China has spent $750 billion on rail lines, much of it wasted.
The culprit is not design, but rather shoddy construction accompanied by fraud, greed, and unrealistic growth targets. If that sounds familiar, it's because it was one of the factors in the US housing bust, and indeed every huge bust in general.
Here are a couple of links on the high-speed rail lines I got from Michael Pettis at China Financial Markets.
'Judgment day' fears for high-speed rail tracks
South China Morning reports Judgment day' fears for high-speed rail tracks
Construction of the mainland's massive high-speed rail network is in danger of becoming a victim of its own success.China Rail Chief�s Firing Hints at Trouble
The breakneck speed at which track is being laid means engineers are likely to have to sacrifice quality for quantity on the lines' foundations which could ultimately halve their lifespan.
The problem lies in the use of high-quality fly ash, a fine powder chemically identical to volcanic ash, collected from the chimneys of coal-fired power plants. When mixed with cement and gravel, it can give the tracks' concrete base a lifespan of 100 years.
According to a study by the First Survey and Design Institute of China Railways in 2008, coal-fired power plants on the mainland could produce enough high-quality fly ash for the construction of 100 kilometres of high-speed railway tracks a year.
But more than 1,500 kilometres of track have been laid annually for the past five years. This year 4,500 kilometres of track will be laid with the completion of the world's longest high-speed railway line, between Beijing and Shanghai. Fly ash required for that 1,318-kilometre line would be more than that produced by all the coal-fired power plants in the world.
Enter low-quality fly ash.
Professor Wang Lan , lead scientist at the Cement and New Building Materials Research Institute under the China Building Materials Academy, said that given poor quality control on the mainland, the use of low-quality fly ash, and other low-grade construction materials, was "almost inevitable" in high-speed railway construction.
And that could have fatal consequences, Wang said. With a catalytic function almost opposite to that of good fly ash, the bad fly ash could significantly weaken railway line foundations and shorten a railway's lifespan by about half. That would mean China's high-speed rail tracks would last only 50 years.
Zhu Ming - a researcher at Southwest Jiaotoing University's School of Civil Engineering who experimented with fly ash at a Beijing-Shanghai high-speed railway construction site last year - was even more pessimistic.
The use of low-quality fly ash would threaten the safety of rail passengers and "judgment day" might come sooner than expected, Zhu said.
"Quality problems with Chinese high-speed railways will arise in five years," he said. "I'm not talking about small problems, but big problems. Small problems such as occasional cracks and slips that delay trains for hours have already occurred. Big problems that will postpone an entire line for days, if not weeks, will come soon.
"When that happens, the miracle of Chinese high-speed rail will be reduced to dust."
The New York Times reports China Rail Chief�s Firing Hints at Trouble
In his seven years as chief of the Chinese Railways Ministry, Liu Zhijun built a commercial and political colossus that spanned continents and elevated the lowly train to a national symbol of pride and technological prowess.China's Vacant Cities
His abrupt sacking by the Communist Party is casting that empire in a decidedly different light, raising doubts not only about Mr. Liu�s stewardship and the corruption that dogs China�s vast public-works projects, but also, perhaps, the safety, financial soundness and long-term viability of a rail system that has captured the world�s attention.
Mr. Liu, 58, was fired Saturday and is being investigated by the party�s disciplinary committee for �severe violations of discipline,� a euphemism for corruption. His high government rank � minister-level officials are rarely fired under such a cloud � hints at far deeper dissatisfaction with one of China�s most publicized and sweeping domestic initiatives.
Until last week, Mr. Liu had led China�s program to lace the nation with nearly 8,100 miles of high-speed rail lines and to build more than 11,000 miles of traditional railroad lines. The sheer size and cost of the endeavor � the investment has been estimated at $750 billion, some $395 billion for high-speed rail alone � has led experts to compare it to the transcontinental railroad that opened the American West.
President Obama hailed China�s program in his State of the Union address and called for the United States to move quickly on high-speed rail plans that had been repeatedly delayed by budget concerns and political infighting.
There are some clues in top officials� public statements since the scandal broke. Speaking on Monday in Beijing, the official who is believed to be the country�s new railways chief, Sheng Guangzu, said the ministry would �place quality and safety at the center of construction projects.� For good measure, he added that safety was his highest priority.
The statement underscored concerns in some quarters that Mr. Liu cut corners in his all-out push to extend the rail system and to keep the project on schedule and within its budget. No accidents have been reported on the high-speed rail network, but reports suggest that construction quality may at times have been shoddy.
Analysts have warned that the construction schedule ordered by Mr. Liu threatens to push the ministry�s debt � already $170 billion last fall � to an unsustainable level.
