Monday, 9 March 2009
China stimulus – Dreamworld
In this unfolding global crisis investors are being given yet another golden opportunity of a market and sectors to short or underweight. Underweight China equities and short stocks of commodity producers and infrastructure equipment companies. This is another false dawn in the mistaken belief that government’s can somehow overwhelm needed private sector consolidations.
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China stimulus – Dreamworld
Jim Walker
7 March 2009
If clutching at straws were a profession equity markets would have a doctorate in it. On Wednesday, China stock markets rallied by over 6%, commodity stocks bounced by up to 10% and global equities rallied with relief on the back of a report that China was going to announce another fanciful stimulus package. In the event, in his work report to the National People’s Congress Premier Wen Jiabao did nothing of the sort and basically reiterated that China would “significantly increase” investment in 2009. What he really meant was that it would significantly increase government investment in 2009 because the private sector will be cutting its plans in lock-step.
Let us pause and consider this first: Chinese economic data suck. That is not a criticism or an assertion; it is just a simple statement of fact. One of the main reasons that people can become so excited about the prospect of China’s government spending loads of money is that no-one can really get a handle on a) its ability to actually spend the money, b) what the amounts really mean in terms of stimulating the economy’s GDP components and c) whether or not government spending will come close to offsetting what is going on in the private sector.
Let us also be clear on three more things: 1) China does not produce National Accounts on the same basis as any other large economy in the world, 2) there is no way of checking China’s claimed growth against the various sub-components of GDP that are employed by economists in every other significant country, and 3) no-one even seems interested in assessing the ‘absorbability’ of the Chinese economy with respect to the numbers produced by the government.
Two more facts: first, China’s trade surplus in the last few months has soared to even greater heights from already unprecedentedly high levels during the boom years. That is indicative of an economy where domestic demand is slowing even faster than external demand. Secondly, Chinese companies in 2008 reported dramatically falling profits in an economy where nominal GDP growth reportedly grew 17% YoY. Isn’t investment supposed to be about returns i.e., earnings, not some abstract, unaccountable rate of economic growth? Please let us know if we are deluded in that belief. In fact, where China’s stimulus package and its domestic difficulties are concerned a willing suspension of disbelief seems to be de rigueur.
China stimulus 2 – The maths
The latest expenditure-based National Accounts for China are for 2007. There have been no quarterly reports issued for private and public consumption, private and public investment, inventories, exports of goods and services and imports of goods and services in the last twelve months. In fact, on a quarterly basis there NEVER have been official expenditure releases. In fact, even in the annual GDP report there is no breakdown of private and public investment and there are no gross numbers for exports and imports, merely a net figure. This makes forecasting, model building and assessment of GDP from the normal expenditure side, not to put too fine a point on it, impossible.
Also, China produces no expenditure-side data in real terms (unlike all other countries). So everything you see on consumption, investment etc, and all the growth rates derived from such, are in renminbi of the day. We don’t know what is inflation and what is real. Given that background, what can we infer about China’s stimulus plans? Assuming that expenditure-based GDP grew at the same speed as the industry-based data (no guarantees of that in China by the way), total nominal GDP in 2008 would have been Rmb30.8bn.
In his work speech, Wen Jiabao stated that total fiscal spending in 2009 was going to rise by 22% to Rmb7.6 trillion (bear in mind that that includes the so-called Rmb4 trillion stimulus programme yet fiscal spending is actually only going up Rmb1.4 trillion). Government’s share of the economy is therefore just shy of 25% based on 2008 GDP. The incremental increase of Rmb1.4 trillion, taken as a percentage of 2008 GDP, would amount to a 4.5% YoY increase in GDP. That is in line with Mr. Wen’s claim that the budget deficit will be no more than 3% of GDP in 2009, compared with near balance in 2008.
The problem though, is how that 4.5% increase in GDP from the government side is supposed to offset what is happening to private investment? In business cycle slowdowns private sector investment goes into reverse i.e., it contracts. (This is also a simple fact of economics and has been readily demonstrated in every economy in Asia over the last two quarters).
