China and the rule of 70

There is a rule of thumb in finance. If you want to know how long it will take for an investment to double, divide 70 by the annual percentage increase and you’ll get the number of years it will take. This will get you within a few months of accuracy. It works for any other number as well – population growth, or the growth of an economy.

China’s Gross Domestic Product has been growing at a rate of between eight and thirteen percent for the past couple of decades. It averages around ten percent. The math works out, since it has been faithfully doubling every seven years or so.

Here’s a chart I copped from Paul Kedrosky of China’s present share of world commodity resources.

 

 (Click to enlarge)

Try to imagine the year 2018, when China (theoretically) will be using 6.4% more than all the concrete that the world now produces, essentially all the iron ore now produced, plus 90% of all the coal, steel, and lead produced today. Add to that roughly three quarters of the present production of zinc, aluminum, copper, and nickel. I think I’m going to have to knock back a shot of Scotch to imagine that freely.

As vital as these commodities are, consider that China, if it continues on its present growth trend, will use 20% of the world’s oil, a number approaching our own. Try to imagine that with growth in oil production stagnant, despite a geometric growth in spending on oil exploration. That extra 10% will have to come out of everybody else’s share.

Short answer: it can’t happen. None of these commodities are on a trajectory to double in seven years. China would have to take demand shares away from other countries, which would quickly become self defeating as the economies of customer nations would suffer. Commodity prices would soar, driving down consumption.

Take one commodity, lead, as an example. It is vital for storage batteries and electronics. World lead production has been essentially flat since 1976. It hit 3.69 million metric tons in that year and didn’t reach that level again till 2007. It’s not going to obligingly rise to 7.4 million tons per year just because China needs it.

World zinc production has doubled – since 1971. It’s not quite keeping up with the seven-year plan. Aluminum production has been doubling on the 20-year plan and copper around 23 years.

World iron ore production has actually doubled in the past seven years or so. At the same time, the price per ton has gone from below $20 to above $170. Could production double again in the next seven years? I’m doubtful, and I wonder what price we will be paying at that time. Let’s say it does.

How will the Chinese mine and process iron ore minus the lead, zinc, copper, and aluminum needed for the motors, transformers, cables, and electronics of the production infrastructure? The production of any one of these commodities depends on the production of many others. The products that China sells to the world are mostly combinations of multiple commodities. What is the probability of all of these commodities doubling production on schedule? If they don’t, will the prices be doubling, and what will that do to demand for Chinese made goods? And what about that demand? As we slog through the beginning of our lost decade, Europe scrabbles at the cliff-edge of currency collapse. It isn’t a promising growth market.

A couple of decades ago the Chinese government cut a tacit deal with its people. Ditch the pursuit of democracy in exchange for prosperity. So far, they have delivered. Chinese GDP per capita has gone from around $200 in the early 1980s to over $3,500 today. It isn’t evenly distributed, but China does have an emerging middle class and some opportunities for the poor to get ahead, however unsatisfactory by our standards. I can’t see the opportunities keeping up with expectations over the next seven years. Even if the Chinese turn their focus away from exports and towards their own infrastructure and internal consumption they will still require those absurd increases in material supplies to fuel their present rate of growth.

If I were a member of the Chinese political elite I’d be planning my exit strategy right now.