Raw Materials Shock Coming From China?

Ratio of raw materials usage to GDP could start to level

Suppliers of raw materials to China such as Brazil, Australian and Indonesia may have a shock awaiting them. So many assumptions are based on China’s economy continuing to grow by 8 percent or so, its need for energy and minerals to grow at least as fast and for its demands for imported food to meet expectations of an increasingly meat and fats focused diet to keep expanding as well.

The shock may not come from sharply lower overall growth. An abrupt decline in growth to the 4-5 percent level would simply make a moderate shock for the commodity exporters into a major one. The issue instead is a reversal of a decade of steep rises in the ratio of materials usage to gross domestic product. According to the investment bank UBS, using data from CEIC, this has doubled over the past decade, from about 60 percent of GDP growth to 120 percent. The rise has been continuous, apart from a decline in 2008 and 2009 which was then followed by a steep rise as massive government-ordered infrastructure spending kicked in, peaking in 2010.

Iron ore was clearly the biggest beneficiary of this surge in road, railway and housing construction but so too was coal to power cement plants as well as for steel production and other minerals from copper to aluminum and nickel and lesser known ones such as tungsten and antimony.

Over the past year materials’ intensity has declined slightly but it could easily fall off a cliff thanks to the problems of the private housing market, the sharp slowing of new railway projects and tougher times for local governments, which had been using revenues from rising land prices to fund all kinds of public buildings and works, many of which were more for show than capable of generating economic return. Some of this slowdown will be offset by increased spending on social housing to combat concerns about excessive housing prices.

But house price stabilization is actually bad for local government revenues and the central government is unlikely to want a new bout of inflation and property speculation by easing monetary policy too drastically. As it is, interest rates remain almost zero in real terms.

Urbanization is also slowing due to the falling number of people in the 15-25 age group still in rural areas. Meanwhile rising real wages are China's best hope for sustaining rapid growth and re-focusing on consumption rather than fixed asset investment. Labor shortages in some regions are a good sign that upward wage pressures will continue. But these increased wages are likely to be spent on items such as consumer durables and services such as internet connections, education, health care and hair styling – none of which are materials intensive.

Growth also promises to be less energy intensive, again a government objective, and energy demand to be increasingly met by wind, solar and natural gas more than coal – of which Indonesia is the most exposed marginal supplier.

So what would be highly beneficial for China looks likely to come as much of a shock to those relying on it for their exports as did the shock around 2004 when iron ore and other mineral producers found that the sudden rise in Chinese materials intensity caught them short of supply as a result of years of low investment in new mines. Now new mine projects are numerous but must face the prospect of a sharp reversal in energy intensity.

The same may apply to a lesser extent to food. China’s buying of soybeans, corn and palm oil to meet demand for fancier diets may almost have run its course as urban China now faces huge problems with diabetes and other chronic diseases brought on by over-rich diets and lack of exercise. For sure there are still many who do not enjoy access to such diets but the growth in demand for animal protein demanding requiring large inputs of animal feed will flatten out. Higher incomes will be spent more on fruits and maybe imported luxury foods.

Feed grain prices are of course much less predictable due to weather-induced annual fluctuations in production and any stagnation in Chinese demand for palm oil maybe offset by Indian and Middle East demand. Nonetheless, the assumption that the forests of Indonesia and Brazil will forever have to give way to palm oil plantations and soybean fields may be mistaken as these crops have their long cycles too.

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