Archive for the Category China


The Financial Times on Chinese data

A few weeks ago I suggested that Chinese data might be roughly correct.  Here’s the FT:

That China’s official economic data cannot be trusted is now received wisdom among western economists, investors and policymakers. To treat the numbers as authoritative is to invite ridicule: believers are naive at best and, at worst, stooges for Communist propaganda.

The problem with this conventional wisdom is that, aside from the closely watched and politically sensitive real gross domestic product growth rate, other official data vividly depict the slowdown in China’s economy that sceptics insist is being concealed. If there is a conspiracy to disguise the extent of harder times in China, it is an exceedingly superficial affair.

And The Economist:

Amid the extreme pessimism about China’s economy in recent months, it is tempting to conclude that rebalancing has failed. Just look at the car market, usually a good shorthand for the health of consumer demand. Automobile sales fell by 3.4% in August compared with a year ago, the third monthly decline in a row. Yet other forms of consumption are accelerating. A property recovery has stoked demand for furniture, home electronics and renovation materials, with sales rising an average of 17% in August from a year earlier. From jewellery to traditional Chinese medicine, buying has picked up in recent months.

Smartphone sales are down in volume terms but soaring by value, as shoppers move upmarket. Companies hit by the anti-corruption campaign under Xi Jinping, China’s president, are learning to prosper despite the new strictures. Distillers’ profits, which fell last year, have rebounded, pulled along by affordable brands for ordinary consumers rather than the exorbitantly priced bottles previously used as bribes for officials.

Overall, China’s retail sales have increased by 10.5% in real terms this year, well ahead of economic growth (officially 7% but closer to 6% according to many analysts). There are, as ever, doubts about the reliability of China’s data, though in this case it may be that the retail figures are too low. Nicholas Lardy, an expert on Chinese statistics at the Peterson Institute for International Economics, a think-tank, notes that retail numbers do not include services, a glaring omission since surveys show that services account for as much as two-fifths of China’s consumer spending.

Read that again.  An estimated 10.5% growth in real retail sales may be too low, the true figure may be even higher.  As my favorite blogger might say, “Scream it from the rooftops.”

PS.  I wish he’d take the lead from his co-blogger, and “shout it from the rooftops”.  Screaming really gets on my nerves.


Asking too much of a central bank

Here’s an article discussing Bill Gross’s views on monetary policy:

Bond guru Bill Gross, who has long called for the Federal Reserve to raise interest rates, urged the U.S. central bank on Wednesday to “get off zero and get off quick” as zero-bound levels are harming the real economy and destroying insurance company balance sheets and pension funds.

In his October Investment Outlook report, Gross wrote that the Fed, which did not raise its benchmark interest rates at last week’s high-profile policy meeting, should acknowledge the destructive nature of zero percent interest rates over the intermediate and longer term.

“Zero destroys existing business models such as life insurance company balance sheets and pension funds, which in turn are expected to use the proceeds to pay benefits for an aging boomer society,” Gross said. “These assumed liabilities were based on the assumption that a balanced portfolio of stocks and bonds would return 7-8 percent over the long term.”

But with corporate bonds now at 2-3 percent, Gross said it was obvious that to pay for future health, retirement and insurance related benefits, stocks must appreciate by 10 percent a year to meet the targeted assumption. “That, of course, is a stretch of some accountant’s or actuary’s imagination,” he said.

Not only are Bill Gross’s views wrong, they aren’t even defensible.  Let’s look at several perspectives:

1.  Money is neutral.  In that case the Fed can only impact nominal returns.  If it wants higher nominal returns then it needs to adopt a more expansionary monetary policy. That’s the opposite of what Gross is proposing.

2.  Money is non-neutral.  In that case the Fed can raise nominal returns on debt with a tight money policy, but only in the short run.  And Gross says the problem is that long-term returns are too low.  However to raise them you need to raise NGDP growth, which means easier money.  Even worse, a contractionary monetary policy that raises the return on T-bills will reduce the return on stocks.

