Pettis: 3% growth coming soon to China

From Michael Pettis comes this sobering series of forecasts for Chinese growth. Wake up, Canberra.

My basic sense is that we are at the end of one of the six or so major globalization cycles that have occurred in the past two centuries. If I am right, this means that there still is a pretty significant set of major adjustments globally that have to take place before we will have reversed the most important of the many global debt and payments imbalances that have been created during the last two decades. These will be driven overall by a contraction in global liquidity, a sharply rising risk premium, substantial deleveraging, and a sharp contraction in international trade and capital imbalances.

To summarize, my predictions are:

  • BRICS and other developing countries have not decoupled in any meaningful sense, and once the current liquidity-driven investment boom subsides the developing world will be hit hard by the global crisis.
  • Over the next two years Chinese household consumption will continue declining as a share of GDP.
  • Chinese debt levels will continue to rise quickly over the rest of this year and next.
  • Chinese growth will begin to slow sharply by 2013-14 and will hit an average of 3% well before the end of the decade.
  • Any decline in GDP growth will disproportionately affect investment and so the demand for non-food commodities.
  • If the PBoC resists interest rate cuts as inflation declines, China may even begin slowing in 2012.
  • Much slower growth in China will not lead to social unrest if China meaningfully rebalances.
  • Within three years Beijing will be seriously examining large-scale privatization as part of its adjustment policy.

There is nothing really new in these predictions for regular readers. These are more or less the same predictions – based largely on historical precedent and the logic of the global balance of payments mechanisms – that I have been making for the past five or six years (the past eleven year, when it comes to the breakup of the euro), but I thought it would be helpful, at least for me, to list them.

Note that although at first glance some of these predictions seem unrelated to others, in fact they all flow from the same basic balance of payments and balance sheet frameworks. To explain each in greater detail:

1. There has been no decoupling of developing economies, or more narrowly the BRICs, from the developed world. All that has happened is that the transmission from one to the other has been delayed.

Since most global consumption comes from the US, Europe and Japan, the collapse in their demand will ultimately be very painful for the BRICs and the rest of the developing world. The latter have postponed the impact of contracting consumption by increasing domestic investment, in some cases very sharply, but the purpose of higher current investment is to serve higher future consumption. In many countries, most notably China, the higher investment will itself limit future consumption growth, and so with weak consumption growth in the developed world, and no relief from the developing world, today’s higher investment will actually exacerbate the impact of the current contraction in consumption.

This delayed transmission, by the way, is not new. It also happened in the mid-1970s with the petrodollar recycling. Economic contraction in the US and Europe in the early and mid 1970s did not lead immediately to economic contraction in what were then known as LDCs, largely because the massive recycling of petrodollar surpluses into the developing world fueled an investment boom (and also fueled talk about how for the first time in history the LDCs were immune from rich-country recessions). When the investment boom ran out in 1980-81, driven by the debt fatigue that seems to end all major investment booms, LDCs suffered the “Lost Decade” of the 1980s, especially those who suffered least in the 1970s by running up the most debt.

This time around a huge recycling of liquidity, combined with out-of-control Chinese fiscal expansion (through the banking system), has caused a surge in asset and commodity prices that will have temporarily masked the impact of global demand contraction for BRICs. But it won’t last. By the middle of this decade the whole concept of BRIC decoupling will seem faintly ridiculous.

2. By 2013 Chinese household consumption will still not have exceeded the 35% of Chinese GDP reached in 2009. In fact it will probably be lower.

For much of the past decade there has been a growing recognition that Chinese growth has been seriously unbalanced, as Premier Wen put it, and that at the heart of the imbalance has been the very low consumption share of GDP. In 2005, when consumption hit the then-astonishing level of 40% of GDP, there was a widespread conviction in policy-making circles that this was an unacceptably low level and that it left Chinese growth much too dependent on the trade surplus and on increases in domestic investment. At the time the former seemed a more dangerous risk than the latter – although even then massive overinvestment was China’s true vulnerability – but I think by now there is a rapidly developing consensus that investment, and the unsustainable concomitant increase in debt, is China’s biggest problem.

