How China’s Massive Automotive Malinvestments Will Affect the World

This Bloomberg article features a fantastic narrative of the boom bust cycle of China’s automotive industry (bold added)

The boom…

For much of the past decade, China’s auto industry seemed to be a perpetual growth machine. Annual vehicle sales on the mainland surged to 23 million units in 2014 from about 5 million in 2004. That provided a welcome bounce to Western carmakers such as Volkswagen and General Motors and fueled the rapid expansion of locally based manufacturers including BYD and Great Wall Motor. Best of all, those new Chinese buyers weren’t as price-sensitive as those in many mature markets, allowing fat profit margins along with the fast growth.

No more. Automakers in China have gone from adding extra factory shifts six years ago to running some plants at half-pace today—even as they continue to spend billions of dollars to bring online even more plants that were started during the good times. The construction spree has added about 17 million units of annual production capacity since 2009, compared with an increase of 10.6 million units in annual sales, according to estimates by Bloomberg Intelligence. New Chinese factories are forecast to add a further 10 percent in capacity in 2016—despite projections that sales will continue to be challenged.

 

Easy money AND government subsidies….

The carmaking binge in China has its roots in the aftermath of the global financial crisis, when China unleashed a stimulus program that bolstered auto sales. That provided a lifeline for U.S. and European carmakers, then struggling with a collapse in consumer demand in their home markets. Passenger vehicle sales in China increased 53 percent in 2009 and 33 percent in 2010 after the stimulus policy was put in place. But the flood of cars led to worsening traffic gridlock and air pollution that triggered restrictions on vehicle registrations in major cities including Beijing and Shanghai.

The frantic race to build supply hounded by diminishing marginal productivity/ diminishing returns…

Worse, the combination of too many new factories and slowing demand has dragged down the industry’s average plant utilization rate, a measure of profitability and efficiency. The industrywide average plunged from more than 100 percent six years ago (the result of adding work hours or shifts) to about 70 percent today, leaving it below the 80 percent level generally considered healthy. Some local carmakers are averaging about 50 percent utilization, according to the China Passenger Car Association.

Excess capacity is raising the pressure on carmakers to step up margin-destroying discounts to goose sales and keep production lines busy, according to Boston Consulting Group. The markdowns can be huge. Motorists can buy an iEV4 car made by Anhui Jianghuai Automobile for 61,100 yuan ($9,642), 60 percent off its sticker price, according to Autohome, a popular car pricing portal in China. Western models aren’t immune to the price slashing. The offering price of Audi’s A1 is being cut by up to 35 percent, to 194,900 yuan, in some Chinese cities, according to Autohome. And with capacity growth expected to continue outpacing demand, the industry’s return on invested capital in China will decline from 19.1 percent in 2014 to 10.5 percent by 2018, Sanford C. Bernstein estimates.

 Yet more subsidies…

Carmakers recently got help when China’s government, prompted by the sharp slowdown in auto sales in this year’s first three quarters, announced a tax cut on vehicle purchases from Oct. 1 through the end of 2016. China’s purchase tax on vehicles with efficient engines 1.6 liters or smaller has been cut in half, to 5 percent. Buyers have responded, with retail auto sales in the first three weeks after the tax cut rising 11 percent from the same period last year, according to the China Passenger Car Association.

The tax break could postpone the day of reckoning for the industry, especially for smaller manufacturers of cheaper models. But analysts worry that even if small or weak players survive, they won’t make enough money to support the investments needed to meet stricter safety and emission standards that China has scheduled for the next few years. The government is requiring auto makers to lower the average fuel consumption of their vehicles to 5 liters per 100 kilometers (1.3 gallons per 62 miles) by 2020, from the current 6.9l/100km. Companies have been developing electric vehicles or adding complex fuel-saving features to meet the tougher standard. But all that takes technical expertise and money—things foreign joint ventures have, but that many small domestic carmakers don’t.

Before the tax cut, China’s auto regulators had repeatedly urged smaller auto companies to merge or be acquired as part of a strategy to pool resources and nurture a handful of manufacturers that can compete internationally. “The tax cut delays the process of eliminating outdated extra production capacity and clouds the judgment of automakers of the market and capacity expansion,” says Xu Gang, a managing director at Boston Consulting Group in Beijing. “Instead of trying their best to become more competitive, some local carmakers are getting used to the idea that the government will help them out when the going gets tough.”

