I know nobody wants to hear this and I know this is going to cause me to get hate mail from those whose livelihoods are tied in to China’s continuing to boom, but I am seeing all sorts of bad news on the horizon with respect to China’s economy.

A client meeting yesterday was the last straw. The client I met with is very sophisticated, very large, and, most importantly, very experienced. The client is a very large commodity seller who sells massive amounts to China. This company typically sells its product to Chinese private companies that use letters of credit. Prior to 2008, this client’s Chinese customers pretty much always paid. Then in 2008, they started contesting the letters of credit and seeking lower prices than that to which they had agreed. Soon after that, they started rejecting the shipments entirely. My client told me that in the last 3-4 weeks, nearly all of his non SOE (State Owned Entity) Chinese clients have contested the letters of credit and have sought lower prices of around twenty percent. They are confessing to my client that they cannot get loans and without loans they cannot pay so much.

If it were just that, I might chalk it up to problems in one industry, but it is not just that. Chinese companies that are going out of business or believe they are going out of business have an annoying tendency to ship bad or fake or no product at all. In 2008, pretty much every week we were getting calls from companies saying that the product they had ordered just was not coming. We handled one case where a company had bought about a million dollars of fish and received containers of cheap bricks surrounded by fish. That fake shipment was the dying gasp of a company that ceased to exist. We have started to get those same sort of calls in large numbers again.

We are also seeing it on the flip side of Chinese companies buying product from our U.S. clients or even trying to buy U.S. companies outright. The numbers are small to begin with, but it just seems like we are seeing an increase in Chinese companies that paid a deposit simply walking away from their deals.

What are you seeing out there? Is it really this bad, cause it sure feels like it?

  • Andeli

    Don’t worry in 6 months the Peoples Bank will open the floodgates of money again and all will be good until next time.
    This will go on until 2025 and than China will have become Japan and EU.

  • G. Brauer

    Over the last few years, a local private high school has had an increasing number of students from China. This fall, only a fraction of the admitted students have come to enroll. (Of course this could be due to visa issues or more students apply to multiple schools.)

  • chinamike

    Hi Dan,
    I just posted my most pessimistic post on China in years right before I came here.
    I am feeling gloomy and pessimistic and the new crackdown on media and internet is the cause.
    http://www.technomicasia.com/blog/
    Michael Zakkour

  • Hey, at least you are willing to tell the truth (whether people want to hear it or not). All of these problems really go back to the fact that companies do not research their suppliers correctly.

  • FWIW – I haven’t seen it yet, but then there has been the Wenzhou crisis. As for the PBOC opening the taps again – well, there’s only so many times that can happen in any given time-period. There’s only so many times you can go to the well before it’s dry.

  • Paul Denlinger

    This is a shakeout affecting companies who have insufficient earnings to move up the value chain. The Chinese govt wants Chinese companies to move up the value chain; unfortunately there aren’t enough consumers worldwide to buy everything they produce.
    We are all running into the end of consumerism. Eventually this will cause the fragmentation of globalization, and people are already moving back to buying local products for food, etc. in the US.
    It is necessary to cultivate our own gardens. Oh well, globalization got a decent shot in the trade arena, but its time has come and gone.

  • Twofish

    Andeli: Don’t worry in 6 months the Peoples Bank will open the floodgates of money again and all will be good until next time.
    Things happen quick in China. Wen has indicated the the floodgates are going to be loosened a little bit.
    Looks like the standard business cycle. Inflation high, government cuts credit. Businesses get starved with credit, they start to fall under. Government relaxes credit, you get back to high inflation. Keep repeating.
    Credit crunches and boom/bust cycles in China are like blizzards in Minnesota or earthquakes in California. They happen so often, that what shocks me is when people assume that when it happens, it’s the end of the world. If you look at the long term trend, the government is getting better at managing the boom/bust cycles.
    Also export manufacturing companies are getting killed, other companies aren’t….. One thing that export manufacturing companies are finding is that the cheap labor is gone. You are starting to get well-paying service jobs which means that you can no longer find cheap workers.
    The other thing that sort of amazes me is when someone gives advice and then is shocked at the consequences when people finally take it. For years, China has gotten this standard lecture that it should raise the RMB, cut the trade deficit with the US, move to higher value industries, boost incomes, and focus on domestic growth rather than exports. Now they are actually doing it, and they are doing it now because people have spent a few years thinking about the consequences, and they are manageable.
    If you squeeze China to get the trade deficit and raise the RMB, guess what? A ton of manufacturing companies go under. It’s part of the plan.
    What is happening is that the Chinese government has set things up so that all of the workers that would have been hired by manufacturers are now doing other things (you see a ton of help wanted signs).

  • Twofish

    FOARP: FWIW – I haven’t seen it yet, but then there has been the Wenzhou crisis. As for the PBOC opening the taps again – well, there’s only so many times that can happen in any given time-period. There’s only so many times you can go to the well before it’s dry.
    As long as you have robust economic growth, you can keep going to the well, and you had to do something anyway.
    The southern China manufacturing engine has reached it’s limits. For those companies to keep going you would have had to keep a trade deficit down and wages low in a way that was both politically and economically unsustainable, so the question was not if they would get shut down, but when and how.
    If you go to the south China factories it is all doom and gloom. If you go outside the factories and on the streets, it isn’t and there are help wanted signs going over the place. Ironically, what is doom and gloom for the factory owners isn’t that bad for everyone else. If you ask the owners what their big problem is, you’ll find that it’s that no one is willing to work for cheap any more.
    If you are a Chinese export manufacturer, it’s awful. If you are a clean energy or software start up, its quite good, and high technology industries create a set of secondary service industries.

