The following is three articles from our columnist Vitaliy Katsenelson.
The second is mainly to correct the first article but it made a few good remarks. I find the third one most disturbing.
The Simple Math of âStaggeringâ Chinese Growth
Chinese non-export economy grew 23% in June!Ă Before you start googling for that number, let me warn you. You wonât find it. Iâve computed it using fifth grade math.
Here is what we know: exports constitute about 35% of theĂ Chinese economy and they dropped over 20% in June, while theĂ Chinese economy (GDP) grew 8%. So the âXâ is the growth rate of 65% of Chinese non-export economy.
0.35 x (-20%) + 0.65 x (X%) = 8%. If you were to solve for X you get 23%.
Enough with math, let me put this number in perspective. Chinese non-export economy grew at 3 times the rate of their GDP. I only have two, very contradictory, explanations for this:
1) TheĂ Chinese government is lying through its teeth about its economic miracle growth. It has the incentives to interrogate economic data until it confesses to the party line numbers. This is very plausible, as for months, theĂ Chinese government was showing positive GDP growthĂ while its consumption of electricity was declining. Obviously this doesnât make much sense. Also, China is not famous for production of intellectual type goods (i.e. software, creation of toxic financial products â that is our specialty) which scale a lot better and donât require proportional electricity consumption to grow GDP. China makes stuff and to make stuff you need a lot of electricity. Also, even if the growth is completely driven by building high story buildings (even if they collapse), highways, schools - these activities still require a lot of electricity.
2) The numbers are real, the monetary base was up 28.5% in June (again if you can trust that number) and thus the quality of growth is horrible. Iâve discussed thisĂ scenario in great detail.
I hate to leave on open-ended note, but only time will tell what is actually going on in China.
P.S. I was not surprised to learn that Jeremy Grantham of GMO â a value investor for whom I have a tremendous respect isĂ concerned about the future of Chinese economy as well.
Reappraising Chinaâs âStaggeringâ Growth
I am not writing this under duress, neither my family nor I were kidnapped by the Chinese government; I simply made a mistake in my last note about China calledĂ âSimple Math of Chinese âStaggeringâ GrowthâĂ and would like to correct it.Ă The Chinese non-export economy is not growing at a 23% rate.Ă This figure would have been right if China only exported and did no imports, which is obviously not the case: imports are about 25% of GDP (exports are 35%, leaving net exports at about 10%).Ă
If we were to assume that exports and imports are declining at the same pace of 20%, then the impact of declining net exports on the growth of the total economy would be about -2%Ă âĂ a much lower number than the -7% I used in my misguided note.Ă Also, the non-net-export economy (about 90% of the total) would have to grow at about 11% (not 23%) to offset declining net exports and for the total economy to grow 8%.Ă Here I am assuming that exports and imports declined at the same rate.Ă Chinese imports declined at a slower rate than exports in June and were dropping at about the same rate as exports in May.Ă
China, as any other country, imports two type of goods: finished goods (i.e., earthmovers, planes, etc.) and raw materials.Ă Raw materials Iâd break into two categories as well: the obvious ones â commodities like oil, copper, etc. â and parts, goods that go into finished products that are assembled in China and then exported or consumed internally.
There is little or no value added to finished goods, but there is a lot of value created in raw materials.Ă Sorry to be going economist on you (I am not one), but to understand the import/export relationship, letâs take a closer look at this example: a contract manufacturer that makes cell phones.Ă The manufacturer imports a lot of parts that go into the phones (the processor, wires, sensors) from other countries and sources some parts (maybe memory) in China.Ă It assembles these parts into a final product and exports the product to the US and Europe.Ă The value-added component here is, for the most part, assembly â the cheap labor.Ă If exports of cell phones drop by 100 renminbi, does it impact the economy proportionately by 100 renminbi?Ă No, if, letâs say, 70 renminbi worth of components were imported from Taiwan, the impact on the Chinese economy is only 30 renminbi (Taiwanâs exports suffer a 70 renminbi loss).Ă As you can see, if we ignore imports and focus solely on exports, we overstate the impact exports have on the economy.Ă I did just that.Ă Wrong!Ă
Things get even more complicated because of the multiplier effect â though net exports are only 10% of the Chinese economy, there is a large number of additional jobs created around them.Ă Plus, donât forget the capital investment that growth of exports brings to the country: factoriesĂ are built and infrastructure (roads, airports, etc.) is needed to support these factories.Ă Capital investment and export manufacturing-related infrastructure projects will decline with plummeting exports.Ă To make things worse, we have overcapacity in China.Ă Huge factories were built to accommodate demand than will not actually be realized for years. Developed-world economies are readjusting to a ânew normal,â consumption of many products will readjust to lower levels, and thus fewer goods will be produced.Ă We can already see this by listening to conference calls of large multinational companies â they are cutting their production in China at a very fast pace.Ă Finally, a very large portion of imported commodities likely goes to support a non-export economy, thus imports true impact on export economy is hard estimate.
