By John Richardson
JUST as it appeared as if the visionary reformers within the Chinese government had won their battle to deflate the most economically and environmentally toxic investment bubble in global economic history, China has taken a step backwards.
As the chart below shows, total social financing (TSF) has once again gone through the roof. TSF growth in January and February was at reasonable levels, but then surged in March. TSF is a measure of China’s total new credit creation – both from the official state-owned banks and the shadow lenders.
What’s behind this new credit splurge? It is largely this:
- Reforming the way that local governments finance themselves remains largely work in progress. They are still heavily dependent on land sales to industrial developers to balance their books – and on tax revenues from factories once they are operating.
- They also remain under pressure from central government officials to hit short term GDP growth targets. A proven way of doing this is to build lots more factories in already oversupplied sectors – and to go slow on closing down existing overcapacity. This is because by so doing, you of course both create jobs and preserve existing employment.
- To this end, the local governments have encouraged local branches of state-owned banks to lend increasing amounts of money to oversupplied industrial sectors. There are other more innovative and risky methods by which this financing is being sourced. I shall explore these methods in a separate post next week.
A great example of what I am talking about is occurring in, of all of industries, the cement industry! China accounted for 57% of global production last year – and in 2011 and 2012 produced as much cement as the US in the entire 20th century, according to the Wall Street Journal.
And yet, as the newspaper adds:
Here in the industrial northeast, Tangshan Jidong Cement, a state enterprise with domestically listed shares, has begun work on a giant 7,200-ton-a-day facility. Bulldozers have ripped a wide gash across low hills to make way for a factory that is likely to exacerbate an already epic glut of cement used to make concrete.
This project—and others like it—helps to explain why signs of an economic pickup in China this year are unlikely to last.
The rebound is supported by struggling local governments desperate for a short-term lift to growth, even if that means encouraging investment in industries linked to construction that are all in monumental surplus.
The WSJ argues that the “logic” behind further expanding cement capacity is also based on the notion of the victory of economies of scale: The new plants being added are world-scale and thus have better unit costs of production than overseas plants. The theory is that it will be the overseas plants that will be forced to shut down to make way for this additional overcapacity, and not Chinese plants.
And you have the issue of ongoing “soft financing” as a further competitive advantage for Chinese manufacturers.
What does this mean specifically for some sectors of the petrochemicals industry? Consider the chart below. It shows the average size of China’s purified terephthalic acid (PTA) plants compared with other countries and regions in 2016 versus 2000. The battle to achieve superior economies of scale has already been won in this sector.
It will be overseas PTA producers, such as perhaps some in South Korea, that seem more likely to be forced to shutter capacity.
If China continues on its current new path, it will also export even more of the manufactured-goods deflation that I have warned about before.
Here are two further pieces of bad news:
- All this extra domestic lending will dig China into a deeper bad-debt hole, and so make the eventual reckoning even harder.
- As existing cement, steel and chemicals plants etc. run at higher operating rates – and new plants are built – this will exacerbate China’s environmental crisis.
The good news, though, is that I think the reformers will eventually win the long term battle, and will set China on a new sustainable path to long term healthy growth.
It was always, however, going to be a case of on some occasions “one step forward and two steps back”.
Equally, it was always the case that the “whack-a-mole” game that the reformers have long being playing – to stamp out wasteful spending and excessive speculation – was never going to be easily won.