China: These Trade Numbers Are Awful

“The most striking real economic fact of the past several months is not continued U.S. economic weakness, but that China’s economy has slowed much more quickly than anyone had forecast,” Australia’s central bank Governor Glenn Stevens said this week.

Not quite “anyone”. Quite a few people who read this blog, some of them quite prominent, have been forecasting very grim numbers for China all year, and much of our discussion in the comments section has revolved around how bad the slowdown would be – above 7%, some of us said, or much lower, others have argued. I still say that we haven’t seen the end of downward revisions. By the way, I was just told by a friend two minutes ago that Goldman Sachs has just reduced their projection of 2009 Chinese GDP growth to 6%. I don’t have the citation so it might not be true, but it wouldn’t be surprising to me, and eventually lots of other banks will do the same.

As I have argued for a long time, if you think about China as being one of the two main players, along with the US, deeply linked within the overall global balance of payments, it cannot possibly come as a surprise that the US adjustment was going to require a Chinese adjustment which, given the relative size of the two economies, almost inevitably meant that China was going to get hit harder than the US. Here is a quote from as far back as September, 2005, in an interview with Hamish McDonald of the Sydney Morning Herald, in response to widespread belief at the time that the US was the most vulnerable to a breakdown in the balance of payments relationship:

“My money says the US could survive a disruption in the dependency relationship much more easily than could China,” says Michael Pettis, professor of finance in Peking University’s management school.

I know this sounds like I am tooting my own horn, and I don’t mean to, but the belief that China was protected from a possible crisis affecting the US trade deficit always struck me as weird. Perhaps American paranoia requires a sense of helplessness in the face of a powerful threat, and clearly the rest of the world takes its intellectual clue (and often cluelessness) from the US, but it couldn’t have been such a surprise that a sharp US slowdown would create trouble in a country so reliant on US consumption for its employment growth. Things have always been this way – why should they have suddenly changed?

Because last night I was invited to be a guest on the CCTV current events show, Dialogue, I tried to get my arms around an easier way of thinking about the adjustment so that I could explain it on TV. Let us assume that the US trade deficit will decline by 50%, from 6% of GDP to 3% of GDP – there are some who have argued that it will go to zero next year and others who have even argued that the US will soon be forced to run a small surplus, but I will assume nothing quite so dramatic. I will also ignore any contraction in net demand from Europe and elsewhere.

Since the Chinese trade surplus is equal to up to 2/3s of the US trade deficit, this suggests that within the overall global balance China should, ideally, absorb about 2/3s of this contraction, roughly equal to 2% of US GDP. This is also equal to about 7% of Chinese GDP, which means that either:

a) Chinese consumption is going to have to expand by 7% of GDP faster than production,
b) Chinese production is going to have to contract by 7% of GDP more than any contraction in demand, or
c) both will have to happen so that the sum is equal to 7% of GDP.

Clearly the first cannot happen very quickly. The second would mean economic chaos for China, so that leaves the third. In the best of cases China would be given enough time to get as close as possible to the first of the three adjustments, but without a very strong international framework and coordinated action the most likely outcome is for at least some contraction in production.

The problem with all my scenarios is that the numbers are so big it is not easy to make the case for a smooth adjustment, except under the assumption that the rest of the world will do everything it can, including suffer rising unemployment, to pull China out of the crisis. That is unlikely.

That brings us to the terrible trade numbers. Last night, as I was on my way to CCTV to do the show, I got a call from Shang Ning, my Peking University student, about the data release. He told me exports were down 2.2% – terrible news given that economists were confidently predicting a 15% increase as recently as a week ago, but no longer unexpected. By the way Tom Holland in the South China Morning Post claims that in RMB terms, the more relevant measure if you want to judge the pain, exports were actually down 10.1%.

Shang Ning also told me on his phone call that imports were down 17.9%. I immediately called my friend Logan Wright from Stone & McCarthy and asked him about the import numbers. According to Logan, only a part of that decline can be accounted for by lower commodity prices. There was a real contraction in import volume.

This is frankly much more worrying to me than the decline in exports because it suggests that demand in China is contracting quickly. I have no idea what the retail sales numbers are going to say, but last month I complained that it seemed inconsistent to me that imports were contracting while retail sales were implying a healthy expansion of consumer demand. Unless the marginal propensity to import is collapsing, I think I trust the import numbers more. Demand in China is looking very bad.

Finally, and most shockingly, Shang Ning told me on the phone call that the trade surplus was $40.1 billion. At first I thought he was saying $30 billion, and I was surprised that it was so high – it would have been the second-highest monthly trade surplus ever recorded. When I finally understood him to say $40 billion, I couldn’t believe it. That is the main reason I immediately called Logan, to see if my student had made a mistake just before I was going to go on TV to debate the economic outlook.

