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What Happens After The Low-Hanging Fruit Has Been Picked?

Tyler Durden's picture




 

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Right now China is at the top of the S-Curve, and the problems of stagnation are still ahead.

What happens after all the low-hanging fruit has been picked? We can phrase the same question using a different analogy: what happens when all the oxygen in a room has been consumed?

One way to understand why the global financial meltdown occurred in 2008 and not in 2012 is all the oxygen in the room had been consumed. In the U.S. housing market, there was nobody left to buy an overpriced house with a no-document liar loan because everyone who was qualified to buy a McMansion in the middle of nowhere had already bought three and everyone who wasn't qualified had purchased a McMansion to flip with a liar loan.

Once the pool of credulous buyers evaporated, the dominoes fell, eventually circling the globe.

What happens after the low-hanging fruit has been picked? Here's an analogy: erect an enormous 13-story building on a thin slab foundation that is barely adequate for a 2-story house, and tie that flimsy foundation to the earth with fragile hollow pilings. What happens? Collapse.


Analysis of the Collapse Of 13-Story Building in China
Shanghai building collapse (Telegraph, UK)

Anyone tracking the global economy has an eye on China, for obvious reasons.China has led the world's growth for the better part of two decades, and now the growth story has entered a new phase. China is weakening its currency (renminbi/yuan), and trying to throttle its vast credit/shadow banking expansion even as Chinese officials claim China's economy is still expanding at a phenomenal clip (7+% annually).

I think we can shed some insightful analytic light by saying that the low-hanging fruit in China has all been plucked, and this creates an entirely new set of problems and challenges.

The first thing to note about nations experiencing rapid growth is the mathematical impossibility of continued break-neck growth: when China's economy (in purchasing power parity (PPP) or nominal dollars) GDP was $500 billion, an expansion of $50 billion equated to 10% a year.

Now that China's PPP gross domestic product is around $13 trillion, a 10% growth rate would require an expansion of $1.3 trillion--roughly the entire GDP of Spain or Canada.

Obviously, fast growth is easy when the low-hanging fruit are abundant, and it becomes progressively more difficult to maintain as the economy expands.
This pattern of rapid growth, maturity and stagnation can be seen in the S-Curve, a pattern that natural and human-made systems alike track.

When a country lacks infrastructure, or the infrastructure has been destroyed by war, then building infrastructure is the dominant activity in the low-hanging fruit/fast growth phase. Nations such as Japan and Germany experienced rapid growth after World War II for much the same reason China has boomed: infrastructure.

China has reached the maturity phase of the S-Curve in a mere 20 years: every major city has a subway system, thousands of miles of rail and highways have been laid, tens of millions of housing units have been built, and so on. As a result of this single-minded pursuit of building, China now sports nearly empty cities, train stations, malls and highrise residential towers.

In other words, all the low-hanging fruit of infrastructure have been picked.
Observers in Beijing see (well, not very far, due to the severe smog) endless growth of housing, due to strong demand. But this rosy view overlooks the fact that housing throughout China is out of reach not just of the millions of poorly paid migrant workers pouring into the cities but for college graduates--assuming they can even find a job (Chinese College Graduates Cannot Secure Jobs)

Even the cheapest condos cost well over $100,000 (in USD) in 3rd tier cities and much more in 1st and 2nd tier cities. The average starting salary for graduates is 2,000 to 3,000 yuan ($326) a month (roughly $4,000 to $6,000 a year), and salaries of around 50,000 yuan a year ($8,600) are considered good.

As a result, a double-income middle class household can only own a flat if the parents' savings are devoted to the down payment, which is usually 50% of the purchase price in China.

So all the stories of housing demand being permanent are misleading, because only a tiny sliver of the millions of people coming to cities can afford even the cheapest flat in the suburbs.

The other problem is that the low-hanging fruit have all been stripped via an unprecedented expansion of credit. Credit has a pernicious characteristic: it inevitably leads to diminishing returns as low-value, high-risk projects get funded in the rush to build anything and everything everywhere.

In other words, once the high-value low-hanging fruit has been picked, the sensible, high-value investment opportunities have all been taken and all that's left is marginal malinvestments.

In the U.S., this led to the famous McMansions in the middle of nowhere. In China, the general faith is that every building project, no matter how marginal, will soon be filled (and regardless of demand, the government will never let housing decline, even in ghost cities).

But as pointed out above, this presumes the millions of poorly educated rural migrants and the 7 million students graduating from college every year will soon be earning upper-middle-class incomes. Once the fast growth phase has ended, this becomes much more problematic. And indeed, reports of unemployed college graduates are now the norm (see below). As for migrants, most toil in very marginal jobs with low, insecure pay.

Another systemic problem arises when the low-hanging fruit have been picked:expectations of future prosperity have been pushed into the stratosphere, and these expectations will inevitably be disappointed as growth slows.

