“Who cares what is going on in China?”
I get this comment a lot. If the Chinese economy was the size of the Vietnamese economy, and it was not responsible for more than 2/3 of our trade deficit and didn’t hold $2.2 trillion in foreign reserves (about half of which is in US dollars), I’d be spending a lot less time thinking and writing about it. However, what happens in China in the near future will have a significant impact on the world, and more importantly our own economy: it will impact interest rates, the dollar, commodities, and demand for industrial goods; and there will be geopolitical consequences We look at the Chinese economy and its reported 7.9 per cent growth and though we won’t admit it to ourselves, it makes us feel inadequate. The Chinese have gotten the economy thing figured out:
- Large population migration from farms into cities boosts productivity
- Abundance of cheap labour gives it a comparative cost advantage
- Through currency controls its currency — the renminbi — is kept artificially low against the dollar and euro, making its cheap goods even cheaper
- Controlled free-market economy (an oxymoron, if you ask me) allows the government to do whatever it wishes on the fly — it decides that banks “have to” lend, banks only ask how much.
Its economy can grow through good and bad times. In fact, there are no bad times for China. You’d think that an export-based economy would at least take a pause when its exports to the developed world drop off the cliff.
No, not China, which spit out growth numbers last week that are the envy of the West even in the West’s best times. The country showed robust GDP growth while electricity consumption declined. The laws of economics appear to be suspended for the Chinese — but they are not. They just have “better” accountants — ones that would make Enron’s bean counters seem like dilettantes. A paper published by John Makin at American Enterprise Institute explains very well how Chinese got their GDP growth:
“Once China had announced its 8 per cent growth target, it began to disburse funds directed at a sharp increase in public-works spending,” Makin wrote.
“It is important to understand that the disbursal of funds is recorded as GDP growth,” Makin continued. “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.”
Nice work, huh?
“Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed,” Makin noted.
So those of you who feel inadequate — stop. If the US were to compute our GDP based on Chinese methodology Google would be our middle name. Why does Chinese GDP growth matter? Well, a significant portion of stock appreciation going into 2008 was driven by deep cyclical companies that make “stuff,” i.e. energy, materials and industrial companies like Caterpillar, ExxonMobil and Arcelor Mittal.
In the beginning it was the US economy coming out of the recession that lifted those stocks — however, in the later stages of the rally the incremental demand was driven by Chinese growth. Though the Chinese economy constitutes only 7 per cent of the world economy, it was responsible for a disproportionate amount of the incremental demand for oil, metals and industrial goods. When the global economy went into recession demand for “stuff” evaporated — and stuff stocks dropped. But recently they had a serious rebound on the hopes that Chinese economic growth would result in revival of demand for their goods. However, the fictional growth coming out of China is putting that hope to rest. If you own these stocks, you’ve been warned.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007). To receive Vitaliy’s future articles my email, click here.
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