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Manufacturing & Industry

China’s commodity subsidising problems are only getting worse


China Stockpiles Cotton

China Stockpiles Cotton

Bloomberg recently reported that China, in order to aid its own cotton farmers by supporting cotton prices, has been buying up excess production into government stockpiles. The world’s biggest producer and user of cotton will have 12.7 million metric tons in inventory by July 31, 2014, 62% of the global total and enough to make about 71 billion t-shirts. But while growers in the U.S. and Brazil cut output, to deal with the price drops related to excess production, Chinese farmers boosted production, having been guaranteed both a minimum price and a buyer.

Further, Moody’s Investors Service has moved its outlook for the Asian steel and coal sectors to negative, highlighting the severe overcapacity problem that China is facing as it strives to resolve its production worries. China’s steel industry had a total profit of 1.58 billion yuan in 2012, a 98% year-on-year drop, caused by rising iron ore prices and a weak market.

And even the National Development and Reform Commission (NDRC) has expressed concerns about excessive overproduction in the non-ferrous metal industries, as it reported that the combined output of the 10 major non-ferrous metals expanded 12.9% year-on-year, and has previously opined that the sector should strictly control its production and intensify its efforts towards eliminating overcapacity.

The overproduction woes continue, and have spread throughout the Chinese economy, as government interference through subsidising markets has only made the problems worse by encouraging more of the bad behaviour they wish to change.

Initially, the Chinese government subsidised their markets through direct payments, cheap interest rates, and low lending standards. These policies ended up driving a boom in Chinese productivity, which led to a dramatic increase in output.

This increase in output was openly welcomed by the world, because processing by Chinese companies was cheaper than processing by domestic companies, and demand for Chinese products grew. Seeing the positive effects of their policies, the Chinese government grew the program, but never took the time to really analyse the situation to find out when the point occurs where they were doing too much.

They are finding this point now, much too late, as they have encouraged the development of too many companies to produce too many goods. Early looks at curbing the development faced concerns about what a pullback might do to the overall economy, and so the process was allowed to continue under the hope it would just work itself out. And with too much construction and development in the pipeline, the problem is only going to get worse.

Things never ended up working themselves out, and makeshift responses to the problem have been the norm ever since they started to see storm clouds on the horizon. However, what they are doing is taking all the wrong lessons from the Great Depression of the United States by following the playbook of Hoover and FDR, which was proven long ago to be a losing proposition.

For example, by buying cotton in order to stabilise cotton prices, so as to avoid the embarrassment of having to go through a “cotton crisis” in front of the world, the Chinese government only exacerbated the problem. Instead of curbing production, the policy ended up encouraging farmers to plant even more cotton. The farmers have taken advantage of a guaranteed government price by expanding their operations in the face of a guaranteed level of income and profit. The responsibility of cutting back in the face of a glut was left to be faced by the “other” farmers.

Now the Chinese government has more cotton than it can know what to do with. Cotton that it must eventually put up for sale in the market, undermining the very prices it was trying to stabilise. Instead of stability, wild price swings will result, as uncertainty about government intentions will lead to overreacting. Just like in the 1930’s United States.

When that happens, the Chinese cotton market will begin to fall into chaos as farmers begin to go bankrupt from having been encouraged to expand their capacity beyond what the market could handle. Being the biggest producer and consumer of cotton in the world, these convulsions will lead to spillover effects in the textile and other industries, as both pricing and supply for these operations will suddenly become uncertain.

These effects will eventually spill over into the global markets, as declining global prices for cotton and massive dumping by the Chinese will hurt everyone across the board.

The positive thing, though, is that it will eventually work itself out. If left to work itself out. Markets will clear, prices will stabilise, production will be adjusted, and profits will return.

Sure, many farmers and workers will be hurt during the adjustment. This is an unfortunate consequence of the situation. But the fault and responsibility lies not with the entrepreneurs and producers, who simply responded to the realities of the situation that was presented to them, but with the policy-makers who skewed the system away from its balance.

What is needed, therefore, is for the Chinese government to step out of the way and let the system correct itself. Frustration and pain will result, but that end cannot be avoided any more. What can be changed is how much pain is to be felt and how soon the system can be turned around.

 

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About colyapi

Colyapi lives in Grand Rapids, Michigan, the United States. Has an engineering background and works as a metal fabricator while advancing economic knowledge during these turbulent times. Specializes in custom problem solving and analytics, and can be heard more often at shadetreeeconomist.wordpress.com

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