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Generational Dynamics Web Log for 2-Aug-05
China heading for deflation as manufacturing index shows weakness

Web Log - August, 2005

China heading for deflation as manufacturing index shows weakness

There are signs that China's bubble economy may be bursting

For over twenty years, China's economy has been growing at a red-hot 9-10% per year.

For 2-3 years, China's been trying to slow down its economy, but have failed to do so. The idea was to slow it down just a little -- enough to stablize it for a "soft landing," but not too much, which might cause a "hard landing." For example, China's economy grew by 9.7% in the first half of 2004, much more than the 7% that Beijing's planners had been aiming for.

Well, you know the old saying: Be careful what you wish for.

There's much one can't be sure of when dealing with a government as secretive as China's, but there are some initial signs that China's economy may be unraveling faster than Beijing would like.

According to an article by the Chinese Xinhua news service:

"At the second China economic observation forum, some economists predict that China's economy may fall into a deflation characterized by persistent consumer price decrease.

Lin Yifu, Director of China Center for Economic Research (CCER) of Beijing University, said at the forum held quarterly by CCER that owing to the overproduction in most manufacturing sectors since 1998 and the to-be-overcapacity from over-investment in some sectors in 2003 and 2004, China is expected to see deflation caused by overcapacity in the latter half of 2005.

Wang Jian, Deputy Secretary General for the Economic Research Institute under State Development and Reform Commission, said that decreasing growth of Consumer Price Index (CPI), dropping enterprise profits, as well as losses in downstream industries are all signals that China's economy has taken a cooling trend."

China is not usually forthcoming when its economy is in trouble, so for a significant Chinese official to admit even the possibility of deflation indicates a great deal of concern.

The first announcement of deflation appeared in recent weeks, as it became clear that Chinese manufacturers are continuing to cut prices. Chinese manufacturers have been increasing production and cutting prices in the hope of catching up.

What's happening in China is the same as has been happening in America, although the details are different.

Since 2002, I've been predicting that America is entering a new 1930s style Great Depression, and that there would be a stock market collapse, with the Dow falling to the 3000-4000 range probably by the 2007 time frame. This is a consequence of the huge 1995-2000 stock market bubble, which has not yet fully unraveled. Even now, as that time approaches, I see no reason to revise that prediction.

The same Generational Dynamics methodology which arrives at that conclusion also predicts that America is in a deflationary period, with prices expected to fall by 30% by 2010.

The reason this happens is because of the crusty old bureaucracy phenomenon, where the new businesses that were created in the 1930s have now become sluggish and crippled from bureaucracy, as employees become stale in their jobs.

In America, this has caused jobs to flee massively to China, where low-paid workers turn out products at less than half the price that America's factories can.

What's a little harder to understand is that China is now also succumbing to the "crusty old bureaucracy" phenomenon. Although China's red-hot economy has been expanding at 9-10% a year for over 20 years, this has been accomplished by Chinese businesses with the same kind of entrenched bureaucracy. For a business to survive it must constantly change, but China's success at making standard products like T-shirts has worked for many years, but left China's businesses as stale as America's are.

Thus, China is passing through the same kind of unraveling generation cycle that America, Japan and Europe are. These regions' economies are all closely linked together so when one goes down, all of them will go down.

The signs of a weakening Chinese economy include a weakening in Chinese manufacturing in recent months.

Baltic Dry Index, 1996-present <font size=-2>(Source: FinData)</font>

Baltic Dry Index, 1996-present (Source: FinData)

Another dramatic sign is the continuing precipitous fall in the Baltic Dry Index (BDI), which measures the shipments of "dry-bulk cargos," commodities like iron ore, grain, cement and coal, shipped in bulk on huge freighters traveling the seas around the world.

When I wrote a lengthy article on this subject last month, I explained how the BDI reflects China's imports of manufacturing commodities, especially iron ore, and that even at that time it had fallen so far since December that a recession in China seemed likely by fall.

Since that time, the BDI has continued to fall, by an incredible 2-3% almost every single business day. This kind of fall in worldwide dry goods shipping prices indicates that something very dramatic is going on.

Yes, it's true that the enormous rise in the BDI in 2003-4 brought additional shippers into the business, with the result that carriers now have some 8% more capacity than they did a year ago, but that alone can't account for a collapse in the BDI from over 6,000 to below 1,800 in a few months.

From the point of view of Generational Dynamics, China, America, Europe, Japan and other countries are all going to suffer the same collapse in stock market value, as stocks are overvalued by 100% or more around the world. The only question is when the cascading fall will begin, and what will trigger the panic that causes it. A failure in China's economy might possibly be such a trigger.

Meanwhile, a new story about a regional mass riot in a Chinese province has surfaced. According to the story in the Washington Post, a student on vacation was riding down the street when his bicycle accidentally collided with a wealthy official's very expensive four-door sedan. Before long, the student had been beaten up, and a riot ensued.

What typically happens in these cases is that word spreads quickly, thanks to mobile phones and text messages, and soon there are thousands of people rioting.

According to the article,

"When anger boils up in your heart so long, it has to burst," said a Chizhou man who was part of the crowd that night....

Recently, the resentment has exploded into violent protests, despite draconian laws against attempts to challenge the party's rule. Although press censorship prevents an independent count, the government-funded Ta Kung Pao newspaper said Public Security Minister Zhou Yongkang estimated that 3.76 million Chinese were involved in 74,000 "mass incidents" during 2004.

So we're not talking about something small here, not with 3.76 million Chinese involved in 74,000 mass riots in one year. This riot involved 10,000 people, but others have brought in 50-60,000 rioters.

The Chinese security police are very skilled at bringing such riots under control, and they obviously were successful 74,000 times in 2004. But it's only a matter of time before one of these mass riots spirals out of control.

As we wrote about in detail in a lengthy analysis that was posted in January, China's social structure is unraveling rapidly, as can be seen from from the tens of thousands of regional rebellions each year, over 100 million migrant workers, high food prices, high rust belt unemployment, addiction to a bubble economy, unraveling of Mao's social structure and secessionist provinces. Things are coming to a head in China, in both its economy and its social structure. (2-Aug-05) Permanent Link
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Generational Dynamics Web Log for 2-Aug-05 China heading for deflation as manufacturing index shows weakness

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Generational Dynamics Web Log for 2-Aug-05
China heading for deflation as manufacturing index shows weakness