After trading up four days in a row, with the SSE Composite closing on Monday at 2091, up 3.6% for the day, the market turned today and the SSE Composite lost 2.5% to close at 2038, less than one point off its intra-day bottom. What drove the four good days was continued talk of government intervention to support the market by buying shares.
What probably caused it to decline today was surprising comments made earlier by Fan Gang, an advisor to the PBoC, about a potential decline in exports in November. Actually the comments were not completely a surprise. Last Wednesday I mentioned in my blog entry that there were rumors swirling around the market that year-on-year exports for November had actually contracted by 7%. I was not able to get any confirmation, but it should not be a total surprise if that happened since Korean exports contracted year-on-year in November by 18%, and Taiwanese exports also contracted, by 23% (both were hugely up as recently as August). Here is what Bloomberg said in its article today on Fan Gang’s comments:
China’s exports shrank last month and industrial-production growth cooled, Fan Gang, an adviser to the People’s Bank of China, said today. “Things are not so good,” Fan said at a forum in Beijing. “November figures will come out soon, and industrial growth will be something around 5 percent and export growth will be negative.”
A collapse from October’s 19.2 percent export growth would add pressure on policy makers meeting in Beijing this week to do more to sustain the expansion of the world’s fourth-biggest economy. The government has already unveiled a 4 trillion yuan ($582 billion) stimulus package and cut interest rates by the most in 11 years as a global recession cuts demand for the nation’s toys, textiles and electronics.
To give a sense of how shocking an actual contraction in exports would be, two hours ago I met with a group of very knowledgeable China-research economists. I told them about the rumors of a contraction and asked for their opinion, and they said that although they definitely expected export growth to continue slowing, they would be really surprised and worried if it actually were negative. A contraction in exports year on year will suggest that the impact of the global slowdown on China is happening far more quickly than anyone expected.
My simple global balance of payments model should suggest, however, that we should have expected a rapid slowdown. After all if Chinese overproduction is the flip side of US overconsumption, and each requires the other, then the astonishing rate at which consumption is contracting in the US should have, as its counterpart, an equally rapid contraction of production or, failing that, a rapid buildup of inventory. Either of these will come as a result of declining sales. There is no point trying to predict Chinese economic numbers independently from US economic numbers. The world imbalance has been built around US overconsumption and Chinese overproduction, and one cannot change with a corresponding change in the other.
Whatever the actual trade numbers turn out to be, I suspect they are a hot topic in the Central Economic Work Conference, which started yesterday. This conference is held every year to discuss what happened during the year and to set the economic strategy for the coming year. Here is Xinhua’s take:
China’s annual Central Economic Work Conference opened here Monday to set tone for the economic development next year. Observers believed the three-day event would give priority to efforts to maintain stable economic growth.
They reckoned in 2009, China would see more risks for worse economic slowdown, more struggling smaller businesses, grim export situation and arduous task of transformation of economic growth pattern. “It is imperative for China to maintain an economic growth of at least 8 percent,” said Zhuang Jian, senior economist with Asian Development Bank’s China Resident Mission.
It was hard for China to bear the consequences of a too slow GDP growth, Zhuang added, citing bankruptcy of numerous enterprises, more migrant workers being laid off and difficulties for college graduates to find jobs.
Later in the article there is a discussion of some of the relevant issues facing the participants at the conference:
China has launched a scheme to subsidize rural residents for buying home appliances since the end of 2007. It is estimated that in a period of four years, nearly 480 million units of refrigerators, washing machines, color TV sets and cell phones, which were in huge demand among farmers, will be sold in rural areas nationwide. That means 920 billion yuan to be spent by rural consumers. “There is still a large room for the government to mull more policies to boost consumption, such as raising the threshold for taxable income and increasing income for lower-income earners,’ said Cai Zhizhou, an economist with the prestigious Peking University.
Export has since long been a major driving force for the Chinese economy. Economists believed the stable development of smaller enterprises, particularly the exporters, which provided jobs for 75 percent of urban employees and rural migrant workers, was related to the stability of the enormous Chinese labor market. How to prevent export from sliding down too fast is one of the top concerns of the Chinese government.
