from Follow the Money

(Green) bamboo shoots?

April 19, 2009

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Economists scouring the globe for highs of hope (or at least a slower rate of decline) have found a few green shoots in China. A smaller fall in the March import data. A faster y/y rise in industrial production in March than in February. Signs of life in the housing market. The (undeniably) large increase in bank lending.

I would feel a bit more comfortable, though, if China’s trade data wasn’t tracking the US trade quite so closely. China exports a bit more than the US and imports a bit less, but they are basically comparable in size. And, well, the y/y change in a rolling 3m sum of China’s exports doesn’t look much different that the y/y change in US exports; and the y/y change in China’s imports doesn’t look much different than the y/y change in US imports.

The green shoot from the March import data shows up in the chart – the pace of the y/y decline in China’s imports slowed in March. But the overall story from the trade data is still quite grim. Making judgments on the basis of a single indicator -- especially a nominal indicator influenced by price swings - is always risky. But the trade data doesn’t suggest that China’s economy is in robust health.

The simplest explanation for the tight correlation between US and Chinese imports would be a fairly synchronized downturn in both the US and China. That would explain why both countries are importing substantially less – and both are experiencing larger falls in their imports than can be explained by the fall in commodity prices.

Other explanations are obviously possible: About ½ of China’s imports are for re-export, so a large share of the fall in China’s imports is a reflection of the fall in China’s exports. And China may import more commodities than the US, and thus falling commodity prices (though there are limits here: the US imports a higher share of its oil than China does) may have a bigger impact on the data.

Both the “import-to-export” and “commodity price” effect would impact China’s imports from the US – but presumably they would have a smaller impact. And, well, if US exports to China are in any way a proxy for Chinese demand, Chinese demand turned down last summer, in July–

The US data ends in February – so it would miss any recent pickup in activity. But it, like the global data, hardly suggests robust Chinese demand growth. A comparison of the y/y change in US exports to China and US imports from China tells a similar story. The fall in US exports to China is actually larger than the fall in US imports from China – and US exports to China turned down before US imports from China headed south. I suspect that the slowdown in US exports to China reflects the broader slowdown in China’s economic growth brought about by the slumping equity market and the slump in private construction – a slowdown that clearly preceded the post-Lehman global crisis.

It is true, as the Economist notes, that US import growth hasn’t been driving Chinese growth for the past couple of years. But that doesn’t mean that exports weren’t driving Chinese growth. US domestic demand started to cool in late 2006 – and that, plus the RMB’s appreciation against the dollar, slowed the growth in US imports from China. Overall Chinese export growth though remained quite robust (see the first chart). China offset slower growth in its exports to the US with more exports to the emerging world – and the RMB’s weakness against the euro propelled strong growth in China’s exports to Europe too. The US, remember, isn’t China’s only market, or even its largest market.

The RMB didn’t depreciate against the dollar over the past six years. It did depreciate against many other currencies. It consequently shouldn’t be a total surprise that the growth in China’s exports to the US lagged China’s overall export growth. Exchange rates do matter.

The Economist continues to assert that exports mattered less to China’s growth than many think.


But the “net exports” unambiguously accounted for between 2 and 3% of China’s growth for most of the past four years. The fall in the imported content of Chinese exports over this period is a big reason for the increase in China’s trade surplus even as China’s commodity imports soared. And recent work by a Li Cui, Chang Shu and Xiaojing Su suggests that fast export growth also spurred a lot of investment. They find, in a paper published by the HKMA, that 10% real export growth produces a 2.5% increase in overall growth – more than can be explained by the direct impact of stronger external demand. During periods when real exports were growing by 20% (or more), their work implies that fast export growth would explain something like 5 percentage points of China’s growth.

Another of the Economist’s arguments – namely that the size of the fiscal stimulus has been unduly discounted -- is more persuasive. Consider that a mea culpa, as I have argued that the large size of China’s announced stimulus overstated China’s true stimulus. China’s headline deficit of 3% of GDP just isn’t that impressive, and the swing in the government’s fiscal balance was far less than the announced size of the stimulus.

But it is now pretty clear that the shift in the government’s formal budget wasn’t the only mechanism for providing stimulus to the economy.

China’s banks are state owned. They were liquid, as lending had been curbed to try to keep China’s economy from overheating. And when told to lend more – whether to state firms looking to invest, state firms looking to stockpile commodities or local governments free to spend on ambitious infrastructure projects, they clearly did.

China’s state banks before the current crisis were a bit like the US Agencies before the August subprime crisis. At the peak of the housing boom, the Agencies’ ability to grow their portfolio was constrained (as a result of past accounting irregularities and the like). Their market share was falling. After the subprime crisis curbed private label securitization though, Washington lifted curbs on their activity, and they responded. Similarly, the state banks ability to lend was constrained by lending curbs and a rising reserve requirement at the peak of China’s boom. When the curbs on their lending were lifted, they responded, and in a big way.

The increase in their lending in the first quarter is staggering. The state banks are a far larger part of China’s financial system than the Agencies are in the US, so the expansion of their lending seems to have had a macro impact.

Wang Tao of UBS has produced a graph that shows that the increase in bank lending in the first quarter looks a lot like the increase in late 2002 and 2003. That blowout eventually led to an uptick in inflation, and then to a decision to curb the state banks’ lending growth.* The current blowout looks bigger.

As a result, y/y investment growth in China in q1 was around 30%. That is huge. It presumably reflects a huge rise in public not private investment.

It likely will have a future fiscal cost. The likely losses on these loans probably can be thought of an additional form of fiscal stimulus.

And if Cao Jianhai of the Chinese Academy of Social Science is right, China retains a lot of underlying vulnerabilities, not the least that home prices are over ten times urban income, and thus there is underlying downward pressure on property prices.

But a surge in lending that keeps Chinese demand up until the world recovers isn’t the worst outcome either. The world needs demand – and a lot of public investment, even money-losing investment, in China is one way to generate the needed demand.

China’s 2009 outlook then shapes up as a race between falling private investment (and shrinking exports) and rising public investment, with the trajectory of private consumption the wildcard. 2010 probably won’t be that different.

Moreover, the internal basis for China’s growth still looks imbalanced. The stimulus to public investment has been far stronger than the stimulus to private consumption. Stephen Green of Standard Chartered has this right; I second his call for another initiative to help boost consumption.

Bottom line: I would be a lot more comfortable saying China had turned the corner if there were stronger signs that China’s imports were starting to pick up, and there were stronger signs that the stimulus was starting to spill over into demand for the rest of the world’s goods.

The blowout in lending growth in 02, 03 and early 04 was accompanied by a strong rise in China’s imports. For now, though, China’s imports are shrinking faster than US imports.

Hopefully, that will change soon. A solid pickup in Chinese import demand would be a real green shoot.

* That decision combined with the decision to allow the RMB to depreciate along with the dollar to produce the big increase in China’s surplus. Until lending was curbed, imports were growing almost as fast as exports, and it was possible that the rise in Chinese inflation would have produced a real appreciation that would offset the real depreciation linked to the dollar’s fall.

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