China’s Bubbles Buoy Economy As Risks Loom – Analysis

By Michael Lelyveld

China’s steel production hit an all-time high in October as manufacturers pumped up output in what may be a bubble in the country’s slowing economy.

Despite international concerns about excessive production and U.S. tariffs on its exports, China set a monthly record of 82.55 million metric tons of crude steel, rising 9.1 percent over year-earlier marks.

Overproduction is likely to be a key challenge for China as it struggles to maintain economic growth following the “truce” in the trade war with the United States, announced over the weekend.

The agreement reached at talks between Presidents Donald Trump and Xi Jinping following the G20 summit in Buenos Aires, Argentina, will suspend additional tariff measures for a negotiating period of 90 days, the White House said.

In announcing the steel figures at a National Bureau of Statistics (NBS) press conference on Nov. 14, spokesperson Liu Aihua linked the surge to expected cutbacks at coal-fired mills this winter.

The government has ordered seasonal reductions in the northern region to keep emissions from adding to pollution from heating systems through mid-March for the second winter in a row.

The boost from steel may be partially responsible for a slight rise in October’s industrial output to a year-on-year gain of 5.9 percent, up 0.1 percentage points from September.

But China’s need for more steel appears doubtful.

Infrastructure investment has risen at a sluggish 3.7-percent pace in the first 10 months of the year and overall fixed-asset investment in long-lasting projects like buildings has grown only 5.7 percent, the NBS said.

In the latest official indicator of the economy last week, the NBS said that the purchasing managers’ index (PMI) for manufacturing declined in November to 50, evenly poised between contraction and expansion, down from 50.2 in October.

The non-manufacturing PMI mark of 53.4 also showed signs of slower growth, declining from a reading of 53.9 the month before.

The figures suggest that higher rates of steel production are only a bubble that could deflate with a bang over the winter. But similar expectations last winter, during the first season of air quality shutdowns, never came about.

Instead, steelmakers staged an unbroken monthly string of year-on-year production gains, ending 2017 with a 5.7-percent increase over 2016.

New records in 2018

So far this year, China’s mills have set new records in four of the last eight months, posting a 6.4-percent increase through October this year.

Despite three years of cutting production overcapacity, there always seems to be a reason why China is making more steel.

During last winter’s government-ordered cutbacks in the region surrounding Beijing, manufacturers shifted production to areas outside the smog-control zone.

When prices were low, steel companies made more in hopes of driving competitors out of business. When steel prices rose, mills reopened their closed production lines and raised output to recover lost profits.

Steel companies have cited the anti-smog cutbacks as a reason for increasing output both before and after the winter period. During the last seasonal cycle, steel prices were supported by fears of output reductions that have yet to take place.

This year, the policies have worked well for producers but less beneficially for air quality, as Beijing has recently been hit with smog alerts at least once a week.

On Nov. 25, the Ministry of Industry and Information Technology said that the total main operating income of China’s iron and steel industry through September rose 14 percent to 5.66 trillion yuan (U.S. $814.5 billion).

Aggregate profit of the sector soared 65.3 percent from a year earlier to 358.7 billion yuan (U.S. $51.6 billion), the official Xinhua news agency reported.

China’s overproduction has been an international problem because the country makes about half of the world’s steel.

October’s record output comes despite signs of weakening demand.

The industry’s steel price index rose by a small fraction of a percentage point from September and nearly 5 percent from a year earlier, the China Iron and Steel Association (CISA) said.

But last week, the London-based Financial Times reported that prices for Shanghai rebar, used in construction, have dropped by more than one-fifth since August, putting margins under pressure.

“The controversy of high output has not been solved, while demand is expected to weaken in the future. That makes physical prices face increasing pressure to plunge further,” said CITIC Futures analysts in a note cited by Reuters on Nov. 20.

Distorted economy

But steel is only one of several sources of distortion that affect China’s economy and frustrate forecasts.

Other examples of bubbles in the economy include recent trade figures, which the government has cited as evidence of China’s “resilience” under pressure.

China’s exports in October jumped 15.6 percent from a year earlier in dollar terms, beating forecasts and the 14.5-percent growth rate a month before, according to customs figures reported by western news agencies.

Dollar-denominated imports climbed 21.4 percent, easily topping the September increase of 14.3 percent, the CNBC financial network and Reuters said.

The October results were buoyed by a 13.2-percent rise in exports to the United States.

But analysts attributed much of the increase to “front-loading” of shipments ahead of Trump’s threat to hike tariff rates from 10 percent to 25 percent in January.

Instead of showing resilience, the trade numbers may be warning that another bubble is about to pop.

“Exports to the United States will flatten or fall next year no matter what,” said Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington, commenting before the tariff postponement.

Scissors said that “exports have been rushed this year, so the first half of next year will be weak, then the U.S. economy will slow, so the second half of the year will be weak. So, yes, this is a bit of an export bubble.”

While steel and trade are examples of current bubbles, the Chinese economy has been under the influence of one bubble or another for years.

In 2016, for example, loose credit policies and lax regulation led to an astonishing 44.1-percent splurge in non-financial outbound direct investment (ODI) as fast-growing investment groups gorged on foreign real estate, entertainment assets and hotels.

In 2017, government regulators cracked down on “irrational outbound investment,” driving ODI down by 29.4 percent and forcing sales of foreign assets. The results for debt growth, defaults and financial risks are still being felt.

“ODI in 2016 was absolutely a bubble — private money rushing out of the country and largely into the United States,” said Scissors. “Even official ODI may fall this year on top of last year’s drop.”

In the previous decade, China’s stockpiling of crude oil in a strategic petroleum reserve at undisclosed rates was blamed for another bubble of double-digit growth in imports, creating a major variable in global oil demand as prices reached record highs.

China’s real estate market has also been a subject of bubble warnings for years, as runaway development has been driven by investment and promises of perpetual price growth, despite government curbs on buying and downturn risks.

‘Data show resilience’

The government’s narrative for the economy has painted a picture of steady growth and slight settling to sustainable levels as far as the eye can see, but the profusion of bubbles has kept expectations on the cusp of a sudden drop.

Despite the uncertainties, state media continue to voice confidence in official economic forecasts and growth rates, reporting cherry-picked positive figures for indicators like railway freight volume and road traffic.

“The data, added to a series of indicators, show resilience in the economy,” Xinhua said in a Nov. 19 report.

“The country’s economy recorded a strong growth of 6.7 percent in the first three quarters, on track to achieve the government’s annual target of around 6.5 percent for 2018,” it said.

A major test of the durability of China’s bubbles may be coming in the next 90 days, if an agreement to settle outstanding differences with Washington is not reached before then.

“Everyone does it, but China forecasting based on official data should not be taken seriously,” said Scissors, who sees serious concern over the value of the yuan if it breaks through the psychological barrier of seven to the U.S. dollar.

“If I had to pick a single, serious China risk to worry about, if they let it fall below seven to the dollar, can they stabilize it at 7.2 or 7.3?” he said.