Signs Of Trouble In The Chinese Economy

Signs are brewing that the Chinese economy is slowing down significantly.

Signs that things may be turning sour in China:

GUANGZHOU, China — After three decades of torrid growth, China is encountering an unfamiliar problem with its newly struggling economy: a huge buildup of unsold goods that is cluttering shop floors, clogging car dealerships and filling factory warehouses.

The glut of everything from steel and household appliances to cars and apartments is hampering China’s efforts to emerge from a sharp economic slowdown. It has also produced a series of price wars and has led manufacturers to redouble efforts to export what they cannot sell at home.

The severity of China’s inventory overhang has been carefully masked by the blocking or adjusting of economic data by the Chinese government — all part of an effort to prop up confidence in the economy among business managers and investors.

But the main nongovernment survey of manufacturers in China showed on Thursday that inventories of finished goods rose much faster in August than in any month since the survey began in April 2004. The previous record for rising inventories, according to the HSBC/Markit survey, had been set in June. May and July also showed increases.

“Across the manufacturing industries we look at, people were expecting more sales over the summer, and it just didn’t happen,” said Anne Stevenson-Yang, the research director for J Capital Research, an economic analysis firm in Hong Kong. With inventories extremely high and factories now cutting production, she added, “Things are kind of crawling to a halt.”

Problems in China give some economists nightmares in which, in the worst case, the United States and much of the world slip back into recession as the Chinese economy sputters, the European currency zone collapses and political gridlock paralyzes the United States.

China is the world’s second-largest economy and has been the largest engine of economic growth since the global financial crisis began in 2008. Economic weakness means that China is likely to buy fewer goods and services from abroad when the sovereign debt crisis in Europe is already hurting demand, raising the prospect of a global glut of goods and falling prices and weak production around the world.

Corporate hiring has slowed, and jobs are becoming less plentiful. Chinese exports, a mainstay of the economy for the last three decades, have almost stopped growing. Imports have also stalled, particularly for raw materials like iron ore for steel making, as industrialists have lost confidence that they will be able to sell if they keep factories running. Real estate prices have slid, although there have been hints that they might have bottomed out in July, and money has been leaving the country through legal and illegal channels.

One of the more troubling statistics comes from the Chinese auto industry:

The Chinese auto industry has grown tenfold in the last decade to become the world’s largest, looking like a formidable challenger to Detroit. But now, the Chinese industry is starting to look more like Detroit in its dark days in the 1980s.

Inventories of unsold cars are soaring at dealerships across the nation, and the Chinese industry’s problems show every sign of growing worse, not better. So many auto factories have opened in China in the last two years that the industry is operating at only about 65 percent of capacity — far below the 80 percent usually needed for profitability.

Yet so many new factories are being built that, according to the Chinese government’s National Development and Reform Commission, the country’s auto manufacturing capacity is on track to increase again in the next three years by an amount equal to all the auto factories in Japan, or nearly all the auto factories in the United States.

“I worry that we’re going down the same road the U.S. went down, and it takes quite some time to fix that,” said Geoff Broderick, the general manager of Asian operations at J. D. Power & Associates, the global consulting firm.

Automakers in China have reported that the number of cars they sold at wholesale to dealers rose by nearly 600,000 units, or 9 percent, in the first half of this year compared to the same period last year.

Yet dealerships’ inventories of new cars rose 900,000 units, to 2.2 million, from the end of December to the end of June. While part of the increase is seasonal, auto analysts say that the data shows that retail sales are flat at best and most likely declining — a sharp reversal for an industry accustomed to double-digit annual growth.

“Inventory levels for us now are very, very high,” said Huang Yi, the chairman of Zhongsheng Group, China’s fifth-largest dealership chain. “If I hadn’t done special offers in the first half of this year, my inventory would be even higher.”

