China's shrinking economy

They did it again.  Beijing’s economic statistics for July, issued last week, appear to have been “made up,” as the Chinese now characterize fictitious numbers.  One figure, whether accurate or not, was especially illuminating.  Last month, the production of electricity, according to the National Bureau of Statistics, increased 2.1% year-on-year.

There is growing evidence that officials have been artificially inflating the closely followed electricity number to make the economy appear stronger than it actually is, but even a 2.1% increase indicates China has flatlined.

Why?

Historically, the growth of electricity in that country has outpaced the growth of its gross domestic product, the most widely followed measure of economic performance.

[pullquote]

The conclusion that China’s economy is probably shrinking is confirmed by manufacturing surveys and prices indexes, but the most telling indicators are the mountains of unneeded commodities.  Copper in recent months has been stockpiled in parking lots, and iron ore has been stored in granaries.  Ships loaded with unwanted coal have been waiting off Chinese ports.  That’s why China analysts are talking about the “heart attack” economy, and Anne Stevenson-Yang of J Capital Research uses the phrase “rigor mortis.”

Most analysts, however, don’t worry.  They believe China’s problems are temporary and will soon be forgotten because the country is in a supercycle upwards.

They’re wrong.  After 35 years of virtually uninterrupted growth, China has hit an inflection point.  The three primary reasons that created more than three decades of growth either no longer exist or are disappearing fast.  The country is no longer reforming, the international environment is not benign, and the “demographic dividend”—an extraordinary bulge in the workforce—is turning into a demographic bust.

It is in this adverse context—not the favorable one of the last three decades—that Chinese leaders will have to act.  In other words, they will no longer be propelled by trends; going forward, they will have to succeed in spite of them.

Unfortunately for them, Chinese leaders cannot do what is necessary to jumpstart growth.  Everyone agrees they have to stimulate domestic consumption—the investment-led, export-heavy model is unsustainable.

Yet Beijing did not try to change this model a half-decade ago when it would have been much easier to do so.  Then, other countries were willing to take China’s products and gave Chinese economic planners a cushion of fat export earnings.  Now, with declining markets abroad, China cannot earn big profits from sales to foreign customers.  Without the export cushion, the transition to a consumption-led economy in China will cause dislocations that are considered politically unacceptable.

The Chinese economy is now in a new supercycle.  This time, the direction of the cycle, which could last decades, is down.  Yes, China has passed its peak and is unable to implement necessary reforms.

So what does this mean for us here in the United States? Many policymakers believe severe troubles in China will rock the United States so we need to support Chinese growth. Clearly, a sudden failure there would roil global markets because institutional investors will be caught by surprise.  They appear to more or less accept Beijing’s official numbers, which portray an economy growing at just under 8%.  When they no longer believe the Chinese government’s line, we could see markets tank.

Moreover, multinationals will be hurt because they have made big bets on China, and even now problems there are already denting earnings.  Ask Caterpillar, for instance.

Yet not all the effect will be negative for us. Smaller American manufacturers, for instance, will undoubtedly be helped as they will face less competition from their Chinese counterparts.  The return of manufacturing to America will accelerate.

So we don’t have to be overly concerned about China’s coming failure.  The truth is that America depends on China much less than China depends on the United States.  Take China’s trade surplus in goods.  Last year, China’s surplus against the U.S. amounted to $295.4 billion.  China’s overall goods surplus was $155.1 billion.  That means its surplus against us was an unimaginable 190.5% of its overall trade surplus.  China, in short, has an economy geared to selling things to the United States.

And, incredibly, China’s dependence on the United States is increasing at this moment.   In the first seven months of this year, Chinese exports to Europe fell 3.6% over the same period last year.  How about China’s exports to America?  They jumped 11.4%.

The United States, on the other hand, does not have an economy geared to China.  Trade for the United States—and especially its trade with China—is a negative for its gross domestic product.  This is not to say that trade does not, in the larger picture, benefit America.  It certainly does.  But it is to say American economic success does not depend on China’s.

And, contrary to a general belief, the U.S. would be better off without Beijing funding its federal deficits.  Our problem has been too many international and domestic investors wanting to lend to Washington, not too few.

So when China’s economy collapses, Americans will realize they have less stake in the Chinese miracle than they have been led to believe.