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Assessing China’s Economic Risks

First quarter GDP in China rose 6.9%, better than expected and above the government’s target (6.5%) for 2017. It stands to reason, however, that if Communist officials thought they could get 6.9% to last for the whole year they would have made it their target, especially since 6.5% would be less than the GDP growth rate for 2016 (6.7%). In only that one way is China’s GDP statistic meaningful. Due to unanswered questions about its accuracy, it barely rates any mention at all.

The problems with China GDP appear to be spreading to other statistics, particularly Industrial Production. IP had been almost perfectly stable exhibiting, like GDP, very little variation. Prior to this latest update, it was steady between 6% and 6.3% for eleven months in a row, and going back to the start of 2015 only twice did it vary so much on the high side (6.8% in both June 2015 and March 2016). It seems quite reasonable that given global conditions particularly for manufacturing and then the trade of goods during that period China was overstating its industrial production to like GDP make a bad situation appear to be at least somewhat more balanced than it might have been (to be clear, this is speculation on my part as there is no evidence there is any directive for IP).

China Industrial Production 2009-2017

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China Industrial Production 2009-2017

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Therefore, the IP figure for March 2017 of 7.6% clearly stands out not just for being the highest growth rate since January 2015 but because it seems to relate to other statistics like export growth. Judging by Chinese exports, industrial production by early 2016 might have been as low as 3%, perhaps even 2%. The acceleration in the IP rate for March 2017 is then the correlation to exports which in Q1 2017 were positive for the first time (on a quarterly basis) in several years.

Chinese Industry 2010-2017

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Chinese Industry 2010-2017

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As I wrote last month:

The rest of China’s statistics propose the same assumptions. Industrial production at 6.3% is no different at all than the level of growth it has been for two years now. The noticeable lack of volatility in the changes month-to-month continues to suggest (louder) less reliability, perhaps, than might be hoped for (like China’s GDP estimates). If there were actually some appreciable acceleration in Chinese industry we would expect to see it here, meaning that it is very likely only the downside that might be obscured by an almost perfect and increasingly likely artificial sideways trend.

Sure enough, as exports turn positive IP might have been “allowed” to at last turn upward with them. The problem, then, is if export growth isn’t actually sustained beyond base effects or the temporary basis for sentiment or whatever else. As above-target GDP, in all likelihood this burst of activity will prove to be an aberration. That was the case the last time Chinese IP was above 6.5%, in March 2016, when in the same month Chinese exports suddenly grew by 11.2% rather than contract as in all the other months around that time.

The rest of the Big 3 economic statistics were more of the same. Retail sales grew by 10.9% in March after rising by just 9.5% in the combined January-February period. That only sounds like appreciable improvement because the latter estimate was the lowest in well over a decade. Instead 10.9% is right about average for retail sales going back to the last slowdown in the summer of 2014.

China Retail Sales 1999-2017

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China Retail Sales 1999-2017

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The government continues to “stimulate” through the capital expenditures of State-owned Enterprises. Though nowhere near as heavy as the beginning of 2016, FAI through this official channel continues to grow at a double digit percentage rate. The accumulated growth rate was 13.6% for SOE’s for the first three months of 2017, and 13% year-over-year in March. Private FAI ticked up to 7.7% on an accumulated basis, 8.6% year-over-year.

Total FAI was 9.2% on an accumulated basis, meaning vital productive investment has increased by less than 10% for the past 11 months. For all the “stimulus” of last year and what might be continued this year, fixed asset investment remains subdued, including the clear improvement in private sector activity. Three years ago, at the outset of the “rising dollar”, FAI overall was growing by 17% with 20% growth on the private side – and those rates were down already quite significantly from the year before which was nearer the well-established historical baseline. The accumulated growth rate for 2017 so far is actually less than in first three months of 2016.

From a more optimistic perspective, it would seem that China’s economy has weathered the storm of the “rising dollar” and at least stabilized without more immediate downside danger. The textbook, orthodox approach attributes that position to the success of “stimulus” both monetary and fiscal.

China Fixed Asset Investment

China Fixed Asset Investment

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A “dollar” perspective might differently look at these same statistics and suspect nothing more than a repeat of 2013-14, only at a lower landing. With global monetary decay in a pause so to speak, China’s economy was like the global economy afforded a reprieve from further erosion and/or attrition which is not at all the same as resurrected growth prospects. I wrote earlier today (subscription required) from that orientation:

If markets seem uninspired by 6.9% Chinese GDP rather than 6.6% or 6.5%, that is because there is no real difference between them. Even industrial production at more than 7% for the first time in a while isn’t actually indicative of much. For one, US economic statistics continue to be somewhere between concerning and abysmal even after spending last year at just the latter. If the last decade has proved anything it is that China’s ascent to a primary global growth factor was more myth than reality.

Indeed, that much is true for all the EM’s who at least after 2012 were supposed to run away from the DM “new normal” – but couldn’t. There may be variations of intensity and geography from time to time, overall, though, this is and remains a globally synchronized trend. The best the Chinese might achieve is a better relative position based on that country’s idiosyncrasies; no matter what, though, they are still subject to the same baseline depravation as everyone else, meaning that it is likely only a matter of time before the next demonstration.

That was certainly the case several other times over the past several years. Chinese industrial production slowed to 8.9% growth in August 2012, for example, only to then accelerate as far as 10.3% at the end of that year and still it meant little or nothing for China (or the global economy) overall (and it was also attributed to the “success” of “stimulus”). Chinese IP at 7.6% only seems to be a step forward because the 10% growth of 2012-13 seems like so long ago, and the 15% growth of 2011 and before an entirely different world. Thus, the only way 7.6% growth in IP can actually indicate something meaningfully positive is if it is but the first step in that direction, a trend for acceleration that becomes durable and sustainable. Given the rest of China’s economic statistics that still fail to show symmetry, including how IP might have been artificially held up for almost two years, it seems unlikely that is the case.

Eurodollar Futures June 2020

Eurodollar Futures June 2020

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Full story here
Jeffrey P. Snider
Jeffrey P. Snider is the head of Global Investment Research of Alhambra Investment Partners (AIP). Jeffrey was 12 years at Atlantic Capital Management where he anticipated the financial crisis with critical research. His company is a global investment adviser, hence potential Swiss clients should not hesitate to contact AIP
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