That is why Premier Wen listed the need to raise the consumption share of GDP second in his speech last March before the unveiling of the new Five-Year Plan. This time, the message seems to be, they are serious about doing it.

But I remain very, very skeptical. Low consumption levels are not an accidental coincidence. They are fundamental to the growth model, and the suppression of consumption is a consequence of the very policies – low wage growth relative to productivity growth, an undervalued currency and, above all, artificially low interest rates – that have generated the furious GDP growth. You cannot change the former without giving up the latter. Until Beijing acknowledges that it must dramatically transform the growth model, which it doesn’t yet seemed to have acknowledged, consumption will continue to be suppressed.

3. In the rest of 2011 and during all of 2012 Chinese debt levels will continue to rise very quickly, in spite of attempts to slow the growth in debt.

The attempts to rein in debt growth will fail because they address specific areas of debt and not the overall tendency of the system to generate debt. So although there may be more pressure to rein in local government borrowing, for example, this will probably fail, and if it succeeds it will only be because other entities, most probably locally-controlled SOEs, are enlisted to fill in the gap. My guess is that next year the general alarm among investors will have switched from local government debt to SOE debt, not because the former will have become manageable, but rather because the latter will surge, albeit in not-always-transparent ways.

With consumption growth constrained and the external environment unsound, increasing investment is the only way to keep GDP growth rates high. China funds almost all of its major investments with bank debt, and it long ago ran out of obvious investments that are economically viable – at least investments that are likely to be generated by what is a distorted system with very skewed incentives – so increases in investment must be matched by increases in debt.

To the extent that investments are not economically viable, this means that the value of debt correctly calculated must rise faster than the value of assets. By definition this results in an unsustainable rise in debt.

4. By 2013-14 Chinese GDP growth will slow sharply, and by 2015-16 predictions of a sustained period of growth rates at 3% or lower will no longer seem outlandish.

I don’t expect a significant growth slow-down until after the new leadership takes power in late 2012, but my guess (and hope) is that by 2013 the stubborn refusal of consumption to rise as share of GDP, and the continuing surge in debt, will have convinced all but the most recalcitrant that China needs a dramatic change of policy. The longer we wait, the more debt there will be and the more pressure there will be on Beijing to use household wealth transfers to service the debt.

Why do I say we will be talking about 3% growth soon? Two reasons. First, I am impressed by the bleakness of historical precedents. Every single case in history that I have been able to find of countries undergoing a decade or more of “miracle” levels of growth driven by investment (and there are many) has ended with long periods of extremely low or even negative growth – often referred to as “lost decades” – which turned out to be far worse than even the most pessimistic forecasts of the few skeptics that existed during the boom period. I see no reason why China, having pursued the most extreme version of this growth model, would somehow find itself immune from the consequences that have afflicted every other case.

Second, I just use a very simple calculus. Remember that rebalancing is not an option for China. It will happen one way or the other, and the sooner the less disruptive. And for China to rebalance in a meaningful way, consumption growth is going to have to outpace GDP growth by at least 3-4 full percentage points (and even then, at that rate, it will take China over five years to return to the 40% that was not long ago considered astonishingly low).

During the boom of the last decade consumption has grown at a very sharp 7-8% annually. If consumption growth remains at that level, China can slowly rebalance with GDP growth of 4-5%. But historical precedent (along perhaps with common sense) suggests that if GDP growth drops so sharply, from 10-11% to 4-5%, it will be incredibly difficult for household income and household consumption growth to be maintained. In that case a 2-3% drop in household consumption growth may be a fairly conservative estimate, and as the growth rate declines, GDP growth will also decline with it. I discuss this more in a WSJ OpEd piece last week.

