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 is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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