He hadn’t made a mistake. In October China’s trade surplus was $35.2 billion, the highest every reached by any country at any time in history. In November that record was smashed. In the last three months China’s trade surplus has been $96 billion, nearly equal to the $100 billion from the first six months of 2008.

The headlines in China and around the world have been dominated by the contraction in Chinese exports, and this certainly is a bad number, but it cannot be a surprise and it is not the number on which we really should be focusing. The trade surplus is much more worrying, and soon enough that is what all the headlines will be reporting. Remember that the trade surplus is the measure of Chinese overcapacity that is being exported onto the world economy, but the world economy is looking for ways to increase net consumption, not net production. While demand in the rest of the world is shrinking, China is providing even more overcapacity, which means effectively that not only is China not absorbing its share of the demand/supply adjustment, it is exacerbating the imbalance. Other countries are going to have to withstand a faster decline in production than otherwise.

I know that China is facing a real problem of economic slowdown, one that seriously worries policy-makers. The other guest on the CCTV show last night was the chief economist of a large local securities firm, and he accomplished the not-inconsiderable feat of making me sound like an optimist. But still, it is wholly unrealistic to assume that the rest of the world will accept that they must bear more than 100% of the adjustment in order to pull China out of its trouble.

As a related aside, one of my former Columbia students, currently a government official in Vietnam, just told me an hour ago that Vietnam’s exports are awful. Declining exports are going to be a real problem for a lot of developing countries. With the collapse of the part of the capital markets that financed developing countries, and the resurgence of capital flight, developing-country trade-deficit countries will be forced suddenly to run trade surpluses (via, almost inevitably, a sharp contraction in domestic demand). If that happens, anti-China feelings are inevitably going to rise. If these result in anti-trade acts, China will suffer far more than it would under even the worst of current economic scenarios.

The chief economist who was on the TV show with me last night clearly understood this, as do many others in China (there is a even rumor that one reason the RMB depreciated before the SED meeting last week was that some people in the PBoC wanted to bring the matter to a head), and it is really important that US, Chinese, European and Japanese policymakers fully understand the problem. The major economies must work out a plan in which they provide for a three or four year period during which China can adjust its overcapacity problem, but if China tries to go it alone and allows the trade surplus to remain at anywhere near these levels, it is hard to see how we can avoid trade trouble. To repeat ad nauseum, the Chinese economy absolutely cannot tolerate a world of trade protection.

By the way I talk mostly about the US and China as being fundamental to the current global imbalance, but there is another pair that is also suffering from some of the same problems. Germany is running a huge trade surplus while the rest of Europe is running huge deficits. Already relationships in Europe are fraying. Paul Krugman, in Sweden to collect his Nobel purse, writes about it:

Everyone here seems to be talking about…the German problem. At a time when expansionary policies are desperately needed, the leaders of Europe’s largest economy seem to have their heads in the sand. This is a huge problem: there are large spillovers in fiscal policy among EU nations — that is, a significant fraction of, say, French fiscal expansion ends up promoting employment in Germany or Italy rather than France. So there’s a crying need for a coordinated policy. But the Germans aren’t participating.

The Financial Times explains it a little more colorfully in an article today (“Berlin hits out at ‘crass’ UK strategy”):

Germany’s finance minister has launched a stinging attack on the “crass Keynesianism” pursued by Gordon Brown, the British prime minister, fuelling tensions on the eve of European economic crisis talks in Brussels. Peer Steinbrück accuses Mr Brown in a magazine interview of “tossing around billions” and saddling a whole generation with a bill for paying off British debt.

His comments come as the European Union’s 27 leaders meet in Brussels to debate a proposed €200bn fiscal stimulus package, designed to stop a protracted economic slump. Mr Steinbrück, a Social Democrat in chancellor Angela Merkel’s grand coalition, has previously accused other European leaders of acting like “lemmings”, borrowing billions to fund tax cuts or higher spending. His irritation has been heightened by efforts by Mr Brown to construct a coalition to put pressure on Germany to follow suit.

…Germany has insisted the summit communique, while endorsing a €200bn stimulus package, should include the need to maintain fiscal discipline. A draft statement says the goal of long-term budgetary sustainability “implies a swift return to the reduction of deficits which have been temporarily increased.” Mr Steinbrück, speaking to Newsweek, questions whether Mr Brown’s £12.5bn (€14.2bn) cut in value-added tax will work. “All this will do is raise Britain’s debt to a level that will take a whole generation to work off,” he said.

He added: “The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking.” He said British policy would simply repeat mistakes of previous years in fuelling credit-financed growth.

