The recent announcement that Tata Steel is looking to pull out of the UK, which places the loss making Port Talbot at risk, has understandably made the headlines. What hasn’t made the headlines however is the vast size of the gulf between global steel supply and demand. To close this gap, it would not only require the closure of this plant, but also, the equivalent of all the capacity from Japan, America and Germany.
Global steel production has risen by 57% over the last 10 years, with virtually all of this growth coming from China. As demand in China now begins to shrink, a supply adjustment is required. It is the same story in a multitude of industries ranging from shipping, glass manufacturing, coal and aluminium smelting. This underlines the potency of the deflationary pulses affecting the global economy.
In open economies, the process of cleansing the system is painful but well practiced. China is not an open economy and policy makers are terrified by the prospect of wide scale layoffs. The factories are looking to expand sales abroad but they are finding that the global market for their produce is already swamped. This is all profoundly deflationary, Chinese producer prices have fallen for 47 consecutive months. Cuts in production have been promised though the Premier Li Keqiang has signalled that unemployment will remain within 4.5%. it is currently 4.1%.
Much capital has been provided to the state owned enterprises, often in the form of loans by banks, which are effectively also instruments of the State. Bears fret that the Chinese financial system is rotten to the core and saddled with loans that will never be repaid. The recent capital flight ($300bn has left the nation’s foreign exchange reserves in the 6 months since August), could be an indication that those in the know are now rushing to the exits. Reassuringly, recent work by the Bank of International Settlements (the central banks’ central banker) indicate that much of this ‘capital flight’ can be accounted by a shrinkage in the offshore renminbi market and Chinese firms paying down their dollar debt. It is not a sign of panicked investors fleeing China. The Peoples Bank of China appears to be picking up the slack as it has continued to cut interest rates and reduce banks’ Reserve Requirement Ratios. These easier credit conditions should help to alleviate some of the short term stresses but will do little to flush the stables clean.
The authorities are nurturing growth in other parts of the economy and it would appear that the odds of an immediate hard landing have markedly receded. One positive of the declining prices in the manufacturing sector is that rebalancing process may be taking place faster than many realise – assuming, and this is a big assumption, that the headline growth rates reflect reality.
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