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TheStreet Open House

China's Overcapacity Bubble

TAIPEI ( TheStreet) -- If we say anything contrary about China's expansive and expanding economy, we normally point to slow export demand in major Western markets and the awkward rebalancing of economic policy that is supposed to replace industrial investment with consumer spending.

The whole sundae of tasty common explanations came up on Monday when China's premier gave an annual political convention his forecast for 7.5% economic growth in 2013, down from 9%-10% levels for most of the past decade.

A less-discussed yet more crucial explanation lies in the 20-year-old crisis of manufacturing overcapacity. Some call this problem the core threat to China's $7.4 trillion GDP, which is No. 2 in the world and an economic engine affecting every continent. The threat, on its face, should add to GDP growth. But eventually it will force today's expansion at least to melt.

Overcapacity in some of the country's anchor industries is already chafing at global trade relations by putting more stuff on the market. If the bloated banana boat finally bursts, foreign companies that have invested in the overwrought makers of steel, copper and aluminum -- three culprit industries -- will find themselves without a life raft. Overseas firms that sell orders to these companies for expansion would obviously need a new source of income.

Utilization rates for six of the most suspect industries ranged from 67% in aluminum to 85% in refining, according to a European Chamber of Commerce-Roland Berger study done in 2009. The other industries were cement, steel, wind power and ethylene chemicals. More recent reports say the problem that began in the 1990s has hardly abated since 2009.

A lot of these companies are just deeper in debt now and less profitable. Often pushed by local governments to boost employment, the manufacturers take out loans for new capacity. Rates are low and state-run companies easily qualify, though some are reluctant to go along with the local government campaigns as profits fall.

"A company will refuse to take on this mandate and say 'our balance sheets are weaker and not making money,'" notes Helen Lau, senior metals and mining analyst with Singapore-based securities firm UOB Kay Hian.

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