#109: Still the Orient Express?

CHINA – a SEEDS APPRAISAL

The development of SEEDS – the Surplus Energy Economics Data System – enables us to put individual economies under the magifying glass, and this discussion responds to reader requests by looking at China.

Before we start, it’s necessary to remind ourselves that China remains a one-party state in which the authorities exercise considerable influence over the private sector. This matters, because the over-riding concern of the government is to avoid the unrest which would be likely to result from unemployment.

This objective can be a tough call. Despite family control policies sometimes criticized by outsiders, the population of China does continue to expand, and has increased by an estimated 68 million – more than the entire population of Britain – since 2006. Additionally, Chinese citizens continue to migrate from the countryside in search of better-paid work in the cities. Together, these trends make it imperative that employment growth continues unchecked.

For this reason, China is far more concerned with maintaining and growing activity than she is with profitability. This difference of objectives is profound, and can confuse observers accustomed to thinking in terms of the corporate profit motive which drives so much policy in the West.

Over an extended period, China has achieved breath-taking rates of growth in headline GDP. In 2016, the Chinese economy grew by 6.7%, and reported GDP has risen by 136% over a decade, from RMB 22.1 trillion in 2006 to RMB 74.6tn last year. The consensus expectation is that headline growth rates are set to remain in the range 6.5% to 7.0% for the foreseeable future.

In the past, some sceptics have questioned the reliability of reported growth figures, comparing them unfavourably with slower rates of increase in volumetric measures (such as the consumption of electricity). It is true that there seem to be continuity issues (where methods of calculation are changed, but without earlier numbers being restated).

But the really challenging issue now isn’t how much growth China delivers. It is how that growth is achieved.

The first chart puts this question into context. Growth in GDP has continued in a linear way, almost unchecked even by the global financial crisis (GFC) of 2008. But what has changed, radically, since the GFC has been the rate at which Chinese debt increases.

The numbers make this quite clear. Between 2008 and 2016, China’s GDP increased by RMB 35tn, or 88%. But economic debt – that is, the combined indebtedness of government, households and business – expanded by RMB 135tn (242%) over the same eight-year period. This equates to net new borrowing of RMB 3.86 for each RMB 1.00 of growth in GDP.

China debt and GDP Oct 2017jpg_Page1

Nor is this all. In addition to economic debt, China has very high levels of inter-bank or ‘financial’ sector debt. This debt increased from 24% of GDP (RMB 6.5tn) in 2007 to 65% (RMB 42tn) in 2014, and is likely to be about RMB 64tn (86% of GDP) today. Inter-bank debt is often omitted from debt/GDP calculations, because – in theory – it would net off to zero if all banks cleared their debts to each other.

As we learned in 2008, however, netting-off is not a safe assumption under all circumstances. So any assessment of China’s escalating debt position needs to take this into account.

Within the rapid build-up of economic debt, it is corporate borrowing which predominates. Of the RMB 135tn of net borrowing since 2008, government and households accounted for only 18% and 19% respectively.

The remaining 63% – net borrowing of RMB 85tn – was undertaken by private non-financial corporations (PNFCs). These businesses, then, have borrowed a lot more (RMB 85tn) than growth in the entire economy (RMB 35tn) since the GFC. Additionally, banks’ indebtedness to each other increased by about RMB 53tn – again, a lot more than total GDP growth – during that period.

Unlike Western countries, then – where most borrowing is carried out by government and households – the majority of debt growth in China comes from businesses. These businesses use this new debt primarily to grow capacity, often to levels far ahead of domestic or foreign demand.

This creation of excess capacity sustains growth in activity – in keeping with the government’s priority – but it exerts major downwards pressure on margins and profits. This has resulted in returns on capital often being depressed below the cost of debt capital. One obvious course of action would be to convert relatively costly debt into cheaper equity. But, when this was tried, it came close to crashing the Chinese equity market.

Rising levels of indebtedness – both corporate and inter-bank – are a clear cause for concern. From a SEEDS perspective, though, what matters more is that debt-financed capacity creation has boosted activity and recorded GDP to levels which simply would not be sustainable if access to ever-expanding debt was curtailed.

