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Plus ça change

Conveniently coming just in time for the crucial Party conference, the official China PMI index inched above the 50-level watershed and so was enough to gladden the heart of loyal cadres and sell-side analysts everywhere. Truly now the bottom is in place and we can return to unbroken months of expanding economic activity under the wise guidance of the new leaders, all the while looking forward to inexorably higher asset prices across the globe!

Well, perhaps. But, is it really sensible to suppose that the weight of evidence offered by this one, single datum is enough to tip the scale of judgement, or would it be better to seek for confirmation elsewhere – not least in the next instalment of said series, given that it is not seasonally adjusted and so is subject to the vagaries of the Chinese lunar holiday calendar?

Certainly, we might be allowed to nurse our scepticism a little longer, if only because one of the main economic sectors contributing to this uptick was the otherwise badly bruised steel industry. Having increased production by a bare 1.7% in the first nine months over the like period in 2011, October’s more favourable constellation of input prices has combined with a long-overdue reduction of inventories to spur the country’s mills to encompass a PMI-boosting, 8% jump in the daily rate of output when compared to late September.

All well and good, but recall this is an industry in which profits of the so-called ‘above-scale’ firms fell 68% YOY, while the listed steel companies actually made an aggregate net loss. Even the mighty Baosteel has been suffering; printing a ‘profit’ partly by dint of asset dispositions – and, even then, returning less on capital than would one of China’s notoriously unremunerative bank deposits. Incidentally, we put the quotation marks around the ‘profit’ to highlight the fact that the explosion in the firm’s accounts receivable has amounted to almost four-fifths of reported operating income over the last six months.

Rationalization, in a business with fast approaching 900mt of capacity servicing no more than 680mt of domestic demand, has proved elusive, largely because of the usual curse of local government politics. Not only are steel companies major local employers, but they pay taxes based on output, not profit, greatly increasing the perverse incentives to which their management is subject.

Adding a certain frisson to the situation is a Bernstein Research report into steel trader fraud. Here, with echoes of the Great Salad Oil Swindle perpetrated by Tino de Angelis exactly fifty years ago, it appears that a number of firms have not only been pledging the same steel as collateral several times over, but that some of the alloy so committed consisted of nothing more than a surface layer of steel laid on top of a pile of near-valueless sand. As a result of this discovery, it is said that Guangzhou traders are now only making good on half their orders, rather than on the already recession-shrunken 70% characteristic of the previous three months, raising the question of just who will buy the new product pouring out of the mills.

Though there are the inevitable murmurings of better things to come as the government launches yet more, white elephant, infrastructure projects, those pinning their hopes on a sustainable upswing manifesting itself in the near future would do well to listen to what Ma Guoqiang, Baosteel’s general manager recently said in an online briefing.

Judging from current global and domestic economic growth, it is realistic to expect the ‘cold winter season’ to last for three to five years, and the steel sector will not be an exception.

Some heed of this ill wind seems to have been taken by the big miners, notably BHP Billiton, which has radically restyled its corporate message in recent months to the point that the most prominent slogan in its latest presentational material was that its focus has shifted from the marginal tonne to the capital efficient tonne.”

A far cry, indeed, from last year’s defiant emphasis on the super-cycle; on ever mounting, Chinese per capita usage; and on the heady plans for the $80 billion in new capex need to surf this envisaged wave.

Highlighting the contrast, Chief Executive Marius Kloppers – fresh from cancelling no less than $68 billion of those projected expenditures – struck a much more sombre note last month, telling his audience that:-

Miners have responded to unsustainably high prices for some commodities such as iron ore and metallurgical coal over the past decade by building new production capacity. Over that period, robust demand growth from China and other developing nations outstripped production growth as the industry grappled with escalating mining costs and strengthening currencies in commodity producing countries…

But the industry has improved its ability to meet incremental demand with low cost supply and commodities demand growth from emerging economies, particularly in China, is forecast to moderate as developing economies transition to consumption-led growth from infrastructure-led growth…

…what we are now witnessing is the rebalancing of supply and demand and a progressive recalibration of prices back to long term sustainable pricing levels. In effect, what this means is that the record prices we experienced over the past decade, driven by the ‘demand shock’, will not be there to support returns over the next 10 years. What we can instead expect is demand growth at more predictable and sustainable levels and more moderated pricing. This ‘mean reversion’ in prices and returns is something we at BHP Billiton have anticipated for some time…

…The physical iron ore demand of China will go down. That high end of the cost curve will disappear. Still a very good business but not the massive EBIT margins we have today… a very significantly less amount of revenue…

It may well be, of course, that Mr. Kloppers will prove no more prescient regarding the genesis of this tough, new reality than he was in foretelling the demise of the old, Klondike era but it would seem foolhardy not to assume that the head of one of the largest and most successful integrated mining companies might be able to give us some pointers as to conditions on (or may be, under) the ground.