  • Hua Qiao

    I’ve been in China long enough to know that nothing is as it seems. And usually that means there is a nice veneer that has been added to make things look nicer and better made than they are. That’s true in business too. Coverups happen all the time. ALL THE TIME. I’ve learned to look at a situation and assume the worst. Then I double that worst case scenario. It is a pretty accurate rule, a kind of Chinese Murphy’s law.
    So, I think things are pretty bad out there. The very worrisome thing is the shadow lending market has become big, a lot bigger than the CBRC will admit and this means regulators cannot control the money supply or the granting and collection of loans. If shadow lending gets big enough, then the playbook that banks used in 1999 and again in 2005 (extend and pretend combined with sales at par to asset management companies) cannot be used. Shadow lenders demand payment, foreclose putting downward pressure on real estate, companies that borrowed and then invested in entrusted loans, wealth management products and informal lending syndicates cannot get their money back, and they default, etc etc.
    Look at the solution put forth by officials in Wenzhou. Banks are not to call in loans or foreclose and they are to extend maturing loans, and so on. This doesn’t work too well if a big part of the implosion is in the private market. Maybe they can avert a panic. Maybe not.

  • CLP

    Apt comparison. It is starting to feel like 2008 and I think that Americans are missing it because as bad as things are in the United States, they are not as bad as in 2008 and they are not as bad as things are in Europe. This idea of China moving upstream in terms of value added is a complete crock. The reality is that China is still very much an export driven economy and with Europe so far down, China is really starting to feel it. What you have written about is not surprise to me. I am just surprised more people are not writing the same thing.

  • Dennis

    Two Fish,
    that seems to be a pretty optimistic assessment. Consumption has dropped down to 33% of the Chinese economy in 2010.

  • Zhonghua Xiaojie

    @CLP – because maybe they live in China instead of the US

  • Twofish

    Hua Qiao: And usually that means there is a nice veneer that has been added to make things look nicer and better made than they are.
    Sometimes. I’ve also been through so many rounds of *CHINA IS DOOMED* that that also gets old.
    Hua Qiao: If shadow lending gets big enough, then the playbook that banks used in 1999 and again in 2005 (extend and pretend combined with sales at par to asset management companies) cannot be used.
    That’s not the playbook for shadow lending. The playbook for shadow lending is count the number of demonstrators. If you have a mob of angry people who are upset they have lost their money, then the government will do something. If not, then not. The thing about shadow lending is that unlike government bank loans, you shouldn’t expect a bailout.
    Hua Qiao: Shadow lenders demand payment, foreclose putting downward pressure on real estate, companies that borrowed and then invested in entrusted loans, wealth management products and informal lending syndicates cannot get their money back, and they default, etc etc.
    Been there done that.
    Hua Qiao: Look at the solution put forth by officials in Wenzhou. Banks are not to call in loans or foreclose and they are to extend maturing loans, and so on. This doesn’t work too well if a big part of the implosion is in the private market. Maybe they can avert a panic. Maybe not.
    If there is any sign of a panic, the government will just start throwing out bags of cash again, but there’s no panic that i can see. If you put your money in a nice safe zero interest bank account, then there’s no reason to worry since the government is going to bail you out. If you have your money in anything else, then if you ask for your money, then what part of “the loan was illegal” do you not understand? If you start asking for a bailout for an illegal loan, people will laugh at you.
    Dennis: that seems to be a pretty optimistic assessment. Consumption has dropped down to 33% of the Chinese economy in 2010.
    There are three parts of GDP. Consumption, Investment, and Net Exports. Net exports are not going to increase. The government will pump enough money into investment to keep up demand.
    Also, living in China makes a big difference. It *doesn’t* feel like 2008. The economy feels a lot healthy now then it did in the beginning of the year. At the start of 2011, the Chinese economy felt like being in the middle of a bubble. Food prices were starting to get crazy and real estate was even crazier. The government popped the bubble before it got out of hand. Factories *are* shutting down left and right, but there are help wanted signs all over the place, and there isn’t much of a sign of unemployment.
    Think of it this way. You have a factory that is barely breaking even. Inflation is 6% and then the cost of labor has risen 20%. The RMB has appreciated 15%, and your customers are not willing to pay any more. You seriously start to lose money. You can eek out for a while by borrowing money, but then the government starts cutting credit so the money disappears, and if you are borrowing from loan sharks, you aren’t going to be in business for long anyway. So everything comes crashing down. However, the key here is that because people end up with jobs in service companies,

  • Andeli

    @Twofish
    Looks like the standard business cycle. Inflation high, government cuts credit. Businesses get starved with credit, they start to fall under. Government relaxes credit, you get back to high inflation. Keep repeating
    I would agree but food inflation worries me. I am not sure what will happen to food prices if the government relaxes credit again. Food prices have not really come down anywhere in world and in China food production is still lacking capacity. Because of this there is not as much room to flush the market with cash as before. So this might not be a standard business cycle.