Stripped of this “borrowed growth”, underlying GDP is estimated to be nearer RMB 48tn than the recorded RMB 75tn (see next chart). Accordingly, underlying growth seems to be nowhere near 6.8%, but closer to 3.1% instead, equivalent to 2.5% on a per capita basis.

China underlying GDP Oct 2017jpg_Page1

Of course, this needs to be kept in context, and growth of 3.1% is impressive by Western standards.

But the risk attending the “borrowing effect” is considerable. If  lenders were to become cognizant of quite how much growth is being ‘juiced’ by the spending of borrowed money, the consequences could be distinctly unpleasant. To be sure, and even if capital flight and higher rates followed, China could probably sustain its debt-funded growth from within its own banking system. But there are, obviously, limits to quite how long any economy can keep on growing its aggregate debt by about 13% annually.

Additionally, the sheer pace of expansion in inter-bank debt has to be a matter of concern.

Meanwhile, China remains an energy-hungry economy, relying on imports for 68% of its primary energy needs.  Renewables still account for less than 3% of energy consumption, so are not, even remotely, a near-term fix.

This energy situation is being reflected in a rising trend ECoE (energy cost of energy). SEEDS estimates China’s current ECoE at 14.4%, which is drastically higher than a world average of 7.5%. According to SEEDS, China’s surplus energy position is already looking perilous, and could derail growth in less than a decade.

The final chart shows per capita prosperity, calibrated in constant (2016) RMB 000s per person. The downwards impact of ECoE (the red arrow) looks small, but this is deceptive – the ECoE effect only looks small because it is dwarfed by the borrowing effect.

Unlike many Western countries, China does still enjoy increasing prosperity on a per capita basis.

But the two threats to Chinese economic prospects – superheated debt expansion, and high-and-rising ECoE – should not be underestimated.

Whilst the former carries an elevated risk of financial shock, the latter suggests that Chinese citizens may face uncomfortably rapid increases in the real cost of household essentials in the not-too-distant future.

China prosperity Oct 2017jpg_Page1

 

 

 

31 thoughts on “#109: Still the Orient Express?

    • View at Medium.com

      The article above says:

      “Similarly, the EROI of China’s oil and gas had reached a high of around 14 in the late 1990s, declining to 9.9 by 2012”
      “China’s largest field, the Daqing oil field, provides a clear case study of this process. Just to maintain existing production levels and to reduce the decline rate, China has had to use advanced enhanced oil recovery techniques known for their “high cost and environmental impact”, leading to a lower net energy yield.
      This has led Daqing’s EROI to drop as low as 6.4 in 2012.”

      However, China now imports more than two thirds of the oil it uses.

      Whether China has or has not hit peak oil (some believe it already has) is perhaps academic when its internal EROI is so low.

    • This is looking like a system error, which will be corrected as a matter of priority. It seems to affect most countries, but does not change the world totals.

      Red faces here, but very grateful, Rob, that you spotted it.

    • Thanks. No need for red faces. You do unique and important work. I asked the question because something didn’t feel intuitively correct. China has been successful to date in part because of it’s plentiful motivated low cost labor AND because of its low cost coal generated electrcity. I would have guessed China’s ECoE to be better than the world average.

    • Thank you, Rob, much appreciated.

      The system calculates domestic ECoE for each year.

      Then it calculates, separately, the ECoEs of:
      – domestic production
      – net imports or exports, plus/minus a trade premium

      These volumes sum to the same as consumption, of course – but ECoE is different.

      Clearly, overall ECoE is: domestic supply ECoE +/- net imports ECoE

      The system seems instead to have added net imports ECoE to consumption ECoE. Ouch!

      It seems the 2016 overall ECoE for China should have been 8.6%.

  1. China is a master in intensive livestock farming. Adding antibiotics in NPL form like there’s no tomorrow. Until there is.

    • I’m not aware of China’s role, but this practice is extremely disturbing – over-use of antibiotics, wherever it happens, is very, very dangerous.

    • I’m sorry doc, i should have been more clear. With livestock i meant the people. NPL’s; non performing loans.