A 2010 analysis by China Minsheng Bank, reported this week by Caijing, found that the ministry�s debts equaled 56 percent of its assets and could reach $455 billion, or 70 percent of its assets, by 2020. In his last months on the job, Mr. Liu had begun an aggressive program to deal with the debt by selling stakes in the railway to investors like large state-controlled banks.
The Minsheng report suggested that the high-speed network may remain a money-loser for the next 20 years, despite heavy use. Ticket prices � several times those for a conventional train � have led to a backlash among some Chinese.
The timing of Mr. Liu�s dismissal may be significant: He was fired at the end of China�s Lunar New Year holiday, when trains are jammed, tickets are scalped at exorbitant prices and passengers are angriest.
The Communist Party has long worried that corruption may undermine its credibility with the public. But outside analysts agree that high-level officials are seldom sacked for corruption alone, in part because kickbacks, favoritism and other below-board activities are so common.
Russell Leigh Moses, a scholar of the Chinese leadership, said that Mr. Liu�s dismissal could signal disquiet over whether expansion of the rail system had gone too far, too fast.
�You don�t take someone down at that level of status unless they�ve done something really egregious,� said Mr. Moses, who works in Beijing. �I don�t know whether it�s politics or policy. But I wouldn�t rule out the second.�
China's problems go far beyond high-speed rail, to construction and malinvestment in general.
I have talked about China's Vacant cities before but here is a quick recap from Chinese Bank Lending Spree Continues; $75 Billion New Loans First Week in January Alone; Inflation Gone Amuck
In case you missed it, please consider Amazing Satellite Images Of The Ghost Cities Of China on the Business Insider.Long Sharp Slowdown or Economic Collapse?"There�s city after city full of empty streets and vast government buildings, some in the most inhospitable locations. It is the modern equivalent of building pyramids. With 20 new cities being built every year, we hope to be able to expand our list going forward."More Vacant China City Stories
- Implosion of the China "Fabric City" Frenzy
- 10 Signs of Speculative Mania in China
- Email from a Chinese on China's Real Estate Bubble
China property bubble will overheat until it implodes. In the meantime, regardless of what China reports on the CPI, inflation remains a huge problem. Once again, those looking for inflation can find it in China, not the US, where consumer credit is contracting.
Inquiring minds are wondering if these malinvestment schemes mean China will suffer an economic collapse. While not a China bull, Michael Pettis makes a case for a long period of sub-par growth rather than an outright economic collapse.
Here is a snip from his latest 13-page newsletter (subscription) , by permission. I added the subtitles in red, black headlines are original. Michael Pettis writes..
Optimist Case for ChinaPeak Oil and Chinese Energy Consumption
Optimists argue that China has far less infrastructure, including high-speed railroads, for its size and population than countries like Japan, and so it will take years of building before we have to worry about excess infrastructure investment. They claim that the externalities associated with expanding the rail network are so high that in spite of the huge costs they nonetheless make economic sense for China, especially over the longer term as productivity rises.
Pessimist Case for China
Pessimists argue that with costs of capital set so artificially low and with tremendous near-term pressure on local policymakers to promote large infrastructure spending, there is an incentive for policymakers to misallocate capital, and when there are incentives to waste money, money tends to get wasted.
I am in the pessimist camp. Not only do I believe that the combination of very low cost of capital, socialized credit risks, and strong short-term political incentives to fund massive projects always leads to capital misallocation, but I also believe that the explosion in NPLs [Non-Performing Loans] a decade ago, and the fact that total SOE [State Owned Enterprise] profits are just a fraction of the interest rate subsidy they receive, is strong evidence that misallocated capital has long been a serious problem in China.
Collapse?
I realize that there is always the possibility that this time really is different, but the constellation of factors � rapid credit expansion, cheap capital, incentives to ignore risk, large-scale fraud � is striking. It is rare to see all of these things come together without a serious correction following, although of course it is folly to try to time it. All we can say is that the later the correction comes, the deeper it tends to be.
By the way this is not to say that China is about to collapse into crisis. I�ve noticed over the past two years that a lot of commentators in China and abroad are citing me or my arguments in support of their own claims that China is about to collapse, but although I have been very skeptical of the growth story here for many years, I have never argued that China would collapse. On the contrary.
In my opinion, a financial collapse requires specific balance sheet structures in which inverted liabilities (i.e. the opposite of hedged) are combined with self-reinforcing mechanisms that exacerbate changes on both the up cycle and the down cycle. I believe however that with Beijing�s control of the liquidation process, of interest rates, and of investor behavior, the Chinese financial system is organized in part to prevent financial crises.