  • Hua Qiao

    @twofish
    I am not saying China is doomed. I’m just saying it is not as strong a picture as people would say, thus the veneer. And you are right, the government can just monetize the problem. But my point is that the playbook for socializing bad investment decisions is different this time around to the extent that shadow lending is a material part of the financial sector. Citizens will take hits to their wealth directly just like what is going on in Ordos and Wenzhou. No national panic yet. Maybe happy talk, supression of news and selective directed bank lending will avoid the problem.
    As to investment continuing to support the GDP, there comes a point when even Chinese Banks, not known for their risk management, will say the emperor has no clothes and stop lending on projects that have no chance of ever being repiad. At upwards of 50% of gdp, investment brings accelerates the spending impact to first year but spreads repayment over multiple years. In China’s case of building a lot of bridges to nowhere, that repayment period is infinite. Just look at the Ministry of Railways which was the most unquestioned credit of all 2 years ago. Now they are having trouble generating the financing to continue their buildout of the system.

  • PaulR

    I can’t speak to the economy as a whole, but it seems that farmers in China, for perhaps one of those rare few moments in Chinese history, seem to be sitting in the cat-bird seat. Agriculture prices are strong, and in many cases, still rising.
    I think that 30+ years of urbanization and one-child policy have left China with less land, fewer farmers to grow things on that land, and a lot of hungry consumers are now used to eating well.

  • Twofish

    Hua Qiao: I am not saying China is doomed. I’m just saying it is not as strong a picture as people would say, thus the veneer.
    All economies have problems, but right now I’m much, much, much more worried about the European and US economies than I am about the Chinese economy. The Chinese economy is in much better shape than the Europe/US economies.
    Also, the idea that “the real situation is worse than what you see” very quickly leads to “China is doomed”. What happens is that someone sees something assumes the real situation is worse, writes an essay. Someone takes that essay, assumes that the real situation is worse writes another essay. Someone takes that essay, assumes that the real situation is worse, writes and another essay. Pretty soon you get China is doomed.
    You can see this in action with discussions about local government debt and NPL’s. Person A quotes Person B, and adds RMB 100 billion to the possible debt. Person C quotes Person B, adds RMB 100 billion. Person D quotes Person C. Etc. Etc. Pretty soon you get crazy figures that are all out of proportion to the real situation.
    Hua Qiao: But my point is that the playbook for socializing bad investment decisions is different this time around to the extent that shadow lending is a material part of the financial sector.
    Shadow banking has always been part of the financial sector. The big banks have never lent to small-medium enterprises or the export manufacturers, so there has always been a network of shadow financial institutions to take up the slack see “Back-Alley Banking: Private Entrepreneurs in China” by Kellee Tsai which was written in 2002 and covers the history of the informal banking sector back to the mid-1980’s.
    The good thing about shadow banking from the government’s point of view is that the liabilities of the shadow banks are to a large extent not subject to a bailout. It’s happened before, so this is not a new thing.
    Hua Qiao: Citizens will take hits to their wealth directly just like what is going on in Ordos and Wenzhou. No national panic yet. Maybe happy talk, supression of news and selective directed bank lending will avoid the problem.
    And government will count the number of demonstrators, and if its not a large number, then nothing will happen.
    If there is a large drop in demand, the government will start pumping money into the system. There are likely a large number of SOE’s that invested in these companies, but because they invested assets rather than liabilities, this doesn’t transmit the losses to the banking system.
    Also Chinese households and businesses have large reserves of cash, which means that people don’t change spending habits much if they lose money in the stock market or through bad investments.
    Hua Qiao: As to investment continuing to support the GDP, there comes a point when even Chinese Banks, not known for their risk management, will say the emperor has no clothes and stop lending on projects that have no chance of ever being repiad.
    Chinese banks have excellent risk management. Also a bank will lend anything if you have someone guarantee the project, and any loans that the government forces the bank to make are implicitly or explicitly guaranteed by the government. The reason that state banks loan very heavily to SOE’s and local government is that they believe (and likely to believe correctly) that those loans are guaranteed by the central government.
    In any case, Chinese banks are arms of the central government, so in the end they will make the loans that the government orders them to, since it’s the government that ultimately makes the basic decisions.
    Hua Qiao: At upwards of 50% of gdp, investment brings accelerates the spending impact to first year but spreads repayment over multiple years. In China’s case of building a lot of bridges to nowhere, that repayment period is infinite. Just look at the Ministry of Railways which was the most unquestioned credit of all 2 years ago. Now they are having trouble generating the financing to continue their buildout of the system.
    So the get the money from the central government, and the central government gets the money for the extra tax revenues that these projects generate.
    The thing about infrastructure projects is that much of the economic growth they create is secondary. For example, with railroads, you not only make extra money from the people that use the railroads, but for the companies that come into existence if the railroad is there. At this point, you can (and should) pay for the railroad out of the extra wealth that is generated from the railroad which gets taxed.
    I think it’s going to work out fine at least for the next two decades. There are schools of economic thought that say that government should stay out of economics because governments inherently misallocate resources more than the private sector, but after 2008, I (and a lot of other people) don’t believe any of this.
    China will reach a point at which building an extra road or railway doesn’t generate new tax revenue, but we aren’t at that point yet.
    In any case, that’s the future. We can argue about whether China *will* have a crisis, but the fact is that outside of the export manufacturing sector in which companies are dropping like flies, China *isn’t* in a crisis.

