Multinational China execs feel chill wind, not hot growth

30 Sep 2015 | Author: | No comments yet »

China Bear Jim Chanos: The Emperor Is in His Underwear.

SHANGHAI (Reuters) – China’s economy is officially growing at a brisk clip of 7 percent, but many locally based executives at multinationals say they wouldn’t know it from the performance of their businesses. Increasingly reliant on each other for sustainable economic growth, the United States and China have fallen into a classic codependency trap, bristling at changes in the rules of engagement.

By China’s standards 7 percent is already the weakest annual growth in 25 years, but on the ground the slowdown in the world’s second-biggest economy is being felt more acutely in many sectors, even those driven by consumer spending, which government data says is growing around 10 percent. “How can China’s economy be growing at 7 percent?” said an executive at a Western conglomerate that does business with a wide range of Chinese and foreign firms in China. He explains how he became concerned that the world’s second largest economy is headed for trouble. *This post originally appeared on the blog for the Institute for New Economic Thinking. Reuters spoke to 13 executives in charge of China operations at international firms, and nine said they felt they were operating in an environment where the economy was growing between 3 and 5 percent. Just the other week, in her press conference explaining the decision to leave the targeted federal funds rate unchanged, Fed Chief Janet Yellen invoked China 16 times, directly or indirectly. Jim Chanos: Way back in fall of ‘09 we were looking at why the global mining business was actually doing so well through the teeth of the recession, the crisis of 08-09.

However, a US survey of China’s economy, based on the Fed’s Beige Book, indicates that the Chinese economy is not nearly as weak as commonly believed, with services, which make up more than 50 percent of its gross domestic product (GDP), growing strongly and gaining momentum. I knew intuitively it was because China was a vast source of demand for commodities, but I didn’t know how much until my real estate analysts put some numbers up on the white board. China’s National Bureau of Statistics made headlines earlier this month with its less-than-compelling revision of its 2015 GDP growth forecast from 7.4 percent to 7.3 percent. For China-watchers, who believe the actual rate is only 4 to 5 percent, the revision confirmed that Chinese economic data is notoriously unreliable, if not plain wrong.

China provided cheap goods that enabled income-constrained American consumers to make ends meet, and the US provided the external demand that underpinned Deng Xiaoping’s export-led growth strategy. Xie Zongyao, chief operating officer at Shanghai’s Super Brand Mall, one of Shanghai’s largest shopping malls, backed by Thailand’s Charoen Pokphand Group, said sales had shown a slowdown over the past two months after posting double-digit growth in the first half of the year. “Performance (in the last few months of 2015) is not expected to be better than the first half, so we will come up with more solutions to drive sales.” E-commerce giant Alibaba Group Holding Ltd said earlier in the month it expected its total value of transactions – one of the most closely watched metrics for e-commerce companies – to be lower than previously thought in the July-September quarter because of lower spending. In 2003, Jim O’Neill, the father of “BRIC,” and his Goldman Sachs GS -0.67% team predicted that by 2015, China’s real GDP growth rate would only be 5.2%, and would drop below 5% by 2017.

But across a large swathe of the industrial north, provinces like Gansu, Liaoning and Heilongjiang are coming in well below their growth targets and many plants are idle. If half of that was office and mixed commercial space, — 30 billion square feet out of the 60 — and China has 1.2 -1.3 billion people, then you’ve got a 5’ x 5’ office cubicle for every man, woman, and child in the country! A China-based executive in the heavy machinery industry said orders at his firm and affiliates were down about 50 percent from a year earlier, mainly because of the sluggish real estate market, and he had his work cut out getting that message across to head office. It has adapted a more muscular foreign policy in the South China Sea, embraced the nationalistic longing of rejuvenation, framed by what Xi calls the “China Dream.” And it has started to reshape the international financial architecture with new institutions such as the Asian Infrastructure Investment Bank, the New Development Bank, and the Silk Road Fund. The US response has put China on edge, particularly America’s so-called “Asian pivot,” or “strategic rebalancing,” with its subtext of containing China.

The US recognises the need to increase China’s role in the existing Bretton Woods institutions (the International Monetary Fund and the World Bank); but when it fails to deliver, it chafes at Chinese institution building. And while the US has long urged China to tilt its growth model toward private consumption, it is uncomfortable with many of the implications of this shift. It is true that China’s stock market has dropped 40% from its peak, but that’s less an indication of China’s slowdown than a correction from an irrationally engineered bubble. There is a feeling that the state-owned banks and enterprises lack the creative flair and freedom to give China’s private sector room to leap forward as it must to achieve this goal. The net national saving rate (businesses, households, and the government combined) stood at just 2.9% of national income in mid-2015, less than half the 6.3% average over the final three decades of the twentieth century.

