Friday, October 5, 2007

China Kettle, Dryer and Scale, Inc.

Big bubbles can be hidden behind seemingly irrelevant observations.

I happened to walk into a large appliance store yesterday; I wasn't looking to buy anything, just filling 15 minutes before an appointment. As I strolled down one aisle, I was struck by the huge number of different counter-top plug-in water kettles for sale. There were 32 different makes and models and the display took the entire length of the aisle. I thought that was odd. As I rounded the corner, I came to the hair dryer section: 42 models. Right next to them were the bathroom scales: 16 models. Nearly every item was Made in China.

By now I was baffled as well as bemused: who needs to choose amongst so many nearly identical items? My first reaction was to chuckle and blame our consumerist society; but that sentiment was immediately replaced by my curiosity for all things economic. Here was a major manifestation of the Chinese economy, on display as Kettles, Dryers & Scales. My conclusion, after some thought, is that its manufacturing-export economy has now reached a level that can best be described as absurd. Let me explain.

The sheer number of makes and models means that there must be dozens of different Chinese companies that make small appliances. There is apparently nothing to distinguish one from the other - there are no name brands that we would recognize as such - so the price competition must be incredibly fierce. Furthermore, the fact that the store is stocking and displaying so many of them must mean that the marginal cost of doing so is nil. Let me put it this way: a few days or weeks ago the store carried 41 dryers - what induced it to accept number 42? The answer is even lower prices and better payment terms - and this pressure is then immediately transmitted back to the makers of the other 41 dryers.

If you are China Kettle, Dryer and Scale, Inc. - one of the dozens of similar companies - what can be your sole business strategy for profitability under these conditions? Make it up on volume, of course. So you keep expanding your manufacturing capacity in the hope that, when the bubble bursts, you will be one of the lucky few that survives. Because it is quite clear that the system is now forcing the creation of a bubble - no way out, except perhaps to take advantage of another bubble and sell out by listing your shares on the Shanghai Exchange.

Can the manufacturing bubble continue? Given the intensely marginal nature of the business, the only way it can continue is by achieving constantly higher sales, i.e. by constantly enlarging the bubble. But if there is even a small slowdown in retail demand, and keeping in mind yesterday's post on the prevalence of the global Just In Time network, the negative effects on profitability are going to be instantaneous and highly destructive. The bubble will explode - not merely "pop".

What is the probability of this happening? Well, given that the largest consumer market on the planet (the US) is now definitely weakening and that the second largest (the EU) is not very far behind, I calculate that a slowdown in total consumer demand has already started. I certainly would not want to be an shareholder in CKD&S, Inc.

P.S. The "eagerly awaited" BLS employment report came out exactly as expected at +110.000 jobs for the month, though the month of August was revised at +89.000 vs. -4.000. The revision had to do almost entirely with the number of teachers going back to work, which was originally estimated too low. However, the relevant data one needs to look at in order to gauge the economy is the number of jobs added by the private sector.

Here is a chart comparing the jobs created during each of the first 9 months in 2005, 2006 and 2007. For the 9m year to date, 2007 is down 49% from 2005 and down 40% from 2006.

In other employment news, the Monster Index came out unchanged at 186 for September, while the BLS did its "birth/death" model revision and subtracted 297.000 jobs from what it had originally reported as created during the 12 months up to March 2007.


  1. given that manufacturing takes large amount of energy, can you explain why oil price will not fall to $20/barrel again?

    [The $20 number is arrived at by taking the lowest price of oil (in 1998) and adjusting for any correction due to fall of dollar.]

  2. totally agree : China is now in classical situation of potential oversupply in every sectors. Low local interest rates and stong capital inflows have pusched to expand everything. The law of deccelerating returns is behind the corner

  3. The price of oil is also a function of rising scarcity and cost of production, as encapsulated in the EROEI ratio (energy returned over energy invested).

    However I am a medium term sceptic about short-term Peak Oil (and thus wildly higher prices) because two huge oil-reserve countries are currently producing with ancient technology and/or face other problems on the ground: Iraq and Iran. They are #2 and #3 after KSA in reserves.

    If those two can ever come on line with modern technology we are going to get a short-term glut. I don't think we will ever get back to $20, but I would not be surprised to see $60 or perhaps $40.Particularly if we concurrently see global demand growth dropping from a recession.


  4. Agree fully with what you said. The China business is all about volume and relatively low margin and no brand name equity.

    And many Chinese companies still use cash-flow account, which means that the impact on profit numbers would be quite immediate once volume start to drop.

    However, I don't expect the Chinese economy as a whole to get into too big a trouble as they have really no real competition on the planet for their current manufacturing power in its totality.

  5. When th US sneezes, the world still catches a cold.

    Jason B

  6. Don't forget that the Kettle, Dryer and Scale will probably last for about a year before you need to get a new one. It's a disposable economy.