“It is no doubt that China’s export situation will become more grim next year. However, if the country manages to maintain a moderately fast growth in foreign sales of machines and electronics, it will likely achieve a growth of more than 15 percent in export at large,” said Mei Xinyu, a trade expert with the Ministry of Commerce.
China has taken a string of measures to boost development of smaller enterprises. “It is necessary for the government to work out more detailed, effective methods to mitigate tax burdens and enhance credit support for smaller businesses, and to help them with their efforts to promote technical upgrading and explore more markets,” said Zhao Yumin, another economist with the Ministry of Commerce. ]
Basically, and not surprisingly, everything is on the table for discussion. The more sophisticated of the commentators, like Cai Zhizhou, are focusing on demand management as the key to resolving the problem. Unfortunately a lot of policy-makers also seem to be focusing on boosting exports, or at least maintaining their level. The trade expert with the Ministry of Commerce, for example, is talking about boosting exports by 15% next year. This is fine only as long as it comes along with a much more sizable boost in imports, but somehow I don’t think the Ministry of Commerce is very worried in boosting imports. But like it or not the trade surplus must come down sharply, or it will indicate that China is still counting on its ability to export overcapacity onto the rest of the world, where there is too much capacity and not enough demand.
On a separate note, one of the blogs I read regularly to impress people with my insider knowledge of Chinese policy-making (I just plagiarize him) is Victor Shih’s blog on Elite Chinese Politics and Political Economy. Here is a recent entry, which suggest to me that my long-running contention – that the government’s fiscal position is going to prove a lot less solid than everyone has always assumed – is not implausible:
More details have emerged about the 4 trillion stimulus package that China has rolled out. The main questions remain: who will get the money? How will it be spent? In a revealing article published the 21st Century Economic Herald (my favorite), reporter Wu Hongying gives a detailed account of how Chongqing (a provincial unit controlled by princeling Bo Xilai) plans to spend the money. I believe the situation faced by Chongqing is similar to that in many Chinese cities and provinces.
Basically, Chongqing SOEs, which focus on land holding, real estate, electricity, and financial services, are in deep trouble. Land prices in Chongqing have fallen by over 70%. The electricity group is in the red by about 250 million RMB. The debt asset ratio for the 8 major SOE groups in Chongqing has risen to 72%. No details are given about the financial holding companies, but considering that their main role is to inject capital in the other SOEs, they can’t be doing too well either. Things are not pretty, and the well off SOEs have to inject capital in the problematic ones.
So, the central government rolls out a 4 trillion stimulus package. As I pointed out in the last note, only a part of the money will be from the central government, but at this point, local governments are desperate to get this part. Thus, a massive fraud whose working and purpose are perfectly clear to all the players involved is perpetrated. Basically, local governments propose projects which may or may not be implemented with the sole purpose of receiving central funding and “supplementary” (peitao) bank loans from the state banks in order to stave off the bankruptcy of local SOE groups, which are heavily indebted at this point.
The local “self raised” part of the capital can be a piece of idle land or a redundant factory. The excuses are many, but both the local and the central governments know that the center and the banking system must give a large chunk of money in order to prevent (delay?) massive bankruptcies of local and a few central SOEs. As for Chongqing, it has applied for 20 billion in investment before the end of 2008 (out of the 100 billion announced by the NDRC for China as a whole). Almost all of the money will go toward large SOEs in Chongqing. Due to Bo’s political connections, Chongqing will probably get at least 5-10 billion, thus staying solvent for some time
Tuesday, December 9, 2008
Yuan Watch : negative feedback loop
My comments last Sunday:
‘Over the next two quarters, China will probably suffer a contraction. How China Inc. will report the numbers is anyone’s guess but putting ‘lipstick on a pig’ with chinese characteristics will only go so far. The economic stimulus announced will not be able to take effect fast enough to offset the accelerated decline in both the export markets and the domestic real estate markets. China has a ‘political risk’ in the absence of a social convenant that will translate into a depreciation premium, be it through export tax rebates or a slight currency devaluation as they hunt madly for lipstick.
In short China is, much like America a century ago, in a boom and bust cycle, with the latter ocurring now. Given the Yin-Yang relationship between China and the United States, we will export deflation with our increasing unemployment and decreasing GDP and they will export their bust back to the West in the form of further commodity declines.’
Michael Pettis’ comments this morning:
Here is what Bloomberg said in its article today on Fan Gang’s comments:
China’s exports shrank last month and industrial-production growth cooled, Fan Gang, an adviser to the People’s Bank of China, said today. “Things are not so good,” Fan said at a forum in Beijing. “November figures will come out soon, and industrial growth will be something around 5 percent and export growth will be negative.”
A collapse from October’s 19.2 percent export growth would add pressure on policy makers meeting in Beijing this week to do more to sustain the expansion of the world’s fourth-biggest economy. The government has already unveiled a 4 trillion yuan ($582 billion) stimulus package and cut interest rates by the most in 11 years as a global recession cuts demand for the nation’s toys, textiles and electronics.”
To give a sense of how shocking an actual contraction in exports would be, two hours ago I met with a group of very knowledgeable China-research economists. I told them about the rumors of a contraction and asked for their opinion, and they said that although they definitely expected export growth to continue slowing, they would be really surprised and worried if it actually were negative. A contraction in exports year on year will suggest that the impact of the global slowdown on China is happening far more quickly than anyone expected.
My simple global balance of payments model should suggest, however, that we should have expected a rapid slowdown. After all if Chinese overproduction is the flip side of US overconsumption, and each requires the other, then the astonishing rate at which consumption is contracting in the US should have, as its counterpart, an equally rapid contraction of production or, failing that, a rapid buildup of inventory. Either of these will come as a result of declining sales. There is no point trying to predict Chinese economic numbers independently from US economic numbers. The world imbalance has been built around US overconsumption and Chinese overproduction, and one cannot change with a corresponding change in the other.
This is the negative feedback loop we should fear (posted by me last Sunday): It is estimated that for every 1 percent decline in U.S. and Europe’s GDP there is a corresponding 7% drop in China’s export growth rate. Orders at the recent Canton Trade Fair fell 17.5% which roughly translates into a 2.5% GDP drop in U.S. and Europe. Obviously conditions now are much worse, with real estate softening in China and the lag in the Chinese stimulus having a delayed effect, even if it is front-loaded; it would appear that the risk of a recession in China is now real.
Posted by Anonymous Monetarist
Sounds so familiar, only because I spent the first 27 years of my life in India.
michael, what probability to you attach to china experiencing negative gdp growth sometime in the next 12 months?
given the sociological feedback that is supposed to be associated with growth < 8%, one wonders how slippery a slope it might be..
I have just a quick question. If China cannot prop its economy by further yuan devaluation (since they are already outside of the profitability window of the currency manipulation regime) and cannot use internal leveraging/monetary expansion to stimulate domestic consumption (this will also lead to yuan devaluation and massive inflation), then how soon should we expect the Chinese foreign reserves to begin a significant diminishing trend?
And one more question. After reading an excellent RGE piece:
http://www.rgemonitor.com/us-monitor/254702/where_did_all_the_money_disappear__liquid_fantasies
I wonder, exactly how much of those famous $2T is available to the Chinese government for a national bailout program and for a domestic consumption stimulus?
America exports American jobs to China
America imports Chinese products.
China imports American jobs.
China exports Chinese products to America.
Now America has finally exported so many jobs that America can’t import Chinese products.
Boom!
@bena gyerek:
“michael, what probability to you attach to china experiencing negative gdp growth sometime in the next 12 months?”
Answer: -200%
You asked seriously; I answer seriously.
@tyaresun:
“Sounds so familiar, only because I spent the first 27 years of my life in India.”
So China is repeating now what India had experienced at least 27 years ago? Interesting.
@CLN:
Be patient: we should be seeing Chinese foreign reserves to begin diminishing in 6 – 12 months time frame. I also expect the economy to collapse with large-scale social unrest in 12 months.
Geez.
Do the Chinese still refer to Beijing as Peking sometimes?
What I mean’t is isn’t it strange the Peking University is called that and not Beijing University?
Bena and greg, I guess my first response is do you mean real growth or official growth? Several economists who know how to construct alternative measures of GDP growth (I don’t) claim that there were at least two periods in the 1990s in which China saw negative growth for at least one quarter, although the official numbers never dip below 5% (I am quoting from memory – perhaps it never dipped below 7%). My guess is that growth will definitely drop below 7%, and even well below, but I think it is impossible to predict without understanding the balance sheet effects, which can have the effect of exacerbating or stabilizing conditions in the economy. Unfortunately the financial system is too opaque for me to figure this out, but my instinct is that it more likely to be exacerbating than stabilizing.
CLN, none of the reserves are available directly for domestic spending. You cannot spend dollars in China, but must instead sell them to the PBoC in exchange for RMB. One of the most widely believed misunderstandings is that reserves are wealth, and can be used for any form of spending. In fact they can only be used to pay foreign obligations and for foreign imports. Indirectly they can be used in the sense that a massive expansion can lead to a trade deficit, which drains money from the central bank reserves. As for whther there are net outflows, I don’t think we are seeing them yet (the trade surplus is still very high and FDI is still positive), but we are all waiting for PBoC numbers with bated breath.
Simon, many universities (and other historic institutions) prefer to use the old names because they have widely circulated for a long time and have historical resonance. So the two leading universities in China are Peking University and Tsinghua University (not Beijing and Qinghua). By the way no one here eats Beijing duck. It is always Peking duck – not sure why.
Michael, how do you think we should view today’s exports number? I guess we have no formal consensus estimate to judge it against, but do you think expectations were low enough that -2.2% actually ends up looking pretty good?
Sorry, I mean consensus among those expecting some contraction. I don’t believe anyone in the survey really thought we were going to see a nearly 15% increase, and if they did I’m not sure how seriously we should take them.
How much of the pain China took in the 1990′s downturn was the result of its recognition that an adjustment had to be made and a great-leap-forward-ish decision to step up, pay the cost and make it?
It seems to me domestic demand will never increase enough to offset declining US consumption and will only increase in any meaningful way over too long a horizon to be a solution to present problems. How likely is it that this view takes hold among the authorities, and is there a greater willingness to make/impose sacrifices in the national interest that may facilitate a shift in near-term priorities from domestic demand support to simply reducing capacity?
Feels like US policy makers will never ask constituents to make sacrifices if it’s in any way postponeable, so we should expect them to keep trying to inflate/reflate and preserve the “value” of existing over-levered capital structures. At the risk of showing my ignorance, my impression is that China might be more inclined to endure (or impose) what it thinks is inevitable and creates a longer-term advantage. Am I wrong? Does the spirit in which factories were closed, etc. during the 1990′s shed any light?
Apoogies for the stream-of-consciousness, multiple posts.
BCG, in my opinion these trade numbers could not be worse. Exports are down — no big surprise, but bad news for China. Imports are way down, and only part of this can be explained by lower commodity prices. That means real demand was down, and this should undermine any good news about consumption that may derive from retail sales figures. But worst of all, the trade suplus is way up — which means China’s export of overcapacity has increased. In a world of shrinking demand, China is increasing the amount of overproduction it is forcing onto the world, which means that not only is China not absorbing its share of contracting demand, it is actually exacerbating it. The rest of the world has to absorb more than 100% of the contraction in demand. This is how trade war starts. If this numnber does not start to shrink quickly, there will be a real problem.
Michael –
Would you believe -6% that you heard from your student or -2% that is published today?
Michael, interesting blog! Maybe an obvious question – Given that the Chinese government doesn’t have too many other options other than Keynesian/New Deal-type spending in order to boost domestic demand- How fiscally able is the government to carry out such large expenditures?
And- in the event of things getting very bad, say in the next year- if there is heavy political pressure in an environment of high unemployment/social unrest, would the government have many indirect ways it can use the foreign reserves for domestic purposes without mass selling off of US Treasury bonds?? (which assumedly, would have similar disastrous effects as the competitive devaluation of the yuan that you talk about) –Is it a possibility that the same political pressures that are ratcheting up contemplation of competitive devaluation/protectionism could also lead to China selling out of US Treasury Bonds??
I’ve discussed the trade situation elsewhere. One thing to look at is the trade balance with specific countries. If China is reducing exports to the developed world and most of the drop in imports comes from commodity imports, this should actually reduce what little trade friction there is.
As far as the banks….
One question is how big the cash reserves of the SOE holding companies are. If they do have large cash reserves, then they should be able to have a more orderly contraction. One interesting thing about SOE’s is that management incentives for SOE’s actually encourages them to hoard cash in good times, which may not be such a bad thing in bad times. One reason American companies and banks got into so much trouble is that the incentives for American companies strongly discourage hoarding cash and encourage maximizing return on equity which creates huge problems when the economy turns downward.
The big question about bank loans is “which banks” get busted. The idea behind banking reform was to move policy lending from the big four banks to the policy banks, China Development Bank being one. If the system works, you should see the government pumping money to SOE’s through direct subsidies and the policy banks, meanwhile the “big three” should keep having healthy balance sheets.
Also I disagree that a bailout only “buys time.” If you stop digging, then you just need to dump the dirt once to fill the hole. This is likely the case with real estate and quasi-banks. The important thing is to stop digging.
Also, if you have a one time capital injection into a manufacturing firm, that firm can suddenly become extremely profitable once it gets rid of debt service.
Don’t think of it as a “bailout.” Think of it as a “clean up.”
Hi Michael,
What concerns me the most is the import number, and specifically the merchandise import (-24% MoM). It looks as if the idea of “china will grow given its strong potential of domestic market” is soon to be shattered.
In addition, I’ve recently looked at China’s employment demographics and surprisingly, non-SOE sector employs 75% of the urban and rural migrant workers (but, it’s unclear as to if this catogary in the National Bureau of Statistics includes listed SOEs like Shenhua or Air China, do you have any idea?)
I am very concerned on the social problems that unemployment will lead to as well as I suspect the stimulus package is nothing more than the moon in a lake, (i believe that the stimulus package is nothing more than the total capex of all SOEs and local govts as I hear from insider of the sasac)
I have many concerns regarding to both the health of the Chinese economy and more importantly, the misleadership role that the govt might play in this diffcult time (CNY/USD, shady stimulus pkge)
Could you please shed some light on your thoughts?
Thanks!
The import number doesn’t particularly bother me because wheat and oil are half the cost of what they were a year ago. Also the demographics of the migrant worker sector seems reasonable.
I’m not too worried about the stimulus package. What has happened is that the government started tightening loans starting late last year, and they’ve stopped tightening those loans. I think that the government should be very careful not to go overboard. Putting together a stimulus package is very easy since there are lots of local officials that will want to spend money.
The trouble will come in about two years, when people are in the middle of building this massive infrastructure, and the economy needs cooling. In that case you may have a problem with half finished bridges. This is one problem with trying to use health and education as stimulus. Two years from now when the economy is overheating, what are you going to do? Close schools? There is need for the government to spend more on health and education, but that should be separate from stimulus.
Also I think that the Chinese government should do OK. Yes, they will make mistakes, but so do all of us, and part of the reason that you need discussion is that it isn’t clear exactly what the right policies are. One thing that I find interesting about Victor Shih’s writings is that I largely agree with him about what the Chinese government is doing, it’s just that a lot of things that he sees as bad, I think are good.
Michael – Can you please tell me a bit more about reserve?
1. In Nov, China as a whole gained $20B by selling more than buying, but when you look at each party involved, no one seems to have made much money.
Exporters made less money.
Importers made less money.
Employees made less money (salary, job).
Government made less money (tax).
So, no one is really capable of boosting domestic demand. But it doesn’t make sense. I think I must be getting something very basic wrong. Can you please help me?
2. Does $20B trade surplus mean that China’s reserve grew by $20B?
3. If so, how does China use this $20B to stimulate local economy? You mentioned that China cannot use US$ in China and it has to go to PBoC to convert it to RMB, but China holds $20B because someone who sold Chinese products in US$ converted it to RMB at PBoC right? So, if the government goes to PBoC and convert it to RMB, then what happens to the US$ PBoC hold???
4. So, is it that China has to issue RMB bond to spend it domestically? Is it because RMB is a managed currency that it cannot buy it in ForEx market?
I feel like I should apologize for asking very basic questions. All I can say is that as basic as my questions are, your help will greatly help my understanding. Thank you.
Twofish,
You said: “One interesting thing about SOE’s is that management incentives for SOE’s actually encourages them to hoard cash in good times, ”
This is very interesting, but I cannot quite picture what kind of incentive structure would encourage such behavior. Could you please give me some example?
Thank you.
How much of the drop in the value of exports was due to cheaper inputs, i.e. the collapse of raw materials prices over the last four months?
According to JP Morgan 40% of the price of a manufactured commodity was on average raw materials, ergo if raw materials have fallen by over half, then couldn’t the fall in exports simply be a result of cheaper inputs?
RBG- one area that did do well is the state oil companies. They were able to sell at prices that reflected oil at 80-90 / barrel (the state controlled prices) but buy on the intl market.
Also, part of the explanation may have to do with an inventory overhang, especially in raw materials. Many trades bought iron ore and the like earlier this year expecting it to appreciate and for the final demand to be there.
Taiwan is hurting too.
How about a massive liberalisation of trade, investment, and transportation links with Taiwan? Get every rich Taiwanes guy to buy another flat in China, and vice versa. Would this be the GDP boost that is needed right now?
RBG: This is very interesting, but I cannot quite picture what kind of incentive structure would encourage such behavior. Could you please give me some example?
That’s actually quite simple. You need to ask what situation personally benefits the managers that make decisions. With Chinese companies, the more money you have in your bank account, the higher the salary and benefits of the managers. If you have large amounts of cash in the bank, you are more able to pay yourself large salaries and give yourself a better car. It doesn’t matter to the management where the cash comes from, but as banks have tightened lending, it becomes harder to use bank loans to create large cash accounts, so the tendency has been to hoard cash from operations. Also it’s not the ratio that matters but the absolute amount of cash. You can have company with huge amounts of cash, but even larger amounts of debt.
By contrast, American managers are rewarded if they have high stock prices and you have high stock prices come from having large amounts of return on equity. This encourages American companies to borrow heavily and have as little in cash reserves as possible. Also US corporate law makes if very dangerous for a large company to have large amounts of cash because any company with huge amounts of cash is susceptible to a leveraged buyout.
The theory behind American corporate governence comes from the University of Chicago is that by rewarding companies based on profitability that you are encouraging efficient use of capital, and unencouraging people not to keep capital and encouraging people to move capital from low return uses to high return uses.
The problems with this idea are that:
1) you get high returns by boosting risk, and by boosting risk, you are putting the people you are borrowing from at risk
2) if you are highly leveraged, you are very vulnerable to economic shocks, and
3) this sort of structure encourages people to borrow short term liquid instruments to fund long term illiquid investments, once this funding runs out, you are in some serious trouble.
My belief is that Chinese companies and banks will find themselves in better shape than American companies and banks because the companies that were not shut down have large supplies of cash and hence are more shock resistant. Being shock resistant is important since it gives you time.
If you are highly leveraged, you could go from seemingly healthy to dead in a few days (see Bear-Stearns and Lehman Brothers) and if you have an economy which is highly leveraged you run the risk of a domino effect that can bring down the entire financial system. By contrast, if you have a lot of cash, and something bad happens, you have a few weeks, months, or in some cases years, to do something about it.
The contrast here is Chinese banks which were far more insolvent than Bear, but in which the government had a decade to deal with the problem, because unlike Lehman and Bear, they had huge cash reserves. Another contrast is between GM and Toyota. Both of them are seeing extremely large declines in sales and both of them are seeing huge losses. The difference is that Toyota has cash reserves whereas GM does not.
I’m feeling fine about the economy next year. We are going to see a very nasty recession with massive job losses and deleveraging. The reason this makes me feel fine is that two months ago, we were on the brink of something much, much worse in which rapid uncontrolled deleveraging was close to destroying the entire world financial system (and I mean this literally). One way of making you feel alright about something bad, it to show you something much, much worse, and we’ve already had enough deleveraging to avoid total meltdown.
Also, I do not think that trade will be a big issue next year. You will see a lot of bailouts, currency games, and capital protection, but I don’t think that either the US or China will call for anything that would require leaving WTO. The reason is that most jobs in the US are dependent on the world trade system being intact, and anything that destroys trade will kill jobs in the US. Things would have been very, very different had things completely self-destructed in September, in which case there would have been no interest in keeping existing jobs, because all of them would have disappeared.
This is also why I think GDP and import projections are bogus since this quantity depend on unforeseen and perhaps unforseeable events. It was a funny moment when the rating agencies downgraded Lehman’s rating from investment grade, several hours after the default.