This is not to say that the Chinese don’t appreciate the utility of a market economy. But one could say that reform in China has led only to a reversion to the historical norm. The Mandate of Heaven applies equally to the CCP as it once did to the Emperors: the Emperor may now be called the General Secretary of the Communist Party of China but the means of rule and social control remain broadly the same: an Emperor served by a devout and well-educated political class, no independent judiciary, local gentry and wealthy property owners supporting the centre and a proletariat with limited rights kept in check by a strong militia and a firm grip on the distribution of food and baubles.
Chinese political logic is circular: if we are in power then we must have the Mandate of Heaven. Therefore everything we do is right. Therefore the right thing to do is whatever we are doing. This can lead to an arrogant attitude towards change and towards alternatives. The Chinese government told Lord McCartney in the late eighteenth century that they had no need of Western baubles, but thanked the King of England for his tribute. Following the global crash in 2008 one senior Chinese central banker told Mervyn King, then the Governor of the Bank of England, that the CCP was very interested in studying Western economic management but felt that the West had not yet got the hang of banking and finance.
What has this to do with shipping? Bear with me….
While liberal democracies in the West dither and fret about how to both engage with China as a trading partner while containing it as a strategic competitor, China is presented as an unstoppable machine with a political and economic system that demonstrably works better. How are we to compete? The Trump administration tries the blunt instrument of trade tariffs. The EU tries to dance but not too close with its Chinese mistress. Countries along the Belt And Road begin to push back against what is increasingly perceived as Chinese investment for Chinese benefit.
The reality is that the Chinese system contains myriad inefficiencies and contradictions. Two examples are relevant to trade and shipping. The hierarchical nature of China’s institutions tends to lead to “report inflation”. This was most evident during the Great Leap Forward. The plan was to sell surplus rice to earn foreign currency. Collectivised villages over-reported rice production and the rice they needed to eat was sold. The famine killed millions. Even today, the Party recognises that State Owned Enterprises are prone to over-report progress and to under-report when they fall short of targets.
The other main problem is that supply-side management can lead to over-production. This has been most evident in China’s steel, coal and thermal power industries. We all know China is the world’s biggest coal producer and consumer. Its coal imports and steel exports go up and down not according to the market but according to the prevailing policy on coal or steel production and domestic consumption.
The organ of state responsible for managing the economy is the National Development and Reform Council. This august body has been working since 2016 on its latest plan for cutting surplus inefficient manufacturing capacity. It has had coal and steel in its sights for many years now, but production of both continues to rise. The NDRC reported its progress on 18 June this year. Adopting the usual Chinese PolicySpeak, some platitudes in statement included, “The country will push supply-side structural reform in the steel sector, accelerate the cuts in overcapacity and encourage the green and innovative development of the sector….The total number of coal mines should be reduced to no more than 5,000, while production by large-scale coal mines should account for some 96 percent of the country's total output.”
(Incidentally did you know that China’s coal mining industry was as vast as that? A reduction to no more than 5,000 mines!)
The NDRC’s work on steel, coal and thermal power generation and is supposed to be completed this year. But inefficient capacity remains to be cut even after four years of efforts. Local government and party interests can act to delay or even reverse closures. The NDRC is forced to react to events as much as it tries to shape them. Just as in the days of the Emperors, local inertia can be enough to prevent orders from the centre from being executed.
Meanwhile as China’s increasingly fraught relationship with Australia puts its iron ore supplies in doubt, the NDRC has been promoting domestic production of the red ore as well as diversifying China’s sources of supply by investing in (buying) overseas iron ore mines. The NDRC has been working for decades on diversifying China’s supplies of iron ore even as the global iron ore markets have consolidated into a handful of suppliers, Sinosteel, Shougang and others have invested in mines in Australia, Africa and Latin America but China has been unable so far to take control of its supplies of iron ore. Instead China reacts to events rather than shaping them. Last year, after the Broumadinho mining dam collapse, China sourced increasing amounts of iron ore from ‘second tier’ suppliers such as Sweden, Saudi Arabia, Iran, Canada and Peru. Much of this was shipped in Supramaxes and Ultramaxes, making use of their gear and flexibility for smaller terminals.
The shipping angle might be coming into focus now…
China is not a market economy. Its success as a centrally planned economy comes despite its inefficiencies, contradictions, policy changes and hierarchical structures.
But these can have major effects on shipping markets, especially those in which the supply of the commodity is limited to a few leading organisations. China gets over 70 per cent of its oil from the Middle East, and a similar percentage of its iron ore comes from just Brazil and Australia. China’s policies, led by the NDRC, can have massive effects on the shipping industry which the economists simply can’t model in their supply and demand fundamentals.
So when you are trying to fathom the reasons for the recent rise in the BDI or the potential volatility of the VLCC market, bear in mind that Chinese domestic and international politics can manifest unexpectedly in freight markets.
The trick, when investing in a market that is unpredictable, is not to go on the fool’s errand of trying to forecast the markets correctly, but to manage your risk as far as possible.