  7. You touched this topic yesterday as well. It seems to me that any economy has a “natural” level of consumption – a rough balance point. This level is affected by changes in demographics, productivity, taxes, saving rates, trade, social norms, etc. It would, left alone, reflect the dynamics of the economy and the society.

    When the levers of fiscal and monetary policy are used to promote consumption, ostensibly to help the economy (e.g., avoid an approaching recession), a new albeit “false” balance point is created. Over time, this point gets pushed further and further in one direction. Consumption becomes an ever larger component of GDP, and each new balance point can be sustained only temporally before it must be pushed again. Whether looking at consumption as a share of GDP, current account balances, public and private debt, etc., imbalances pile up necessitating ever greater policy interventions to maintain a semblance of economic order.

    At some point, the imbalances are going to overwhelm the ability to effectively intervene. I don’t know when or what will initiate the unwinding. But it will be a mess.

  8. Great post....

    Funny how we have similar observationss...

    I was walking through Brands Mart a few days ago thinking exactly the same thoughts. However, I was in the television isle.

    I believe the question here is about the spread. Or should I ask, how thin is the ice they're skating on?


  9. Dial up then name your gadget. You'll find scores of manufacturers. Massive enterprises. Entire campuses dedicated to popcorn poppers and dormitory accomodations for rural workers.

  10. Their margins are tiny. They will not sell ANYTHING in lots less than containerload. A friend is an importer from China and has some really interesting stories. You simply won't believe how cheaply they sell the stuff at wholesale and what kind of markups we end up paying at retail. Or how many manufacturers of the exact same items there are - particularly clothing, toys and "notions". Tens of thousands...

    This also means that our retailers have large scope for cutting prices to drive volume (this is what they will do first), though at a big hit to profitability.


  11. Re:

    Hair dryers - 276 manufacturers
    Kettles - 185
    Bathroom scales - 130

    Can anyone perhaps smell "trouble"?

    Many thanks for the link, much appreciated.

  12. Why is having so many manufactures trouble. is that not how it is in emerging economies or industires. Huge amount of companies initially, then some will go out of business, and the rest consolidate. Like the US Auto, computer and every other industry.

  13. It just looks like there are massive M&A opportunities in China.

  14. I have been thinking for some time that we seem to have inflation in things that we need (healthcare, education, commodities, etc.) and deflation in the things that we want (HDTVs and other electronics, clothes, etc.). However, we are acquiring much of it with debt. (Think higher deductibles on your health insurance, student loans for education and higher energy prices on the one hand and exorbitant credit card interest and fees on the consumer items on the other.)

  15. ,...but I would not be surprised to see $60 or perhaps $40.

    I'm not sure OPEC would let that happen in the face of rising demand (which I expect), and both countries you mention are members (admittedly the US occupation makes Iraq a question mark).

    Moving on...I'm starting to think the proliferation of bearish blogs, which I've definitely noticed since the housing slowdown got serious, is another contrary indicator.

    Or maybe it's just the markets trying to prove once again that they can remain irrational longer than bears can stay solvent.


  16. re: "...have inflation in things that we need need (healthcare, education, commodities, etc.) and deflation in the things that we want (HDTVs and other electronics, clothes, etc.)."

    I believe the correlation is -

    Inflation on services (education & health care)..especially union and govt (which is also union) based services

    and deflation on free market, free trade products.

    Commodities are increasing because of supply and demand.

    As long as there is lots of competition, prices will stay low...except for limited supply of raw materials that can't be mass produced.

    Funny, taxes are my biggest expense and also increasing faster than all of my other expenses, but no one mentions this.

  17. re: Chinese bubble in manufacturing. Let's keep in mind that capital investment in China constitutes some ridiculous percentage of Chinese GDP. Over 40%.

    My assumption is that capital investment is primarily of two types: real estate (which is local) and building factories (the output of which is local to some degree but at the critical [large] margin headed overseas).

    Moreover, the flip side. All those Chinese consumers? Well if capital investment makes up 40% of Chinese GDP, where's all the consumption. Growing certainly but from a very small base. And with a theoretical upper limit capped by GDP/capita. This being very low in China's case (enormous population in the denominator [obviously]).


  18. Great video:

    The Paradox of Choice - Why More Is Less

  19. Yes, there's been a soon-to-be-evident overaccumulation of production capital in China,,,'to-be-evident' in the sense of declining utilization, still greater competition, price decline, rising tensions between the Chinese state and an increasing mass of unemployed, steep drop in an already low rate of production profit (often this latter generates a speculative bubble as capital, seeking to maintain its old rate, flows from production to finance; a bubble that breaks down as real economy decline encompasses more sectors and deepens), and, of course, increased concentration and centralization of previously independent firms. All of these interact as both causes and consequences.

    Or, basically what some economists continue to label a crisis of overproduction which, since one of its semi-autonomous sides is the pre-crisis change in capital to labor ratios and rise in total mass of production capital, cannot be prevented through countercyclical policy actions which can, though, mitigate if the degree of overaccumulation is not extreme.

