This is a syndicated repost courtesy of David Stockman's Contra Corner » Stockman’s Corner. To view original, click here. Reposted with permission.
No wonder the Red Ponzi consumed more cement during three years (2011-2013) than did the US during the entire twentieth century. Enabled by an endless flow of credit from its state controlled banking apparatus and its shadow banking affiliates, China went berserk building factories, warehouses, ports, office towers, malls, apartments, roads, airports, train stations, high speed railways, stadiums, monumental public buildings and much more.
If you want an analogy, the 6.6 gigatons of cement consumed by China during 2011-2013 was the equivalent of 14.5 trillion pounds. By comparison, the Hoover dam used about 1.8 billion pounds of cement.
So in 3 years China consumed enough cement to build the Hoover dam 8,000 times over—-160 of them for every state in the union!
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Having spent recent time in China, we can well and truly say that the Middle Kingdom is back. But its leitmotif is the very opposite to the splendor of the Forbidden City.
The Middle Kingdom has been reborn in towers of preformed concrete. They rise in their tens of thousands in every direction on the horizon. They are connected with ribbons of highways which are scalloped and molded to wind through the endless forest of concrete verticals. Some of them are occupied. Alot, not.
The “before” and “after” contrast of Shanghai’s famous Pudong waterfront is illustrative of the illusion.
The top picture below is from about 1990 at a time before Mr. Deng discovered the printing press in the basement of the People’s Bank of China and proclaimed that it is glorious to be rich; and that if you were 18 and still in full possession of your digital dexterity and visual acuity it was even more glorious to work 12 hours per day 6 days per week in an export factory for 35 cents per hour.
Whether or not this image is precisely accurate as to vintage, by all accounts the glitzy skyscrapers of today’s Pudong waterfront did ascend during the last 25 years from a rundown, dimly lit area of muddy streets on the east side of Huangpu River. The pictured area was apparently shunned by all except the most destitute of Mao’s proletariat.
But the second picture we can vouch for. It’s exactly what you see from the Peninsula Hotel on the Bund, which lies directly across on the west side of the Huangpu River.
Today’s Pudong district does look spectacular—–presumably a 21st century rendition of the glory of the Qing, the Ming, the Soong, the Tang and the Han—all rolled into one.
But to conclude that would be to be deceived. The apparent prosperity is not that of a sustainable economic miracle; it’s the front street of the greatest Potemkin village in world history.
The heart of the matter is that output measured by Keynesian GDP accounting—-especially China’s blatantly massaged variety— isn’t sustainable wealth if it is not rooted in real savings, efficient capital allocation and future productivity growth. Nor does construction and investment which does not earn back its cost of capital over time contribute to the accumulation of real wealth.
Needless to say, China’s construction and “investment” binge manifestly does not meet these criteria in the slightest. It was funded with credit manufactured by state controlled banks and their shadow affiliates, not real savings.
It was driven by state initiated growth plans and GDP targets. These were cascaded from the top down to the province, county and local government levels—–an economic process which is the opposite of entrepreneurial at-risk assessments of future market based demand and profits.
China’s own GDP statistics are the smoking gun. During the last 15 years fixed asset investment—–in private business, state companies, households and the “public sector” combined—–has averaged 50% of GDP. That’s per se crazy.
Even in the heyday of its 1960s and 1970s boom, Japan’s fixed asset investment never reached more than 30% of GDP. Moreover, even that was not sustained year in and year out (they had three recessions), and Japan had at least a semblance of market pricing and capital allocation—unlike China’s virtual command and control economy.
A Credit Driven Madhouse
The reason that Wall Street analysts and fellow-traveling Keynesian economists miss the latter point entirely is because China’s state-driven economy works through credit allocation rather than by tonnage toting commissars.
The gosplan is implemented by the banking system and, increasingly, through China’s mushrooming and metastasizing shadow banking sector. The latter amounts to trillions of credit potted in entities which have sprung up to evade the belated growth controls that the regulators have imposed on the formal banking system.
For example, Beijing tried to cool down the residential real estate boom by requiring 30% down payments on first mortgages and by virtually eliminating mortgage finance on second homes and investment properties. So between 2013 and the present more than 2,500 on-line peer-to-peer lending outfits (P2P) materialized—-mostly funded or sponsored by the banking system—– and these entities have advanced more than $2 trillion of new credit.
That’s right. A new $2 trillion credit channel erected virtually overnight.
The overwhelming share went into meeting “downpayments” and other real estate speculations. On the one hand, that reignited the real estate bubble——especially in the Tier I cities were prices have risen by 20% to 60% during the last year.
At the same time, this P2P credit eruption in the shadow banking system has encouraged the construction of even more excess housing stock in an economy that already has upwards of 65 million empty units.
In short, China has become a credit-driven economic madhouse. The 50% of GDP attributable to fixed asset investment actually constitutes the most spectacular spree of malinvestment and waste in recorded history. It is the footprint of a future depression, not evidence of sustainable growth and prosperity.
