by Christopher Balding
The NanfangToday, 9:41 AM
So the Fed has opted to leave rates unchanged and one of the primary, if unspoken, reasons is the global slowdown brought by China. The global slowdown has China at the epicenter through a variety of channels such as reduced demand and prices for commodities, which results in lower growth primarily in other emerging markets and downward price pressures. China should be sending Janet Yellen a fruit basket this morning because any raise would have placed even more pressure on the RMB/USD peg. There is an important distinction here that needs to be made. While the Fed keeping interest rates unchanged does not raise the pressure on the RMB, it certainly does not lessen it. Despite the PBOC assurances, capital continues to flood out of China and shows no signs of falling. Just yesterday there was a story that outbound investment from China was on pace to hit $1 trillion for the year. I generally view internationalization as a positive. Just keeping up this pace will place enormous pressure on the RMB as foreign investment in China definitely isn’t keeping that pace, with many categories falling, and the trade surplus is not enough to offset the difference. In other words, the RMB will remain under pressure and the Fed should be receiving fruit baskets from the PBOC for not turning up the pressure.
There is a question I’ve seen arise in both explicit and implicit ways that I believe needs some exploration. Many have noted that capital outflows are not related to economic growth. That is generally true but the truth is more complicated and indirectly untrue in keyways. Let me explain. First, Chinese investors are telling you what they think of the Chinese economy. There is a dearth of good investment opportunities in China. Falling credit quality, deflation in producer prices, surplus capacity in a range of sectors, coupled with an awful investment climate do not inspire confidence in even Chinese investors, despite calls for unity and national pride. Second, capital outflows are placing downward pressure on the RMB. That is going to require an implied tightening to maintain the RMB/USD peg, which would require secondary loosening. If a devaluation takes place, this would reduce consumption and have minimal impact on exports unless the devaluation was sizeable. Third, an enormously under-appreciated part of the China growth story for the past decade or longer was how the money supply simply exploded whether through sterilization of trade surpluses or credit. Chinese M2 growth lags only serial inflators like Russia, Turkey, and Argentina in the past decade despite reporting some of the lowest inflation among all major emerging and developed countries in the world. Reducing the money supply will have an enormous impact on Chinese growth. Fourth, capital outflows will place enormous stress on Chinese financial institutions. Any drying up of liquidity will place significant stress on institutions with high levels of short term loans that they need to roll over. In other words, while capital outflows generally have no direct impact on GDP growth, the reality is decidedly more nuanced and does have significant indirect impact.
What is interesting in the debate over the quality of Chinese data and attempting to ascertain the true state of the economy is to watch people hear what they want to hear and disregard the rest. Bloomberg has released a short paper on its opinion of the quality of Chinese data and economy writing that “naive suspicion of China’s growth rate based on a limited set of industry-related indicators is misplaced.” They note that the “default” position of many market participants now is to doubt official data using electricity consumption as an indicator of Chinese GDP growth. They go on to cite perma-panda Nicholas Lardy that consumption and services is holding up well because movie box-office revenue is up strongly this year. So apparently, replacing electricity growth with box-office revenue is not narrow but an acceptable use of data analysis. The bigger problem with this analysis is it is willfully overlooking enormous amounts of data that has been produced about the Chinese economy. Whether it is retail sales or output data, including consumer products and significant amount of services, Bloomberg is simply choosing to ignore quality work that has been done by a variety of people demonstrating weakness in the Chinese economy and the major discrepancies between top line official data in the granular data underneath it.
There are three final points worth noting. First, Bloomberg is flat out wrong on one specific point of fact according to the data I downloaded from Wind. They write that “gains in passenger volumes are robust.” Based on the data I downloaded from Wind on passenger volumes and distances traveled, this is simply false. Second, Bloomberg and Nicholas Lardy not only provide virtually no evidence to support their rosy scenarios, they fall prey to one of the class blunders in economics: the lipstick fallacy. Lardy and Bloomberg cite rising movie box office sales as proof that consumption and services are strong. However, economists have long noted the relationship between the increase in “affordable luxuries” during economic downturns. It is frequently referred to as the lipstick effect, as consumers increase their purchases of affordable luxuries compared to bigger spending items. Think lipstick compared to a new purse. Third, Bloomberg and Lardy rely completely on official NBSC data to support the argument that consumption and services have risen as a percentage of GDP. Given the enormous discrepancies we know exist between underlying data and headline in these areas in the past few years, this is not an assumption to take lightly. To claim that critics of Chinese data are overly obsessed with electricity consumption to track the overall economy is an incredibly poor read of the work that has been done in the market. The market and myself are looking at a wide range of data and finding that the data simply doesn’t fit the 7 percent growth story and the data discrepancies are much larger and systematic than Bloomber recognizes. There is a reason the new market default position is skepticism.
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