    In short, Hellasious, you are correct but there's usually more to it than declining monetarily effective demand which - strictly speaking - can be called a realization crisis (crises based on the failure of capitalists to realize their expected profits. A realization crisis occurs when any significant number of capitalists are not able to sell their products at a price that reflects their value).

    Price of crude oil has, since the earlier 1990s but expecially post-2002, been financialized, i.e. less dependent on real cost of production/supply/demand both on and off-exchange speculation in paper barrels.

  20. sorry, last pp should read '...demand but on and off-exchange speculation..'

  21. The financial crowd that makes a living on BS now propagates the notion that we don't need to worry as the US sinks under the weight of plummeting real estate values, because the "global economy" will steam ahead.

    The propaganda word they have coined for this is "decoupling".

    But forget about the fact that the Asian economies are export and investment driven---not consumption driven. Consumption is about 35% of GDP in China (compared to 70% in the USA).

    And secondly, forget about the fact that their exports are driven by the US consumer.

    And thirdly, forget about the fact that their investment is driven by massive printing of their local currency as their central banks accumulate giant stockpiles of US dollar reserves (which are causing their economies to overheat big-time as we speak).

    This notion of "decoupling" has been part of what has propped up global stock markets and commodity markets lately (in addition to "the Fed will save us" mantra).

    The US consumer is the driver of the global economy--pure and simple. A US consumer that has been propped up by a US credit securities creation machine (fuelled by recycled foreign capital).

    As well, the plain fact of the matter (which be should be very obvious by now--but nonetheless ignored by many) is that the world financial markets and the world economy over time have become increasingly SYNCHRONIZED as a result of globalization of capital flows and advances in communications technology.

    EVERYTHING moves up and down increasingly together. If you calculated the correlation co-efficient among the world's stock markets and the world's bond markets, I'm very confident it would be very high, and far higher than it used to be 10, 20, or 30 years ago. The same thing goes for the world's various economies---there is far higher synchronization in growth then their used to be and I am sure that a correlation co-efficient would demonstrate that in spades.

    But nonetheless, the Wall Street propaganda machine would have me believe that there is going to be this big DIVERGENCE in growth patterns (between the US and the rest of the world), and that for this reason I should just go ahead and plow my money into stocks and commodities.


  22. Anonymous said...

    I believe the correlation is -

    Inflation on services (education & health care)..especially union and govt (which is also union) based services

    Oh yeah, it's all the union's fault. It can't be supply and demand there (aging baby boomers for health care combined with a failure to increase the supply of medical professionals or student loan's hidden/delayed costs with a consumer with no bargaining power combined with a banking industry which has received favorable treatment from government regulators even though government loans would be cheaper).

    and deflation on free market, free trade products.

    Oh yeah, it can't be because of exploitation of cheap labor combined with a disempowered work force.

    Commodities are increasing because of supply and demand.

    This part, I think, is largely on the money. Although, having said that, a lot of commentators have been alleging that oil prices are out of whack with what the market should be at.


    Funny, taxes are my biggest expense and also increasing faster than all of my other expenses, but no one mentions this.

    Interesting bias you have there.

    Funny, your taxes would be a lot higher if we actually paid for the government we had. The debt load of the federal government has been skyrocketing because of tax cuts. But you're probably not complaining about that. You say your taxes are going up, but I don't know how. Tax rates have been falling for the last 7 years (funded by debt).

    Oh, by the way, the government is basically a large service-based industry. All those (many) services get lumped together into a single payment. At some level, they are all necessary to make this country what it is. You need to think about all those services you are paying for (in taxes) that you are utilizing. You have to pay for those services just like you would for any other service.

    I think of it as a cost of doing business.


    Was just posting (in French) on this very subject. The article has some nice figures.


    "demand for all the goods churned out by China will slacken just as thousands of new factories come online next year, collapsing profits inside China Inc. and exposing mountains of problem loans at state banks. The ultimate result will almost surely be a global slowdown. "This is the biggest credit crunch we've ever seen"

    "Fixed- asset investment (construction of ports, factories, condos, etc.) now accounts for about 45 percent of China's GDP. Its trade surplus has grown from almost nothing in the late 1990s to 9 percent of GDP today. Meanwhile, private consumption has shrunk from half of total economic activity in the late 1990s to just 35 percent this year. "

  24. Malinvestment is not just a feature of western real estate markets. Building factories to produce goods for which their is a finite market is also dumb.

  25. A couple of interesting articles:

    China won't save the world

    The Alarming Parallels Between 1929 and 2007

    I think the Chinese leadership feels significant pressure to industrialize rapidly in order to ameliorate what is really still significant poverty there; this benefits them politically, of course. It would not be surprising if they did not have the whole transition to rampant capitalism thing down pat.


  26. Those two articles cited by Anonymous in the previous comment were excellent. A must read.


  27. deflation on free market, free trade products.

    Where does one find such things?

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