Elsewhere in Asia, PMI’s were mixed in terms of month-on-month changes, but were almost universally mired on the contractionary side of the ledger – though you would never have guessed this to be the case, given the positive glow elicited by the one or two less gloomy releases seen in the region of late. We would only reiterate that the place still suffers from a widespread reliance on exports to a faltering Europe as well as to a still-tepid America. Together with the complex entanglement which much of the Orient has woven with a China still wrestling with the superposition of a Gosplan-like growth directive and layers of rampant nest-feathering on top of a very Austrian credit bust, this strongly implies that it will take more than a brief – and possibly random – interruption of the downwave to instil any confidence that the worst truly is behind us. Just ask Panasonic, HTC, Dongyang, or Sharp.

Adding to the suspicion that things are not exactly steaming full ahead, the first intimations of October’s banking figures from China suggest that an almost complete reversal of the prior month’s large deposit increase was suffered by the Big 4, while, on the other side of the balance sheet, lending was very weak right up to the last three days of the month when an extraordinary CNY100 billion late burst saved the day. Word is that much of this took the form of corporate credit – but how much of that represents distressed borrowing, only time will tell.

Amid press comments to the effect that SME loan demand was weak (not surprising perhaps, given the lacklustre showing at the autumn instalment of the Canton Fair), that lending was about complete for the year, and that even local infrastructure finance was largely being limited to roll-overs and to ensuring completion of existing projects, matters seem a deal less settled than the permabulls would have us believe.

And let us be in no doubt just how pivotal Chinese banks are to the whole, top-heavy, output-driven, malinvested superstructure. In the year through end-September, just sixteen of them were responsible for no less than 54% of the entire sum of aggregate profits posted by the country’s 2,493 listed companies – even if they could only manage this unhealthy predominance by the determined misrepresentation of their bad loan levels. After they had extracted their bounteous harvest of rents, the nation’s commercial and industrial rump of 2,477 firms saw their revenues inch up by less than 5%, their pre-receivable ‘profits’ fall 18%, and their already exiguous operating margins slump 22% to a mere 4.3 cents on the dollar.

Nor was there much cheer to be had from Li Zibin, president of the China Association of Small and Medium Enterprises, who announced that his members were facing more difficulties this year than they did in 2008. Citing the slowdown both home and abroad, Li said that rising labour costs, pricier raw materials, fund-raising difficulties, and the appreciation of the RMB were among the private sector’s litany of woes.

Then again, a certain degree of caution is only to be expected when we take into account the ongoing rumours that the imminent leadership handover is still the subject of internecine strife between the factions. Not only has former leader, éminence grise – and ‘conservative’ hard-liner – Jiang Zemin been unusually prominent of late but reformists Zhu Rongji and Li Ruihuan have also resurfaced from self-imposed obscurity to root for the opposing team, if to little obvious effect if we believe the spin the SCMP has put on events.

Tellingly, the PLA Daily issued a forthright declaration of its loyalty to the Party and Chairman Hu, warning of the need to guard against the existence of hostile forces in and outside China… ready to make trouble. Note the ominous use of the first of those two positional prepositions.


Faced with what could be the appearance of the most tenebrous of cygneous waterfowl in Economy No.2, the results of the upcoming vote in Economy No.1 might seem to offer far less chance of triggering a decisive shift. After all, the cynic would see the difference between the candidates as one more of degree than of kind, especially if he were to limit his concern to the policies the two candidates will actually get around to enacting, rather than those whose superficial distinctions have been grossly exaggerated at the hustings.

As the inimitable H. L. Mencken long ago phrased it: 

Each party steals so many articles of faith from the other, and the candidates spend so much time making each other’s speeches, that by the time election day is past there is nothing much to do save turn the sitting rascals out and let a new gang in.

Yes, there is a chance that, freed from the personal need to secure further re-election, Obama might become more radical in his final term – and thus enact a greater programme of tax-and-spend, as well as giving rein to a more undiluted brand of eco-alarmism and green energy boondoggling. Little of that strikes your author as at all helpful to the chances of a meaningful American renaissance.

Against this, Romney promises to be more business-friendly – though one has to doubt whether his proposed menu of tax cuts will really be offset as it should by a like, much less by a desirably greater, reduction in outlays. One unalloyed plus is that he purports to offer far less in the way of impediments to further entrepreneurial success in securing the development of America’s rich mineral legacy. In contrast, his rather crude, eschatological take on foreign policy could prove horribly disruptive to us all if he surrenders control over his country’s might to the implicit furtherance of another, far less heedful country’s warlike agenda.

Whoever wins, we are sure to wake up on Wednesday morning with the Bernanke Fed continuing to wreak havoc by destroying the pricing ability of capital markets; with Federal debt growing at the rate of $40,000 a second – not all that far shy of what a typical family earns in a year – with a debilitating dependency on the state all too elevated, and with any number of restraints to peace and progress not only unresolved, but utterly unresolvable under present conditions and under the leadership of two such solidly mainstream candidates.