Rapid industrialization leads to rampant pollution. China has spent very little of its GDP on environmental investments, and now the bill is coming due. It is mathematically impossible for China to spend what needs to be spent (say, 5% of GDP for a decade) on cleaning up the environment and maintaining 7.5% annual growth. Promising people both will only set up a profound disappointment as neither goal can possibly be met.

Lastly, China lacks the cultural capital of maintaining infrastructure. In the 20 years of picking low-hanging fruit, buildings have been routinely torn down and replaced. The idea that a building will have to last 50 years, never mind 100 years, does not compute: if a building shows signs of aging, the solution for the past 20 years has been to tear it down and replace it with something grander.

This was possible in the fast-growth phase, but it is impossible in the stagnation phase for the same reason noted above: it's possible to tear down and replace 1,000 major buildings a year in the early years, but it becomes physically and financially impossible to replace millions of aging housing units.

Those familiar with construction and this lack of infrastructure to oversee and fund maintenance foresee tens of thousands of buildings that will slowly but surely become uninhabitable as elevators break down, pumps stop working, leaks cause concrete to spall, etc.

Anyone with even modest construction experience can see that the foundation beneath the toppled 13-story building is not even remotely adequate; the slightest temblor will destabilize all such buildings, and such feeble footings built directly on grade will lead to cracked pipes and a host of other impossible-to-fix problems.

Right now China is at the top of the S-Curve, and these problems of stagnation are still ahead. The most severe challenge in my view is not material or fiscal, it's psychological: when sky-high expectations crash to earth, social discord starts its own S-Curve of rapid growth.

Chinese College Graduates Cannot Secure Jobs: 28% Of Beijing's 2013 Graduates And 44% Of Shanghai's Have Found A Job:

This year a total of 6.99 million students graduated with a master's, bachelor's or technical college degree in China, an increase of 190,000 from 2012. In contrast, the number of jobs available decreased by 15 percent compared with 2012, according to China Youth, a state-run youth newspaper. Combined, these statistics mean a large portion of graduates will not have a job coming out of school.

Making matters worse for graduates, the "lucky" ones with jobs can expect an average salary of 3,000 yuan per month ($487.89). Netizens have calculated that at this rate, a 2013 graduate will have enough money to purchase a bathroom in the suburbs of Beijing in 10 years, if she doesn’t eat and chooses to live on the street.

 

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Wed, 04/02/2014 - 10:37 | 4617231 NoDebt
NoDebt's picture

I guess it's nice to know that China builds crap just as cheaply for themselves as they do for the rest of the world.

Wed, 04/02/2014 - 10:44 | 4617253 DoChenRollingBearing
DoChenRollingBearing's picture

Indeed.  I wonder what their earthquake construction codes are like and how well they are enforced...

Wed, 04/02/2014 - 10:49 | 4617270 max2205
max2205's picture

Wie tu chep

Wed, 04/02/2014 - 11:01 | 4617319 onewayticket2
onewayticket2's picture

"bullish....they'll need to dig that hole again!"   -krugman

Wed, 04/02/2014 - 12:13 | 4617566 Dark_Horse
Dark_Horse's picture

 

Construction just cheap enough for their 50year lease.

...Well, sometimes even cheaper.

Dark_Horse

Wed, 04/02/2014 - 11:01 | 4617318 Stuck on Zero
Stuck on Zero's picture

China needs to invest in worthwhile things other than infrastructure.  For example, they could follow the lead of the U.S. and sink trillions into foreign wars, F35s, welfare, a huge intelligence apparatus, and making trillionaires richer.  get with the program China.

 

Wed, 04/02/2014 - 10:37 | 4617232 TahoeBilly2012
TahoeBilly2012's picture

Not Smith again....eeek. Deep State...

Wed, 04/02/2014 - 10:38 | 4617238 madbraz
madbraz's picture

There is a dearth of high quality collateral (like US treasuries) to support the exponential growth in debt and asset values and there is no solid ownership of this collateral - players simply don't own it (the 25% growth in reverse repos by the NY FED is all evidence you need - from $200 billion in Q413 to $250 billion in Q114).

 

Stock market up fractionally on the 1st quarter, collateral needs up 25%.  Trouble ahead.

 

 

 

 

Wed, 04/02/2014 - 10:47 | 4617264 whatsinaname
whatsinaname's picture

Have any of the banks that benefitted from the Reverse Repos returned any of the money ? Any way to track that ?

Wed, 04/02/2014 - 12:21 | 4617599 scraping_by
scraping_by's picture

Another take on Dr. Engali's question below: HFT uses speed to substitute for real capital. I mean, order stuffing is buying without having to come up with real money. Tradional meat-based frontrunning requires at least a credit line to grab the stock before the real order. An HFT transaction is done too quickly for a bank to even initiate a transfer.

