China's Growth: Far Less than Meets the Eye 49 comments
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For those who, like me, are skeptical of the solidity of China’s economic growth and the basis for the commodity rally, this article is for you:
Copper’s 76 percent rally this year may soon end on signs that China has stockpiled more than it can use in new homes, cars and appliances.
Inventories monitored by the London Metal Exchange posted their first back-to-back weekly gains since February, increasing 8.3 percent from an eight-month low. Sumitomo Metal Mining Co., Japan’s second-largest smelter, said Chinese imports are slowing after record purchases boosted domestic supplies, and U.S. copper-scrap exporters report shipments to Asia are dropping.
. . . .
Refined copper imports by the Chinese more than doubled to 1.78 million metric tons in the first half and reached a monthly record of 378,943 tons in June, customs data show.
“China’s copper imports are likely to fall in the second half of this year because it bought so much in the first half, the government has stopped buying and demand from end-users may not be as big as people anticipated,” said Zhao Mingwang, manager of futures trading at Zhuji, China-based Zhejiang Honglei Copper Co., which produces about 100,000 tons of wire and rods a year. “The imports were so large it’s hard to fathom where it all went.”
Most of the gains in LME-monitored inventories during the past month reflect the eightfold jump in the volume of material in warehouses in Singapore and South Korea, the closest to China.
. . . .
Inventories monitored by the Shanghai Futures Exchange more than doubled this year, sparking concern the pace of consumption in China hasn’t kept up with imports.
. . . .
Imports may have exceeded manufacturing demand by as much as 1.3 million tons in the first half, Kaku said on July 24. “I don’t think copper prices climbed because of a dramatic improvement in supply-demand conditions,” he said. “I’m skeptical about a strong recovery in the market.”
. . . .
Chinese lenders responded to the economic slowdown by tripling loans in the first half of 2009 from a year earlier to 7.37 trillion yuan, according to the nation’s central bank.
The increased lending spurred demand for properties, helping home prices in 70 major Chinese cities rise for the first time in seven months in June. Passenger-vehicle sales climbed 26 percent to 4.53 million in the first half, while commercial-vehicle sales fell 0.5 percent to 1.57 million, the China Association of Automobile manufacturers said July 9.
Dollar Slide
Investment in fixed assets, including water and road projects, jumped 34 percent to 9.13 trillion yuan, the National Bureau of Statistics said. Spending on capital projects accounted for 87 percent of China’s economic growth in the period, according to Morgan Stanley Asia Ltd. Chairman Stephen Roach, who is based in Hong Kong.
China's answer: Make another bubble
This all suggests that the 8 percent (annualized) Chinese growth in the second quarter is far less than meets the eye. It is the result of unleashing a flood of credit to finance “capital projects,” the quality of which is highly dubious; tripling the quantity of loans, to an amount representing 40 percent of the loans already on bank balance sheets, inevitably means that a large fraction of these loans are financing uneconomic projects.
Think about it. Chinese banks are lending three times as much during the most severe world economic downturn since the depression as they did when the Chinese economy was booming last year. A tripling of lending would inevitably lead to the financing of numerous negative net present value projects even in normal times. In current circumstances, the waste of resources must be astounding.
As I’ve written before, massive government stimulus like that being undertaken in China and being funneled through the banks can lead to increases in measured output. But the return on the projects funded is usually negative, and substantially so. In other words, you pay people to dig holes, and buy cement to fill them in, the expenditure counts as economic “output,” but all you’ve got in the end is cement filled holes that will not do what capital is supposed to do: provide a stream of benefits into the future.
What’s more, when a large fraction of these projects come a cropper, this dramatic expansion of credit will leave the lending banks with a slug of bad debt, forcing the government to: (a) bail them out, or (b) watch them fail or turn into zombies, thereby constraining their ability to finance viable projects in the future.
In other words, the Chinese have responded to a financial crisis caused in large part by an excessive creation of credit in the US and Europe by engaging in their own excessive creation of credit. The great exporting nation has thus imported the Hair of the Dog theory of economic policy: Respond to one massive distortion by creating one’s own.
I don’t see how this can end well. I understand the tremendous social pressures that make the Chinese leadership feel compelled to engage in this policy, but they are, in my view, just deferring the day of reckoning–and arguably making it far worse.
