China's Economy Needs Spending Power, Not Steel Factories - Fullermoney
Expect some "sky is falling" headlines on Friday when China releases its most recent figures oneconomic growth, estimated to clock in at an annualized 7.7 percent, the slowest rate in three years.
The more important issue is what China's leaders should, or can, do about it.
China has produced a tattoo beat of disquieting news since March, when Premier Wen Jiabaolowered the government's growth target for 2012 to 7.5 percent, down from the 8 percent target in place since 2005. Real estate prices, trade growth, construction and luxury watch sales are all declining. The government has issued stern edicts for officials to cut back on flashy cars, banquets and other perks.
Overseas, the global economic slump and the persistent crisis in Europe have left China's mighty export engine revved up but with fewer places to go. Increasing exports to the U.S., which just displaced the European union as China's biggest foreign market, risks even greater trade tensions in a U.S. election year.
As a result, Wen is focusing on homegrown methods to boost growth, such as promoting domestic investment. This strategy risks repeating the excesses of the 4 trillion yuan ($586 billion at the time) stimulus package of 2008, which fueled inflation, pushed credit beyond sustainable levels and led to a property bubble. It also favors large, and often inefficient, projects by state-owned enterprises over small and medium-sized companies: Witness the government's decision in May to approve an $11 billion steel plant, for an industry in which there is already excess capacity.
Public Goods
A better approach would be for China's government to help its people and their economy by putting more money into public goods. According to World Bank data for 2008, China spent only about 1 percent of its gross domestic product on health, 3.7 percent on education, and 4.7 percent on pensions and other forms of social protection. The averages among members of the Organization for Economic Cooperation and Development are 6.3 percent, 5.4 percent and 15.2 percent, respectively. With more than $3 trillion in foreign reserves and a relatively light public debt burden, China is in a better position than most to shoulder such expenditures.
Beyond that, China needs to rely more on domestic consumption -- a point Bloomberg View has argued. To some extent, this is already happening: In the first quarter of 2012, domestic consumption accounted for 43 percent of GDP growth, versus 28 percent a year earlier. Rather than trying to support this trend artificially with cheap credit, China should put in place the kind of structural reforms that will create real spending power.
My view - With its western export markets remaining soft, to put it mildly, China knows that it needs to develop its domestic economy, and it is. It will balance this with some carefully targeted infrastructure spend, thus the modern steel plant mentioned above, which will be more efficient and less of a polluter than earlier mills.
Email of the day (1) - On a bearish article in the FT:
"I have pasted below an article in today's FT written by Jamil Baz (GLG). It is a coldly objective piece. If correct, it is a strikingly bearish scenario. Have you any thoughts considering your wise and philosophical perspective on markets?"
My comment - Thanks for this email and article, certain to be of interest to many subscribers.
In terms of "wise and philosophical perspective", I do not think any of the delegates or speakers at last year's Contrary Opinion Forum will forget your prescient summary of the Eurozone crisis during the concluding Q&A session.
Regarding Jamil Baz's article: Current debt crisis merely a warm-up act, which I have posted in the Subscriber's Area, it is certainly sobering. I have spent a career to date saying that we should regard extreme forecasts - up or down - as probable contrary indicators. Therefore, how nice it would be if we could dismiss Jamil Baz's view as a gratuitous rant from an inexperienced hack and congenital bear. He has certainly been bearish in the last few years but is a highly experienced and successful hedge fund manager, and also a lecturer at the University of Oxford, as you will see from this condensed portion of his biography on Bloomberg. He also has two degrees from Harvard and another from MIT.
None of this guarantees that his latest views are correct, but it does suggest that they should be taken seriously.
This feature continues in the Subscriber's Area.
The Weekly View: Nominal Growth and Government Rates Explain Europe's Problems and US Stability - My thanks to Rod Smyth, Bill Ryder and Ken Liu of RiverFront for their ever-interesting strategy letter. It is posted in the Subscriber's Area but here is the opening:
Nominal growth - the annualized change in the amount of goods and services sold multiplied by prices - drives sales for companies and drives government revenue (i.e., taxes), which allows governments to service their debt. Government bond yields are the cost of funding that debt. As long as nominal growth is higher than the cost of funding debt, even heavily indebted countries can buy the time to restructure their economies. This has been the US story since the Lehman Bros crisis.
For Spain, Italy, Portugal, Greece, and Ireland, borrowing costs that are higher than nominal economic growth have created a vicious circle of economic depression, rising deficits, chronically high unemployment, and rising government interest rates as investors conclude that some form of default is inevitable. France and perhaps even Germany are now coming close to falling into the same dilemma. In our view, a total commitment to achieving nominal GDP growth, even at the risk of future inflation, can prevent the economic crisis in Europe from getting worse. Germany is trying to decide if it is willing to adopt that approach.