5. The decline in Chinese growth will fall disproportionately on investment and, because of this, it will severely impact the price of non-food commodities.

In the past, as the consumption share of GDP declined sharply, the investment share rose. By definition as China rebalances, this process must reverse. This must mean that consumption growth will speed up (relatively, at least) and investment growth decline even if overall GDP growth remains unchanged. Of course if GDP growth drops, as it absolutely must, investment growth must drop even more.

The implications are inescapable, although I think many people, especially in the commodities sector, have missed them. If GDP growth drops by X%, investment growth must drop by substantially more than X%. This is what rebalancing means.

6. What happens to real interest rates will determine when the process of Chinese adjustment begins. In fact there is a chance that we may see growth in China slow significantly in 2012, perhaps even to 7%, although I suspect that it will probably be in the 8-9% region.

This is a bit of wild speculation on my part, but depending on what the PBoC is allowed to do with interest rates, we may see the beginnings of an adjustment as early as next year. In the past year the PBoC has raised interest rates by roughly 125 basis points. Obviously, as I have argued many times, this has not been nearly enough given the much higher increase in inflation and it is part of the reason why the domestic imbalances have seemed to have gotten worse in the past year, not better.

But I expect that inflation will begin to decline soon, and it may even drop quite sharply. In that case what will the PBoC do to interest rates? If they can refrain from lowering them, the higher interest rates will reduce overinvestment while putting more wealth into the pockets of household deposits. This will both slow growth and speed up rebalancing.

Will it happen? I have no idea. What the PBoC does to interest rates is likely to be the outcome of a struggle in the State Council between policymakers that are worried about growth and those that are worried about imbalances. If the PBoC can hold off the former, and especially if wages continue rising, we might begin to see Chinese rebalancing taking place a little earlier than expected. Of course this must, and will, come with much slower GDP growth.

7. Growth rates of 3% will not necessarily lead to social and political instability. Most analysts argue that China needs annual growth rates of at least 8% to maintain current levels of unemployment. Anything substantially lower will cause unemployment to surge, they argue, and this would lead to social chaos and political instability.

I disagree. The employment effect of lower growth depends crucially on the kind of growth we get.  The problem is that China’s current growth model encourages a heavily capital-intensive type of growth – wholly inappropriate, in my opinion, for such a poor country.

But since rebalancing in China requires less emphasis on heavy investment and more on consumption, and since rebalancing also means a sharp reduction in free credit provided to SOEs and local governments and cheaper and more available credit for efficient but marginal SMEs, a rebalancing China would presumably see much more rapid growth in the service sector and in the SME sector, both of which are relatively labor intensive.  Much lower growth, in that case, could easily come with minimal changes in overall employment.

That is why Japan is a useful reminder of what can happen.  After 1990 GDP growth collapsed from two decades of around 9% on average to two decades of less than 1% on average, but there was no social discontent, and unemployment didn’t surge.  Some analysts credited Japanese lifetime employment or invoked the natural docility of Japanese people (a bizarre argument at best) to explain the lack of social upheaval, but for me it was because Japan genuinely rebalanced in the past two decades.

Before 1990 GDP growth sharply outpaced consumption growth, whereas after 1990 their positions were reversed – consumption growth sharply outpaced GDP growth.  In that time the Japanese savings rate declined sharply, the household income share of GDP rose sharply, and Japan became less dominated by the industrial giants that were almost synonymous with Japan of the 1980s.

So as I see it the Japanese didn’t react to Japan’s “collapse” with outrage or horror largely because Japan didn’t really collapse in any meaningful sense.  Japanese standards of living on average continued to rise after 1990, and on a real per capita basis probably only a little slower than they had before 1990.   It was the state sector that bore most of the brunt of the slower growth, and this shows up as the explosion in government debt.  Households were fine because although the GDP pie was growing at a much slower rate after 1990 than before, their share of the pie was growing after 1990, whereas it shrank before 1990.