Why is there so much confusion on this point?  Perhaps because people forget that most central bank decisions are endogenous, on any given day or week the Fed usually follows the market.  Here’s a perfect example of why people get confused, look at the first paragraph of a recent Reuters article:

Euro zone government bond yields dropped by more than 10 basis points on Friday after the U.S. Federal Reserve prolonged the era of nearly-free money amid concerns about a weak world economy.

Most readers probably think there is a connection between these two events.  And there may be one.  But it’s not the connection you might assume at first glance. It’s obviously not that case that the Fed deciding to keep rates steady on Wednesday caused eurozone bond yields to fall on Friday.  That makes no sense. Instead both the Fed and the bond market are reacting to the same facts—a weakening global economy.  People see short and long-term rates rise and fall at about the same time, and draw the erroneous conclusion that Fed policy is causing those changes.

The Fed can’t magically produce strong long run real returns on investment for insurance companies, especially with tight money.  That’s far beyond their powers, according to all models I’m aware of (monetarist, Keynesian, Austrian, etc.)  If Bill Gross has a new model, I’d love to see it.  In the 21st century, insurance companies will have to learn to live with lower returns.  They may have to raise the price of insurance. If they lose business, then . . . well, tough luck!

Off topic, Tyler Cowen recently noted that China’s September PMI fell to 47, and then asked:

How quickly do services have to be expanding for the entire Chinese economy to be growing at anything close to six percent?

Since I’m on record predicting 6% RGDP growth, I’ll address this question.  First we need to determine how fast industrial production is growing.  Here’s a graph of the growth rate of IP since 1990:

Screen Shot 2015-09-23 at 11.12.40 AMOther than the post-Tiananmen crash, China’s industrial production has maintained a strong upward trend.  However there are three notable slowdowns.  The slowdown in the late 1990s was caused by China’s currency being overvalued due to its peg to an appreciating dollar, at the same time the emerging markets were struggling and devaluing, and at the same time the US and Europe were growing. Sound familiar? And notice that the gradually slowdown since 2012 looks a lot like the late 1990s.  And then there was a sharp but brief slowdown during the global recession of 2008-09.

The most recent figures show 6.1% growth (YOY) in August, and September may show further deterioration.  After than I expect Chinese IP growth to begin recovering, although the YOY figures may worsen for some time.

So to answer Tyler’s question, if industry is growing at 6%, then services would also need to be growing at roughly 6%, in order to produce 6% GDP growth.  Is it plausible that China’s industrial production could be growing at 6% with such horrible manufacturing PMIs?  See for yourself, here’s the PMI index as far back as I could find:

Screen Shot 2015-09-23 at 11.20.34 AM

The recent numbers are a bit worse than usual, but as you can see the PMI often dipped to 48, with no obvious ill effects on the China boom.  I believe that this time China is slowing a bit more than usual, which explains my bearish forecast of 6% growth in 2016, vs. the consensus of 6.7% by China experts.  So like Tyler I’m currently bearish on the Chinese economy, just not as bearish.  My bearishness comes from the fact that I believe China experts are underestimating the impact of the strong dollar, which is making China’s currency overvalued.

I’m also more bearish than the Fed on the US economy, for much the same reason.

The Fed’s wise decision

I thought yesterday’s policy announcement would offer a nice natural experiment, but instead it served up perhaps the most muddled stock market response I’ve ever seen.  Indecision, then a big move upwards, then an even bigger move downwards.

One problem is that it’s harder to interpret market responses when the more likely outcome occurs.  The response to “new information” will be much smaller.  But even so, there was some genuine uncertainty.  And if you look at other markets you could see a clear response.  Indeed it almost looks like Wall Street was hit by two shocks—easier than expected money, and then (an hour later) slower than expected RGDP growth.

I still believe a 1/4% rate increase would have reduced stock prices, but of course the response to yesterday’s announcement doesn’t really provide any support for that.  One alternative is that the announcement didn’t matter at all.  But then why did the other markets clearly respond?  Most likely, the various markets were hit by two shocks, easier money and weaker expected growth.  In the equity markets those two shocks worked as cross purposes, whereas in the bond and forex markets they both pushed in the same direction. Both shocks tended to depreciate the dollar and also reduce bond yields.