It’s not as if we’re going to give Ron Paul a chance to fix things, now is it?

Already, real net private product per capita has been stagnant for more than a decade, mirroring its poor showing during the inflationary disaster of forty years ago. Even if Romney and Ryan were to win and Bernanke were then to tender his resignation to two men who have openly disparaged him during the campaign, the latter’s replacement would be both outnumbered by a dovish FOMC and a prisoner of the initial conditions from which he must start. To expect a radical turnaround under such conditions would be to display as much naivety about the prospects for ‘change’ as did the incumbent’s worldwide fan club of bien pensants four short years ago.


In Europe, the Greeks and Spaniards continue to play fast and loose in the face of looming catastrophe – each seemingly about to founder between the Scylla of economic inevitability and the Charybdis of an ECB intransigence which is fully buttressed by the craven mendacity of those northern politicians who have tried to pretend that the dispelling of that illusion of EMU ‘convergence’ on whose maintenance they have long staked their careers will bear no direct consequences for their own electorates.

Beyond this we must repeat our recent – and ever more widely echoed – musings about the vulnerability of a French nation almost completely bereft of any fiscal sea-room while it wallows, rudderless on the lee shore of its intrinsic lack of industrial competitiveness and as its leaders either squabble on the bridge or fly hither and yon as diplomatic busybodies, full of empty pretensions to winning La Gloire abroad.

In recognition of this, no less a figure of the European left than Gerhard Schröder – the former German Chancellor and the present, heavyweight sponsor of prime SPD candidate (and after-dinner entertainer par excellence) Peter Steinbruck – has publicly called upon President Hollande to admit that his election promises cannot possibly be kept; that the lowering of the retirement age cannot be financed; that his taxation policy will lead both to capital flight and to lower job creation;  and that problems will arise as soon as France starts to struggle to rollover its debts.

In France itself, the employers’ lobby Medef has talked of an economic ‘hurricane’ afflicting its members and of business leaders being in a state of ‘quasi panic’ at the prospect of a further turn of the screw. Bearing this out, the INSEE reading of employer expectations for their own future production has slumped to a two standard-deviation low, putting it well down among the depths recorded during the GFC, the Maastricht crisis, and the turmoil of 1983 when a former socialist President – François Mitterand – nearly wrecked the ship of state in his turn.

All this is taking place in a land which was the locus of much of the dreadful banking policy which financed the boom and, ergo, is the place for whose defence the current, ill-conceived interventions have largely been concerted. It is a country clearly in decline. The current account has slid, slowly but surely, from the typical surplus of around €40 billion-a-year when the euro was launched to the point where the French are now piling up an equal-and-opposite deficit of €40 billion a year. Debt/GDP has doubled in twenty years to reach a ratio of close to 90%. Overall unemployment has hit a 13-year high, with 25% of those under-25 officially currently out of work. Total employment has barely grown in a decade, while almost half the country’s manufacturing jobs have disappeared over the past generation.

Taxes are already at their highest proportion of private income in more than a decade helping the state spend an eye-watering 55% of GDP (where, naturally, its outlays greatly outstrip private, net income) and yet all M. Hollande can think of to do is to expand its enervating sway even further.  Hardly the best way to promote a national revival, one feels.

Whether the ECB can afford to make good on the Draghi boast in the case of Spain is one thing (whether it can do so by adhering to its own rules on collateral eligibility appears to be a second!). Whether it could go beyond that and shore up an increasingly restive Italy is another. But the idea that it could then keep France afloat in its hour of need seems altogether a stretch too far. Even such consummate operators as Merkel and Schäuble would struggle to tell their weary voters that the only way to avoid another, Versailles-scale transfer of resources to Paris would be to undergo another socially-destructive bout of unbridled monetary inflation.

If the Hollande administration does as expected, it will this week reaffirm its purblindness by quietly burying the forthcoming report on national competitiveness being compiled by former EADS boss Louis Gallois. Worryingly wedded to the failed prescription of the Keynesian mainstream – and hence terrified that consumption will suffer, however unaffordable it may be when production is so unprofitable – ministers have already spoken out against Gallois’ eminently sensible suggestion to cut welfare payments, to lower employment charges, and to hike VAT as a budgetary offset – which combination would make work pay better for both contracting parties while introducing many of the rebalancing forces to be expected of an internal devaluation without entraining many of its unnecessary side effects.

Here, in the response to Gallois’ report, we may look for our first indications of whether France’s political elite are even aware of the monumental nature of the task which confronts them. If not, we may begin to end our doubts about whether their policies will end up posing the greatest threat to the Grand Project by which they and their predecessors in office have long set such great store.

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