The wasteland

The world of ‘alternative’ energy has been no stranger to embarrassment of late, whether it be leading windmill-maker Vestas’ 96% plunge to a 14-year low or the threat of bankruptcy stalking the cloudy, Northern Europe’s own welfare queens as the continent’s ill-conceived ‘Energiewende’ staggers onward, squeezed between the pressing fiscal need to abjure all such dirigiste fantasies and the growing backlash from both consumers and industrialists who are slowly awakening to the harsh reality that the aspirations inherent in their right-on, Green indoctrination cannot be squared with their anguish at needlessly soaring utility bills.

In the US, too, the red faces have been multiplying, with the Obama administration generating far more political heat than economical light for its complicity in several  hopeless boondoggles, perhaps best epitomised by the failure of erstwhile campaign donors, Solyndra, $535 billion federal loan guarantee and all.

But, of course, when it comes to ‘blind investment’ larded with goodly helpings of political – and often pecuniary – advantage-seeking, nothing ever quite trumps what the Chinese get up to.

Thus it was that, last week, the National Energy Administration announced that, henceforth, it would ‘tighten approval’ for solar projects so as to ensure that they were actually hooked up to a grid, or at least one of sufficient capacity to deal with their potential output! The trigger for this blindingly obvious diktat seems to have been that the agency feared that an arms race of cadre self-promotion might result if the decision by Qinghai province to install a 1 GW solar ‘farm’ were to give rise to a wave of indiscriminate keeping-up-with-the-Jiangses on the part of the other regional heads.

Nor does the competition for the wooden spoon end there, as the case of LDK Solar – the nation’s second largest producer – exemplifies. With debts of CNY30 billion stacked up against a collection of assets with a stated value of CNY33 billion, this was not a firm which was well placed to survive a 65% YOY slump in revenues, nor a disastrous six months during which $620 million in sales generated $740 million in losses. Little wonder it finds itself in such a parlous condition when the company has suffered a cumulative negative free cash flow of $3.6 billion (~CNY23 billion) over a four year stretch when the market price of polysilicon has slumped 95% from $475/kg to barely more than $20.

Controversy mounted over this private company’s failure when one of its creditors – a member of one of China’s burgeoning shadow army of Trust Co.s – managed to cajole the local Xinyu municipality into including the CNY500 million it had extended to LDK into the region’s annual budget and so secure repayment. Given the widespread, if often unfocused, fears about the role of such Trusts in what appears to be a massive, CNY39 trillion layering of credit on top of the nation’s CNY113 trillion mountain of on-balance sheet, bank assets (equivalent to 75% and 215% of GDP, respectively) – not to mention the tangled webs of mutual credit guarantees prevalent among such lenders and creditors – one can perhaps understand the municipality’s pliability in keeping this particular can of worms firmly sealed.

Since then, there have been further rumours (officially denied) that the Shanghai Pudong Development Bank was on the hook for CNY1.5 billion in unsecured loans to the firm. Whatever the case may be, what has been reported in the official media is that several SOEs have been ‘invited’ to sniff over the corpse of LDK, while “creditor banks including China Development Bank, Bank of China, and China Construction Bank have established a ‘special committee’, working with local government, to oversee LDK’s capital flows.”

But why focus on LDK? For hardly a day now goes by without some other tale of misplaced investment, financial chicanery, or growing commercial distress filling the pages of the local business press.

In real estate, for example, Beijing is said to have become sufficiently alarmed at what the creaking state of developers’ finances could mean for bank balance sheets that they have formed a ‘task force’ to investigate the true extent of exposure. Another story is of the deceits practised by credit-hungry developers, whether ‘paying’ suppliers in apartments, not cash; lending otherwise unqualified buyers the deposit they need to secure a mortgage; or raising false sale documentation with which to provide anxious lenders evidence of cash flow.

