The release of September trade data earlier this week was pretty interesting, although because of two or three extra working days last month, plus the very big holiday at the beginning of October which might have pushed activity into September, some of the comparisons are misleading. Exports were down 15.2% year-on-year, better than the expected 20-21%. Imports were down 3.5%, much better than the expected 15%. Month-on-month figures showed a rise in both imports and exports.
So much ink has been spilled in discussing these numbers that I won’t try to summarize, but it is worth noting that for many analysts the numbers were a very positive surprise. Typical was this Reuters report reprinted in the New York Times:
China reported surprisingly strong trade figures on Wednesday, providing fresh evidence that the world’s third-largest economy is firmly on the path to recovery and that global demand is improving too.
…Brian Jackson, an economist at Royal Bank of Canada in Hong Kong, said the slower pace of decline was good news for China’s recovery because growth this year has depended too much on the government’s 4 trillion yuan ($585 billion) stimulus package.
But even in this article there were hints that the numbers, especially the import numbers, might not be as positive as expected.
Commodities were a driving force behind the sharp improvement in imports. China bought a record 64.55 million tons of iron ore in September, up 30 percent from August; imports of copper rose 23 percent.
Merrill Lynch’s October 14 research report puts it this way: “Commodity import growth was stunning.” Andrew Batson in an article in today’s Wall Street Journal explains why the high commodity share of imports might not be as positive an indicator of surging demand as the headline numbers suggest:
A pickup in China’s metal imports in September is stoking debate about how much of the nation’s commodity intake this year is driven by demand and how much is stockpiling that will soon end.
…The trade figures issued Wednesday showed China’s imports of copper rebounding from July and August slowdowns to post a 87% rise from a year earlier. Iron-ore imports also hit a monthly record, at 64.55 million tons in September, up 65% from a year earlier. The gains in imports defied many forecasts that purchases would slow after China took advantage of low prices early this year to build up stocks of many commodities. The data could be a signal that underlying demand for raw materials is stronger than first thought.
I read the data differently – not so much as evidence that demand is stronger then we thought but rather that real imports are weaker than we thought. According to the October 14 research report by Mark Williams, of Capital Economics, “We do not expect the trend to last. China’s recovery is being driven by investment, but the recent pace of commodity import growth has been much faster than justified by the rise in current demand. Inventories of many metals have more than doubled since the start of the year (copper inventories are up 500%).”
I think I agree with Mark. I already discussed in last week’s entry the recent conversations I have had with chemical and steel analysts and investors who were puzzled by their inability to match China’s imports with any reasonable estimate of the end use of these products. One place where we might see the discrepancy is in a rise in inventories, but although these have been rising, they haven’t been rising fast enough to account for the differences.
Are investors stockpiling?
It seems that there may be another explanation, and that is stockpiling by private investors. From what I am being told, it seems that a number of wealthy Chinese investors have been speculating directly in commodities, and so some of this inventory buildup is occurring not at the company level but at the investor level. The Wall Street Journal article mentions this possibility:
Copper stockpiles also have increased. Royal Bank of Scotland analysts estimate that as much as 900,000 metric tons of unreported copper stocks have built up in China this year. There has been some official purchasing by the State Reserves Bureau, but also a lot of private traders buying imported copper because it could be resold for a higher price domestically.
I have no information about how these positions might be financed, if this is true, but I would worry if they were debt financed, and I would worry even more if corporations were financing them indirectly by lending to principles. Shang Ning, the very smart secretary of the PBoC Shadow Committee seminar I run at Peking University, has been trying to figure out ways of indirectly measuring this kind of stockpiling, but frankly we don’t as of yet have any very good ideas.
Clearly a lot of policymakers are worried about excess commodity stockpiles. Earlier this week Bloomberg reported on plans to curb steel production.
China, the world’s largest steel producer, is working on plans to curb excess capacity as the nation faces “severe oversupply,” according to the nation’s third-largest mill. The government may have detailed plans on how to close obsolete mills, advance mergers and reduce the number of iron ore importers by the end of the year, Deng Qilin, the general manager of Wuhan Iron & Steel Group, said in an interview.
