03/18/2013, 00.00
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Overproduction and monetary distortion: the crisis of the Chinese "giant" and currency wars

by Maurizio d’Orlando
Beijing begins to acknowledge the failings of its economic model. Its steel sector is in trouble because of overcapacity and a drop in profits -98 per cent). As the economy's main engine, exports, stutters, fears are growing of economic and social implosion. Currency wars in the Far East could threaten the peace.

Milan (AsiaNews) - China's steel sector is suffering from an acute case of overcapacity. Profits dropped by 98 per cent last year,[1] this according to the Hong Kong-based  South China Morning Post. The mainland has at least 900 million tonnes of crude steel production capacity, far higher than its official total output of 716 million tonnes last year, this out of a total world production of 1,548 megatonnes (Mt).[2]

Until a few decades ago, steel output was a measure of national economies (unfiltered by variable and sometimes arbitrary exchange rates). Once upon a time, the Soviet Union showed off its steel production as a measure of its economic progress. Today, although relevant from an economic point of view, steel production has lost its old lustre. In many fields, other basic materials have replaced steel (for example, plastic in car production).

Yet, steel remains a key component in the construction industry, which is a key sector of the economy. This mean that trends in steel sales are a good measure to understand what is going on in the real economy.

Steel sales and the real economy

However important, steel would not be that significant for AsiaNews, which is after all a missionary publication and not industry newsletter, were it not for what it says about the real economy.  Indeed, even though the South China Morning Post may be concerned by steel overproduction in China, the situation is worse in the rest of the world. In 2012, the mainland's average capacity utilisation ratio stood at 79.55 per cent in China against 78.8 per cent in the rest of the world.[3] This is an interesting because it lets us look at how monetary distortion[4] impacts on the real economy.

We must start with the fact that China's crude steel production in 2012 represented 46.25 per cent of world output even though its population constituted only 19.2 per cent of the total. In per capita terms, Chinese production is thus 240 per cent higher than average. To achieve this, China has to import iron ore as well as coal. At the same time, since most of its plants are obsolete, technology plays little in its comparative advantage compared to more technologically advanced nations. What is more, even if wages are generally low, labour costs generally play a minor role in the overall picture.

One major factor that partially explains China's lead in steel is the absence of an adequate legal framework to regulate pollution. However, even the "freedom" Chinese steel plants have to pollute, which everyone can see, does not explain the mainland's bloated steel industry.

The main factor is the exchange rate policy China has maintained for the past 20 years, since 1994 to be more precise, when the value of the yuan was arbitrarily set at 45 per cent of the Purchasing Power Parity (PPP) of the average of foreign currencies.

From production overcapacity to export crisis

Under a trading regime established by the World Trade Organisation based on international accords aimed at eliminating tariffs, the monetary distortion imposed by China on the rest of the world was the price to pay for its gradual implementation of an open market (today we would call it globalised) economy in replacement of its old Maoist centrally-planned economy.

Yet, labels aside (turbo capitalism, hyper-liberalism or capitalist communism), China is anything but a market economy since its exports, thanks to the exchange rate, benefit from a 45 per cent subsidy (plus other administrative incentives).

This also applies to the rest of the economy, not only the steel industry, but is especially true for industrial minerals, metals, raw materials and basic industrial products. Hence, China's economic success in the last two decades is not due to increased efficiency but to currency distortion.

The logical consequence of export subsidies on China's development has been the growth, like some cancer, of an economy based on the intensive and abnormal use of resources. In plain English, we call such inefficiency waste. One of its effects has been on the cost of raw materials, something that we at AsiaNews have often written about in the past ten years.[5]

What is new this time is that a large mainstream paper has acknowledged the problem of production overcapacity. The admission that there is a problem in overcapacity is very significant because it amounts to acknowledging indirectly, and this for the first time, that China's export-driven model is linked to the outside world.

With China's steel production at almost 50 per cent of world output, with highs of 70 per cent and more in other industrial sectors, it is clear that the margin for growth is currently nil. As exports stall, China's growth stutters.

Risk of implosion for China's steel industry

For Chinese leaders, this is serious problem. High rates of economic growth must be maintained if they want to avoid further alienating their people, turning what is now localised unrest into a nation-wide movement that could overthrow the ruling clique.

With world demand in the doldrums, the link between the outside world and the mainland becomes more clearly recognisable. Under the circumstances, the Chinese regime can no longer export the effects of its internal contradictions.

So far, Beijing has met popular unrest with high levels of growth. Until 2008, this was made possible by booming exports. After that, the construction of ghost towns picked up the slack, adding further production capacity to an already existing overcapacity.

Even though it had a distorted financial and monetary system, China's real economy could function but up to a point. Now the underlying contradictions are getting to the point where they are likely to burst one way or the other.

All this highlights the theoretical mistakes of the past 50 years made in China and the world.

Under Keynesianism, governments make people dig ditches and then fill them up so that they can have an income and generate growth.

This error is not only based on a lie-that any job is good job, a value that can be appreciated and used-but is also a recipe for a disaster of greater proportions.

To build in order to "create" jobs out of nothing, employing people to make goods that no one wants or needs, especially build flats for China's real estate market, is a poor way of allocating resources, a waste, a bad investment that has a price in social terms, one that can lead to military conflict.

Waste and bad resource allocation can cause to tensions among nations vying for control over them. This happened in the 1930s, when Nazi Germany rearmed. Government expenditures on weapons and public works initially allowed the German economy to recover. However, greater demands for food and raw materials by German industry sparked by an arbitrary rise in public spending led to a policy of territorial expansion. Hitler's goal of lebensraum or living space was aimed at giving Germany privileged access to resources. The war that followed is a well-known chapter in history.

A (currency) war in the Far East

Japan's recent decision to devalue the yen by about 28 per cent has in a few months led to the devaluation of China's yuan and South Korea's won. The currency wars that preceded last century's wars appear to be back.

Those who rationalise that the evil and suffering of WWII at least allowed us to emerge from the crisis of 1929 are wrong. The United States recovered from its pre-war economic crisis because it was the only industrial economy that was able to avoid extensive destruction. The rest of the world had to wait until the early 1960s to see high levels of growth after two decades of relative peace. For this reason, we in AsiaNews now fear for peace in the Far East.


[1] "Mainland China steel sector facing closures," in South China Morning Post, 13 March 2013.

[2], "World crude steel output increases by 1.2 per cent  in 2012," in World Steel Association, 22 January 2013, retrieved on 18 March 2013.

[3] Ibid.

[4] D'Orlando, Maurizio, "Bernanke's choices, no help for the real economy of emerging nations," in AsiaNews, 4 March /2013.

[5] See for example, ibid, "Greater conflict in Gulf would spark economic and social crisis," in AsiaNews, 24 April 2004, and ibid, "Chinese yuan set to replace dollar," AsiaNews, 3 January 2009.


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