And since the commodity rally is based in large part on Chinese purchases, this also means that the rally is considerably overdone. Indeed, another Bloomberg article suggests that the copper market (and arguably, other commodity markets as well) is the economic equivalent of a crack addict, dependent on a continuing supply of Chinese government largesse:
Copper climbed in Shanghai, after falling the most in two and a half months yesterday, as China’s central bank damped speculation it would curb lending, boosting the demand outlook for raw materials.
Futures tumbled yesterday as speculation the Chinese government would limit bank loans sent the country’s stock market plunging by the most in eight months, dragging base metals lower. Equities rallied today after the central bank said it will maintain a “moderately loose monetary policy,” aiming to consolidate the nation’s economic recovery.
“The tightening of bank lending has been the major fear in the minds of copper importers and dealers,” Lin Xu, analyst at China International Futures Co. in Shenzhen, said by phone today. “So the reiteration of a loose monetary policy from the central bank helped sentiment.”
Downside for commodities
Just further illustration that the Chinese are riding the tiger. It’s damn hard to get off. The problem is, you can’t ride it forever.
The statistics in the first article regarding the immense quantity of copper imports are truly staggering; perhaps the ChiComs have a special affinity for the Red Metal... Note that China’s imports during a worldwide recession are double what they were when the Chinese economy was booming in 2008. Stocks in LME warehouses are also beginning to increase even as prices are increasing. (The same is true for other metals.) Oil inventories are also increasing. And for the most part, these measured inventory increases do not include Chinese stocks. Thus, commodity prices have been supported by massive Chinese stocking. Chinese consumption, such as it is, and as indicated by the inventory build it is far less than their purchases, is driven by a massive stimulus that is not sustainable for an extended period. The signs of recovery in the U.S., Europe, and Japan are faint, at best. And even a recovery in manufacturing in the OECD, or an increase in OECD consumer demand that would give a jolt to Chinese output for export, would have to work through massive stocks in order before any price-supporting fundamental tightness occurs. Other measures of demand, such as ocean freight rates, have been flat.
Commodity prices and inventories can move together if there is a spike in economic uncertainty that leads people to increase their demand for precautionary inventories: the only way to accommodate the increased demand for inventories is to raise prices to discourage consumption and encourage production. But if anything, the main metrics of economic uncertainty–such as the VIX volatility index–have been declining while commodity prices have been increasing. Price volatility for oil and other commodities was at historic levels in December of last year. (Oil price volatility was higher during December than during the 1990-1991 Gulf War.) So, increases in uncertainty/risk cannot explain the co-movement of prices and inventories.
All of this suggests that there is considerable downside risk in commodities. The markets are supported by a Chinese stimulus program that even many Chinese officials recognize is not sustainable, and which is leading to sectoral distortions. The stimulus has encouraged a buildup of inventories that will weigh on the market for a long time. The signs of recovery in the U.S. and elsewhere in the OECD are very fragile. Even the slower-than-expected decline in U.S. GDP in the second quarter is somewhat misleading as it conceals weaker than expected consumption. Fundamentals remain very weak, and the market is dependent on extreme Chinese fiscal and monetary policy. That translates into serious risk of a big selloff in commodities.
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I think that there is some truth in what you and others write, I think there is also some wishful thinking or envy. After all, how could the bad Chinese get it so right with their stimulus package - how could they do it better than us? It couldn't be that we have weak leaders? Hmmm......well you know that last part seems fairly plausible to me :)
This view holds that the Chinese are buying important commodities not only for conversion to goods and services but as a store of value. Here, the commodity becomes a proto-currency that is a dollar substitue or dollar displacement as store of tangible value.
The Chinese, probably, are embarked on a multi year, graduated, prudent and administratively feasible, strategy of demoting the dollar as sole global reserve currency.
The Chinese have 2 reasons for demoting the dollar: geostrategic, esp in Asia/Pacific, Latin America, Central Asia and Africa and of course, purely financial.The former is aggressive; the latter is defensive.
The Chinese need focus only on major commodities they need and import in large quatities anyway: eg oil, copper, iron ore.
Leveraging off their well established trade and financial infrastrucrture for acquiring from abroad, transporting over conventional sea lanes, stroring and distributing these few vital commodities makes administrative sense and also disguises motives and plans.
