A Trip To China...

I recently traveled to China for two weeks both to visit a company we are invested in and also to visit a publisher who has translated into Chinese my father’s book on life as a newspaper reporter in China in the 1930’s (Haldore Hanson, Humane Endeavour, Farrar Rinehart, 1939).

No matter how often I visit China I am always amazed at the changes. Here are four things I noticed this time.

1. Infrastructure on steroids. The best way to travel today in China is on their high speed rail network (“Gao Tie”). China has 12,000 miles of high speed rail and is planning on building another 10,000 by 2025. America is still working on its first mile!

The high speed trains are fast (anywhere from 120 mph to 180 mph), terribly comfortable, to-the-minute punctual and they allow you to see the countryside, something air travel doesn’t.

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China continues to aggressively urbanize. Blocks of apartment buildings are everywhere (see picture) and they don’t build just one tower, they build maybe 25 towers together, housing upwards of 10,000 people. The issue of how many apartments are bought on speculation and are held empty now was difficult to assess from a fast moving train, however.

 2. The consumer economy. A criticism of China has always been they won’t develop an internet economy because they have no credit rating system, no credit cards and no delivery infrastructure. Well China does it China’s way. Alibaba and Tencent have developed sophisticated non-bank payment systems similar to our debit cards. Everyone pays for nearly everything with their cell phones. Credit cards are way behind. In addition China has cobbled together a sophisticated delivery system using whatever works - from motorcycles to small vans. The market economy with Chinese Characteristics!

3. The sharing economy is all the buzz. China’s State run press agency Xinhua says there are four great new inventions in China today: mobile payments, e-commerce, high speed rail and bike sharing. The Chinese are enthusiastic adapters of new technology and Didi Chuxing, their Uber ride sharing equivalent, is an enormous success. Now bike sharing is taking off (see photo). The Chinese have added a unique twist. You use your cell phone to unlock and rent a bike ($0.16 a half hour) but then you leave the bike wherever you want – no need for docking stations. You see large numbers of bikes in high traffic areas and also lone bikes in quiet neighborhoods. Wherever you are, just pick up a bike, use it and then leave it for the next person. Sometimes it is a bit of a mess on the street, but it sure is convenient.

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4. Pollution. This is the bugaboo of China’s major cities. The country is maybe like Chicago 100 years ago where making money was Priority #1. Cleaning up the environment came later. The picture above is one I took of an all too typical Beijing day from “Coal Hill” looking towards the Forbidden City.

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In the next five years as China’s middle class gets wealthier and more demanding, the government will be pressured to work harder on the environment. Don’t expect improvements in human rights but the environment is something the government can slowly but surely deliver.

China may still stumble or implode as some predict but for now it is still the World’s miracle economy. 

We Are The New China

Well not exactly but it is looking more like this.  For many years China was the engine of the world. It was reassuring to see China growing 10% to 12% per year while we in the developed world were stumbling from one Bubble to another. 

Now the tables have turned a bit.  China is still growing but more like 7% to 8% and there are questions about Bubbles in their real estate market.  Europe has weakened and some feel it is on the edge of another recession, and emerging markets are mixed, some doing well while others struggle with political and economic problems.

The U.S. is the bright spot today. We are creating 200,000 net new jobs  per month, GDP is growing at a 3% annual real rate, our energy production continues to be the marvel of the world and we seem to be less fragile and more insulated from the global economic ups and downs.

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The chart above indicates that although exports are important to us they are not as important as for other countries. Weakness abroad does not get translated as quickly into weakness here. The new found energy in the U.S. has helped push our oil and natural gas prices down. Companies from all over are locating new energy intensive plants here.  The International New York Times recently reported that the Dutch multinational, Royal DSM a maker of nutritional supplements and high tech materials, used to go through a lengthy process of deciding where a new plant would be located. Now, “we won’t even do the study, it is clear the plant will be in the United States.” 

There are problems with this story however. The big one is wages.  The chart at the bottom shows that real wages in many industries have been flat since 2009.  This is not how it is supposed to go. Productivity has increased since 2009 but most workers have not benefited.  Many reasons have been put forth. There are the pressures from lower cost areas, and technology has replaced people with machines. Every company is doing more with less. But this can’t go on forever.

To make long term progress workers will have to make more money. Otherwise demand for housing, autos, etc. won’t grow. With the unemployment rate notching down to 5.8% today and the economy getting closer to full employment, many analysts predict that companies will start increasing wages to attract and keep quality workers. This would be helpful. We are in a healthy recovery now but to keep it so, we need to see across the board income growth for those below the top one percent.

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China: Royal Flush or House of Cards?