While all this happening in the real world, the government is Beijing is essentially pretending that the problem doesn’t exist, at least publicly. They’ve halted the release of any number of data points that would point to evidence of declining sales and rapidly rising inventories. Surely, the leadership is aware of this at an internal level, but likely they have no idea what to do about. That’s largely because there isn’t much that they can do. China’s economy has been running on overdrive for years, and for a long time analysts have been suspecting that the government has been cooking the books. It’s inevitable that a Day of Reckoning would come, and that day may be arriving.

As Noah Smith correctly points out, the real question at this point is what kind of a “landing” we’ll see from the Chinese economy:

No country can sustain 10% growth forever. Eventually, the twin forces of Solow catch-up and slowing technology transfer will bring growth down. If China follows the pattern of history, it is due for a moderate slowdown, perhaps to 7% growth, as demonstrated inthis paper by Barry Eichengreen and Kwanho Shin. In fact, the more sober economic forecasters have already assumed that 7-8% will be China’s “trend” growth rate going forward. 7-8% is not bad at all; hence, a “soft landing”.

The soft landing scenario is fundamentally a story about long-run supply. Hence, we should not expect unemployment to result. And indeed, for the past year, even as growth and investment slowed, Chinese unemployment stayed low.

In contrast, a “hard landing” would be the kind of thing the developed world saw in 2008 (and the developing U.S. saw in 1929) – a financial crisis, followed by a general flight to safe and liquid assets, a collapse in bank lending, and a rise in unemployment. This would bring growth down substantially below the 7-8% level. The “hard landing” is basically a gigantic aggregate demand shock.

In the case of China, the danger here is the combination of house prices and local government debt. House prices rose a lot in recent years, and many companies and local governments took out debt using the suddenly-more-valuable real estate as collateral, often making use of a “shadow banking” system(sound familiar?). If these debts default, banks will have to take big losses; since the banks are state-owned, they will certainly be bailed out by the federal government. Although China’s federal deficit is low – bailouts will not bankrupt the government – we’ve seen how even a successful bailout is not generally sufficient to get banks lending again after a financial crisis. China would have to respond by cutting interest rates; if rates hit zero, a liquidity trap would result and the recession would be prolonged.

Smith puts the odds of a “hard landing at about 20%, while Tyler Cowen thinks it’s more in the range of 5%. Meanwhile, another blogger points to a report from the Dallas Federal Reserve Board that the slowdown in China is worse than many think it is. Whatever the truth is, it seems like all anyone can do at this point is guess because the official statistics are quite obviously being cooked, and the government is, as noted above, hiding the extent of the inventory problem. That suggests that if a hard crash comes, it could come totally out of the blue with very little warning.

A guest author at The Big Picture points out the reasons for China’s problems, and what has to happen if they’re going to fix them:

China has relied one quantity expansion to sustain economic growth for a decade. This model was stretched by borrowing from the future: excessive use of worker overtime, high debts for financing, ignoring the environment to cut costs, relying on asset bubbles for profits and government revenues, and overexploitation of natural resources. There is only one resource left to sustain growth in the future: the productivity of Chinese workers. Their wage is still one-eighth of the level in developed economies. Only through rising labor productivity can China sustain another decade of growth. Rising wages could sustain consumption, and rising productivity could sustain supply growth. There is just not another path forward for the country.

Productivity growth depends on efficient resource allocation. The current growth model relies on the government to allocate resources. Financial resources are under the control of a government-owned banking system. Investment projects are mostly subject to government approval. The combination gives capital allocation power to the government. Without changing this model, productivity is unlikely to become the main source of growth.

The expansion of the government sector, now spending about half of the money in the economy, has severely decreased efficiency through increasing waste and gray income. As gray income has become a major reason for capital projects, their efficiency has declined. This is why China’s economy is so dependent on investment and so inflation-prone.

Most discussions on the economic and social issues frame China’s problems as similar to other countries’. They miss the point and mislead. China’s economic problems originate from government intervention in the market. Real reforms must involve changing the role of the government. Any reform that doesn’t focus on this is bound to fail.