The inconvenient truth is that it is very difficult to measure the true impact that declining exports have on the Chinese economy â it is lower than I estimated in âSimple Math of Chinese âStaggeringâ Growth,â but likely higher than the number I came up with above.Ă The bottom line is that the growth of non-net-export economy is lower than I originally estimated, but it is still staggering considering its significant acceleration on top of already high growth.
All in all, though I am not glad I made the net-export mistake; at least, it sent me on a mental refresher course of economic concepts that unfortunately Iâd forgotten.
P.S. More stories are coming out aboutĂ outrageous real estate projects in China. ThisĂ video of empty skyscrapers in ChinaĂ reminds me of empty condo buildings in Miami.
Chinaâs growth an accounting miracle
I hope you are enjoying the last month of summer.Ă Iâve gone fishing twice this month â caught absolutely nothing.Ă Actually I donât think Iâve caught a single fish over the last five years. But Iâve been mainly reading, listening to music and drinking beer while I was fishing.Ă So the fish probably did not take me too seriously.Ă Iâm taking the wife and kids to Steamboat this weekend.Ă We had a lot of fun there last year, thus Iâve been waiting for it since.
Now we are learning how ChinaĂ has achieved its âmiracle growth.â The country showed positive GDP growth while its electricity consumption declined in the beginning of 2009 â creative accounting that makes Enronâs accountants appear as dilettantes. A paper published byĂ John Makin at American Enterprise InstituteĂ explains it well:
But wait, it gets worse:
I am not convinced if China will have inflation in the long-run. It appears that deflation is a more likely scenario as China is ridden with overcapacity â the country was geared for much higher global growth. I can, however, see inflation erupting in a very short timeframeĂ as money has been thrown at the consumer/companies, and we are seeing thisĂ in the stock market and real estate. But in the long run, inflationĂ appears an unlikely outcome: overcapacity and slower demand from the US and Europe will force Chinese producers to cut prices to increase utilization and stimulate demand.
Lately, weâveĂ started hearing whispers of the Chinese renminbi contending for the status of the worldâs reserve currency. On the surface it more or less makes sense. The US is struggling andĂ Europe has structural problems. John Mauldin correctly put it,Ă âEU was designed for prosperity not for adversity.â It will be hard for the EU experiment to survive in the long run.Ă But thatâs a topic for a different discussion.
China on the other hand is chugging along. I heard (though not confirmed) theĂ Chinese stock market now has a greater market capitalization than Japanâs. Though theĂ Chinese economy has the size of aĂ global currency contender, it lacks one not-so-little element that the global economy will require for renminbi to become theĂ worldâs currency â political stability. We forget that China is still not a democracy. I am not sure what to call the political system of the Peopleâs Republic of China but I donât think itâs the âpeopleâsâ nor is itĂ a ârepublic.â TheĂ rule of law is a nascent concept in China.Ă Something isĂ only legal if the government thinks it is legal.
And finally, Iâm sure China doesnât want the renminbi to beĂ theĂ worldâs currency as it would drive up the value â a suicide for an export-based economy.
P.S. I highly recommend you read Peter Druckerâs paper calledĂ Managing OneselfĂ â it is terrific. Iâve read it the first time about six years ago, had a huge impact on my life.Ă Also, a friend forwarded aĂ very interesting articleĂ by Anatole Kaletske (Iâve never heard of him until today), he makes a very interesting case that European Central Bank has outdone even our mighty Fed in quantitative easing.
Vitaliy Katsenelson
http://contrarianedge.com/2009/07/28/
The second is mainly to correct the first article but it made a few good remarks. I find the third one most disturbing.
