Jun 222011

China has become enormously important to the Pacific Northwest economy. Marple’s Letter reports that China was the primary driver behind a 41% jump in Douglas Fir log exports from the Pacific Northwest last year. It is great news for timber owners — log prices are sharply higher — but bad news for sawmills that provide family-wage blue-collar jobs.

I am always looking for fresh perspective on China’s economy, which has grown at or near double digit rates for two decades and which last year passed Japan to become the globe’s second-largest economy. My ears perked up a couple of months ago when I spotted this headline in the Financial Times: “Cautionary tale for China’s rail boom.”

In the article, Edward Chancellor, a former journalist now a member of the asset-allocation team at Boston-based GMO, the giant global asset manager, argued that there are certain parallels between China’s hell-bent-for-leather boom and the U.S. economy in the period 1865-1873, when the rails were being extended westward. Settlers were lured to the West, Chancellor writes,

with the promise that $50 lots would soon rise 100-fold in price. Property in Chicago, a railway hub and the gateway to the West, attracted wild speculation. Land values climbed by 500 per cent in the five years to 1873 on the general belief that the Windy City would shortly become the world’s largest metropolis.

It all ended badly. It turned out that subsidized credit was being used to build what Cornelius Vanderbuilt complained were railways “from nowhere to nowhere.” Chancellor writes that “[a]n inquiry into Chicago’s public finances revealed “lavish expenditures, downright thievery on a mammoth scale, and the creation of sinecures for political abettors.”

China today, he writes, is engaged in “breakneck expansion of its public infrastructure,” most notably a nationwide high-speed rail network that, like America’s in the 1860s and 1870s, is funded with public land grants and debt. Chancellor writes that the “prospect of high- speed rail connections has sparked a property boom across the country.”

The parallels aren’t perfect. America’s railroad bubble was financed with European capital. China finances its public spending domestically ( in part, it should be noted, by restricting the convertibility of the currency). Yet Chancellor concludes that “[w]hen investment in infrastructure runs out of control, and is combined with widespread property speculation and public corruption, a happy outcome is unlikely.”

The man in charge of China’s high-speed rail project was fired in February for “severe violations of discipline,” China-speak for embezzlement. The Washington Post’s Charles Lane reported April 24 that

his ministry has run up $271 billion in debt – roughly five times the level that bankrupted General Motors. But ticket sales can’t cover debt service that will total $27.7 billion in 2011 alone. Safety concerns also are cropping up. . .  On April 13, the government cut bullet-train speeds 30 mph to improve safety, energy efficiency and affordability. . . [The] system . . . could drain China’s economic resources for years. So much for the grand project that Thomas Friedman of the New York Times likened to a “moon shot” and that President Obama held up as a model for the United States.

Chancellor of GMO wrote in the Financial Times that “[g]iven China’s vast size and relatively low per capita income . . . an extensive high-speed network seems extravagant.” A long and savage depression in the U.S. followed the collapse of the rail boom and its related real-estate frenzy. Is China’s economy a bubble about to pop? My honest answer is “I don’t know,” but I do know that the situation bears close monitoring.

Chancellor’s 12-page white paper on “China’s Red Flags” published March 2010 is available without charge at GMO’s web site; registration required.

I haven’t seen much lately about the speed restrictions mentioned in the Washington Post article. And the New York Times remains unrepentant. Here’s an excerpt from an article that appeared on the first page of the Business section June 23, 2011:

Just as building the interstate highway system a half-century ago made modern, national commerce more feasible in the United States, China’s ambitious rail rollout is helping integrate the economy of this sprawling, populous nation — though on a much faster construction timetable and at significantly higher travel speeds than anything envisioned by the Eisenhower administration. Work crews of as many as 100,000 people per line have built about half of the 10,000-mile network in just six years, in many cases ahead of schedule — including the Beijing-to-Shanghai line that was not originally expected to open until next year. The entire system is on course to be completed by 2020.

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