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Jubak's Journal
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| | Jubak's Journal
3 big threats to Chinas economic miracle
China won't remain an export superpower forever. Food and energy shortages and the growing influence of multinationals like Wal-Mart could change everything.
By Jim Jubak
To many people in the United States, the China story goes like this: A huge emerging industrial power eats U.S. jobs and buries the U.S. economy under a mountain of cheap imports while erecting barriers to U.S. goods. The only suspense in that story is whether America will fight back or simply roll over.
That storys easy to grasp, and theres enough real pain in the U.S. economy these days over lost jobs to China to give it emotional clout.
Unfortunately, its wrong.
It's much more complicated
That story is too narrowly focused on the relationship between the United States and China. In fact, China (with a big assist from other big-population developing economies such as India and Vietnam) is a leading player in a global economic makeover that presents much of the rest of the world with challenges that dwarf any U.S. problems.
And the ending of the story is nowhere near as cut-and-dried as it sometimes seems from the United States. Its much too early to assume we know how it will turn out, who the main characters will be and even when the climax will take place.
Another version of the story
Let me give you another global version of this story, at least as we know it so far. It gives full weight to the twists and turns, surprise dead ends and sudden plot reversals that make the China story equal to anything that Charles Dickens wrote.
Ill start my China story with Korea. In the United States, were obsessed with our trade deficits with China, and rightly so. In 2003, we ran a huge trade deficit of $542 billion (or almost 5% of GDP) with the world: China alone accounted for $124 billion of that total.
But China runs a huge trade deficit with the rest of the world. In 2003, China imported $23 billion more from Korea than it exported.
For years, the huge U.S. economy has been Koreas biggest export market. American consumers gobbled up cars from Hyundai Motor (HYMLF, news, msgs), air conditioners from LG Electronics and wireless phones from Samsung Electronics (SSNLF, news, msgs).
But no more. In 2003, Korean exports to China surged 48% to $35 billion, and China became Koreas No. 1 customer, absorbing 18.1% of all Korean exports.
The situation is much the same throughout Asia. China ran a $7 billion trade deficit with the countries of the Association of Southeast Asian Nations (ASEAN -- Vietnam, Thailand, Malaysia, Indonesia, the Philippines and Singapore among others). Japan has been a major exception, but even Japan ran a trade surplus with China in February, the first monthly trade surplus for Japan with China in 10 years.
Whats causing these huge deficits? The existing economic order in Asia has China importing a lot of the expensive high-technology parts that its cheap labor then turns into finished products. Add in the growing Chinese demand for high-technology consumer products and, wham! Trade deficits with Korea, Singapore and Malaysia explode.
Will Korea and others face the same problems we face?
But this story looks like its about to take its first big narrative twist. You see, Korea remains an export-driven economy. Koreas economy grew 3.1% in 2003. Exports generated 98.2% of that economic growth..
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That would be swell, except that its already clear that China has no intention of remaining the backward neighbor that trades low-tech goods for Koreas high-tech exports. By 2010, China could be on a par with Korea in wireless handsets, computer and TV displays, petrochemicals, and refrigeration systems, the Korea Development Institute estimates. By 2011, Korea could be facing a trade deficit with its bigger neighbor.
From there, the story could be a replay of the U.S.-China subplot with China becoming an export engine that swamps the economies of its neighbors with cheap but increasingly high-technology goods.
But will it? If you read the global story carefully, youll find potential plot twists that put this ending in doubt.
Let me provide you three.
China faces a potential two-part agricultural crisis. As incomes rise in China, demand for chicken, beef, wheat, vegetable oil, and corn increases. At the same time, however, the amount of arable land in China has been falling, thanks to factors ranging from an encroaching desert in the west and north, to runaway industrial and residential development that has gobbled up some of the countrys best farmland. This is no small problem in a country that must feed 20% of the worlds population on 7% of the worlds farmland.
The Chinese government has long had a goal of self-sufficiency in food production. Today, China imports only about 3% of its agricultural needs, about the same as in 1994, according to UBS Ltd. But despite efforts to promote domestic production, to limit new development on farmable land and even to reduce the acreage being planted in trees to hold back the desert, the acreage devoted to crops is falling.
