China: A Gloomy Outlook

I have written several times now on the likely adjustment of consumption in the United States and to a lesser extent Europe. The United States has supported its unsustainable consumption growth through ever increasing imports. And, China has been a willing provided of both the goods and the financing. As a result, China has experienced an era of amazingly high economic growth.

This era has come to an abrupt halt. Or, more accurately, this era came to an abrupt halt in the summer of 2008.

There are many indicators of Chinese malaise. The picture below, however, is all I need to tell me China is in big trouble. Since 2000, China has emerged as an export-import economy. China imports primarily commodities and unfinished goods, adds value through processing, and then exports the finished goods abroad.

Nominal exports have fallen 18 percent over the last twelve months, incorporating about a 10 percent decline in prices and 7.5 percent in volume. The fall in nominal exports is a decline in income for China. The fall in volume shows the decline in units processed. Nominal imports have fallen 43 percent. The bulk of this decline reflects a decline in prices but 12.5 percent is a decline in volume.

The fall in exports reflects the global fall in demand. This is bad for the Chinese economy but is not unexpected. Whatever happens in China, we expect their external demand to fall. To me, the fall in imports is far more important as an overall indicator of the health of the Chinese economy.

As an axiom in economics, if a fall in price corresponds with an increase in volume, it’s a supply shock. If a fall in price corresponds with a decrease in volume, it’s a demand shock. China’s demand has fallen. And, since China’s imports are almost all intermediate inputs, this means manufacturing output in China is falling. No country, let alone a country with complete reliance on the external sector, could withstand such a large fall in exports. (Can anybody find a country that experienced such a large decline without a contraction? Email me at secreteconomist ‘at’ gmail.com.)

So far, domestic Chinese statistics have held up better than the picture implied by exports and imports. Both IP and GDP have slowed, but do not indicate contraction. Taking a stab at converting the year-on-year growth into quarterly changes, both series grew in the low single digits at the end of the year. Retail sales growth continues apace.

There may be a timing issue. The contribution from net exports may be sufficient to offset the decline in production; however, this cannot last. Alternatively, there may be forthcoming revisions to the GDP and IP data that will give a clearer picture of the economy. (I am not saying they are miss-stating their statistics. National income accounting is hard and many countries, including the United States, have large revisions to the data.)

In any event going forward, the Chinese economy will follow the path of its neighbors. I know that I am in the minority. Every China analyst seems bullish on China. They see signs of an imminent recovery around every corner. They are wrong. China will contract and cannot recover while the rest of the world remains in freefall.

China may, in the long run, reorient its economy and grow without external demand, but we are a long way from the long run.