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.