I don’t want to wade into these very deep waters, but I think Steinbrück is right to warn Britain and France against excessive fiscal spending to get their economies going. Given their trade deficits a lot of their spending is going to be used to pull non-British and non-French workers out of unemployment, as Krugman notes. But on the other hand they are right to insist that German do more to expand fiscally. It is German overcapacity that is now the European problem. Perhaps Germany, like China, should be doing more to rebalance its excess capacity and foist less of it on the rest of Europe – struggling as they are with rising unemployment.

As distressing as it is to say this, I think few things are going to raise more irritation and anger next year than global trade.

Comments

[puttster:]

I like the conversion of US deficit into Chinese. I read an article on the subject some time ago that went something like "Exports are only 5% of China GNP. Even if they lost half of that it would only mean growth falls from 12-13% to 10%. Big deal."

I don't know who is right but at least here is another opinion.

2008 Dec 11 11:44 AM

[Firat Ünlü:]

Horrible trade numbers????
They've been growing for more than a decade at breakneck speed and now this slight downturn amidst a worldwide recessions makes you panic?
Come on...
There's something called business cycle, I'd hope people would start actually coming to terms with the fact that downturns are not only a part of conducting business but also healthy.
During the Asian Crisis China did not devalue its currency so any talk about that is just pure speculation.

2008 Dec 11 12:47 PM

[raytayzmd:]

Where's Jim Rogers?...he's always good for a China pump.

2008 Dec 12 10:33 AM

[Douglas Rob...:]

M,

Deutsche Bank - Equity Research HK/China Daily Update - 12 ...
By Garfield(Garfield)
Deutsche Bank - Equity Research Today's Highlights: We downgrade earnings forecasts of China banking sector due to more our bearish macroeconomic forecasts (CMB downgraded to Hold, TPs cut for all other banks). ...


Have you seen any discussion as to why all this commenced a month after the Beijing Olympics?

I was tracking capital and HR flow-reversals away from China since June. Redirection favored certain Eastern European countries and India.

I am "positioning" (via my book, Foreign Capital Investment Banking for China, due out in late January by Wuhan University Press in Beijing) that central government planners might consider immediate, significant policy revisions to realign WTO obligations with current policies and practices...

Rule of law is a mantra that could advance if not save China's cause to preclude erosion what it has gained these past years since being awarded the games...

What is the utility of this banter about China being so important for the world economy with its $2t foreign capital reserves?

Some $1.5t of currency trades everyday on the Forex. The US Dollar is the underlying currency on one of the two sides of all those trades some 84% of the time.

Consistent refusals (not failures) to "meaningfully" open media, banking, and finance sectors of China have not gone unnoticed -- among toxic toys, espionage, IPR (not DVDs) theft, etc…

There appears to be a disconnection. Inbound-outbound comprehension among central as well as provincial leaders is myopic, shaded by guanxi commitments focused only on domestic concerns. Fair enough, the same holds true within US and EU configurations.

The difference is that a rule of law via code moderates those protectionist reverberations over there. Over here, even the cash-bloated UAE is complaining that trade with China is one-way to an unacceptable point – we might note their bankers (not Chinese).

Is a shift now emerging? Can you confirm?

I call it the "otherway" response by US and EU concentrics. Tiring of China’s lack of accommodation to open key markets, centrist concerns (non-emotive, balance sheet types) are nominating Mexico and much of Latin America, which in recent months started gaining promotional focus among manufacturing associations. EU brethren are doing the same with former communist block countries – hence Russia attempting to draw a line with its timid, all but impotent military incursion during the games (also worth of note regarding timing).

If the party centrists here do not act quickly (12 months, tops) to make good on prior trade (a la WTO) commitments as well as send some of that foreign cap to develop offshore guanxi, then they stand to face one thing worse than a bunch of empty housing and commercial development complexes…empty buildings surrounded by filled streets of angered citizenry.

Shortly after arriving in March 2006, I came to the conclusion that the government here was either setting itself up with or being set up by US-EU related nation building interests. In the year of the Rat, it is now clear that the Chinese guanxi-go-go-boys (and girls) took the cheese.

The bill came due post 30 day grace period upon the closing ceremony.

Funny thing… given all the self-imploded rhetoric trickling out (and down) from government and party appendages, it appears that no one really understands what is going on. This possibility became apparent on the day that China’s (non- stimulating) stimulus package was announced, which appears not much more than the Chinese version of a bailout plan for its SOE’s.

There then comes the rub… making your comments so true about China confronting a far more painful reality than its US-EU counterparts...

Compounding the problem here, unlike in the US, the party-government matrix already owns or controls China’s hubs of finance and industry. Therefore, in effect, it is only bailing out itself, a bankrupt system, which is what it was recognized to be upon Openness and Reform was so declared.

