China's Growth Is No Miracle

Be careful about investing your hard-earned dollars in the latest Chinese five-year economic miracle.

One should not confuse China's latest economic growth -- retail sales up 14.8 percent, industrial production up 7.3 percent and car production ahead 18 percent -- with sustainable growth.

Now that the US consumer is de-leveraging and the global appetite for goods is declining, Chinese exports dropped 22.6 percent in April.

But this raises a question: How can China, a mainly export economy, continue to thrive when its exports are falling?

The answer is that today's China is a story of two competing economies: the real economy, producing goods and services for mostly external consumption, which is declining at a tremendous rate and the government-spending stimulated economy, which is currently expanding on steroids.

The latter one is clearly winning, for now. Here is why:

• The Chinese central bank has a significant advantage over ours. The Fed can print a lot of money -- and it has -- but there's almost nothing it can do to speed our spending. The Fed cannot force corporations and consumers to spend. Since China isn't a democracy, it doesn't suffer the problems of the democracy.
• China's communist government owns a large part of the money-creation and money-spending apparatus: Money supply therefore shot up 25.5 percent in March. Since it controls the banks, it forced them to lend.
• Finally, China can force government-owned corporate entities to borrow and spend. And the government itself can spend quickly -- which is important when trying to build infrastructure. If the Chinese government decides to build a highway, it simply draws a straight line on the map. Any obstacle -- like a hospital or a school -- becomes a casualty of the greater good.

The Chinese government goes to great lengths to stimulate its economy because it doesn't have the kind of social safety net one sees in the developed world, so it needs to keep its economy going at any cost.

Millions of people have migrated to its cities, and now they're hungry and unemployed. People without food or work tend to riot; to keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system re-stabilizes.

This type of growth is simply not sustainable, as it comes from borrowing. Its quality is low -- hundreds of billion-dollar decisions made on the fly don't inspire a lot of confidence in their efficiency. It will result in a huge pile of bad debt -- forced lending is bad lending. The list of negative consequences is very long, but the bottom line is simple -- there is no miracle in Chinese miracle growth, and China will pay a price -- the only question is when and how much.

Comments

[robert99:]

I prefer India to Brazil, Brazil to Singapore, Singapore to China. Australia and Canada also trump China. I just can't seem to get very excited about investing in a communist economy.

May 20 03:06 PM

[ChinaAnalyst:]

Forced lending through its banks is nothing new in China, it's regularly been done to institute economic policy. For enterprising individuals with the right "guan xi" (i.e. connections), its a gold rush: secure the money first, then figure out what to do with it. For government agencies, its rife with corruption: hooking up friends with contracts and finding ways to launder the money. The only thing the PRC stimulus plan changes is the scale.

Unfortunately there's no way to independently analyze the strength of bank loans. Moreover, banks can simply transfer any toxic assets to a private holding company. Regulation and oversight, after all, is essentially done by the same people forced the loans in the first place. Those with first-hand experience of doing business in China already know there's no miracles, just bad aftertaste.

May 20 03:59 PM

[MfgCrunch:]

As much as we read about China's wage advantage, the truth is, countries don't compete on the basis of wages, but on the total competitiveness package. In the US, the burden of costs from Washington is greater than anywhere else in the world, starting with legal costs (where we are the undisputed #1) to energy costs (no other country puts its own natural resources off-limits) to corporate tgax rates, where we are narrowly #2 behind Japan. So China is growing, but we are the ones putting the brake on our own growth.
mfgcrunch.ning.com/pro...

May 20 04:00 PM

[Xin's inves...:]

Basically I dunt see any logic in this article.
All I can say is that, if your arugment is true, then your conclusion must be wrong.
Indeed, if your argument is right, then China's economy is very 'sustainable' in the sense that
1) when the global economy went wrong, it can stimulate itself with their domestic demand.
2) when the global economy picks up again, China can thrive again with its exporting.

May 20 04:54 PM

[RiskReturnO...:]

China is still the most powerful economy with the ability to maintain high GDP growth rate for the next 3-5 years and drive global commodity prices higher.

Having said that, FXI has run up quite a bit, and I would not be surprised to see some profit taking ahead of the 20th anniversary of June 4, 1989 (Tiananmen Square event).

For those who are underweight China, perhaps wait for pull back in the summer, monitor events in China (and sensitive areas like Tibet), and plan for a re-entry before huge rally tied to the celebration of 60th anniversary of Communist Party ruling China (founding of People's Republic -- October 1, 1949-2009).