  • Dennis

    “There are three parts of GDP. Consumption, Investment, and Net Exports. Net exports are not going to increase. The government will pump enough money into investment to keep up demand.”
    So out of the three components the only one that is growing is “investment” and its the only one that has been growing the last 3 years, and at the same time consumption has been collapsing. Hmm could they be related to each other?
    And how does that translate into a consumer economy? And how do you know those investments are actually economical,? Building airports all over 3rd string cities ups the GDP numbers but it seems unlikely that its the kind of investment that will provide a return on capital. The Ministry of Rail has 330 billion USD in debt, how is that going to be solved? Another 1990s style bad debt asset managers?
    When you say “the government is going to pump money into the system” all you are really saying is “real interest rates are going to drop further, decreasing consumption further, increasing future non-performing loans”

  • Hua Qiao

    @ Twofish
    If Chinese Banks are such great risk managers, why did they have to be recapitalized in 1999 and again in 2005? I am in the industry in China and so i can see it firsthand. Who blew the lid off local government investment platforms? Victor Shih, a US economics professor. Who exposed the issues with the shady practices of wealth management products, loans peddled by banks to wealthy individuals carrying an implied bank guarantee? Charlene Chu at Fitch’s. CBRC was in denial on both and have since come around to focus on these issues.
    When you have the lack of transparency and denial that you have in the China financial and fiscal arenas, such contrarian speculation is natural. The reason i agree with you that a true crisis probably won’t happen is that the prc has a very pliant population, able to bear a lot of pain, far more than the europeans who whine when they are told they may not retire until 58 years old.

  • Twofish

    Hua Qiao: If Chinese Banks are such great risk managers, why did they have to be recapitalized in 1999 and again in 2005?
    Because they were lousy risk managers in 1995, and they were lousy risk managers because in 1995, the commercial banks were mainly employment agencies rather than profit-seeking institutions. Maybe that wasn’t a bad thing.
    What ended up happening in the 1990’s was that there were massive costs associated with corporate restructuring of SOE’s and these were undertaking through bank loans which were ultimately to be paid for by the government.
    In the current situation, it’s likely that the central government will be the ultimate payer of a lot of the loans that went out. What is likely to happen is that the loans went to local governments, and so to insure payment the government will increase transfer funds to local governments which is something they were planning to do anyway.
    Hua Qiao: I am in the industry in China and so i can see it firsthand.
    So can I.
    Hua Qiao: Who blew the lid off local government investment platforms? Victor Shih, a US economics professor. Who exposed the issues with the shady practices of wealth management products, loans peddled by banks to wealthy individuals carrying an implied bank guarantee? Charlene Chu at Fitch’s. CBRC was in denial on both and have since come around to focus on these issues.
    CBRC and the Chinese government are not and have never been in denial over these issues. However the government made a policy decision (and in my view a correct policy decision) that any bad effects from local government debt would be smaller than the results of a massive economic contraction. All of that spending in the end goes to reduce unemployment and without that spending you’d end up with this persistently high unemployment that you see in the United States.
    Victor Shih has written a wonderful book on decision making in the Chinese financial system. There are two factions in the Chinese government. The spenders and the cutters, and you end up with those two factions interacting with the business cycle.
    Hua Qiao: When you have the lack of transparency and denial that you have in the China financial and fiscal arenas, such contrarian speculation is natural.
    You are focusing on the wrong numbers. There are certain numbers that are extremely transparent and hard to fake, and you can use those to figure out what is going on. The numbers that are hard to fake are inflation, GDP growth, unemployment, foreign reserve numbers, import/export numbers, and bank balance sheets (since they are audited by global accounting firms). With those numbers you can figure out the amount of money that the government pumped into the system, guesstimate the amount of bad loans that are likely to result, and those numbers are not that bad.
    I’m more worried about the deep health of the US economy than I am with the Chinese economy. What’s happened with the US is that incomes have been stagnant for over a generation, and people have been able to get by only by going into increasing debt. That’s blown up.
    Hua Qiao: The reason i agree with you that a true crisis probably won’t happen is that the prc has a very pliant population, able to bear a lot of pain, far more than the europeans who whine when they are told they may not retire until 58 years old
    It’s deeper than that. China has massive savings which are being put into infrastructure which generates wealth which increases incomes which allows people to save even more. If your income has gone up 20%, it’s easy to spend 10% more and save 10% more.
    The problem with the US and Europe is that you don’t have savings that can generate economic growth and therefore wealth. All of the talk of “efficiency” goes with the idea that with a good financial system, you can get economic growth without large amounts of savings, but that’s all turned out to be snake oil.
    H.L. Mecklen onces said that it’s not what you don’t know that will kill you, it’s what you know that isn’t. In the case of China, since you know that statistics are fudged, you spend the extra effort to figure out what is going on. In the case of the US, people assumed that everything was great, and it’s now a mess when it turned out that it wasn’t.

