China's latest economic data cast further doubt on the sustainability of its growth model...
HOW LONG is a piece of string? asks Dan Denning in the Daily Reckoning Australia.
It's as long as the Chinese government says it is!
We wonder whether statistics or prices can be trusted any longer. As a reminder of what's at stake in this great debate about the veracity of China's economic data figures and the viability of its growth model, there's this from the Chanticleer column in this weekend's Australian Financial Review:
'The slowest rate of economic growth in China since the global financial crisis is not a reason to panic but investors ought to be dusting off scenarios that involve a hard landing.
'It is better to have at least thought about the implications of a worst-case scenario rather than be taken by surprise when markets react to lower Chinese demand for Australian commodities...
'The majority of Australians in default superannuation funds will have a high exposure to resources and will be vulnerable to a China slowdown. In fact, those with a typical default fund should brace themselves for negative super returns for the year to June 2012 of between 5 and 7 per cent simply because of their exposure to companies such as BHP Billiton and Rio Tinto.'
We can't argue with any of that. The next ten years are not going to look anything like the last ten years for Aussie investors. And the next ten months may be a lot riskier than anyone expects.
But first, the data! After much wailing and gnashing of teeth, the second quarter Chinese GDP figures turned out to be about what everyone expected...below par, but not a calamity. The numbers showed Q2 GDP growth of 7.6%. That was down from Q1 at 8.1% and the slowest rate since 2009. But it was still 7.6%, which is higher than 2-3% and a lot higher than zero.
There was a palpable sense of relief on financial markets, and Aussie stocks ended higher on Friday after the Chinese numbers came out. Europe is mired in a perma-crisis. This showed up in the fact that the US surpassed Europe as China's largest trading partner in the second quarter. With that slowdown baked into the second half of 2012's cake, markets need a 'pro-growth' narrative to keep investors all in.
The trouble is China's economic data figures are...troubling. Can they be trusted? Truthfully, no government statistics should ever be trusted. We don't say this because we think there is intentional deception by government all the time. Sometimes it's just unintentional stupidity. There is also another explanation, which we'll get to in a second.
The first troubling aspect of China's economic data statistics is that they've come out less than two weeks after the end of the second quarter. Compiling GDP figures for the world's second largest economy is either a fearsome feat of command-economy-efficiency, or a highly suspect sign that the statistics may be more 'aspirational' than 'informational'.
Come to think of it, 'aspirational' is probably the right word. Full employment is the political imperative that trumps profits in China. Growth is the necessary by-product of a political goal. This leads to troubling investment decisions.
For example, the Q2 data show that Chinese electricity output was flat in June. Yet industrial production grew at 9.5%. Ask yourself, dear reader, how factories can crank out more products while using less energy. Is it the power of positive thinking? Or of concentrated rainbow serum and powdered unicorn horns?
Maybe it's more energy efficient production. That's what the spokesman of China's National Bureau of Statistics said. Sheng Laiyun told reporters, 'Everywhere in China is extremely focused on cutting energy use and cutting emissions, and focused on technological innovation...So there was great progress in the first half of the year in cutting energy consumption. The amount of energy consumed per unit of GDP decreased.'
That's certainly a plausible explanation for an economy more oriented toward consumption-led growth. Mature industrial economies generate and distribute electricity more efficiently. And GDP is driven more by retail sales and consumption than industrial production. This is the case in Australia and the United States. But has it suddenly become the case in China in just six short months?
Well, the Bureau reported that consumption's share of GDP was up 57.7% in the first half of this year compared to 47.5% in the first half of last year. Investment, meanwhile, went from 53.2% of GDP in the first six months of last year to 49.4% in the first half of this year. So yes, there is a hint of structural change in the composition of China's GDP growth.
This is dangerous territory, though. A little consumer-led growth is okay. A lot, and you get the same food, fuel, and property inflation that followed the $586 billion stimulus plan in 2009. That plan was to inject money into the economy through fixed asset investment in construction and infrastructure projects.
That plan certainly saved Australia's bacon at the time. It led to a reversal in a declining terms of trade and in weaker coal and iron ore prices. But here's the question: how sustainable is an economy that allocates capital based on a political (and profitless) economic imperative?
Fixed asset investment (bridges, roads etc) was up by 20.4% in the first half of the year. Bank lending increased by $144 billion in the month of June. Both are signs that the government is geared up to goose the Chinese economy by accelerating approval of more investment projects. What will those projects produce?
If the past is prologue, you can expect more steel production. China's central planning agency, the National Development and Reform Commission (NDRC) announced $35 billion in new projects in late May. Baosteel Group and Wuhan Iron and Steel Group were the big winners. Both got approval for a combined $22.75 billion in capacity expansion.
Does China need even more steel producing capacity? It already produces some 700 million tonnes of steel per year. That's more than Europe, the US, Japan, and Korea — combined. Bloomberg reports that the new steel plants will deliver steel to Japanese car makers with factories in southern China.
There are two ways to look at all of this. One way is that China is investing in its economy's future. Nations need transportation infrastructure to conduct internal and external commerce. China has only relatively recently embarked on its industrial journey. Perhaps this is the investment required at the right time.
Yet five years ago, Premier Wen Jiabao said China's growth model — heavily reliant on fixed asset investment and exports — was 'increasingly unstable, unbalanced, uncoordinated and ultimately unsustainable.' That was five years ago. Since then, the state-controlled banking system has funneled even more captive savings into state-controlled enterprises.
No sensible person would doubt that an economy needs bridges, roads, factories and steel. A sensible investor would question whether Chinese central planners are better at allocating capital than markets. But then again, there are no free markets anymore.
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