China Looking Vulnerable

Ambrose Bierce, in The Devil’s Dictionary, defined an alliance as:

In international politics, when two thieves have their hands plunged so deeply into each other’s pocket that they cannot separately plunder a third party.

The corollary is that when your ally stumbles, you fall down too. China is learning that lesson the hard way. By pursuing a relentless mercantilist strategy, and becoming dependent on the US as a customer, it is sure to show lower growth as the US economy pulls back.

While a decline to a growth rate of 8% no doubt sounds plenty robust to Americans, that magnitude of reduction would create pressures within China, which has used rising prosperity to paper over domestic fissures. And while we have no insight into China, somehow that 8% figure, which is presented in an article below, seems a tad optimistic.

Two sightings from reader Michael, first on the general conundrum facing China, and a more specific one that suggests that growth is faltering. First, from the International Herald Tribune:

After living beyond its means for many years, America will have to rebuild its savings, so consumption will fall. Exports to the United States from China, Taiwan, Hong Kong and now South Korea are already weakening.

“I think this is a wake-up call for China,” said Stephen Roach, the chairman of Morgan Stanley in Asia.

Roach says that he expects U.S. consumption growth to halve – to about 2 percent – as debt burdens are pared.

As economic weakness spreads to Europe and Japan, the impact on China’s exports could cut its growth rate from about 10 percent now – already down from 11.9 percent in 2007 – to about 8 percent.

“It just underscores the fact that when you have a vibrant but very large export sector, when you have an external shock and you don’t have a lot of dynamism on the internal demand side, you have greater risks to growth,” he said…

But stoking domestic demand also requires changes that sometime shake the foundations of an economy – like scrapping deterrents to foreign investment in Japan, ending protection for favored groups in Malaysia or subjecting dominant companies to more competition in the Philippines and Hong Kong.

These are politically arduous tasks at the best of times. That’s why economists wanted governments to get cracking on them while the going was good.

Countries instead largely shirked the challenge, content to rely on export-led growth by holding down their exchange rates. Quite apart from hindering the needed rebalancing of the global economy, an undervalued currency acts as a tax on domestic demand, Hong Liang and Yu Song, economists who follow China for Goldman Sachs in Hong Kong, said in a report.

The result is evident in the case of China, where household consumption last year came to just 35.3 percent of gross domestic product – an unprecedented low in peacetime for a major country.

This means that a lopsided economy has scant domestic demand to fall back on as the global downturn deepens. “The real costs of China’s resistance to yuan appreciation are now becoming more apparent,” Liang and Song wrote.

So what is to be done?

In the case of China, Beijing must provide affordable health care and education and beef up its flimsy pensions system so people need to save for a rainy day. But setting up the administrative structures to ensure extra money is well spent takes time.

“My worry is that there are a lot of things that China can do to boost domestic consumption, including on the fiscal side, but none of these things are going to happen very quickly,” said Michael Pettis, a finance professor at Peking University.

From Reuters, “China buyers default on India iron ore deals“:

Chinese buyers of Indian iron ore are defaulting on import contracts and refusing to lift the ore unless the seller offers a discount on contracted prices, a top industry official told Reuters on Monday.

“Our exports are in deep red as there is no demand from China,” said Rahul Baldota, president of the Federation of Indian Mineral Industries and managing director of miner MSPL Ltd.

Chinese appetite for Indian ore has fallen despite rival Brazilian miner Vale’s demand for higher prices for the ore it exports to China — a move that initially cheered Indian suppliers.

Nearly 75 percent of India’s annual iron ore exports of about 100 million tonnes go to China, and shipments normally rise after the annual rainy season ends in September.

“The Chinese are backing off old contracts. They are saying either you reduce the price or we can’t take the shipments,” Baldota said. “I, myself, have had to suffer two cancellations.”

He said importers were willing to buy high-grade 63.5 percent iron ore at about $75 a tonne, about 45 percent less than rates of around $140 in June.

Sesa Goa, Dempo and Salgaocar from India’s western region and Essel Mining and the Rungta group of mines from the eastern sector are among the members of the Federation of Indian Mineral Industries.

Exports in the first half of September dropped to 1.99 million tonnes from 2.7 million tonnes in the same period last year. Shipments in August were also lower at 4.57 million tonnes against 5.39 million a year earlier, according to FIMI.