  • Twofish

    Dennis: So out of the three components the only one that is growing is “investment” and its the only one that has been growing the last 3 years, and at the same time consumption has been collapsing. Hmm could they be related to each other?
    Well if everything adds up to 100%.
    Dennis: And how does that translate into a consumer economy? And how do you know those investments are actually economical,?
    Look at history of other countries. Also keep in mind that in a demand crunch even bad investment is better than no investment. Even if you are doing nothing useful, you are keeping people employed and developing skills. An example of that was World War II. You hired a ton of people to build machines that would get blown up, but that led the ground work for the 1960’s.
    Dennis: Building airports all over 3rd string cities ups the GDP numbers but it seems unlikely that its the kind of investment that will provide a return on capital.
    Over 30 years? It’s hard for me to think of a scenario in which that doesn’t happen. The history of previous infrastructure projects in China is that after a decade, bridges to nowhere suddenly become some somewhere.
    There will be a point at which China has built everything that can be built, but we aren’t nearly there yet.
    Dennis: The Ministry of Rail has 330 billion USD in debt, how is that going to be solved? Another 1990s style bad debt asset managers?
    Central government recapitalizes the railroads out of tax money that comes from the economic growth that comes from railroads.
    Dennis: When you say “the government is going to pump money into the system” all you are really saying is “real interest rates are going to drop further, decreasing consumption further, increasing future non-performing loans”
    You pump money into the system, people keep their jobs, and that keeps consumption flat. Also if real interest rates drop, this increases consumption.
    Whether it’s a good idea to respond to an economic crisis by spending more or spending less is one of those things that economists will argue about. China did one thing, the US/Europe are doing another, and right now it looks like China has ended up with a much better outcome.

  • Hua Qiao

    @twofish
    Will disagree with you on CBRC in denial. They minimized the problem. Then they overreacted and told banks to stop funding the LGFPs. Party cadres realized that was a big mistake. So they leaned on the local CBRC offices to define the LGFPs as commercial, which allowed the banks to continue funding. That, by the way, is a classic example of Victor Shih’s thesis that you incorrectly label spenders and cutters. Shih describes the struggle between the generalist factions, which are geographically aligned, and the technocrats, which are centrally empowered. The central CBRC, under Liu Ming Kong, came down on LGFP’s but his lieutenants in the field yielded to pressure from their local party bosses and reclassified most LGFPs as commercial.
    Disagree with you on inflation too. Go look at the FT’s article last week on the huge gap between the Chinese CPI and the GDP Deflator which is running at double digits. Sorry but the regimes track record for accurate statistics leaves much to be desired. Just like when the Beijing Environmental Agency reports a blue sky day when i can barely see my hand in front of my face.
    I agree there is a lot worry about in the US and Europe. But the question here was about China. You can say you tire of the doomsayers.

  • andeli

    @Twofish
    “The numbers that are hard to fake are inflation, GDP growth, unemployment, foreign reserve numbers, import/export numbers, and bank balance sheets (since they are audited by global accounting firms)”.
    Sorry but you are wrong on this. First of all pig, rice, corn and wheat prices all rose at > 9% annually since 2009. Rent or housing prics have also been rising >15% annually since 2009.
    Now this constitutes 85 % of a Chinese household’s monthly expenses, so we have been looking at minimum yearly inflation of 12% not the official 4 – 6 %. for 2009 / 2010 / 2011
    The problem is that data is too hard to survey and the CPI basket is still not open for all to see. By the way the quality of food has been eroded so much that even Chinese consumers are making noise. That’s inflation too.
    Chinese food price are now just one more money flush away from fully and wholly losing its competitive edge over foreign products.
    Unemployment numbers are hard to fake ? are you serious ? University students have to fake employment papers to graduate.
    High skilled value creating employees are still not easy to find, but that how its been for years.
    All the help wanted signs you see around in the big cites are there because no one will do the job for the pay given, so the quality of service is going down instead. If in doubt please try to take a Beijing Taxi. People will rather be unemployeed then do a job that is below them.
    So there is work alright, but no one will do it anymore, because they can sit at home and live off their mom and dad. That really the situation right now a massive youth unemployment right, because the right jobs don’t exist.

  • They have laws in China?
    Love,
    Mike in Shanghai

  • Andeli

    The reason food inflation is coming back in China is that food prices need to rise in order to support the Chinese agriculture sector.
    The problems are many: Investments in irrigation system, industrialization of the agricultural production etc. have been in serious lack since the 1990s. Rural land disputes have been the single largest source of trouble since 2001, because farmers are not compensated correctly. Prices of agricultural products have not risen enough to create an incentive to reinvest or continue because of price control.
    The overall increase in Chinese food production has come because of people leaving the sector not because of increased effectivity. This seem very differcult to increase effectivity because of the issues mentioned above.
    International food production has been increasing and international food prices have not really been increasing that much yet, but there is nothing to indicate that food prices should go down:
    1) Food is a safe investment right now,
    2) The idea of dumping food through exports have been abandoned as it does not help poor people in the long run,
    3) All BRIC countries are getting richer and will use more of their own food production.
    4) The price of oil will keep going up

