Can China Save the World?
02/15/09
Over the last three decades, the value of Chinese trade has approximately doubled every four years. This rapid growth has transformed the country from a negligible player in world trade to the world's second largest exporter, as well as a substantial importer of raw materials, intermediate inputs, and other goods. The Chinese economy approaches about $4 trillion in size and as of this month has also become the worlds largest car market. The China Association of Automobile Manufacturers said Tuesday that 735,000 vehicles were sold in China in January. That surpassed the 656,976 vehicles sold in the U.S. the same month. Obviously, car sales slowed in China as well as in the U.S., where sales plunged 37% in January to a 26-year low. Vehicle sales in China dropped 14.4% from a monthly record 860,000 in January 2008. Last week, Mike DiGiovanni, General Motors Corp.'s executive director of global market and industry analysis, forecast that China's car sales could hit 10.7 million vehicles in 2009, more than his estimate of 9.8 million unit sales in the U.S. The data therefore point to China's rising importance in all manufacturing markets, despite its breathtaking decline in the 4th quarter of last year. The Chinese economy lost 20 Million (!) jobs last quarter (versus 2 Million in the US). How can one stem a tide like that? Let us take a look at some charts and then investigate. China has seen its year-over-year exports drop by 17.5% (imports by 43%) due to falling exports to Europe and the US. China's economy is in a state of extreme distress. Chinese authorities therefore had to lower interest rates, increase dramatically provisions of credit to manufacturing companies, reduce export tax rebates, reduce corporate taxes, and stall earlier discussions over increasing minimum wages. The government also announced a $586-billion package on November 9 to boost domestic demand and shore up investment. Though the central government will shoulder one-third of the cost, banks will play an important role in financing the construction of bridges, railways and highways. $586 in a $4 trillion economy amounts to about 14% of GDP. If the US wanted to provide stimulus of a similar magnitude, the stimulus package would have to amount to $1.96 trillion. Now that would be a commitment!
The first chart above shows the macro-economic cycle index. The climate is cooling considerably. The second chart is from the same data series and shows the coincident and leading indicators. While the coincident indicator is still falling, the leading indicator has been rising for three months. Leading indicators often use monetary indicators as their components and that is probably why the leading indicator has been rising since November, when the stimulus package was approved. M2 for example, which includes cash and all types of bank deposits and indicates overall liquidity in the financial system, grew in January by 18.8 percent year-on-year. It increased 17.8 percent in December. Chinese banks issued 1.62 trillion Yuan ($237 billion) in new loans in January, up 101 percent year-on-year. The massive jump in lending is equal to about one-third of the loans issued in the whole of 2008, a year that began on a generally tight credit line, the central bank said yesterday. The central bank has cut the benchmark lending rate by 2.16% in the past four months and reduced the reserve requirement in order to provide enough liquidity to boost the economy. "Credit expansion in the first quarter of this year is expected to be very high because banks can maximize investment returns by front-loading new loans," said Jing Ulrich, managing director of China Equities at JP Morgan. Nevertheless, the Chinese unemployment rate continues to skyrocket. The government is desperate and needs to pull out all the stops in order to prevent riots in the streets. They have the advantage, however, that China's economy is command controlled and therefore very responsive when time is of the essence in extreme situations like this. In addition, China does not have to worry about finance deficits. The savings rate is above 25% and the budget surplus is so staggering that they can easily finance the stimulus by investing just a little less in US treasuries. China's trade surplus for January was a mind-blowing $39.1 billion, just a smidgen under November's all-time high of $40.1 billion. That puts the trade surplus over the past four months at $153.4 billion, well over half of all of last year's record $297.5 billion trade surplus in just four months. So no, they will not have to sell US treasury securities in order to finance their stimulus package.
The first chart above shows you the PMI Index for the last 7 months going back to the peak in July 2008. The second chart shows you a collection of further indicators that are not part of the PMI index but interesting nonetheless. Even though all economic indicators are still below 50 and therefore indicate contraction, they have started to increase from their November lows. I conclude that the stimulus measures initiated by the government are having some positive effect. It seems that China is leading the global re-flation efforts successfully as far as its domestic econometrics is concerned. Many data indicate that China's demand in commodities such as steel, iron ore, and copper have been rising in the last few months. Electricity demand is also catching up. Stock markets illustrate the difference.
The China Shanghai Index SSE has risen over 22% from its bottom whereas the Dow Jones Industrials is very close to its November bottom. Given all this evidence then, the answer to the question posed in the headline seems to be a resounding "yes". There is only one problem. In a world where extended consumers in the US and Europe are buying less and saving more, China provides incentives to businesses to build even more factories to produce even more stuff to sell to tapped out consumers around the world. The world is drowning in overcapacity already; more factories are not going to do the trick. China must enhance consumption, not production, if it wants to save the world. In 1980, 65% of output of developing Asia was accounted for by consumption. Today it is about 47%. The main reaction to the Asia crisis of 1997-98, when economies' vulnerability to "hot money" financial flows were exposed, was to build up exports. In doing so, Asia has swapped one kind of dependence for another. As stated above, China's exports dropped by 17.5% compared to last year, imports, however, dropped by 43%. This means that China has not helped but hurt the world economy by importing much less than it was exporting. The trade surplus with the rest of the world needs to shrink, not rise, for China to start helping. This may have been the thought behind Geithner's comment when he said that China was "manipulative". But I will try again to close on an optimistic note. Read the blog at the World Bank "China's 4th Quarter GDP: Glass half full?" The author makes the point that in the last quarter of 2008, the primary sector grew at 7.3% whereas the service sector grew 8%. This may indicate that the much hoped for rebalancing takes place where the service sector (think consumer) becomes the growth leader. Real retail sales growth was about 17.5% in both November and December. The Chinese consumer may finally become the bright spot in an otherwise daunting global picture. If I had to make a prediction, it would be this: The US consumer is probably going to consume a lot less over the next 5 years. The Chinese consumer on the other hand will consume a lot more over the same time period. This makes China the driver for any incremental commodity demand. Sustained improvement in Chinese consumption will therefore be first reflected in rising commodity prices. Perhaps the Shanghai Stock market is discounting such a development.
Hermann Vohs
"Worry does not empty tomorrow of its sorrow; it empties today of its strength."
Corrie Ten Boom
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
