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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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New Silk Road A Disaster Waiting To Happen?

New Silk Road A Disaster Waiting To Happen?

For much of the last fifteen years, Chinese growth has been a source of hope across Asia. Now that growth is slowing and China appears to be hitting some significant turbulence in its effort to shift its economy from an investment-focus to a consumption-focus.

To help combat this emerging economic stagnation, China is turning to external investments and trade. China’s goal is to avoid a fate similar to Japan, which saw stagnation in the 1980s from which it never fully recovered.

At the center of China’s strategic plan is the “Silk Road,” a collection of more than 300 investment projects aimed at fostering trade and collaboration between China and other countries from Singapore to Turkmenistan. The country is enlisting the help of many of its state-owned enterprises in this massive international trade program. Recently, Chinese bank CITIC announced that it would invest $100 billion in various Silk Road projects. Related: Arctic Drilling Future Now Rests On One Well

All of this sounds good in theory, and international trade is a long-standing mechanism to improve macroeconomic development. That’s why trade pacts like NAFTA and the TPP get so much support from so many leaders around the globe.

Unfortunately for investors in Chinese equities, that is not what’s going on with the Silk Road project. Instead, the Silk Road is really a geopolitical maneuver on the part of China – a strategic program dressed up as economic projects in an attempt to make itself more important to the overall Asian economy. And investors who are not careful could find themselves dragged into an uneconomical political morass.

Politicians like to talk about infrastructure projects as being useful economic generators, but in many cases the projects simply end up being white elephants. The Olympics are a classic example of this. China’s Silk Road plan is too small to have a meaningful impact on the overall rate of Chinese growth, but it could easily lead to billions of dollars in wasted investments across many countries. The Chinese government is pushing to have these projects financed by private investors and state companies but that could leave many investors on the hook if questionable projects go bad. Related: Top Shale Takeover Targets

The best example of the perils of China’s new Silk Road project may be one of the first initiatives the country is funding. The Chinese have been actively working on a deepwater port in Gwadar, Pakistan for several years. The port will be run by the Chinese under a long-term lease, and will serve as a launching point for an Iranian-Pakistani natural gas pipeline that will eventually be extended to China.

But the project is geographically questionable since it will have to cross substantial mountain ranges and it faces competition from India. India is looking to build its own pipeline to counter the Pakistani pipeline and the U.S. is supporting that effort despite its misgivings around India’s need to deal with Iran as a site for the Indian pipeline port. Related: Are We Headed For Global Warming Collapse?

This project, and many others like it, are rapidly devolving into political projects rather than economic ones. That is a bad formula for investors. The Chinese stock market is already experiencing upheaval related to economic uncertainty. The Chinese GDP is roughly $10.4 trillion. The amounts being invested in any given year for the Silk Road are likely to be around 1 percent of that figure once most projects get underway. So the investments will not move the needle on national growth. Investors should avoid getting too optimistic on this front.

Some commenters have drawn parallels between China today and Japan in the 1980s, but the truth is that China’s situation may be direr. Japan at least stagnated at the point when it was a developed nation – China may be pinning too much hope on a series of political projects for the country’s future at a point in time when, on a per capita basis, the country is still mostly mired in poverty.

By Michael McDonald for Oilprice.com

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  • Roland on July 02 2015 said:
    Any 'Silk Road' railroad project will have to go north of the Caspian & Black seas due to mountains & politics. It will then be hampered by a very big hardware problem: "Russian gauge":
    https://en.wikipedia.org/wiki/5_ft_and_1520_mm_gauge_railways
  • Kadin on January 24 2016 said:
    The author clearly does not understand the importance of the Silk Road. This is not just a economics project, but also one to hopefully bring some peace to the Middle East while securing import and export routes.
    This will be good for all nations along the new Silk Road, One belt project. However, the project will definitely pull resources away from Europe and the US. The Chinese know what they are doing, that is pretty clear, afterall they aren't in a mess like the Eurozone.

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