China’s economy has drawn a lot of attention recently. The following article in Bloomberg was forwarded to me when it was published:
This article -and almost all of the economic ‘news’ regarding China- misses 3 crucial points.
1.) Quoting GDP Statistics
The Bloomberg article linked above begins as follows:
Once again, the world’s investors are turning their worried gaze toward China. And for good reason. Economic growth in the third quarter sank to 6.5 percent, the slowest pace since the depths of the global financial crisis in 2009.
Quoting Chinese GDP growth is confused at best and disingenuous at worst. In China GDP is an input, not an output. The Chinese government sets economic growth rates before the year starts. From Reuters regarding 2019 GDP targets (emphasis mine):
The proposed target, to be unveiled at the annual parliamentary session in March, was endorsed by top leaders at the annual closed-door Central Economic Work Conference in mid-December…
In order to achieve this growth, the Party manufacturers high rates of investment so that total economic output at the end of the year equals goals set before the year begins. In other countries, GDP is-roughly- calculated by measuring economic output in a given year. In China, GDP is set before the year begins and economic activity is conducted until output equals the set goal. To say that Chinese GDP sank to 6.5% is wrong. Chinese GDP was ordered to 6.5%. The number itself says very little about actual growth in China.
As a thought experiment, consider what would happen to US GDP if the city of Chicago was recreated on the opposite side of Lake Michigan. Initially, the US would see a large spike in GDP as concrete, steel, and labor outputs increase to build the new city. These assets wouldn’t be value-creating, and they would eventually be recognized as wasteful and non-productive. This is what happens in China. To achieve growth targets set at the start of the year, the Party manufactures SOE growth and state planned lending to provide artificial growth to GDP.
GDP slowdowns simply mean that the government has set more modest targets, fewer recreated-Chicagos.
2.) State Advance and Private Sector Retreat
If GDP is artificially stimulated, how do we measure what is wasteful and nonproductive? How do we differentiate recreated-Chicago versus real economic growth? We can measure state growth relative to private sector growth. Consider the following two charts:
I highlight investment because it is the most important driver of Chinese growth. From Goldman Sachs:
China’s debt buildup since the global financial crisis has been one of the largest in modern history, with total debt-to-GDP rising to an estimated of 317 per cent at the end of 2017 (or 282 per cent if we exclude financial sector debts, compared with 158 per cent at the end of 2008).
And from the Financial Times:
The debt, equivalent to 260 per cent of gross domestic product, has brought with it dramatic declines in credit efficiency. The International Monetary Fund points out that in 2016 it took four units of credit to raise GDP by one unit. A decade ago the ratio was 1.3 to one.
The Party is increasingly driving growth, but that growth is increasingly inefficient.
Amazing that state ROI is so stable when private sector returns are reducing.
3.) The Music Isn’t Planned to Stop
When does this all come to ahead? When is the crisis? Is it imminent?
No one knows.
China is continuing its state-planned, debt fueled model, and eventually that will have to stop. However, it is impossible to say when that stop will occur. I currently keep my eye on two things.
First, where does M1 growth go from here? Can China manufacture more fiscal growth in the face of increasingly inefficient lending?
Second, is China rebalancing from state planned growth to private sector growth? Is the Chinese private economy still shackled?
For this question, I highly recommend you read China Dashboard. They write:
China’s private sector is shrinking for the first time in two decades – an extraordinary development contrary to the hopes seeded by the 2013 economic reform objectives and decades of talk about withdrawing the state from the marketplace.
Credit growth, debt, economic reform. This is the story that matters regarding Chinese economic activity.
Blue sky today.
Cool, right?
Discussions at Tsinghua taught me that gross capital account flows matter. They matter a lot. In 2007-2008 Europe’s banks were at least if not more dangerous than their American counterparts. They straddled three giant credit bubbles: in the US, in the hot spots of the Eurozone, and in Eastern Europe. Their leverage was enormous, their capital laughably thin, and unlike their US counterparts they had considerable currency mismatch on their balance sheets. They needed to raise dollars to hold huge portfolios of America subprime. Their primary home funding sources were in European currencies.
Writing in Grey 