China: Turning the Supertanker
To say the least, super tankers are not the most nimble vessels on the seven seas. This is almost 25 times the turn radius of an Arleigh Burke Destroyer. Today, China is a super tanker in the global marketplace. It is the second largest economy on the planet, the largest manufacturer and the largest importer of commodities. However, it is an economy that is overheating, and the authorities are taking steps to slow it down. The Chinese economy grew 9.5% y/y during the second quarter of 2011, similar to the 9.7% y/y growth rate that was posted during the first quarter of the year. Although this is below the 11.4% growth rate that was recorded in 2007, it was still fast enough to fuel inflationary pressures. Consumer prices are expected to crest over 6% y/y in 2011, creating enormous social problems. Unlike the U.S., where food prices are not reflected in the core inflation rate, it is a third of the Chinese consumer basket. Unfortunately, food was on the rise since the end of 2009. The prices of many basic food products doubled in 2010, creating widespread social discontent. This helped fuel the strikes at Foxconn and Honda which led to large increases in the minimum wage. Nevertheless, the increases were not enough to offset the social problems. With a population of 1.3 billion and growing income inequality, Beijing knows all too well that the country could explode into a political storm. The economic authorities have a fine line to tread, with the need to create employment opportunities for the population entering the workforce and the need to keep consumer prices under control. It is a herculean task that requires the navigation skills of a Formula One pilot trying to do slaloms with a fully-loaded super tanker.
So far, the impact on commodities has been muted. The CRB index is off its high, but the debt problems in the U.S. and Europe left many investors looking for tangible assets to replace financial products. Nevertheless, a large slowdown in Chinese growth could lead to a major reduction in the demand for commodities. This would be devastating for many Latin American economies. China represents 23.2% of Chile’s exports, 13.2% of Brazil’s, 15.3% of Peru’s and 6.6% of Argentina’s. It would also be very painful for many developed economies, such as Japan. It sends 19% of its embarkations to China and Korea which sends 23.9%. A slowdown in China would be terrible for the global economy, given the current international environment. The Chinese economy saved the day in 2008 and 2009, when large fiscal and monetary expansion packages allowed it to counter the problems in the U.S. However, it is no longer in any condition to play the white knight. According to official sources, Chinese local governments have $1.7 trillion in debt, representing 27% of GDP. This is in addition to the 20% of GDP in central government debt. However, some analysts argue that contingent liabilities and the obligations of state-owned enterprises increase the debt load to 150% of GDP. This puts China on par with the most indebted countries of the developed world, thus reducing its ability to maneuver.
Nevertheless, the Chinese government continues to work on slowing the economy. Social unrest is simmering, with a series of bloody strikes and riots shaking the industrial cities of Guandong and Zengcheng. The Communist Party of China (CPC) is well versed on the country’s historical capacity to break apart. Therefore, it will do all it can to keep the economy in check.
In the meantime, Chinese manufacturers are being urged to move up the value-added chain in order to pay higher wages. Factories in Wenzhou, for example, used to dominate the world’s production of cigarette lighters. Now they are trying to find new products to produce. The problem is that China’s labor force, while cheap, is highly inefficient. Labor productivity in China is 12% of the U.S. This is the reason why many companies are decamping back to North America. Low education levels, poor infrastructure and thin social services are why China’s labor productivity suffers. A good example of the limitations of Chinese technology occurred two weeks ago, when a bullet train in Zhejiang slammed into another locomotive that was disabled by a bolt of lightning during a summer storm. A flaw in the signalling system failed to warn the oncoming train and 32 people lost their lives. The incident highlighted the limitations of Chinese technology and its potential to quickly move into higher value-added production. These flaws will make it that much more painful when the Chinese economy begins to run out of steam.