Tags: China | construction | bubble | rebound

China’s Construction Bubble is Popping

By    |   Monday, 08 October 2012 07:41 AM

This article is about two issues. Both important. Both related. The first issue is that China’s construction bubble is popping. The second issue is that everyone expects it to naturally rebound.

First, let’s discuss China’s construction bubble. One of the better indicators of construction growth is sales of construction equipment. More construction equipment sales means more construction. It is a bit of a leading indicator, since construction firms have to buy equipment before they start or expand construction.

In China, sales of construction equipment are plummeting. Sales of excavators, a workhorse of construction, fell 38 percent in the first six months of 2012, according to a Chinese machinery trade association. Overall sales of construction machinery are expected to drop 24 percent this year from 2011, according to London-based Off-Highway Research. U.S. engine maker Cummins reported that its second-quarter revenue from China plunged 55 percent from a year earlier. Caterpillar reported that it can no longer sell all of its Chinese production in China and has started exporting construction equipment out of China. Other companies are doing the same. Exports of equipment rose 115 percent in July from a year ago.

Editor's Note: 'It’s Curtains for the US' — Hear Unapologetic Warning from Prophetic Economist.

Clearly, China’s construction bubble is popping. I have often spoken about China’s economy being an even bigger bubble than the United States’. The various government stimulus programs implemented since the collapse of their exports in the 2008 financial crisis, including massive lending from government-controlled banks, have produced an artificial construction boom of enormous proportions. However, it will pop. The Chinese government cannot maintain it. The buildings and infrastructure that the government is building are empty and cannot pay for themselves. We are now starting to see the early signs of the pop in these construction equipment sales figures.

So, what’s the normal response by so many financial analysts? No big problem. The government will come to the rescue and provide more stimulus to get the economy back on track. Of course, that analysis ignores the fact that the whole reason the construction boom exists IS government stimulus. The government is straining just to continue the enormous stimulus they are doing. That strain is now showing. They can’t keep doing this forever.

Could they prop things up a bit with some more talk about new infrastructure projects and slowing down the decrease in government stimulus to keep hopes alive? Sure. But the bubbles are a popping in China, that’s all there is to it. The construction boom won’t last that much longer.

So, that leads us to the second important and related issue: The natural rebound in construction everyone expects due to a natural economic growth rate in China. Yes, most people in the industry expect a natural rebound to the earlier very rapid growth rates. In fact, Caterpillar is maintaining its plans to increase excavator production by an astounding 400 percent by 2015. They expect the Chinese construction boom will just cycle out of this downturn fairly quickly and return to the torrid growth rates of the past.

Of course, expecting a bubble to rebound is the key to denying that it’s a bubble. When a bubble pops, that’s it. It doesn’t rebound. On the other hand, if an economy is cycling down, it is reasonable to expect that it will cycle back up at some point, preferably very soon. There is a big incentive for industry members and financial analysts to ignore the bubble and just assume it is a cycle. It will greatly benefit the industry and the economy if the bubble continues. However, I have to admit the extent to which people believe China’s explosive growth can just go on forever when the rest of the world is slowing down dramatically just astounds me.

It is reminiscent of many people’s view of the Japanese economy as its bubble economy was reaching its peak. In the case of both Japan and China, people are overlooking the fact that the previous growth was due to very real productivity increases. Japan had explosive productivity growth after World War II and, hence, explosive economic growth. Japan, with America’s help, made huge changes in its economy to create that productivity growth.

For China, it was the same in the 1980s. It made huge changes to its economy that created productivity growth — like Japan it also had a lot of outside help in the process. But those changes only create a certain level of productivity growth. Eventually, productivity growth plateaus and, hence, economic growth plateaus until a country makes the next round of productivity changes.

However, instead of making changes, both countries created bubbles. Bubble making wasn’t the actual policy directive, but that’s what happened nonetheless. So, the recent growth in China after the 2008 financial crisis is very much bubble-driven, just as the last years of Japan’s extraordinary growth were bubble-driven.

Editor's Note: 'It’s Curtains for the US' — Hear Unapologetic Warning from Prophetic Economist.

As I have said before, there is no natural growth rate. Economic growth only occurs from productivity growth, and productivity growth only occurs when a country makes the necessary changes to its economy to increase productivity. There is nothing natural about it. No change, no growth.

When Caterpillar and others expect a rebound to the explosive growth of China’s recent past, they are assuming a natural growth rate that simply doesn’t exist. They are ignoring the fact that recent growth was bubble-based and not productivity-based. Therefore, it is guaranteed to pop and not rebound. This same rule holds true for other bubbles around the world, whether in Europe — particularly Spain — or in the United States.

The moral of the story is: China’s massive recent construction bubble won’t automatically rebound because it wasn’t based on productivity growth. When China makes more changes to increase productivity, economic growth and construction growth will rebound, but not until then.

About the Author: Robert Wiedemer
Robert Wiedemer is a managing director of Absolute Investment Management, an investment-advisory firm for individuals with more than $200 million under management. He is a regular contributor to Financial Intelligence Report, the flagship investment newsletter of Newsmax Media. Click Here to read more of his articles. Discover more about his latest book, "Aftershock," by Clicking Here Now.

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This article is about two issues. Both important. Both related. The first issue is that China’s construction bubble is popping. The second issue is that everyone expects it to naturally rebound.
Monday, 08 October 2012 07:41 AM
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