I think the same might happen, or at least could happen, in China.  It depends in part on how resistant the elites are to the process of rebalancing, which almost by definition means eliminating the distortions that had benefitted them for so long.  As Jeffrey Frieden points out in his brilliant Debt, Development and Democracy (1992), the elites that benefit from economic distortions are traditionally the ones most likely to prevent necessary adjustments, and if they actually run the whole show, adjustment can be incredibly painful and disruptive.

If I am right, and China begins to rebalance (and it has no choice but to rebalance unless it has infinite borrowing capacity and the world has infinite appetite for Chinese surpluses), then the debate must shift from economics to politics.  We need to understand how and under what conditions China’s elite will permit an elimination of the distortions that benefitted them.  For example, under what conditions will the export sector and its defenders allow the RMB to rise, or will SOEs and provincial governments tolerate an increase in interest rates, and so on?

8. Because of its rapidly rising debt burden, the only way for China to manage a smooth social transition will be through wealth transfers from the state sector to the household sector. In the past, Chinese households received a diminishing share of a rapidly growing pie. In the future they must receive a growing share. This will probably be accomplished through formal or informal privatization.

The right way to engineer the transition to a system in which household wealth isn’t used to subsidize growth is to raise wages, raise the value of the currency, eliminate SOE monopoly pricing, and raise interest rates. The problem is that all of these have to adjust so far that to do so quickly would lead to massive financial distress. It would also lead to rising unemployment and, with it, declining consumption, so that the rebalancing would occur through low consumption growth and perhaps negative GDP growth. No one wants this outcome.

Doing so slowly, however, so as not to cause financial distress and a surge in unemployment will result in worsening imbalances over the medium term. It will also lead to a continued building up of debt – and I think we only have four or five more years of this kind of debt build-up before we hit the debt crisis that every other investment-driven growth miracle country has faced.

So what can Beijing do? They’re damned if they go slowly and they’re damned if they go quickly. There is however an alternative solution that is relatively easy (easy economically, not politically). It is to increase household wealth through a one-off transfer from the state sector. The state can privatize assets and use the proceeds either to increase household wealth directly (gifts of shares, improvement in the social safety net, etc.) or indirectly (clean up the banking system and pay down debt).

Right now it is hard to find anybody who really thinks Beijing will engage in a massive privatization program, but this is the only logical alternative I can come up with, and it is the least painful. So my guess is that in two or three years privatization will become a very popular topic of policy discussion.

There is much more at his blog.

Comments

  1. Pretty sobering stuff. It could be a lot worse I guess. Still FutureBoom Swan/Gikllard/Stevens to name a few will be totally surprised, and “we didn’t see this coming”

  2. And no doubt, when this all occurs, our enlightened leaders in Canberra will look back and say something like, ‘geez, who would have seen that coming?’

    No doubt we will get the odd, ‘China is different’ apologists, but I do have a lot of time for Pettis. He doesn’t paint doom and gloom pictures, but doesn’t sugar coat either. I see no reason why his predictions won’t come to being. The question now is where to for us?

    Given this scenario, the days of booming commodities and $22b profits will be but a distant memory. Governemnt revenue will be absolutely hammered, so you can basically junk any forward estimates. The counter-balance? Our education sector will be forced to compete with European and US institutions, and they just do not have the prestige attached to do so. Tourism is dead, dollar or not. It is a tired, lazy and thoroughly expensive model, and once you’ve seen a koala or two, there aint much else. Manufacturing………..next!! Retail, like housing is toast, all black and crispy from the debt binge. Banks will find new and improved methods of extracting blood from stones, but like BHP, no more record profits.

    Not a good picture at all. I just can’t for the life of me see how it will end in any way positively for Australia. If you have some ideas, please do share because my pessimistic side is starting to take over.

    • Iron ore and met coal prices are halved, taking the Aussie dollar with them.