The International Comparison Program, a loose coalition of the world’s leading statistical agencies, recently reported that China will become the world’s largest economy this year based on purchasing power parity. PPP measures what money can actually buy. For instance, a hair cut in China is much less expensive than one in the U.S. When you adjust for this you can better compare economies.

The United States has been the world’s largest economy since 1872 so in one sense the recent announcement is a big deal. But in another sense it is not. China is still a low income country. Its per capita income is only 10-20% of the U.S. and globally China ranks just above Turkmenistan but behind Libya and Suriname. 

Source: Financial Times

Source: Financial Times

It is interesting that China fought the release of the ICP data. One reason is that when you are the Number One economy you are expected to take on more global responsibilities. China wants to avoid this, leaving the tricky and expensive problems to the United States. It will not be so easy in the future.

As China gets ever wealthier it will be buying more of what the rest of us produce. This is good news. China today exports 14% more than the U.S but its imports are 30% smaller than the U.S. China’s appetite for imports will increase.

So what could go wrong with China? A big economic question mark is real estate. Apartments and commercial buildings are the investment of choice in China. Hands down. Constructing and outfitting apartments accounted for 23% of China’s GDP in 2013.  This is higher than housing’s share of GDP here in the U.S. prior to the housing bust. In addition, two- thirds of Chinese household wealth is tied up in real estate. At the peak of the U.S. housing boom only 30% or so of our household wealth was in real estate.

Source: Financial Times; ICD; IMF; World Bank

Source: Financial Times; ICD; IMF; World Bank

There are signs of over building in China now. The stories of brand new but empty apartment towers are increasing. Tier one cities such as Beijing, Shanghai, Guangzhou and Shenzhen will probably be fine but second tier and especially third and fourth tier cities could be vulnerable. The Chinese government has done an excellent job controlling the ups and downs of the economy the past thirty years. Whether they can deal with the big elephant in the room now -  real estate - is today’s big question.

Peak Coal? Not Any Time Soon

Every December, the International Energy Agency (IEA) produces a report that looks at the projected demand for coal over the next 5 years.  For those of us concerned about the environmental impact of carbon emissions, the report offered a glimmer of hope.  According to the authors, the demand for coal is expected to grow 2.3% annually each year through 2018.  This rate is down from the 3.4% annual growth experienced between 2007 and 2012. 

Unfortunately, while the rate of growth in coal demand may be slowing, there is little reason to believe that total coal production will decline anytime soon.  Today, coal is the second largest energy source worldwide making up 40% of the total electricity needs.  As the chart below shows, three countries, China (47%), the United States (14%) and India (9%) account for almost 3/4 of coal demand.  Two of these countries, China and India, continue to grow relatively rapidly and, whether we like it or not, energy consumption is closely linked to economic growth.  Today, approximately 280 gigawatts of coal burning power station capacity is under construction around the globe and much of it is in India and China.

In the U.S., growing exports have been a boon to the coal industry which has seen domestic demand decline in the face of tougher environmental regulations and competing cheap natural gas.  In 2012, U.S. companies shipped approximately 114.2 million tons of coal abroad or approximately three times the level of a decade earlier.  A good deal of the ore comes out of Wyoming’s Powder River Basin which is home to some of the country’s least expensive mines.

Of course, the business of making economic forecasts can be tricky.   Remember the often cited prediction by one commentator upon seeing waste piling up on Manhattan streets in the late 1800s that “…by 1930 horse manure would reach the level of Manhattan’s third story windows.”  What the prognosticator failed to contemplate was the possibility that human invention (ironically in the form of the combustion engine) would alter events. 

But trying to clean up coal and use it effectively has been devilishly difficult.  Billions of dollars have been spent on efforts to capture carbon emissions and store them underground with little success. 

To date, the widespread use of coal has made sense; the fuel is both abundant and inexpensive when compared to alternative energy sources.  But coal’s relative attractiveness may finally be changing.  Last fall, the U.S. government passed regulations effectively requiring all new electric generating plants to burn clean coal. Several banks such as the IMF have refused to lend against projects with poor carbon footprints and China has toughened environmental regulations especially in areas around eastern coastal cities plagued by particularly bad air quality. 

Ultimately, how China handles its energy needs will be the dominant factor in determining coal production in the years ahead.  The country is the largest consumer worldwide using three times as much coal as the United States.  Most of the demand inside the country comes from the electricity generating and industrial sectors.  Importantly, central government efforts focusing on modernizing coal-fired electric plants and fostering the use of alternative fuels such as nuclear and natural gas could well have some success in the years ahead (see chart above). 

Growing environmental pressure and emerging cheaper fuel sources, appear to be slowing the rate of growth in coal production.  But unseating coal’s position as the world’s dominant fuel source will require a multi-pronged approach focusing on improved energy efficiency, regulatory mandates and technological breath-throughs.  Let’s hope the global community is up to the task.