But, if the central government is sticking to its story about keeping residential real estate in check, it appears that no such qualms exist when it comes to the commercial kind. Take the city of Chengdu where more than 90 such complexes are under development and where there are plans to construct a brand-new financial centre, consisting of 30 skyscrapers, each of 60 stories or more. Nationwide, 2011 saw a 26% increase in floor space, the increment of 11.6 million square metres being greater than four years’ worth of US development at current rates of construction.

Already, signs of duplication are in evidence as the word ‘bubble’ is bandied about by domestic investors. So mad has the rush become that prestige Western retailers are said to be able to take up space on terms which saddle the property company with all the costs in the event that the site does not prove viable. Let us just hope the owners are not relying too heavily on business generated by local firms instead, given that the nation’s No.1 home appliances retailer, Suning, just warned of a possible 30% fall in profits, while industry No.2, Gome, saw its shares hit their lowest ever level when it indicated it was actually trading at a loss.

No word how much of this new retail space will be located at the airport, but with plans announced to build 82 new ones and to upgrade 101 more by the end of the current Five Year Plan in 2015 – putting the joys of baggage checks and the scramble for overhead locker space no further than 100kms away from 80% of the population by the time the programme has been fulfilled – we can be forgiven for expressing doubts. Whether any return on capital will be made is the crucial issue since more than two-thirds of the existing 182 facilities are losing money at present, while UPS has just slashed Asian flights by 10%, declaring that business there had ‘fallen off a cliff’.

No matter, says CAAC chief Li JiaXiang, the current woes are not the result of a surfeit, but a dearth of landing strips “It’s like planting trees,” he explained gnomically. “One tree will die, but if you plant more, it will become a forest, and the trees will grow higher and higher.”

It might be a novel slant on business economics, but it certainly encapsulates China’s whole approach to modernisation in one, fortune cookie-sized soundbite.

Where next shall we venture? The textile industry where Adidas has followed the lead of rival Nike by closing down production? Understandable enough when business leaders in the key province of Zhejiang are to be heard bemoaning the loss of business not just to lower-wage Asian competitors such as Vietnam and Cambodia, but also to Eastern European alternatives such as Romania.

What about metal-bashing? Well, despite the plunge in profitability in the steel business – HRC has fallen 15% in price in just three months to touch the lowest levels since the autumn of 2009, while rebar is a quarter cheaper than a year ago and no more expensive than it was in 2003 – naturally, no-one has thought to trim production which is still therefore running at close to a record 2 million tonnes a day, comprising 45% of the world’s total output. Note, too that the pain is being spread wider, given that net steel exports have climbed nearly 50% yoy of late to reach a 4-year high.

Across in the aluminium smelters – also responsible for 45% of planetary output – the mighty Chalco spent the first half of the year mired in red. In fact, Charles McLane, Alcoa’s CFO reckons that almost a third of such companies ran at a loss last year. So, production cuts, anyone? Not likely, that’s only something which need be contemplated by capitalist running dogs like Alcoa, Rio, or Rusal! No, instead output hit a new record of 1.7 Mt in June as, according to  Yao Xizhi, an analyst at state-backed research firm Antaike, around 500,000 tonnes of idled capacity came back online in May, while the first half as a whole saw a million tonnes added, with another million likely to come on stream in the second half. How can this be? Well, the clue is that several local governments were said to be offering artificially cheap electricity in order to keep the fires burning. Helps with the nation’s Himalayan-scale, 300 million tonne stockpile of coal, one supposes.

Not surprisingly, about the only business being done in the machinery industry is the classic Chinese one of buying something physical on long-term credit and then raising one (or more) cash loans using the ‘purchase’ as collateral. As a case in point, the finger of suspicion has been pointed at Zoomlion which managed QI profits of CNY2.1 billion – practically unchanged from QIV despite a fall in turnover of 11.5% which was ostensibly quite creditable given rival Lonking’s 37% sales plunge. Interestingly, accounts receivable rose by a slightly greater CNY2.2 billion (these have doubled since the end of 2010 while sales have only risen 40% in the same period). Cash flow from operations was, needless to say a negative CNY1.7 billion, or -76% of reported profit. It’s not only in front of the company’s diggers that red flags are being waved.

