The resurgence of China pessimism

Agree or not, it has returned.  Here is David G. Landry from Foreign Policy:

A recent Foreign Policy piece points out that individuals and firms have made up an increasingly large share of China’s total foreign asset purchases in recent years, from 12 percent in 2011 to nearly 40 percent in 2017, as the People’s Bank of China’s share of total foreign direct investment shrank. It turns out that these new investors are poor asset judges. As their share of China’s portfolio grew, its aggregate returns dwindled. In 2016, the total return on Chinese foreign investment was 0.4 percent, which is dramatically lower than the 4 percent earned by foreign reserves.

And Gabriel Wildau at the FT:

…fixed-asset investment — a core driver of Chinese growth that includes spending on new buildings, machinery and infrastructure — grew at its slowest annual pace since at least 1995 through the first five months of this year. Retail sales, an indicator of consumer demand, also increased at their slowest pace since 2003. China’s currency, meanwhile, hit a six-month low against the dollar this week, while the Shanghai Composite index, the country’s key stock market index, dropped 10 per cent in June. Last weekend, the People’s Bank of China cut the reserve requirement ratio, the amount of cash that banks must hold in reserve at the central bank, freeing up Rmb700bn ($106bn) for new lending and investment. The PBoC insists that monetary policy remains “prudent” but the cut to the RRR is the latest in a series of “ subtle easing” moves in recent months, including other forms of cash injection into the financial system.

…much of the recent slowdown is perceived to be the result of Beijing’s policies. A sharp fall in infrastructure spending by local governments led the drop in fixed-asset investment, as the central government reined in runaway borrowing by local governments.

One way or another, you will be hearing more about this.


I have heard speculation that this is being driven by wealthy Chinese people, desperate to evade capital controls and a weakening economy, who are buying up any foreign assets they can.

'China’s currency, meanwhile, hit a six-month low against the dollar this week'

That is not a cause of pessimism in terms of China's economy - exporting economies always favor a lover currency than their competitors. Since the U.S. is not a competitor to China as an exporter, this benefits China compared to other exporting competitors.

Apparently, it has been so long since the U.S. was anything but an import economy that this perspective seems normal while talking about how one should be pessimistic when a currency sinks.

The Germans have been completely fine any time the euro drops against the dollar, and would oppose a strong euro policy to the extent practical.

Supply chains of the goods that are exported extends outside of China. IIRC China adds less than 20% to an exported iphone. So that margin will come down. And it was amply evident in the recent ZTE saga how much high tech Chinese companies are dependent on US suppliers for critical components (some 30-40% by value with ZTE that essentially shut them down overnight).

China is also a very big consumer of mostly imported oil and gas which will further reduce margins all around for exporters who are already struggling with overcapacity and debt across the board.

Also, it is tautological that US must have a trade deficit with the rest of the world given that the dollar is the reserve currency.

'And it was amply evident in the recent ZTE saga how much high tech Chinese companies are dependent on US suppliers for critical components'

This is where it gets complicated - ZTE needs to pay for the American IP represented in products that are often manufactured elsewhere (think Taiwan). If the current international trade order as represented by the WTO were to break down badly enough, acquiring (or copying) the physical chips will not be much of a problem - the Americans owners of the IP found in those chips will have much more of a problem collecting their money.

'China is also a very big consumer of mostly imported oil and gas'

As is the U.S. Arguably, the Chinese are much more aware of the need to increase efficiency in their use of such imports than the U.S., and having a higher price of fuel reflected in dollars be compensated in the future by paying in its own currency, backed by trade based on actually producing a variety of things that oil exporting nations desire. This is not the same as exchange rates, per se - to say that oil is traded in dollars is true, but China is fully capable of making contracts with oil producers like Sudan or Venezuela that never involve dollars, or a banking system that is based on dollars.

'Also, it is tautological that US must have a trade deficit with the rest of the world given that the dollar is the reserve currency.'

Kind of - the fact that the euro could have stepped in to have at least created a situation where two currencies could have functioned as reserve currencies (at least potentially) was definitely not pursued as part of American policy, in part because such a policy would likely lead to a weakening of the dollar.

