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Inquiring
minds as well as commodity bulls need to consider the likely economic impact
of China's commodity imports and how sustainable those imports are.
For example, please consider China’s
Cotton Reserves Enough to Meet Deficit for Six Years
Cotton stockpiles in China, the
world’s biggest importer, are set to climb to about 9 million metric
tons this season, enough to cover the country’s deficit for the next
six years, according to Allenberg Cotton Co.
Inventories are rising as the government boosts purchases to support domestic
prices and lift farmer incomes, Joe Nicosia, chief executive officer of world’s
largest cotton trader, said at a conference in Hong Kong today. The country
may buy 5 million tons for reserves this year, up from 3.2 million tons a
year earlier, he said.
“As long as China maintains this regime to subsidize cotton farmers,
the world will be prone to overproduction,” he said. “Can you
imagine a world without China importing any cotton for six years? They hold
all the cards.”
What About Copper?
A similar setup has developed in other commodities, especially copper. Please
consider the FT Alphaville story China’s
growing copper fetish
Commodity Imports and Balance of Payments
Michael Pettis at China Financial Markets has given considerable thought to
the economic impacts (and distortions) of commodity speculation and writes
via Email ...
When it comes to defining the balance of
payments components I don’t think all commodity imports should be
treated equally. Commodities that are imported for use or for working
inventory should certainly show up in the current account, as they do.
Commodities that are imported for speculative purposes or for stockpiles,
however, should be included in the capital account, since they really are a form
of external investment more than a form of domestic consumption.
This is how they would recorded, for example, if rather than import physical
commodity for storage a local speculator purchased a commodity-linked note
from abroad. There is no real economic distinction between the two
transactions, but the former would be treated as a current account import
while the latter would be treated, correctly, as a capital account export.
This matters because the numbers can be significant, and so heavily distort
the balance of payments numbers. br />
Cotton stockpiles in China, the world’s biggest importer, are set to
climb to about 9 million metric tons this season, enough to cover the
country’s deficit for the next six years, according to Allenberg Cotton Co.
When you have stockpiled enough cotton to cover the next six years of
imports, it seems to me, most of your stockpile represents a speculative bet
on cotton prices. It should be treated no differently than any other
speculative bet, and the fact that it warehoused domestically rather than
off-shore is largely irrelevant.
It is not just cotton, of course, for which large speculative positions
distort the balance of payments numbers. FT Alphaville
quotes a Goldman report on copper.
This, of course, is an old story, and it is not hard to figure out what the
consequences of this kind of thing are likely to be.
China Daily says Steel
industry outlook worrisome
China's steel industry is a big cause for concern in the fourth quarter
due to shrinking demand and heavy losses, according to an industry official.
The fears were outlined by Huang Libin, an official
from the Ministry of Industry and Information Technology, in an interview
with China National Radio.
"The steel sector's performance has been bad since the beginning of the
year," Huang said. "Their revenues are falling and demand remains
weak." The entire steel sector is now operating at a loss and struggling
with problems of oversupply and a broader economic slowdown, he said. MIIT
data show that 45 percent of the country's steel companies suffered losses in
the first nine months of 2012.
Clearly there has been too much stockpiling of a wide range of commodities,
and just as I have warned for many years, Chinese stockpiling of commodities
is a very dangerous balance sheet management given the positive relationship
between Chinese growth and commodity prices. It was just a matter of time
before a slowdown in Chinese growth would cause a collapse in commodity
prices, saddling already-struggling Chinese producers with soaring inventory
losses. This seems already to be happening, and of course there is a lot more
to come.
Understanding the Balance of Payments
We are probably stuck with this very distorted way
of recording commodity purchases in the balance of payments, and there is not
much we can do to change it. It does suggest however that rather than accept
the commonly accepted definitions of the balance of payments – or of
other things, like GDP, and whether housing must be classified as consumption
or as investment – as if they were fundamentally meaningful, we should
constantly remind ourselves why exactly we need the information and then adjust
the numbers accordingly.
In the case of China, this means that to the extent there has been an
increase in commodity imports held for speculative or investment purposes, we
should reduce imports and increase the current account surplus
correspondingly, in our private calculations. We should also increase our
estimates of capital account exports.
One way to think of it is that in the past China shifted out of whatever
foreign assets Chinese owned abroad (or borrowed privately) into US and
European government bonds. Now China is shifting out of US and European
government bonds into whatever assets wealthy Chinese are acquiring abroad as
they flee the country. The numbers are pretty big, especially if the current
account surplus is understated, which it almost certainly is, and so the
effect of these various shifts should show up in relative pricing.