The question is, by how much will private investment reduce GDP? Because we have such poor information on the breakdown of Chinese economic statistics we cannot estimate the private sector investment share of GDP. Our guesstimate is that it is no less than 20% but is probably much more. Under normal cyclical circumstances a 20% growth rate (which is the minimum that most people claim for recent investment growth) will go to at least a 20% decline. That alone wipes out the full effect of the government’s planned stimulus. China’s overall growth rate for 2009 then comes down to what happens to private consumption and the net effect of the external sector.
The government has already said that 20 million workers have lost their jobs over the last year (although again, that is impossible to verify) and it is also the case that consumption growth – regardless of government policies – NEVER accelerates into an economic downturn. We therefore know that around 35% of GDP (the nominal share of private consumption in GDP in 2007) will be growing more slowly than last year but we do not know by how much (neither does the government by the way). If we assumed 10% growth – which would be a pretty remarkable result – then that would add 3.5 percentage points to GDP. Net exports could go either way depending on the relative strength of domestic versus external demand. At the moment the signs are that net exports would actually ADD to GDP growth because imports are collapsing so quickly – such is the weakness in GDP accounting ie, that a sign of demand collapse can add to GDP growth. But let’s assume that government spending does take place and the net export contribution stays at zero, even with the drop in Chinese exports. All of this adds up to NOMINAL GDP growth of around 3.5% of GDP based on realistic maths. Eight per cent real, the government’s forecast, is to dream the impossible dream.
China stimulus 3 – Input-output
More pedantically, what happened to the Rmb4 trillion ‘stimulus’ package that suddenly became Rmb1.6 trillion in Mr. Wen’s speech? The answer is that it is still there but much of it is now recognised as pipeline expenditure that was already budgeted to keep fiscal spending from falling relative to the previous year’s level. Remember, the Rmb7.6 trillion mentioned by Mr. Wen involves a 22% YoY increase in spending. This implies that government spending was Rmb6.2 trillion in 2008. A four trillion yuan increase in spending on top of Rmb6.2 trillion would have meant a 64% YoY increase in overall public spending.
We come back immediately to one of the questions raised above: absorbability. Would the Chinese government’s vast bureaucratic infrastructure – both national and local – have the ability to absorb such an increase in public spending in one year? Of course not. Li Zhaoxing, the NPC’s spokesman, admitted as much on Wednesday when he said that only Rmb30 billion of the Rmb100 billion stimulus amount allocated for 2008 has been disbursed.
Yet again the word ‘impossible’ pops into our mind when we consider the promised spending. In fact, a more appropriate word would be ‘absurd’. The people who bandy these numbers about as if they were gospel truth are simply not thinking straight. Unfortunately, that includes the economic leadership in Beijing. One aspect of China that seems to have escaped most western observers is that the trappings of communism are still very much alive. The political philosophy of communism values production above all else. Unfortunately, it makes no distinction between efficient (profitable) production and inefficient (unprofitable) production. That is why communist systems across the world have gone bust – including China’s early version – and ended up impoverishing their populations. However, the production mentality inherent in communist teaching manifests itself in the hierarchy of the Party.
In other words, engineers dominate. Deng Xiaoping worked as an engineer while in France (he ‘studied’ only Marxism-Leninism while there). Li Peng, Jiang Zemin, Zhu Rongji, Hu Jintao and Wen Jiabao – the last two generations of Chinese leaders – all have engineering degrees. Even Zhou Xiaochuan, the head of the PBoC and often described as an economist, studied at a college for chemical technology and then received a PhD in ‘economic systems engineering’. The engineering philosophy – and no offence meant to any readers from a similar background – is ‘add fuel, get fire’. In engineers’ eyes, economies are all about input and output. We are witnessing that philosophy being put to work in China now, regardless of its sustainability, efficiency or worth. It is a terribly flawed way to run a country as the history of the last ninety years has shown conclusively (capitalism has flaws but it has never systematically impoverished people in the way that socialism has).
In this unfolding global crisis investors are being given yet another golden opportunity of a market and sectors to short or underweight. Underweight China equities and short stocks of commodity producers and infrastructure equipment companies. This is another false dawn in the mistaken belief that government’s can somehow overwhelm needed private sector consolidations.
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