The Chinese can claim its all in advance of their impending boom in internal demand and the rulers in the US and the complicit MSM will readily agree with this position since it means they can continue debasing the dollar with increasing abandon.
To avoid Tiananmen Square like discontent, the Chinese government is inflating its economy with a huge debt bubble. And what will happen when that debt bubble bursts, the Chinese politicians don't worry about. Perhaps they'll blame speculators. And hope that the people won't notice the role of the Chinese government in all of this.
Such an approach seems to have worked in USA. It's the investment bankers in USA who are the real villains now and not the US government. And that might be why now China is doing the same.
As it turns out, the actual number of 8% may be mathematically correct but when it includes output that is digging holes and filling them with cement, or more specifically, building roads, digging them up, repairing them, destroying them and the rebuilding them, you can see that this "output" is suspect as author Greg Pirrong correctly notes:
"the expenditure....will not do what capital is supposed to do: provide a stream of benefits into the future".
And this, spending on capital projects, is what accounts for 87% of China's economic growth. That fact alone should give anyone pause to consider whether or not the Chinese did "get it so right with their stimulus package", as the post by daviddbc states.
Pirrong's thesis is based on research, not wishful thinking or envy.
There is another view of Chinese stockpling behavior that is favorable for selected, globally traded commodities over the next several years.
This view holds that the Chinese are buying important commodities not only for conversion to goods and services but as a store of value. Here, the commodity becomes a proto-currency that is a dollar substitue or dollar displacement as store of tangible value.
**********************...
That's it in a nutshell. The US$ is the elephant in the room.
So now we are at the point where everyone recognizes it, but we can play a game of chicken for months, quarters or indeed years before people bail. If only we knew when the "burst" happens. Until them its ride 'em cowboy.
In February I wrote, is China pulling an Alan Greenspan?
www.fundmymutualfund.c...
Yes! :)
"There is no better example of this [Chinese] speculative activity than what is being seen in the copper market. It is easy for global merchants, hedge funds etc to ship cathode into China and warehouse it outside the reporting system, so fueling investors' sentiments that copper demand in China is soaring and at the same time draining copper from the rest of the market.
"It is not so much industry which is doing this buying in China, but individuals, financial institutions and even small companies divorced from the copper industry who are buying and holding the metal because copper is a store of value and prices will go up is the common response. We updated our numbers for the first half of this year. They are truly staggering. Over 1 million tonnes of cathode is sitting in China mostly outside the reporting system as a punt on rising prices."
There have been a lot of comments deriding the dollar and the intention of China to stockpile commodities as alternate currency.
The problem here re: China's intention to pressure the USD down is that (a) Chinese yuan, being pegged to the dollar, also moves down in relation to other nations. So those who claim that $ weakness is a bad thing, should also assess the yuan along those lines. It weakens along with the USD (b) China holds massive USD reserves. So essentially by weakening the USD, it will have bought the USD at high prices and will hold/redeem at lower prices. (c) The Chinese economy is still very export oriented (evidenced by the fact that consumption-led growth is actually declining relative to investment-led growth). Vast numbers of Chinese are employed by this sector. The US, relatively speaking on the global scale, is the consumer of all these exports. A weak USD will make Chinese exports less competitive.
Weakening the USD is the last thing China wants. While it might engage in a lot of rhetoric, the politburo is smarter than trying to cut its nose off to spite its face.
Secondly, just like any currency, the value of a commodity is based on the demand for it. Does it make sense for China to expend its resources acquiring these commodities _if_ it expects reduced consumer demand for it? It would be acquiring it at higher prices than what would be supported by economic demand. The reasons one would keep buying commodities in the face of uncertain demand is if one expected shortages in the future (i.e. strategic reasons to protect supplies during war, protectionism etc) or for speculation (tactical reasons to trade it). I suspect the latter case here.
On Aug 03 12:31 PM Graham and Dodd Investor wrote:
> The troubling thing about Chinese growth is that it is coming at
> the "wholesale" level (new loans), rather than "retail" (consumer
> spending). The former is a spigot that can be turned off as easily
> as on.
