China’s August Data Confirms Both Optimists and Pessimists

Regular readers of my blog will have noted all sorts of unfortunate goings on here in recent days. It has become impossible to get into the comments section, or indeed into any other section of my blog except the front page, and so to my great dismay the excellent discussions that have been so useful for me have been temporarily halted. I am not sure why this is the case, and now that school has started again I hope to get one of my terribly smart Peking University students to find out and fix it.

Actually in recent months a large number of China scholars who I know – and me too – seem to have been targeted by very specific viruses, with emails and attachments cleverly disguised to look like something we would want to read from someone we would trust. I am not smart enough to know what those viruses do, but I have been warned that they probably allow someone access into my computers.

Perhaps for the same reason my own blog has been hacked in some way, but it seems to me that if anyone really wanted to close me down they would have closed down the blog altogether and not just the comments section, so unless there is a commenter that regularly raises the ire of some censor out there, I suspect the problem has more to do with my blog site than with any malicious intent. Of course if my blog suddenly begins posting pornographic pictures, spewing venom, or otherwise does some unexpected and obnoxious things, please know that it was probably not me who came up with the idea.

I have also had a lot of trouble getting my regular proxies that allow me to jump the great firewall and post onto my blog. That is why my posting has slowed a bit, but it seems that yesterday and today the anti-proxy regiments have been at least temporarily defeated.

That’s good, because of course Friday the National Bureau of Statistics has released a whole lot of data. A European TV station asked me to comment on the import of the data, and while I hate to make too much of a few data points, I was able to say rather glibly that the data pretty much confirmed the hopes of the optimists as well as the fears of the pessimists.

I will explain why I think this below, but I should note that most analysts were pleased with the results, and the stock market surged on the news. The SSE Composite was up 2.2% today. Surprisingly it was down 0.7% yesterday, suggesting that there was probably no information leakage. Things seem to be improving on that front.

To summarize the data, manufacturing output was up by 12.3% year on year, better than last month’s 10.8% and higher than consensus, although I think last August, during the Olympics, a lot of factories were closed so that this number may not be as impressive as it seems. Steel output was up 29% and auto production was up 90%, which as my friend Mark Williams at Capital Economics points out is not likely to soothe worries about overcapacity creation.

Urban fixed-asset investment was up 33.0% for the first eight months of the year, which slightly exceeded already-high estimates of 32.5%. This suggests that it is still investment that is in the driver’s seat, as far as growth is concerned.

This might not be as obvious as all that. A lot of people were excited that retail sales climbed 15.4%, slightly higher than consensus and the highest growth rate all year after seasonal factors are stripped out, but remember that retail sales are not a very good proxy for consumption growth. Also remember that this surge in liquidity can easily cause consumption to rise in a temporary way without indicating anything structural about changing consumption and saving patterns in China. In 1988-89 consumption in Japan also surged, probably as a consequence of the investment boom, but it was unable to survive, if I remember correctly, the contraction in that boom in the 1990s.

The most interesting piece of information is that net new lending for the month was RMB 410 billion, less than half the monthly average this year (RMB 1,105 billion). This seems small given the huge numbers we’ve seen but, as I pointed out two weeks ago, last August new lending was around RMB 272 billion, and if you strip out the bills coming due the real increase in medium- and long-term lending is closer to RMB 550-600 billion. More importantly, RMB 410 billion is a lot more than the rumors of RMB 300 billion that had panicked the market last week.

The one piece of news that everyone read as negative was the trade data. Exports were down 23.4% and imports down 17.0%, both substantially worse than expected, although leaving the trade surplus at a still-hefty $15.7 billion, which is roughly average for the year.

For the optimists, the economic numbers, with the exception of the trade data, were all positive and suggest that China is on track to recovery. For them, the great risk to China was that the global contraction in demand would result in terrible damage to China’s export industry and, with it, would cause factory closings and soaring unemployment. Rising unemployment would lead to a collapse in consumption, and of course would not make China’s transition easier

The main purpose of the stimulus package, in this view, was to forestall an economic contraction and with it the possibility that the economy would fall into an ugly process in which rising unemployment would cause a contraction in Chinese consumption which, when added to the contraction in foreign demand for Chinese exports, would push the economy into a tailspin. In that sense the stimulus has proven to be a great success. Chinese growth has slowed, but by a lot less than expected, and unemployment seems to be manageable. The August data points pretty solidly to continued growth.