Chinese non-export economy grew 23% in June!Ă Before you start googling for that number, let me warn you. You wonât find it. Iâve computed it using fifth grade math.
Here is what we know: exports constitute about 35% of theĂ Chinese economy and they dropped over 20% in June, while theĂ Chinese economy (GDP) grew 8%. So the âXâ is the growth rate of 65% of Chinese non-export economy.
0.35 x (-20%) + 0.65 x (X%) = 8%. If you were to solve for X you get 23%.
Enough with math, let me put this number in perspective. Chinese non-export economy grew at 3 times the rate of their GDP. I only have two, very contradictory, explanations for this:
1) TheĂ Chinese government is lying through its teeth about its economic miracle growth. It has the incentives to interrogate economic data until it confesses to the party line numbers. This is very plausible, as for months, theĂ Chinese government was showing positive GDP growthĂ while its consumption of electricity was declining. Obviously this doesnât make much sense. Also, China is not famous for production of intellectual type goods (i.e. software, creation of toxic financial products â that is our specialty) which scale a lot better and donât require proportional electricity consumption to grow GDP. China makes stuff and to make stuff you need a lot of electricity. Also, even if the growth is completely driven by building high story buildings (even if they collapse), highways, schools - these activities still require a lot of electricity.
2) The numbers are real, the monetary base was up 28.5% in June (again if you can trust that number) and thus the quality of growth is horrible. Iâve discussed thisĂ scenario in great detail.
I hate to leave on open-ended note, but only time will tell what is actually going on in China.
P.S. I was not surprised to learn that Jeremy Grantham of GMO â a value investor for whom I have a tremendous respect isĂ concerned about the future of Chinese economy as well.
I am not writing this under duress, neither my family nor I were kidnapped by the Chinese government; I simply made a mistake in my last note about China calledĂ âSimple Math of Chinese âStaggeringâ GrowthâĂ and would like to correct it.Ă The Chinese non-export economy is not growing at a 23% rate.Ă This figure would have been right if China only exported and did no imports, which is obviously not the case: imports are about 25% of GDP (exports are 35%, leaving net exports at about 10%).Ă
If we were to assume that exports and imports are declining at the same pace of 20%, then the impact of declining net exports on the growth of the total economy would be about -2%Ă âĂ a much lower number than the -7% I used in my misguided note.Ă Also, the non-net-export economy (about 90% of the total) would have to grow at about 11% (not 23%) to offset declining net exports and for the total economy to grow 8%.Ă Here I am assuming that exports and imports declined at the same rate.Ă Chinese imports declined at a slower rate than exports in June and were dropping at about the same rate as exports in May.Ă
China, as any other country, imports two type of goods: finished goods (i.e., earthmovers, planes, etc.) and raw materials.Ă Raw materials Iâd break into two categories as well: the obvious ones â commodities like oil, copper, etc. â and parts, goods that go into finished products that are assembled in China and then exported or consumed internally.
There is little or no value added to finished goods, but there is a lot of value created in raw materials.Ă Sorry to be going economist on you (I am not one), but to understand the import/export relationship, letâs take a closer look at this example: a contract manufacturer that makes cell phones.Ă The manufacturer imports a lot of parts that go into the phones (the processor, wires, sensors) from other countries and sources some parts (maybe memory) in China.Ă It assembles these parts into a final product and exports the product to the US and Europe.Ă The value-added component here is, for the most part, assembly â the cheap labor.Ă If exports of cell phones drop by 100 renminbi, does it impact the economy proportionately by 100 renminbi?Ă No, if, letâs say, 70 renminbi worth of components were imported from Taiwan, the impact on the Chinese economy is only 30 renminbi (Taiwanâs exports suffer a 70 renminbi loss).Ă As you can see, if we ignore imports and focus solely on exports, we overstate the impact exports have on the economy.Ă I did just that.Ă Wrong!Ă
Things get even more complicated because of the multiplier effect â though net exports are only 10% of the Chinese economy, there is a large number of additional jobs created around them.Ă Plus, donât forget the capital investment that growth of exports brings to the country: factoriesĂ are built and infrastructure (roads, airports, etc.) is needed to support these factories.Ă Capital investment and export manufacturing-related infrastructure projects will decline with plummeting exports.Ă To make things worse, we have overcapacity in China.Ă Huge factories were built to accommodate demand than will not actually be realized for years. Developed-world economies are readjusting to a ânew normal,â consumption of many products will readjust to lower levels, and thus fewer goods will be produced.Ă We can already see this by listening to conference calls of large multinational companies â they are cutting their production in China at a very fast pace.Ă Finally, a very large portion of imported commodities likely goes to support a non-export economy, thus imports true impact on export economy is hard estimate.