    • I think I misunderstood – there has been a lot of coverage in the last few days of antiobiotic-resistant bugs. But yes, there are financial equivalents.

  2. Hi Tim, The New Seeds Spreadsheets are great, lots to get our teeth into thanks.
    Looking forward to the Russian Figures to wit this interesting article in Russia Observer is relevant to the wider Energy based economics analysis.endeavour.https://patrickarmstrong.ca/2017/10/12/exchange-rating-russia-down-and-out/

    “What of the future? Well, there’s a simple answer to that question – compare Russia in 2000 with Russia in 2017: all curves are up. Meanwhile, sanctions are driving the Russians to create new industries, oilfield services for one, or to boost others: agricultural products are now the second-largest export sector. Understandably, many Russians prefer the longtime gain to the immediate (and declining) pain and hope the sanctions continue. For what it’s worth, PwC predicts Russia will be first in Europe in 2050, but, even so, I think it misses the real point: Indonesia and Brazil ahead of Russia? No way: it’s not GDP/PPP that matters, let alone how many USDs your currency buys, it’s full service. (Anyway, by 2050 the renminbi or gold will likely be the measure and how will the USA itself look by that measurement?).”

    “What’s the good of Mercator’s North Poles and Equators,
    Tropics, Zones, and Meridian Lines?”
    So the Bellman would cry: and the crew would reply
    “They are merely conventional signs!

    http://letthemconfectsweeterlies.blogspot.se/2017/09/mish-shedlock-dr-tim-morgan-warren.html

    “We need new ways to talk about progress
    and new ways to measure progress.
    We need to change the paradigm
    and the measures that are used at all
    levels of society—from international
    down to individual.”

    Click to access PP-004-GDP.pdf


    Table 1: Values for GDP per capita (GDP) vs. household consumption expenditure per capita (HCE), welfare-related government expenditure per capita (HWGE), net household savings per capita (NHS) and personal disposable income per capita (PDI) in 2005 international dollars PPP. Values are for the year 2005.
    http://cadmusjournal.org/node/11

    See Table 1 for some 2005 comparisons of different measures of SocioEconomic Development.

    This endeavour is far from easy as you well know Tim, I am trying to be enthusiastic and encouraging as your work is very inspiring and at the same time calling for some sort of Levilised Metric which points to the Paradigm changing analysis needed to move the general understanding of what Future potentials can look like.

    • Thank you.

      You’ll have noticed that Russia isn’t yet included in the published version of SEEDS. Modelling the Russian economy before about 1996 is difficult, verging on impossible. After that, it’s not too difficult in local currency, but the dollar equivalents throw up some oddities.

      I’m working on it, as I am on Brazil, Mexico, Poland and South Africa – and also the Euro Area.

  3. Pingback: EXCHANGE RATING RUSSIA DOWN AND OUT | MUSO MUSINGS ON FATHERHOOD THEORY AND STUFF

  4. Good comments all the way around here. It’s obvious that the global economy is falling in direct relationship with global net energy decline.

    https://www.bloomberg.com/news/articles/2017-10-14/imf-panel-says-no-room-for-complacency-as-global-tensions-rise

    After so many years of warning by researchers we are finally witnessing the effects of high cost energy eroding economic growth. In its most basic sense we are experiencing what Limits to Growth predicted. As the cost of energy increased it would strip the capital from the industrial production. If we just look at the glut of cars now present we see exactly that happening. And right on time as LTG plotted energy would decline before pollution became a real crisis. What few would have imagined were industries like Tesla and Solar PV ponzi’s confusing the issue. But now they’re cracking.

    http://www.zerohedge.com/news/2017-10-14/amid-management-exodus-tesla-fires-hundreds-workers

    It amazes me how people are unable to do simple mathematical analysis of these products. Tesla was impossible from the beginning. First of all an S weighs 4700lbs, technically with passengers it exceeds the weight limit for the Brooklyn bridge. Simple physics would tell you more weight requires more energy to move it. Of coarse the weight is primarily the 1200lb 85kw battery which has the same energy storage potential as 15lbs of diesel. Think about that it is mind boggling. To scale EV to trucking transport would require a semi rig to carry a 40,000lb battery. This would limit its net carrying capacity by 2/3 meaning that in real terms to replace our existing system would require 3 EV for every ICE on the road.