And yet, and yet….

For pessimists like me the global contraction underscored Chinese vulnerability to out-of-control US consumption, and the need to develop a more balanced approach in which Chinese consumers take a larger share of China’s production. This vulnerability existed in large part because China was overly reliant on investment for its growth. China has had probably the highest investment rate ever recorded for a large economy, and for years there has been widespread concern that much of this investment was misallocated.

It is only because the cost of capital is artificially so low (thanks to Chinese households, who are forced to earn a miniscule return on their savings) that many companies are able to show profits at all. A few months ago I wrote about an HKMA paper that suggested that the implicit interest-rate subsidy to SOEs – not relative to the “right” interest rate in China (whatever that may be but which is certainly many percentage points higher than the official lending rates) but relative to the borrowing cost of large Chinese private corporations – accounted for 100% of SOE profitability. If China had reasonable interest rates, in other words, (and in fact there were negative real rates for much of the recent past), SOEs would on average be value destroyers.

This, by the way, is why China’s supposedly puzzling addiction to capital-intensive growth rather than labor-intensive growth – more befitting to an economy with lots of unskilled labor and very poor technology – is not so puzzling. If you artificially lower the price of a particular input, it is not surprising that producers will use more of that input than might otherwise be considered optimal. With capital practically free, capital is everyone’s favorite input in spite of incredibly low labor costs.

With the recent surge in government financed investment (and I include most bank lending in this category), it would be surprising to me if much of this year’s new investment were not of even lower quality than the older investment, with very low or even negative expected returns. If this turns out to be true, it means that the only way these investments could be viable is by effectively continuing to “tax” Chinese households to subsidize state-owned enterprises and large manufacturers. This tax of course will come mainly in the form of low wage growth and extremely low deposit rates on the savings of Chinese households.

This is why we all hope Chinese growth will become more reliant on rising consumption rather than on rising investment, much of which is certain to be unprofitable. The current path requires a large trade surplus to absorb the difference between what China consumes and what it produces, but it is not clear that foreign consumers will absorb the balance. China is trying to plug the gap by a surge in government-financed investment, but this is likely only to widen the gap in the future.

So the August data suggests that while China is growing, it is actually more reliant, not less reliant, on investment. What is worse the very poor import numbers suggest that in spite of high retail growth figures, consumption growth in China is still sluggish.

For the pessimists, then, the August numbers confirm that the stimulus package may be boosting production solely because of government-financed investment, and that a serious misallocation problem will result in more future pressure on Chinese households to foot the bill. The export numbers show that China’s external accounts continue to deteriorate, and it will take more than simply an end to the global crisis to return to the good old days.

So who is right, the optimists or the pessimists?

In fact both are right. If the purpose of the stimulus package was solely to protect China from the immediate employment impact of the global contraction in demand, it has been an almost unqualified success.

But if at least part of the goal was to help China shift its unbalanced growth model to one less reliant on foreign, and especially American, consumers, it is not clear that any progress has been made. In fact to the extent that a significant share of new investment has been wasted, it may actually make future imbalances worse.

China’s response to the global crisis needs to be seen as a two-part process. The first part is to goose economic growth in response to the rapid deterioration in the external environment. The second part is to rebalance the economy away from its excess reliance on investment and foreign demand. The August data seem to confirm that China is very successfully managing the first part. Whether it has made any progress on the second part is still very much open to question.

Comments

[CautiousInv...:]

I think when you at the scale of the stimulus package, which would be around $4 trillion in terms scaled to the US, the product of the effort is not overhwelmingly impressive.

The challenge for China is to cultivate new export markets and boost consumer spending before fiscal stimulus must be pulled back or withdrawn completely; the latter face enormous structural challenges and face obstacles of equal magnitude.

Very surprisingly in light of bank lending that expanded 230% in H12009 from the comprable period last year, is that consumer prices declined slightly in August while producer prices cratered at a rate of around 7%. Clearly, there are imbalances and deflationary currents running through the system.

Sep 11 09:45 AM

[djackson:]

I thoroughly concur that the pricing data make one wonder at just how robust the economy really is. Particularly when many of the Chinese economic statistics are suspect. I love the way they calculate GDP.