Unlike our market regulators who often find it politically impossible to take the punch bowl away without being slaughtered by politicians, the Chinese regulators have a record of being viligent and willing to crack heads and tighten at signs of future trouble.
And indeed they already are dropping hints, and that will keep greed in line and growth on track.
On Aug 03 12:31 PM Graham and Dodd Investor wrote:
> The troubling thing about Chinese growth is that it is coming at
> the "wholesale" level (new loans), rather than "retail" (consumer
> spending). The former is a spigot that can be turned off as easily
> as on.
Many China sceptics have been influenced by Prof. Michael Pettis's worries about excessive lending and future bad loan problems from the Chinese stimulus package. While Pettis analysis multi-faceted and layerd and appreciated as good reference, those who lacks big-picture understanding about Chinese systems often is unable to inteprete those analysis correctly. They are advised to read Pettis;s latest article from yesterday, it will help them to stand back and review their whole positions.
On Aug 03 11:42 AM TraderMark wrote:
> Yes but when they bail out the banks, it will come from surpluses.
> Not stealing more from future generations.
>
> So now we are at the point where everyone recognizes it, but we can
> play a game of chicken for months, quarters or indeed years before
> people bail. If only we knew when the "burst" happens. Until them
> its ride 'em cowboy.
>
> In February I wrote, is China pulling an Alan Greenspan?
>
> www.fundmymutualfund.c...
>
>
> Yes! :)
As another astute commenter pointed out, the fact that China is currently accumulating more commodities as it's using is to replace worthless U.S. dollars with hard assets has nothing to do with "bubbles".
With China's domestic economy growing at 20%, the idea that 8% growth is so unsustainable as to be a "bubble" is simply ignorance combined with a lack of understanding of arithmetic.
Reinforcing the viability of China's next growth cycle is the fact that the economy is relatively debt-free. And China's banks are EXTREMELY healthy because the Chinese government RAISED their reserve requirements FIVE times just before the current economic meltdown in the U.S. - showing CHINA had a much better understanding of where the U.S. economy did, than the U.S. itself.
However the stimulus policy they have engaged on is suspect. Government is never as good as the private sector at allocation of capital, even if it is smart government. And despite the love expressed here the track record of corruption in China is pretty bad so I really doubt that all decisions being made in this area are altruistic.
One area that I think there is evidence of strain lies in debt auctions - China did not participate in US debt auctions last week - by itself not too much of an issue for China if you suggest it was because China doesn't want any more T-Bills, but there was another thing going on - China's own debt auctions are now becoming undersubscribed which suggests people are becoming skeptical regarding China's financial situation. So may be the lack of purchase of US debt is more because imports are way down and China is using dollars for other things.
All and all I would be careful about China here.
Western governments can lose elections and go back into the private sector. If the Chinese government falls, Hu Jintao & Co. could end up being beaten to death, much like the steel company executive several days ago.
That's pretty impressive - to think that Mao Zedong's mass famines (Great Leap Forward and Great Proletarian Cultural Revolution) were planned 5000 years ago. It's also kinda cool that 5000 years ago, the Chinese were planning to ditch all their traditions (polygamy, legal prostitution, traditional costume, absolute monarchy) and adopt Western customs wholesale.
China is simply hell bent on continuing its policy of exporting- export at any cost - cheapest cost -> export deflation. This will put upward pressure on dollar - that is the only way we will/can import their unneeded stuff.
China is portrayed as the great hope for world growth, but people forget its' economy is simply 1/4th of US and about 1/10th of OECD: US-Japan-Euro Zone. They simply do not have the size to pull everyone else up; the entire OECD is in a great recession.
So Deflation and Great Recession will continue, never mind the Chinese effort.
The Chinese Central Party are better at long term planning and the commodity stock piling is long term (smart) purchases when prices are low, a hedge against the monetizing of the US debt (buy with USD) and an inflation play when "they" run the dollar down.
China's old customer is a dead beat (United States) and has new trade agreements with many more developing countries with trade settled in Yuan. It will be very soon that CHINA will make a run on the dollar and accept a couple hundred billion investment as a cost of economic war.
I say investment because they have learned from Goldman that you can pump and dump and when they dump the dollar they will buy every type of hard asset they can get and own the US.
Obama blew his chance to make a real change by not looking at the macro view of the shifting balance of power.