    In addition to that problem we have the limits of lithium production. Presently at current production it would take 200years to produce the amount needed to transform our petroleum based transport to EV. Of course that is all dependent on diesel being available to continue mining lithium, which is kind of the problem in the first place. It would require a 1600% increase in production to come anywhere close to the predicted EV development. And that would become far too little considering that Lithium Batteries only have a 10 year life cycle. So the real production would have to increase by 3200-6400% to be meaningful. But frankly it’s impossible because of two limiting factors. One there isn’t enough know lithium resources to meet that demand ( not referring to reserves which are far less ). Secondly there isn’t enough primary energy to accomplish that level of mining. This is particularly true when we consider that lithium unlike oil is not a source of energy. So besides the production of lithium we need to find the energy to power the transportation system. It’s really just an act of desperation.

    To top it off the carbon intensity of EV production is 400% higher then our present transport system. This means that to break even a Tesla must be driven 100,000 and be charged with something other than coal or gas power generation. And that’s if we discount the fact that the battery at that point would need replacement. So the whole thing from a pollution and energy perspective is a ponzi built on surplus energy from the fossil fuel system.

    A similar analysis on PV Solar exposes the same conundrum. It is simply mathematically impossible to become a Solar based power system. When all costs are included, meaning the energy to mine, manufacture, transport, install, and maintain the system and the infrastructure to distribute exceeds the production of power over it’s life cycle. It has been estimated that the true EROEI is .85 a ponzi. To add to that is the impossibility of running our present power grid on renewables.

    Besides hydro all renewables are intermittent. And we might argue that hydro is intermittent considering India came close to blackout this year because of higher then usual coal consumption, because water levels at there hydro dams are unusually low. The fact remains that our modern industrial driven economy needs a 24/7 power grid to operate. This has been developed by constructing demand generating plants to meet the demand driven grid. What this means is our entire system is built to meet our variable demand driven control. So supply can be ramped up and down at will to meet an unpredictable demand. In a way the system is a huge Perpotional Integral Derivative control. For the grid to work only one variable can exist. Power must be generated at the moment of consumption. This must be matched or you have spikes or browns. It has never been demonstrated that variable demand can be matched with variable supply. As a matter of fact just the opposite has been demonstrated that’s why Miracal Musk is in Australia right now. The fact is without storage a renewable system can never meet the power requirements of our present system.

    Here’s the problem with storage of renewables. The EROEI never works because of utilization rates. For example a 100mw gas plant produces 0-100mw on demand 24/7. However a 100mw solar array produces 100mw only in optimum solar conditions. This on average occurs globally only 1/3 of the year on aggregate. So for a 100mw gas plant to be replaced by a solar array one would need at least a 300mw solar installation combined with at 200mw storage. Unfortunately however this still isn’t enough because peak demand globally is during the northern hemisphere winter period which is the lowest production period. So now we are at a factor of 2-3times nominal installed rating. When you combine this with a 30-35 year life cycle on the PV and 10 year life cycle battery storage with utilization rates in real terms of15-20% it becomes simply impossible to achieve a sustainable system.

    The grand illusion has been that technology will come to the rescue, as if technology has brought us to this present state of development. Well I hate to bust that bubble but technology wasn’t what got us here. Abundant low cost energy is what got us here. If you don’t believe that ask yourself why did the Concord stop flying? Is it because no one wants supersonic passenger flight? Or did the cost become too much because of net energy decline? If it was really technology that produced supersonic passenger flight then why didn’t technology preserve it?

    There are many other examples to prove we are experiencing the effects of net energy decline right now and technology won’t improve the situation.

