Charting China’s Year of the Rat

China’s growth is slowing

In 2019, China’s real GDP growth clocked in at just over 6%, its lowest in the modern era.

It’s nearly cliché to talk about China’s excess capacity, ghost cities, etc., but official data on capacity utilization and inventories often has a short and spotty history. Hence, we need to rely on prices to confirm these underlying trends.

Take real estate, for example. Chinese cities are unofficially broken out into a 4-tier classification system. Tier 1 cities are considered to be the most developed while tier 4 cities are least so.

The real estate price growth of tier 1 cities is well below its mean, while tiers 2-4 remain within normal range.

Macrobond moment: Use Cross-Section to create mean indices for medium to large datasets.

Then there is industrial capacity. Here, consistent with excess capacity—e.g. low capacity utilization and excess inventories–, producer price inflation is falling after a brief spike in 2016-17. Further, in a certainly unintentional homage to the late Arthur Burns–as official statistics of China’s real activity are falling (dark blue), consumer price inflation is above 4% and rising (red).

Is this the beginning of Chinese stagflation?

The bear case

The pessimist’s case for China’s outlook goes something like – “China is old and indebted.”

It’s true. China is old—really old for a country at its moderate stage of per-capita income. The Old Age Dependency Ratio is the percent of persons 65+ relative to those 20-64. The higher the ratio the larger the economic burden on citizens of working age. Here, the negative consequences of China’s one-child policy are clear. China’s demographics resemble the old, rich developed world—with all its attendant issues—rather than those of other rising economies.

Similarly, in its indebtedness, China again compares—unfortunately—to the slow-growth rich world. While it is not Japan, according to the BIS, China’s overall debt (public and private) as a percentage of GDP is much closer to that of high-Income economies than its middle-Income peers.

China has used this debt to fund massive infrastructure projects and other fixed-asset investment. However, this “catch-up” investment-led growth has diminishing returns in the form of “ghost cities”. Evidence of continued infrastructure spending can be seen in the recent large uptick in local government bonds, which today account for around 1/3 of all bonds outstanding in China.  These local bonds are used to finance infrastructure projects and stimulate growth. China plans to issue another ¥1 trillion yuan (~$140 million USD) as counter-cyclical policy.

Not so fast, Dragon-Slayer!

It wasn’t so long ago that China was a verified economic basket-case. For much of the 20th century, China experienced wild swings in economic growth during periods of revolution and upheaval. Gradually, in the 1980s and 90s, China began its great “opening-up”.

Today China is the economic envy of other developing countries. Called “one of the great [economic] stories in human history.” Since 1990, with reforms to its economic system and its embrace of the global market, China has lifted nearly 1 billion people out of poverty.

That’s (well-deserved) praise for an absolute living-standard improvement for a country with a very large population. What about a relative comparison?

In relative terms, it is not so clear that China’s 30-year economic boom is much more impressive than other East Asian success stories, such as Japan, Hong Kong, and South Korea.

In order to overcome some of the issues associated with China’s alleged smoothing of short-term fluctuations, we looked at the annualized 5-year percent growth for a set of East Asian economies. We then lagged these series (i.e. dragged them forward) to compare China to other high-income East Asian economies. The chart below shows China’s real GDP growth today to its Tiger peers 40, 30, and 20 years ago, respectively.

Note: We are well aware of issues with Chinese GDP data and its remarkable stability. We recommend Arthur Kroeber’s China’s Economy for more on these and other issues.

Will China catch up to its other high-income East Asian peers?  Whether we look at real GDP or population, China’s growth may be slowing but its general trajectory is on par with other countries that eventually became rich.

The (tepid) bull case

China’s social financing is a measure of overall credit creation in the Chinese economy. There are 2 recent trends in the data of note.

Firstly, increases in this indicator are typically followed by increases in real activity—such as vehicle and housing purchases—with a 6-month lag.

Secondly, there has been a significant increase in non-bank lending. An unintended consequence of macroprudential and regulatory policies? Perhaps. In any case, the significant increase in non-bank indicates that (a) on the bright side there is, in fact, demand, but (b) on the downside, this demand is not being met by traditional lenders within the Chinese financial system.

Note: Shown is a “credit impulse”, which approximates the contribution of credit growth to GDP growth. In this case, we took a ratio of social financing, using trailing 12m social financing flows and 4q trailing GDP, and applying a YoY difference.

A corona-curveball

Although the US Center for Disease Control estimates the flu kills nearly 291,000 people per year globally, alas, we could not write a post at the end of January 2020—believe us, we tried–without mentioning the dreaded coronavirus, which has claimed 200 lives as of this writing. At Macrobond, we are macroeconomic data and time-series analytics experts, not epidemiologists. So, what—if any–are the immediate economic risks of the outbreak?

Beijing’s response to coronavirus has been aggressive. To contain the spread of the virus, the Chinese government has quarantined the city of Wuhan and other cities in the land-locked province of Hubei. In doing so, the PRC has restricted the movement and activity of approximately 56 million citizens.

To outsiders unfamiliar with China’s domestic terrain, the Hubei province is a sizeable economy. If it were a country it would rank between Saudi Arabia and the Netherlands in terms of GDP (in USD).

The Hubei province is China’s 7th largest province, accounting for over 4% (and rising) of China’s GDP, as well as over 6.5% of its fixed asset investment—a key component of China’s investment-led growth.

Should this viral outbreak turn into a verified pandemic—if it has not already–, the first-order economic impact of a localized catastrophe is large enough to impact China’s aggregate statistics due to Hubei’s size.

We will continue to follow China’s development throughout this Year of the Rat.

Authors: Wadsworth Sykes and Alex Pelle

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