But since they're buying and selling stocks that are watered into oblivion anyway, it might not matter. Fake capital for fake capital instruments. Buy and hold is for sheep. The Chinese are buying things that have a life instread of moments in time, and it shows.

Wed, 04/02/2014 - 10:41 | 4617245 LawsofPhysics
LawsofPhysics's picture

Adapt or die...

 

Meh, same as it ever was...

Wed, 04/02/2014 - 10:44 | 4617256 caShOnlY
caShOnlY's picture

401(k)s are still believed in so in fact all the low hanging fruit has not been harvested by the elites, yet.

Wed, 04/02/2014 - 10:49 | 4617271 Dr. Engali
Dr. Engali's picture

What does this have to do with HFTing?

Wed, 04/02/2014 - 12:06 | 4617539 scraping_by
scraping_by's picture

Once real investments with real returns are used up, that leaves loophole diving, irrelevant intermediation, and other forms of crumbcatching. Along with speculation based on insider arrangements and outright embezzelment.

In America, while we still have our traditional public asset grabs and snake oil frauds, the Chinese are stuck with trillions of dollars from their grafting onto our economy. Financialization, which HFT is a late stage example, is probably in the works. Though they'll probably make it some kind of protection money or vigorish, and avoid all this hand wringing and hullabloo. Their gangster capitalsts don't have to make the nice front our gangsters show.

 

Wed, 04/02/2014 - 10:52 | 4617287 Spungo
Spungo's picture

How about we abandon creditism and go back to capitalism? That might work. Allow things like housing or stocks to rise at a moderate pace as the economy grows. 

Wed, 04/02/2014 - 10:53 | 4617289 ...out of space
...out of space's picture

 china will crash , china will crash.

global economic will crash. it is call a cycle. 

... but in the end china will do just fine

Wed, 04/02/2014 - 11:25 | 4617405 slightlyskeptical
slightlyskeptical's picture

A housing crash in China will not have the same effect as it does in the West, because

"As a result, a double-income middle class household can only own a flat if the parents' savings are devoted to the down payment, which is usually 50% of the purchase price in China."

Basically values can halve before the banks are exposed to losses.

Wed, 04/02/2014 - 10:56 | 4617299 Spungo
Spungo's picture

"I guess it's nice to know that China builds crap just as cheaply for themselves as they do for the rest of the world."

It's not just China being China. That kind of shitty quality happens every time there is a credit bubble. Houses built during our boom are of remarkably terrible quality as well. They don't fall over, but they have problems like foundations that crack easily, weather stripping that falls off after a year, low quality insulation, poorly done vapor barriers, etc. Watch the show Holmes on Homes to see what boom period housing looks like.

Wed, 04/02/2014 - 12:25 | 4617616 scraping_by
scraping_by's picture

Yes. Consider this - most US houses built after, say, 1980 are increasingly built of laminates, composites, and construction adhesive. How long will all that glue hold together?

Wed, 04/02/2014 - 10:56 | 4617300 Who Laughed
Who Laughed's picture

take the 'made in china' tag off and no one will know

Wed, 04/02/2014 - 11:22 | 4617396 TrustWho
TrustWho's picture

Law of diminishing marginal returns is one of the most stable economic theories. 

People think science and R&D will always lead to a more productive society and ignore this Law. Law of diminishing marginal returns is as stable, but less time-predictive, as entropy with the second law of thermodynamics. Today, Economics is defined by the Wizards of OZ who practice on FOMC with the Queen defining stupidity.

Wed, 04/02/2014 - 11:26 | 4617407 SgtShaftoe
SgtShaftoe's picture

What! The building didn't explode into pure dust like the WTC buildings! It just fell over? Even shittily built Chinese buildings seem to be strong enough to remain intact during a collapse event.

Wed, 04/02/2014 - 12:26 | 4617625 RaceToTheBottom
RaceToTheBottom's picture

You are correct.  I bet they just built it that way and now are trying to cover it up......  It could happen, someone just looked at the plans wrong.

Wed, 04/02/2014 - 11:28 | 4617416 SheepDog-One
SheepDog-One's picture

Nonsense! The ONLY reason there was a 'crisis' and they pulled the rug out was because someone big was no longer able to scam on the derivatives!

Wed, 04/02/2014 - 11:30 | 4617424 Dr. Bonzo
Dr. Bonzo's picture

Solid analysis Charles. One thing that's overlooked in all the furor over the Chinese growth story is the incredibly unimaginative nature of the infrastructure investment. Not only are the majority of the vast construction projects of questionable quality, they're also hopelessly antiquated. Rather than build a "new" infrastructure around innovative and adaptive models with energy conservation, eco-friendly, innovative commuting solutions or a "new" economy in mind, basically Chinese developers threw up as much concrete as they could, as fast as they could. The result is that as the energy crunch starts to really bite moving forward China is saddled with an infrastructure that is hopelessly unable to cope with the rapidly changing demands of new energy models.

