AustaliaCanadaFranceGermanyHang SengJapanSwitzerlandUnited KingdomUnited States
Individual Global Investor Logo 
Blog

Is No One Bearish on China?

March 12, 2009             by        Bryan Banish

 

 

I was a little taken aback at Bloomberg’s March 11th article covering the latest economic news out of China.  Exports were reported as to have fallen 25.7% but the gist of the article was, “no problem, urban fixed-asset investment was up 26.5%.”  It even quoted one analyst saying that net export growth is just a small fraction of economic growth and is easily offset by investment.  Let’s be clear: China’s economy is slowing rapidly.  Industrial production is in decline, not slowing growth, in decline.  I understand that with every asset class in the world seemingly in freefall, we’d all like to believe the Chinese economy is going to keep the world afloat.  The downward revisions to global GDP growth keep coming.  The World Bank, Goldman Sachs, and the IMF are all calling for negative growth globally, a first in six decades.  Recent revisions, though, are not so much driven by the situation in developed, OECD nations.  The latest updates are simply a final capitulation on the “decoupling” theory that said emerging markets had reached sufficient critical mass to drive their own demand regardless of what the U.S. and other OECD countries do.  This means that, sooner or later, the numbers for China will be ugly too.  The point is not that China is so much worse off than the US or Japan, simply that the gravity applies to China as well as every other country.  What goes up…


Chinese exports are falling quickly.  This should not be a surprise to people watching the headlines around global trade.  Trade globally is declining at a very rapid rate.  Japan is getting the most attention with a 35% drop in December exports versus a year prior.  Their drop is across the board but is underpinned by high dependence on auto exports to the U.S. Germany is reporting less severe but equally surprising numbers.  So why should China be immune?  When consuming nations like the U.S. and the U.K. contract, shouldn’t exporting nations feel some pain?  You should expect that.  It is happening in Japan, South Korea, Germany, AND China.  China’s exports to the U.S. have experienced double digit month-on-month declines in November and December of last year.  These are not slowing growth, they are declines.  Of course, there are counter arguments that China-bulls offer.  The argument is simple and almost plausible: China will simply shift its economy to offset the demand that is dropping off in developed nations.  The government will steer a portion of its foreign currency reserves into infrastructure projects and manufacturing output will be redirected exports towards domestic consumption.  It is true that the Chinese government has a lot of savings to deploy and can do so more quickly and efficiently than western governments.  With consumer confidence declining in China, the latter assertion is more questionable.  If domestic demand is substituting for exports, it would be evident in Chinese industrial production data. 

                                                

Unfortunately, industrial production in China is declining rapidly. The National Bureau of Statics in China tracks industrial production output monthly on 70 different categories from TV production to chemical output to steel production.  In any one category, growth can vary greatly due to seasonality and month-to-month fluctuations but in aggregate they paint a good picture of the manufacturing economy.  Early last year when global demand was brisk a half dozen to a dozen might be negative but the bulk would register year over year growth of 20% or more.  This began to change last August and in the final two months of the year more than 60% of the categories (44 out of 70) had turned negative.  Many categories have output still increasing but the across the board reversal has been abrupt.  In the month of December 2008, for example, steel production declined 10.5%, motor vehicle production dropped off 18.9%, air conditioner production was cut by 31.4%, and the number of small tractors built were less than half (-52.5%) from December 2007.  Is China doomed?  Hardly.  It is simply mortal and vulnerable in this unprecedented global slowdown.  The picture doesn’t show an economy shifting gears seamlessly to generate growth simply by different means as the pro-China investment folks have suggested.

 

Let’s do the math.  Annual figures for Chinese trade have not been finalized but should be roughly $1.4 trillion for 2008.  If exports were to decline in 2009 simply 15% (roughly a return to the 2007 level), this is about $200 billion to offset somehow.  Most every economist in the world is still forecasting growth in China, just not at the 9% level experienced last year.  Even at half that growth rate (4.5%) off a base of $4.4 trillion economy, the government must come up with another $200 billion in economic activity that was not there in 2008.  Thus to offset the decline in exports and grow at 4.5% (dangerously low level of growth for China), there needs to be an additional $400 billion of economic activity with no further marks to the downside.  The government did announce a roughly $600 billion (4 trillion Yuan) stimulus package, over $200 billion which is targeted at infrastructure projects.  For that to do the trick you need a few assumptions:

  1. Two-thirds of the stimulus is spent in 2009.
  2. The spending is 100% efficient, every Yuan spent creates a Yuan’s worth of economic activity
  3. No further downside is seen: foreign direct investment holds up, unemployment does not spike, consumers continue spending.

 

To me, these assumptions are a stretch.  With the terms “decoupling” and “contained crisis” solidly replaced in our vocabulary with “global recession” it is clear: we are all in this together.  A consumer-led recession starts with net consuming countries, extends to net exporters and will eventually hit the commodity producing nations.   We are in the second stage of that process with the full acknowledgement that Japan and Germany are going the way of the United States.  Strangely, though, just as the Chinese decline is finally starting to show in the numbers, there is a pervasive belief that something special about the Chinese economy will allow it to avert the fate of others.  The law of gravity does not apply there, it seems.  Get ready to shift your mindset: what goes up does come down.  By late summer this year, I expect this notion should be wiped away.  There might even be pressure on the Yuan to devalue, a further complication to tenuous global trade discussions.

 

Is China going to emerge from this “great recession” (a term coined by the IMF this week) stronger than before? Quite possibly.  Is the Chinese government doing a better job managing its economy?  Maybe.  Is China going to be spared from this downturn?  Definitely not.  There may be some GDP growth for China in 2009 but it could just as likely be near zero.  The global credit boom elevated the demand for manufactured products to unsustainable levels.  The world has far too much capacity to produce, much of it in mainland China.  It will take some time to work this off.  Stimulus efforts by the government will likely be effective in limiting the damage to the Chinese economy and the much needed improvement in infrastructure, if done right, will benefit the country in the long run.  Any notion, though, that the laws of supply and demand don’t apply here are mistaken.  Invest cautiously here. 

 

 

For more see: http://www.individualglobalinvestor.com/HangSeng1.html