China’s Manufacturing Crisis: The Real Story

We’re pretty much dead now. We cannot pay our workers’ salaries. We are about to be bankrupt.

- Mao Youming, Factory Owner, Shaoxing, China Oct 30, 2008

The Chinese government claims that their annualized GDP grew by 9% between July and September.

Mainstream media outlets are parroting the cheery party line despite an avalanche of data from the manufacturing sector that suggests the Chinese economy is faltering and on the brink of collapse.

Forbes asks, “Hard Landing in China?”

The Financial Times warns, “China’s manufacturing economy braces for the impact of the global financial crisis.”

As we’ve been saying for a while, the Chinese economy is not immune to a global recession. The Shanghai Composite Index plunged 70% in the past year anticipating more weakness than the Chinese government’s GDP numbers would imply.

Here’s the problem - China is not a diversified economy. More than 45% of China’s GDP comes from manufacturing (compared to 12% for the U.S.). When global consumers stop shopping, China is hit hard. In the last six months, 67,000 Chinese factories have shut their doors. According to Cao Jianhai, a researcher at the Chinese Academy of Social Sciences, “By the year’s end more than 100,000 plants will have closed.”

For 25 years, China’s version of capitalism has only known success. These are new challenges, and they are being met clumsily. Hundreds of factory owners are simply closing their doors and walking away. Last week, Tao Shoulong, a textile tycoon with 6,000 employees burned his financial books, sold his fleet of Mercedes and disappeared, leaving behind $200 million in debt and an army of angry factory workers.

Despite the calm exterior, the Chinese government is showing signs of panic. In the last decade, over 100 million rural Chinese have flooded into the cities in search of manufacturing jobs that typically pay about $200 a month. After years of being treated like robots, performing mind-numbingly repetitive tasks, these workers are just not equipped to jump to a new industry.

All across China, newly unemployed factory workers are staging protests – or “mass incidents” as the Chinese government calls them. They are confused, frightened, and they want to be paid for the work they’ve done. The Chinese government has improvised a system to stop widespread rioting. They simply show up at the factory gates and hand out cash to the disgruntled workers. “The government is very afraid,” says unemployed factory worker, Hu Weicai, “They paid us to stabilize our moods.”

Meanwhile Beijing is frantically trying to stimulate the manufacturing sector. China has slashed taxes on exports in the past few weeks.

Ye Hang, an economics professor at Zhejiang University said:

Honestly, I think whatever measures government takes will not turn around this trend. The government can only try its best to put out the fire.

The Purchasing Managers’ Index [PMI] is designed to give a clear snapshot of business conditions in the manufacturing sector. It tracks new orders, inventory levels, production, supplier deliveries and employment data. A PMI of more than 50 indicates expansion of the sector, while a PMI of less than 50, indicates a contraction.

China’s PMI fell to 44.6 in October. Along with the employment data, output and new orders both declined at record levels.

Eric Fishwick, an economic researcher said:

The fall in the PMI reading underlines the extent to which China’s fortunes are tied to those of a slowing global economy. Chinese manufacturers are seeing their order books cut, both at home and abroad, as the world economy falls into recession.

There’s no manufacturing sub-sector that has been able to dodge the dramatic downturn. China’s $6 billion toy making has been hit especially hard. About 50% of China’s toy factories have shut down in the last 10 months.

Michael Pettis, a Beijing University Professor of Finance, said:

China has to make a transition from being export-oriented toward domestic consumption-oriented. Any large continental economy can’t depend on external demand for its own growth.

As the global recession deepens, the Chinese have a very different set of challenges than the U.S. For one, America is broke, whereas China has been running massive surpluses for a decade.

China currently holds about $2 trillion in foreign exchange reserves including about $1.3 trillion in U.S. Treasury Bonds. If China tried to collect the money from the U.S., they would mortally wound their best customer. Therefore, they probably aren’t going to do that. However, it’s a dangerous balancing act. China will be stretched politically and financially trying to find jobs for its restless army of unskilled, unemployed workers.

At Q1 Publishing, we believe in using industry-specific economic data to reveal the key subplots that affect our investments. The rest of the world is starting to catch onto the problems in China. On Wednesday, the trading volume of Proshares Ultrashort China ETF (FXP) spiked 50%, and it went up at twice the inverse of the FTSE/Xinhua China 25 Index (FXI). It’s a way of betting against the performance of China’s Stock Market.

Clearly, China’s official GDP growth rate is obscuring a growing crisis in the manufacturing sector. Look for very different numbers coming out in the final quarter of 2008.

America has a new President, who is bright, moral, and sane. There is a lot to be hopeful about. Despite an across the board sell-off which has crushed everything from REITs to mining stocks, there will continue to be compelling buying opportunities. In the meantime, it’s critical that you look at the facts behind the headlines and take action to repair the damage that has been done to your portfolio.

