The Chinese commenting Treasury Secretary Janet Yellen’s improved chopstick skills during her recent visit has taken damning with faint praise to a new level.
To let the cat out of the bag at the top and annoy those predisposed to be annoyed early on: yes, Yellen made a fool of herself and the US by going to China, making demands, not appearing to have anything to horsetrade, and acting as if China should concede because we are entitled white customers. But that does not mean that a case could not have been made regarding one of her pet points, that of Chinese overproduction. The fact that Yellen made no attempt whatsoever to substantiate her position only further undermined weak US credibility, not just in China but among third parties. Even worse, by trying to act as if the China should constrain itself simply the US says so has likely poisoned rational discussion of this issue.
Instead, due to Yellen’s messaging not even rising to the level of “lame,” a lot of commentators are picking up the Chinese argument, that China has invested and innovated, and why should it be punished?
It’s a bit ironic that many of the same people who take this view have also touted Keynes’ bancor as a potential solution to the problem of “How does the world move away from the dollar as reserve currency?” Keynes recognized that countries that ran persistent trade surpluses were financially and geopolitically destabilizing. The ideal state was for countries to run balanced trade, so bancor arrangements required surplus countries to appreciate their currencies and deficit countries to weaken them to achieve parity. Keynes’ bancor envisioned punishments for members that would not curtail their trade surpluses. From Wikipedia:
For chronic creditors, it would include currency appreciation and payment of a minimum of 5 percent interest on excess credits, rising to 10 percent on larger excess credits, to the ICB’s Reserve Fund. Keynes never believed that creditors would actually pay what in effect were fines; rather, he believed they would take the necessary actions … to avoid them.
Now the US can hardly argue from Keynes’ principles now, having been content to run big deficits with China for a very long time. And that’s before getting to another issue which no doubt sticks with China, that we outsourced pollution to them via our manufacturers and/or their suppliers.
Further recall that aside from multinational greed, a motivation for letting China into the WTO even though it did not meet the requirements was the bizarre US belief that they would become more like us (particularly more “democratic”) by virtue of trading with us. So any negotiating position with China is complicated by the fact that we created this mess and were officially happy with it until recently, because it benefitted the right people.
To turn to Yellen’s inept case-making, there really is such a thing as overinvestment. The US has had bouts of it. And critically, if you look at their denouements, investors, lenders, suppliers to and employees of the afflicted industry look like winners until they become losers, In China, if you read our posts, derived from the work on Jonathan Sine, on China’s financailization and its local government financing vehicles, the lenders in the end are overwhelmingly banks and households. And as we explained in comments, based on the analysis of Michael Pettis, the way China dealt with its last big bank crisis (early 2000s) was to dump the costs on households, via markedly negative real returns on savings products. That made them keen to buy what they saw as better stores of value, meaning housing. Therein lies the original sin behind China’s housing bubble.
One example was during the railroad boom of the mid-later 1800s. Lines would often be built along similar city routes. Since railroads has very high capital costs and pretty high fixed costs but low marginal costs, the response to too much capacity was price-cutting, aka “ruinous competition”, which led to many bankruptcies. Yet railroads continued to be built despite that….because new railroads were a hugely popular stock market play, so the builders/promoters could cash out early on, leaving shareholders and lenders holding the bag.
Another was the dot-com era, when young things were able to raise $5 million with a ten page business plan. The result was companies like Pets.com and Boo.com, which went bust. The loss of paper wealth in the dot.bomb collapse was so great that despite the stock market not being seriously leveraged, Greenspan lowered rates into negative real interest rate territory and kept them there for a full nine quarters, unlike the typical Fed practice in recessions of dropping them that far only for a quarter. The seeds of ZIRP were planted then.
Looking abroad, Japan famously build roads and bridges to nowhere in the early 1990s, to try to reflate its economy and preserve employment in its politically-connected construction industry.