Only by drawing down the countrys massive food stockpiles has China been able to limit imports. That policy is probably good for another year or so, experts say, but, after that, China may need to import more agricultural products -- probably at higher prices. (Global wheat prices are up 20% in the last year.) Efforts to prop up domestic production are likely to divert some internal investment away from the industrial sector.Plot twist: The countrys need to import food puts increasing strain on the Chinese economy and will shift global trading power toward the worlds biggest food exporters. Some of these happen to be the biggest markets for Chinese exports as well. China runs a huge energy deficit that will only get larger. Ten years ago, China was a net exporter of crude oil. In 2004, China overtook Japan to become the worlds second-largest importer of oil, behind only the United States.
That has set China racing to lock up reliable sources of oil before the rest of an oil-hungry world does. Earlier this year, Sinopec, the Chinese chemical and oil refining conglomerate, was awarded a gas-exploration license in Saudi Arabias Rub al-Khali basin. China National Petroleum and Sinopec signed production deals in the Sudan when Western investors pulled out. The companies are moving ahead with plans to build a new refinery even as the countrys civil war rages. In January, China signed a 30-year deal to buy crude oil from the west African nation of Gabon. And China inked a $21 billion deal to buy liquefied natural gas from Australia.
But securing oil supplies is only part of the solution. China is also suffering from a huge domestic shortage of electric power. Last summer, rolling blackouts shut factories in 21 of the countrys 31 provinces. Chinas shortage of generating capacity hit 44,850 megawatts in 2003, up 120% from 20,350 megawatts in 2002, the Development Research Center of China reported. As youd expect, Chinese investment in the power-generating sector climbed by almost 20% in 2003 and then speeded up to a 60% rate of increase (year-over-year) in early 2004. Investments in the sector accounted for 20% of Chinas total industrial investments in early 2004.Plot twist: Chinas need to invest in its energy sector limits the countrys economic growth at the same time as the countrys aggressive hunt for oil damages relations with its oil-hungry trading partners. Real economic power in China increasingly is in the hands of multinational corporations. Just like any other nation-state in the 21st century.
China probably has a better chance of winning a battle or two against Wal-Mart Stores (WMT, news, msgs) than a Vermont village does in trying to keep the discount chain out. Chinas odds of winning the war, however, arent good.
In February, the China Daily trumpeted a story headlined Domestic Retailers Keep Stranglehold that proudly noted that the Shanghai Bailian Group topped the rankings of the countrys biggest retailers in 2003. Plus, Chinese companies claimed the top four spots.
But the trend certainly isnt running in favor of the Chinese companies. Six overseas retailers, including Wal-Mart and Europes Carrefour (CRERF, news, msgs) and Metro (DE:725750, news, msgs) also cracked the list in 2003. That was first time foreign retailers made the top 30. Moreover, the foreign retailers accounted for 18% of the sales of the top 30 retailers.
And this is before the Chinese lift restrictions on capital structure and location, changes mandated by the countrys entry into the World Trade Organization.
This isnt the most telling sign of the way the battle between the traditional nation-state and the multinational corporation is going in China. Last year, Wal-Mart bought an estimated $15 billion in goods from China. Thats more than the $14 billion the 10 member-nations of the ASEAN imported from China in 2003. Projections say that Wal-Marts sourcing from China will hit $25 billion within three years.
With that volume comes power over the Chinese economy that mere countries such as Thailand or Korea cant hope to wield. Wal-Mart has been known to demand that its suppliers change their bookkeeping systems and improve their logistics to meet tight delivery schedules. In exchange for Wal-Mart contracts, Chinese companies have been required to open up their books to Wal-Mart and cut prices if Wal-Mart decides the suppliers profit margins are too fat. The Wal-Mart system is enforced by 200 Wal-Mart staffers from procurement centers in Shenzhen and Shanghai. Not only do they monitor suppliers, they also stay on the lookout for replacement suppliers that can do the work for less.
