I observe market sentiment is not where it was, but we called for an advance of gargantuan proportio...
Is the speed of China's economic growth a fiction?
08/11/2009 8:30 am EST
Any first year accounting student knows that the easiest way—in the short term--to make a company’s revenues and earnings look good is to change when a company recognizes a sale or an expense.
Recognize a sale as soon as the sales person puts down the phone, and revenues—and earnings go up. Recognize a sale only when the money is in hand or even more conservatively spread it out over the life of a contract, and revenues go down.
China knows this too. And, according to John Makin of the American Enterprise Institute, the country’s official economic figures—we’re talking the government’s numbers here and not those reported by individual companies—systematically over-state the speed of the country’s economic recovery.
In an August article entitled “China: Bogus Boom?” (www.aei.org/outlook/100061) Makin explains that China’s system is designed to report production activity and not, as in U.S. statistics, expenditure growth, which is the sum of consumption, investment, government spending, and net exports.
That’s why China’s November stimulus package has already got the Chinese economy humming at a close to 8% growth rate—according to the official numbers—even while Washington’s package is still finding its way into the economy.
Here’s how it works, according to Makin.
Beijing decides on a $586 billion stimulus package in November. That money gets recorded as GDP growth as soon as it’s disbursed by the central government. None of this waiting around for the money to stimulate economic activity before anything gets recorded as GDP. Nope, the money is counted as spent in national economic statistics by state-owned companies and local governments as soon as the check leaves the building. None of this messy lag, for example, while local governments identify projects, send out requests for bids, sort through bids, award the contracts, and then wait for contractors to get to work.
But the system doesn’t stop there. As soon as something is produced it goes into the national numbers in such categories as retail sales. Make it and ship it and it’s a sale. As Makin writes “Shipments to retailers are counted as retail sales on the apparent assumption that ultimately all goods shipped will be sold at some point in the future.” China’s retail sales numbers have climbed by about 15% in the first half of 2009 from the first half of 2008. How much of that actually went home with a customer and how much is still sitting on shelves or in store rooms is anyone’s guess.
I wouldn’t argue that U.S.-style national accounting is perfect or even superior to the Chinese system. A hurricane that destroys New Orleans requiring massive rebuilding counts as a boost to GDP in the U.S. system, for example, since it increases economic activity. (Of course, it decreases national wealth but GDP measures activity and not wealth.)
But investors get into trouble when they assume that China keeps score like the U.S. does.
For example, investors have bid up the price of commodities and commodity stocks in the belief that China is buying more iron, coal, copper, you name it to fuel its manufacturing sector. A few economists have wondered if the buying that global commodity markets are seeing is actually being consumed in China. They worry that much of it is going into stockpiles. If these commodities are going into actual products, they ask, shouldn’t we be seeing a bigger increase in Chinese exports? Instead Chinese exports are still declining, dropping 20% in the first half of 2009.
To which other economists and the great bulk of investors reply, Don’t worry. Look at the numbers for internal consumption in China. Remember retail sales have climbed by 15% recently. That’s enough to soak up all those commodities.
In the short run, of course, it doesn’t make any difference if those domestic numbers show products made that haven’t been sold at all to customers. A stove rusting in a warehouse and one carted out the door by a customer still uses up the same amount of raw materials.
But in the long run it does matter. China watchers report anecdotal evidence of peasants “buying” washing machines and other appliances—often because the government is supplying enough cash to make these free to purchasers—when they don’t have running water or electricity in their homes. Unless you assume that the Chinese government has an unending ability to pour cash down a rat hole—and even China’s government isn’t that rich—then at some point all those “sold” goods still in the market clog the economy.
How true are these anecdotal stories? How many billions in “sales” do they represent? No one knows. And the government numbers are constructed so that we can’t know.
Now before you dismiss those anecdotes as just more China bashing consider this example. We do know that the Beijing government has set ambitious goals for its domestic wind energy industry. They’ve provided billions in funding and written strict goals into law.
But look at exactly what those mandates require. By the end of next year, renewable energy, excluding hydroelectric power, has to account for 3% of generating capacity at Chinese utilities.
That’s generating capacity, mind you. Not actual power generated. So the Chinese government has given its utilities incentives to buy the cheapest renewable energy equipment possible, even if it breaks down frequently, so they can up their generating capacity from renewable sources. And because it’s capacity that counts toward meeting the government’s goals, it doesn’t matter if the equipment they buy actually works or not.
By the end of the year, Chinese wind turbine companies, some of whom have never built a turbine before this year, will have 75% of the domestic market. Four years ago, foreign companies owned 75% of the market.
And looking at that, you’re completely justified in asking whether the goal of Chinese policy was to increase supplies of electricity from wind power or to create a domestic wind turbine industry.
In the same way you’re justified in asking whether the goal of Chinese economic policy is real sustainable growth or the appearance of enough growth to keep the domestic peace.
Investors don’t need to answer, or even be interested in, those philosophical questions. But they do need to consider the possibility that China’s huge acceleration in its growth rate is merely an artifact of the way the country keeps its national books. And that the effects of China’s stimulus will wear off the moment that the government stops sending out the checks.
There is one thing that might tell us which view—sustainable growth versus accounting gimmick—is correct. If China’s growth is real, investors can expect that the People’s Bank, China’s central bank, will start to slow growth in the money supply—growing at a mind-boggling 28.5% annual rate in June—before the economy, stock prices, and inflation get out of control. If, on the other hand, China’s continued reported economic growth rests on Beijing keeping the money pump running because the real economy is still in a slump, then the People’s Bank will rattle its sword but do nothing.
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