In this context, it is also of note that Caterpillar saw a QII fall in regional revenues of 11% in QII which, it noted, consisted of a ‘large decrease in China which more than offset increases in other countries’. The company announced plans to scale back production, to increase exports (!), and to offer more ‘merchandising incentives’. Have bright, yellow, cellophane-wrapped, wheel-loader – will rehypothecate.

Shipyards? Overbuilt enormously in the boom and now facing a 50% slump in orders as global freight rates plunge, taking new-build prices to an 8-year low on an index compiled by shipbrokers Clarkson. About half of China’s 1,536 shipbuilders may close within three years, Tan Zuojun, general manager of state-owned China State Shipbuilding Corp was quoted as saying in the Serenities Daily. Meanwhile, even the coastal trade is suffering, the Ministry of Transport admits. As Crienglish reported, even the important Qinhuangdao Port on China’s northern coast – ‘seen as a barometer of the economy’ – has seen daily throughput drop from ‘at least 50 vessels per day’ to ‘only one-quarter of that capacity’ so far this month.

The vehicle market, then? Granted, passenger car ‘sales’ rebounded smartly in June – possibly in a rush to beat the looming registration restrictions shortly to be imposed in several major cities – though even this only took the overall YOY tally for the first half up to an anaemic 2.9% increase, but the problem is that a ‘sale’ in China means the maker has delivered the car to a dealer, not to a satisfied customer who will soon be proudly driving off the lot in his gleaming new roadster.

The mismatch becomes apparent when we take the testimony of Cui Dongshu, deputy secretary-general with China Passenger Car Association, who told Reuters that: “Previously, only dealers that sell local Chinese brands were under the inventory pressure, but now those handling foreign brands have also started to feel the pain too”. Other spokesmen confirmed his gloomy assessment, revealing that at many dealers selling BMW and other luxury models, inventory levels over the past few months have swelled to 60 to 90 days of stock, compared with more normal levels of 30 to 45 days. More ominously yet, for a nation still supposedly ploughing its way resolutely through the softest of soft landings, commercial vehicle sales slid 10.4% in the first semester, compared to the same period in 2011.

Far from being a picture of robust health, more than half of China’s plethora of 1,300 domestic automakers – many of which are little more than shell companies used by outside investors to play what was once a booming market – will disappear over the next three to five years, in the eyes of Dong Yang, vice chairman and secretary general of the China Association of Automobile Manufacturers. With a quarter of these already in or near bankruptcy, the relevant Ministry is pondering steps to disbar them from further production so as to tidy up the market, it was announced this week.

As the China Daily noted, against a hoped for 20 million sales this year, it is estimated that the planned auto capacity of China’s 12 major automakers will soon surpass 30 million units, thus exceeding market demand by a cool 50%, according to the National Development and Reform Commission, the country’s top economic planner.

“There is overcapacity in the automotive industry. We will most likely see some consolidation,” said James Chao, Asia-Pacific director with IHS Automotive Consulting, in what sounds like an heroic understatement of the case.

China bulls will not heed any of this, of course, for they are prisoners of the nested illusion that all increases in outlay represent genuine growth (cf, Occidental property bubbles) and that higher growth must imply greater profitability. They will also argue, on any uptick in the macro numbers, that the worst is not only behind us, but that it has been more than fully priced in.

That remains a matter of debate. For it is not to be overlooked that the Chinese authorities are still giving off signals that they will not repeat the indiscriminate orgy of spending which was unleashed at their behest in 2009-10. Indeed, the very same day that President Hu noisily categorised the employment situation as ‘complicated and grim’ (his own included, one might add), the usual party organs were rehearsing front-page arguments against another mass infusion of credit, while positing the view that some ‘friction’ was an unavoidable concomitant of the nation’s necessary rebalancing.

Attacking the problem from another angle, we might wonder how – if things have gone as far as they seem to have done – even an authoritarian regime can drive sufficient temporarily-productive credit outside the coterie of its biddable, capital-destructive, princeling-packed, SOEs and into the hands of owners and managers of less coddled enterprises which are already struggling with chronic over-capacity, elevated costs, and, consequently, vanishing returns.


