Thursday, October 11, 2012

Global Overcapacity in Autos, Debt Induced Demand Bubbles Bursting and the Paradox of Thrift ... Looking at China


One of the most misunderstood things about the lengthy global financial slowdown the past several years is the lingering negative effect of overcapacity and what this impact this has on consumer spending and ongoing economic weakness.

Over the long haul, successful businesses are able to match capacity with demand while those who suffer from excess capacity are forced to cut prices to drive demand or close facilities, either of which weakens the company and industry as well. When lingering excess capacity exists in an entire industry, a shakeout occurs and it takes several years to get back to equilibrium.

And when the home based companies in these overcapacitized industries are protected by their home countries, getting to the end game can take a very long time. Subsidies merely prolong but aren't able to stop the inevitable resizing of the industry's capacity and reshaping of its various competitors. To gain a clear insight into how this works, we'll look at the auto industry and focus on China, the world's largest market for cars.

First, let's address the issue of how industries as a whole get into a state of long term as opposed to temporary overcapacity and what's often done about it, albeit incorrectly, once the excess capacity becomes widely acknowledged.

Getting to a state of industry overcapacity is very easy to do, especially when a credit bubble precedes it. As a result, this debt induced "excess demand" materializes over a period of years as new factories are built, and more widgets are produced than can be sold in a normalized market.

Thus, during the debt bubble building days, auto demand (housing, too, although that's another story for another time) was artificially stimulated by the easy and abundant credit available to car buying consumers. We simply spent way beyond our means by taking on burdensome debt to do so. Then we retrenched and stopped spending so much when the debts became onerous, and a glut of auto making overcapacity was the result. Now the capacity is in place but consumer demand has shrunk.


Thus, consumer spending has slowed, and consumers are spending below their long term means, thus exacerbating the overcapacity and debt problems for everyone involved. It's called the paradox of thrift as individuals act rationally by curtailing their own spending, begin saving and start paying off their debts. It's the right thing for the individual to do, of course. But when everybody does this, weak demand becomes weaker, prices are cut further, profits disappear, factories are closed and many companies go bankrupt. Even higher unemployment results, consumer spending is further weakened and the economy continues to struggle, ending in more unemployment.

The paradox of thrift merely suggests that individuals acting rationally to curtail spending, pay down debt and increase savings create even bigger problems for the already suffering general economy. This can come back to harm the rationally acting individual saver over time. Thus, a vicious spiral results which has been labeled the paradox of thrift. It's a paradox, and a powerful one at that.


The world's biggest auto market is China and it has big overcapacity problems, as do Europe and the U.S.  as well. The problems of each will negatively impact the others.

 How a Downshift in China Could Hurt GM, VW and Toyota describes the situation in China as follows:

"The Chinese auto market looks like it’s slowing down, and that’s not good news for big global auto makers including General Motors Co., Volkswagen AG and Toyota Motor Corp.

. . . Toyota Motor Corp. and Nissan Motor Corp. suffered deep drops in their Chinese sales last month, amid an upsurge in Sino-Japanese tensions over disputed islands in the East China Sea.

Chinese consumers may be shunning Japanese cars for nationalistic reasons, but there are signs that it’s getting tougher for all auto makers to hit their ambitious sales targets in the world’s largest auto market. Sales in July, the last month for which there’s comprehensive data, fell 12.6% from June levels, according to the China Association of Automobile Manufacturers.

A prolonged slowdown in the growth rate of Chinese auto sales – let alone a real contraction – will expose how oversupplied with car factories and car brands China has become . . . .

All together, domestic and foreign auto makers have the capacity to build 28.5 million cars and commercial vehicles in China – about 9 million more than customers are likely to buy this year. The country’s 48 domestic car makers together account for 30% of the passenger vehicle market, and their brands are on track to average annual sales this year of about 87,500 cars a piece. That’s “a paltry number by industry standards,” says Humphrey.

“If purely market dynamics were at play, a lot of those organizations would have gone out of the business already,” he says.

The structure of China’s auto market, he says, is in many ways like the United States in the early 20th Century, where dozens of automotive brands fought and died. By the 1950s GM, Ford Motor Co. and Chrysler Group LLC dominated the market — until Asian and European brands invaded during the 1970s and 1980s to challenge their hegemony.

. . . Chinese auto makers are working hard to build export sales because of the glut at home. So far, Chinese auto exports by homegrown Chinese brands are paltry. The overcapacity problem for domestic Chinese brands is exacerbated by the preference many Chinese car buyers have for Western brands.

Analysts have forecast a shakeout in the crowded Chinese auto market for years. Steady, strong growth during the past decade rubbished their predictions. Now, one of the questions confronting global auto makers — who’d benefit greatly from a thinning of the herd —  is whether China’s political leaders will sit by and let homegrown auto makers who employ thousands of workers wither and die.

Early signs suggest Chinese government officials are no less committed to saving their auto makers than officials in the U.S. or Europe. . . .

Western brands such as VW or GM’s Buick may be winners in the long run, but the big profits they’ve come to expect from China could diminish if price cutting and subsidies become the norm." 


Industry overcapacity issues in one country will cause problems for companies in other countries.

And protection subsidies in one country will lead to problems, and probably subsidies, in other countries.

These subsidies only prolong the agony for both the eventual winners and losers, of course. They don't solve permanent overcapacity issues of a global nature. 

Only customer choice, competition, time, pricing and factory closings will do that.

Thus, GM hasn't been "saved." Neither has Toyota, Nissan, Chrysler, Ford, VW, local Chinese auto manufacturers or countless other auto makers around the world.

There will be a long term industry shakeout where it's good to be a consumer and good to be a surviving strong and viable competitor able to offer the winning combination of cost, quality and delivery to the world's discerning consumers. 

Value for money is what it's all about, in other words, all as determined by the individual buyers. And not by the governments of the world, including ours and China's, too.

Thanks. Bob.

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