Capital goods are the first derivative of consumer goods

When analyzing product demand, a distinction should be made between consumption goods,  like toys and clothes and capital goods, like machines and trucks.  Capital goods can be defined as goods that are used to manufacture consumption goods.  Demand for capital goods can again be split in demand for growth and demand for replacement. Demand for replacement of Capital Goods is not the issue here: we focus on Demand for Growth. Demand for growth means the production capacity needs expansion.  If the production capacity grows at a constant rate, growth-demand for capital goods is stable. If production capacity is constant, growth-demand of capital goods is zero. If there is overcapacity, growth-demand of capital goods is negative, and because you cannot return machinery, it is zero. This relation is equivalent to the mathematical expression that growth-demand for capital goods is “the first derivative”  of demand for consumption goods. This 4th Law of Flostock may seem trivial or overly mathematical, but it has important implications.

Growth demand for capital goods goes through a peak when the demand for consumer goods merely goes through its inflection point (i.e. the point where the curve goes from stronger and stronger growth to weaker and weaker growth). Since the inflection point is much earlier in the economic cycle than the peak of consumer goods, capital goods peak much earlier. So all companies that produce capital goods go through an earlier cycle than all companies that produce consumer goods.

Labor in this comparison is also a Capital Good and there is supply of labor (hiring) for Growth and supply of labor (hiring) for Replacement. When consumer goods go through their deflection point, supply of labor for growth goes through its peak and starts going down. Supply of labor for replacement continues to take place untill the consumer goods go through their peak, then becomes negative and people are fired. Temporary labor suppliers like Randstad always remind us that they are early-cyclic, therefore they are a leading indicator. This is true, but they are only a good indicator because it is easier to see a peak than to see an inflection point. For the rest temp labor is just the first derivative of the main cycle. 

China is another implication of the 4th law : China has grown strongly over the last 25 years, but mainly in capital goods for the own industry and export of consumer goods. When the export growth slows down (so it is still growing, only slower), Chinese production of capital goods will decline.  If China does not manage to get its population to increase their consumption fast, and it is unlikely that they will, the Chinese industry will decline. This has already started. If the export of consumer goods will reach its peak, so when export markets become saturated, growth demand for capital products will be zero (or negative). In addition, the Chinese industry is young, so there is not yet much demand for replacement. This means that both types of capital goods production will stop.

On the other hand (because I don't want to stop with the word 'stop'), if demand for consumer products starts growing again, as it may be doing in the USA, Japan and Europe, growth demand for capital goods will once again see a strong growth indeed.

Chinese Housing Market is in trouble

A Construction bubble has fuelled the economic growth in China over the last 15 years in the same way it has in Ireland and Spain since the Euro and as it did in Japan in the eighties. When the bubble bursts, it will hurt.

The prices of houses in China have already reached a peak and have now started to go down. In response buyers will delay purchasing in the expectation that prices will go down further. This will become a self-fulfilling prophecy if sellers cannot pay the cost anymore and have to reduce prices to find buyers.

Dropping prices will be a strong incentive for construction companies to stop building, also because there already is a large reservoir of unsold houses in China. Construction is 10% of the Chinese economy (acc Mr. Wei Yao of Societe Generale). In addition, following a dip in construction all supplying industries will loose turnover (for many a substantial part of their existence). Especially the upstream companies, at the beginning of the supply chains, will see a significant dip because the whole chain will de-stock. This supplying industry is a much bigger part of the economy than the 10% mentioned by SG.

Dropping prices will also give strain on the banking system if the value of the houses drops lower than the mortgages. A Chinese banking crisis will be felt throughout the world. And dropping housing prices will reduce Chinese end market consumption, affecting all other industries as well.

The Chinese government might want to keep their trillion in the pocket to solve these problems, in stead of investing it in Greece or Italy.

The only consolation is that housing prices in China have gone so high that many ordinary people cannot afford a house. So if the prices drop 50%, a whole new market may emerge.