China is going to have to collapse in order for radical change to occur. But it's the only way forward for China.

Wed, 04/02/2014 - 12:12 | 4617563 scraping_by
scraping_by's picture

The PRC government is shameless about importing western technology, with or without premission. The idea of creating their own based on tradional Chinese culture, or heck, even socialist utopian culture, isn't in the cards. Think 1950's futurism based on 1960's textbooks.

Wed, 04/02/2014 - 11:34 | 4617438 WhyWait
WhyWait's picture

 Upheaval is coming in China.  All you folks rootin' for Putin (I'm one too): Pray that somehow China comes through this with its government intact or a new one able to control its territory and committed to preserving China's financial independence.  

A "Color Revolution" and a lowering of China's guard, or a Chinese civil war, would leave Russia in a dangerously weakened strategic position.  US bases in China would be game over.

Wed, 04/02/2014 - 12:46 | 4617489 Lordflin
Lordflin's picture

We are entering an age of warfare and revolution... or, as the author of all things once said... wars and rumors of wars. If one is reading a book, or watching a story, there is always a sense of eagerness upon nearing the end... the desire to see how it all pans out... not so here, not for me. I try to consider that man, in what is increasingly appearing to be a resolution of the past 6000 years of recorded history, is reaching the conclusion of some grand plan... or perhaps he is about to pass into nothing, as there is nothing to pass into... and thence he will never know his fate. Either option seems cause for celebration... so to speak. I suppose oblivion bothers most folks, but I have long sense adjusted to it... besides, I don't really believe that is what awaits.

But all I really feel is sadness... This is the best that we can do? Bridges to nowhere? Corruption that has become so rampant that a man of moral character is now an outcast... and those of us with children, what hope do we give them? I lost my only son about two years ago... a strong, brave, moral man of great depth... in fact, it was only a week before he was killed that I told him that it had been a true honor to be his father, and as I was sitting next to him along side the highway... he was killed by a logging truck about a quarter mile from the farm, and I was with him only minutes later...  the first thought that entered my mind was 'at least he won't be forced to fight in any of these immoral wars'. I was far more concerned for his soul than his body, and facing the choice between loyalty to his comrades, and loyalty to his fellow man, would have been crushing for him.

Oh well... sorry for the moribund outpouring... Perhaps this will all have a happy ending and I will rightly be accused of being... what is the term... a doom and gloomer...

Wed, 04/02/2014 - 14:15 | 4618055 TrustWho
TrustWho's picture

Either option seems cause for celebration....

When death is seen as a better option than life, something basic to life has been transformed. I see this in our youth, especially the Japanese youth. When hopelessness reigns, why have children? 

You make me ponder as I think we will face the option to fight, to be a serf, or die. Death is PEACE. May your son rest in peace.

Wed, 04/02/2014 - 11:53 | 4617496 Squid Viscous
Squid Viscous's picture

I thought this article was going to be about Obama, based on the headline...

Wed, 04/02/2014 - 12:01 | 4617527 soopy
soopy's picture

Pick the high-hanging fruit. DUH!

Wed, 04/02/2014 - 12:31 | 4617632 NuYawkFrankie
NuYawkFrankie's picture

re What Happens After The Low-Hanging Fruit Has Been Picked?

Use your little finger.

Wed, 04/02/2014 - 14:06 | 4618009 Fuh Querada
Fuh Querada's picture

For the 50th time, Chuck, what do the x- and y axes on your S-curve represent? Was your bachelor's degree in sociology?

Wed, 04/02/2014 - 14:52 | 4618205 Not My Real Name
Not My Real Name's picture

X: time

Y: reach of financialization

 

Wed, 04/02/2014 - 15:50 | 4618433 Fuh Querada
Fuh Querada's picture

Thank you.

And the units

x  in minutes ?

y in yards ?

Wed, 04/02/2014 - 14:07 | 4618011 John Law Lives
John Law Lives's picture

"In the U.S. housing market, there was nobody left to buy an overpriced house with a no-document liar loan because everyone who was qualified to buy a McMansion in the middle of nowhere had already bought three and everyone who wasn't qualified had purchased a McMansion to flip with a liar loan."

This is a good analysis sprinkled with good humour.  Well done.

MiddleKingdomFUBAR.

Wed, 04/02/2014 - 22:13 | 4619741 Notarocketscientist
Notarocketscientist's picture

China Finance Minister Fuk U Hard just announced a new stimulus package --- they will begin construction on subway lines from Beijing to London, New York and Los Angeles in two weeks.

Global stock markets soard on the news

 

 

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