As China shifts from surplus saving to saving absorption—using its surpluses to build a safety net for the Chinese people rather than subsidise the savings of Americans—a saving-short US will find it tough to fill the void. During the last 20 years when China was experiencing rapid growth, its stock market barely budged barring occasional irrational exuberance and correction. By citing international concerns—especially China’s slowing growth—as a major reason for deferring its long-awaited interest-rate hike in September, the Federal Reserve has left little doubt concerning the key role that China plays in sustaining a still-fragile US recovery.

Now, you may end up with lots of white elephants and a banking system with lots of bad loans, and that’s the problem, whether you’re a closed system or an open system or somewhere in between (which is what I believe): a closed system with lots of leakage. So the outlook for China, the US’s third-largest and most rapidly growing major export market, is crucial for a Fed that has failed to gain much traction from its unconventional post-crisis monetary policies. This is aggravated by deterioration in banks’ asset quality with exposure to ailing mining, manufacturing and provincial sectors, which have seen a steep dive in profitability. What has made 2015 much different from 2010, other than magnitude (almost everything I saw in 2009-2010 is twice as big today: the banking system, the economy, debt to GDP), is that the veneer of technocratic excellence has been wiped away.

Speaking in Seattle on September 22, Xi stressed the need for both the US and China to deepen their “mutual understanding of strategic intentions” as a key objective for the bilateral relationship. Reforms on the local government financing platform and the shadow banking system, which is estimated to be around 25% to 50% of GDP, are already under way. The agenda was shaped more by disconnected issues—cyber security, climate change, and market access—rather than by an appreciation of the strategic challenges that both countries face alone and together. Both sides hailed a newfound commitment to high-level exchanges on cyber crime; but the US is about to impose sanctions on Chinese companies that have benefited from egregious hacking. From a South African viewpoint, the focus on China is through the lens of commodity prices, which have tanked in recent years as the key buyer has slowed down.

The other thing that’s changed dramatically, and I think more ominously, is the rise of Xi Jinping, who is a much different leader than the previous two groups of party leaders. The market had risen by 150 percent in quite a short time, boosted by a “close your eyes and buy” retail casino mentality on the back of margin credit. To its credit, China did announce an important shift in environmental policy—a nationwide cap-and-trade system for greenhouse-gas emissions, to go into effect in 2017. Despite demographic problems stemming from the one-child policy, over the next decade the huge population, massive urbanisation, economic reforms and infrastructure spend will gradually turn China into the world’s biggest consumer and services economy, with all the scale benefits that implies.

Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China Then Xi comes in, and his first speech is a fiery speech in Guangdong Province, where he absolutely rips into the Soviet Union for being soft on Perestroika. Verified email addresses: All users on Independent Media news sites are now required to have a verified email address before being allowed to comment on articles.

I think that that’s just a factor of the law of large numbers and the fact that when you have an investment-driven model — they long ago stopped being an export-driven model — by its very nature, you begin to show diminishing returns on capital. So, yes, they can keep GDP up by putting up another hydroelectric damn or building another highway, but if nobody travels on it, and there’s no river there, plus you have all this stuff you have to maintain, it’s expensive! Finally, I believe a good 40-50 percent of that 50 percent I mentioned (physical investments as a percentage of GDP) — i.e. 20-25 percent of it — is residential real estate. Finally they realized that just strengthening the RMB was going to simply kill their manufacturing business because most of the stuff manufactured in China is not for domestic consumption.

So I think inexorably they were the last holdout in the worldwide beggar-they-neighbor/cut interest rates/flood money trend, and now they’ve joined in it. LP: We hear a lot about China’s “new normal” – that what we’re seeing is just an extended period of slower expansion as the country transitions from an infrastructure-led economy to one driven by consumption, and that everything will turn out ok. I mean, when I first looked at China, investment was 48 percent of GDP and five years later after all this hand-wringing and realization that we have really get serious, it has plummeted to 46 percent of GDP. So they talk about it, and they talk about reform, but the fact of that matter is that to get to that point, they would have to drop investment and that would put the economy immediately into a tailspin.

So they’re caught between this rock and a hard place of not being able to do exactly what they know they should do, which is to cut the investment, because that will bring on a recession. Every time it seems that the economy takes another leg down, they pull out another set of infrastructure projects and announce they’re going to build them. That’s what a little bit of 2015 in China has been all about –the realization that the emperor might not be naked, but he’s pretty much in his underwear.

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