Consider a boundary case analogy. With enough fiat credit during the last three years, the US could have duplicated China’s cement consumption spree and built 160 Hoover dams on dry land in each and every state.
That would have elicited one hellacious boom in the jobs market, gravel pits, cement truck assembly plants, pipe and tube mills, architectural and engineering offices and so on. The profits and wages from that dam building boom, in turn, would have generated a secondary cascade of even more phony “growth”.
But at some point, the credit expansion would stop. The demand for construction materials, labor, machinery and support services would dry-up; the negative multiplier on incomes, spending and investment would kick-in; and the depression phase of a crack-up boom would exact its drastic revenge.
In fact, that’s exactly the kind of crack-up boom that has been underway in China for the last two decades. Accordingly, it is not simply a little over-done, and it’s not in some Keynesian transition from exports and investment to domestic services and consumption. Instead, China’s fantastically over-built industry and public infrastructure embodies monumental economic waste equivalent to the construction of pyramids with shovels and spoons and giant dams on dry land.
Accordingly, when the credit pyramid finally collapses or simply stops growing, the pace of construction will decline dramatically. In turn, as we suggested above, the collapse of its construction boom will leave the Red Ponzi riddled with economic air pockets and negative spending multipliers.
The Mother Of All Malinvestments
Take the simple case of the abandoned cement mixer plant pictured below. The high wages paid in that abandoned plant are now gone; the owners have undoubtedly fled and their high living extravagance is no more. Nor is this factory’s demand still extant for steel sheets and plates, freight services, electric power, waste hauling, equipment replacement parts and on down the food chain.
And, no, a wise autocracy in Beijing will not be able to off-set the giant deflationary forces now assailing the construction and industrial heartland of China’s hothouse economy with massive amounts of new credit to jump start green industries and neighborhood recreation facilities. That’s because China has already shot is its credit wad, meaning that every new surge in its banking system will trigger even more capital outflow and expectations of FX depreciation.
Moreover, any increase in fiscal spending not funded by credit expansion will only rearrange the deck chairs on the titanic.
Indeed, whatever borrowing headroom Beijing has left will be needed to fund the bailouts of its banking and credit system. Without massive outlays for the purpose of propping-up and stabilizing China’s vast credit Ponzi, there will be economic and social chaos as the tide of defaults and abandonments swells.
Empty factories like the above—–and China is crawling with them—–are a screaming marker of an economic doomsday machine. They bespeak an inherently unsustainable and unstable simulacrum of capitalism where the purpose of credit has been to fund state mandated GDP quota’s, not finance efficient investments with calculable risks and returns.
The relentless growth of China’s aluminum production is just one more example. When China’s construction and investment binge finally stops, there will be a huge decline in industry wages, profits and supply chain activity.
But the mother of all malinvestments sprang up in China’s steel industry, as we outlined above.
And that’s where the pyramid building nature of China’s insane fixed investment spree comes in. China’s humungous iron and steel industry is not remotely capable of “rationalization” as practiced historically in the DM economies. Even Beijing’s much ballyhooed 100-150 million ton plant closure target is a drop in the bucket—-and it’s not scheduled to be completed until 2020 anyway.
To wit, China will be lucky to have 400 million tons of true sell-through demand—-that is, on-going domestic demand for sheet steel to go into cars and appliances and for rebar and structural steel to be used in replacement construction once the current one-time building binge finally expires.
For instance, China’s construction and shipbuilding industries consumed about 500 million tons per year at the crest of the building boom. But shipyards are already going radio silent and the end of China’s manic eruption of concrete, rebar and I-beams is not far behind. Use of steel for these purposes could easily drop to 200 million tons on a steady state basis.
Bu contrast, China’s vaunted auto industry uses only 45 million tons of steel per year, and consumer appliances consume less than 12 million tons. In most developed economies autos and white goods demand accounts for about 20% of total steel use.
Likewise, much of the current 200 million tons of steel which goes into machinery and equipment including massive production of mining and construction machines, rails cars and the like is of a one-time nature and could easily drop to 100 million tons on a steady state replacement basis.
So it’s difficult to see how China will ever have recurring demand for even 400 million tons annually, yet as we indicated above that’s less than one-third of its massive capacity investment.
In short, we are talking about wholesale abandonment of a half billion tons of steel capacity or more. That is, the destruction of steel industry capacity greater than that of Japan, the EC and the US combined.
Needless to say, that thunderous liquidation will generate a massive loss of labor income and profits and devastating contraction of the Chinese steel industry’s massive and lengthy supply chain. And that’s to say nothing of the labor market disorder and social dislocations which will occur when China is hit by the equivalent of dozens of burned-out Youngstown’s and Pittsburg’s.
And it is also evident that it will not be in a position to dump its massive surplus on the rest of the world. Already trade barriers against last year’s 110 million tons of exports are being thrown up in Europe, North America, Japan and nearly everywhere else.
This not only means that China has upwards of a half-billion tons of excess capacity that will crush prices and profits, but, more importantly,that the one-time steel demand for steel industry CapEx is over and done. And that means shipyards and mining equipment, too.
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