People don't believe China's growth figures, and the truth about the economy could be far worse

Chinese flag painting China communist hammer sickleREUTERS/Chance ChanWorkers peel papers off a wall as they re-paint the Chinese Communist Party flag on it at the Nanhu revolution memorial museum in Jiaxing, Zhejiang province May 21, 2014. REUTERS/Chance Chan

China’s latest growth figures are out, and they’re not good — growth of 7% from this time last year is the slowest in six years.

Industrial production, retail sales and investment all missed their forecasts. If China measured growth the way the United States does (measuring the quarter-on-quarter change and then annualising it), it would only have recorded a 5.2% expansion (barely faster than the US in Q3 last year).

That growth might not seem too bad, but with a significant slowdown, China is going to find its growing debt mountain much more difficult to handle. The economy is geared towards rapid growth, and changing that will be a painful adjustment.

But the real situation could be even worse than those figures suggest.

Everyone treats China’s official statistics with a pinch of salt — in a single-party autocracy, there’s not much benefit for a statistician to publicly reveal that the government is dramatically missing its single most important target. The accusation that the figures are fiddled has come up a bunch of times before.

Kevin Lai at Daiwa Capital Markets suggested as much in a comment to Reuters :

“If you look at Q1, exports were poor, industrial production was poor, FAI (fixed asset investment) was much slower, retail sales soft, so how can GDP in real terms still be 7 per cent?”

A note from Daiwa’s China analysts goes into even more detail about how bad the situation in China really is. Here’s a snippet of what they sent out early Wednesday:

In our view, China’s GDP number is becoming less exciting these days. A number that is very close to the consensus forecast will probably keep everyone happy. Many other indicators, however, are showing that economic conditions are much worse than what the GDP number suggests.

Here’s one of their alternative GDP indicators, power output, which should closely track the economy and is barely growing at all:

During China’s early-noughties “Goldilocks period,” power output rose by about 15% per year. It’s been much more volatile since the financial crisis, but it’s now growing at its lowest pace since 2009 — with a rise of just 0.03% year-on-year in Q1 2015.

Either China is suddenly worked out a way to get growth without raising its power output, or something fishy is going on. Daiwa have another measure that they think works well to show how weak the Chinese economy is too:

Our favourite chart in terms of China’s imports from Australia and ASEAN (major suppliers of commodities for China) shows that the current state of growth appetite in China is almost parallel to the ‘hard-landing’ scenario in 2008.

Here’s how that looks:

Every time Chinese growth is a news topic I can’t help but recall this passage from Michael Pettis, a renowned expert on China’s economy. He expects it to slow down considerably as the economy changes from its recent rapid growth model:

I cannot work out arithmetically any meaningful rebalancing process that is consistent with average GDP growth much above 3-4% during President Xi’s 2013-23 term in office. This used to be considered a shocking prediction not so long ago, but not anymore…

I have studied most of the major growth miracles of the past 100 years (and directly experienced some), and in every case there have been pessimists that predicted a difficult adjustment process with much slower growth. In every such case, however, these pessimistic predictions were met with general incredulity (and for some odd reason almost always written off as “wishful thinking”) but while I have indeed found that the pessimists have always been wrong, it always turned out that they were wrong because actual growth turned out to be much worse than they predicted.

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