And it doesn’t even end there.  European markets plunged today, and the dollar regained the ground lost yesterday.  Go figure.

The only thing I have some confidence in saying is that it was a wise policy decision.  Even today the bond markets are clearly signaling the Fed will fall short of its inflation target; next year, next 10 years, next 30 years.  Money is still too tight, and Kocherlakota (who called for a rate cut) is the only one who got it right.  As usual, the VSPs laughed at him like he was your crazy uncle, hid away in the attic—the usual reaction when someone points out that the conventional opinion in monetary policy is wrong.

Although money is too tight to hit the Fed’s goals, it’s not necessary too tight for a well functioning US economy, and that also might help explain the muddled response.

Off topic, a commenter directed me to a very interesting podcast on Chinese data.  The five China data experts all seemed to think the Chinese data was not manipulated for political reasons, and that the statisticians in Beijing do the best job they can under difficult circumstances.  I learned that a lot of what you read in the press is misinformation.  For instance, this LA Times story on bad Chinese data is based on interviews with one of the people in the podcast, but totally mischaracterizes her views—making her seem much more of a China skeptic than she actually is.

Over at Econlog I have another post on Chinese data accuracy, for those who aren’t sick of the subject.  (I tried to inject some humor this time.)

And I highly recommend this Lars Christensen post, which discusses the echoes of the 1930s in the current political environment.

The problem with “existing store sales”

Quick follow up to my previous post.  Some commenters seem confused about the distinction between existing retailers and new retailers.  New retailers can have a dramatic impact on growth rates, even if a small part of the total.  For simplicity, assume that 94% of the Chinese retail sector is more than year old, and 6% is comprised of new brick and mortar retailers. (Many retailers in China are small family firms, and the country is urbanizing rapidly.)  Also assume that the growth rate of sales at existing brick and mortar retailers (plus those that closed down) is 0%. The growth rate of online is 33% and they comprise 15% of retail.  The new firms might not seem to be a big enough share of the market to dramatically impact the overall growth rate.  In fact, if new firms are 6% of the market, then their contribution to retail sales growth would also be 6%, as (by assumption) they were zero percent of the market one year earlier.

I’d guess that about 5% of China’s 11% retail growth is from online firms, another 6% from new firms, and essentially zero from existing firms.  (That’s based on information in a recent Tyler Cowen post that suggests existing retailer sales are flat.)

I’m sticking with my 6% RGDP forecast for 2016.

Off topic, suppose markets are OK with 1/8% but not 1/4%. How should they respond if this is the Fed’s strategy?

At VTB, global strategist Neil MacKinnon says a 1/8 percentage point increase — which would be the first such move since December 1986 — should be accompanied by a signal from Chair Janet Yellen that the Fed will act again in October if the initial shift has proved acceptable to markets.

And are all Cretans still liars?

China’s retail boom

In my view many pundits are excessively pessimistic about the Chinese economy, focusing too much on the weakness in heavy industry and exports. Offsetting that weakness is booming growth in retail sales, as Chinese incomes rise very rapidly. BTW, if China really is doing so poorly, then precisely WHY are Chinese incomes growing so rapidly?  There are possible answers — fast rising unemployment or fast rising inflation — but I see no evidence of either.  Here’s a recent report from Forbes:

Beijing’s National Bureau of Statistics reported that retail sales in China jumped 10.8% in August compared to the same month last year. That was substantially better than every consensus estimate. Analysts had predicted sales would come in at 10.5%, the same increase as July’s.

Most observers are bullish about consumption as the next driver of the Chinese economy. The dominant narrative tells us China is in a transition from investment-led growth to growth propelled by consumer spending. The oft-cited Andy Rothman, now at Matthews Asia, calls the country “the world’s best consumption story.”

