Will U.S. Growth Beat China's in 2009?

Quite conceivably, based on the shockingly awful data now flooding out of an imploding Chinese economy. In October, exports in RMB terms fell over 10% yoy, but despite this the trade surplus hit a record $35bn. The explanation is a collapse in imports (not just because of the commodity price slump, but also by volume) which is very bad news for Asian exporters into China.

Other measures that cannot be massaged by government statisticians suggest economic free fall; electricity consumption for instance is down 9.6% in November, reflecting huge industrial contraction such as pig-iron production down 16% and raw steel down 12%. I predicted that the export/investment based growth model in China was set to collapse back in March in China 'Miracle' Faces Meltdown at a time when the consensus was wildly bullish, and forecast that GDP growth would halve to mid single digits. That would now be a very good outcome, and I think the country could well flirt with recession next year as it suffers outright deflation (which cannot conceivably occur in the US despite the media hype).

A key mistake made by the Fed in the 1930s Depression (and one identified by Ben Bernanke in his PhD thesis) was to constrict money supply at a critical juncture after the Wall Street crash, and that is an error the current Fed is taking extreme pains not to repeat. However, Chinese authorities, lacking that institutional memory, are set to repeat this mistake just as the country's merchandise exports slump despite ever increasing export subsidies and a recently depreciating currency.

I've discussed the strange distortions of the closed Chinese capital account previously (and the huge 'informal' banking sector), but the massive flows of speculative foreign capital betting on an RMB revaluation until the Summer undoubtedly boosted Chinese inflation, which has since tumbled from over 9% to just 2% in November (on a PPI basis) against 6% the previous month; that screams serious monetary contraction to me, as do slumping asset prices. China's financial infrastructure remains primitive and dysfunctional compared to its physical and industrial one, and that raises the risks of underestimating the severity of the crisis the country now faces; disjointed as the US response has been, at least the Fed and Treasury have transparent and deep capital markets to reflect economic stress.

The greatest risk for 2009 is that China's financial immaturity causes it to pursue unsustainable trade policies that ignite a political backlash in the US (Germany is being equally intransigent in accepting the new reality but that's another story). Ultimately, as I've explained in previous posts, the US trade deficit will steadily disappear as consumers forcibly retrench and the US private sector savings rate climbs to 8-10%. China will be the biggest loser, and had better find a Plan B fast, which will essentially involve boosting domestic consumption, particularly in labour intensive service sectors, from structurally depressed levels rather than pouring more concrete (See my 11 November post, China: Following Japan's Failed Reflation Model) Policies that attempt to sustain the unsustainable, whether Chinese export growth or US consumption levels, are set for destabilizing failure.

While the lagged impact of the oil price crash and unprecedented fiscal/monetary stimulus mean the US housing market and broader economy should be tentatively recovering by end 2009, China will likely be experiencing negligible growth and possibly violent social unrest like that rocking Greece recently. While Greece has suddenly woken up to the explosive danger of 25% youth unemployment (and France, Italy etc won't be far behind) China additionally faces a growing demographic surplus of tens of millions of young males, who if allied to angry laid-off industrial workers, could cause historic upheaval. When the Chinese say 'May you live in interesting times' they mean it as a curse.

Comments

[Shaun Rein:]

"A key mistake made by the Fed in the 1930s Depression (and one identified by Ben Bernanke in his PhD thesis) was to constrict money supply at a critical juncture after the Wall Street crash, and that is an error the current Fed is taking extreme pains not to repeat. However, Chinese authorities, lacking that institutional memory, are set to repeat this mistake just as the country's merchandise exports slump despite ever increasing export subsidies and a recently depreciating currency."

Ummm... China announced 2 days ago that it was increasing money supply by 17%...

2008 Dec 17 08:46 AM

[Sean Maher:]

Shaun, indeed they have, and the PBOC is now frantically slashing rates, but given the lags in monetary policy it's all too late to avert a deep slowdown in 2009...the point is that the Fed has been quick to react to the looming US slowdown from late 2007, while the PBOC has retained a very tight stance (notably to squeeze rampant real estate speculation) until very recently, exacerbated by the reversal of opaque speculative flows circumventing official capital controls. Controlling an economy via monetary policy is like steering a supertanker, and China is now way off course.


On Dec 17 08:46 AM Shaun Rein wrote:

> "A key mistake made by the Fed in the 1930s Depression (and one identified
> by Ben Bernanke in his PhD thesis) was to constrict money supply
> at a critical juncture after the Wall Street crash, and that is an
> error the current Fed is taking extreme pains not to repeat. However,
> Chinese authorities, lacking that institutional memory, are set to
> repeat this mistake just as the country's merchandise exports slump
> despite ever increasing export subsidies and a recently depreciating
> currency."
>
> Ummm... China announced 2 days ago that it was increasing money supply
> by 17%...

2008 Dec 17 10:56 AM

[huangjin:]

The producer to the world, U.S.A., suffered the most in the first Depression. Producer to the world, China, may suffer more this time, if history repeats. Whether your theory is right or wrong, you are right to ask the question.

In my opinion, it's the idle factories (malinvestments) that matter, not the money supply.

2008 Dec 17 11:09 AM

[huangthomas:]

The latest figures available from World Bank (2005) indicates Chinese are still very poor. Their per capita income (per capita GDP, all adjusted for purchasing power parity, PPP) is slightly less than half of world average and at par with Sub Saharan countries such a Namibia, Botswana.....and way below South Africa, Egypt.......etc. How these poor people are going to respond to a set of economic policy is every-one's guess. Do they respond to lowering interest rate by going out to buy a Cadillac?

The Chinese policy makers are well aware of this. That is why they are subsidizing and financing the purchase of electric appliances, especially in the country side where the poor concentrate. This will also sooth the feeling of unemployed poor. Construction of low income housing will also benefit the poor and warm up economy. American may not understand all this and look at the policy as something strange and less than transparent.

2008 Dec 17 11:17 AM

[M.R. Henderson:]

Or will China continue to juice its stimulus package of export rebates by devaluing the RMB, and the rest of the world, fearful of depression, will not respond with tariffs but rather swallow, sinking deeper into debt, while China accumulates more savings and continues to expand?

2008 Dec 17 12:44 PM

[Inst:]

I can make one criticism of your criticism of China's reflation model. China is a large and diverse country; there's tons of highly-populated places out in the boondocks with backwards infrastructure. Apparently the cant was going around Chinese business circles that relocating your factories towards lower-cost regions didn't make sense, simply because Chinese transportation infrastructure was not up to snuff. This was in 2007. If I recall correctly, the Chinese government is aiming to improve infrastructure in lower-cost regions, so that factories can be moved to areas with lower labor costs.

2008 Dec 17 12:59 PM

[MaxWeber:]

Yeah this reads a bit like paranoia to me. It's the type of panic-induced fear of others' incompetence that exacerbated the first Asian collapse. The Asian "tigers" pulled out fine even after a financial market that relegated the entire region into economic pariah status. Even if China stumbles, the memory of soviet/communist poverty and underdevelopment is more than likely recent enough to keep them from making large irrational errors (though there are bound to be errors, of course just as in the US!)...

Jan 03 04:32 PM