NEW YORK (CNN/Money) - Companies around the world, it seems, have caught China fever. When the fever breaks, there could be hell to pay.
Building out operations in China, with its business-friendly environment and low-cost work force, is all the rage these days. Flip through the financial pages and you'll find that Toshiba plans on boosting its notebook production in China by 70 percent in the next half year, that Ford plans to spend over $1 billion on two new plants there, that $2.8 billion of Motorola's sales last year were made in China.
And this does not even take into account China's booming homegrown companies, which, thanks to cheap credit from state banks and intense rivalry between local governments, are stepping up production of everything from cars to cement.
Put it all together, according to Credit Suisse First Boston chief non-Japan Asia economist Dong Tao, and you have a classic overinvestment story. Tao reckons that China's steel-production capacity, already more than that of the United States and Japan combined, could double in three years. Ditto for China's mobile-phone production, which already accounted for 43 percent of sales globally in 2002. A swath of other industries -- from automakers to ethylene producers -- could see similar surges.
What's unclear is how the world is going to absorb all the capacity coming on line in China. Or, putting it another way: Who is going to buy all this stuff?
Fire burn and cauldron bubble
"There's a thought that says Japan had a capacity bubble in the 1980s, we had one in the 1990s and now it's China's turn," said Brown Brothers Harriman global fixed-income manager Richard Koss.
It's a thought that has apparently crossed the minds of Chinese officials. In the third quarter, China reported gross domestic product grew at a 9.1 percent annual rate, but many economists believe that official figures on the economy are understated. Rising property values and capacity growth have prompted the Chinese central bank to try to slow lending growth, and Beijing is working to limit overinvestment in areas like steel and autos. Some analysts believe China will revalue its currency, the yuan, within the next year -- not because of pressure from the United States and European governments, but as part of an effort to cool down a too-hot economy.
China has dealt with such overheating in the past. The difference this time is that its footprint on the world is much larger -- it is the world's sixth-largest economy -- and it produces far more tradable goods. A Chinese economic slowdown might stem capacity growth, but it wouldn't affect the production capacity that's already there. And because domestic demand would be stifled, it could result in a flood of Chinese products into the global marketplace.
"If China slams on the brakes, there's going to be a wave of pricing pressure," said Bill Sterling, chief investment officer at Trilogy Advisors.
Merchant of menace?
Not that a downturn would slow the long-term trend in China's economy. The allegory for China, whose rural population is flocking to cities, may be America in the 19th century, which saw massive population growth as immigrants flooded in. There are millions of workers that industrial China must absorb every year, and the only way to absorb them is to keep boosting growth. Maybe this will end up being a bad thing for China's economy in years to come, but the idea of accepting high unemployment now to ensure longer-term economic health is doubtless just as unpalatable in Beijing as it would be in Washington.
Just as overseas manufacturers had a hard time keeping up in areas where America boosted production in the 19th century (fittingly, textiles come to mind), it will be tough to keep up in areas where China is aggressively adding capacity.
"Nibbling at the edges by making China revalue the yuan by 10 percent or putting restrictions on bra imports isn't going to change things," Lehman Brothers chief U.S. economist Ethan Harris said.
Eventually, China's standard of living should grow to the point where it is able to absorb more of the goods it produces and where there will be a rising demand for many of the services that the United States has to offer.
In the meantime, just as we learned during the tech bubble, when companies' business investment runs amok, investors in such companies will pay the price.