      However by 2015 black coal production has peaked in China (same as China reaching a peak in energy extracted from coal). As this supplies China with 75% of their current energy needs, energy prices in China start to rise substantially. Combined with civil unrest from high inflation and pollution, Chinese manufacturing loses its low cost advantage.

      With the Aussie dollar much lower, and with competitive energy prices, Australia can once again make steel and aluminium for a profit, using new plant setup by BHP/Onesteel/Hydro (!!)

      Lots of mining investments are cancelled, taking pressure off interest rates and engineering/trade shortages. This leaves room for Australia to invest in electric rail and sustainable energy solutions, and the air cooled solar thermal becomes a booming industry.

      Although interest rates are low the banks and Australian public, still fearful of debt, continues to deleverage. If you can save for the 20%+ minimum deposit, you can buy a house that is now affordable.

      Using Karratha as a base, we build HVDC links to Indonesia and Malalysia to sell energy made in the desert from our own resources.

      (You said be optimistic!)

      • Agree with Delraiser, some visionary thought, time frame a little optimistic but then you never know.

        China’s manufacturing edge may erode, only to be picked up by other emerging nations – it is the Way. So demand for resources likely to remain, record pricing perhaps not, even better if we are again manufacturing exportable quantities of steel from domestically sourced iron ore, for which there is always likely to be a need…furthermore, the potential to utilise waterflows from the north to develop viable large scale agriculture – being ‘foodbowl’ to the region.

  3. “The implications are inescapable, although I think many people, especially in the commodities sector, have missed them. If GDP growth drops by X%, investment growth must drop by substantially more than X%. This is what rebalancing means.”

    This comment gave me pause. It’s hard to tell the timing of this; it could conceivably go on for some years yet. Pettis is estimating 2013-2014.

  4. I’ve always had this ‘thing’ in regard to China, it’s current growth trajectory and our export relationship – I’ve always called it 2015…

    The Chinese leadership will continue to do whatever is possible to stave off such a devastating end to growth. The social dislocation and unrest a frightening prospect, something to be avoided the leadership well know.

    And yes, a reminder not to hitch ourselves to China thinking the ride may be forever. No ride ever is. Having said that, China remains our most important trading partner, we have little else with whom to take a journey.

    There is a always the possibility that events as described by Pettis either don’t come to fruition until 2020 or later, easy to be out a little when forecasting years ahead; or alternatively don’t happen at all (if recession occurs in developed nations it is of short duration and economies experience a modest revival, the Chinese sort out the NPLs).

    Very hard for anyone to predict economic conditions so many years forward. We can’t even predict the US and Europe three months hence!

    It ain’t over until it’s over.

    • Very true. And Pettis is actually much more bearish than I am.

      But, it’s about risk isn’t it.

      The risk is significant that China will slow significantly within the next few years.

      We should plan appropriately instead of gambling.

      • Well, at the moment having a seat at the roulette table is about our only option. But we fear being handed the loaded revolver – in the short to medium term, a risk worth taking.

        Demand comes to us, we satisfy that demand. It is at record levels, prices are too. This is a good thing for any nation with few other economic positives. So in my opinion, we run with it.

        Equally, we need have the broader discussion of just what sort of an economy we desire in the longer term. Most agree that a diversified base is better, one that includes for example retaining manufacturing capability, which remnants of which remain are in danger of being squeezed out by the pressures of the high AUD. Some thoughts on manufacturing survival:
        http://www.macrobusiness.com.au/2011/08/another-way-to-help-manufacturing/#comment-68584

        To my mind these are issues which require a slight ideological shift of gear, not resolvable simply by the MRRT, nor even for that matter a SWF (although if invested O/S, as you have explained, may bring downward influence to the AUD).

        When you say plan appropriately do you mean other than adjustment to the MRRT (Saul Eslake’s proposal) and a SWF?