  • Twofish

    Hua Qiao: Shih describes the struggle between the generalist factions, which are geographically aligned, and the technocrats, which are centrally empowered. The central CBRC, under Liu Ming Kong, came down on LGFP’s but his lieutenants in the field yielded to pressure from their local party bosses and reclassified most LGFPs as commercial.
    Sure. At which point what I think happened was that things got bounced up to the Politburo/State Council, and the loans were reclassified as commercial with an implicit central government guarantee. There’s going to be a need to recapitalize the LGFP’s, but my guess is that what’s going to happen is that it’s going to get done with transfer payments to local governments.
    Hua Qiao: Disagree with you on inflation too. Go look at the FT’s article last week on the huge gap between the Chinese CPI and the GDP Deflator which is running at double digits. Sorry but the regimes track record for accurate statistics leaves much to be desired. Just like when the Beijing Environmental Agency reports a blue sky day when i can barely see my hand in front of my face.
    This is exactly what I mean by “statistics that are hard to fake”. You should never take what the Chinese government (or any other government) says at face value, but what you can do is to look at the numbers, take a walk on the street, and then apply a correction factor to see what is going on. We can argue whether the rate of inflation is really 5% or 20%, but it’s not 100%. Same with unemployment statistics. The official unemployment statistics for China vastly underestimate the actual degree of unemployment (so does the United States) but you can dig into the statistics and figure out what is going on.
    There are statistics that are by contrast much easier to fake, because there is no way of checking against actual data. Bank assets and liabilities for example.
    The problem with not digging into what is going on is that then you end up with vast doomsaying. We agree that LGFP are a problem. How big of a problem is it going to be? Latest numbers say US$400 billion.
    One question that comes up is how come the Chinese economy has not fallen apart yet, and part of the problem is that people think “well the statistics are wrong, the government is lying, and thus everything is going to blow up tomorrow” when in fact that doesn’t happen.
    Hua Qiao; I agree there is a lot worry about in the US and Europe. But the question here was about China. You can say you tire of the doomsayers.
    The question here was about what is happening to Chinese exporters. Chinese exporters are getting killed right now, but that’s because of what is happening in US/Europe. Also everything is connected. Right now Europe is going to China for a bailout of its banks, and my guess is that China is going to be very, very careful about that, because it needs to have the cash to bail out the LGFP’s once the bills come due.

  • Twofish

    andeli: Now this constitutes 85 % of a Chinese household’s monthly expenses, so we have been looking at minimum yearly inflation of 12% not the official 4 – 6 %. for 2009 / 2010 / 2011
    It gets complicated. Most people with urban hukou were given their houses outright by the government in the mid-1990’s, so older urban residents don’t pay rent and really want high house prices. Same for rural residents. Also, high food prices are good for farmers.
    You end up with wildly different inflation numbers based on the weights that you put different sectors.
    andeli: The problems are many: Investments in irrigation system, industrialization of the agricultural production etc. have been in serious lack since the 1990s.
    The reason for that is that if you make Chinese farmers too efficient then you end up with massive unemployment. Industrialization has been seriously lacking since the 1990’s because it’s a disaster unless you find jobs for the people that would be put out of work by the making agriculture more efficient.
    andeli: Rural land disputes have been the single largest source of trouble since 2001, because farmers are not compensated correctly.
    Rural land disputes happen when local governments seize land and sell them for development. The trouble is that if you have a farmer sell land outright, he goes to the city, and things go badly. In a freehold tenure system, he can’t go back to the farm.
    andeli: Prices of agricultural products have not risen enough to create an incentive to reinvest or continue because of price control.
    Agricultural products are not price controlled. The first thing that Deng Xiao-Ping did was to remove price controls on agriculture. That’s why inflation hits farm products first. Manufactured goods in China have inputs that are to some degree price controlled.
    andeli: Chinese food price are now just one more money flush away from fully and wholly losing its competitive edge over foreign products.
    Chinese food prices have never had a competitive edge over foreign products, but agriculture is one area in which the government puts a ton of protectionist barriers on imports.
    andeli: So there is work alright, but no one will do it anymore, because they can sit at home and live off their mom and dad.
    There are a lot of Chinese peasants that would be glad to work in 7-11. You take a peasant out of the fields, put them working at 7-11, replace that farmer with a machine. GDP goes up. Repeat for another 20 years.

  • Chris

    Another great discussion on the CLB. I suspect it is a huge mixed bag out there. Those reliant on cheaper exports with low margins (including OEM outfits) are in real pain. Those reliant on credit and Govt projects are also in pain as the credit crunch hits hard. The Railways Ministry has incredible outstanding payments to contractors and projects have stopped across the country. The real estate sector has also been hit hard.
    In many other sectors, particularly those focused on consumption, all is quite OK. Company profitability for those big enough to list in China and overseas is quite good. The consumer sector is racking up solid sales growth, numbers validated by both company announcements as well as govt statistics. Tax growth continues at over 30% YTD, indicating that enterprises are continuing to grow (and a govt focus on compliance) though I’d think the tax bill is hitting margins hard. Banks, telecoms and other SOE monopolies reliant on consumers are pulling in great profits.
    Wage growth has been very strong, though in Chinese enterprises, that growth is hidden through accounting tricks to reduce the onerous social insurance burden. In my sector, front line staff incomes are up 40% compared to 2009 and staff have been negotiating aggressively to achieve better outcomes.
    Overall “out there” there is the usual mix of the positive and negative.