Reducing the power of the government to manipulate the economy, and cook the books, would quite obviously reduce the power of the Politburo and party insiders who have made such things the center of their power base, many of them profiting quite handsomely from it along the way. For that reason alone, it seems unlikely that China’s leaders are going to cede power to the marketplace, especially since doing so is likely to lead to increased demands for liberty in other areas from the populace. If China truly is headed for an economic slowdown, though, they may have no other choice. A bad economy is likely to lead to a restive populace especially now that many Chinese have had a taste of what prosperity looks like.

FILED UNDER: Asia, Economics and Business,
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010. Before joining OTB, he wrote at Below The BeltwayThe Liberty Papers, and United Liberty Follow Doug on Twitter | Facebook

Comments

  1. We actually discussed signs of trouble in the Chinese economy back in July.

  2. Dave Schuler says:

    There may be another try from the at this point somewhat discombobulated Chinese leadership to boost domestic consumption via infrastructure spending. What I think they really need to do is to accelerate the plans for a universal system of social insurance to reduce the private savings rate and raise wages so more Chinese people can buy the stuff they’re making.

  3. stonetools says:

    Most discussions on the economic and social issues frame China’s problems as similar to other countries’. They miss the point and mislead. China’s economic problems originate from government intervention in the market. Real reforms must involve changing the role of the government. Any reform that doesn’t focus on this is bound to fail.

    This is nonsense really. Is there MORE government intervention in the Chinese economy now than in the boom years? Obviously not. This is right wing propaganda, pure and simple.

    Why is the Chinese economy slowing now? Because its part of the WORLD economy- a world economy that’s been in the toilet since the 2008 financial crisis.
    Now China responded to the 2008 crisis with a big stimulus that kept its growth going for a while longer, but eventually their stimulus ran out and the drag from the sluggish world economy has caught up to China.
    Austerian policies in Europe since 2008 and in the USA since 2010 hasn’t helped much either. Eventually the central bankers and governments in the USA and Europe will get their heads out of their collective @$$es and pursue more stimulative policies and growth will return here and in China.
    Dunno about the chances for political revolution in China, but increased government intervention in the Chinese economy is NOT the reason for the current slowdown.

  4. Dave Schuler says:

    @stonetools:

    Why is the Chinese economy slowing now? Because its part of the WORLD economy- a world economy that’s been in the toilet since the 2008 financial crisis.

    Because it’s excessively dependent on exports. That’s the reason for my prescription: more personal domestic consumption.

  5. stonetools says:

    @Dave Schuler:

    Because it’s excessively dependent on exports. That’s the reason for my prescription: more personal domestic consumption.

    I bet that the Chinese government do realize this and are moving to encourage more domestic consumption, but there ‘s no magic wand that the Chinese government can wave to accomplish that overnight-and no, deregulating the private sector will not immediately accomplish this, regardless of whether that would be a good idea or not.

    You might also want to look at this, from November 2010:

    The strong report also showed that China is increasing domestic consumption and is increasingly insulated from the struggle in the world’s advanced economies to recover from the Great Recession.

    LINK

    Apparently , increasing domestic consumption DID’NT insulate China forever from the world slowdown

  6. Dave Schuler says:

    @stonetools:

    There are multiple kinds of of domestic consumption. Unfortunately, too much of China’s increased domestic consumption has taken the form of infrastructure spending rather than personal consumption. IMO the personal savings rate is too high and the wages are too low.

  7. Jib says:

    Stop trying to tie this to any pet theories on economics and politics. We have 200 years of historic data on what happens when countries industrialize. No country, NONE, have ever industrialized without going through multiple economic panics, depressions and usually war(s). Industrialization is the ultimate in destructive creation, destroying millennium old social structures and replacing them on the fly with…..whatever you come up with at the time.

    This has nothing to do with more govt intervention in the economy or less. We industrialize in a libertarians wet dream of an economy virtually free of regulation and had almost 100 years of increasingly worse panics and depressions, massive social unrest and 1 civil war topped off with the great depression and the new deal while getting sucked into 2 world wars triggered in no small part by Europe’s industrialization.