        • If China continues booming, the non-mining economy withers and dies, and we will need a big chunk of savings to support people currently employed in these sectors.

          If China slows markedly, the resource boom will end with a thud. This will see the AUD crash and (eventually) stimulate the non-mining economy, but its so weak at the moment the recovery will take time.

          Either way Australia is going to need substantial savings to see us through this difficult period, and the only place those savings can come from at the moment is the mining sector.

          I don’t see any other way.

          BTW, I read your comment yesterday about supporting manufacturing, but mandating an Australian component in big projects would probably violate or free trade commitments, and is only going to support a small segment of the manufacturing sector. It doesn’t help other trade-exposed sectors such as tourism, education, services exporters etc.

          Our biggest problem at the moment is policymakers are cheering the mining boom (and AUD) higher. They are sending a strong signal to the market that Australia is happy for the dollar to rise, and will most likely raise rates in the near term, adding more fuel to the carry trade.

          The market needs to hear that policymakers are deeply concerned about the non-mining economy, and that the RBA is more likely to cut than hike. That would have an immediate effect on the currency.

          • OK. In the short to medium term there is a limited amount that can be raised from the mining boom via usual corporate taxes and the MRRT. Nothing can nor will be done about this. It is what it is.

            You call them ‘savings’ but in effect they will very quickly transform to expenditure, to fund bureaucratic processes, general social welfare programmes, the NBN and not out of the realms of possibility, perhaps even a revived homebuyer assistance package or Hardly Normal stimulus handout. There will be NO savings. The history of Australian governments would seem to support this.

            Any form of ‘mandated’ Australian component would indeed trangress WTO Free Trade obligations, hence a modest percentage suggested. Surely a nation has the right to argue a small tweaking to its obligations in the wider national interest – whilst maintaining general adherence to the philosophy (a philosophy that struggles to be as effective when endless credit is pulled and countries move relentlessly to natural comparative advantage. There is always a cheaper/more efficient/more excellent provider mentality leads to the hollowing out of economies, it is a natural progression. If we decide we want a little more than housing and holes I believe it requires an slight adjustment to the prevailing ideology.

          • I agree it will be difficult for politicians to keep their snouts out of the trough.

            Unfortunately the message the politicians are getting from Treasury and the RBA — that China will boom forever — is not helping their inclination to save for a rainy day.

            Our top bureaucrats are in deep denial about risks of a China slowdown, and the current weakness in the non-mining economy.

        • The other issue with mandating australian content is the local capability to supply on the required timeline. This would create and even sharper boom / bust in other areas of the economy as all these projects are one off.

          • There would be problems encountered but not insurmountable. My suggestion was not limited to resource projects but ALL projects over a given contract value, say $100m. Resources projects, government projects, NBN – based more broadly should help level boom/bust impacts.

          • Was thinking more in terms of if you remove the proprietary stuff you are pretty much left with concrete (most of which is sourced locally anyway) or steel work in big projects. Both of these are very large, very short term requirements that is all needed at once.

            With things like the NBN you may be able to justify constructiong of a FO plant based on a 10yr rollout.

          • Much to Barnett’s horror all the concrete pavers/sleepers on one major site was sourced offshore. Concrete for goodness sake – it was then even he started questioning the lack of locally sourced product.

            Yes, what you suggest is correct – but it can extend all the way down to rivets, screws, compression nozzles, some electrical componentry, packing for said product, designers – stuff traditionally keeping small workshops in every industrial estate humming. And again, as the decline has been over decades, any resurrection is likely to take time. Resurrection is not likely without something more than a lower dollar. The high AUD a recent phenomenon, the departure of manufacturing a long and ongoing one.

          • Understand entirely, one wonders about how overseas concrete sleepers could underbid locally manufactured ones.

            I have recently had this discussion on an east coast project where local suppliers wanted us to break down work packages to minute <$1m scopes. So that they could bid on them, because they only had the capability to do that much work. Starts to become some very expensive engineering to try to support local content.