  • Twofish

    Comparing what China did with what US/Europe did is instructive because what China did was to flood the economy with money. This left China with a massive debt problem (say 50-60% of GDP) that it has to clean up, but things are “back to normal” so that China can deal with this debt problem through continued economic growth. Also much of that spending went into stuff that is going to be useful. China has a high speed rail system. It’s not the world’s best high speed rail system, but it’s there and in the long run it’s going to be economically useful.
    This contrasts with US/Europe which didn’t dump enough money into the system and so things are not back to normally. Ironically, the rationale behind not dumping money into the system was to avoid debt, but that doesn’t work because US/Europe are having to deal with debt issues anyway. Ultimately, you can’t cut your way out of debt, you have to grow, and it’s not obvious where US/Europe is going to get the growth from.
    Part of the problem is that people think in terms of “good” and “bad” when often there are not good decisions. It is “bad” that you have massive local debt, but the alternatives were worse, and looking at the US/Europe, we see what the alternative really was and is. The fact of the matter is that China has recovered from 2008. There is a ton of cleanup to do, and my guess is that it will take a decade to pay down the debt at which point, there will be another crisis, but China no longer in the economic ditch, and the same can’t be said for US/Europe which never got out of the ditch.

  • James Wu

    Round and round they go, where they’ll stop, not a soul on earth knows….

  • Hartmann

    The Chinese credit crunch was initiated by the central bank with two primary macro-economic objectives, slowdown of the CRE (commercial real estate) industry by suspending loans to both developers and market demands and exhalation of local government borrowed credit.
    Impacts of credit crunch to Non-SOE, especially Non-SOE SMEs, are, in effect, unintended consequences.
    Nevertheless, chinese economy overall comprises of three major GDP-creating components: export, investment and spending. And a stiffened credit policy hurts all of them…..
    Footnote:
    Well ,the government never admitted that there should be some proper adjectives qualifying these three nouns, which make the Big three read like: private sector SME export, government investment and real estate spending.

  • Chris

    @ Twofish: “Also much of that spending went into stuff that is going to be useful. China has a high speed rail system. It’s not the world’s best high speed rail system, but it’s there and in the long run it’s going to be economically useful.”
    Spot on. At the very least China did something at a time costs continue to be relatively low. There is a lot to show for the post GFC splurge, not least a flashy high speed railway system. A lot more useful infrastructure around the country that will continue to grow in value as costs inflate. In some respects, this round was perhaps the last blast of the old model where infrastructure costs were cheap by global standards.
    I took the Beijing – Shanghai high speed rail last week. 100% occupancy in all the days around when I traveled. Great train and flashy stations. Great experience. A few raw edges including the toilets in the Beijing station that now look 5 years old and the taxi exit point. Other than that very impressive overall. Despite Wenzhou it is obviously very popular.

  • andeli

    @Chris and Twofish,
    I have never put in a link before because I usually think its better to argue with ones own words, but this really disagrees with both of you on the infrastructure investment and your views of the great investment in expressways and highspeed railroads.
    http://english.caixin.cn/2011-10-31/100319471.html

  • Twofish

    That article makes good points, but there is a counter-point that Paul Krugman and John Maynard Keynes points out
    http://www.nytimes.com/2011/10/31/opinion/bombs-bridges-and-jobs.html?ref=paulkrugman
    The point is that when you are in a demand shock, the important thing to do is to keep the money moving so that the economy doesn’t cycle downward. Both Krugman and Keynes point out that in that situation people weirdly prefer spending that is *totally* wasteful versus spending that is *partially* wasteful. If you have some spending that has some practical use, then people will apply different standards, whereas if you just dig for gold or build bombs, that’s fine.
    Put another way, it’s better to have a useless highway, than someone unemployed doing nothing. Highways don’t feel. People do. More to the point, one reason the Chinese government is really, really interested in getting people to build highways and railroads is so that they are too busy moving steel to demonstrate.
    The problem with using demand forecasts is that the economy can just spiral downward. You think that the demand is going to be low, so you don’t build the road, because you aren’t building roads, people aren’t employed, because people aren’t employed, demand is going to be low, and things just spiral downward. What has tended to happen in China is that building things puts money in people’s pockets, they spend, once they spend, then the road is useful.
    China now has a bad railroad system. Now that China has a bad railroad system, there are jobs for safety inspectors, and you can then spend more money to put factories at the end of the empty railroads so they then aren’t empty. If China has a ton of empty expressways, then you build factories to build cars so that the expressways are not empty. Repeat until you read Japanese levels of development.
    Also, one reason that people are building railroads and freeways now is that it’s going to be very hard to do later. One big problem with building a new railroad in the US is that everything is already built, and you just can’t build anything new without tearing something up. With China, there is less stuff built, and the railroads and expressways go over farmland. Yes there are issues with compensation, but they are less bad than having a 50 story building in the way. The other thing to remember is that railroads and expressways last a long time. The US is still using expressways from the 1950’s and railroads from the 1920’s. China isn’t at European levels of development, but the expressways that are being built now will be used in the 22nd century when China is. If you don’t build expressways and railroads because China is not developed enough, the chicken meets the egg.
    Victor Shih makes some good points, in that he argues that Chinese policy is a fight between two factions. One that wants to cut debt, the other that wants to pave China. Where I think Shih makes the mistake is that he seems to sympathize with the debt cutters, and so he seems to believe that China would be better off the the “road builders” just disappear. I disagree, what ends up happening is that because you have different factions in the government arguing over the issue, China ends up with just the right amount of infrastructure.
    Take a look at the railroads. In 2008, China had this problem with potential unemployment, so that the “road builders” ended up in control. Once China moved back into “normal economy” then “debt cutters” start getting back in charge. Now it looks like the economy is slowing a bit, so that the “road builders” are moving back in control.
    Finally, I’m more worried about the US *underinvesting* than China *overinvesting*.

