highmax's  Instablog

China's GDP grew by 6.1% in the first quarter, sufficient to provide jobs for new university graduates entering the workforce every year. But the easy growth is probably over for now, the advantages of low wages and exponential productivity gains from new infrastructure investments are diminishing. The 'network effect' that these investments benefitted from has largely been maximized, and the incremental gains from new infrastructure builds will likely be considerably less.

Developed countries won't be outsourcing any more production for perhaps years, and export penetration won't be a repeating theme in a recessionary globalscape. Reforms to encourage household spending through wealth redistribution have not yet been implemented.

Government revenues have climbed rapidly over the past three decades, in many cases outpacing wage gains and corporate profits, and of course many marginally profitable SOEs were subsidized to achieve employment level goals. This will likely change in future as efficiency has to improve to keep driving productivity gains, meaning that excessive government control must give way to free market forces. This is not an easy expectation in a country where the internet, for example, is tightly censored.

And, as Andy Xie of Rosetta Stone advisors notes, inflation could become a concern:

  If inflation surfaces while the economy remains sluggish, the government mayenot be willing to tighten down sufficiently to cool inflation. It may lead to a prolonged period of high inflation rates and sluggish growth. This risk of stagflation is quite significant for China, the United States, and the world. While the initial burst in lending was needed to stabilize the economy, its continuation may carry more negatives than positives. It is not worth risking virulent inflation merely for a gain of one or two more percentage points in this year's GDP growth rate.

And, from a Bloomberg article today by David Wilson:

Rallies in commodity prices and mining-company shares stem from a “bubble of belief” in China’s economy that is likely to burst, according to Albert Edwards, a strategist at Societe Generale.

“I believe we will look back on the Chinese economic miracle as the sickest joke yet played on investors,” Edwards wrote yesterday in a report. To support his argument, he cited falling earnings at the country’s industrial companies.

The CHART OF THE DAY shows year-over-year percentage changes in profits, as compiled by China’s National Bureau of Statistics. The chart combines monthly data from 2005 and 2006 with a quarterly index, started in 2007, that tracks companies in 22 provinces. This quarter’s report is set for June 26.

Commodity prices climbed 21 percent this year through yesterday, according to the UBS Bloomberg Constant Maturity Commodity Index. Mining stocks paced a 23 percent gain in the MSCI World Materials Index, the year’s top performer among 10 industry groups in the MSCI World Index.

While the Chinese economy expanded 6.1 percent in the first quarter from a year earlier, Edwards wrote that he was skeptical about its ability to sustain that level of growth during a global recession.

“The bullish group-think on China is just as vulnerable to massive disappointment as any other extreme example of bubble- nonsense I have seen over the last two decades,” his report said. “The fall to earth will be equally as shocking.”

While a shift to a more consumption driven economy will no doubt eventually occur, offering better opportunities for investment in China, there could be a long adjustment period. We'll have a better idea after this report comes out.

Disclosure: No positions