Can You Smell the Burning Rubber?

Jim Brown
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China's economy is overheating despite a series of hikes in the reserve rates. The country will eventually have to slam on the brakes and slow the economy dramatically before they crash into the reality barrier.

China's economy grew at a 9.6% rate in Q4 despite seven reserve rate hikes since 2009. Officially the inflation rate dipped to 4.6% in December, down from 5.1% the prior month. Unofficially many analysts believe the inflation rate in China is closer to 20%. If this is true then China is aware of it and is letting the country rally out of control to build to avoid a revolution from screw tightening.

Even at China's official inflation rate of 4.6% that is still way too strong. Unless everyone in China is getting raises of more than 5% per year then the impact on the population is going to be severe. China acknowledged the problem recently when they raised the minimum wage by 20% for the second time in a year. That is clearly an indication the working class was struggling with the difference between the cost of living and the basic wage.

Investors are afraid China is finally going to take some giant step to slow the economy. As the biggest consumer of commodities on the planet and the second largest consumer of oil that is a valid concern. Quickly slowing a stampeding economy is like halting a cattle stampede. You can turn the herd but it is very hard to stop them until they run out of breath.

China is hoping the continued baby steps it has been taking with raising the reserve rates would eventually shut off the money flow to loans and slow the economy. It probably will work eventually but today each little hike is like a bee sting to a cow in the stampede. It may distract that one cow but the rest of the herd continues to charge forward.

In order to drastically slow the economy China is going to need real interest rate hikes and probably quite a few or several severe hikes.

There is the question few are really asking. Does China really want to slow the economy or do they need it to continue at this feverish pace in order to fund the many government programs? They have built bridges to nowhere and highways to nowhere just to keep citizens working. They have built entire master planned cities that sit unoccupied because nobody can afford to live there. Google "China vacant cities" and you will see what I mean. New Ordos City is one of those. Video of Ordos Pictures of other cities It was built from the ground up over the last five years with complete infrastructure, homes, apartments, office buildings, parks, museums, schools, etc for one million people. The city is vacant and almost completely uninhabited. The problem is cost. A new city for one million built from the ground up is an expensive proposition. Many want to live there but the cost of the homes and apartments is far more than most citizens can afford. With no activity in the city there is no economy to support shopkeepers, stores or even citizens. You can't run down to the corner to buy bread if there are no functioning stores. The city and dozens of others like it were built as stimulus projects to keep unemployment low and reduce crime. Those workers have now moved on to other projects funded by a seemingly bottomless pit of government money. In China the term "build it and they will come" has proven false.

I believe China is unhappy with the high inflation but they need to inflate at a higher than normal rate in order to raise the living standards and keep unemployment low. With 1.3 billion people you can't afford to have a high unemployment rate. Unemployed workers cause crime, civil disobedience and political unrest.

China has to continue building to survive. This has inflated their GDP for years and going back to "normal" un-stimulated growth could actually be very destructive.

As far as oil demand is concerned I seriously doubt investors have anything to worry about from China. As long as the building continues, oil demand will continue. As long as they produce 1.2 million new vehicles a month, oil demand will continue. As long as China continues to upgrade the standard of living for 1.3 billion people, oil demand will continue.

China is on GDP crack. They have to maintain their current activity level or risk a serious hangover and economic letdown. They have to continue running in circles until the population can afford the standard of living China is building under the stimulus plan. I believe they are more concerned about the economy slowing than inflation rising and that is why they are not taking any material action on inflation. Believe what they do not what they say. China is very "face" conscious. They will do anything not to lose stature in the global community. Part of that stature is the hottest GDP on the planet even if that GDP is created by massive government spending.

China's downfall is going to be peak oil. As the price of crude rises and the availability of crude declines over the next several years the high prices are going to wreck this constant GDP high. The U.S. is going to suffer but China will be right behind us with a crashing economy. Fortunately for China they have been buying up oil reserves all over the world for the last five years while the U.S. has been fighting wars and arguing over healthcare. They will have a fallback position for oil and the U.S. will not. The U.S. does not buy foreign oil reserves. The U.S. relies on the open market controlled by nations that hate us and on private companies producing oil that belongs to other countries. Available production from both of those sources could dry up in a heartbeat when those countries decide to save their oil for future generations.

We know how this movie turns out. We just don't know for sure when it will arrive but 2012-2014 is the projected window today.

Jim Brown

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The OilSlick Newsletter is based on the expectations for global oil production to peak and begin to decline in the 2012-2014 timeframe. This is called "Peak Oil." This is the point where global production of conventional oil supplies can no longer be supplemented by enough oil sands production, deepwater oil production, biofuels and natural gas liquids to offset the decline in existing fields. The roughly 6% annual decline of existing production due to depletion is larger than the rate of new discoveries and new production being added each year. The Peak Oil countdown clock is ticking and time is growing short. Peak Oil is coming, are you prepared?