My two years of research here detail a shell game built upon a ponzi scheme. Again, fair enough, Wall Street does it par excel lance…

However, EU and US shoulders bear hundreds of years of experience with cyclical economic gyrations. China? 20 at best – not any 5,000 years.

I had an epiphany yesterday en route to a guanxi-fueled hot springs visit with a former student’s family – father is a securities firm branch manager. Most of the guys driving (or being driven around in) those black Audis were peddling bikes just 10-15 years ago.

Where does that leave us?

Well, trade numbers are the least of the problem…

dr

2008 Dec 12 10:44 AM

[HaavBline:]

Very good perspectives as usual from up close.

Question: How exactly does China 'export its overcapacity' when US Treasury need to divert money from Chinese new treasury bond purchases to TARP and other bail out programs, and American consumers are getting their credit cards clipped in half?

2008 Dec 13 01:24 AM

[HaavBline:]

Another question: How to decide whose capacity is "overcapacity"?

If buyer tells factories A & B that his is now poor and can not afford their products now, does it make both A & B 'overcapacity'?

Now if A lowers its price by 10% while B can not match the discount, and the buyer decides to buy from A, does that means only factory B is 'overcapacity'?

"Free Market Capitalism is the best path to prosperity", CNBC always chant this 'Kunlow Creed'.

But, "Managed market capitalism is the better path to peaceful conexistance".

Fortunately, the Chinese has understand the value of 'Harmony' for 2000 years.

2008 Dec 13 01:58 AM

[Inst:]

This is where the idea that China is relatively insulated from a global downturn came from, an article by a UBS economist: www.allroadsleadtochin.... I have the sneaking suspicion that Professor Pettis isn't aware of this article as I've never seen him offering a rebuttal.

Mr. Anderson (lawl teh matrix?) argues that when looked at in value-added terms, the amount of Chinese economic growth supplied for by the export sector is actually quite minimal, especially when compared to countries like Taiwan and South Korea. The fact that Taiwan and South Korea are already experiencing economic contraction, while China is not provides evidence for this contention.

If you hold on to the limited-export-damage theory, then you need alternatives to explain why the Chinese economy has been doing so horribly as of late. I've seen arguments that what really did the Chinese economy in was the collapse of the real estate market and a major decline in investment. There's also arguments that the collapse of the export sector has influenced consumer confidence, and if I understand the Professor correctly, part of it has to do with the Chinese money supply.

2008 Dec 15 03:38 AM

[Simon Smelt:]

Inst counters the gloom of Prof Pettis by citing a paper by Anderson at UBS which argues that in value added terms, exports account for something like 8-10% of the Chinese economy, not the 36% suggested by China's export to GDP ratio.
There's nothing magic about either approach in showing how exposed China is globally.
To see the limitations of the value added approach, consider the example of NYC and its financial sector. The value add approach would consider only the value add of that sector, stripping out the costs of inputs - electricity, office rentals, taxis, deliveries etc. You end up with quite a small sector, so not too much of a problem if it contracts, right?
Wrong. Because all of those inputs now have to find another use or cease to have value. And the salaries of all those fired executives are no longer around to pay for restaurants, and flowers and luxury apartments. And the restaurateurs are no longer using the local laundry or hiring dish washers. And so on.
Now the NYC financial sector with its high spending practices will have driven out other businesses, which will move in to take up some of the slack. So, don't get carried away with multiplier effects. But still a nasty shock for NYC as the sector contracts.
Similarly, China will face wrenching adjustments if there is a fall off in exports. About two thirds of the US economy is household consumption, as against about one third in China. Much of the rest in China is dependent directly or indirectly (e.g. through transfer payments to dinosaur industries) on earnings generated by exports. The household sector has limtied capability to compensate - even assuming wage growth is maintained.
So, alas, Professor Pettis is correct on the internal impact.
Similarly, in terms of international trade, it is China’s trade surplus which is of concern. This, of course, already nets out imports including those that are re-exported as inputs to export goods.

2008 Dec 17 02:45 AM

[Inst:]

I believe you misunderstood me. There's no way I can deny the facts of economic slowdown, increasing unemployment, and shuttering factories in the PRD region. On the other hand, I'd like to dispute the cause; I don't think that an imbalanced economy overly based on exports is to blame.

The problem with your analogy criticizing the value-added approach is that in NYC's case all of the inputs come from the city economy. In China's case, the inputs come from outside the country. So when demand for inputs fall, the detriments are primarily experienced by the supplier countries instead of the producing country. Perhaps I misunderstood something? I thank you for taking the time to write a detailed response to my link; if I'm still mistaken, would you please be kind enough to correct me?

2008 Dec 17 11:19 AM