But in so doing it is also organized to exacerbate underlying imbalances and ultimately to increase the cost of the adjustment. This means that if we are nearing the end of the growth model�s life (in the next year or two if there is a strong consensus at the top, or in the next three to four years if there is a difficult leadership transition), the adjustment will not occur as a crisis but rather as a long and sharp slowdown in economic growth.
But to get back to the main story, investment-related fraud can occur at any time and during any period, but as many historians have noted, they become extremely hard to cover up during the stressful period just before a major balance sheet contraction � just think of Bernie Madoff, who managed successfully to hide massive fraud for many years. The rising revelation of fraud is one of the warning signals we should be tracking. Is this happening in China? Perhaps not yet, but if we see too many of these stories pop up in the next year or so, it should increase the sense that we nearing the end of the growth model�s life.
China Hikes Reserve Requirements
On Friday the PBoC announced yet another 50-basis-point hike in minimum reserves (making it the fifth hike in five months).
But will these measures bite? My guess is that they will at first, but that when they do they will be quickly reversed. Any real attempt to reduce the sources of overheating will cause economic growth to slow too quickly, and Beijing will change its mind, especially if, as I expect, inflation peaks soon and starts to decline.
Mission Impossible
Let�s face it � most Chinese growth is the result of overheated investment, and removing the sources of overheating without eliminating growth is going to prove impossible. I have been making the same argument for at least two or three years, and so far we have seen how Beijing veers between stomping on the gas when the economy slows precipitously and stomping on the brakes when it then grows too quickly. I don�t believe anything has changed.
Deposits are down
If you count all lending, and not just the formal lending that shows up on bank balance sheets, loan growth has been greater than ever, and what�s more total lending in 2010 was actually higher than in 2009. Remember that in 2009 new lending was RMB 9.6 trillion, and last year it was just under RMB 8 trillion. This was widely presented as a �prudent� reduction in credit expansion. It turns out there was no such reduction.
On a related note, the most interesting number in the NBS release, perhaps, was January the level of bank deposits. They were down. Dong Tao at Credit Suisse says that this is the first time this has happened since January 2002:
What was more concerning was that it was corporate deposits that went backwards, not household deposits, as may have been expected around Chinese New Year. This gives us reason to believe that the fall in deposits is not seasonal.
So why did corporate deposits drop? My guess is that large businesses may be finding it much more profitable to lend money to other businesses, especially those who don�t have easy access to bank credit, than to deposit cash in the bank at such negative real rates.
Zaiteku again?
But not a good one. Those of us old enough to remember the 1980s will be reminded that the Japanese had a word for this kind of activity: zaiteku.
According to the Japanlink website, zaiteku is an abbreviation of zaimu tekunorojii, which means "Raising profit by utilizing capital for securities investments, real estate and the like." In the late 1980s Japanese companies, faced with the combination of highly repressed borrowing costs and the prospects of ever-rising asset prices (sound familiar?), discovered that it was far easier and more exciting to make money by speculating than by normal operations, and it became the great fashion among Japanese corporations.
But it came with a huge cost. Japanese companies began relying increasingly on zaiteku for profits and imbedded increasingly risky structures into their balance sheets. When the seemingly impossible happened, and asset prices stopped rising inexorably, the impact on Japan�s subsequent contraction was made much worse.
From the Japanese experience (and many others) it is clear that when SOEs and large businesses find it profitable to speculate on asset markets, intermediate loans, or otherwise earn financial profits, they usually do, in which case we need to worry about three things. First, financial transactions � especially when they largely replicate risks that are being taken already within the financial system � increase systemic risk even as they disguise risk-taking. A problem in the financial markets is reinforced by a drop in corporate profitability tied to financial speculation, which then reinforces the problems in the financial markets.
Second, Chinese banks already do a bad enough job of assessing credit (why not, when most credit risk is socialized?), and it is hard for me to believe that we are going to see much better credit risk management from corporate treasurers, and even harder not to wonder if guanxi will play an important role in this whole process.
Third, the more lending occurs away from the purview of the PBoC and the CBRC, the less control and oversight monetary authorities will have over the financial system.
Of course within the banking system it is pretty clear that the regulators continued to be worried and are stepping up measures to control lending.
On the one hand overinvestment, excess liquidity and credit expansion, off-balance sheet activities, and zaiteku are generating huge growth and, along with it, huge risks, while on the other the PBoC and the CBRC are doing what they can to monitor, manage, and limit risks in the banking system. I wonder if they can pull it off.
One factor Pettis did not mention was the effect of peak oil on China's growth.