Other global retailers are moving to gain the same kind of control over their Chinese suppliers. Carrefour and Target (TGT, news, msgs) have recently opened their own procurement centers in Shanghai and Shenzhen, respectively.Plot twist: Like other nation-states have discovered, economic sovereignty in the 21st century aint what it used to be. The battle over who has the power -- the countries that produce the goods or the companies that control access to customers -- is just beginning. And as these three examples suggest, we still have chapters and chapters to read before we know how the China story will come out.
In my next column, the last in this three-part series, Ill take a far less global look at how the China story is likely to change life as we live it in these United States.
Changes to Jubak's Picks
Sell The Washington Post Co.
As I noted in my last update, The Washington Post Co. (WPO, news, msgs) was firing on all cylinders last quarter. But when I cranked the numbers, that performance looked pretty much priced into the stock, so I wasnt able to raise my target price for the shares. That leaves me waiting for a 6% gain at a time when the stock market as a whole looks increasingly prone to weakness. The odds are that this weakness will extend into June, and, frankly, Id like to have more cash in Jubaks Picks to pick up any bargains that might present themselves. So Im selling The Washington Post Co. out of Jubaks Picks with a gain of 21% since I added the shares to this portfolio on Dec. 19, 2003. (Full disclosure: Ill be selling my shares of The Washington Post Co. three days after this column is posted.)
Sell Noranda
This sell is part of a switch, completed by the buy of Inco (N, news, msgs) below, thats designed to reduce my copper exposure in Jubaks Picks and add a position in nickel. With Southern Peru Copper (PCU, news, msgs) in the portfolio, Ive got a position in one of the worlds low-cost copper producers and one that is expanding production to boot. So Im going to take my profit in Noranda (NRD, news, msgs) -- Im up 25% since I added the stock to Jubaks Picks on Nov. 7, 2003 -- and put the money to work in shares of Inco. (Full disclosure: I will be selling my shares of Noranda three days after this column is posted.)
Buy Inco
Now that the Wall Street Journal is running stories on the end of the commodities boom, I think its time to rebuy Inco (N, news, msgs) for Jubaks Picks. As the Journal pointed out on May 6, the price of nickel has tumbled to $11,200 a ton from $17,000 a ton at the beginning of 2004. That to me is a sign that the speculative excess has largely been wiped out of the nickel market and fundamentals are free to take over again. And the fundamentals for nickel are very good: Despite production increases from Inco and Russias Norilsk Nickel, nickel supply will run about 37 to 40 kilotons short of demand in 2004, according to estimates from UBS and Goldman Sachs. In 2005, the global supply deficit is likely to be about 19 kilotons, according to UBS. With China making up about 10% of global nickel demand, a drop of one percentage point in the growth rate of the Chinese economy would represent just about 10% of the global supply deficit. UBS calculates that the potential upside to nickel prices from the current spot price is about 38%. Last time I did this trade, I recorded a 38% gain from Sept. 23, 2003, to Dec. 23, 2003. This time, Im looking for a 20% gain by September 2004. As of May 7, Im setting a target price of $36 a share by September 2004. (Full disclosure, I will buy shares of Inco three days after this column is posted.)
New developments on past columns
Im insuring my portfolio with land
The St. Joe Co. (JOE, news, msgs) turned in another solid quarter, reporting earnings per share of 17 cents, a penny ahead of the Wall Street consensus, on April 20, and increasing guidance for full year 2004 earnings from an increase of 10% to 15% to an increase of 15% and maybe more. But to me the April 19 announcement that Simon Property Group had purchased 90 acres in Panama City Beach, Fla., for a 1-million-square-foot retail and entertainment center overshadowed the quarterly earnings report. With the Simon Property news following quickly on a similar announcement from Home Depot (HD, news, msgs) at the end of 2003, The St. Joe Co. has succeeded in creating a commercial hub on its land in the area that will increase the value of surrounding land that the company owns. As of May 7, Im raising my price target to $48 a share by September from the current $45 by June. (Full disclosure: I own shares of The St. Joe Co.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Noranda, Southern Peru Copper, The St. Joe Co., The Washington Post Co. He does not own short positions in any stock mentioned in this column.
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