GEM Strategy - Chinese output gap: deflationary pressures are here to stay

The purpose of this note is to show how dramatic the Chinese excess capacity is and how hard it will be to narrow the output gap in the near future unless some capacity is shut down. One way of looking at the output gap in China is to measure any excess capacity relative to population. We have indeed looked at the global market share by various product categories net of share of China in world population. The list of products with excess supply against population is provided in the chart up front.

Excess capacity and deflationary outlook

The markets may find it rather inconvenient to talk about risk of a prolonged recession in China and her trading partners. The truth is the contribution of production capacity in China to global market is and remains massive and it could take years to reduce the excess. Assuming there are no additional government controls and any other impediments over trade, the burden of adjustment falls on prices, which should decline to clear the market. That some of these products are cyclical in nature or they may not be easily tradable do not change the argument materially.

Output gap widest in building materials, steel and aluminum

Market shares in global production of China-based manufacturers in a range of products are in multiples of China's share in world population (19%). The production capacity in each of aluminum, construction equipment, cement, steel, and construction glass is well in excess of 40% of corresponding world capacity. China also commands 25-40% of global production in plastics, various chemicals, cotton fiber, and automobiles among others.