Will China’s Growth Falter Post Olympics?

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We’ve believed that China would have to hit a speed bump, or worse, at some point. To resort to cliche, trees do not grow to the sky and rapid GDP increases often wind up seeding their own undoing.

There are already signs of trouble. Exports are a big driver of Chinese growth (the other is domestic investment) and high fuel prices are wreaking havoc. Bloomberg reported last week that Hong Kong businesses may shutter 20,000 factories in the neighboring province Guangdong out of 70,000. Similarly, EconomPic argues (with charts) that:

Are commodities being driven up by Chinese demand or has China been powered by cheap commodities? The story goes as follows:

High growth in China increases the demand for commodities, such as oil
The increased demand increases the price of commodities
A spike in commodity prices hurts Chinese growth prospects
Slower growth decreases the price of commodities
Rinse, repeat…

Since Fall there has been a dramatic shift in the relationship between the two with it looking like China’s success may have indeed been enabled by cheap commodities (cheap labor is not enough when commodities spike).

More skepticism on the “China’s growth as manifest destiny” comes from a story by Edward Chancellor in BreakingViews($, free trial):

The Chinese economy has been sprinting towards the Olympics at a blistering pace. But what happens when this summer’s games draw to a close? Most observers seem to expect more of the same….

While this view of China’s prospects may prove correct in the long term, serious clouds are appearing on the horizon. That’s the view of Dr. Jim Walker, former chief economist of CLSA and founder of the Hong Kong-based consulting firm Asianomics. Walker adheres to the Austrian school of economics….

Austrians are obsessed with interest rates, and most particularly about what happens when central banks apply the wrong rates. When interest rates are too low, they argue, credit expands too rapidly. This stimulates investment and fosters asset price bubbles. Eventually, credit “inflation” shows up in rising consumer prices. But by then, it’s too late to stop the damage. The end of the boom reveals the misallocation of capital, or “malinvestment” as the Austrians insist on calling it. After which, there follows a painful process as the economy is forced to adjust back to equilibrium….

Walker believes that Beijing has allowed an Austrian-style bubble to inflate in China. In equilibrium, he argues, short-term interest rates should be roughly in line with the economy’s nominal GDP growth. But China has actually enjoyed interest rates well below the rate of inflation at a time when its economy has been expanding rapidly…

The result has been strong credit growth. This, in turn, has fuelled an extraordinary investment boom. Investment has been growing at 25% a year and constitutes around 40% of GDP. Most of the fruit of this new investment has been exported abroad. The trade surpluses generated by these exports have meant yet more intervention in the foreign exchange markets and further credit growth. For a while, this must have seemed like a virtuous cycle. Now it’s turning vicious.

Chinese export growth is set to fall sharply. Europeans initially took up the slack after the housing bust dented the appetite of American consumers for all things “Made in China.” But the credit crunch is wreaking havoc on both sides of the Atlantic. Recent data suggest that European export demand is slowing. Many claim that Chinese domestic consumption will take up the slack. This is unrealistic. As Walker points out, the UK alone consumes more than China and India combined….

There’s another problem. The credit boom has finally erupted in widespread inflation…The costs of commodities and wages of semi-skilled workers have been soaring. This leaves the authorities with little choice but to tighten monetary policy into a slowdown. Real credit growth has already slowed sharply to around 6%, which suggests the economy will be far weaker next year than is generally expected.

After falling for years, Chinese export prices to the US have started to climb. The combination of rising inflation and the revaluation of the RMB against the dollar means that China in some sectors is losing its position as the world’s low-cost producer. Stratfor recently reported that the textile industry, which accounts for half of China’s trade surplus, is under stress and clamouring for the reintroduction of export subsidies. As a result of rising costs, Chinese containerboard companies recently stopped shipping their products abroad, according to Fischer International. Newspaper reports relate that some American companies are moving their manufacturing from China back to the US.

There’s little doubt that many ill-conceived projects have been financed during China’s investment boom….

An Austrian analysis suggests that the outlook for Chinese companies looks bleak. Profits are set to be crushed by a combination of weak export growth and rising input costs at a time when a record amount of new investment comes on stream. China’s “malinvestment crisis,” as Walker calls it, will not damage the country’s long-term prospect… It….makes a revaluation of the RMB less certain. As economist Andrew Hunt points out, the Chinese business cycle normally ends in devaluations, not revaluations, of the currency. Yet in April some $50bn of hot money entered China in the belief that a revaluation was a sure bet. It’s difficult to think of a better way for Beijing to punish noisome speculators than by frustrating such expectations.

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  1. Bob_in_MA

    One thing that’s puzzled me about forecasts for China (and India, et al.) is that they seem to discount the chance of a plain-old, straight-forward cyclical downturn. Just like the West encountered every few years for the last 200 years.

    Fast growth leads to increasing wages, over-investment and higher interest rates, which forces a slowdown and exposes areas with over-capacity, etc., etc.

    It’s just that the timing with a US/UK/Spain/Ireland asset bust is very unfortunate.

  2. Anonymous

    Old story worth watching:

    UPDATE 1-Fortis gets $630 mln from Russian billionaire – WSJ

    Belgian-Dutch financial services group Fortis received $630 million in capital from Russian billionaire Suleiman Kerimov as part of its recent share issue, the Wall Street Journal said, citing people familiar with the matter.