“If the situation continues like this, we will export only around 50 million tonnes in the year ending March. The problem has become severe in the last one month, though it was evident for the last three months,” Baldota said.

The China Securities Journal reported on Friday that Chinese steel mills would not import iron ore from Brazil in the near term, after Vale asked for the price hike.

Export demand for even low-grade iron ore, 57 to 60 percent iron content, which are shipped mainly from the western Indian state of Goa, is also flat.

“Hardly any exporter is doing anything even though our shipments usually start picking up around this time,” said Glenn Kalvampara, secretary of the Goa Mineral Ore Exporters Association.

This begs the question of whether China has suddenly decided to become a shrewd bargainer or whether the importers are retrading the deal due to a slump (in that scenario, they hope to break some deals). The latter seems a lot more plausible.

Print Friendly, PDF & Email


  1. doc holiday

    Re: "Nearly 75 percent of India's annual iron ore exports of about 100 million tonnes go to China, and shipments normally rise after the annual rainy season ends in September."

    >> Perhaps a tad of this problem is oil related, in the form of inflationary transportation cost increases?

    See also: The Baltic Dry Index, which measures shipping rates on 40 routes across the world, sank 8.2%, or 287 points, to 3,217, on Tuesday, down from 3,504 on Monday – its seventh straight day of decline.

    Lazard Capital Markets analyst Urs Dur said China’s Golden Week holiday has been keeping charterers at bay. While conventional wisdom is that next week, once the holiday is over, activity will begin to pick up again, Dur said high iron-ore inventories in China and plummeting freight rates means it will take a while for the shipping market to right itself. “If you had asked me a month ago, I would have said a turnaround would have come at the end of September, before Golden Week,” he said.

  2. satan

    China’s banking system makes the american system looks angelic. No one confronted them for years because of the economic growth story..Now the chickens are coming to roost.

  3. EvilHenryPaulson

    Wow, the one fact standing out for me is a decline from 100mn tonnes to 50mn tonnes of iron ore exported from India

    Looks like those steel and mining mergers are going to have been fairly expensive

  4. dh

    Recession Threat Hits Oil Prices

    Energy consumption overseas is also expected to drop, even in fast-growing developing countries such as India and China, where booming demand for cars and other goods helped drive the oil bubble earlier this year.
    "With demand falling at the pace it is, nothing can support crude at levels above $100," said James Cordier, president of Tampa, Fla.-based trading firms Liberty Trading Group and "There's no underlying demand from any pocket."

  5. dh2

    efferies analyst Douglas Mavrinac said, because of a Chinese boycott of Brazilian iron ore.
    Last week, an association representing the largest Chinese iron ore suppliers formalized a boycott against a major Brazilian supplier, as that company announced plans to hike prices to Asian customers by about 11 percent.
    Mavrinac said he expects iron ore deliveries from Brazil to China will remain “limited” in the near future, but will need to increase as China runs of its own supplies of the commodity, used to make steel.
    Until then, drybulk stocks and the heavily watched Baltic Dry Index will likely fall further, he said.
    But possibly by as early as November, Mavrinac said the boycott should be lifted and drybulk trade — which also includes shipments of grain, coal and cement — should pick up.

  6. Anonymous

    When are the analysts going to question Chinas $1 trillion bad/non-performing loan book. Guess it pales into comparison to Paulson taking a $700 billion baseball bat to a $55 trillion gun fight.

  7. RK

    The smartest line I have yet read about the emerging markets is that they are equivalent to an option on the
    “developed” (read consumption based) markets. Thus far, the price action of emerging markets seems to
    confirm this notion.

  8. Anonymous

    The China Iron & Steel Association estimated that iron ore imports in 2007 was about 375 million tons. That represented about 50% of the international markets and an astonishing 15% rise in imports over 2006. Chew on that a bit and you'll realize China will soon run into raw material constraints that make double digit growth unsustainable as long it's based on exporting goods.

    This also means the slump in Chinese iron ore demand is likely to be very temporary.

  9. "Cassandra"

    Nice to see you quoting from the Devil’s Dictionary! Mr Bierce is as wicked and fresh as ever nearly a century after it’s original publication.

Comments are closed.