In July 2010 the Wall Street Journal reported China Tops U.S. in Energy Use
China has passed the U.S. to become the world's biggest energy consumer, according to new data from the International Energy Agency, a milestone that reflects both China's decades-long burst of economic growth and its rapidly expanding clout as an industrial giant.US China Peak Oil Doomsday Clock
China's ascent marks "a new age in the history of energy," IEA chief economist Fatih Birol said in an interview. The country's surging appetite has transformed global energy markets and propped up prices of oil and coal in recent years, and its continued growth stands to have long-term implications for U.S. energy security.
The Paris-based IEA, energy adviser to most of the world's biggest economies, said China consumed 2.252 billion tons of oil equivalent last year, about 4% more than the U.S., which burned through 2.170 billion tons of oil equivalent. The oil-equivalent metric represents all forms of energy consumed, including crude oil, nuclear power, coal, natural gas and renewable sources such as hydropower.
China, meanwhile, disputed the IEA figures, but didn't offer alternative data, according to Zhou Xian, spokesperson for China's top energy agency.
The U.S. had been the globe's biggest overall energy user since the early 1900s, Mr. Birol said.
China overtook it at breakneck pace. China's total energy consumption was just half that of the U.S. 10 years ago, but in many of the years since, China saw annual double-digit growth rates. It had been expected to pass the U.S. about five years from now, but took the top position earlier because the global recession hit the U.S. more severely, slowing American industrial activity and energy use.
China's economic rise has required enormous amounts of energy�especially since much of the past decade's growth was fueled not by consumer demand, as in the U.S., but from energy-intense heavy industry and infrastructure building.
Mr. Birol, formerly an economist at OPEC, said China is expected to build some 1,000 gigawatts of new power-generation capacity over the next 15 years. That is about equal to the current total electricity-generation capacity in the U.S.�a level achieved over several decades of construction.
Please consider China's Oil Consumption and Imports: A Growing National Security Threat to the West.
At the current rates of growth of US and China oil imports and consumption, China's oil consumption will match US oil imports by '16-'17. China's oil imports and consumption will reach parity with the US by '21-'22, at which point the US and China will together consume 60% of peak global oil production (assuming 73-75M bbl/day) versus 37-38% today, leaving the rest of the world to adapt to receiving the remaining 40% (35-40% less than is received today).Granted that is a "down the road" kind of problem, but it is yet another reason to be skeptical about China's perennial 10% growth targets.
However, at the same trend rates of imports and consumption, the US and China will consume 80% of global oil production by the late '20s to early '30s, leaving the rest of the world just 20% of supplies, and China is on track to consume the entire world's oil production by the '40s-'50s; needless to say, this cannot occur.
China signals intention to curb oil demand via price hike
Inquiring minds are reading China signals intention to curb oil demand via price hike
21 Feb 2011China is not only overheating badly, but it is also on a peak oil collision course with the western world in general and the US in particular. Something has to give, and it will.
China's top economic planning body, the National Development and Reform Commission, has again signaled that it intends to curb runaway demand for petroleum products by adjusting prices through the price mechanism.
Late Saturday, Beijing announced that domestic guidance prices for gasoline and diesel will be increased by Yuan 350 ($53.14)/mt from midnight Sunday.
The hike follows an increase in the price of international crude oil, but the timing was "properly postponed" and the rise was "limited," the central planning authority said in the statement.
The adjustment is the first this year but the second in the past two months. The increase will hike the benchmark retail price of gasoline by Yuan 0.26/liter and diesel by Yuan 0.30/l, the NDRC said.
Liu Zhenqiu, vice director of the NDRC's price department, told the official Xinhua news agency that the rise in fuel prices was also aimed at restraining rapid increases in China's oil consumption and boosting energy conservation. In 2010, China's dependence on imported oil jumped to 55%, from 33% in 2009, with crude imports rising 17% to 239 million mt, he added.
According to the NDRC, China's domestic car sales surpassed 18 million units last year, which was a growth of 32% year on year.
Based on an annual consumption of 1.5 mt of gasoline per car, domestic refined product consumption would be increased by 27 million mt, or equivalent to an increase of 45 million mt of crude oil, the NDRC said.
"The situation of oil security is not optimistic ... there is an urgent need to adjust prices to guide and control the excessive growth in oil consumption and promote resource conservation," the NDRC said.
Preliminary data released last week by the country's General Administration of Customs showed that China's oil demand is continues to grow at a breakneck pace as measures to tighten its monetary policies to rein in its economy appears to have have failed to damp demand.
According to the data, crude oil imports in January rose 27.41% year on year to 21.8 million mt (5.15 million b/d), the highest in four months.
Refined product imports jumped 42.07% year on year to 3.85 million mt as domestic companies increased purchases to ensure ample supplies during the week-long holiday from February 3 to celebrate the Lunar New Year.
Meanwhile, the longer China sticks with its current policies, the longer and deeper the resultant slowdown. China bulls are oblivious to these facts.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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