Chinese overproduction hits the wall

If you travel to China and visit a market filled with individual vendor stalls, the one thing that stands out is the inventory. Many stalls are packed to the brim with supply and there's clearly a solid chunk of working capital tied up in it. I've heard that this inventory is financed on credit—good news for the individual vendors, but bad news for the financial system and economy.

China Confronts Mounting Piles Of Unsold Goods
“Across the manufacturing industries we look at, people were expecting more sales over the summer, and it just didn’t happen,” said Anne Stevenson-Yang, the research director for J Capital Research, an economic analysis firm in Hong Kong. With inventories extremely high and factories now cutting production, she added, “Things are kind of crawling to a halt.”

Problems in China give some economists nightmares in which, in the worst case, the United States and much of the world slip back into recession as the Chinese economy sputters, the European currency zone collapses and political gridlock paralyzes the United States.
That is not the worst case scenario, not by a long-shot. That is the most likely scenario.

Manufacturing leads the economy because it is a higher stage of production. Unlike the Keynesian model, recessions do not begin with a fall in consumption, they begin with a fall in manufacturing that is more severe than the economy-wide recession. (Think of how industrial commodities behave during a recession, demand can plummet even when the economy only slows a few percentage points.) Therefore, the increasingly sharp slowdown in China is a sign of a major global recession, likely worse than the recession in 2008 because governments have already fired most of their bullets and the debt situation in most countries is worse, not better.

“Sales are down 50 percent from last year, and inventory is piled high,” said To Liangjian, the owner of a wholesale company distributing picture frames and cups, as he paused while playing online poker in his deserted storefront here in southeastern China.

Wu Weiqing, the manager of a faucet and sink wholesaler, said that his sales dropped 30 percent in the last year and he has piled up extra merchandise. Yet the factory supplying him is still cranking out shiny kitchen fixtures at a fast pace.

“My supplier’s inventory is huge because he cannot cut production — he doesn’t want to miss out on sales when the demand comes back,” he said.
In the face of collapsing wholesale demand, manufacturers are still pumping out supply. This is why the economic data looks strong. Since recessions begin with manufacturing, gunning the engines can work if there's enough government support for the sector. The distortions in the economy build up though, and when the policy reaches the point where it doesn't work, what follows isn't a recession, but a depression.

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