Friday, 1 June 2007

Has the Long Slow Fuse Been Lit?

How long can China maintain its recent growth rate?

I was sitting on a passenger train next to a freight train that was full of containers going to and from China musing on just that question. A quick calculation revealed that, if current growth in port and shipping capacities continue, and if Chinese exports of manufactured goods continue to grow at their present rates, then by 2012 to 2014, every ship in the world will be involved in the China trade and, sadly, there will be insufficient port capacity to land the goods.

If this ridiculous scenario is to be avoided, then more carrying capacity needs to be developed (a possibility), or the Law Of Large Numbers will apply to the Chinese economy (far more likely). The Law Of Large Numbers is easy to comprehend. If we want to increase our income by 10% each year, then it is easier to move from £10 to £11 than it is to move from £100,000 to £110,000. As China weighs heavier in world trade, we would expect the rate of growth in China’s trade to diminish. This is the Long Slow Fuse.

We have seen something similar in the recent past in relation to Japan. In the 1960s, the growth rate of Japanese exports was quite considerable when compared to European and US growth rates. However, the Long Slow Fuse had been lit. It detonated in the 1980s, and consigned the Japanese economy to an unwinding that has taken the best part of a generation to work out. We are of the view that a similar process will occur to the Chinese economy.

Three recent stories support our view. First, there was a story in the Wall Street Journal about the triangulation of Chinese exports to avoid quota restrictions (see article). Second, there was an article in The Business about how the Chinese sovereign wealth fund ($300 billion this year) is being steered away from US T-Bonds, where the weight of Chinese money (currently $1.2 trillion and rising) is forcing down rates for investors, and into Private Equity in a search for higher returns (see article). Finally, there was a report on the BBC about how the Nanjing Automobile Corporation had re-opened a car plant in the UK (see story). This is part of a trend where Chinese companies assemble within the EU as a means of avoiding export quotas to the EU.

What all three of these stories have in common is that they represent actions taken by Chinese companies to avoid the Law Of Large Numbers, and represent, to our view, evidence that the Long Slow Fuse has been lit. If so, we might ask, will it end with a bang or with a whimper? That is, possibly, a more important question.

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