Seeking Alpha

Improbable China Part II

Includes: CAF, FXI, GXC, PGJ
by: Joseph Trevisani
Joseph Trevisani
Fundamental analysis, research analyst, currencies

The Peninsula Hotel in Beijing has far more staff than its counterpart in New York. Squads of doormen hail cabs, busboys compete for baggage, water glasses are filled in the restaurant without asking. In the department stores nearby dozens of sales clerks idly rearrange merchandise and getting there is simple, Beijing may be the easiest major city in which to find a cab. Service positions are more than plentiful in the Chinese capital. Which raises a question about Chinese business, does it not value efficiency?

The obsession with maintaining or increasing employment represents the peculiarities of the Chinese economy and the political and social necessities of governing China. The overriding goal of the government is to provide jobs and consequently enough wealth to obviate political disenchantment and dissent.

Chinese society has a long history of rural disaffection and a long history of respect for students. The first has been manifested many times of the past decade. Protests are usually in objection to corrupt officials and practices, in 2005 the government admitted to 70,000 incidents in the prior years. But such disputes can easily become a condemnation of the central government. This is one reason for Beijing’s harsh treatment of corrupt official and firms. Execution is a common punishment for financial crimes. The second was typified by Tiananmen twenty years ago when normal Beijing residents stood in the way of tanks on their way to Tiananmen Square, throwing up barricades to protect the students. It is an event that the Beijing Government will go to almost any length to avoid repeating and an unmentionable in political life.

In the previous column we looked at GDP growth rates as reported by the government, 8.9% in the third quarter, 7.9% in the second and 6.1% in the first, and some possible contradictions. If the Chinese economy really grew at 8.9% in the 3rd quarter then secondary statistics should concur. But several important measures cast doubt on the probability that all is as reported.

For one exports and imports seemed to be out of line. Exports were down an average of 20.5% monthly in the third quarter and imports fell an average of 11.8%. The Chinese economy is 38% dependent on exports for GDP and it seems odd that goods produced for export orders are then not exported. Imports include both industrial and consumer products, raw materials, components and finished products. It is counter to logic that an economy that is expanding at an 8.9 % rate would not need more imports to produce its manufactures especially since a good deal of Chinese exports are assembled from imported components.

In this column we will look at a more basic comparison, money supply and prices. The question is the same, do the statistics make sense? If the M2 is growing at the documented rates but deflation exists at all levels of the price chain, are retail sales really expanding at the reported 15%? Where are the price pressures? If exports are down and retail sales are questionable is the 8.9% GDP creditable or sustainable?

Chinese M2 money supply grew at a year over year average rate of 28.75% in the third quarter, 26.70% in the second quarter and 21.59% in the first. These are Chinese government figures from the People’s Bank of China (PBOC) via Bloomberg. At the same time all price measures, from wholesale goods to CPI, have fallen.

The wholesale price index, the price of goods in inter-business transactions is down an average of 7.0 % in the third quarter, 7.6% in the second and 5.6% in the first (PBOC via Bloomberg). The producer price index representing changes in post production prices dropped 7.7 % in the third quarter, 7.2% in the second and 4.6 % in the first. Prices of retail goods slid 2.25 % in the third quarter (July and August only), 2.03 % in the second and 0.8 % in the first. The producer and retail indices are from the National Bureau of Statistics (NBS) via Bloomberg. Likewise the purchasing price index (raw materials, fuels and power) dropped 11.06 % in quarter three, 10.4 % in quarter two and 7.1 % in quarter one (NBS via Bloomberg). And finally the overall CPI was off 1.26 % in Q3, 1.53 % in Q2 and 0.6 % in Q1. The uniformity of the price direction is striking.

For comparison United States M2 year on year growth averaged 7.6 % in the third quarter, 8.6 % in the second and 9.4 % in the first. The US Producer Price Index (PPI) was down 5.3% year on year in Q3, 4.3% in Q2 and 1.9% in Q1. CPI is down an average of 1.6% in the third quarter, 1.1% in the second and 0.06% in the first.

Chinese M2 grew 3.8 times faster than the US in the third quarter, 3.1 times faster in the second, and 2.3 in the first. However Chinese CPI is essentially the same as the US and Chinese producer prices at several levels fell at a much faster course despite more than triple the money supply growth.

The purpose of this exercise is not to make minute comparison of the composition of inflation rates and money supply between China and the United States but to ask the logical question--can M2 grow at these rates in an economy where GDP is expanding at 8.9% and retail sales are rising at 15% and not produce appreciably different inflation rates? And if that is logically farfetched then which parts of the M2, GDP, retail sales equation is overstated?

Or to put the question differently where is all that money going? It is not going into goods purchases or production demand because prices are falling at the consumer level and falling dramatically at the producer level. Some of this cash must be making its way into the equities; the Shanghai Exchange is up 73% this year. Property prices are reported higher in many of the coastal and developed cities but statistical proof is sparse.

The Chinese Government and the PBOC have flooded the economy with cash and loans. But money by itself cannot create demand and without demand it does not even produce inflation. Judging from the price levels in the Chinese economy consumer demand is minimal. If exports do not pick up who will buy the products of 8.9% growth?