The vampire squid has wrapped itself around China’s face

Over three decades, China has steadily opened its economy up to the influences of markets to advance human utility. Over that period it has always been careful to try to avoid the financial excesses that overtake capitalism from time to time. On this basis, after the Global Financial Crisis, Beijing expressly eschewed the Western model of over-liberalisation and financialisation.

For instance, China was never so foolish as to let the Wall Street “vampire squid” loose in its mortgage market, as the US had done in the post-millennium period, resulting in the greatest mortgage bond and property price bubble and bust in history. Equally, China has been very cautious in freeing up its interest rate markets and currency, preferring to keep them largely under centralised control.

But, for all of its efforts, China found homegrown methods to blow its own, even larger property price and construction bubble after the GFC.  In China’s case, it was more political than financial greed that was the key driver. The ruling Communist Party felt its legitimacy hung upon endless high GDP growth and the only way to deliver it was to build vast cities of apartment buildings whether occupied or not.

That is until COVID came along and changed the calculus. After COVID, Beijing has drawn two conclusions.  The first is that it can no longer afford to pointlessly build empty apartments to meet growth targets. There is too much debt. Second, that as all other nations simulate like crazy, and by doing so suck in huge quantities of Chinese exports, now was a great time to address the property bubble.

This makes perfect sense. The Chinese export boom will keep unemployment low and sustain incomes as the property bubble is deflated. Australia did something similar in the 2010-11 period quite successfully.

But something has gone wrong with this plan. China’s industrial export boom has turned out to be so large that its power consumption has boomed. Unlike developed markets, the vast majority of Chinese electricity is used in industry. At its peak earlier this year, Chinese power output was up an astonishing 16% year-on-year, though that has slowed to about 5% in September:

This had led to power shortages and big demand for electricity raw materials such as coal, LNG, oil and even uranium.

There is plenty of such fuel to go around in the global economy. All of these markets are fundamentally well-supplied. Or, they were before COVID. Virus disruptions introduced some new short-term curtailments, as did Russian geopolitics, at an inconvenient moment. Even so, any disruptions should have been manageable.

But that is when the Wall Street vampire squid got involved. Unbeknownst to Beijing, which has so studiously avoided the American carpet baggers, Wall Street tentacles wrapped around the face of the Chinese economy this year when its investment houses started selling the idea that the green energy revolution will leave the world short of key commodities for decades. A new “supercycle” it was called.

This notion has very little actual mathematics behind it. Most, if not all, of the posited shortages are made up. Energy raw materials like coal and gas were never central to the idea. But there is nothing the Wall Street cephalopod loves more than to blow air into a great story. The result, today, is a full-blown commodity mania and hoarding cycle. Especially in the energy commodities that China needs to keep its industry powered up.

So, just as China has deliberately crushed its property developers, Wall Street’s vampire squid has relentlessly jammed its blood funnel into the arteries that pump its commodity lifeblood. The resulting bubble has grown so large that it is forcing power curtailments upon the Chinese industrial economy. Suddenly, instead of one accelerator and one brake, the Chinese economy has hit two brakes. Hence, it barely grew at all in the September quarter and faces much the same in the December quarter.

Australia has been both beneficiary and victim of this strange turn of events. The great iron ore crash was the first signal that the Chinese property developer shakeout had arrived. But, since then, we have enjoyed a historic boom (in both speed and scale of price gains) in our energy commodity exports. So much so, that it has completely wiped out all of the losses from iron ore.

In the short term, this will mean a few things. The benefits of the commodity boom will swing from the budget of WA to those in NSW and QLD, where the coal exports happen. Gas is not taxed very well anywhere so that won’t much difference to anybody.

Moreover, while the Wall Street parasite remains fastened to the Chinese economy, the property adjustment will worsen because Beijing can’t support the economy with stimulus for fear of blowing Wall Street ‘s energy bubble sky high and in the process shutting down its industry anyway.

Thus, Chinese property is on its own, downside momentum in that market can gather pace and, if it overshoots, then the greatest victim of the short-term energy bubble may ultimately be lower iron ore prices, along with energy.

Houses and Holes
Latest posts by Houses and Holes (see all)

Comments are hidden for Membership Subscribers only.