May 20 07:24 PM

[Thomas Wagner:]

I spent seven years traveling to China as part of my investment advisory and trading practice. While i do agree with the author about the potential negatives of Chinese bank lending, i do not agree with his assertion that millions have migrated to the cities and are now starving and out of work. My contacts in several provinces have confirmed that small company loan growth, personal income's and the general standard of living continues to rise in China, despite the slow down in exports. I also cannot ignore the logic of XIN post above. Sounds like he or she is chinese and has a first hand knowlege of China. The fact that China does control the banks and influences SOE capital spending plans does give it a more efficient mechanism to stimulate growth through monetary and fiscal policy. To a certain extent China is in a sweet spot. If it wants to stimulate activity it still controlls the SOE's as well as the Banks. At the same time it has had the benefit growing millions of private enterprises over the last 15 years that now dominate its domestic economy. That being said, directed economies are usually the most inefficient allocators of capital. Im hoping that the Chinese gov't has learned its lesson when it comes to directing production. The best way for China to ensure a stable domestic growth is to make capital avaliable to the small and medium private enterprises that now dot the landscape and dominate the creative talent in China. Pension reform and medical insurance company regulation would go a long way in providing a safty net for that segment of the Chinese population that is still saving instead of spending.

May 20 09:46 PM

[Dirk McCoy:]

China has a billion people, most of them pretty close to ocean transportation hubs and willing to work for significantly lower wages. Poverty there is defined as less than a couple bowls of rice a day, whereas we're going to subsidize families who lack air conditioning and equal access to education and healthcare. And last time I was in Beijing the english language newspaper carried an article on the execution of a manager for embezzlement.

I wouldn't want to live there, but don't underestimate their drive for economic superiority, which will create continued growth given their still very low base and trillions of US dollars to buy raw materials.

May 20 10:57 PM

[Dirk McCoy:]

Oops, dated myself there- more like 1.4 billion people.

May 20 11:03 PM

[Apolloinves...:]

I am taking the counter-argument because the points that author illustrated appears more like an advantage to me under the current economic condition... and I certainly don't buy the idea that China is still has a communist economy.

I think the miracle is gonna continue for the following reasons besides the ones listed by the author :
1. As the biggest raw material importer in the world, China has taken the advantage of current crisis to stockpile or secure sources of many key commodities such as oil and metals, which in the past China has been vulnerable to
2. While the developed countries are busy fixing their financial system, China is further improving its infrastructures such as transportation system and technology, which is already far advanced than most developing countries, through large government spending. This investment will generate promising "sustainable" output in the future

What I like the most was that the Chinese government seems to be able to prioritize issues pretty well, if you take a microscope to check Chinese economic and political system there are problems and issues all over the place but overall, China has been very successful in past 3 decades in terms of improving its economy and living standard of its people.

May 21 12:31 AM

[ChinaAnalyst:]

The devil's in the details. I'd be interested to see some figures that could help gage the PRC's ROI. The author brings up a valid point: there is no doubt a great deal of wasteful, or at the very least inefficient, spending done through the banks. But to call this a bubble would be immature since China still has a lot of room to grow. (Keep in mind there have already been bubbles in the Chinese economy. The Shanghai real estate market, for instance. But they've been small enough to have little effect on the overall economy.)

I'll give an example: During a trip to the outskirts of Ningbo, what you'd call a 3rd or even 4th tier city a few hours south of Shanghai, I witnessed a massive infrastucture project. Stretching for miles in every direction on what used to be farmland, construction cranes dotted the skyline building apartment complexes. There were a number of stadiums / large exhibition buildings that were surrounded by... nothing. Some people had already moved into recently completed apartment complexes, but other than construction businesses, no other businesses had set up yet.

Obviously, government funded construction fueled the entire the economy in this area. All the construction workers and their families were formerly farmers. What will fuel the economy once the construction is finished?

May 21 01:40 AM

[beijingpaddy:]

I do live in China and have done so since the early 90s. I like it here. I am not ethnic Chinese.

The world’s production center has moved east and mostly to China. The consumers are in the west. Yes, they have reduced their consuming, but at some point they must come up for air. They can not live on bread and water forever. The world has changed over the last 20 years and there is no turning back the clock. It’s ticking.

