China: Manufacturing Numbers Reinforce the Pessimist’s Outlook

There is some good news about Chinese retail sales, although I am not sure how useful it is because retail sales numbers in China have always been a little hard to reconcile with other indicators of domestic demand. According to an article in today’s Bloomberg:

Retail sales in China rose 13 percent during the three-day New Year holiday from a year earlier as both rural and urban consumers spent more, state television reported, citing commerce ministry data. Retail sales were 12.5 billion yuan ($1.83 billion) in the first three days of the year, China Central Television reported, citing a ministry survey of 1,000 major retailers. Household appliances and cars topped the list of purchases, CCTV said.

Against this, two recent indices indicate that manufacturing output continues to fare badly. The CLSA China PMI, released Friday, was 41.2 in December, the second worst month since the index started in 2004 (November clocked in at 40.9), and the fifth month in a row that in comes in below 50, which indicates a contraction in manufacturing output. The PMI produced jointly by the China Federation of Logistics and Purchasing and the National Bureau of Statistics was released today and, coincidentally, also came in at 41.2. According to an article in today’s Xinhua:

The Purchasing Managers’ Index (PMI) of China’s manufacturing sector climbed 2.4 percentage points month-on-month to 41.2 percent in December, China Federation of Logistics and Purchasing (CFLP) told Xinhua Sunday.

The index has been lower than 50 percent for three consecutive months. It was also the fifth time the index remained below 50 percent within last year after it fell to a record low of 38.8 percent in November. The new monthly figure reflected the country’s economy had further contracted, analysts said.

The article then goes on to quote Zhang Liqun, a researcher with the Development Research Center of the State Council, as saying that “the PMI figure indicated the economy remained in the tank but the number of purchasing managers who were bullish on the economy was on the rise. He said with previous macro-management policies taking effect, the economy would embark on a relatively fast growth track after the spring next year,” although the news agency regularly tries to put a positive spin on bad economic news, so perhaps we shouldn’t take Mr. Zhang’s comments too seriously.

The contraction may not be as bad as it seems because some of it seems to represent the running down of overstocked inventories, and so output could rebound in one or two quarters as inventories decline to the minimum necessary levels. Still, according to the CLSA report “Chinese manufacturers reduced the size of their workforces at the fastest rate recorded by the series to date.” An employment index it created suggests that in December we completed the fifth month of net layoffs, and of course rising unemployment is likely to lead to further contractions in demand. The risk is that we get caught in a spiral in which output declines to meet lower demand, but firing workers further forces demand to decline further. Unless there is a sudden rebound in export orders (don’t hold your breath) it will be up to new government spending to absorb unemployment and prevent demand from contracting further.

On that note Xinhua yesterday published a less upbeat story:

Cai Fang, a renowned labor expert in China, warns the country may see more job losses among urban workers in 2009 after millions of migrant workers became unemployed last year. The majority of job losses in 2008 were mainly reported among migrant workers, Cai, head of the Population and Labor Economy Institute under the Chinese Academy of Social Science (CASS), wrote in an article published in Caijing Magazine in December.

Migrant workers, who often work in factories, are among the first to bear the brunt of the current global financial crisis. Statistics from the Ministry of Human Resources and Social Security showed 10 million of China’s total 130 million migrant workers went back to their rural hometowns jobless last year after some exporters were forced to shut down or halt production to avoid losses as a result of decreased overseas demand. As a result, the income of rural and urban residents could grow at a slower pace, Cai said. The deceleration of income growth would definitely hurt consumption, he added.

There is a lot of hope being placed on either a revival of the export environment in early mid-2009 or on the success of the government fiscal expansion. The fiscal expansion plan is still too fuzzy to inspire much confidence and a number of Chinese economists I have spoken with recently are openly disparaging – even in print and on TV. One of them told me that he was worried that the government would be so desperate to boost growth that he wondered if we might not find ourselves having to choose between allowing growth to decline more sharply than anyone is comfortable with, or pulling out all the stops to jam growth forward, but in so doing create so much unsustainable and un-repayable debt that both the government and the banking system find themselves in real straits in two or three years.

Since this is something I also have been writing about, needless to say I agreed with him that there is a real risk that we “solve” the current problem by creating a more-difficult-to-solve debt problem in a few years. This is in line with my longstanding contention that there is no policy solution to this problem if by “solution” we mean some way of avoiding the consequences of massive overcapacity. It is just going to have to run down one way or the other, and without serious international cooperation the real policy choices for China are between “bad” outcomes and “worse” outcomes.

Actually quite a few local economists have been talking about the explosion in bad lending that they are expecting, and – no local economist, since he is American, but someone with a great view on Chinese policymaking – Victor Shih at Northwestern had a Wall Street Journal Asia Op Ed a few days ago which got a lot of attention and discusses exactly this problem. He says:

Risk-prevention institutions built up over the past decade are now under enormous pressure to forgo prudence in the interest of maintaining economic growth.…Meanwhile, if the economy worsens in the first quarter the government may be tempted to abandon prudent regulation altogether. Beijing could order the CBRC to disregard risk targets or even abolish the CBRC. This would plunge China back into the old days when the only risks that bankers faced were political ones.

I confess this is the thing that worried me most about the fiscal expansion plans. Since the social and political stakes are higher in China than in many other places, I think there is too great a risk that we overreact to the current mess by creating a potential debt disaster. This means that the next two years might not be as bad as I am expecting, but they will be followed by an even greater problem – another banking crisis – and without the furious global growth and ample liquidity of recent years, it will be much harder for China to grow its way out of a repeat of the late 1990s banking crisis.

I am struck in my conversation with Chinese economists about how openly dismissive they often are of recent policymaking. This adds some substance to the claims by my more politics-savvy friends that the debate – I hesitate to say warfare – within policy circles is hotter than ever. Blame, apparently, is flying back and forth, and even leaders at the highest level are facing strident criticism. This isn’t bad for China, of course, since one of the problems here has been the difficulty of changing policy once it has been decided, and a more intense debate should lead to a more realistic understanding of the consequences. It does suggest however how nervous people are.

One last comment before closing – I mentioned that there is still some hope in many quarters that there will be a revival in exports that may help pull China out of the current mess – even to the extent of people feverishly citing the explosive growth in Sino-Indian trade as an indication of things to come (although funnily enough Sino-Indian trade is almost negligible). I suspect that only people who have the dimmest understanding of the global environment and no sense of how the global balance of payments works hold this view (which is not to suggest that they aren’t the overwhelming majority), but it is probably reflected in the continuing debate about what must be done for China to regain its “competitiveness.”

In that light I though I would quote from an interesting article I read published by The Economist a scant few weeks (November 23) after the stock market crash of 1929. Perversely enough I love reading old article on economics and business news, and The Economist is a great source. This one says:

In any case, against any disadvantage arising from American competition must be set the great advantage which we mentioned at the outset, namely, the return to cheap money conditions. This should assist trade recovery throughout the world, which has been handicapped for so many months past by the abnormal financial conditions in New York. If we are justified in assuming that the setback in American industry will only be temporary, we may look forward to steady development in 1930, free from the incubus that has of late been hampering world conditions.

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About Michael Pettis 166 Articles

Affiliation: Peking University

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.

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