China is not just dominating the electric vehicle (EV) market, it is catastrophically glutting it.
The oversupply is so bad, China is producing a flood of excess EVs that nobody wants — not even Chinese consumers within China.
It is so bad that China's leaders are speaking in dire tones of the need for excess production to slow down or stop.
But production is not likely to stop. There are signs it is ramping up further.
For example, BYD, which is already the global leader in both hybrids and pure EV production and sold more EVs worldwide than Tesla in 2023 — is close to completing a new $5.6 billion plant in Hefei, China that could add as many as another 1.3 million vehicles.
The glut of EVs being jammed down the world's throat is bad for everyone, even the Chinese. It is a government engineered disaster with ugly impacts for the global economy, not just China.
For example: China's tsunami of EV oversupply has crashed the lithium market, where prices have fallen more than 80% in the past 12 months.
How does an EV production glut lead to a lithium crash?
It's a result of the non-economic signaling created by China's artificially jacked-up EV demand curve.
Global lithium producers calibrated their output levels to sky-high levels of lithium demand coming out of China. But that demand was artificially boosted by government subsidies and state-directed loan programs that fueled a breakneck level of expansion, which proved impossible to sustain.
And so, when the subsidies were pulled and the demand curve flattened in the midst of an EV price war, for lithium demand it was like stopping the music in a game of musical chairs. China suddenly went from an aggressive importer of lithium to sitting on large stockpiles of lithium as marginal demand evaporated, causing lithium prices to plummet.
Dangerously Decentralized
To understand how this happened — and why China's EV flood is bad for everyone, including China itself — you have to grasp how messed up China's state-directed planning system is.
Top-down, state-directed planning is bad enough already because government decisions are not subjected to market discipline.
That is to say, in a market-based system, if the CEO of a business makes a bad decision in terms of how to allocate resources or how much to produce, the market punishes that bad decision via declining profit margins or losses.
If the declines or losses get bad enough, investors can pull their capital, the CEO can be fired, or the business can face bankruptcy or a hostile acquisition.
But when a government sets production levels, there is no feedback mechanism of market discipline. Not only are bad decisions left unchecked, the decision makers tend to double or triple down on bad ideas.
In China you have to take this problem and multiply it by 50, because China does not have one single authority making top-down planning decisions. It has dozens of them.
Here is how that works:
China as a country is too big and sprawling for any one entity to manage directly, even the Chinese Communist Party (CCP).
Though the CCP rules with an iron fist, decisions around financial management and hitting local growth targets are left to regions, provinces, and cities.
In this semi-decentralized model, the CCP communicates a growth target to a city or a province — say 6% annually — and then local managers are left to figure out how to achieve that target.
Imagine a giant conglomerate with 50 different divisions where none of the division heads talk to each other, all of them compete with each other, and there isn't really a company-wide CEO, only a chairman of the board and a board of directors.
In this situation, the chairman of the board could say, "more electric vehicles!" as a kind of hand-waving directive, and the 50 different division heads could all jump up and go to work producing electric vehicles in direct competition with each other, with nobody coordinating whether this is a terrible idea at the company-wide level.
That is a very simplified model of what is happening in China.
Chairman Xi Jinping and his "board of directors" (CCP officials) want China to be hyper-competitive in EV production, batteries, and renewable energy.
Rather than coordinating levels of production and output, though, Xi just communicates a top-down message and the 50 "division heads" — analogous to state-run regional and city governments all across China — all focus on fulfilling the mandate. And they all do the same thing. At the same time. Without coordinating.
And then, just to make matters worse, the situation is even more messed up because local cities and provinces are not only responsible for their own budgets, they are responsible for generating profits to sustain their growth.
In this sense they have the pressures of a capitalist system — "figure out how to make money" — combined with the mandates of a communist system — "be sure to invest in XYZ" — in a way that creates the worst of both worlds.
He Ain't Hefei, He's My Neighbor
For a long time, Chinese planners at the province and city level were in love with "the Hefei model." Hefei is a city in central China that perfected the art of economic growth through government-led investment.
Hefei's vehicle production has tripled since 2019 and now exceeds that of the entire state of Michigan; Hefei is also where BYD is building its new $5.6 billion plant that could churn out as many as another million-plus vehicles per year.
Hefei became an EV and solar juggernaut over the years with a series of steps dubbed "the Hefei model" because of the city's grand success. The Hefei model works like this:
A regional or city government uses profits from land lease sales to invest in electric vehicle production and renewable energy production (or whatever the CCP likes at the time).
As production ramps up, capacity is expanded further via subsidized loans from state-owned or state-directed banks (because the CCP generally approves of EV and solar production, and in broad terms, the CCP tells the banks who to lend to and how much).
As the city or province becomes a hub known for its high tech production, funds are used to attract suppliers to the same location, which adds to the flywheel of local economic growth. The Hefei model looked brilliant while it lasted.
As production levels increased, the city met economic growth targets and created local wealth. This was bullish for real estate values, which increased the profitability of land leases — the staple revenue driver at the local government level — which allowed the local governments to invest in more production and attract more manufacturers and so on in a flywheel of growth.
But then China's $55 trillion real estate bubble started to deflate, and the EV and solar spaces became glutted, and the Hefei model stopped working.
Hefei is in a lot of trouble now, primarily because its real estate values are collapsing (like many cities across China) even as Hefei's primary industries are facing a reckoning from oversupply.
The I's Have It
As Warren Buffett has observed, there are "three I's" of every business cycle — "Innovators, Imitators, and Idiots."
Within China, Hefei was the innovator. Other cities and provinces that adopted the Hefei model soon after were successful imitators.
And all the too-late actors who piled in were the idiots — and now you have high-ranking CCP officials like Xin Guobin, vice-minister of industry and information technology, declaring Beijing will take "forceful measures" against "blind" EV production. In other words, "Cut it out you guys! You did too much!"
In the meantime, the world is facing a deluge of excess EV supply, which has Europe so irritated an EU-China trade war could soon break out, even as Americans show a preference for reasonably priced hybrids over expensive and hard-to-charge EVs.
How will China fix the situation? We have no idea.
It's not as if China's cities and provinces can simply shut off production after plowing tens to hundreds of billions of dollars into state-subsidized projects, even if those projects are competing disastrously with another. Those local entities still have to hit growth targets and pay bills.
In our view, the EV market could wind up like the boom-bust solar market of years past, where China has already crashed prices more than once via state-backed production gluts.
And they are still at it with solar, too — China installed more solar panels in one year, 2023, than any other country in all years put together per Bloomberg.
Until next time,
Justice Clark Litle Chief Research Officer, TradeSmith
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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