          • Agree that limited capacity is a constraint – but we did manage do it once, why not again. Your example well illustrates the hurdles encountered when capability in a sector is in terminal decline, hence if we do want a manufacturing sector into the future, hurdles we have to get over.

            Recall the Woodside LNG modules constructed in Henderson, a terrific project, loads of work, sourced to a lot of smaller contractors and then remarkably floated north. Would not happen now – shipped complete from Korea or China to Hedland or Karratha. We did it once.

          • The East Spar Buoy floating production system was also designed and built in Perth.

            As you say….once were warriors.

          • And again, as the decline has been over decades, any resurrection is likely to take time. Resurrection is not likely without something more than a lower dollar

            Bullshit.

          • Bullshit? Really?

            How then do you account for two decades of decline with the AUD mostly at 70-80c.

          • You’re like a broken record Fanboy:

            – Manufacturing has been in decline for decades
            – All our problems are due to credit/housing boom (not mining)
            – Carbon tax, carbon tax, carbon tax.

            Sure manufacturing has been trending down for a long time, but the rampant dollar has put a rocket under the process. Manufacturing was doing ok in the early 2000s when the AUD was in 50s and 60s. It would do ok again if the dollar returned to those levels.

            Yes the housing/credit boom created a lot of problems, but that’s not what’s killing manufacturing, tourism, education and retail. Its the strength of the currency.

            I’m sick of your bullshit.

            Tell the whole truth for once, and stop omitting facts you find inconvenient.

          • Lorax, you’re a little tense today. Chill.

            I suspect it is your selective interpretation that frustrates you.

            Now you are adding the decline of retail on to the high AUD blame list. A portion has shifted to online however the very same high AUD has made many electronic and computer goods attractively priced in JBs etc, so a benefit overall! I would reiterate my belief that the decline in retail is more closely associated with the new more reserved consumer exercising restraint in the face of peak debt and economic uncertainty.

            You are obsessed with the carbon tax, not I. In a genuine effort to assist the manufacturing sector I suggest a moratorium on the imposition of the tax on affected sectors, after all exemptions exist in a range of other areas. Manufacturing has been on decline for years. The high AUD will accelerate this decline.

            I always say what I think, not what I think others will want to hear…

            Cheers.

    • China Fanboy, the 2015 date is what I hear a lot from mining MD’s (small, and mid size)as to when Australia will struggle, and this is based on China gettinmg it’s othersupply line sources (coal,iron ore, etc. on the boat). I’ve read many articles giving a similar narrative, and so we are linked to China, but are they linked to us after 2015 or some other date?

      Would appreciate you view if you’re in the know.

      • Walt Disney's Frozen Head

        Supply/Demand. The current scenario is a massive expansion of iron ore supply comping online by 2015 — primarily from the majors, plus a tripling of capacity from FMG and a few smaller mid west types which are small by comparison but still add to capacity. A possible qualifier is that timelines for projects have a habit of getting put back but I guess 2015-2016. That should force down prices considerably, barring Chinese steel expansion at an equal rate, which no one seems to be forecasting.

        So that means aside from the arguments and skepticism I have about a SWF, the current projections only give us about 4 more years to reap from the windfall profits.

        • Thanks Walt. The other suppliers I’ve been told of are outside Australia. I know the details of some of them like Rothschild Indonesian mine, but others like Brazil, Canada, and Africa have been mentioned. I’ll try and find out from a Chinese commodity guy I know; he might not tell me however.

        • And there are the overseas projects, Vale flat out, projects in Africa and India (far more problematic in my view). Raises the spectre of a number of new operations coming on line based on optimistic pricing models, but this should be of less issue to the majors.

          Note that Kloppers when asked similarly, smiled a little and said they were confident of conditions remaining buoyant for 1,2,3 years and then, perhaps some adjustment, stressing it very difficult to put a longer timeframe on it. I’d put my money on the views of the miners rather than Treasury, they are the ones taking the calculated risks.

