Thoughts on the Chinese Export Puzzle

Investors are skeptical of Chinese economic data.  However, news yesterday that Chinese exports fell by a quarter in February was shocking. Many worry about the implications not just for China, but for world growth.  It comes as the IMF is signaling it will likely cut its 3.4% global growth forecast next month.

There are three separate forces that impacted Chinese trade figures.  First are price changes.  The dramatic drop in commodity prices, for example,  distorts the value of imports (and exports).  Chinese producer prices have been falling on a year-over-year basis for nearly four years.  Second, there actually is a slowdown in Chinese trade,  reflecting softer domestic demand and foreign demand.  However, the actual decline in trade was likely exaggerated by the Lunar New Year celebration.  Third, with the threat of additional yuan weakness, there appears to have been a revival of tactics of using trade invoicing to hide capital flows (now outflows).

Distortions caused by the Lunar New Year are well known.  In 2015, the Lunar New Year was in late February and the effect carried into March.  That suggests that investors will have a better idea of this year's distortion with next month's report.

Economists typically average January and February data to get a better picture.  Doing so this year shows a 17.8% decline in exports and a 16.7% decline in imports.  The export order components of official and Caixin PMIs warn of weakness.  Global demand is soft.  The decline in China's shipments to Taiwan fell for 13-months through February.  Exports to South Korea fell for the 14th month.

China reported exports to the US, Germany, France, Japan, Canada, ASEAN, and Hong Kong all fell by more than 20% in February.  But combining the January and February performance may offer some clarity.  For example, exports to the US fell 23% in February and almost 10% in January.  Combined exports to the US fell by around 16.5%.  Chinese exports to Japan fell 20% in February and 6% in January, averaging a 13% decline.

However, if trade invoices are being used to disguise capital outflows, averaging the January and February figures may not always be helpful.  Consider Chinese trade with Hong Kong.  We must again protest that this is called trade in the first place.  Hong Kong is part of China. To consider trade and capital flows between the two as international is misleading.

In any event, China reported that it imports from Hong Kong surged 108% in January and 88.7% in February.  This is suspicious, to say the least.  In January, Hong Kong reported exports to the mainland fell almost 8%.     The suspicion is that mainland businesses over-invoiced imports from Hong Kong to circumvent capital controls on moving funds offshore.

Hong Kong reports its February trade figures on March 29.  Investors will track this and other countries' trade figures to glean insight into China's trade figures.  Not that there is a one-to-one correspondence between Chinese trade figures and their partners, but the sharp fall in Chinese exports to the US could point to a smaller US trade deficit.

China's economy is slowing, and officials are responding.  The recent 50 bp cut in reserve requirements is estimated to free up around $100 bln for domestic banks.  The government has indicated that the budget deficit will rise this year to 3% of GDP from 2.3% in 2015.  This may not sound like a large deficit from the US or Europe's perspective, but it will be the largest national deficit for China since the late 1970s.  The PBOC increased in M2 growth target to 13% this year from the 12% target that it overshot last year.

China is contributing to the slowing of world trade.  In value terms, world trade shrank slightly last year, but in volume terms, it edged higher.  In recent years, the cross-border movement of goods and capital have not recovered to pre-crisis rates.  However, there are three mitigating factors.

First, this is partly a function of prices.  Imagine a simple two-country, one-product model.  Say the price of the product (oil) falls 50%. All else being equal the value of trade would be halved.  China's imports of crude oil reached a new record in February, and the volume of iron ore import rose 6.4%.

Second, many economists had argued that global imbalances were a threat to the world economy.  The weaker growth in trade volumes coincides with a general reduction of these imbalances.    On the other hand, slower growth may translate into weaker trade.  This suggests as growth improves so will trade.

Third, for numerous reasons, it is possible that we are also in the early days of a new form of globalization.  On top of the network of linkages for trade and capital, there has been a dramatic increase in a new type of cross-border movement--information.    Think about instant messages and emails across national frontiers, Skype calls Ebay/Amazon orders.  Imagine in the future, downloading a "blueprint" for a widget from a foreign website into your 3D printer.