China’s Investment Addiction

China’s economy slowed unexpectedly in the second quarter of this year, and, just as unexpectedly, most data released since July suggest that China’s growth has stabilized – eliciting a collective sigh of relief in markets worldwide. But investors should still be holding their breaths.

BEIJING – China’s economy slowed unexpectedly in the second quarter of this year. Just as unexpectedly, most data released since July suggest that China’s growth has stabilized. Markets, not surprisingly, have breathed a collective sigh of relief. But should investors still be nervous?

Currently, the most severe problem confronting Chinese authorities is overcapacity. For example, China’s annual production capacity for crude steel is one billion tons, but its total output in 2012 was 720 million tons – a capacity utilization rate of 72%. More strikingly, the steel industry’s profitability was just 0.04% in 2012. Indeed, the profit on two tons of steel was just about enough to buy a lollipop. So far this year, the average profitability of China’s top 500 companies is 4.34%, down 33 basis points from 2012.

Some say that today’s overcapacity is a result of China’s past overinvestment. Others attribute it to a lack of effective demand. The government seems to come down in the middle.

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