Saturday, January 30, 2010


Asian stock markets finished January in a falling streak worst since last March. This is partly due to US rebound and rising dollar, but also fundamental disbelief in China's hard to believe economy that claims to be overtaking the size of Japan to become World #2 - is it an economy bubbling fit to burst? There is reason to believe China's economy is only half the size it claims, no bigger than say California or Italy?
The waning investor appetite since equities hit 15-month peaks 10 days ago is most obvious in Asia-Pacific stock markets. Jitters about the impact of monetary tightening in China that expose then burst its own fragilities never mind the fragile global economy is debated from New York to Tokyo and reflected in investment bank notes.
A report from Reuters shows mutual funds in China share those concerns.‘Risk Aversion Trade’ (RAT) that feasts off sovereign debt woes, e.g. Greece or Ireland; the approaching unwinding of stimuli (government exiting the banks) in the US, UK and EU; plus concern that financial assets remain badly priced, again overpriced, and growing if reluctant respect for good-old-fashioned economic analysis, encourage bubble-talk such as is Chinese property running of a cliff and maybe a year or two down the track is EU still heading for its real recession? China's fund managers appear to be cutting real estate stock weightings by a third.
The dollar’s days as the symbol of risk aversion are over. Yesterday it rallied to a 6-month high. The Anglo-Saxon economies are determined to deliver positive news e.g. UK out of recession and US fourth-quarter GDP rising faster-than-predicted 5.7 per cent, which in its wake will pull UK out of its morass. Volatility continues however as trader jockey to keep their jobs and focus on shorter-run profit plays.
Let's look at China's GDP - is it believable?
The economic success of China dominates its image in the world. Stats reports are perceived to be critically important, major (even dominant) factors in maintaining growth. But, official statistics about China’s economy do not make sense for many reasons. It is realistic to place more confidence in India’s official statistics. It is compelling to conclude that China’s statistics are political window-dressing – propaganda- driven to maintain an image that is deemed vital to its continued growth, but resulting in the economy being measured to be approximately twice its actual size.
When average wages are about $200 per month per person in labour force (800+ million labour force and probably really only 90% in work) while national income is $300 per month per capita (for whole 1300 million population)! The misalignment is not explained by trade surplus, net foreign investment inflow (inflow worth $50 per worker per month, $20 net) – but by over 40% of GDP explained as annual new infrastructure investment (fixed capital investment i.e. construction & machinery investment in a ratio of 1 to 4, without depreciation calculations) that is $150 per worker per month. Household spending is $180 per worker, or 35% ratio to GDP compared to 70% in developed economies. The likelihood is that assets growth values of fixed capital investment between project start and finish are being somehow included in GDP!
In 1985 to 2000 fixed capital investment was 30-36% ratio to GDP, half a high again as ever was in Japan (peaking in a construction and property bubble that burst in 1990) or Germany except in immediate post-war years. When the property bubble bursts in China its economy will deflate greatly and the banks all become technically busted as happened in the 90s! Chinese GDP components, which might look reasonable at first blush. But, subtracting investment, net exports, and government spending from GDP, we arrive at sum of consumption spending plus inventory investment, represented by a steeply falling curve than dived in ‘05, even if officially not shown until '07, and can't remotely be explained by inventories. The implausible behaviour is clearer when plotted as growth rates. In '05 for example citizens spent 17% less on daily necessities and luxuries than the previous year, but not what other official statistics say - that retail spending for the year was 14% higher than the previous year, alone double the remainder calculated for all personal consumer spending.
It is impossible to calculate China’s true GDP without independent access to growth statistics across the entire country. All regions report higher growth when that is most unlikely. In OECD countries growth is never evenly spread and they have policies to transfer income from rich to poor regions that China lacks. In OECD countries it takes 2 years of hindsight to make GDP figures accurate. In 2002, I recall the senior economist for HSBC writing: "We suspect that certain local officials may have seriously overstated fixed-asset investment in their areas to boost their political credibility. Analysts can still reach useful conclusions by focusing on trends rather than exact amounts in the official figures. Sometimes, however, the problem can exceed itself.”
