Föhrenbergkreis Finanzwirtschaft

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Good News: China Is Making Less Useless Stuff

Posted by hkarner - 26. Juli 2017

Date: 25-07-2017
Source: The Wall Street Journal

China’s fight against overcapacity is finally showing some results

One of Western politicians’ biggest complaints against China is that it invests and produces too much, consumes too little, and expects the rest of the world to absorb the remainder. But in the worst-offending sectors, including global trade flashpoints like steel, aluminum and petrochemicals, the picture is brightening at last. That could help put a floor under commodity prices, even if Chinese overcapacity is far from cured.

The recent improvement partly stems from an uptick in construction at home taking in more steel and cement. But there is also evidence that China’s endless campaigns against dirty steel and aluminum plants have been working, slowing the country’s reckless overinvestment.

One way to tell things are different is that gross profit margins for producers of metals like aluminum and copper are no longer declining. Those margins had halved between 2011 and mid-2015 to just 6%, dragging that of global competitors down with them.

At that point, though, investment in areas like metals smelting, cement and chemicals turned negative and hasn’t recovered since. Beijing appears to have realized that allowing China’s army of small producers to keep spewing dust and chemicals into the faces of unhappy middle-class citizens, while simultaneously crushing margins at key state-owned companies, was no longer viable.

With investment in superfluous capacity stalling, the decline in margins in the coal and steel sectors appears to have bottomed out. Aluminum is now in the crosshairs: an April directive to shut illegal smelters by this fall could cut capacity equal to 9% of China’s total 2017 output, according to energy consultancy Wood Mackenzie.

Such trends should give investors confidence that, for example, the 10% rally in aluminum prices this year is sustainable. The remaining worry is that longstanding distortions in China’s financial sector will keep money flowing to places it doesn’t belong—signs of increasing overinvestment in the oil-refining sector is one example.

It is too soon to declare the war against Chinese industrial overcapacity is over. But that shouldn’t blind investors from incremental victories.

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