Sep 11 12:23 PM

[Alphameister:]

And this year's weather patterns are supportive of both the global-warming lemmings and those who fear a new ice age! Please explain why you regard the level of imports (heavily influenced by a surge in commodity stockpiling followed by a slowing of same) a better indicator of Chinese consumption than a 15% growth rate in retail sales......other than the fact that one supports your negative bias while the other contradicts it.

And this new surge of investment will be even more ineffective than past mal-investment (by your insights) that has made China's growth the envy of the world? Do you ever take your eyes off the trees to observe the forest?

If China's movement in the direction of free markets during recent decades is an indication of their economic sophistication, they must surely realize that their stimulus program will be expensive in terms of efficiency, but it is an expense they can well afford while transitioning to an economy more substantially driven by consumer spending and more diversified export markets. They should also be coming to realize that state-sponsored enterprises are no more likely to be wealth generators in China than they are in developed countries like the US.

I see Friday's economic news out of China as unadulterated food for the China bulls. And I continue to value each new brick you add to the Great Wall of Worry on which my Chinese ADRs have been climbing.

Sep 11 05:51 PM

[Michael Pettis:]

CautiousInv, I am not sure China should be looking for new export markets to replace the US. Europe for structural and political reasons cannot absorb anywhere close to the deficit levels of the US and no other market is big enough. At any rate, a continental sized economy, and soon to be the second biggest in the world, should not rely so heavily on foreign consumptionj for its growth.

Alphameister, I wonder if you are old enough to remember the same nonsense that was said during the credit-fueled bubble in Japan in 1988 and 1989. And if you really do look closely at Chinese data you may be one of the few who do who nonetheless accepts retail sales as a measure of consumption growth. For the past five years retail sales have always been higher than GDP growth, and yet consumption as a share of GDP has declined, which at the very least is mathematically curious.

Sep 12 04:55 AM

[BIOWOLFF:]

Well, that's ugly, Tony. As a longtime China watcher I find his remarks in this case accurate in detail, and well balanced in opinion.
What is your purpose is using personal invective Mr. Daltorio?

Sep 12 12:32 PM

[Alphameister:]

I don't profess to be a China expert. I rely on purported experts such as yourself to provide a range of perspectives. I make judgments as to the seeming objectivity of such experts as well as the consistency of their perspectives with other evidence and perspectives. I don't worry a lot about the precision of varioius economic data emerging from that country. I understand that in a huge and still relatively underdeveloped country like China, with all the conflicting motives at different government levels to understate or overstate economic data, there is likely to be a significant margin of error in any individual reported datum. If retail sales are growing at a rate of 12% instead of 15%, it won't change my opinion of the merits of investing in China.

When I see someone play a game of intellectual Twister in order to put a negative spin on positive news and I know that person is invested intellectually in a bearish perspective, I tend to form negative judgments of his objectivity. And when I see that person make a comparison that I (and others) regard as fatuous between today's China and Japan of twenty years ago, it further reduces the likelihood that I will give much credence to his views.

My investments in China are not based on the expectation that its export markets will soon return to "the good old days." It seems reasonable to conclude that much of the weakness in imports is more likely related to the contraction of exports rather than to weak domestic consumption.

When you comment that there has been widespread conceern for years that China has been misallocating capital (despite producing the world's fastest growth rate), are you referring to prior articles by you and others with similar negative views of China's economy?

When I hear one international company after another report that its strongest markets are in asia, especially China, it is easy enough to discount suspicions in other quarters that China is fabricating data to create the illusion of growth where none exists.

Sep 12 07:23 PM

[Andeli:]

Mr. Daltorio is a "troll" Do not feed him.


On Sep 12 11:38 AM Tony Daltorio wrote:

> Why does SA keep posting this nonsense? The Financial Times has already
> shown Mr. Pettis to be no more than an educated "fool'.

Sep 13 01:46 AM

[odin:]

I am curious as to the breakdown of retail sales. Where is this growth concentrated? It is clear that asset prices in China have skyrocketed in the past few months. Is it possible that this has made a small segment of the population feel wealthy and splurge (just as rising house prices in the US led to better times for the luxury market)?

