Caution on Asia and commodity prices (page 1 of 3)

'Asia is firing on all cylinders. Consumer spending has more than recovered from Sars. In an increasing number of countries investment too is picking up. China is roaring ahead as a source of demand for both consumer and investment goods and, after a soft summer, export growth has picked up again. Add in a recovery in the United States, our bullish forecast for Japan and some signs of life in the EU and you have an economic environment that is better than has been seen for years and maybe the best since before the Asian crisis', so says CLSA in its fourth quarter Asian Economic Research bulletin, dated September 11, 2003.

I agree! Asia is experiencing economic boom conditions although not everywhere and not for every sector of the economy. Moreover, what concerns me regarding the view of CLSA is the statement that the economic environment in Asia 'maybe the best since before the Asian crisis'. Let us hope that these 'boom conditions' will not end the same way they unraveled in 1997!

Over the years, I have been immensely impressed by China's economic development, the relatively smooth and peaceful progress of its society post communism and the rise of standards of living in that country. More recently, I have also been impressed by the changes that have taken place in India over the last two years and which are likely to ensure future trend-line GDP growth in the 5-6% range or even higher.

But, as the economist Clement Juglar wrote in the 19th century, 'paradoxically as it may seem, the riches of nations can be measured by the violence of the crises they experience' and, therefore, I am now more cautious about China's and Asia's economic prospects as well as about the potential for commodities to rise much more in the near term. There are several reasons for this more cautious view.

Whereas CLSA actually predicts economic growth in China to accelerate in 2004, I take a more conservative approach and believe that its growth will slow down considerably or even be temporary interrupted by a mini crisis. In addition, since China's rapid economic expansion had a very beneficial impact on Asia by sucking in imports from the region, I have to assume that any slowdown in its growth rate would also have a negative impact on the rest of Asia as well as on commodity prices.

Let me explain. Unlike in the US, growth in China is driven by net capital formation and exports. Like in the US, growth in China is also driven by strong consumption growth and consumer credit growth, albeit unlike in the US in unsaturated markets. In recent years, China's fixed investment growth has been accelerating and accounts now, according to some experts, for 42% of GDP. Now, let us assume that this figure is grossly overstated and that capital formation only accounts for say 20% or 25% of GDP.

The problem does, however, not relate to the size of current capital spending in China, but to the fact that is has expanded rapidly over the last few years and that large over-capacities have come about in almost every sector of its economy (according to Chinese statistics fixed investment growth is up 30.5% year-on-year in the first nine months of 2003). In other words, it would appear that China's current economic boom has much to do with significant over-investments, which were so common in the American economy of the 19th century and repeatedly led to vicious downturns.

Now I am the first one to admit that the Chinese learnt very quickly from the US government how to doctor economic statistics and, that therefore, the year-on-year growth in fixed investments could be much lower than Chinese statistics would have us believe.