…“The government will impose strict measures to effectively close outdated mills and boost consolidation,” Deng, also the chairman of the China Iron and Steel Association, said while attending the World Steel Association annual meeting in Beijing yesterday. “We bigger players will surely benefit from such a move.”
There is more than just steel. An article in yesterday’s Xinhua reports the following:
The National Development and Reform Commission (NDRC) will mainly redress production overcapacity in six sectors, said Chen Bin, director of the Department of Industry of the NDRC, Thursday. The six sectors include steel, cement, plate glass, coal-chemical industry, polycrystalline silicon and windpower equipment.
The NDRC also warns of obvious production overcapacity in sectors like electrolytic aluminum, ship manufacturing and soybean oil extraction, said Chen during an on-line interview on www.gov.cn., the website of China’s central government. He said China would fight serious overcapacity in sectors like steel industry and offer guidance for new-born industries like windpower equipment to avoid low level repetitive construction.
China has achieved preliminary progresses in fighting the global economic downturn, but the foundation for economic recovery is not stable yet and overcapacity might lead to bankruptcy, unemployment and bad bank loans if it was not checked in time, he said.
Industrial policies create overcapacity
I agree with the last paragraph, but otherwise I am pretty skeptical about the fight against overcapacity. According to my model of China’s overcapacity problem, the source of the imbalance is a set of industrial policies that systematically shift income from households to producers, and as long as these policies continue there is little chance of resolving the problem of excess production. I have a longish piece coming out next month as a Carnegie Brief on the Carnegie Endowment website, in which I discuss this as part of a discussion about why I expect a rising US savings rate to lead almost inexorably to trade tensions. Here is the relevant section from the first draft:
Although China is still a very poor country, there is no question that Chinese household income has grown substantially over the past few decades, but it has not grown nearly as quickly as GDP. While China’s GDP grew at 11-12% over the 2002-2007 period, for example, MIT economist Yasheng Huang estimates that household income grew at a much lower 9%. If we were able to adjust Huang’s measure to take into account changes in other forms of household wealth – which are described below – growth in household income would have been even lower. This is why consumption has declined as a share of national income, and why China’s total production has exceeded its total consumption by a large and growing amount. This is at the root of China’s high savings rate.
Why haven’t Chinese households maintained their share of national income? Largely because the rise in household income was constrained, especially in the last decade, by industrial polices which were aimed at turbo-charging economic growth. These policies systematically forced households implicitly and explicitly to subsidize otherwise-unprofitable investment in infrastructure and manufacturing. Although these policies powered employment and manufacturing growth, they also led to wide and divergent growth rates between production and consumption. These policies included:
- An undervalued currency, which reduces real household wages by raising the cost of imports while subsidizing producers in the tradable goods sector.
- Excessively low interest rates, which force households, who are mostly depositors, to subsidize the borrowing costs of borrowers, who are mostly manufacturers and include very few households, service industry companies or other net consumers.
- A large spread between the deposit rate and the lending rate, which forces households to pay for the recapitalization of banks suffering from non-performing loans made to large manufacturers and state-owned enterprises.
- Sluggish wage growth, perhaps caused in part by restrictions on the ability of workers to organize, which directly subsidizes employers at the cost of households.
- Unraveling social safety nets and weak environmental restrictions, which effectively allow corporations to pass on the social cost to workers and households.
- Other direct manufacturing subsidies, including controlled land and energy prices, which are also indirectly paid for by households
By transferring wealth from households to boost the profitability of producers, China’s ability to grow consumption in line with growth in the nation’s GDP was severely hampered. Of course the gap between production and consumption is the savings rate, and as production surged relative to consumption, a necessary corollary was a rising Chinese savings rate.
The basic problem, then, is that there are very powerful policies that force a discrepancy in production and consumption growth, and the only way to eliminate overcapacity is by reversing these policies. I am not sure that attempting to address overcapacity by administrative means can succeed, and certainly the track record of other efforts over the past year to address the imbalance doesn’t suggest otherwise.