          As we all know, our resources story is built on the China story, let’s hope it’s a magnum opus!

          Finally, say there are three to five more really good years (but good years will come again). In reality, barely enough will be raised from any SWF to be of merit in any case – most resources companies do not make profits in the league of BHP and RIO – even BHP has not previously made profits like these before. The horse has bolted.

          • Thanks Fanboy. I have read that it’s not long before BHP looses in Manganese dominance for example, so the super profits might fall off a bit over time due to that and other suppliers coming on line. In the meantime China need our secure supply chain.

            I don’t trust the Treasury, or RBA to give us an honest view, and that’s why we need to have other sources to give a macro view.

            I don’t think any political party has any answers to what we’re about to fall into, and for now I’ll put my money with the miners.

          • There’s no doubt there’s a huge supply response happening in the iron ore markets. Iron ore isn’t oil or gold — its not rare — so if the world demands more iron ore, more iron ore will be produced.

            So more supply is baked in. The real problem for Australia happens if the increase in supply coincides with a slump in demand from China.

            Remember, this mining boom is not about “Asia’s insatiable demand for resources” its about China’s demand for iron ore. You only have to look at BHP’s results to see where all the profit is coming from.

            We have allowed ourselves to become highly leveraged to the Chinese construction boom, and our policymakers are in deep denial about the risks of a China slowdown.

          • Thanks, didn’t see that. My best guess is that they would have briefed Government but as HnH has said, the demise of manufacturing being just one of the costs associated with the transition to our natural comparative advantage, which certainly in 2009 was about the only available option to take. The high AUD has really accelerated the decline, IMO.

    • Like you, If mining industry leaders see China growth slowdown beyond 2012, guess what will happen to the mining investment pipeline NOW?

      • I think most see good prospects the next few years (always aside from any calamity) and reasonable (but hard to guesstimate accurately) prospects into the future. Here in WA a lot of those big projects are in development currently and frankly, I don’t know if there is capacity for more right at this point (crazy busy).

        Think BHP, announces record profit largely on the back of WA iron ore; announces $4.3b rapid expansion project to completion say 2012; even a a couple more good years pays for the investment in multiples. If Pettis’ view proves too gloomy by half (which I hope it does), no problems at all. In worst case scenario, has built first class infrastructure prepped ready to go when demand resumes, after all the ore isn’t going anywhere without the wherewithal of the resources companies.

        As I have long argued, resources companies invest massively in projects based on best information calculated risks, and risk is always there. It is the nature of mining and when it pays off, the rewards are deserved. Honestly, who thought a few years ago commodities would be at current prices – but you know what, mining companies took the risk at what were then much lower returns because you’re not in resources to just sit there and contemplate your navel!

  5. Can somebody please make sure Saul Eslake and Warwick McKibbin see this. Somebody, please….

    Actually they might not buy it. Not enough charts and econometric analysis.

  6. I keep saying that the single biggest indicator of future economic trouble, if only economists and analysts would learn to use it, is the level of “planning gain” (or its equivalent) being captured in urban development. i.e. the escalation in price, of raw farmland, up to the point at which it gets sold with housing on it.

    Try this predictive tool for yourself. Asian crisis 1990 – Japan, Korea. California. Nevada. Arizona. Ireland. Britain. Spain.

    Now look at China today – and India. And Australia.

    And run for cover.

    • Corruption and variants to western concepts of it are a real problem.

      Good grief, almost as bad as Wall Street.

      • Re: Wall Street.

        +1

        None of my money has been used to bail out banks due to China. Quite the contrary…

  7. just a casual observation. it seems market has priced in some kind of China slow down.

    BHP trade at $40, PE 10,4x book value

    expected next growth in next two years:
    – earning growth 17.5%
    – div growth 14%