How a Slowing Chinese Economy is About to Hand Australia a Pay-Cut

Yesterday we learned that HSBC’s China manufacturing index contracted for the first time since October 2012. That suggests global economic consumption remains weak.

It also suggests that China’s latest round of credit stimulus has done very little for the Chinese economy, apart from exacerbate it’s imbalances for no discernible benefit.

The late 2012 and early 2013 credit stimulus set China’s economy back on its road to rebalancing. The Wall Street Journal reports that:

‘A more detailed look at China’s economic performance in 2012 shows it tipped further off balance, relying more than ever on credit-fueled investment, a trend it had tried to rein in.

‘The share of fixed investment in China’s gross domestic product rose to 46.1% in 2012, up from 45.6% in 2011, according to National Bureau of Statistics data, published by data provider CEIC. China’s headline GDP data have been available for some time, but the detailed breakdown between the shares of investment, consumption and exports was published this week.

‘The data also show the share of net exports at 2.7%, down from 8.8% in 2007, reflecting the transition from reliance on foreign demand to domestic investment to drive growth.

‘Meanwhile, the share of household consumption was flat at 35.7%.’

Meanwhile, today’s Australian Financial Review tells us that steel prices in China are at three and a half year lows. Given the huge demand for steel stemming from China’s infrastructure bubble over the past few years (which hasn’t even started to deflate) supply continues to expand, leading to falling prices. In April, China produced 2.1 million tonnes of steel, a monthly record.

Chinese steel mills are notorious for churning out uneconomic production. But if China wants to rebalance, it will need to rationalise its steel industry, meaning fewer plants producing less steel. That’s not exactly bullish for iron ore and coal prices.

The same article cites a capital economics study that says 2.75 million new homes in China remain unsold, double the number from 18 months ago. There’s overcapacity everywhere…

That’s why we think you’re going to see sub-US$100/tonne prices for iron ore before the year is out. It’s why Treasury’s forecasts for iron ore are wrong and why the budget deficit forecasts are likely to be wrong too.

And it’s why you’re seeing the Aussie stock market display consistent weakness. As we’ve been saying, a slowing China will hand Australia a pay-cut, after providing years of pay rises without a commensurate improvement in productivity.

How will the highly leveraged banks hold up in such an environment? Clearly investors are starting to ask themselves the same question…they’re taking profits on the great bank rally of 2012/13.

So while Japan and the US get all the attention based on what side of the bed their central bankers got out on that day, we think the major issue for the global economy is China and the problems brewing there. Australia already sees it.

China’s economic problems are not front and centre yet, but it won’t be too long before you see economic fundamentals trumping central banker rhetoric…

Greg Canavan
for Markets and Money

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From the Archives…

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Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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2 Comments on "How a Slowing Chinese Economy is About to Hand Australia a Pay-Cut"

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Rick W

You have left out a critical words “per day” in this sentence:
“In April, China produced 2.1 million tonnes of steel, a monthly record. ”

The monthly Chinese steel production for April 2013 was over 65Mt. It would be extraordinary disappointing if they could only manage 2.1Mt of steel from the 19.3Mt of iron ore from Australia alone in April. Then there is Brazil and their own mines.


drinking a fine single malt Scotch from Orkney we await Greg’s applause …

anticipate getting rolling drunk

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