China’s Excess Capacity Problem

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There is a real world outside the financial world. In that world, people use energy every day. And so out in the middle of Australia, in the Cooper Basin for example, Aussie companies are busy finding and producing that energy. The search never ends.

That’s the story your editor will be talking about at the Broken Hill Resources and Energy Investment Symposium. The show runs from May 19th to May 22nd. The on-shore oil and gas sector may be one of the only sectors in the resources industry that sees more investment in 2013, not less. That’s because the long-term opportunities for unconventional oil and gas in Australia are so good.

In the meantime, it could be a rough day for the rest of the resource complex. China’s official Purchasing Manager’s Index reading came in at 50.6 in April. That was below March’s reading of 50.9. It shows expansion in China, but only just.

The real question is will China’s economy get any boost from all that credit created in the second half of last year? So far, it looks like China’s credit growth isn’t flowing into the real economy. We’ll come back to this in a moment. It’s the mirror image of the problem the counterfeiters at the Federal Reserve are having with their money printing program. But first, here’s the problem as described by Nomura economists Wendy Chen and Zhiwei Zhang:

Economic growth in China has weakened surprisingly despite rapid credit growth in the second half of 2012 and the first quarter of 2013. Many investors ask us the same question: where has all the money gone? We believe a large part of the new credit supply in the first quarter did not go into the real economy.

Why didn’t money flow into the real economy? We think it is partly because the underlying demand for investment is weak.

Fixed asset investment growth for the manufacturing industry has been on a downward trend since 2011, and dropped sharply in the first quarter of 2013, despite strong infrastructure fixed asset investment growth, which should have generated some positive spillover effects for manufacturers. The over-capacity problem in the manufacturing industry has been exacerbated by aggressive policy easing in 2009 and 2012.

It is not surprising to us, as many infrastructure investments projects are not yet profitable. Therefore, local government financing vehicles need to continue borrowing new funds for debt financing.

Gulp.

China’s excess capacity problem has its roots in US monetary policy. Since China’s currency is pegged to the dollar (they say it isn’t, but it is), China effectively imports US interest rate policy. That’s led to a big credit boom and significant manufacturing overcapacity.

This is all textbook credit boom stuff, according to Austrian economics. And so is the next phase, where local governments must borrow more money just to pay interest on the money they already borrowed. That’s your basic Ponzi finance, and it happens when the asset you’ve invested in doesn’t generate a real return.

Regards,
Dan Denning
for The Daily Reckoning Australia

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From the Archives…

Gold Demand: The Great Disconnect Between Paper and Bullion
26-04-13 – Greg Canavan

Lest We Forget
25-04-13 – Greg Canavan

Praying for Government Incompetence
24-04-13 ­– Bill Bonner

The Cracks in Solidarity at the Recent G20 Gabfest
23-04-13 – Greg Canavan

How Central Planners are Committed to Ruining the Economy
22-04-13 – Joel Bowman

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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