But the dollar has been pretty much a global reserve currency my entire life, originally because of the gold standard still being in place for foreign holders of dollars. The imbalance between imports and exports has steadily grown, without any apparent concern of the part of those who have benefitted from it. Which most definitely does not include the (often former) holders of high paying jobs involving manufacturing in America.

We let other nations do that, as our service? post-industrial? information? economy continues to churn out the jobs it does, where many of those employed in it can only afford imported Chinese goods.

1. Oil is priced in dollars. It is not necessarily traded in dollars. It can be settled in whatever way the two parties agree to.

I realise that this is consistent with your overall point, but did want to make the clarification.

2. To this point, 'China is also a very big consumer of mostly imported oil and gas' you said: "As is the U.S."

Not really. In volume terms the US is a significant importer, but imports account for less than a quarter of UD petroleum product use.

'In volume terms the US is a significant importer, but imports account for less than a quarter of UD petroleum product use.'

The problem is that the U.S. uses such a large amount of oil, that its 25% imports looks quite large when viewed against oil imports in general (and yes, the U.S. exports refined product - it is not a 1 to 1 relationship). Here is the EIA 06/22/2018 number in thousand of barrels per day - 8,356.

Whereas the EU number from 2015 found here - seem to work out to the EU importing somewhere around 11 million barrels a day. (And at least a not trivial fraction of that is also exported as refined product, though still distinctly less than that of the U.S.)

The U.S. is in a class by itself, and it is easy to lose sight of that fact.

Particularly as the EIA continues to muddy the waters compared to a couple of decades ago. Here is the EIA definition of pretroleum - 'Petroleum includes more than just crude oil

Petroleum includes more products than just crude oil. Petroleum includes refined petroleum products such as gasoline, diesel fuel, jet fuel, unfinished oils, and other liquids such as fuel ethanol, blending components for gasoline, and other refinery inputs.' Basically, the 'fuel ethanol' involves double counting, though with what factor is open to reasonable dispute. The corn that is grown for ethanol in the U.S. requires a not insignificant amount of oil to be produced - however, the oil that is consumed is not subtracted anywhere in the data. To put it simply - one barrel of domestically produced oil burned to create 1.5 barrels of (energy equivalent) ethanol does not mean petroleum production of 2.5 barrels. At least if one is interested in actually accounting for the energy that one can use as a net value. (That a barrel of ethanol is not energy equivalent to a typical barrel of crude is another discussion, with a number of variables.)

It is best to try to only use crude numbers, as the petroleum numbers are not very precise in a sense - a cynic would say on purpose, of course, to make America look more like an energy producing powerhouse. (However, C&C as a measure is a legitimate enough, if also another change - if natural gas fracking produces condensates that can be used to fuel a vehicle, there is no reason to ignore the energy produced through such means by using an overly strict definition of crude.)

Let's understand fixed asset investment for what it really is: it's the national religion of China. When mainlanders travelled to Europe and America in the 90s, they didn't envy our legal systems, our Church, or our multiculturalism. No they envied skyscrapers, fast trains, bridges and overpasses. This is what excites the Chinese, and defines their identity. In their worldview engineering above all else is the hallmark of civilization, from which everything else proceeds. It was Yu the Great who founded dynastic China in their origin myth. He is remembered as a Noah who stayed put, defending China with his levees. And what good did the Great Wall do other than stand as a great cathedral in the North? It claimed the lives of hundreds of thousands of workers, and could not keep barbarians out, but perhaps it convinced some Chinese to stay in. What good did the Grand Canal do but rob the coast of maritime advantage? Its promotion caused an end to coastal shipping, all perhaps to give the heartland a tiny taste of the commerce, but more importantly something to marvel.

So fixed asset investment will never slow in China, unless there are severe economic forces countervailing. And the Chinese will never cease to be impressed, unless the cease to be Chinese.

Yet, Americans keep supporting Chinese-Japanese-Indian Satanist regimes.

...whatever ya say, buddy.

