Short thoughts regarding the trade war today. In short, don’t attribute too much to tariffs yet, and most evidence (see below) shows potential economic weakness in China is self-made.
1.) I highly recommend the following reading from the South China Morning Post: Slowing manufacturing and Beijing’s response to said slowing. The articles contend that Chinese manufacturing, particularly small and medium sized enterprises (SMEs), is seeing reduced output due to the trade war.
2.) Yes but, the trade deficit has been high in 2018; a five month high was reached in July. Newest data for September has the US deficit with China at its largest amount ever.
Are the tariffs already showing results by squeezing manufacturing profits? Is July’s trade deficit a thing of the past?
3.) Maybe, but there are a few things worth noting that make me skeptical. As an aside, I constantly refer to credit growth in different sectors, because credit growth drives China.
- 3a.) SMEs have long had financing problems, and these firms aren’t taking on new loans. In the first half of this year, new loans for micro and small businesses made up mere 20.9 per cent of new corporate loans, the lowest rate since the data was first published in 2012.
- 3b.) Private enterprises in China have been slowing for years now. Recent data fits a larger trend in which SOEs are growing/consolidating at the expense of private industry. See graphs below:
- 3c.) There are still more than 150,000 SOEs in China.
- 3d.) Two-thirds are owned by local governments.
- 3e.) These state owned enterprises eat about half of all bank loans though they represent less than one-fifth of the economy.
4.) Chinese credit growth is still growing faster than GDP, and how it grows matters. I sincerely encourage you read Christopher Balding‘s most recent post in which he describes how shadow banking, which largely finances SMEs, has reduced while traditional bank loans have grown. Seriously, it is a little long, but Balding’s piece is excellent.
5.) In summary, China’s economy is still state led, and it is impossible to discern if current SME manufacturing woes are a result of the trade war or a continuation of a trend line we have observed for more than a decade.
6.) 1st Quarter Chinese economic activity is always low due to Chinese holidays. Further tariffs might come to fruition in February of 2019. I don’t think we will have a meaningful data set for the tariff effects until this time next year at best.
Clear sky today.
I love Macro Polo. I read it regularly and urge anyone with a passing interest in China to give it a browse. I also love Macro Polo’s most recent post about bikes in China. The love I have for the post is deep, because in the recesses of my heart exists a counterweight of hate for bicycles in Beijing. The almost romantic whirl of millions of wheel spokes captures many visitor’s hearts. The cursing of average commuters funneled into artificially narrow sidewalks induces PTSD for others.
I loved my bike in China. I loved that the back brakes didn’t work. I loved joining a throng of pedestrians and motorists with one governing rule: there are no rules. The secret to appreciating a foreign culture is to live as they do: eat their food, speak their language, and hurl concise insults at motorists you play chicken with. My bike wasn’t just a way to drastically shorten my commute (leave it locked near your subway exit of choice), it was a quintessential manifestation of modern China, good and bad.
I have roughly 4,000 pictures of my time in Asia. One of the first folders I created is simply titled ‘bikes.’ These are my favorites.
Shared bikes in Beijing’s CBD clog sidewalks. Rush hour pedestrian traffic is greatly constrained due to this.
Users can pay more for ‘cooler’ bikes. Note the width of the tires in the second photo.
Bikes can be found everywhere due to an army of shirtless men that deposit bikes (bikes are equipped with GPS) in high traffic areas.
Bikes can be found in crosswalks. Note the couple struggling to make their way across.
Bikes can be found in rivers.
Bikes can be found in piles.
Most importantly, bikes can be found clogging sidewalks.
There are many types of bikes. Pictured above are university bikes (清华大学).
Bikes pulled by dogs.
Really unwanted bikes.
In France in the 1880s, the cheapest model of bicycle listed in catalogs and sales brochures cost the equivalent of six months of the average worker’s wage. And this was a relatively rudimentary bicycle, “which had wheels covered with just a strip of solid rubber and only one brake that pressed directly against the front rim.” Technological progress made it possible to reduce the price to one month’s wage by 1910. Progress continued, and by the 1960s one could buy a quality bicycle inFrance for less than a week’s average wage. One can use bikes in France to see how purchasing power rose by a factor of 40 between 1890 and 1970. Transportation, whether by Toyota or trike, matters.
Thanks for reading.
A crucial aspect of ‘socialism with Chinese characteristics’ is the absence of risk in key assets, namely real estate. As I have previously written, Chinese policy to increase household wealth revolves around strategic asset inflation. There is an explicit idea in Chinese society that certain asset classes cannot lose value and value must always increase.
The Chinese stock market is one such asset class. This article explains how, in 2015, China set a floor for its stock market by ordering brokers to not sell below 4,500 points. The stock market was to fall no lower. It worked. Life moves on. Asset inflation continues.
In Beijing, homes that went for an average of around 4,000 yuan (US$580) per square metre in 2003 are now above 60,000 yuan (US$8,600) a square metre, according to property price data provider creprice.cn
The key questions should then be:
1.) Can this go on forever?
2.) What happens when it stops?
Luckily there is some insight. People have been protesting drops in real estate prices for years. Here is a good article from the SCMP on the matter. Here is what a real estate protest looks like (it is really worth watching).
Something that foreign pundits regularly misunderstand about China is the amount of protests that happen. They do happen and are often allowed to happen. For example, here is a good video of recent veteran protests. However, it is worth watching how the expectation of constant growth interacts with a slowing -healthy or otherwise- Chinese economy.
In this 7 minute YouTube video, US Trade Representative Robert Lighthizer is unable to answer Senator John Kennedy’s question. Kennedy asks why a current account deficit is bad for America if the dollars are later recycled to fund investment in America. The key question from Senator Kennedy is as follows:
If we are running a negative in our current account, our financial account has got to be positive, right? Which means that those dollars are coming back to the United States and they’re being invested.
Mr. Lighthizer should have said that Senator Kennedy’s example is assuming that foreign investment is productive and has no ill effect on the US economy. If capital in America was scarce, foreign funds could fund the gap between domestic investment needs and low domestic savings. The problem here is that America has the deepest, most liquid, open capital markets in the world. American banks are industry leaders and capable of funding America’s investment needs. If America’s domestic financing needs are met by American financial institutions, what are the effects of America’s consistent capital account surplus?
1.) Excess capital could find its way into asset bubbles. Asset bubbles in real estate, particularly regarding Chinese investment, have become normal. Speculative flows of money into assets can make households feel richer. For example, if you perceive the value of your house as increasing due to living in an asset bubble, you may be more willing to spend more or take on additional debt. Lastly, if American firms lessen their investment or productive investments are funded by foreign capital, America is outsourcing its capital allocation mechanisms to foreigner institutions. This could have great ramifications for a country if the foreign institution is run by communists, building military islands in the South China Sea, or responsible for the slavery of its ethnic citizens. Becoming a part of the capital allocation mechanism may also let a foreign institution interrupt democratic debate, because those who benefit or have the best relationship with said institution may be unwilling to abandon their patron.
2.) Good FDI, fairly logically, means that a foreign entity has industry knowledge or practices that make them competitive in a domestic market. A win-win is created by the foreign entity being competitive in a large market and the foreign market learning new knowledge/practice. Why would a developing country so regularly invest in a developed country considering the developing country is much less likely to have best practices?
I think there are a few reasons that Robert Lighthizer didn’t give Senator Kennedy a satisfactory answer. However, if he did give him an answer in which he stated that America’s problem isn’t its trade account but its open capital account, he would have to admit that tariffs won’t fix the problem and his administration is failing.