OK, enough about China. It’s time to take a look at marvels performed by SuperMario, the Goldmanite of the hour, who single-handedly saved Spain and Italy several €10s of billions in interest payments this week with one lapidary utterance.

‘Within our mandate’ – a framework he had craftily tried to exceed by pretending that high Olive Belt yields were enough to put the debtor nations’ shrinking ability to finance themselves somehow within the remit of monetary, rather than fiscal/structural, policy – ‘the ECB is ready to do whatever it takes to preserve the euro,’ he boldly declared to a London conference audience, before vaunting, ‘believe me, it will be enough.’

We had begun the week, you will recall in a paroxysm of selling, after the Bundestag debate on the Spanish bank bailout left the impression that its endorsement by Europe’s paymasters was, after all, conditional upon any aid so granted becoming a full liability of the state. This was a setback quickly compounded by the plea for assistance issued by a number of that blighted country’s semi-autonomous provinces and made worse by news that, across the wine dark sea, not only was Sicily in similar straits, but potentially several major Italian cities, as well.

12% was wiped off the IBEX and 10% off the MIB in a blink, triggering the usual short covering ban. 10-year Bonos quickly climbed 100bps in yield, with the front end suffering even greater pain in soaring from 4.65% to a 16-year high of 7.20%.

Enter our Mario and, to the eager applause – if not the outright complicity – of the French (who publicly exulted at the prospect of an ‘inexhaustible source of money’), his Jovian admonition served to unwind 195 bps of the damage wrought at the short end and almost all of it at the long as the shorts scrambled to cover and the bottom fishers (aided, for now by a juicy looking price excess on the charts) dared to trawl these perilous waters, once again.

There are, of course, only a few minor problems which lie betwixt turning a cleverly timed piece of verbal intervention into a concrete programme of action. Firstly, it must be asked whether he will be able to persuade a sufficient number of his colleagues on the ECB council to endorse his naked casuistry and so attempt to put a Draghi Cap on Club Med spreads and, beyond that, whether he will be able to do so without provoking another ruinous round of Bundesbanker resignations.

The Dutch have said that bond-buying remains in ‘deep sleep’ and, as we write, word emanates from Frankfurt that such measures are ‘not the best way to address the crisis’ and that the Buba remains ‘critical’ of the proposals because they ‘blur’ the policy line in the sand. As for the status of the ESM: “A banking licence for the bailout fund would factually mean state financing via the printing press and would be a fatal route, which therefore is prohibited by the EU treaty.”

Though we should perhaps be more dubious of his consistency, if not his sincerity, FinMin Schäuble also sneered that ‘the world won’t end if people have to pay a few percent more on their bonds.’ Perhaps not, but it still remains to be seen if he will be again culpable of telling the German public one thing and agreeing another with his pals in Brussels.

Beyond this internecine squabble, we must consider the ramifications of such an avowed policy of Philaustralic Bernanke-ism for an increasingly febrile German domestic politics – not to mention the possible impact it might have upon certain delicate deliberations being undertaking in the quiet, judicial chambers of Karlsruhe.

Predictably, the first reactions from that quarter have been savage. Die Welt fulminated that “The ECB is turning into a Trojan Horse” – ‘Beware of Greeks demanding gifts’, perhaps – which “no longer stands for stability and a principled course, but for a Europe in which the South has the say” with the bitter prospect that there would be “a giant shifting of burdens onto the North without solving a single one of the current problems”

FDP finance spokesman Frank Schäffler was equally forthright, Handelsblatt reported, saying it made an outbreak of inflation the most likely outcome. “Draghi is no rescuer,” he thundered, “but the plunderer of the peoples’ nest-eggs!” From Hesse, his party colleague Jörg-Uwe Hahn demanded that the ECB be hauled before the European Court of Justice for its temerity in mounting a “direct attack on German savings”.