When I think of and hope for rising domestic consumption in China, that is not quite the rise I trust. Consumption by a small segment of the population based on paper wealth is likely to come down just as fast. The consumption that global companies get excited about is broad-based -- driven not just by buying cars and luxury goods but by spending on mass-marketed goods (appliances, apparel etc) -- and based on rising wages and consumer confidence. To some degree, that is the hallmark of Chinese growth story (and while export subsidies did transfer away wealth from the workers to the exporters, its also undoubtedly true that a significant portion trickled down).

As to the risks facing the Chinese (and global) economy due to its export orientation and a point that Prof. Pettis has been making for a while (nations running a surplus are a lot more vulnerable than those running a deficit when there is overcapacity in the system), read these shades of Smoot-Hawley: www.ft.com/cms/s/0/f67...

Sep 13 05:46 PM

[djackson:]

Earlier you referred to China's growth being the envy of the world. Here you dismiss the possibility of weak domestic consumption and manipulation of the numbers. Go where you want, but if you would like to learn why the numbers are so suspect, try Makin's article on the AEI's website: www.aei.org/outlook/10...
It is easy to make growth look good when you count production rather than finale sales and disbursement of state loans rather than their final expenditure. It is precisely at a turning point from exports to domestic sources of growth that official statistics would be most misleading.


On Sep 12 07:23 PM Alphameister wrote:

> I don't profess to be a China expert. I rely on purported experts
> such as yourself to provide a range of perspectives. I make judgments
> as to the seeming objectivity of such experts as well as the consistency
> of their perspectives with other evidence and perspectives. I don't
> worry a lot about the precision of varioius economic data emerging
> from that country. I understand that in a huge and still relatively
> underdeveloped country like China, with all the conflicting motives
> at different government levels to understate or overstate economic
> data, there is likely to be a significant margin of error in any
> individual reported datum. If retail sales are growing at a rate
> of 12% instead of 15%, it won't change my opinion of the merits of
> investing in China.
>
> When I see someone play a game of intellectual Twister in order to
> put a negative spin on positive news and I know that person is invested
> intellectually in a bearish perspective, I tend to form negative
> judgments of his objectivity. And when I see that person make a comparison
> that I (and others) regard as fatuous between today's China and Japan
> of twenty years ago, it further reduces the likelihood that I will
> give much credence to his views.
>
> My investments in China are not based on the expectation that its
> export markets will soon return to "the good old days." It seems
> reasonable to conclude that much of the weakness in imports is more
> likely related to the contraction of exports rather than to weak
> domestic consumption.
>
> When you comment that there has been widespread conceern for years
> that China has been misallocating capital (despite producing the
> world's fastest growth rate), are you referring to prior articles
> by you and others with similar negative views of China's economy?
>
>
> When I hear one international company after another report that its
> strongest markets are in asia, especially China, it is easy enough
> to discount suspicions in other quarters that China is fabricating
> data to create the illusion of growth where none exists.

Sep 14 09:36 AM

[Jim888:]

I also think Alphameister is a bit off base by thinking Retail Sales IS consumption, while Mr. Pettis is correct in his discarding of it as a partial and perhaps irrelevant value except at a gross level over a period of time. I remember that consumption is the amount the entire economy consumed - of which Retail Sales is a component of - but not the end all - of that value (I hope the US learns this, but fear it is groveling for the consumer to spurge more instead). As for any spin here - you can read it many ways, and Mr Pettis allows us to make up our own mind, while making clear his own viewpoint - judge that from the last several articles - a review of this past work will show he is consistant.


On Sep 12 04:55 AM Michael Pettis wrote:

> CautiousInv, I am not sure China should be looking for new export
> markets to replace the US. Europe for structural and political reasons
> cannot absorb anywhere close to the deficit levels of the US and
> no other market is big enough. At any rate, a continental sized economy,
> and soon to be the second biggest in the world, should not rely so
> heavily on foreign consumptionj for its growth.
>
> Alphameister, I wonder if you are old enough to remember the same
> nonsense that was said during the credit-fueled bubble in Japan in
> 1988 and 1989. And if you really do look closely at Chinese data
> you may be one of the few who do who nonetheless accepts retail sales
> as a measure of consumption growth. For the past five years retail
> sales have always been higher than GDP growth, and yet consumption
> as a share of GDP has declined, which at the very least is mathematically
> curious.

Sep 14 06:29 PM