The trade impact
In the steel sector here is one consequence of the continued surge in production, according to an article in this week’s Financial Times:
The unexpectedly swift recovery in China’s steel production has sparked fears that a glut of exports could puncture steel prices as the global industry struggles to emerge from the economic downturn, rival steelmakers have warned. SK Roongta, chairman of the Steel Authority of India Ltd (Sail), said Chinese over-production was “a point of concern” for the world’s steel producers.
During the past year, producer margins have come under severe strain from falls in prices and high input costs. Global output fell more than 20 per cent in the first half of 2009. The head of India’s largest state-owned steel group said that Chinese production accelerated 15 per cent in the past quarter, beating forecasts of just reaching double-digit growth.
“We believed that China would grow, but the growth in the past three to four months has certainly been a surprise. I’m not sure this level can be sustained,” he said. “The magnitude of the growth is a surprise; not the growth per se.”
Meanwhile on Tuesday in the New York Times the always-perceptive David Barboza spells out very explicitly the implications in a much-discussed article titled “In Recession, China Solidifies its Lead in Global Trade”:
With the global recession making consumers and businesses more price-conscious, China is grabbing market share from its export competitors, solidifying a dominance in world trade that many economists say could last long after any economic recovery.
…China is winning a larger piece of a shrinking pie. Although world trade declined this year because of the recession, consumers are demanding lower-priced goods and Beijing, determined to keep its export machine humming, is finding a way to deliver. The country’s factories are aggressively reducing prices — allowing China to gain ground in old markets and make inroads in new ones.
There are lots of reasons given for why China is able to increase its market share so dramatically, but there is little doubt in my mind that this process will cause rancor and increasing hostility, especially among trade competitors, and the focus will be on policies that continue to subsidize manufacturers. Barboza goes on to say:
One reason is the ability of Chinese manufacturers to quickly slash prices by reducing wages and other costs in production zones that often rely on migrant workers. Factory managers here say American buyers are demanding they do just that.
…Because China produces a diversified portfolio of low-priced and essential items, analysts say the country’s exports can hold up relatively well in a recession. Few other countries can match what has come to be called the “China Price.”
“China has a huge advantage,” says Nicholas R. Lardy, an economist at the Peterson Institute for International Economics in Washington. “They can adjust to market changes very rapidly. They have flexibility in their labor markets. And as consumers trade down the quality ladder, China can benefit.”
The expiration of textile quotas in large parts of the world this year has also allowed China to increase its market penetration. But equally important are government policies that support this country’s export sector — from Beijing keeping its currency weak against the dollar to its determination to subsidize exporters through tax credits and billions of dollars in low-interest loans from state-run banks.
Although the “wage flexibility” enjoyed by Chinese corporations may seem like a huge advantage, remember my earlier comments about how sluggish household income growth relative to GDP growth is the source of the overcapacity problem (consumption is likely to grow as fast as household income grows). If I am right, it means that measures that can improve China’s export competitiveness are not good for the rebalancing effort if they exacerbate, rather than reverse, the process of transferring income from households to corporations. Lower wages, of course, do just that, and so they cannot be a solution to China’s underlying overcapacity problem except to the extent that they allow China to expel trade competitors. This is not a permanent solution by any means, especially in a world of rising trade tensions.
New loans still soaring
There are two pieces of related recent news. The first, released on the same date as the trade data, was the PBoC announcement of new loans for the month of September. According to an article Wednesday in Xinhua:
China’s new yuan-denominated loans in September rose to 516.7 billion yuan (75.68 billion U.S. dollars) from August’s 410.4 billion yuan, the People’s Bank of China, the central bank, said Wednesday. New yuan-denominated loans in the first nine months stood at 8.67 trillion yuan, 5.19 trillion yuan more than the same period last year.
China’s foreign exchange reserve hit a new high of 2.2726 trillion U.S. dollars at the end of September, according to the central bank. China’s monthly new loans had slowed from June’s high of 1.53 trillion yuan to 355.9 billion yuan in July as a result of bank contracting credit and the central bank’s open market operations. The figure rose to 410.4 billion yuan in August and then to September’s 516.7 billion yuan.
