The consensus view of China is that the country is imploding due to the collapse of the export sector. This view is widely held and considered almost obvious by experts ranging from Jim Chanos to Marc Faber to just about every private equity investor I know. And all of the arguments make sense. But they may also be dead wrong.
I come to the subject of China having read East Asian history at Villanova University in the 1980s under the wonderful lecturer Cornelius Kiley. Later I worked with many Asian firms as a consultant and then as a researcher covering the semiconductor capital equipment space with Fred Ramberg and Ry Ward. This last experience was most revealing because of the intense competition between China, Taiwan, Japan, Korea and the other nations of the region in terms of manufacture of silicon based components and finished electronics.
The China meltdown scenario is based on the idea that China’s economic activity is entirely based upon export sectors and that domestic demand is not sufficient to support the country. But as my friend and colleague at Tangent Jim Rickards noted recently, if the economy slows the Chinese government will just build a few more cities. Or to put it another way, the Chinese could flush most of the banking sector and just start more banks. After decades of socialist construction, what we think of as market mechanisms are still primitive and tightly controlled political constructs.
When my friend Leland Miller started the China Beige Book (“CBB”) earlier this year, I was fascinated by his reporting that said that the non-export sector is actually stronger in China than most western observers believe. CBB reports in the upcoming Q3 2012 analysis:
“China’s economy is not just manufacturing, and there has been a general over-reaction to that sector’s problems. While CBB Q3 results confirm manufacturing weakness, our survey extends to retail, services, property, and other sectors. Most other sectors show more resilience and greater confidence than manufacturing.”
What is more interesting is that CBB reports a decline in the demand for credit in China, this even in the face of a loser monetary posture by the central bank. There may be a finite limit to China’s ability to absorb the disastrous decline in exports, but perhaps the west is over-estimating the importance of such a shock, both in political and economic terms.
Having worked in a number of “emerging markets,” the western fixation with government economic data in China and other nations always astonishes me. Jeffrey Sachs scandalized the Chinese government years ago by suggesting that the data was “too good to be true,” and indeed it was. Or as CBB put it in their Q2 report: “Astonishingly, virtually all economic analysis of China—even by the most high-profile China experts, macro- economists, investment Banks and hedge fund managers—still relies on this sorely limited set of state-sanctioned figures.”
So is China really imploding? My sense is that the reality is a lot more complicated than western audiences believe. Jim Rickards, who travels to Asia regularly, told me today that the CBB report which says that more credit may have lowered interest rates without increasing loan uptake “is completely consistent with the information I received in Hong Kong.”
Rickards adds: “This is why we should expect a decline in the reserve ratio and an increase in the loan to deposit ratio because those are both more powerful ways of stimulating lending than lowering rates. China cannot do QE because there's nothing to buy. Lowering rates does not work because of the asset-liability mismatch. So the only way to ‘ease’ in China is to increase leverage. That works.”
So when you hear western experts wringing their hands over the impending collapse of China’s export driven model, it is useful to remember that this economic model is merely the latest experiment by China’s leaders in imitating western paradigms for growth. This experiment is conducted under the tight control of China’s communist party.
Just look at the news reports today about China deploying an aging aircraft carrier purchased from the Ukraine. China has neither the aircraft nor the trained cadres to actually operate an aircraft carrier at sea, but the desire to emulate the military capabilities of the US and other western nations makes such an expensive endeavor worthwhile.
The fact of having an aircraft carrier is not so much a statement of military might as of geopolitical pretensions as well as internal political need. It is that political prism, ironically, which we also should use to assess economic data coming from China.