Tuesday, December 9, 2008

Yuan Watch : Negative feedback loop

My comments last Sunday:

'Over the next two quarters, China will probably suffer a contraction. How China Inc. will report the numbers is anyone's guess but putting 'lipstick on a pig' with chinese characteristics will only go so far. The economic stimulus announced will not be able to take effect fast enough to offset the accelerated decline in both the export markets and the domestic real estate markets. China has a 'political risk' in the absence of a social convenant that will translate into a depreciation premium, be it through export tax rebates or a slight currency devaluation as they hunt madly for lipstick.

In short China is, much like America a century ago, in a boom and bust cycle, with the latter ocurring now. Given the Yin-Yang relationship between China and the United States, we will export deflation with our increasing unemployment and decreasing GDP and they will export their bust back to the West in the form of further commodity declines.'

Michael Pettis' comments this morning:
Here is what Bloomberg said in its article today on Fan Gang’s comments:

China’s exports shrank last month and industrial-production growth cooled, Fan Gang, an adviser to the People’s Bank of China, said today. “Things are not so good,” Fan said at a forum in Beijing. “November figures will come out soon, and industrial growth will be something around 5 percent and export growth will be negative.”

A collapse from October’s 19.2 percent export growth would add pressure on policy makers meeting in Beijing this week to do more to sustain the expansion of the world’s fourth-biggest economy. The government has already unveiled a 4 trillion yuan ($582 billion) stimulus package and cut interest rates by the most in 11 years as a global recession cuts demand for the nation’s toys, textiles and electronics."

To give a sense of how shocking an actual contraction in exports would be, two hours ago I met with a group of very knowledgeable China-research economists. I told them about the rumors of a contraction and asked for their opinion, and they said that although they definitely expected export growth to continue slowing, they would be really surprised and worried if it actually were negative. A contraction in exports year on year will suggest that the impact of the global slowdown on China is happening far more quickly than anyone expected.

My simple global balance of payments model should suggest, however, that we should have expected a rapid slowdown. After all if Chinese overproduction is the flip side of US overconsumption, and each requires the other, then the astonishing rate at which consumption is contracting in the US should have, as its counterpart, an equally rapid contraction of production or, failing that, a rapid buildup of inventory. Either of these will come as a result of declining sales. There is no point trying to predict Chinese economic numbers independently from US economic numbers. The world imbalance has been built around US overconsumption and Chinese overproduction, and one cannot change with a corresponding change in the other.

This is the negative feedback loop we should fear (posted by me last Sunday): It is estimated that for every 1 percent decline in U.S. and Europe's GDP there is a corresponding 7% drop in China's export growth rate. Orders at the recent Canton Trade Fair fell 17.5% which roughly translates into a 2.5% GDP drop in U.S. and Europe. Obviously conditions now are much worse, with real estate softening in China and the lag in the Chinese stimulus having a delayed effect, even if it is front-loaded; it would appear that the risk of a recession in China is now real.

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