The Impact of China's Manufacturing Crisis

It’s looking like a case of too little, too late in China.

The country which bet on becoming the world’s manufacturer is in very bad shape. The manufacturing sector is in decline, thousands of factories are closing each month, and millions of people are facing unemployment for the first time. As the situation worsens China’s government is doing everything in its power to get things turned around.

We are so used to China growing that we’ve forgotten it needs to be fed. China’s economy cannot thrive without the rest of the world buying its manufactured goods.

The rest of the world has been catching on to China’s manufacturing crisis in the past few weeks, but China’s government is starting to figure it out. In the past two months China has (in no particular order):

1. Cut interest rates three times
2. Reduced export taxes
3. Announced an additional $425 billion in road construction
4. Supported the U.S. dollar, making Chinese-made goods cheaper in the U.S.
5. Lifted restrictions on bank lending

Clearly, things in China aren’t as great as they seemed just a few months ago. These are not the types of measures taken by a country whose GDP growth is dipping from 9% to 6%. They are aggressive moves that mask a deteriorating situation behind the “official” numbers.

And the analyst community is finally starting to catch on, reducing expectations for China’s GDP growth rate. The range is now expected to come in somewhere between 3% and 8% growth.

That’s just not enough to keep the lights on at most factories when you combine the slow growth with a worldwide downturn in consumption.

What does all this mean?

Over the short-term, it means there will be quite a bit change in the global manufacturing sector. After 30 years of near double-digit economic growth, China’s workers have become accustomed to prosperity and opportunity. The current economic downturn, however, has put the continuous prosperity in jeopardy.

To counteract this, China will be very aggressive in keeping the lights on at factories and keep people working. Also, China will really ramp up infrastructure spending. The $425 billion in new road projects recently announced will only be a small part of the eventual investment in infrastructure there.

It also means the U.S. dollar will continue to be supported by the exporting country. The U.S. may be bankrupt, but China will still lend to it in order to help its manufacturing based economy get back on its feet.

Over the long-term, it means China will continue to grow even stronger. It’s keeping their people at work, taking the lull in the economy as an opportunity to allow its infrastructure to catch up to the rest of the economy, and will have all the groundwork laid for a smoother-functioning world-leading economy.

We’ll probably be looking back in a couple years and realize lower oil, cement, and commodity prices made the building blocks of society extremely cheap and helped lay a foundation to accelerate China’s growth.

Basically, if you’ve got the time and are willing to use a fairly conservative investing strategy, it’d be tough to go wrong buying almost anything China related.

Comments

[je:]

This is a better report than normal from you although I think there are a couple of more considerations in the slow down and the long term outlook.

How much of this slowdown can be attributed to the olympics and that they are trying to over come the downward momentum exacerbated by the consumpmtion loss from the world. It would be nice to be able to calculate their internal growth next to the recessionary affects.

I am not so sure about the U.S. dollar support. If you look at what they are doing - they are trying to build internal consumption in their own country. They will miss us but they will get over us.

When all of this stimulus hits the streets our dollar will go down and the cost of all imports will go up and China will lose even more of our trade. There support of our dollar has less and less value to them and they are not a charitable organization.

2008 Nov 10 10:30 AM

[HaavBline:]

Unfortunately for the author, he apparently wrote this article before China announced the 4 Trillion Yuan stimulus package on Sunday, a day before he published his article.

Where does he get the GDP growth numbers from? It seems consistely lowered by 2-3 % from widely quoted numbers from financial media?

Author seems to suggest China's encountered manufacturing recession on its own, rather than being the consequence of G7 consumer credit crisis.

China's has been gradually shifting this focus toward domestic-driven growth for a couple of years, though few western observors noticed it because export-driven growth overshadowed domestic growth. This now willl changed.

The stimulus package made it abundently clear. It focused on rural development, transport infrastructure, healthcare, environment, research labs, education, low cost housing. Basically everything but export manufacturing will be receiving expedited additional investment.

2008 Nov 11 12:57 AM

[Consider_this:]

Invest in China's infrastructure companies.

This is the era that China builds infrastructure to match previous USA's equivalent of the I-95 and the east-west railroads, the equivalent of Hoover's Dam, upgrade schools and sewers, and the communication networks.

There is money to be made if you invest it right.

Building these right now, when there's slack in the economies and the materials, is EXACTLY the RIGHT TIME.

The author's right on. This will allow china upgrade project to be done cheaply.

2008 Nov 11 02:33 PM

[Chris B:]

I'm not sure how the author supposes the Chinese will support the dollar - by not selling their holdings to buy their own currency? They've always done that.

More importantly, if the Chinese export less to the US due to declining US demand, they will take in fewer dollars. If the Chinese have fewer dollars, who will buy all the new treasury debt from all these bailouts and wars? US debt supply just exploded at a time when Chinese dollar supply is declining.

What will it take for the US to attract buyers for its debts? Will interest rates have to rise? Will the dollar fall again? Both?

2008 Nov 11 03:51 PM

[Consider_this:]

Response to Chris B:
What will it take for the US to attract buyers for its debts? Will interest rates have to rise? Will the dollar fall again? Both?

Note that in an environment where there's no active Chinese supporting of the dollar:

if the dollar falls, then the interest rate has to raise even MORE for a foreign country to justify buying the "new supply" of govt bonds.

So as Chinese support drops, either dollar stays same, interest raise; or dollar drops and interest raise MORE.

Pick your poison.

2008 Nov 11 04:09 PM

[InvestBaboo:]

To ConsiderThis:

I have read several of your comments. Very astute and I think you are right on the money.

What I don't understand in this mess is how does Gold get impacted if indeed U.S. dollar collapses. Historically speaking this should be good for Gold because there is no other currency that can occupy dollar's place and investors will rus to gold.

Am I getting it right? What is your perspective on this?

2008 Nov 12 10:51 PM

[Chris B:]

Gold is a short term option on higher U.S. inflation expectations, and little else. This is why it went up as oil prices and inflation indicators rose and went down as oil prices fell and temporary deflation took hold, as often occurs in deep recessions. It's historical rate of return is only slightly less than inflation: 2% in the 20th century. In the 70's, it went up despite the recessions because inflation was also high (stagflation). It should be noted that gold has the property of an inflation option because people decided it does (i.e. fiat), and there is no established return that one can calculate for a given increase in inflation. Furthermore, the value of gold is far more volatile than the value of the euro, pound, yen, Canadian$, or even peso.

What happens if the US dollar devalues Argentina-style and loses the status of reserve currency, but this devaluation pushes up the value of another currency or currencies, resulting in low inflationary expectations in the rest of the world? As gold is increasingly a worldwide market, the dollar and gold could go down together in such a scenario (which would look like the price of gold in dollars staying about the same, but forex prices for the dollar falling).

Conclusion: The difference between international dollar devaluation and inflation has never been tested on gold. For all we know, Euros or Yuan might end up performing better.

2008 Nov 13 01:54 PM