Chinese manufacturing numbers reinforce the pessimist’s outlook

There is some good news about Chinese retail sales, although I am not sure how useful it is because retail sales numbers in China have always been a little hard to reconcile with other indicators of domestic demand.  According to an article in today’s Bloomberg:

Retail sales in China rose 13 percent during the three-day New Year holiday from a year earlier as both rural and urban consumers spent more, state television reported, citing commerce ministry data.  Retail sales were 12.5 billion yuan ($1.83 billion) in the first three days of the year, China Central Television reported, citing a ministry survey of 1,000 major retailers. Household appliances and cars topped the list of purchases, CCTV said.

Against this, two recent indices indicate that manufacturing output continues to fare badly.  The CLSA China PMI, released Friday, was 41.2 in December, the second worst month since the index started in 2004 (November clocked in at 40.9), and the fifth month in a row that in comes in below 50, which indicates a contraction in manufacturing output.  The PMI produced jointly by the China Federation of Logistics and Purchasing and the National Bureau of Statistics was released today and, coincidentally, also came in at 41.2.  According to an article in today’s Xinhua:

The Purchasing Managers’ Index (PMI) of China’s manufacturing sector climbed 2.4 percentage points month-on-month to 41.2 percent in December, China Federation of Logistics and Purchasing (CFLP) told Xinhua Sunday.

The index has been lower than 50 percent for three consecutive months. It was also the fifth time the index remained below 50 percent within last year after it fell to a record low of 38.8 percent in November.  The new monthly figure reflected the country’s economy had further contracted, analysts said.

The article then goes on to quote Zhang Liqun, a researcher with the Development Research Center of the State Council, as saying that “the PMI figure indicated the economy remained in the tank but the number of purchasing managers who were bullish on the economy was on the rise.  He said with previous macro-management policies taking effect, the economy would embark on a relatively fast growth track after the spring next year,” although the news agency regularly tries to put a positive spin on bad economic news, so perhaps we shouldn’t take Mr. Zhang’s comments too seriously.

The contraction may not be as bad as it seems because some of it seems to represent the running down of overstocked inventories, and so output could rebound in one or two quarters as inventories decline to the minimum necessary levels.  Still, according to the CLSA report “Chinese manufacturers reduced the size of their workforces at the fastest rate recorded by the series to date.”  An employment index it created suggests that in December we completed the fifth month of net layoffs, and of course rising unemployment is likely to lead to further contractions in demand.  The risk is that we get caught in a spiral in which output declines to meet lower demand, but firing workers further forces demand to decline further.  Unless there is a sudden rebound in export orders (don’t hold your breath) it will be up to new government spending to absorb unemployment and prevent demand from contracting further.

On that note Xinhua yesterday published a less upbeat story:

Cai Fang, a renowned labor expert in China, warns the country may see more job losses among urban workers in 2009 after millions of migrant workers became unemployed last year.  The majority of job losses in 2008 were mainly reported among migrant workers, Cai, head of the Population and Labor Economy Institute under the Chinese Academy of Social Science (CASS), wrote in an article published in Caijing Magazine in December.

Migrant workers, who often work in factories, are among the first to bear the brunt of the current global financial crisis. Statistics from the Ministry of Human Resources and Social Security showed 10 million of China’s total 130 million migrant workers went back to their rural hometowns jobless last year after some exporters were forced to shut down or halt production to avoid losses as a result of decreased overseas demand.  As a result, the income of rural and urban residents could grow at a slower pace, Cai said. The deceleration of income growth would definitely hurt consumption, he added.

There is a lot of hope being placed on either a revival of the export environment in early mid-2009 or on the success of the government fiscal expansion.  The fiscal expansion plan is still too fuzzy to inspire much confidence and a number of Chinese economists I have spoken with recently are openly disparaging – even in print and on TV.  One of them told me that he was worried that the government would be so desperate to boost growth that he wondered if we might not find ourselves having to choose between allowing growth to decline more sharply than anyone is comfortable with, or pulling out all the stops to jam growth forward, but in so doing create so much unsustainable and un-repayable debt that both the government and the banking system find themselves in real straits in two or three years.

Since this is something I also have been writing about, needless to say I agreed with him that there is a real risk that we “solve” the current problem by creating a more-difficult-to-solve debt problem in a few years.  This is in line with my longstanding contention that there is no policy solution to this problem if by “solution” we mean some way of avoiding the consequences of massive overcapacity.  It is just going to have to run down one way or the other, and without serious international cooperation the real policy choices for China are between “bad” outcomes and “worse” outcomes.

Actually quite a few local economists have been talking about the explosion in bad lending that they are expecting, and – no local economist, since he is American, but someone with a great view on Chinese policymaking – Victor Shih at Northwestern had a Wall Street Journal Asia Op Ed a few days ago which got a lot of attention and discusses exactly this problem.  He says:

Risk-prevention institutions built up over the past decade are now under enormous pressure to forgo prudence in the interest of maintaining economic growth.…Meanwhile, if the economy worsens in the first quarter the government may be tempted to abandon prudent regulation altogether. Beijing could order the CBRC to disregard risk targets or even abolish the CBRC. This would plunge China back into the old days when the only risks that bankers faced were political ones.