 The seminal bust…

Even big automakers are tapping the brakes. BMW says it cut production in China in the first seven months of the year by 16,000 vehicles. And Toyota Motor, despite seeing an 11.5 percent increase in China sales in the first nine months of 2015, is treading carefully. It’s scheduled to begin production of an assembly line in Tianjin by mid-2018, which will allow it to make an additional 100,000 vehicles a year. But Toyota says that output will be mostly offset by ending production on an existing assembly line elsewhere on the mainland. That kind of caution is fast becoming the new normal for carmakers in China.

Through the years, China's automotive industry’s growth model has been heavily RELIANT on easy money and government subsidies. Said differently, the industry depended on DEBT financed car purchasing (DEMAND), and most importantly, debt financed race to build capacity (SUPPLY)

Apparently, excess capacity has reared its ugly head. It’s a symptom of boom-turned-bust. And basically this comes from two things: supply has grown faster than demand, and second, slowing demand reinforces and magnifies overcapacity.

As with the strains on the stock market or the property market, the Chinese government’s response has been to apply more subsidies or the bailout of the industry. Yet these will merely “postpone the day of reckoning”

However with the immense outgrowth of supply, the initial industry reaction has been to dive selling prices through “margin-destroying discounts”. In short, price deflation of autos.

The second feedback mechanism has been, and will be, the “tapping the brakes”. Insufficient sales and profits will lead first to the suspension of capacity expansion. Eventually losses will translate to capacity destruction. In short, the markets will clear on these excesses.

China’s boom bust cycle in the automotive industry also means that it will “export deflation” around the world.

Perhaps “margin-destroying discounts” will be pushed to markets abroad. That’s if there will be demand enough to absorb it or even just a portion of it to partially allay the overcapacity troubles.

And that’s if the government’s of her trading partners abroad won’t erect trade barriers to prevent China’s auto exports from affecting their domestic producers. 

You see, inflationism runs opposite to free trade. Instead, inflationism raises the spectre of protectionism. Hardly any free trade agreement will offset the inherent protectionist proclivities and impulses brought about with tampering with credit and money prices.

Alternatively, China’s automotive industry can also export deflation INDIRECTLY.

Suspension of capacity expansion, and worst, capacity destruction entails of jobs and output slowdown or losses, and similarly, financial stresses to sectors attached to these industries or the non-linear supply chain and credit networks depending on and have been related to the industry.

Think the current annihilation of commodity prices. Palladium, for instance, supply over half of catalytic converters mostly used by automotive industry. 

China’s mammoth oversupply dilemma has been contributing to the ongoing collapse of palladium prices.

Yet since the Chinese government keeps throwing obstacles to prevent markets from clearing, then such process will only get extended and will even be more painful.

And as for the Philippine version where "STRONG MARKETING and varied financing options helped drive vehicle sales to reach 28,667 units in October, 29% more than the tally a year ago, and 5.9% up from September, according to latest figures from the country’s two biggest auto industry groups."

Understand that this has hardly been about G-R-O-W-T-H, but about INFLATIONISM.

Current events in China should serve as a blueprint.

   

WikiLeaks Unveils TPP Secret Documents

The Trans-Pacific Partnership (TPP) is a proposed trade and investment agreement, that involves 12 nations from Asia Pacific led by the US. The member states are Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. 

It’s been a controversial agreement that has raised various protests because of the secrecy of negotiations covering the agreement's expansive scope, and the attendant controversial clauses in drafts that  previously has been leaked to the public.

Austrian economist Dr. Richard Ebeling at the Epic Times clarified that this hasn’t been a free trade agreement: (bold mine)

What should be most clear is that the Trans-Pacific Partnership is not a free trade agreement. Parts of it may, no doubt, lower some trade barriers, thus making easier the production, sale and purchase of a wider variety of imports and exports. However, TPP, like all other trade agreements in the post-World War II era is a managed trade agreement.

That is, governments of the respective participating nations negotiate on the terms, limits and particular conditions under which goods and services will be produced and then bought and sold in each other’s countries. The Japanese government, for instance, is determined to maintain a degree of trade protectionism for the benefit of Japan’s rice producers, who are fearful of open competition from their American rivals.

The U.S. government is under pressure from the American auto industry, for example, to continue limiting greater competition from the Japanese automobile industry. American labor unions want to restrict the importing of goods produced at lower labor costs abroad than U.S. manufactured goods, because American consumers might prefer to buy the lower priced foreign products and thus risking the loss of some of their union members’ jobs.