  • Twofish

    Quoting Krugman since the article is behind the paywall.
    —————
    John Maynard Keynes himself offered a partial answer 75 years ago, when he noted a curious “preference for wholly ‘wasteful’ forms of loan expenditure rather than for partly wasteful forms, which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.” Indeed. Spend money on some useful goal, like the promotion of new energy sources, and people start screaming, “Solyndra! Waste!” Spend money on a weapons system we don’t need, and those voices are silent, because nobody expects F-22s to be a good business proposition.
    To deal with this preference, Keynes whimsically suggested burying bottles full of cash in disused mines and letting the private sector dig them back up. In the same vein, I recently suggested that a fake threat of alien invasion, requiring vast anti-alien spending, might be just the thing to get the economy moving again.
    ————

  • Andeli

    @Twofish,
    Paul Krugman sets up too few alternatives.
    If we say GDP = C + I + G +(X – M) then in the last 10 years the US GDP growth has been running on C + G and China’s GDP growth has been running on I + G + X. (In China G and I are related)
    This means that for China there where and are alternatives to Highways, Real Estate, Railways (HRR). C and M are the most direct alternatives. Rising wages for public servants (G), rising pension payments (G), massiv investments in the agriculture sector (G/I), reforming the short term credit system (C) and the credit card system (C) are others. My point being put the money in the hands of the consumers instead of builders.
    The Chinese education system is already focused on educating people to work with service and high-tech not mixing cement, that’s why you have such a high unemployement amoung university students. People are not educated to build roads or railways anymore they want to do travel, value adding of food products and financial products. Those who build railroads and highways or real estate could easily have worked in the agriculture sector, which would be a better investment in the future then fixed assets.
    I believe that one economical argument renders Keynes or Krugsmans reading of Keynes void. This argument is that no matter if you are private or public, when you allocate resources they are finit. Therefore resources should ideally be put to the best use, at the right time, to the benefit of the largest number of people. (Utillitarism in economics)
    The market or the state are both equally good or bad at this. I have no preference, but will argue that sowhere in the middle of the two extremes lies the right way.
    Creating a fake alien attack or putting money in a hole for someone to dig up later do not live up to this ideal.
    In that sense China should not have choosen I + G to create GDP growth in 2008/09 as this was not the best use of resources, not the right time and not to the benefit of the largest number of people. Instead they should have put the finit resources in C, alternative ways of G and I. Because then people and the economy would have grown in a more balanced way.
    When i mean finit resources I refer to that when making one economical choice you forfeit another (investment in I, X and G forfeits invesment in C). Micheal Pettis argues just that.

  • Casandra

    Some of it here feels like 2008, but some feels worse and some feels better. What most troubles me is the fall in real estate prices because I think real estate has been used so much as collateral I fear that soon everything else will start falling along with it.

  • Marcel Wiedenbrugge

    This is an interesting discussion, however, discussion like these always tends to move into the direction of too many details and arguments, because:
    1) we don’t know all the facts
    2) we don’t know which facts are relevant or not
    3) we don’t know how facts exactly impact each other and
    4) and there is always this phenomena called the ‘black swan’ (he’s there, but you never know when and where he will show up)
    For me, as a European, I actually don’t care so much about all the things that may go wrong. I rather prefer to focus on the structure, because once you understand the structure you can also more easily determine what may or may not happen (of depending on the stability and reliability of the structure – so there we go).
    In case of China, there are so many things that are one way of the other related to each other, that it is difficult if not impossible to make correct predictions.
    If I try to look into the future of China (say from 2015 to 2050) demographics tell me that China will have two long term problems to deal with:
    1) an increasingly ageing population
    2) an increasingly unequal male / female population
    No one can really predict what the real impact will be (social unrest?, poverty?), but generally speaking this may cause future social and economic problems. As I once read in another blog: ”China grows old before it gets rich”. That could be true, so I believe that the focus of Chinese government on gaining knowledge, education and innovation is a logical / smart choice (even though the mentality of the people needs to change for that as well – but that’s another topic).
    In terms of economics, China / the Chinese have a few benefits:
    1) hard workers
    2) used to saving money
    3) have a controlled currency policy (backed up by the CCP)
    4) have a solid – still low cost – export base
    However, in a globalized interconnected system 2, 3 and 4 also pose a strong risk.
    In an global economic and trade system you have to think in terms of supply chains i.e. how are systems intertwined and to what extent have significant changes in region A an impact on region B, C, etc. and vice versa.
    The main problem imho in this global system is credit based growth and short term thinking. As we can see in the USA and Europe, we have created systems that got used to living beyond their means, backed up by banking facilities and loans that were supposed to be ‘safe’. So if it is true that the Chinese banks have a lot of NPL’s on their balance sheets (loans to Chinese municipalities and other government related activities), the Chinese central government may face some problems in the near future (if they are not already taking place). Of course they may solve that problem by printing even more money, but we all know what will happen in the long run when you just print money without any (valuable) collateral.
    I think it is important that we try to get away from this unsustainable path of thinking in terms of economic growth. I have seen quite some ambitious master plans of many Asian countries (all focus on massive growth), but. what sense do they make if you have no people who can afford to buy from you?
    So back the topic: will China see gloom and doom? Maybe, maybe not. I believe that the Chinese are practical and can easily adjust to changing circumstances, so even when we define it as doom, things may not be so negative as we may perceive it.