Disclosure: None

Comments

[Stone Fox C...:]

Lots of rearview comments. What about the future? Will the US have to turn first and China follows?

2008 Nov 06 09:56 AM

[MarvinMBA:]

I believe were going back to the 30's believe it or not...government intervention does not seem to help main street...in fact its been hurting throwing dollars away and increasing the debt....China will have to take a few steps back to survive...see if you can find your Victory Garden yard tools and start to work...were going back to the 30's believe it or not...MarvinMBA

2008 Nov 06 10:18 AM

[Glen!:]

The Chinese boom could only last for so long... It was set up for bust from the beginning. Their governments failure to adapt and failure to allow many freedoms does not bode well in the long term for economic success.

2008 Nov 06 01:04 PM

[Chinese Zod...:]

Well I was under the impression that Chinese domestic demand was/is going to save the day for China-- this article seems to totally downplay that.
Also, when it comes to Chinese equities, which have fallen so far already, on has to wonder when they start to head back up again, as stock markets tend to be leading indicators..

2008 Nov 07 08:16 AM

[huangjin:]

China's bad debts are in the banking system, not the government. They may suffer something similar to the S&L crisis, and they will blow through those reserves rapidly in order to protect their economy.

The Chinese are in better shape overall because they are a people hungry for success and will do whatever it takes to succeed. Chinese debate how to get the economy moving, Americans debate how to save welfare and government spending.

2008 Nov 07 09:19 AM

[Alex Stanczyk:]

Difference between China and USA from a consumer perspective is acutally quite huge. Chinese citizens have shown a respectable 40%+ savings rate, whereas US Citizens spend more than we make with a negative savings rate of around -2.5%.

This alone is a massive difference.

Weathering a storm while one has reserves built up is very different than entering a storm without anything to fall back on, worse, being the largest debtor nation in the world.

2008 Nov 07 09:28 AM

[China Traveler:]

True.
China is in as much trouble as other countries all over the wolrd. Miracle can not go on forever. They will have to face many challenge and go through painful experience they never thought of in the past 25 years.

However, I believe China, as a whole, is like in a teenager stage. They will go through growing pain, do stupid things, and make a lot of mistakes. But their recovering capability is strong and their tolerance level is high.

On the other hand, US is like a person who has passed his/her middle age. One heartattack, or one fall down can hurt your health so bad that you may never recover from the damage.

2008 Nov 07 02:38 PM

[notsosmart:]

you cant believe anything either gov.(china or usa) says.of course the control under a dictatorship is better.we are in debt to them & what they hold is monopoly money & phony rated wortless paper.LOL

2008 Nov 07 03:13 PM

[whidbey:]

Good review, but the end conclusions seem oddly over done.

Is the writer suggesting that a new American President can influence the American market? Not for long he won't. The US moves on performance and expectations (which a president can influence, not control). The new president may be bright, sane and moral, but is he also alien to markets and their values? That remains to be seen. We may not have it so different from China as you seem to suggest.

2008 Nov 07 06:50 PM

[whidbey:]

Excellent points. But, both EU and USA have age issues (Japan too), so state-ageism may not explain much except that China, India, Brazil have different developmental problems in becoming "developed". We must wish that each emerging society does well. This is no longer a competitive issue between economies but a problem in coopertion.


On Nov 07 02:38 PM China Traveler wrote:

> True.
> China is in as much trouble as other countries all over the world.
> Miracle can not go on forever. They will have to face many challenge
> and go through painful experience they never thought of in the past
> 25 years.
>
> However, I believe China, as a whole, is like in a teenager stage.
> They will go through growing pain, do stupid things, and make a lot
> of mistakes. But their recovering capability is strong and their
> tolerance level is high.
>
> On the other hand, US is like a person who has passed his/her middle
> age. One heartattack, or one fall down can hurt your health so
> bad that you may never recover from the damage.

2008 Nov 07 07:01 PM

[investor88:]

Good article that gives insightful analysis of the problems facing China rather than just the slogan of usd2trillion reserves, double digit growth etc.

2008 Nov 14 11:54 AM

[M.R. Henderson:]

Everyone talks about Chinese savings, but the tragedy may be where they saved: what happens when it becomes apparent that the "banks" have invested this money in bust property schemes?


On Nov 07 09:28 AM www.rapidtrends.com/bl.../ wrote:

> Difference between China and USA from a consumer perspective is acutally
> quite huge. Chinese citizens have shown a respectable 40%+ savings
> rate, whereas US Citizens spend more than we make with a negative
> savings rate of around -2.5%.
>
> This alone is a massive difference.
>
> Weathering a storm while one has reserves built up is very different
> than entering a storm without anything to fall back on, worse, being
> the largest debtor nation in the world.
>

2008 Nov 16 10:14 AM

[Sucker4lush:]

How much of that 12% manufacturing number comes from the "hamburger manufacturing", ie fast food sector?

Jul 01 08:21 AM