CDU member Klaus-Peter Willsch lent his voice to the chorus, telling the same paper that “An increased inflation rate is the unavoidable consequence of this policy.” He went on to warn that: “The signs are already clearly to be observed – rising prices for prime property, farm and forest land, gold, and collectibles such as coins and art prices show us that the ‘Flight to Real Values’ has already begun”. A resonant phrase indeed, for those with a knowledge of the 1920s

Does this sound extreme, given Europe’s current woes? Not at all, for the drain of money from South to North, from Crust to Core, has mean that while the rest of the EZ languishes under a real monetary contraction 1.5% pa, German M1 is rising at a whisker under 10% per annum in nominal terms and at 7.4% in real ones – rapid enough by anyone’s lights. German M3 is also brisk enough at 7.1% nominal v the Rest’s lacklustre 1.5% gain.

If we have been taught anything by recent events it is not to map directly from rates of monetary growth to price rises, since the picture is complicated here by shifts from credit substitutes to money proper, from ‘inside’ (or bank) money to ‘outside’ (or CB) money, and by changes in the willingness of the recipients of that money to hold onto it. However, it cannot be denied that, in the country least likely to be affected by a penchant for precautionary ‘hoarding’ (by dint of its residual economic strength), the differential between the rate of its money growth and that of its neighbours has only been exceeded twice before in a three-decade record – the first time during Reunification, the second, briefly, during the post-Lehman money flood.

No wonder the GfK Institute surveys find that: “The lack of trust in financial markets and historically low interest rates mean that saving money does not appeal. Consequently, consumers are more likely to make high-value purchases, such as real estate and also furniture.”

Be that as it may, a further near-term worry shared by Herr Willsch and his colleagues – not just in the coalition, but also by members of the opposition SPD – is that the government has set up an all-party ‘Committee of Nine’ which is empowered to decide – in secret – on the purchase of bonds, as opposed to the offer of a formal assistance package, which latter still requires open debate and ratification by the full assembly. The rationale for this derogation was the insidious concept of not alerting market speculators to the possibility of bond purchases being conducted: a precaution which, as Capital magazine tartly points out, is rather redundant, given that such a policy is the burning issue of the day, not least thanks to the intervention of Signor Draghi.

The farce, it seems, has plenty of time to resolve itself in tragedy ere we are done.

That only leaves us to consider the US where the whole of Wall St. is still hoping and praying that Blackhawk Ben will be firing up his twin T700s any day now in order to lift all their bad analyses and foolish wagers up on the flood tide or a renewed monetary helicopter drop.

Things are certainly no where near as bright as they were a month or two back, but whether that means they are dusty enough to allow the Fed to surmount the ever-rising hurdle of the electoral calendar is another matter. The danger is that the associated hope that action is imminent is giving artificial support to an equity market reporting barely positive income growth and a troubling, per-share aggregate earnings decline. Other data remains in No Man’s land, too.

Money growth is running at a 4.6% annualized real rate, the slowest since QEII was launched in the autumn of 2010 and surely sluggish enough to depress not just speculative asset pricing, but macro variables as well.

Sure enough, core durable goods orders are going nowhere – a doldrums into which the formerly vibrant core capital goods orders have also wandered. For all the bally-hoo about a recovering housing market, the MBA purchase index is still where it has been for the past two-years – stuck at 1995-6 levels. The lesser Richmond Fed index went so far as to offer a frisson or two when it effected its steepest drop in history, but this is hardly a bellwether series. Of more import – if less methodological validity – was the fact that the first estimate of QII GDP crept in at a mediocre 1.5% yoy with HI private GDP slipping to the bottom end of the last three year’s range at 2.7% annualized. Soggy enough, but a reason for Ben to get his flight suit on? We think not.

The US will not this time be the cause of our woes, but neither is it – nor its monetary chief – likely to be counted among our ‘saviours’ or the more violent ‘plunderers of our nest-eggs’ any time soon.

1 Comment

  • harry koza says:

    Should not that paraphrase of Homer’s old warning more properly be “Beware of Greeks swearing thrift?”

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