Satan is not good. Americans should oppose him, not support his allies.

Well, how interesting. Who knew that talking about the illustrious Xi Jinping apparently meets with some functionary's displeasure.

Toeing the political line is always such an art form.

Be careful what you wish for. If China's economy falters, that will greatly increase the risk that China's government will resort to the old standby: the military and military adventurism. If America's economy falters, that will greatly increase the risk that Trump will resort to the old standby: the military and military adventurism. If those two occur in the context of an already existing trade war between China and America, the world is in big trouble.

I'm in support of whatever gets the Space Force implemented the fastest. China's already targeting American aircraft with lasers. America needs to "Up" its game.

Get it? "Up"? Like, higher into the sky?

China stock markets and things i follow in HK are down quite a bit this year which are leading indicators of the kind of pessimistic articles cited above. The Landry article is hard to follow -- random anecdotes and numbers presented in an incoherent way.

That's my take too. Last year was strong for emerging markets and China currency. The dollar strength is also part of the equation likely due to rising interest rates and anticipated stimulus.

Didn't we learn our lesson on this following the last China panic? The China economy is not a fragile house of cards poised on the tip of some pumped up money supply pencil. It is a real economy, fully of productive assets and people. Look at it this way - all the debt in China could be cancelled tomorrow but the people and the assets will be still there.

>Look at it this way - all the debt in China could be cancelled tomorrow but the people and the assets will be still there.

But all the trust that went into building the economy would be gone. That's what a sudden involuntary unwind of accumulated voluntary transactions would do. The idea of jubilee is nothing new, but it carries tremendous risk.

It may be that with their secretive financial system the Chinese central command could forgive or otherwise neutralize much of their national debt.

'Ellen Brown says that china's public banks are not too concerned if they ever get their money back; if they do, then great, but if they don't, it circulates in the economy creating jobs and prosperity instead.'

Only if things were so easy. There might be free money but, alas, no such thing as free value or wealth. What China's public banks lend out are the value and wealth created by the people of China (note that I didn't say money deposited by them or some such nonsense). So when such debt is forgiven it would mean the vast majority of Chinese would be made poorer and their hard work worthless. A few would do well I guess.

If that money went out to create infrastructure or jobs and that resulted in more wealth creation, then people up and down the ladder might benefit. The poorer people in that benefit group certainly didn't lose out.

These articles suggest a few things:

1. China’s government is letting individuals and firms play a greater role in foreign investment, and, due to inexperience, they’re not very good at it. This seems like a straightforward learning curve situation.

2. Less credit means less fixed asset investment. Given that Western economists have been lamenting Chinese over-investment for years, this seems like a long term positive with short term downsides.

3. Domestic demand is down. This one’s harder to judge, without more details as to why. If, for example, people are saving mor, it could be a positive indicator. Alternatively, if they’re making less money, it’s probably a negative one.

Overall, there isn’t a case for pessimism here.

The Chinese CEO of a company in China I invested in stole all the assets of the company and the government did nothing. Massive fraud.

As always, watch the reserves. The yuan has tracked the currency basket it's pegged to, the only question is what that costs PBOC to keep that going, especially with their trade surplus suddenly smaller than expected last month.

China's "nothing fails" model implies a loose monetary policy relative to its basket. The 2014-6 inflection point at which reserves began to fall rapidly marks the point at which capital began to want out at current RERs as the promise of real growth began to dry up -- they cannot loosen capital controls until reserves begin to climb again or they could lose the ability to peg. Probably no one in PBOC/CPC would even much dispute that the currency would probably devalue if capital were allowed to move freely right now.

China missed a great opportunity around 2010 to float the currency, recognize individual rights, and hold multiparty elections (which they might have even won handily). The capital misallocations are terrifying in scale (they are still pouring more concrete every few years than the US did all last century) but they can probably keep the facade of growth going quite awhile because of the $3T in reserves they accumulated during China's pre-2014 growth. With true reforms, they might even grow their way out, but given China's income disparities Xi is probably nearly as terrified of another Communist revolution as he is of elections.

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