    Fortis, which last week raised 1.5 billion euros ($2.4 billion) from the heavily discounted share issue, secured the money from Kerimov’s Swiss-based investment vehicle, Millennium Group, as part of the share issue, the people told the newspaper.

  3. Anonymous

    Fortis agrees to sell ABN Amro ops to Deutsche BAnk for 709 million euros

    Under the terms of the deal with Deutsche Bank, ABN Amro will provide initial credit risk coverage for around 10 billion euros of Risk Weighted Assets (RWAs).

    The capital required for this coverage will be released over time.

    Fortis said the sale price represents a discount of about 300 million euros to the businesses’ net asset value, as previously indicated by Fortis last week when it announced its capital hike.

  4. Anonymous

    The dollar fell to a two-month low against the euro as a report showed U.S. companies shed more jobs last month than economists forecast, reducing bets that the Federal Reserve will increase borrowing costs next month.

    The U.S. currency also weakened as economists predicted that the European Central Bank will raise its main refinancing rate by a quarter-percentage point tomorrow while the U.S. Labor Department will say employers eliminated jobs in June for a sixth straight month. The Australian dollar approached a 25-year high as retail sales grew at the fastest pace in six months.

  5. Peripheral Visionary

    The post-Olympics problem is that China does not fully know what to do with itself following the Olympics. My suspicion is that it will fall back into old habits; with the limelight having moved on, we may see more of the insecurity, market manipulation, and heavy-handed authoritarianism that dominated China in the past. None of that bodes well for China’s economic prospects, even setting aside the specter of spiraling inflation.

    The one piece of good news is that the the race to the bottom on wages may have hit a global rock bottom. As wages in China increase sharply and wages in India follow close behind, there simply are no more major markets to tap out for cheap labor. The U.S. is still a long way from being competitive, but at the margin, on low labor products, its competitiveness will start to see some improvement.

  6. Anonymous

    This pre-Olympics/post-Olympics argument is naive at best. The stock market already falled more than 50%. The government already hiked the oil/energy price by 18%. A large number of companies have already moved and shut down. The tourism has already been hurt.

    So why do so many people obsess with this Olympics stuff? It is not a magical term that would change policies and realities overnight. It is just a sport event for God sake. There are plenty of businesses to take care of regardless the game. You got to be really foolish to assume that Beijing does not know this.

  7. Peripheral Visionary

    Anonymous, to the Chinese the Olympics is more than “just a sport event.” In speaking to a family member who lives in China and is in the thick of the Olympic frenzy, the Olympics has come to be an opportunity for the Chinese to address a deeply-held sense of insecurity regarding their global image. The Chinese have long felt that they have not received the attention and respect they are due, and the Olympics is seen as their opportunity to change that.

    The Olympics, for the Chinese, is HUGE. They have spent phenomenal amounts of money and time in preparing for it, but more than that, have literally shifted policies and even laws to adjust for it. The entire nation is waiting breathlessly for this one event.

    And just as their policies and focus have shifted in preparation for the Olympics, they will shift as the Olympics departs. The question, under discussion here, is what next? No one really knows, but the steady loss of their economic competitive edge, and the spectacular fall of their stock market, does not bode well.

  8. Anonymous

    Peripheral Visionary,

    As a Chinese myself I can assure you that I spoke to more Chinese people than you did. What you said probably was true at the beginning of 2008, but now lots of things have changed.

    People are pareparing for a difficult time now. By all means it is already there. I wonder why you still believe that the whole nation would have a high expectation on that game after the first 6 months in 2008. The people I spoke to, all ordinary people, almost all hoped that we should get over this game without fuss and focus on the day-to-day problem.

    It is weird to me that you ask “what next”? Government is there to govern and improve life. People are busy dealing with their own everyday businesses. Nobody as I know of are living just for a 3 weeks game. After game, life will continue. There are tons of problems to be solved.

    About China’s economic competitive edge, I personally would like to see some of this edge losing since the migrant workers could finally get some benefits out of it.

  9. Anonymous

    “Government is there to govern and improve life.”

    If you want the root of the problem, it’s right there in anon’s post, regarding China. The government is NOT there to improve life. The Chinese government has created a bubble of epic proportions over the last 10 years replete with massive malinvestment and corruption. This will in no way “improve life” for the average Chinese person 1-2 years from now.

  10. Independent Accountant

    About 25 years ago the WSJ had an article following the change in the Dow on a virtual minute-by-minute basis as Congress debated the Smoot-Hawley (SH) tariff. The SH tarriff disrupted world trade. This week it dawned on me what has brought the Chinese stock market down about 55% in the last eight months. In addition to exposing Austrian “malinvestments”, today’s SH tariff, high oil prices. Increases in transportation costs act like tariffs, the economic analysis is virtually identical. As transporation costs rise, the effect on export oriented economies like China will be greater than on other countries, like India. High oil prices are disrupting world trade patterns. The market sees more, faster than we usually do.

  11. Anonymous

    Anonymous said…
    “Government is there to govern and improve life.”

    If you want the root of the problem, it’s right there in anon’s post, regarding China. The government is NOT there to improve life. The Chinese government has created a bubble of epic proportions over the last 10 years replete with massive malinvestment and corruption. This will in no way “improve life” for the average Chinese person 1-2 years from now.

    July 2, 2008 8:53 PM

    Say whatever you want dude, but reality shows the opposite up to now. Well, we do not know what will happen in the future. That depends on our hard work.

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