As the world looks on entranced at the drama playing out in Washington, an equally significant but far less visible event has been unfolding in our very own time zone.
In Beijing, the all-important Third Plenum, a summit that takes place just twice a decade, has just concluded.
And what a contrast. While Americans have been subjected to a rhetoric-laden, chaotic and violent lead-in to this year’s election, China’s supreme rulers have just concluded the forum with a self-congratulatory memo that delivered a “highly positive assessment” about everything undertaken by President Xi Jinping.
Missing from the communique, however, was any real mention of the problems plaguing China’s economy, let alone any serious measures to alleviate them.
Growth is slowing at an alarming pace. The most recent figures, for the three months to the end of June, were the worst in five quarters while consumer prices again threaten to tip into negative territory.
More alarmingly, the three-year meltdown in its property market continues unabated. What once was chipping away at personal wealth is now running a wrecking ball through the economy, hitting terminally weak household consumption.
From there, its problems extend into regional and local government authorities, which for years have relied upon real estate sales to pay interest on massive debts.
Lower-income households, meanwhile, continue to flounder while better-off households, stung by declining property values, have cut spending which, in turn, is fuelling an already serious trade problem that could spark an outright trade war.
China’s trade trap
US presidential hopeful Donald Trump points to China’s trade surplus as a deliberate attempt by Beijing to take advantage of Americans, to create a common enemy.
There’s an element of truth to his rants. At least, there was.
Beijing may have succeeded in its quest to become the world’s biggest factory by cleverly circumventing trade rules. But two decades ago, it realised that for it to fully transform into a developed nation, it needed to spur household spending; to focus on consumption rather than just investment.
Try as it might, it failed at each attempt and had to keep reverting to big spending infrastructure programs to keep the economy firing.
In the wake of the global financial crisis, Beijing doubled down on investment and since has been caught in a trap. Each time the economy hits rough waters, it has fired up the stimulus cannon.
Office towers, bridges, highways, high-speed rail, and entire cities sprang up where there once was agricultural land.
But Chinese households, rather than consume, continued to save and invest, many in property.
The end result was that China, while exporting to the world, didn’t return the favour through imports.
It’s now getting worse. The real estate implosion has seen household consumption drop to 39 per cent of GDP.
Compare that to the US, where household spending accounts for around 68 per cent of GDP.
That imbalance is now showing up in trade figures. Its monthly trade surplus reached an all-time record in June, providing ample fuel for a Trump administration to spark a fiery trade war with Beijing.
How bad is China’s property bust?
Commodity markets are already preparing for a further downturn.
Iron ore is perilously close to dipping below $US100 a tonne and copper, after hitting a new record in May, is in retreat while aluminium, tin and nickel all slid over the weekend.
For more than a year, China watchers have anticipated that Beijing would either hit the stimulus button again to arrest its flagging growth or to tackle its long-term problems at a more grassroots level.
Instead, it has opted for piecemeal and insufficient measures to improve funding, while happily allowing major developers like Evergrande to crater and thereby send international investors scrambling for the sidelines.
As a measure of just how dire the situation has become, funding for property developers slid 24 per cent in the first five months of this year with little improvement since.
Property and construction accounts for more than 40 per cent of steel consumption, a factor that must alarm Australia’s biggest miners.
As CBA analysts note: “Until property developer funding improves, it’s hard to have confidence that steel demand from the property sector will recover.”
The graph below highlights just how far China’s construction industry has contracted. The lime green line with squares at the bottom — floor space built so far this year — illustrates the extent of the slump in construction.
Construction in May was about 80 per cent lower than the same month four years ago, it is the worst in more than six years and continues to track lower.
Where does that leave us?
While Beijing’s reluctance to ride to the rescue has perplexed investors and worried commodity traders, it has continued its efforts to ensure it has adequate iron ore supplies for decades to come.
More than half our national exports comprise iron ore and metallurgical coal, the two key components in steel making, with iron ore exports largely focused on China.
The property market collapse shows no sign of abating any time soon. Not surprisingly, iron ore stockpiles are building at ports across China.
This decrease in demand, which could take years to play out, has coincided with a massive uplift in global production.
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While Australia and Brazil are expected to dramatically lift production from new and expanded mines within the next two years, the biggest impact is likely to come from Guinea in West Africa.
After 20 years of political upheaval and delays, the giant Simandou mine is almost ready to begin shipping vast quantities of iron ore to China.
Not only is this massive ramp-up in production likely to depress prices, it will also deliver a whip hand to Beijing in any further diplomatic confrontations with Australia.
It’s highly likely that it will impact our national income as well. In 2016, iron ore dropped below $US60 a tonne, denuding the federal budget of much-needed income and putting high-cost miners under extreme pressure.
At that level, BHP, as the lowest-cost producer, is still making good returns with Rio Tinto the second cheapest producer and Fortescue slightly higher than Rio.
Rio Tinto, which features a Chinese state-owned enterprise as its biggest shareholder, is a major player in Simandou with two of the four blocks at the world’s biggest untapped deposit.
Australia has done exceptionally well riding the China boom. But the political and economic uncertainty surrounding the world’s two biggest economies point to tougher times ahead.
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