- Money Morning Australia

Chinese Production Versus US Consumption – Economies of Failure

Written on 04 September 2012 by Nick Hubble

Chinese Production Versus US Consumption – Economies of Failure

The Chinese haven’t figured out the answer to the chicken and the egg problem yet. But they sure have answered the economics version of the same question: What comes first, production or consumption?

You can’t consume without producing, but why produce if you’re not consuming?

The Chinese have decided that production is more important. They run the entire Chinese economy on the premise of keeping people employed, not buying stuff. The Americans are the opposite. They think the desire and ability to consume comes first.

Their answer to the chicken and egg problem is to eat both. That’s why, when the financial crisis hit, the Americans stimulated ‘demand’. While China’s economy built stuff, putting things into production.

The demand for Australian resources that resulted from China’s production is what kept us out of trouble during the financial crisis. Finding out who is right about production and consumption, China or America, could determine the source of the world’s future economic growth. And the demand for our resources.

Unfortunately, both sides are wrong. It’s all about producing and consuming at the same time. It’s pretty difficult to produce if you’re not consuming anything. And it’s pretty difficult to consume if you’re not producing anything. Unless you’re a lawyer.

The key is the proportion of the two. And to make sure you produce the right stuff.

Coconut Picking and Ladder Building

Here’s the catch. To enhance your production and consumption, you have to consume less at first. That’s because enhanced production first requires you to work on how efficiently you produce. You need to take the time to build a new tool, or machine. In other words, you need to invest. You can’t consume what you spend on investment. So you have to save it first.

Here’s a quick example to prove the point. You’re stuck on a desert island with a bunch of palm trees. To survive, you need to consume 20 coconuts each day. Any more than that and you’re living a life of luxury. You can pick 4 coconuts an hour (production), or you can produce wood (save) to build yourself a ladder (investment), which will take 5 hours.

With a ladder, you can double your production to 8 coconuts an hour. How do you apportion your time between coconut picking and ladder building without starving or dying of exhaustion?

The Chinese answer is to produce more ladders. The American answer is to consume more coconuts. Obviously, you want to do both. But just wanting more of one or the other isn’t going to achieve anything.

The real question you face is how to apportion your time between coconut production and ladder building.

What’s interesting is that every individual would answer the question differently. We have different preferences for how many coconuts we want and how hard we want to work. Not only that, but the amount of coconuts we need and are able to pick differs. So does our ladder building ability.

But when the government makes the decision on whether the economy needs more production or consumption, everyone is along for the ride.

That’s why hundreds of millions of Chinese are suffering in terms of not being able to consume very much. And millions of Americans are suffering in terms of not having a job.

Over in America, they’ve been so busy consuming coconuts, they haven’t even maintained their ladders, let alone increased them.

That’s why ‘American incomes declined more in the three-year expansion that started in June 2009 than during the longest recession since the Great Depression, according to an analysis of U.S. Census Bureau data by Sentier Research LLC.’ Oops.

Over in China, they’ve got multiple ladders up any given coconut palm. That’s another way of saying the Chinese have been building bridges to nowhere. In fact, reality is even more absurd than the metaphors.

German newspaper Der Spiegel has a great article (in English) on what is really going on in China. Here are some highlights, or lowlights if you own shares in Australian mining companies:

‘Duan, the official in the west, is … in a hurry. Duan builds things, and he does so because he can. The sheep walk across Duan’s wonderful, multi-lane, freshly asphalted street, and they’re disruptive.’

The sheep probably don’t appreciate their new highway any more than the occasional drivers do. Der Spiegel visited one of China’s empty cities, built to create jobs:

‘It’s a gloomy day, and the wind is howling through the shells of buildings. According to the plans, there will be 300,000 people living here in 2015, 600,000 by the year 2020 and eventually as many as a million… Everything is already there: airports, railways and highways. Second, there is “unlimited electricity”. And third, the province has rich mineral resources, including coal, oil and nickel. Of course, he adds, it also has plenty of workers.’

Why there are Ghost Cities in China

The beautiful irony of China’s ghost cities is that America is facing a similar problem in its former industrial hubs. Just look at Detroit, the world’s former industrial miracle. You can now play golf from one side of the city to the next. Much of it is abandoned and crumbling.

The problem with overconsumption is obvious. You become unproductive because you didn’t invest in production. The problem with China’s overinvestment is less obvious.

In fact, most economists wouldn’t spot the problem if it was woolly and walked across the highway in front of their car. The term for this is malinvestment. And China is a textbook case. The Age reports on some examples:

‘China’s banks are coming after the country’s steel traders, hauling executives into court to chase down loans that some traders say they didn’t initially need and can’t now repay…

‘”After the financial crisis, when the government released its stimulus, banks begged us to borrow money we didn’t need,” Li Huanhan, the owner of Shanghai Shunze Steel Trading, told a judge at a recent hearing. “We had nothing to do with the money, so we turned to other investments, like real estate.”‘

Debt is one problem even a mainstream economist can spot. It is difficult to repay debt if you don’t earn an income from your investment. And one characteristic of a malinvestment is that it doesn’t earn enough of an income to justify it.