What are Chinese currently buying? They are buying homes and real estate in a
number of countries, especially Australia, Canada, the United States, and, to
the extent that they can get around newly imposed restrictions, Singapore and
Hong Kong. They are also buying commodities and commodity-related companies.
They seem also to buying a lot of unrelated businesses in places like
Australia, which is good for Australian asset prices but perhaps bad for
Australian manufacturers.
This has at least one implication. Real estate and commodity prices have been
dropping, but this has come in spite of a massive program by Chinese
effectively to swap out of US and European government bonds and into
commodities and real estate. Where would prices have been absent this Chinese
swap? Probably much lower, right?
So what will happen next? The demand for real estate may or may not abate at
some point in the future, given the size of Chinese demand to hold assets in
a safe place – a demand which is not likely to drop with slower Chinese
growth but rather to speed up. The demand for commodities, however, will
certainly do so once Chinese long positions, combined with much slower
growth, make them excessive.
This can’t be positive for commodity prices. My point more generally is
that growth in China is likely to be negatively correlated with Chinese
demand for foreign real estate and positively correlated with Chinese demand
for commodities. It will also affect other things for which China has
effectively been swapping US and European government bonds, after many years
of doing the opposite.
You can accelerate investment forever
It is, to me, astonishing that China in just five years is “replicating
the entire US commercial banking sector”, and yet so many analysts are
expressing delight with China’s return to growth. Of course you can
generate growth if you force such a tremendous expansion in credit, but this
is simply unsustainable.
I know I’ve said this many times, and I apologize for boring regular
readers, but while I expected that politics would require a jump in growth
over the rest of this year and the beginning of the next, this “good
growth” tells us nothing about the health of the underlying economy. It
only tells us how difficult politically the transition is likely to be.
My guess is that the more difficult the consolidation of power, the longer
the period of above 7% growth – which is perhaps another way of saying
that the happier the sell-side analysts are, the more worried long-term
investors should be.
I Side With Pettis
Michael Pettis is in a debate with the Economist on
the future of Chinese growth as noted previously in The Dating
Game: Michael Pettis Challenges The Economist to a Bet on China.
Just this month there has been further discussion and debate in the Wall
Street Journal.
·
Lardy vs.
Pettis: Debating
China’s Economic Future
·
Lardy vs.
Pettis: Debating
China’s Economic Future, Round 2
I know clear economic thinking when I see it, and Pettis is thinking clearly.
What About Canadian and Australian Real Estate?
Pettis states "The demand for real estate may or may not abate at
some point in the future, given the size of Chinese demand to hold assets in
a safe place – a demand which is not likely to drop with slower Chinese
growth but rather to speed up."
Demand to get money out of China will likely speed up. However, and in a rare
(albeit slight) disagreement with Pettis, I suggest demand for real estate is
likely to plunge once real estate investment is no longer considered a safe
haven.
Property bulls in Australia and Canada will not know what hit them once that
"safe haven" status disappears (and it will). When it does, Chinese
demand will go down the drain as well, further depressing the markets.
Actually, Australia is already burnt toast and Canada's turn is coming.
Ghost Malls, Ghost Cities, Infrastructure Malinvestment
China is home to the world's largest shopping mall and it sits empty. For a
discussion and video, please see How Will
China Handle The Yuan?
Also recall that China is home to numerous vacant cities. For a discussion,
please see World's
Biggest Property Bubble: China's Ghost Cities Revisited; 64 Million Vacant
Properties
The Video of
Ghost Cities is a must
see eye-opener for those overly bullish on China.
In effect China already has accelerated investment forever forward, so much
so that it's no longer even investment but rather massive speculation, a
point Pettis makes easily in his latest email.
GDP
I was laughing when I read the following paragraph from Pettis "I
apologize for boring regular readers, but while I expected that politics
would require a jump in growth over the rest of this year and the beginning
of the next, this “good growth” tells us nothing about the health
of the underlying economy. It only tells us how difficult politically the
transition is likely to be."
I can offer the same apology for harping about GDP.
As I have pointed out before, GDP is an essentially useless measure. For example,
government spending, by definition, adds to GDP. If the government paid
people to spit at the moon, it would add to GDP.
Here's a more practical example: If the government gives out a union contract
to repair a bridge for $10 billion, GDP will rise by the exact same amount as
if it fixed 200 bridges using non-union labor for the same amount.
Is dropping bombs in Iraq or Afghanistan productive? I suggest it has
negative benefit because of the enemies it makes and the economic distortions
it causes.
In regards to government spending, the bigger the waste, the higher the GDP.
Everyone is worried GDP will drop. Given unsustainable government spending
and Massive
Misdiagnosis of the Fiscal Cliff, the worry should be that GDP doesn't
drop.
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