China bubble

The southwest monsoon has hit Kerala, and other parts of the country are awaiting rains to get some relief from the blistering heat. While the monsoon brings relief to most, it means trouble for some sectors, particularly cement and steel. With construction activity slowing down due to the rains, demand for cement and steel falls, resulting in lower prices.

This of course is a regular phenomenon and the industry recognises it. Steel secretary Atul Chaturvedi told DNA Money on Monday, “The onset of the monsoon will also impact the prices as construction activity slows down during this period.”

What has helped both these industries is the construction boom in China. The country currently has around 5 lakh bridges in comparison with 6 lakh in the United States, which is astonishing given that the United States has 5 times more rivers than China. In the last five years, China has built 15,000 bridges every year, on an average. Over and above this, there is a huge real estate boom in China, which is consuming tonnes of cement and steel. This has helped keep global prices of cement and steel firm.

Let us look at some numbers to get an idea of the hugeness of what the Chinese are up to. As a recent report tilted China’s Investment Boom: The Great Leap Into the Unknown brought out by Pivot Capital Management points out, “China currently produces 500 m tonnes of steel, more than EU, Japan, US and Russia combined...China has capacity to produce 660 m tonnes per year, meaning that idle capacity in China is about the size of capacity for Japan and South Korea combined...Cement provides an even more vivid illustration of the scale that Chinese manufacturing has already reached. At 1.35 billion tonnes, China consumes more cement than the rest of the world combined. China’s estimated spare capacity (about 340 m tonnes) is more than the consumption in India, USA and Japan combined.”

This capacity has been built up to fuel the infrastructure boom in China, which in turn has been helped by the easy money policy by the People’s Bank of China, the Chinese central bank. New bank lending in 2009 went up by 10 trillion renminbi or around 29% of GDP. This was the biggest stimulus provided anywhere in the world. And China was not in trouble like large parts of the Western world have been.

As Edward Chancellor, one the world’s foremost bubble watchers, wrote in a recent white paper, “These loans largely went to fund infrastructure projects, property developments… It was as if the economy had received an enormous adrenaline shot.”

Estimates suggest this government-directed investment was responsible for nearly 70% of China’s growth in 2008 and almost 90% growth in the first half of 2009. “Many projects, however, were clearly intended to meet the government’s GDP growth target. A news clip on YouTube (originally from Al-Jazeera) shows the newly constructed “ghost town” of Ordos, in Inner Mongolia. An interviewee suggested that building this empty city, with housing for a million, had enabled local officials to meet their growth targets,” writes Chancellor.

Since the beginning of this year, the Chinese government has directed banks to go slow on lending, on the concerns of there being a huge property bubble. But the price rise has continued unabated. In the month of April, property prices in China shot up by around 12.8% on an average.

The market clearly is getting worried. A Bloomberg report said, “Amid concern the nation’s property market is overheating...investors are demanding greater yields to lend to China property firms, a sign they expect borrowers will have a harder time meeting debt payments amid a government clampdown down on lending. Goldman Sachs Group Inc. and Credit Suisse Group AG cut their profit estimates for Chinese real estate companies after a 12.8% jump in real estate prices in April from a year earlier.”

It is very difficult saying when a bubble will pop. As John Maynard Keynes once famously said, “The markets can remain irrational longer than you can remain solvent.” But the available evidence seems to suggest that the Chinese property bubble cannot go on for long. And as when it pops, Chinese manufacturers will start dumping all the steel and the cement that they produce, on other parts of the world. As and when then happens, steel and cement prices will crash.

At that point of time, you wouldn’t want to be holding these stocks, anywhere in the world, India included.