Where's ANDY "the expert on China" XIE????????????
Global: Wrong on the China Slowdown
[Roach capitulates on the China slowdown. Let the slowdown begin - Mish]
morganstanley.com
Stephen Roach (New York)
The long-awaited China slowdown has failed to materialize. There have been some brief periods of hesitation over the past year but nothing on the order of magnitude of the cyclical downshift I had been expecting (see my 23 May 2005 dispatch, “What if China Slows?”). This raises a key question for the global economy: Can anything temper the Teflon-like resilience of a rapidly growing Chinese economy?
The Chinese data have zigged to the upside at just about the time I thought they would zag to the downside. Almost all the major macro indicators in China were stronger than expected this past summer. That’s not only true of real GDP growth, which was just reported to have held at +9.4% y-o-y in 3Q05, but it’s also true of the September comparisons for industrial output (+16.5%), the broad money supply (+17.9%), and imports (+23.5%). Lest you dismiss China’s data as flawed -- a common Western bias -- there is corroborating evidence from outside the national statistical system that also points to a renewal of Chinese economic vigor. That’s the message to take from the recent acceleration of export growth elsewhere in Asia -- precisely the result that would be expected from a pan-regional China-centric supply chain that is reflecting a firming pace of the Chinese economy. Resilience in the Chinese economy is also corroborated by a recent turn in the commodity price cycle. After decelerating steadily since early 2004, the Journal of Commerce’s price index for industrial materials has turned back to the upside in the past few months -- reversing the modest declines in non-oil industrial commodity prices that were evident in the two middle quarters of 2005. Given China’ s increasingly dominant role as a consumer of strategic materials, the recent rebound in commodity prices could well be yet another verification of the underlying strength of the Chinese economy.
So where did I go wrong? When I first sounded the alarm on the China slowdown, I worried about two major sources of deceleration -- an internally-led downshift of fixed asset investment and an externally-driven slowing in exports. The investment slowdown was supposed to have been driven by official actions to contain China’s property bubble. The announcement of a major tightening campaign in early May seemed to fit this script to a tee. Property prices in Shanghai immediately softened and construction activity seemed set to slow with a lag. Well, the lags never kicked in -- at least, not yet. The real estate development piece of fixed asset investment continued to grow at a 22% y-o-y rate through the first nine months of this year -- little different from comparisons earlier in the year. I have discussed the construction outlook with some of China’s leading property developers, and they all speak of a likely softening in new building activity in coastal property markets. At the same time, they are quick to speak of the property they have just purchased and the new projects that are on the drawing boards. I have to concede that the case for an administratively directed slowdown in Chinese residential construction activity now seems like more of a stretch than it did last spring.
An equally significant piece of the Chinese investment puzzle lies in the explosive capital spending growth now occurring in the Chinese materials sector -- most likely a conscious effort on the part of the nation’s leadership to alleviate potentially serious bottlenecks in the domestic industrial production supply chain. That’s especially true of the Chinese energy complex. Investment growth in coal mining was up 77% in the first nine months of 2005 relative to the comparable period of 2004, and investment in domestic oil and gas extraction is up 31% over the same timeframe. China is very concerned over potential shortages of strategic materials and seems to be going flat out in order to lessen the blow of the energy shock of 2005 by ramping up on low-cost coal production. Not by coincidence, investment in rail transport -- the major distribution channel for a coal-intensive economy -- is up 41% over the first nine months of this year.
Notwithstanding China’s seemingly never-ending investment boom, the issue of sustainability is now an increasingly serious question. The latest GDP statistics raise a major warning flag in that regard: Fixed asset investment surged to an astonishing 54% of GDP in 3Q05 -- up fully six percentage points from the 48% share a year earlier. Such investment ratios are unheard of in the modern-day realm of economic development. Even in their heydays, investment ratios in Japan and Korea never climbed much above the low-40% channel. Yes, China has huge investment needs as dictated by the imperatives of urbanization, industrialization, de-bottlenecking in strategic materials, and infrastructure. But an investment ratio that is now in excess of 50% -- and still rising -- goes well beyond these fundamental imperatives. Ultimately, it is a recipe for both a misallocation of resources as well as for an overhang of excess supply -- both of which could well exert significant deflationary pressures on China and the broader global economy. But the key word in this indictment is “ultimately.” That could well imply a deceleration of investment at some distant point in time -- hardly the imminent adjustment that I was looking for.
My call for an export slowdown in China went equally astray. For 3Q05 as a whole, Chinese export growth averaged about 29% -- down only slightly from the 35% growth in 2003-04 but well above the 19% average growth over the 2001-03 period. I thought there would be two forces squeezing Chinese exports -- the first being a possible downshift of the US consumer. Inasmuch as the US is China’s biggest export market -- accounting for about 33% of all Chinese exports -- a capitulation by the American consumer would take a major toll on China, as well as on the rest of Asia’s China-centric supply chain. Alas, there was no such capitulation -- real US consumption growth has held at a 3.4% average annual rate in the first three quarters of this year. Little wonder Chinese export momentum remained intact. Externally-imposed trade friction was a second force that I thought would impede Chinese export growth. Tensions in the US-China bilateral relationship are especially noteworthy in this regard in light of strong support in the US Congress to impose stiff sanctions on a broad array of Chinese imports into the US. China has tried to address this issue by finally unveiling a new foreign exchange mechanism last July. But the failure of the Chinese leadership to allow much of an adjustment in the foreign exchange rate only serves to underscore the possibility that trade frictions and protectionism will have to be given a higher weight over the years to come. One way or another -- currency appreciation or trade sanctions -- external pressures on Chinese exports are still likely to intensify in the years ahead.
Here, as well, the issue is whether the call for a China export slowdown was simply early. Actually, I am more sympathetic to this excuse than I am for the mistake on the investment call. The reason: The energy-shocked American consumer now seems to be in imminent danger. Barring quick relief in energy product prices, US households will have to face an annualized energy tax that Dick Berner estimates at around $130-billion; moreover, consumers will have to cope with an energy shock with a “zero” personal saving rate -- a far cry from the 8% saving rate prevailing, on average, during the three previous energy crises. A significant cutback in discretionary consumption is inevitable, in my view -- a cutback that will, in turn, take a meaningful toll on China largest export market. This is a clear and present danger for China. It is also a big challenge for what is still a two-engine world economy -- the American consumer on the demand side and the Chinese producer on the supply side. The time-honored rhythm of the business cycle tells us that if the producer gets hit with a demand shortfall, a production adjustment is necessary to clean up the resulting inventory overhangs. That remains a distinct possibility for China in 2006, in my view.
The China boom is a sight to behold. As impressive as the data are, they don’t do justice to the true power of the Chinese growth miracle. But the laws of the business cycle have not been repealed. Nor has China been granted special dispensation from those laws. I was wrong to expect that the confluence of investment and export pressures would trigger a China slowdown in late 2005. That mistake tells me that there may be a good deal more near-term momentum to the economy than I had previously thought. But I would be wary of extrapolating this resilience indefinitely. Because of China’s excess dependence on the over-extended American consumer, the Chinese export outlook faces far more immediate risks than those which eventually might come to pass on the investment side of the equation. Even so, the mounting overhang on China’s supply side -- underscored by an aggregate investment share that has now hit an astonishing 54% of GDP -- is increasingly worrisome. It’s mea culpa for now, but I still feel there could be a serious test to an unbalanced Chinese economy in 2006. |