The broad measure of money supply, M2, which covers cash in circulation and all deposits, was up 29.31 percent from a year earlier to 58.54 trillion yuan at the end of September. The narrow measure of money supply, M1 (cash in circulation plus current corporate deposits), was up 29.51 percent to 20.17 trillion yuan.
I think most people were surprised by the September net new loan number, expecting something in the RMB 450 billion range (last September total new lending was RMB 378 billion). Although the current new lending of RMB 517 billion is much lower than the astonishing RMB 963 billion monthly average this year, when you include the net paydown of bill financing in September of RMB 353 billion, the total new medium and long-term financing in September was actually RMB 870 billion. This suggests that in fact September lending was equal to this year’s monthly average (especially if you think of the explosion in bill financing early this year as a form of “anticipated” lending).
Regular readers of my blog will know that I have no doubt that this kind of loan expansion can only make the overcapacity problem worse, since either it directly boosts current or future production, or, by leading to a rise in NPLs that will ultimately be paid for by Chinese households, it constrains future consumption growth. Interestingly enough, according to an analysis in Caijing, the share of new loans from the Big 4 was only 21%. This is down substantially from 40% in August, 47% in July, and a whopping 70% in the first six months of 2009.
What gives? For one thing, it means that most of the decline in lending from the insane levels of the first half of the year is explained by the decline in lending among the Big 4. It is not so much that new lending is being pushed downward, since the smaller banks are increasing their lending at roughly the same rate as they have all year.
Chen Shanshan, an analyst at Bocom International Holdings, said large commercial banks scaled their lending after regulators tightened credit controls at the start of the third quarter. Also, medium-sized banks saw their lending capabilities restrained by the tighter regulatory controls on capital requirements, he said.
“Banks are now actively selling loans,” and mostly selling them packaged as syndicated loans, an executive with a large commercial bank told Caijing.
I am not sure from this whether they are selling down to other banks or to investor groups. Any color from any of my readers would be much appreciated. As an aside on the reserve numbers, I haven’t done the numbers yet, and I have not had a chance to discuss this with Medley’s Logan Wright, but my initial back-of-the-envelope calculation suggests that hot money inflows may have moderated but are still positive.
The second piece of related news was the release yesterday by the US Treasury Department of its semi-annual report on exchange rate policies. “Both the rigidity of the renminbi and the reacceleration of reserve accumulation are serious concerns which should be corrected to help ensure a stronger, more balanced global economy consistent with the G-20 framework,” the report said. “The Treasury remains of the view that the renminbi is undervalued.”
While the People’s Daily headline today was “U.S. says China not currency manipulator”, and most of the focus of the article was positive (although it did acknowledge that “it also alleged that the Chinese currency renminbi’s exchange rate showed a ‘lack of flexibility’ in recent period”), the Financial Times article was a little more nuanced:
The Obama administration said on Thursday that it had “serious concerns” about the value of the renminbi, but stopped short of accusing China of manipulating its currency in a closely watched report to Congress.
The Treasury toughened its language on China in its semi-annual report on exchange rate policies. While acknowledging that Beijing had been important in steadying the global economy, it said recent moves to accumulate more foreign exchange reserves “risk unwinding some of the progress made in reducing imbalances”.
But the Treasury did not say China was manipulating its currency, in spite of pressure from US labour groups and scores of legislators who argue that the undervalued renminbi makes China’s exports unfairly cheap . Pressure has built this year as manufacturers suffer huge job losses and the US unemployment rate creeps towards 10 per cent .
I am willing to bet that over the next year or two the language gets tougher, not easier.
Finally, I saw the following very interesting article on today’s Bloomberg:
China’s Ministry of Finance is, for the first time, allowing local governments to use the proceeds of land sales to fund stimulus projects, the China Daily reported, citing a ministry circular. Local governments are required by the end of this month to have provided 1.18 trillion yuan ($173 billion) out of the 4 trillion yuan stimulus plan announced by Premier Wen Jiabao in November, the English-language paper said. Many local governments are finding it difficult to secure funds for projects because of the economic slowdown, the newspaper said.