The inconvenient truth is that it is very difficult to measure the true impact that declining exports have on the Chinese economy â it is lower than I estimated in âSimple Math of Chinese âStaggeringâ Growth,â but likely higher than the number I came up with above.Ă The bottom line is that the growth of non-net-export economy is lower than I originally estimated, but it is still staggering considering its significant acceleration on top of already high growth.
All in all, though I am not glad I made the net-export mistake; at least, it sent me on a mental refresher course of economic concepts that unfortunately Iâd forgotten.
P.S. More stories are coming out aboutĂ outrageous real estate projects in China. ThisĂ video of empty skyscrapers in ChinaĂ reminds me of empty condo buildings in Miami.
I hope you are enjoying the last month of summer.Ă Iâve gone fishing twice this month â caught absolutely nothing.Ă Actually I donât think Iâve caught a single fish over the last five years. But Iâve been mainly reading, listening to music and drinking beer while I was fishing.Ă So the fish probably did not take me too seriously.Ă Iâm taking the wife and kids to Steamboat this weekend.Ă We had a lot of fun there last year, thus Iâve been waiting for it since.
Now we are learning how ChinaĂ has achieved its âmiracle growth.â The country showed positive GDP growth while its electricity consumption declined in the beginning of 2009 â creative accounting that makes Enronâs accountants appear as dilettantes. A paper published byĂ John Makin at American Enterprise InstituteĂ explains it well:
âOnce China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers. Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed. In fact, the funds go out to the state-owned enterprises and provincial governments and may be held until actual projects are identified and undertaken.â (Emphasis is mine.)
But wait, it gets worse:
ââŚAmbitious planners count shipments [consumer products] as retail sales while end-use demand may be absent. In such cases, the âsalesâ are made to happen by virtually giving away the products that have already been produced and counted as GDP growth.â
I am not convinced if China will have inflation in the long-run. It appears that deflation is a more likely scenario as China is ridden with overcapacity â the country was geared for much higher global growth. I can, however, see inflation erupting in a very short timeframeĂ as money has been thrown at the consumer/companies, and we are seeing thisĂ in the stock market and real estate. But in the long run, inflationĂ appears an unlikely outcome: overcapacity and slower demand from the US and Europe will force Chinese producers to cut prices to increase utilization and stimulate demand.
Lately, weâveĂ started hearing whispers of the Chinese renminbi contending for the status of the worldâs reserve currency. On the surface it more or less makes sense. The US is struggling andĂ Europe has structural problems. John Mauldin correctly put it,Ă âEU was designed for prosperity not for adversity.â It will be hard for the EU experiment to survive in the long run.Ă But thatâs a topic for a different discussion.
China on the other hand is chugging along. I heard (though not confirmed) theĂ Chinese stock market now has a greater market capitalization than Japanâs. Though theĂ Chinese economy has the size of aĂ global currency contender, it lacks one not-so-little element that the global economy will require for renminbi to become theĂ worldâs currency â political stability. We forget that China is still not a democracy. I am not sure what to call the political system of the Peopleâs Republic of China but I donât think itâs the âpeopleâsâ nor is itĂ a ârepublic.â TheĂ rule of law is a nascent concept in China.Ă Something isĂ only legal if the government thinks it is legal.
And finally, Iâm sure China doesnât want the renminbi to beĂ theĂ worldâs currency as it would drive up the value â a suicide for an export-based economy.
P.S. I highly recommend you read Peter Druckerâs paper calledĂ Managing OneselfĂ â it is terrific. Iâve read it the first time about six years ago, had a huge impact on my life.Ă Also, a friend forwarded aĂ very interesting articleĂ by Anatole Kaletske (Iâve never heard of him until today), he makes a very interesting case that European Central Bank has outdone even our mighty Fed in quantitative easing.
Vitaliy Katsenelson
http://contrarianedge.com/2009/07/28/