The evidence supporting that proposition looks compelling. Apple, from the first indications of a few hours ago, immediately sold out its iPhone 6S and iPhone 6S Plus in China. Express parcel deliveries were up 47% in July compared to the same month in 2014. Box office revenues? For the first eight months of this year, theyskyrocketed 48.5% from the corresponding period last year.

Consumption contributed 50.2% of growth of gross domestic product in 2014. In the first half of this year, it accounted for 60.0% of GDP.

In recent years it has become trendy in China to buy goods online.  Alibaba is by far the largest online retailer, so I thought I’d take a look at its numbers:

Screen Shot 2015-09-15 at 8.50.45 AMThat graph is a bit misleading for two reasons.   First, the latest figures are actually 2015:2, not 2016:1 (their fiscal year ends in March.)  And second, growth is expected to slow modestly in Q3 due to the stock market plunge.  But clearly the trend is very strong, and other online retailers show the same pattern:

Three Chinese Internet companies—Alibaba, Tencent Holdings Ltd. and Baidu Inc.—are now among the world’s largest in market capitalization. The industry’s rise has come even as China’s economic growth has slowed from its double-digit pace of a decade ago.

Some other competitors are expressing caution, though many are signaling still-strong growth. Executives at Alibaba rival Inc. said last month that they expect third-quarter revenue growth of between 49% and 54%—compared with a year-earlier 61%—reflecting a “conservative outlook in light of the recent Chinese stock-market correction and the slowing macroeconomic conditions.”

Of course just as in America, some of this growth is coming at the expense of brick and mortar firms, and there are indications that sales are flat for many ordinary retailers.  But don’t underestimate the importance of online; Alibaba alone now sells more than $100 billion dollars per quarter.  If we assume the entire online sector is around $150 billion per quarter, then growth in that sector (year-over-year) is probably on the order of $50 billion per quarter, or $200 billion per year. Thus online growth alone can explain about half of the growth in China’s $4 trillion retail sector.

This relatively sunny view of Chinese retailing is one argument in favor of the Fed raising rates in September, although on balance I still think that would be a mistake.  (Of course if China were actually sliding into recession, a rate increase now would be a mistake of epic proportions.)  I strongly agree with Ray Dalio’s recent take:

Ray Dalio, the founder of the world’s largest hedge fund Bridgewater Associates, said the firm believes the next big move by the Federal Reserve will be to loosen U.S. monetary policy, not tighten it.

In a client note sent out on Monday, Dalio said the Fed is paying too much attention to the short-term ups and downs of the business cycle rather than the longer-term ramifications of central banks driving interest rates to zero, which now leaves them no room to act if worldwide deflation takes hold.

“The ability of central banks to ease is limited, at a time when the risks are more on the downside than the upside and most people have a dangerous long bias,” said Dalio, who helps manage $162 billion at Bridgewater. “Said differently, the risks of the world being at or near the end of its long-term debt cycle are significant.”

.  .  .

Dalio said the Fed has overemphasized the importance of the cyclical short-term business cycle in its desire to raise rates, but has been less attentive to the longer-term trend toward deflation.

He said the Fed will react “to what happens,” suggesting it should undertake more quantitative easing, or QE, but he isn’t positive of that, given Fed officials’ desire to raise rates.

Dalio warns of global disinflation, slow global economic growth, and the lingering risk aversion that is behind the proclivity to hold cash despite its significant negative real returns.

“Our risk is that they could be so committed to their highly advertised tightening path that it will be difficult for them to change to a significantly easier path if that should be required,” Dalio said.

That final comment is especially important.  This was precisely the mistake the Fed made in mid-2008, when many at the Fed assumed their next move would be higher.  It was really hard for them to re-orient their thinking to the need for a rate cut, and hence they did not cut rates during the May through September period, when interest rate cuts were desperately needed.  This effective tightening made the recession (which had already begun) much worse.

This time the probable consequences would be more benign, a slowdown in growth and undershooting the inflation target, not recession. But it would leave the Fed with fewer options when the next recession occurs.

HT:  Ben