Jubak's Journal
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China: the dragon that isnt
China just isn't the economic threat many think it is. In fact, it faces a double-barreled economic crisis in coming decades. Here's why.
By Jim Jubak
In my last column, "Let China buy Unocal," I had the temerity to say that I'd let the free market -- rather than ranting U.S. politicians -- decide whether California-based ChevronTexaco (CVX, news, msgs) or China-based CNOOC (CEO, news, msgs) will own Unocal (UCL, news, msgs).
As I expected, my e-mail was filled with abuse. I was called naive, wrongheaded, weak-minded, foolish, a pinko, a commie and a traitor to the United States. "You are forgetting," one reader scolded, "China is still ruled by a communist government. Much of the money for this deal comes from the government and communist doctrine still calls for world domination."
Can I suggest that everyone take a deep breath or two? Stop hyperventilating. Pop a Valium or meditate. Whatever it takes.
Not the juggernaut we think it is
China is not as big an economic threat to the United States as some of you seem to think. In fact, I think China is looking at a horrific double-barreled economic crisis over the next 30 years. The real danger to the United States is that the Chinese won't figure out how to solve this crisis and will resort to domestic and international violence, the last resort of all failing regimes. (Or that we'll fail to solve our own economic and demographic crisis over that same period.)
China's still-developing economy is far more inefficient than the juggernaut of our nightmares. And those inefficiencies will, over time, take a bite out of Chinese economic growth.
That may already be happening. The Chinese government recently lowered its forecast for 2005 economic growth to 8%. That's a rate most countries in the world envy, but for China it's a slowdown from the 9.5% growth in the first quarter of 2005 and from 9.4% for all of 2004. And some analysts are projecting that growth could slow to 6% or 7% in 2006.
The problem seems to be a developing profit squeeze -- ironic, no? -- now hitting Chinese companies. The costs of raw materials such as oil and iron ore are up, but Chinese companies can't raise prices. Remember how mega-retailers such as Wal-Mart Stores (WMT, news, msgs) used the threat of buying from low-cost Chinese manufacturers to wring almost every last penny of profit out of suppliers based in the U.S. and Europe? Well, now Chinese suppliers are getting a dose of the same medicine, and it hurts. And even in China, companies hire fewer people, expand more slowly and build fewer new plants when the books show red ink.
The Chinese profit squeeze
The profit squeeze is widespread. It's hit the petrochemical sector, where Jinzhou Petrochemical on July 13 forecast a loss of $70 million for the first half of 2005. That's 10 times higher than the loss the company predicted for the same period back in April. Profits in China's auto industry are projected to decline by 50% in the first half of 2005, and profits actually have already declined 60% in the first four months of 2005, according to the Chinese Ministry of Commerce. TCL, one of the country's largest companies, will lose enough money in its mobile-phone business to throw the whole company into the red for the year.
Related China news and commentary on MSN Money
Press releases from individual Chinese companies and Chinese government ministries reel off a list of reasons for the profit squeeze. The standard causes are sluggish sales growth, fierce price competition and rising prices for raw materials.
Not surprisingly, though, no one in Beijing ever adds to the list the inefficiencies of a Chinese economy that's still relatively primitive and shockingly bad at allocating capital. The result is massive over-investment in sectors already bloated with excess capacity.
Take a look at the steel industry. Steel production in China grew by 23% in 2004 to 273 million tons. It is on trend to grow by another 50 million tons, or about 20%, in 2005, and it is projected to increase by yet another 50 million tons, or about 15%, in 2006.
Considering that major steel-consuming companies are growing at much lower rates -- auto-industry production grew by just 1.5% in the first four months of 2005, for example -- is it any wonder that steel prices are falling?
And yet, it's still remarkably easy to raise massive amounts of money in China to build a new steel plant. On July 12, Wuyang Steel announced a plan to invest $700 million to build an iron ore and steel-plate plant in central China.
Politics drives capital allocation
Why? Because capital in China is still largely allocated by politics. You can raise money to build a steel mill if national politicos, who want to develop the slowly growing inland provinces, put the muscle on national banks to make the loan. (And, of course, you get the loan if you've dressed up your board with the sons and daughters of high-ranking party officials who can put the muscle on just about everyone.)
Any investor in the United States watching the judge hand down a 25-year prison sentence to former WorldCom CEO Bernie Ebbers knows our own capital markets don't do a perfect job of allocating capital. But our markets are still much more efficient than the Chinese system.
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