpeace blog, quoted above.

    Technically correct, but it ignores context. Yes, many new coal power plants are being built — and many are being SHUT DOWN. The ones being shut down are older, inefficient and highly polluting. The ones being built are much better, albeit not faultless. China is transitioning to renewables and nuclear as fast as it can, but coal is still (and will remain, for at least 50 years) an important part of the mix. That being the case, what is to be done right now, for the couple decades? Answer: build MUCH BETTER newer coal plants (higher efficiency, with air quality control systems) and shut down the awful old ones. This is a good and appropriate investment, for the time being. However, within as little as a decade, the economics of renewables will make it foolish to construct any more fossil fuel-dependent infrastructure. When that moment arrives, coal will finally begin its long descent into well-deserved oblivion. China will likely lead the way in the conversion.

    PS: China is not “falling”. It is entering its period of economic maturity, i.e. the wild young growth years are over. This will continue for a half-century or so. Likely growth: 6-7% per year, next decade or two.

    Here’s What China Closing Coal-Power Plants Means for Emissions — April 19, 2015
    The [coal plant] closures are part of China’s plans to close as much as 20 gigawatts of capacity that doesn’t meet environmental standards in the five years ending in December. China has already shut 18 gigawatts, according to Greenpeace…. China is expected to close another 60 gigawatts with facilities that are more efficient between 2016 to 2020, though three times as many plants are scheduled to be built using newer technology, BNEF’s Lu said. New plants will produce about 90 percent fewer pollutants such as dust and sulfur dioxide per kilowatt-hour of electricity generated, she said.

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