It may be wise to be long on China. Let me share with you an example. Last year, the Chinese government formed a huge aviation giant that is directly under the State Council. China hands should know what this means in terms of money and other resources available. As part of the aviation reform, next year the government will allow helicopters to fly without getting PLA permission first. This restriction for the most part kept helicopters out of the market. Now think about this. A county with 1.4 billion people, one of the fastest growing economies in the world and presently has only a few helicopters to its name. This new aviation giant will have a near monopoly on helicopter production. There are a few foreign players now also but the government has DECIDED TO CREATE AN AVAITION FOOTPRINT AND BE SELF SUFFICENT. If you get my point. There are also exports to be considered. Last year a big part of this helicopter production capacity (AVI II) was selling in Hong Kong for .60 HK cents and now is closing in on 2.00 HKD. The exchange rate is roughly 7.60 HKD = 1.00 USD. It is a very long horizon to be sure (shorter for helicopters than the airplanes) but check out other large global helicopter positions for an idea of where the price for this stock could go. I think it is a bargain. Yes, I already bought some.

By the way, I never tire of saying that the real strength of the Chinese economy is not the system but the people. They are out to win. It will take a war (please not in my lifetime) to stop them. And the people support the system. There is little chance for social turmoil not for fear of the government but because they know themselves all too well and more importantly have a goal in mind. Restore their dignity and get rich!

May 21 02:02 AM

[Simon Smelt:]

OK, for the sake of argument, let's accept that China's government - through the banks, SOEs and provincial powers - is making poor quality investment decisions with its stimulus package. But, with high savings, there is no Chinese debt position to exacerbate. And, as the spend is additional to normal, it is not necessarily removing funds from better internal use. It's just money not well spent. What will probably happen is less investment by China in the U.S. as the trade gap shrinks. So, the loser from the poor quality Chinese stimulus package is the U.S.

The danger for China is inflation: lots of spend without increasing productive capacity will lead to inflation somewhere in the system. Higher unemployment should keep down wages - unless the government develops a social welfare system. That would raise reserve wages and thus push up low skill wages, spoiling the whole game for China's elite. Otherwise, inflationary pressures may be expressed in rising asset prices (again).

May 21 05:48 AM

[coreopsis:]

What country are you talking about, the US or China?


On May 20 09:46 PM Thomas Wagner wrote:

< Pension reform and medical insurance company regulation would go a long way in providing a safty [sic] net [etc] >

May 21 10:16 AM

[BuddhaHead:]

I think you totally missed the boat. First of all most of the factory work force comes from the rural areas where they worked marginal farms. These farmers went back home when the factories closed. The government is spending money on rural areas to increase domestic spending. The spending is focused on infrastructure(roads, railways, airports, power, health). The Chinese save about 40% of their income. The government is spending to improve health, education, and social security. The government cadre know they will lose their jobs if social unrest rises. The domestic catalyst takes the form of subsidies for fuel, appliances, cars, and food. These people had it worse under Mao and they know they are better off today even though they are out of work. Though life is hard, the Chinese know how to survive. Basic food is fairly cheap so they will survive. They are waiting for the Dragon to roar again when the world gets healthy. How do I know? I live there for the last 6 years.

May 21 10:17 AM

[huangthomas:]

Well said. Western press rarely mention subsidies (of 10% of the price) in the rural areas for electric appliance (water heaters, microwave ovens, refrigerators.....etc), bikes, motor bikes and cars. Considering the rural population is 800 million, this must be a massive program. The final figures of the expenditure are not known yet, but it is an important stimulus of the domestic consumption to replace dwindling export. It is more effective than the infrastructure construction.

May 21 12:50 PM

[Alphameister:]

Happy to live in the US and focus on China for most of my investing. Export sector should rebound on the inventory restocking here and in other parts of the world. I don't believe in miracles, but I do believe that investments in China offer the best reward-risk ratios in today's messed-up world.

May 21 01:16 PM

[Observer45:]

Quote from above: "Millions of people have migrated to its cities, and now they're hungry and unemployed. People without food or work tend to riot; to keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system re-stabilizes."

You are seeing things from a very narrow perspective. In where you live, this might happen but in China the more likely thing is that factory workers return to their villages (not all though) and farm and continue with their lives in a useful manner.Go and visit that country and stay there for a while if you can and tune in to their CCTV broadcast (skip the propaganda but observe the facts). You will learn many useful lessons.

Jun 10 12:06 PM