    China is going at it much more like other European countries did, top down old institutions slowly giving up control and it too will go through depressions and wars and end up wherever it is going to end up. It will have depressions and panics and protests and even wars before this is over. Hopefully it wont get too bad but if history is any guide, it probably will.

  8. @stonetools, @Dave Schuler:

    One chronology I like is that the commie Chinese looked around Asia and noticed that economic growth could come with one-party leadership. I believe Lee Kuan Yew’s Singapore was a pivotal example.

    I think commentators who view China through a US prism miss the completely different Asian perspective. China was not “intervening in markets,” China was loosening specific sectors to recreate the Asian model of development through exports.

    It is widely accepted that China’s next move should be to develop internal consumption and etc. but it’s new territory. There isn’t really a previous model for that kind of planned transition.

    As I understand it, in the other Asian Tigers consumption grew naturally, over time, with wealth.

  9. Shorter: There aren’t many billion-person countries in transition. And of the two, China is holding it together amazingly well … so far.

  10. Nikki says:

    The problem is that those in power, whether it’s in China, the Eurozone or the US, can’t or are unwilling to figure out how to continue allowing the ultra-rich and the mega-corporations to abandon their civil obligation (through payment of revenue-generating taxes) to the rest of the world and still maintain a viable global economy based on consumerism.

    Sucks to be us.

  11. michael reynolds says:

    When do you suppose we can stop pretending that politicians in any given country have either the knowledge or the power necessary to somehow steer what is obviously a global economy?

    Go left! Go right! I told you to go left! Hey: there’s no map. Also: no steering wheel.

    Isn’t the world just Europe writ large? A vast interconnected economic beast governed in random chunks of irrelevant territory by governments that have as their sole goal holding onto power?

  12. Jib says:

    @michael reynolds: Yes but we have been here before, many times. Finance crosses borders, money and trade flows and govts appear weak. Then finance blows up, as it always does, govts get back in charge, borders are tightened, cross border trade and money flows reduced. Wash rinse and repeat.

    The thing is, some of the best economies in history have happened when international trade is restricted and finance is heavily regulated. The long term trend is for freer movement of capital and goods but nothing goes in a straight line.

    We are clearly headed back to less international trade and more restrictions on finance. For any country currently running a trade deficit, this will be good, for any country running a surplus, this will mean some hard times. But when exactly this happens, how long it lasts, who knows. Again if history is any guide we are talking about a 20 to 30 year cycle but each time is different in the details and we all live in the details.

  13. sam says:

    @Dave Schuler:

    There may be another try from the at this point somewhat discombobulated Chinese leadership to boost domestic consumption via infrastructure spending.

    More ghost cities?

  14. Dave Schuler says:

    It kicked the can down the road worked last time.

  15. Ben Wolf says:

    @Dave Schuler: I don’t expect any significant movement from the Chinese on stimulating domestic demand. More likely they’ll choose to double down on stimulus via exports and hammer the U.S. economy even harder, given that we sit on our hands when other nations drain our economy to fuel their own.

  16. Dave Schuler says:
  17. jd says:

    Of course they’ll have a soft landing. They don’t have their bankers tossing them an anvil and then betting how hard they’ll hit.

  18. Ben Wolf says:

    @jd: It will be interesting to see just how smart the PRC leadership is, whether they’ll realize the incredible power government has as the issuer of currency, and whether they’ll use that power in the next year. China is beginning to suffer from the same sort of balance-sheet recession which is afflicting the developed world: will they simply hit the reset switch and eliminate that debt, or will they attempt to ride it out through stimulus spending?

  19. Ben Wolf says:

    @Dave Schuler: You know the score here just as well as I do.
    Everyone is still running the same playbook, depending on U.S. spending to pull their feet out of the fire. So far it has avoided a global depression, but at some point these countries need to take responsibility for their own economies.

  20. Dave Schuler says:

    They’re getting away with it so far.