    As it turns out with an honest evaluation of the present situation is that our current way of life has been an endowment from the biological and geological life on this planet. The abundant energy we have been blessed with was a product of biological life storing energy over the millennia that we’ve tapped and consumed in only 100-200years. For that matter when we discuss sustainability a simple set of rules apply. First all systems are dissapative. Second only systems that can organize and replicate themselves, meaning they produce surplus in relation to their exsistance can sustain themselves. Third they must be 100% recyclable meaning they can have entroponic losses when recycled. Only biology exhibits these conditions. Plants produce more then is required for there continued existence, and reproduce. This is also true of animal life. Interestingly the Physiocrats in France came to similar conclusions.

    The fact remains that wealth is a function of surplus. Surplus has been and always will be a function of biological and geological life. So far biological and geological life are the only systems that can overcome the second law of thermodynamics. The only other system that has attempted to challenge this law is modern economic theory. All of us are in a way placing our bets on one theory or another but we are betting with our lives. My personal opinion is millions of years of demonstrated success versus a few decades of theory clearly exposes the eventual victor.

    The big question remains that if the universe and life in it is a function of the second law, simply stated everything travels from a low entropy to high entropy state, where did the low entropy state come from? And how on earth did a system develop that can sustain it self in that environment come into existence? The mathematical probability is beyond calculation.

  5. Superb comment. Solar, wind and wave fantasies, maybe even hydro, should be abandoned.

    The only viable civilisation is a bio-mass civilisation: energy from wind and water – captured using machines largely made of wood, such as wind and water-mills – and from the sun.

    Sunlight that produces multi-use fibres and woods, and high-heat combustible plants like furze.

    And energy from human and animal muscles. Minimal use of metals.

    Not one of the great managed woods of medieval England was actually exhausted by industrial and construction consumption, contrary to the old myth. In fact, managed trees can live far longer than untouched specimens.

    Mankind is potentially intelligent and disciplined enough to manage such resources for the long-term: we did it once, before lured away by the easy gains to be derived from coal, and the quick profits of clear-cut softwood plantations.

    But ‘transition’ backwards is probably not at all possible at this stage. No civilisation of this extent has ever unravelled before, to state the obvious. It is also possible that ecological devastation has gone too far already in most regions.

    The great eroders of self-discipline, intelligence and wisdom – manifested in true long-term plannning of resource use – are Capitalism and Industrialism (including Socialist Industrialism).

    • I agree with you on the one way nature of technology. There is no way to back out of the predicament. The skills needed no longer exist nor do the environmental circumstances.

      Something that is a fascinating side study is how technology increased capitalisms rise to dominate control of civilization. It’s interesting to consider that fossil fuels have been used for thousands of years but until Watts steam engine industrial production was limited to available sources of energy. This resulted in greater power to the labor class because it wasn’t easy to replace them regionally, and their energy input was higher as a percentage of production. With the steam engine, production could be moved to higher population centers. This put more control in the hands of the industrialist who worked directly with capitalist. As production became more and more mechanized the power gradually shifted toward capitalist market makers. The capital markets soon realized that not only had the industrialist become dependent on capital for production they were also dependent on capital to bring their products to market.

      The system was well developed in Britain by the mid to late 18th century. By this point some have argued that manufacturing had become a lead loss element in the British economy and only served to grease the global system of commerce. The real money was being made by the banking and transportation sectors. Fundamentally as this developed the means of production drifted toward capital market makers which can be seen in today’s venture capitalists.

      Why this is interesting is that it guts the traditional concepts of supply and demand economic theory. Adam Smith assumed that supply and demand would meet civil necessity. However an unvarnished view of economic development reveals that cost of production actually sets the price because it has to be affordable at a scale of efficiency that justifies the effort.

      For example the general public didn’t demand an automobile until the cost was less than the alternative, such as a horse. But it wasn’t pent up demand, but rather cost of production that drove the transformation. That is a repeating pattern. It explains the off shoring of production to China. It explains the development of smart phones. It explains the price of gold and explains the value of bitcoin.

      If we can break out of the the traditional thinking proposed in the university’s we can actually see how things work. And we can see why Yellen and the rest of the CBs actions are not working and are irrelevant.