To return to Yellen’s China visit, the fact that she could have made a case is proven by the fact that both Telegraph columnist Ambrose Evans-Pritchard and Brad Setser have done so. Yellen has access to all sorts of academic economists, at Treasury, the Fed, friendly think tanks like Brookings, and even McKinsey’s Global Institute. She could easily have gotten relevant data worked up and encouraged some allies to have written op-eds. Even if this would not have cut any ice with China, it would have made the US effort appear more thoughtful and legitimate to third parties. And keep in mind that even though the US is an extreme case, there are plenty of countries, and not just in the EU, that are also overeating Chinese imports.
Since Evans-Pritchard’s article was back in January, I hope he will not take offense at hoisting heavily from it now. From his article China is stealing growth by dumping its vast excess on the world. And note its subhead: “Vast overinvestment is self-destructive – and intolerable for the global economy.”
One cardinal fact governs the world economy today. China produces 31pc of global manufactured goods: it accounts for 13pc of total consumption.
The rest of us must absorb China’s increasing excess capacity. If the country is to meet the Communist Party’s growth target of 5pc over the next decade with the current hyper-investment model, it can do so only by eating further into the industrial core of Europe, America, and India…
Xi Jinping is not reforming the old model. He is reverting to galactic overinvestment in everything from clean-tech, semiconductors, and steel – all tradeable goods that find their way onto global markets – in order to offset the deflating property bubble and to prevent youth unemployment rising further above the political danger threshold of 20pc.
This is intolerable for the world. It is ultimately even more destructive for China itself.
Note that some experts have said the decline in Chinese house prices is worse than it appears, due to the weak level of sales plus some transactions being excluded from the official figures.
Evans-Prichard was alarmed that China, rather than trying to boost consumption at home, is firing up even more manufacturing investment to offset the housing slump and need to dial back investment there. He continues:
Prof [Michael] Pettis says investment is already 42-44pc of GDP. No major country in modern economic history has come close to these levels before. Other Asian tigers peaked in the low-30s before dropping back as they matured.
By the end of next year, China will have built enough solar and battery capacity to quadruple the entire global demand for these products in 2022.
It already has enough EV plant to meet global demand three times over. This surplus supply is hitting foreign markets with tidal wave force and at cut-throat prices. Car exports rose 84pc from January to November.
A story today in the Financial Times corroborates Evans-Pritchard’s claims about EVs. China is making and shipping them to Europe even with dealers having no place to put them. From European ports turned into ‘car parks’ as vehicle imports pile up:
Imported vehicles are piling up at European ports, turning them into “car parks” as automakers and distributors struggle with a slowdown in sales and logistical bottlenecks including the lack of truck drivers.
Port and car industry executives have pointed to a pile-up of Chinese electric cars as one of the leading causes of the problem, with some companies booking shipping delivery slots without ordering onward transportation. In other instances, carmakers in general are struggling to order trucks because of the lack of drivers and equipment to move the vehicles on.
“Car distributors are increasingly using the port’s car parks as a depot. Instead of stocking the cars at the dealers, they are collected at the car terminal,” said the Port of Antwerp-Bruges, whose port at Zeebrugge is Europe’s busiest port for car imports. “All major car ports” were struggling with congestion, the port added, without specifying the origin of the vehicles.
Some car industry executives said Chinese carmakers were not selling their vehicles in Europe as fast as they expected, which was a major contributor to the glut at the region’s ports.
“Chinese EV makers are using ports like car parks,” said one car supply chain manager.
Some Chinese brand EVs had been sitting in European ports for up to 18 months, while some ports had asked importers to provide proof of onward transport, according to industry executives. One car logistics expert said many of the unloaded vehicles were simply staying in the ports until they were sold to distributors or end users.
And from the pink paper a week ago, Global glut turns solar panels into garden fencing option:
Solar panels have become so cheap that they are being used to build garden fences in the Netherlands and Germany, as a boom in Chinese production saturates the global market.
The panels capture less sunlight when used as fencing than they do on roofs…
“Why put up a fence when you can just put up a load of solar panels, even if they’re not aligned exactly to the sun?” says Martin Brough, head of climate research at BNP Paribas Exane. “Where the panels themselves are just incredibly cheap, the constraints become the installation costs and the sites . . . you get a bit of a DIY mentality.”…..
Longi Green Energy Technology, one of the world’s biggest panel producers, said recently it had fired thousands of factory workers as the oversupply has sent Chinese manufacturers into retreat….