In short, the TPP is a trade agreement designed to promote the interests of politicians, cronies, and related politically connected vested interest groups on a regional scale. 

As a side note, the TPP could be seen as a part of the geopolitical strategy by the US government to 'rebalance' military and diplomatic relations toward Asia. Or this could be part of the Asian Pivot. The Asian Pivot, according to former US secretary of state, Mrs. Hillary Clinton consist of six courses of action: namely strengthening bilateral security alliances; deepening America's relationships with rising powers, including China; engaging with regional multilateral institutions; expanding trade and investment; forging a broad-based military presence; and advancing democracy and human rights. 

With the seeming growing rift between the US and China, TPP perhaps could now seen an instrument to compete or even limit China's sphere of influence.

Nonetheless, following a bounty recently setup by the anonymous organization WikiLeaks to publish secret information, news leaks, and classified media from anonymous sources, the same group unveiled some of the shroud from negotiations

From the Guardian

WikiLeaks on Wednesday released 17 different documents related to the Trade in Services Agreement (Tisa), a controversial pact currently being hashed out between the US and 23 other countries – most of them in Europe and South America.

The document dump comes at a tense moment in the negotiations over a series of trade deals. President Barack Obama has clashed with his own party over the deals as critics have worried about the impact on jobs and civil liberties.

On Tuesday, WikiLeaks put a $100,000 bounty on documents relating to the alphabet soup of trade treaties currently being negotiated between the US and the rest of the world, particularly the controversial Trans-Pacific trade agreement (TPP). The offer, announced yesterday, has already raised more than $33,000.

Wednesday’s leak is the third time that WikLeaks has published sections from secret trade agreements. In January it leaked a chapter from the TPP related to the environment. In November 2013 it made public a draft of the agreement’s intellectual property chapter, containing proposals that Wikileaks founder Julian Assange said would “trample over individual rights and free expression”. 

Among the text leaked on Wednesday are Tisa’s annex on telecommunications services, an amendment that would standardize regulation of telecoms across member countries, according to WikiLeaks. Other documents in the batch of files relate to e-commerce, transportation of living people and regulation of financial services corporations.

I guess the Wikileaks just unveiled part of the grand scheme to promote the globalization of cronyism.

The Paradox of the ASEAN, China, Japan and the US Free Trade Agreement Talks

From Japan Times

The Association of Southeast Asian Nations and its six regional partners, including Japan, China and India, declared Tuesday the start of negotiations for a free-trade agreement that could create a huge integrated market compromising more than 3 billion people.

The move toward creating the Regional Comprehensive Economic Partnership comes as the United States is seeking to create another vast free-trade bloc through the Trans-Pacific Partnership initiative.

If the RCEP and TPP, which is currently being negotiated by 11 countries, are created, each could be similar in economic size to the European Union. The 16 countries involved in the RCEP negotiations have a combined nominal gross domestic product of about $19 trillion, or about 30 percent of the world's GDP.

The RCEP negotiations are expected to begin early next year and to be completed by the end of 2015. But it will be a challenge for the 16 countries with their diverse backgrounds to realize a high-quality agreement to liberalize trade in goods, services and investment.

The countries involved are the 10 ASEAN members — Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam — plus China, Japan, South Korea, India, Australia and New Zealand.

Two things here

Any thrust towards the expansion of voluntary trade is always welcome.

Although free trade doesn’t really require FTAs as nations can just unilaterally engage in reducing all forms of trade restrictions (tariffs or non tariff based).

This means that FTAs are not necessarily "free" as they conditional to certain terms and or to specific industries or to particular areas of the economy.

As the great dean of Austrian Economics Murray Rothbard wrote,

If the establishment truly wants free trade, all it has to do is to repeal our numerous tariffs, import quotas, anti-"dumping" laws, and other American-imposed restrictions on trade. No foreign policy or foreign maneuvering is needed.

If authentic free trade evers looms on the policy horizon, there'll be one sure way to tell. The government/media/big-business complex will oppose it tooth and nail. We'll see a string of op-eds "warning" about the imminent return of the 19th century. Media pundits and academics will raise all the old canards against the free market, that it's exploitative and anarchic without government "coordination." The establishment would react to instituting true free trade about as enthusiastically as it would to repealing the income tax.