I confess this is the thing that worried me most about the fiscal expansion plans.  Since the social and political stakes are higher in China than in many other places, I think there is too great a risk that we overreact to the current mess by creating a potential debt disaster.  This means that the next two years might not be as bad as I am expecting, but they will be followed by an even greater problem – another banking crisis – and without the furious global growth and ample liquidity of recent years, it will be much harder for China to grow its way out of a repeat of the late 1990s banking crisis.

I am struck in my conversation with Chinese economists about how openly dismissive they often are of recent policymaking.  This adds some substance to the claims by my more politics-savvy friends that the debate – I hesitate to say warfare – within policy circles is hotter than ever.  Blame, apparently, is flying back and forth, and even leaders at the highest level are facing strident criticism.  This isn’t bad for China, of course, since one of the problems here has been the difficulty of changing policy once it has been decided, and a more intense debate should lead to a more realistic understanding of the consequences.  It does suggest however how nervous people are.

One last comment before closing – I mentioned that there is still some hope in many quarters that there will be a revival in exports that may help pull China out of the current mess – even to the extent of people feverishly citing the explosive growth in Sino-Indian trade as an indication of things to come (although funnily enough Sino-Indian trade is almost negligible).  I suspect that only people who have the dimmest understanding of the global environment and no sense of how the global balance of payments works hold this view (which is not to suggest that they aren’t the overwhelming majority), but it is probably reflected in the continuing debate about what must be done for China to regain its “competitiveness.”

In that light I though I would quote from an interesting article I read published by The Economist a scant few weeks (November 23) after the stock market crash of 1929.  Perversely enough I love reading old article on economics and business news, and The Economist is a great source.  This one says:

In any case, against any disadvantage arising from American competition must be set the great advantage which we mentioned at the outset, namely, the return to cheap money conditions. This should assist trade recovery throughout the world, which has been handicapped for so many months past by the abnormal financial conditions in New York. If we are justified in assuming that the setback in American industry will only be temporary, we may look forward to steady development in 1930, free from the incubus that has of late been hampering world conditions.

3 Responses to "Chinese manufacturing numbers reinforce the pessimist’s outlook"

  1. Guest   January 5, 2009 at 10:54 am

    Will Bernanke and Paulson’s plan to re-inflate the US debt bubble economy work? Not a snowball’s chance in hell. United States lived in Lever-Lever Land too long. Like Peter Pan, the country has refused to grow up. The object of the stimulus plans offered by the present and the next US administrations is to return to Lever-Lever Land, that is, to debt-financed consumption. It won’t work. Leverage is for the young, who borrow to build homes and start businesses. The financial crisis forces Americans to act their age, that is, to save rather than borrow and spend.America’s leaders haven’t yet had the required moment of clarity. Its financial leaders still think the problem is a mere matter of confidence. These were the same people who swallowed their own sales pitch.Aging workers, who soon will predominate in the American workforce, missed their chance to accumulate savings for retirement and education during the boom years of 2002-2008. Instead, they borrowed cheap money from foreigners and gambled on real estate. Many analysts have drawn attention to the link between America’s zero-percent personal savings rate and the current account deficit. Americans’ home equity probably is worth half of what it was three years ago, and fall a great deal further. If they had a retirement savings plan, it is probably down by 40% or so. If they still have a job, they need to save as much as they can and make up for lost time. All the stimulus in the world won’t persuade them to spend now that they know that they can’t retire on the price of their houses.America will endure a lost decade more depressing than Japan’s during the 1990s.

  2. Guest   January 5, 2009 at 1:34 pm

    You are right. I think the princelings would have pushed for Wen’s resignation if he weren’t such a folk hero. Also, Wen pre-empted it by offering his own resignation, which was rejected by Hu….

  3. Guest   January 12, 2009 at 7:46 am

    My wife and I spent a few hours dining and socializing with friends last night. One of the men is a nicely-paid finish carpenter, the other an accountant. The two of them were talking about flipping houses. In this economy! The carpenter says “I saw a house the other day – 3,000 sq ft – for $40,000. If we could put another $40,000 into it …..”The two men spent a few minutes dreaming, calculating, and drooling over the profit they could make. So I asked them, “which one of you has the $40,000 cash to put up to do the refurb? ‘Cause there isn’t a bank on the planet right now that is going to lend either of you $10,000 without a 740 beacon, positive cash flows on the property and a debt-to-income ratio of less than 30%.”That ended the conversation pretty quick, because both men had two car payments, one of them had recently taken his family to Disneyland (last summer), one is still going to college and neither of them had a dime saved. They have spent like drunken sailors.Ahhhh, but they have a dream.