But economists don’t recognise many of the other problems, which are obvious to the rest of us. Producing things that nobody wants, like empty cities, is incredibly wasteful.

Eventually, China will experience an economic crisis. The debts they ran up to malinvest can’t be repaid. When the economy tries to shift towards a more stable balance of consumption, investment and production, it will be extremely disruptive.

Jobs and all the industries catering to construction will take a major hit. You can’t turn an investment and production focused economy into a balanced one overnight.

Unfortunately, all this means a collapse in demand for Australian resources. The mining boom will be over. The iron ore price will plunge. Treasurer Wayne Swan’s budget will be in tatters. As will the speedy half of Australia’s two speed economy.

Worst of all, many of those predictions have already come true. As for what to do about it, you can watch Greg Canavan’s presentation on the matter here.

Nick Hubble
Editor, Money Morning

Related Articles

Australian Resources Boom Curse…or Industrial Renaissance?

Take Advantage of the High Australian Dollar While You Can

Why the Australian Economy’s Bet on China Will Fail

Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...

Nick Hubble
Nick Hubble is a feature Editor of The Daily Reckoning Australia . Nick has spent the last three years discovering lots of new, exciting and surprisingly simple ways to generate money for retirement. He’s put all these ideas into his investment publication The Money for Life Letter. If you're already a subscriber to these publications, or want to follow Nick's financial world view more closely, then we recommend you join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au

Comments are closed.

How Money Morning Can Help You Can Become a Smarter, Better, Investor

Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

Diggers and Drillers

A 3-Point Plan to Re-Engage with the Aussie Mining Boom

This new video reveals a way for Aussie share investors like you to RE-ENGAGE with the next phase of the mining boom…while valuations are still dirt-cheap…

The plan centres round three specific stocks.

To find out what they are, click here.

Australian Small-Cap Investigator

The Australian wildcatter
exploring oil's 'final frontier'

The US Geological Survey says this area contains up to 71 billion barrels of oil.

Only a few explorers have secured licences to drill.

One of them is a daring little Aussie firm that begins drilling 'in early 2014'.

According to small-cap analysts Tim Dohrmann it's impossible to speculate just how high this one could go. Find out why here.

World War D

Couldn’t make it to our
‘War Summit’?

Don’t sweat it. Click here for the next best thing…

World War D was the most important meeting of minds of the decade so far. What came out of it will almost certainly force you to reshape your investment plan for the rest of the decade. There's no way to go back in time and get inside the Savoy Ballroom of the Grand Hyatt.

But you can do the next best thing…
to find out what it is, click here.

  • ^NDX3533.086+45.233 - +1.30%
  • ^FTSE6584.17+42.56 - +0.65%
  • ^AORD5432.500+19.900 - +0.37%
  • ^AXJO5439.900+19.600 - +0.36%
  • AUDUSD=X0.939
  • USDJPY=X102.065

Graphic Ad 1 – Blue Chip Stocks Report

Revolutionary Tech Investor

This report is about TECH MOON-SHOTS

Four of them, to be precise.

It's an early-days project. But one biotech aiming for the cancer moon-shot is already up - get this - 497.14% since tipped.

For four more tech moon-shots, click here.

Gowdie Family Wealth

The worst mistake you can make when handing wealth on to your kids

This brand new investor briefing shows you what your family’s in for if you don’t take care to leave your wealth to them in exactly the right way.

And it shows you precisely how to prevent infighting, recklessness and misunderstanding over money.

Read it here.

The Money For Life Letter

Holden. Toyota. Qantas. BUST

Do you really expect the share market to boom in times like these? That's why Nick Hubble says the best thing you can do right now is invest for safety and income.

This brand new video shows you how you can get predictable, reliable and rock solid cash flow no matter what happens in the wider economy.

You could lock in up to $20,000 a year - and that's just the start. See how here.

Sound Money. Sound Investments. [bullish prediction]

Greg Canavan's first bullish prediction in four years

Greg Canavan
doesn't make forecasts like this often.

When he does, it's because he’s found something that could make you money for years to come.

Read more here.

Is the Australian Housing Boom Really Back?

The Denning Report

2014 Predicted

Dan Denning accurately forecast 2013's flight from
bonds to stocks, the commodities crash and the
Aussie dollar top…to the exact week

In this brand new forecast report, he shares his
three critical predictions for 2014…

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

Done properly, a retirement business can not only help fill a retiree’s time and replace their work [Read More...]

Free speech is no longer really a right at all. Governments, vested interests, and lobby groups are [Read More...]

Australian house prices are going to remain high. Perhaps finally, when the last baby boomer retires [Read More...]

Make sure that the changes you make to your financial plan are from a credible source. Otherwise the [Read More...]

It was day two of the World War D conference, and the final session was starting. We were closing th [Read More...]

Services will boom according to the Reserve Bank of Australia. Sales assistants and tour guides are [Read More...]

In the many years since the creation of the US Federal Reserve System as America's central bank [Read More...]

In business, as in other things, we are being roughened up… and toughened up. We promised a grim acc [Read More...]

The worry is that the Russian and Ukrainian economies are suffering badly while politicians enjoy th [Read More...]

During good times, convertible notes behave like debt financing. But if there’s a bank crisis, the b [Read More...]


"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery