The Citibank rescue Monday caused markets around the world to surge, but China was buying none of it. Yesterday the SSE Composite dropped 3.7% and, after a morning rally, it declined a further 0.4% today to close at 1889. The economic news continues to be bad and it is hard to find any enthusiasm anywhere, at least among the people I normally deal with. Tuesday morning the World Bank revised its prediction for next year’s GDP growth sharply downward to 7.5%. Its previous estimate for 2009, made three months ago, was 9.2%
One of the easiest forecasts I made at the beginning of this year was that we were going to see a long process in which every month or so forecasters would revise their growth forecasts for China downwards. I suggested that this would happen because forecasters base their forecasts on predictions about the performance of the asset side of the economy, and generally ignore balance sheet effects (and, apparently, balance of payments effects).
But in developing countries, with their typically unstable and inverted balance sheets, this is especially misleading. There tends to be a great deal of pro-cyclicality embedded in financial, corporate and government balance sheets, and in the behavior of the financial system more generally, so that growth begets changes in the balance sheets that enhance growth and economic contraction begets balance sheet contractions that exacerbate economic conditions. One consequence is that good periods typically involve continual upward revisions from forecasters as the economy systematically outperforms expectations, and bad times involve consistent downward revisions.
We have not reached the end of this process because I don’t think we have seen the end of the balance sheet effects. The rise in NPLs has only just started and we haven’t yet seen a very strong response on the part of the commercial banks, although perhaps in the informal banking sector the unraveling is well under way (I don’t know, but there is some circumstantial evidence to suggest it). I am not even including the possibility that we may see sharper export contraction in the future as the world of international trade turns uglier.
Next quarter the World Bank will almost certainly revise its forecast even further down. As I said early this year (jumping the cue by assuming standard balance sheet effects), I think it is much safer to assume that next year’s growth is going to come in under 7%, perhaps well under, although please note that this prediction is not based on any terribly sophisticated knowledge of the functioning of the economy. My whole model assumes that balance sheet effects add unpredictability, although the directional impact on growth of that unpredictability is often predictable (although this probably isn’t the most elegant way to phrase it – sorry).
The Chinese leadership is clearly worrying about this. A number of senior leaders have made pilgrimages to various economic centers during the past two weeks to get more of a sense of how quickly conditions are deteriorating. According to an article yesterday’s Xinhua:
The spreading global financial crisis and economic slowdown are having bigger negative impact on Chinese economy, vice premier Zhang Dejiang said on a weekend inspection tour to central province of Hubei. Zhang, who aims to learn about performance of the industrial sector during the trip, urged the local officials to give strong support to key enterprises and sectors and also small and medium-sized enterprises and labor-intensive businesses.
The government has also warned, more than once, that as a consequence of the slowdown they expect an increase in social disturbances (a euphemism for rioting). They are also trying to control the process of layoffs, with some provinces requiring companies to get approval before they fire more than a certain number of workers. This obviously can have negative impacts on the adjustment process for businesses, but I think that one of the ways that China can boost private consumption is by various forms of income redistribution, and raising minimum wages and preventing firings may have some positive impact here.
Meanwhile provincial governments have turned eagerly to the government in order to help fiscal expansion plans. According to an article in the South China Morning Post:
Mainland provinces have drawn up long wish lists for roads and other projects since Beijing unveiled an economic stimulus plan, state TV reported, as local leaders take advantage of a new willingness to spend amid the global crisis. Spending proposals announced over the past week by provinces total 10 trillion yuan (HK$11.3 trillion), China Central Television said on Sunday. But the report gave few details and no indication how much of that might be approved by the central government.
The 21st Century Business Herald said few investments announced by provinces were new. It said most are either under construction, have been under discussion for some time or were planned but not begun due to lack of money. The newspaper said much of the proposed provincial spending is still awaiting national approval.
Today’s Xinhua also had a similar article:
Many officials in the less-developed central interior felt that Beijing had been penny-pinching in financing local projects for most of the year until only recently when the focal task of macro-economic control shifted from curbing inflation to slowdown prevention. “The situation reversed completely in less than two weeks. It used to be projects waiting for capital, now it’s the other way around,” said Qiu Yunyang, chief of the Development and Reform Bureau of Hubei’s Zaoyang City.
To seize the opportunity for a boost of local economy, Qiu and his colleagues have put in extra hours these days to screen out projects that were mostly needed locally and had a better chance of getting a portion of the 100-billion-yuan investment newly endorsed by the State Council, or the Cabinet, for the fourth quarter.
Aside from the inevitable graft and waste that this will entail (it is almost impossible to book rooms in hotels near the main government offices responsible for doling out spending approvals, according to a number of reports, because of the rush of provincial officials eager to get in on the handouts), to the extent that this represents real spending it is likely to be good in the short term. Any real boost in domestic demand will help take the sting off the contraction in US and European demand. I just worry that the combination of a slowdown in growth, with its accompanying rise in unemployment, will make it harder socially for ordinary Chinese to stomach the sight of a new army of petty officials suddenly getting rich. I hope the rush to spend comes with relatively stiff safeguards.
Hi Michael,
Like most Europeans, I would value China industrial muscle considerably. However, was wondering how fast can China industry move significantly from an export-driven consumer-products manufacturing scheme to massively building the kind of infrastructures such as the ones being discussed to-day.
Would it not make more sense to have Chinese households to enjoy more of what was exported? Not only on a political basis but for timing purposes as well.
Since time may run short. Why?
I have been working in this kind of industry. State infrastructures for the early part of my work life. Boosting them here in France – we did in the mid-80s – would typically require a couple of years… For some obvious reasons. Not all of them being business ones.
In Europe these are business sectors would certainly not be in a situation take the heat fast enough to tackle what is is store. And Eurozone is certainly not bad at this.
I’d like to hear from you that China able to do that with limited collateral damages. As an aside question, you mentioned.
“I just worry that the combination of a slowdown in growth, with its accompanying rise in unemployment, will make it harder socially for ordinary Chinese to stomach the sight of a new army of petty officials suddenly getting rich. I hope the rush to spend comes with relatively stiff safeguards.”
Your comments just complement the article by Chinastake on the subject. Thank you for voicing this issue again.
Michael, I posted this at your previous website, but I think it might have gotten lost during the transition. I have a lot of questions and musings on China, and since I don’t run my own blog (yet!) I figured I’d just write them all here and perhaps get your take on it.
As someone who watches a huge amount of data releases worldwide, the trade data in China is among the most interesting to me in the sense of creating cognitive dissonance. On the one hand, all I hear about is pain in the export sector, lots of bankruptcies, and related job losses; much of the street characterizes this episode for China as something that started with an export driven slowdown. Yet the trade data just plain does not fit with this hypothesis, at least not yet. Export growth is around 20%, levels most countries would kill for; on the other hand, there seems to be far too little attention paid to import growth which is surprising to the downside. As China is a significant commodity importer, this may in large part be price effect (I need to spend some time going through the data). But the result of this has been three consecutive months of record trade surpluses- something not a single economist was considering a few months ago. Indeed after each release I hear comments along the lines of “Well, export growth is about to fall off a cliff.” And it may…but more on that later.
Just as an aside, the Economist did a survey a few months back ranking the quality of China’s data and ranked the trade data as the best in the country (what that means in absolute terms is up to debate). But I don’t see much reason to think hot money inflows disguised as exports have seen a huge surge over the last few months, and indeed if the government wanted to manipulate the data they would be incentivized to manipulate it lower, not higher, if they eventually want the flexibility to depreciate the currency and justify it to trade partners. Along these lines, I believe Zhou first said he saw no chance of depreciating the currency but then seemed to realize that this kind of statement reduce his flexibility, something every central banker is averse to, and gave an interview a little later saying that he doesn’t rule out depreciating the currency because he doesn’t rule out anything.
Back to trade. China is an exporter primarily of finished goods, and an importer of commodities. Historically deflation in finished goods is very lagged compared to that in raw materials, and there is especially high stickiness in many finished consumer goods. In addition, China generally has taken market share in the lower end of the spectrum, whereas Japan, Korea, and Europe export higher end goods that, one might hypothesize, are more discretionary and susceptible to a downturn. The flip side of this is that Walmart is one of the best performing large companies this year. In other words, I would contend that China’s export mix is more stable than most other countries that are large exporters to the US.
Thus in theory, and -from the data- certainly in practice, it is far from clear whether China is facing a negative or a positive terms of trade shock. Just visually looking at the trade surplus data, there is no sign whatsoever that anything is changing in China from the same thing we saw in previous years- trend rising surplus with a seasonal dip around Feb-March. This kind of data is hardly something that China could use to justify currency depreciation to its trade partners. Of course, China has done much to skirt around WTO rules with its on again, off again export rebates and import tariffs, so the currency itself, strictly speaking, isn’t the whole issue.
There is one force though that hardly anyone talks about, which could do _something_ to change the situation, which is the fact that the RMB has been appreciating very rapidly in trade-weighted terms lately. This has a lagged effect, so we don’t know how this will change things going forward. But perhaps the laws of economics dictate that the dollar will become rather expensive in order to effect significant currency appreciation in China, if China continues to hue to its policy of undervaluation specifically against the dollar. Your previous post “Will China Adjust to the US Adjustment?” is exactly an issue I’ve been thinking a lot about for the last few weeks, given the sheer scale of the amount of domestic demand in China that would need to generated to offset the US- a near impossible feat in the time horizon in question. It’s hard to say how this will play out, but there’s one related point that’s worth making, which is that, now with the large decline in commodities, all the major trade deficits or surpluses that were getting more pronounced over the last few years are now contracting. Here I’ll put the world into a few basic geographic categories: US, Europe, Latam, Middle East, Asia ex-Japan ex-China, Japan, and China. All the major trade imbalances in the world are contracting- all except for China. Even in Japan the trade data isn’t looking so hot, and the yen has been the strongest currency in the world (and free from intervention since 2004 in response to some of the posts above).
It seems like it isn’t clear that the trend of China “pushing” its trade surpluses on more and more of the world has run its course yet, especially now that commodities are down massively. I wonder if we might even see China run a surplus with Japan in the not-too-distant future. One related musing- up until a few months ago China had an inflation problem. In dealing with this problem China decided not to let the currency appreciate much (by any country’s standards other than China’s) and instead clamped down on credit, forcing marginal interest rates, via the black market, into the stratosphere. I know credit growth in China is something you have in the past had strong opinions on, but I would contend for the sake of argument that for some of the sectors most clearly corresponding to domestic demand, such as housing development, things were truly very tight. China put in place several other regulations specifically targetting this sector as well. Thus, from the perspective of sustained global development, and China’s as well, China pursued exactly the wrong policies by tightening credit but refusing to appreciate the currency- it clamped down on domestic demand (and thus imports) instead of export growth. One can conjecture that the result of those policies would logically lead to exactly what we’re seeing now- a slowing economy but a trade surplus continuing to boom. Maybe this isn’t that surprising- I believe 2004 was a similar episode that produced similar results.
One last piece of the puzzle, and I’ll leave it there as this is already quite long and I’ve given you a lot to chew on. The picture of the economy right now, from the data at least, is weak IP, weak PMIs (though this data series only goes back a few years so we have no way to contextualize it outside of total boom years), slower GDP growth, still relatively strong retail sales and fixed asset investment, moderating but still relatively healthy exports, and imports slowing to a greater degree. Without getting into a debate about the quality of China’s data, I wonder how much of what we are seeing now is a massive inventory wind-down. This is consistent with the data and with what I hear anecdotally (both in the export sector and among commodity importers), but anecdotes are a dime a dozen in China I don’t suggest that this wind-down is benign, or China’s only issue, but sorting through this facet of the story would really help understanding the overall picture.
Thoughts very much appreciated.
[...] Pettis expects that the World Bank will be continuing to revise their projections downward. He also comments that the ruling party in China will use all the policy tools they have by [...]
Something that I’d like to see someone do is to do a systematic comparison between projected GDP/inflation/unemployment growth and actual figures. My sense is that projected numbers are pretty horrible predictions, but really numbers regarding current confidence.
The stimulus package came out so bluntly (when previously all officials were still saying China was in a healthy shape despite of the global economic meltdown) that it gave the people (at least myself) the feeling that this is urgent and all this money has to be spent very quickly. Now if that feeling is true, which i think it is, it is almost certain that there is no way to safeguard the 4tr-yuan spending no matter how stiff the supervision mechanism is because the predetermined timeframe will override the power of checks and balances, i.e. if you stop me from granting money to this specific project on time, you are going against the central government’s economic agenda, and that is some serious mistake. And moreover, it is difficult to evaluate the projects immediately after the money is allocated, so it is hard to argue if the money is being correctly distributed within a period of time.
Maybe we should all quit our jobs and go set up a project company and ask for some money, cuz there is a good chance we will get it…ha
It’s interesting and superficially paradoxical that to mitigate the effects of a world recession China is in a mad rush to become more socialist…
I read an article, by Strafor I think, which explained that one of the forces behind China’s massive growth and massive savings is very low taxation and correspondingly low expenditure on Health Social Welfare and Education.
Wouldn’t spending in these areas be a good start? Rather than rushing off to build roads. Here in New Zealand spending on massive projects during the 70′s turned into a nightmare as ill conceived projects sent the country nearly into bankruptcy.
Ha, PBOC just cut rates, big time! Let’s build more roads..
Simon, you are right. An affordable health care system and a dependable social security safety net are what China urgently needs. Who can forget the turmoil in the late 1980s when universal health care was dismantled? The U.S. spends more than 15% GDP on health care, China less than 1%. The infrastructure building should include a lot of hospitals, nursing homes, medical schools and other allied health care schools, all of these are still sorely lacking in China. This is the opportunity to jump start the service industry, focusing on the health care and education sectors. Blindly stimulating consumption will be futile at the best, and disastrous at the worst, considering what Americans went through.
Also, both China and the U.S. share the problem of income disparity, to the detriment of healthy consumer spending. The super rich put their money in overseas tax heaven instead of investing or spending domestically. The middle class and poor simply have no money to spend once the credit line is cut off.