Alessandro Barin, chief executive of Italy’s FuturaSun, which makes panels in China to sell in Europe, said crates of panels had been sitting unsold in ports and warehouses even after a factory shutdown, when it extended the closure for the lunar new year holiday to three weeks from a normal one-week break.
And remember, the Chinese plan is to increase manufacturing investment and output even higher than its current level.
Back to Evans-Pritchard:
China’s current account surplus is officially 2.2pc of GDP. Brad Setser from the Council on Foreign Relations says the real surplus is twice as high once you drill into the customs data.
Furthermore, China’s foreign exchange reserves exceed the declared $3 trillion. They are closer to $6 trillion. Large sums are being placed abroad through state banks. This suppresses the yuan and gives China an extra edge in global trade….
China’s exports over recent months have been weak in dollar terms but strong in volume terms. Firms are escaping the slump at home by slashing prices to gain global share. Or put another way, the country is exporting its deflation on a grand scale.
The European Central Bank says Chinese export prices have fallen 6pc over the last year in yuan, 12pc in dollars, and 18pc in euros….
China is now in a toxic feedback loop of its own making. The latest PMI surveys show that Chinese firms are cutting prices further as new orders fall….
China risks slipping into a debt-deflation trap where interest costs rise faster than output in money terms, pushing up the debt ratio mechanically via the denominator effect. Chinese local governments already face $850bn of annual debt service costs….
If China sticks to the current strategy there will be two consequences: the arithmetic of excess investment will push China’s debt ratio from 300pc of GDP to 450-500pc within a decade, precipitating a crisis; before that happens there will be a global trade war, also precipitating a crisis.
Evans-Pritchard points out these dynamics are uncomfortably like those leading into the Great Depression, when the US was “the great surplus disruptor.” And that crisis hit creditor countries harder than debtors.
Brad Sester, in a recent tweetstorm, focused more narrowly on the argument about overcapacity, stressing that one needs to look at the question in terms of particular industries:
There is now a bit of pushback against concerns about Chinese overcapacity. That is in part because the notion of overcapacity is itself poorly defined (capacity v domestic demand, v global demand or v the demand needed for decarbonization)
But there is a real issue imo
1/x
— Brad Setser (@Brad_Setser) April 6, 2024
and some look at China’s 5m in vehicle exports (mostly passenger cars these days) relative to 25m in domestic sales and say exports aren’t that large a share of Chinese vehicle production.
6/ pic.twitter.com/lqt0GaZIqx
— Brad Setser (@Brad_Setser) April 6, 2024
And it isn’t hard to show that China was buying 25m ICE cars a few year back, and likely had the capacity to produce more than 25m. Current sales are 15m — there is clearly a large latent export capacity there
8/ pic.twitter.com/OTzrltaBdi
— Brad Setser (@Brad_Setser) April 6, 2024
China’s EV export capacity (in a world where exports command a premium v domestic sales and thus firms can switch to exports) is still excessive relative to the domestic political consensus around decarbonization in the US/EU
10/
— Brad Setser (@Brad_Setser) April 6, 2024
That’s likely oversupply v global demand — and clearly an oversupply relative to the political reality that both the US and EU are determined to build out their own battery industries (using the tools China used)
12/
— Brad Setser (@Brad_Setser) April 6, 2024
And in solar, where global supply is already more or less Chinese supply (especially for wafers), Chinese capacity exceeds optimistic estimates of demand — and will thus force Chinese suppliers themselves out of the market
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— Brad Setser (@Brad_Setser) April 6, 2024
Again, to return to the key point: even though Yellen didn’t bother making a case, Chinese output in EVs, solar panels and batteries are already bumping up against market demand….yet China seems determined to double down and invest even more in capacity.
And the key point is that even though trade partners suffer first from the influx of underpriced (as in not “cheap” but priced to secure demand and survive in an oversupplied market), in the end the behemoth export nation takes the bigger hit in the end via the scale of forced cuts in production, resulting in write offs, job losses, bankruptcies and hits to banks and other lenders.
So this indeed is a looming problem, even though Yellen’s whinging would persuade you otherwise.