Energy consumption and other physical indicators do not support the reported growth of national income and some countries dispute the trade data. Note: GNP is essentially wages + net profits + trade balance, also explained separately as consumption spending + savings + new investment. If the two sides do not add up as they should – is the balance achieved by inflating capital investment as a residual estimate? It is impossible to maintain Chinese wages at low levels to compete with India and other much poorer Asian economies and at the same time expect to become the world’s second largest national economy, to seek a status as globally wealthy when the people remain domestically poor?
Bank loans have grown by 15% and then last year 30% with a fiscal stimulus to force growth but when inflation has been reported for years as very low or negative, including currently negative, despite years of 20-35% money supply growth. In much of 2009, 2% consumer price deflation and 6% producer prices deflation – to push excess output into exports to a now unwilling importing world i.e. via massively subsidized exports. Bank lending (business debts and redit supported property asset values) must now be unserviceable by borrowers – unsustainable and heading for collapse, hence the recent decision to radically rein in lending by a third, which will not put the cat back in the bag, but trigger borrower defaults sooner than later! The State Statistical Bureau takes only 15 days to survey the economic progress of 1.3 billion people. Revisions are a farce: No growth figure was ever been revised down, and upward revisions are incomplete to the point of uselessness. At best, earlier activity is measured; at worst, results are manufactured to suit the propaganda. The aim is to be able to announce that the economy has overtaken the size of Japan’s economy (when in reality it is probably not yet bigger than France, Italy or California) or about 4-5 times the size of the USA trade deficit.
In mid-2009 the main engine for growth, again, was fixed investment, rising by one-third or twice the speed of retail sales, and equivalent to a staggering 65% ratio to GDP, an unprecedented figure for an economy that is supposed to have a significant market element and a figure that cannot be reconciled with a transition to the market. Either investment recedes or the market does.
For China’s economy to be producing $4.9 trillion and growing at 9%, China must be an economy worth 25 Hong Kongs and building equivalent of two new complete Hong Kongs every year. HK’s population is 0.5% of China’s but HK has 12 times higher average incomes – just under the level of Japan and USA. Japan’s exports are $5,500 per capita, HK’s $25,000 and China’s $1,000 (or 62% of all employment wages, which is a measure of how exposed the economy is to trade – worth 25% ratio to GDP!)
India’s data is more convincing. Exports are high at 14% ratio to GDP (proportionately twice that of USA, which has high imports at 10% ratio to GDP).
Beijing's response to the crisis is to intensify pre-crisis policies instead of recognizing that it must restructure the economy – change its business model – to deepen and broaden the economy internally and relay far less on trade and export-dependent capital investment and allow wages to rise, enforce 40 hour week and encourage domestic consumer spending, even to the extent of several years, perhaps 1-2 decades falling trade surplus turning into trade deficits, which its currency reserves can well afford. The damage caused by a global demand bubble inflated by overly loose American money has been talked up by the media as something to be healed by help of Chinese production and asset bubbles inflated by overly loose Chinese money. Brookings Institute in USA went further to look forward positively to the OECD world being dragged into higher growth by poor countries (Third World as was) falling into large trade deficits to be paid for by increases in ‘western’ aid.
But China appears to have decided to put off restructuring into some indefinite future when the external situation is better, whatever that means? Of course, at that ‘better’ time, the economy will appear yet again to be firing on all cylinders (except workers’ wages) and reform will--again--be dismissed/postponed. This is the same mentality that led the banks into the credit crunch.
Keeping one's eyes pinned to current GDP growth shows an improving Chinese economy. A realistic view shows a credit boom economy (but not for the mass of the citizenry) that is unsustainable, trying to drag itself and the rest of the world back along the trail that led to the current economic crisis and heading for a steep fall into a hole of its own digging.

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