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Special Report: China Slowing: The Worst of All Possible Worlds?

By all indicators, growth in China is slowing rapidly. A recent report in the New York Times pointed out that inventories are piling up as factories continue to churn out goods at a record pace. Asian stocks have leveled out on concerns that China will not meet its growth target. The Bank of China has shown falling profits, raising the specter that bad loans made during the boom will spark a wider banking crisis.

China slowing



China export manufacturing PMI has fallen. Any number below 50 indicates contraction.


“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, research director for J Capital Research, an economic analysis firm in Hong Kong, as quoted in Worcester Telegram and Gazette.


In the garment and apparel sector, growth was already slowing due to contraction in Europe and stagnation in the United States. Wages have risen to the point where some orders are moving off shore, and even Chinese firms have begun outsourcing to Pakistan, Vietnam, and Bangladesh. Chinese factories have had difficulty finding workers at any price, though one advantage of a slowing economy could be an ease in the labor crunch. This has already shown up in slowing wage increases.


Beijing recently cut its economic growth expectations to 7.5% for the year. This is significant, because in the past officials have stated that GDP growth of 8% is necessary to insure social stability. Chinese society is characterized by a high degree of stratification and corruption, and the global consensus holds that the Chinese leadership essentially “buys” the complicity of its population by delivering regular increases in the standard of living. Without economic growth to keep wages rising, the government is believed to lack legitimacy in the eyes of the population.

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Even that lowered number may prove unattainable, as the nation failed to make that target during the first half of the year, so the economy would have to expand at greater than 7.5% for the rest of the year.


In a research note to its clients, London’s highly regarded Lombard Research is blunt, saying, “China is in the midst of hard landing as demand remains weak both at home and abroad. The effects of the cash flow squeeze on de-stocking and commodities have been clear and there is mounting evidence that the labor market is next in line to feel the pinch.” The prospect of broad layoffs and rising unemployment may prompt additional government stimulus.


China has maintained strong growth during the global recession, largely due to government stimulus and the China-to-China market. Government sanctioned lending created an enormous property bubble that banks and the government are now seeking to deflate. Reduced lending has sparked contraction in the construction sector, with hundreds of thousands of workers being laid off in recent months. Deflating the property bubble is essential to long term prosperity in China, as housing for workers has become unaffordable, and a rapid collapse of commodity prices could spark deflation. However, spillovers from the construction sector were major drivers of economic growth, and the loss of that sector may be dragging down overall numbers.


Demand for lending is falling as well, as indicated in the lower profits and falling stock prices of banks. Everyone is hoping the government will release an additional round of stimulus, tapping its massive $3 trillion war chest of foreign currency reserves. Such stimulus will likely only emerge if there is widespread social unrest, as China is grappling with staggering local government debt and high inflation from its last round of stimulus.

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The overall situation may be worse than official statistics indicate. Chinese statistical agencies are often too politicized to be trusted, and that is never more true than during a downturn. Many agencies have simply stopped releasing statistics, indicating that their release would worsen the downturn by harming confidence.


A prominent third party manufacturing index has tracked six months of declines in export orders, a key driver of economic growth. In order to track activity more accurately, foreign statisticians look at electricity consumption relative to industrial production. Electricity data has been lower this year than statistics would indicate. In addition, utilities stocks are down, indicating lower demand moving forward.

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Signs of social unrest may already be emerging in China, as indicated by recent anti-Japanese protests in several major Chinese cities. The intersection of nationalism and economic decline could be nasty, if the Chinese government uses anti-Japanese sentiment to focus attention away from the Communist Party. Additionally, the Chinese people may turn their frustrations on the government. Protests are a regular feature of life in China, but they rarely include middle class or elites. A contraction may spur them to join opposition movements, as happened during the Arab Spring.


The impact on the US economy could be significant. Many brands and firms have staked their long-term growth on continued Chinese expansion. Luxury brands in particular have large Chinese exposure. Mid range brands have mainly expanded in the E-Commerce sector, and many discount brands have exposure through their sourcing strategies, but not otherwise. However, US capital goods manufacturers and the auto industry have invested heavily in China expansion in recent years, and many firms such as GM are seeing the majority of their profits come from China.


In addition, if Chinese exports slow the government will have less incentive to buy US treasury debt. China has been propping up US government spending by buying large amounts of debt and holding it as foreign reserves. Without China as a major lender of last resort, it is likely that interest rates will rise and non-interest government spending will fall, which could push the United States back into recession. This could spark a vicious feedback loop of reduced consumption in the United States, reduced manufacturing in China, and reduced lending in both economies.