I am now wondering if Google censors posts (I use Blogger), I put this post up at 1:33 AM, and even had a reader e-mail me that the post had disappeared (with no listing in “Recent Posts” which happens if I put up a post and then remove it). I have a record that it was indeed posted, but it was nowhere to be found as of 8:30 AM in my post archive. Hhhm.
The text as originally posted follows:
George Jankovic, serial entreprenuer (former president of NutriSystem) and quantitatively oriented investor, sent us a guest post that questions conventional wisdom about the growth prospects for China. Analysts have raised the specter that GDP growth would drop to 5%, which internally would be allegedly be tantamount to a recession (5% growth is necessary to absorb the increase in workforce). But just about no one seems to take seriously that China could have zero or negative growth.
For instance, in the daisy chain by which information often travels, one investor buddy told us that an economist who has advised the Chinese government is sanguine about the situation there. He believes that an export bubble is reversing as speculative capital flows leave the country, which he contends is not so much a decline in real effective demand. Moreover, China is not burdened by high debt levels, so it has room to manoeuver.
Similarly, the World Bank’s latest China Quarterly gave a cautiously optimistic update (Brad Setser provides something of a summary, although he insists readers read the report). However, one forecast already seems to have been trumped by events. The World Bank predicted that China’s current account surplus would rise in 2009, and it would add as much in foreign exchange reserves (in dollar terms) in 2009 as 2008 (and 2008, at least so far, showed eye-popping growth).
But although the World Bank saw China’s FX reserves moving rapidly from $2 trillion towards $3 trillion, Bloomberg reported last weekend that China’s FX reserves fell:
China’s foreign-exchange reserves dropped for the first time in five years as a result of the global financial crisis, Market News International reported, citing Cai Qiusheng, head of the investment management bureau under the State Administration of Foreign Exchange.
The current figure must be lower than the peak of about $1.9 trillion, Cai told a trade forum in Beijing over the weekend, the English-language wire service said. He didn’t specify which period he was referring to or give a figure.
The lack of detail is troubling, but the source would be in a position to know.
Again, none of these indicators are definitive, but Jankovic focuses on a statistic, power genration, that is part of the official government releases, which suggests the decline is more pronounced than has been widely acknowledged. Perhaps the Chinese are in denial, as our fearless leaders were until the downturn had morphed into a crisis. Note that electricity consumption fell even more sharply.
Power generation in developing economies where manufacturing is a high % of GDP should correlate well with GDP growth. China’s power generation declined more than 8% in November. In his FT.com Long Room posting, Joules Watt concludes that would correspond to a GDP growth of only 1.5% y-o-y based on his regression analysis of power generation vs. GDP growth. I think things will get even worse for China in 2009 and secular growth will never return to the levels we have gotten accustomed to during the last 30 years. The impact of these cyclical and secular slowdowns on a variety of products, such as oils and metals, will be huge.
Whether the official GDP data will confirm it or not, Chinese yoy real GDP growth will turn negative in the first half of 2009. Perhaps for all of 2009. This is the first time that China has been hit by both an external shock and an internal one. They are still blaming the US for their problems, but they were a co-participant in this bubble: their T-bill purchases fueled the credit bubble in the US which, in turn, fueled their export bubble. Everybody’s credit bubbles fueled everybody’s export bubbles, and vice versa, worldwide. So the Chinese export bubble has to collapse, as well. The same is true for their real-estate bubble (although this one was much smaller than US and UK bubbles).
Rare is an analyst willing to even contemplate low-digit growth rates for China in 2009, let alone NO GROWTH (Jim Walker from Asianomics (ex CLSA) predicts 0-4% growth). But, while history doesn’t repeat itself, it rhymes. During its first 30 years of recovery and industrialization after WW2, Japan experienced several “growth recessions” when its growth halved from the boom times. But in the mid 1970s recession, it got much worse. Industrial production growth went from +16% y-o-y throughout the first half of 1973 to -19% in February 1975! Real y-o-y GDP growth went from more than 10% to solidly negative for a few quarters in late 1974 and early 1975.
While it’s always dangerous to draw direct analogies from one country to another or from one time period to another, a country that is 25+ years into its industrialization, that is heavily dependant on both net exports to the world at the time of a global GDP and trade collapse, and that is also dependant on its real estate construction, has to get into deep trouble.
Can the rest of the fixed infrastructure investment help (infrastructure investment commands by far the highest % of GDP)? If you exclude investments in factories etc. (which will plunge with plunging exports) and home and office building construction (which are already plunging), what’s left has already peaked. 2008 should have been the peak railroad construction year based on their 5-year plan. 2009 will, at best, match it if the Chinese government does move up some of the planned future construction. Road construction already peaked couple of years ago. The same is likely true for ports. Airports should have a brighter future, but only long-term. So, no help from this largest sector of the economy either.
I don’t think there will be any help from consumer spending either. While the Chinese were not buying stocks in Shanghai on margin as the US investors did in 1929, they still lost a lot of money there. And since that was an epic bubble (based on cyclically-adjusted P/E ratios, it exceeded the Japanese bubble of 1989 and vastly exceeded the US 1929 and 2000 bubbles), it has still to deflate. What’s more important is that wage growth in China didn’t match its GDP growth over the years, so wages declined as a share of GDP. Consumption as % of GDP has roughly matched that fall.
As all kinds of businesses downsize now not only because of the recession, but also because of the new labor law, wages as % of GDP will further decline. Confidence has also been hit by multiple factors — hey, all you need to do is read the papers (anywhere in the world, for that matter). These two factors will hurt consumption growth. You can already see this in declining car sales. Auto manufacturing was, along with its upstream industries like car parts, one of the strongest growing industries in China during the boom times.
So there will be no place to hide in 2009. But, that’s not all…
Japanese growth never exceeded 10% after 1975. It never got even close to 10% while it routinely exceeded it prior to the mid 1970s. I believe that China will experience the same. It is not only much a more mature economy now, but the one that has already completed a good chunk of its industrialization and its exports are currently so high compared to the world GDP (much higher than Japan’s ever were) that one can’t expect their super high growth to persist. Long-term demographics don’t work in their favor either.
While this doesn’t mean that a great Chinese growth story ends, it will be a shock to many. For instance, while the current recession will hit hard the immediate Chinese demand for oil, metals and other commodities, the secular growth slowdown along with a more efficient energy and metals usage (they have just decided to raise taxes on oil, for instance, which will lead to more efficient usage over time) will hit the long-term demand, as well. Is the world ready to contemplate a much slower growing China? It better be.