      Rule number one cost of production sets the price of goods and services. Rule number two markets are controlled by affordablity. So ultimately the goal of industry has been to reduce costs and increase markets. This all works well and fuels growth until you reach maximum efficiency. At that point you can no long create productivity gains. The only way to increase productivity is by reducing cost. That’s when capital comes to the rescue by moving production from high cost energy environments to low cost.

      So globalization was a fundamental necessity not a conspiracy. Without the ability to move production the fixed costs would have ruined the ability of industrial production to fulfill their debt obligations. ( this includes pension obligations) This would have lead to economic stagnation. By moving the most energy intensive elements of production to lower cost areas, the system could continue to increase production and expand markets. Hence continue to grow revenue and meet its debt obligations.

      With a proper perspective it’s clear why we are seeing the global downturn we are now experiencing. And why there is so much debt and under funded pensions. In short it’s been an effort to maintain affordability and growth simultaneously as productivity collapses on net energy declines.

    • I grew up listening to Casey Kasem’s weekly American Top Forty show. Before playing the number one song for the week he would sign off with excellent advice for aspiring artists:

      “Keep your feet on the ground and keep reaching for the stars”

      In the present context “Keep your feet on the ground” means “Remember, we couldn’t be where we are without fossil fuel”.

      If it was ever actually appreciated, this has variously been forgotten, never learned or ignored, by most people.
      For myself, I only learned it in the last two years by chance.

  6. ”It explains the price of gold and explains the value of bitcoin”. I am not sure I understand the statement Mr. Roberts. Could you explain that further please?

    • It’s not easy to fully grasp. But firstly we must dismiss Supply and Demand as the primary market makers. We have to recognize that supply has always preceded demand. The demand follows affordability. That’s why the traditional thinking that oil prices will skyrocket as we near peak production is inherently wrong. Economists have created a false sense of security that the market can miraculously adjust for scarcity.

      When we look at gold what we notice is it trades remarkably close to its cost of production and fluctuates relative to energy because energy is the primary cost when your mining gold.

      Bitcoin is similar. If you calculate the energy required to complete the iterations needed on a block chain to receive a Bitcoin the cost has been very close to the value of each Bitcoin produced. Recently Botcion has spiked because of speculation and currency flight. The architecture of Bitcoin however creates a pyramid type structure. Each proceeding Bitcoin requires greater and greater calculations hence more energy hence higher cost of production. If you got in early you did great if you got in late you might break even. The interesting thing is the cost is exponential so it’s possible that the last Bitcoin will never be mined because of an infinite number of iterations. When that happens the value will either be infinite or zero.

  7. Every movement in the metabolism requires conversion of high grade fuel to unusable waste heat. It is the fuel that is valuable. As fuel becomes scarce, gold will become more worthless as it will take more and more gold to purchase the same amount of fuel. Perhaps gold will be outlawed and fuel will be rationed.

    • Good point often gold bugs miss that fact. Gold will trade to energy based on depletion not based on previous yield. So gold is not the store of value people think it is.

    • When our current fiat system implodes due to thermodynamics, lack of growth, severe deflation or hyperinflation, all those billions become worthless. Maybe Russia will sell its oil in exchange for the crypto Ruble, maybe a gold backed Yuan. Fact is that without continuous growth our fiat system dies. Good quality handtools are a form of wealth preservation, so is gold, but only when people choose to. A new system is on the horizon and this new ‘form’ cannot be backed by trust, faith or promises.

      So get rid of your fiats.

  8. Thank you Mr. Roberts for the clear explanation. WRT other comments on this topic, if bitcoin purchased earlier is more valuable because of its relatively cheaper cost of production, so should the existing stock of gold since those were mined at lower energy costs. Given the sharp increase in the price of all financial assets, gold appears to be relatively better priced since it still trades at near production cost. I am not a gold bug but admit to be puzzled by these relative valuations. On the inflation/deflation issue, I would think the enormous global debt overhang requires inflation. The UK just reported 3% inflation possibly a result of the falling currency value but the US is going up too. Capital investment in energy extraction is low, so all signs point to inflation from cost push factors, not deflation.

    • If Supply Demand function was true I would agree but it appears to be an affordability issue. Any inflation at all will curb spending. Wages aren’t growing because productivity is falling.

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