Wise Man Not Invest in Overcapacity
'When a country has an investment rate over 50 percent of GDP and rising, you say this country is not suffering from over-capacity...are you serious!?'
-Yu Yonding, Institute of World Economic and Politics, Chinese Academy of Social Sciences
Of course that was a long time ago, but have things really changed? As I wrote in a piece in The Sunday Telegraph, the ancient ethical system of Confucius has nothing to say on the subject of modernisation.5 There is no aphorism counseling wise men not to invest in overcapacity, but perhaps one day there will be since the Chinese seem hell-bent on a similar course of action. Investment spending has tripled since 2001 and the consequences are staggering.
A country that represents just 7% of global GDP is now responsible for 30% of global aluminum consumption, 47% of global steel consumption and 40% of global copper consumption. Similar to what happened during the Japanese capacity build, I doubt the ability of foreign markets to absorb such slack without some hostility arising.
At one level of abstraction I accept that China should be congratulated on its efforts to repel the 1920s-style deflationary trap in which surplus countries reign in their monetary and fiscal policies, thereby exacerbating the difficulties of the weaker debtor countries. It is just that I suspect the Politburo may have gone too far by embarking on a policy to match the US fiscal surge nearly dollar-fordollar despite having an economy one-third that of its American counterpart. Surely, Chinese officials must regret the explicit state blessing for a frenzied doubling in domestic bank lending last year. Exuberant credit creation and its associated, although officially unrecognised partner, hot money, have strengthened the twin problems of commodity hoarding and property speculation. This fiscal surge has many Australian and Brazilian commodity producers, as well as Japanese manufacturers, brimming with financial gratitude, but it will have the hapless Chinese household paying the bill should the rest of the world fail to sustain a vigorous economic recovery.
Where is the value in shuttling Chinese peasants, typically earning less than $1,000 per annum, back and forth at over 200 km/hour from the country's poverty-stricken interior to its prosperous coastal regions? Will the expected productivity enhancements succeed in generating sufficient profits to service the state's gargantuan investment spending? This is not to mention the railway ministry's proposed high-speed rail link between Shanghai and London, penciled in for no later than 2025 (see The Economist April 10th edition)!6 It is behaviour of this kind that brings to mind Buffett's witty dictum that, "to a man with a hammer everything looks like a nail."
Many optimistic investors will assail my argument and ask where the harm is in these policies. The harm is that such spending probably guarantees the continued impoverishment of the Chinese household sector at a time when there is much international enthusiasm for autonomous and consumption-led Asian growth. The fashion of our investment age is to upbraid economies like America's that have high levels of consumption and to instead look approvingly at the high saving contemporaries, the Asians. I think, though, we have it the wrong way round; one new hot dog vendor may be better for a nation than any number of state financed projects that fail to pay their economic rent., Let me explain.