Yet inflationist policies undertaken by all these nations, especially by the US, Japan and China, which signifies a form of protectionism, essentially offsets any free trade agreement that would be forged.

Nonetheless this leads us to the second point. We have repeatedly been told that frictions over territorial claims have led to political brinkmanship in the region. 

And indeed the open display of mutual animosity has even adversely affected trading output between two major participants, China and Japan, in the FTA.

Tourism between both countries, aside from car sales of Japanese brands have reportedly slumped in September, even after the end of anti-Tokyo protest. 

It has been alleged that China's anti-Tokyo street protests has been orchestrated by the Chinese government that even led to a water cannon shootout between the coast guard patrol boats of Japan and Taiwan, another claimant on the disputed island.

So we are once again seeing the strange case of Dr. Jekyll and Mr. Hyde in terms of regional political and economic relationships between China and Japan (over Senkaku) and China and ASEAN (Scarborough and Spratlys). 

Certainly the conflicting status in trade relations and regional politics means one is a signal and the other is a noise. That’s unless there has been little coordination within their respective governments or that one of the two represents a smokescreen for other veiled agenda.

World Economic Trend: Mercantilism or Globalization?

To paraphrase a recent comment I received from a mercantilist: Because of the US dollar standard, mercantilism have been more prevalent today.

It is easy to dismiss such an argument as post hoc fallacy since two distinctive variables have been made to function as causally related. Nevertheless let us see from a few charts and graphs whether this claim has validity, even if we exclude the role of the US dollar.

To rephrase the issue: Has the world economic trend been more about mercantilism or globalization?

According to Google’s Public Data World merchandise trade as % of GDP has ballooned from a little less than 20% in 1960s to about nearly half of the world's economy today.

Even trade balance of services, again from Google Public Data, based on OECD economies volume has leapt sixfold since 1996.

Above is the breakdown of global trade per sector in 2010 (World Trade Organization)

Add to the current dynamic the dominance of intra-region trade

One major reason for the surge in global trading activities has been due to major moves to LIBERALIZE trade via substantial reductions tariffs which came from Regional Trade Agreement (RTA), Multilateral Trade Negotiations (MTN) and or even unilateralism (WTO)

Bilateral investment treaties peaked in 1995 but the effects of these are still being felt today through massive growth in cross border investments

While there have been some protectionist pressures as consequence to the financial crisis of 2008, generally speaking trade liberalization has been minimally affected.

From IMF Finance 

The number of new protectionist actions peaked in the first quarter of 2009 and bottomed in the third quarter of 2010. However, recent GTA data suggest that protectionist measures are increasing again; protectionist actions in the third quarter of 2011 alone were as high as in the worst periods of 2009 (Evenett, 2011).

The Group of 20 (G20) advanced and emerging economies account for most of the trade measures, most of which did not involve tariffs, imposed since 2008. There has been no significant increase in the overall use of tariffs or temporary trade barriers, such as antidumping measures, aimed at assisting local firms injured by import competition (Bown, 2011). Such measures affected only about 2 percent of world trade (Kee, Neagu, and Nicita, 2010; WTO, 2011). The trend of gradual tariff liberalization observed since the mid-1990s has not been affected

The World Trade Organization (WTO) notes of the recent increases in Non-Tariff Measures (NTM). But these have been based on technical barriers to trade (TBT) regarding standards for manufactured goods and sanitary and phytosanitary (SPS) or measures concerning food safety and animal/plant health, and partly domestic regulation in services which have hardly been about restricting competition.

From the WTO,

“I think it is a good time for the WTO to have a closer look at non-tariff measures (NTMs)”, said WTO Director-General Pascal Lamy, at the launch of the Report. “A clear trend has emerged in which NTMs are less about shielding producers from import competition and more about the attainment of a broad range of public policy objectives. The new NTMs, typically SPS and TBT measures but also domestic regulation in services, address concerns over health, safety, environmental quality and other social imperatives. The challenge is to manage a wider set of policy preferences without undermining those preferences or allowing them to become competitiveness concerns that unnecessarily frustrate trade.”

The above trends seems quite clear. Globalization has been the dominant theme of the world economy over the past decades, regardless or in spite of the role of the US dollar.

Now of course, events of the past may not extrapolate to the future. 

Bottom line: The religion of politics makes many people see fantasies as self constructed reality.