China's Credit Bubbleicious Trade Balance Pain

Recent German economic data has been interpreted as indicative of a renaissance in the Eurozone's primary economy. Aside from the fact that Germany is ill prepared to handle its so-called "second credit crisis wave" (the ECB having much less free reign over printing wheelbarrows worth of Euros may have something to do with this), looking purely at GDP components one would note that a primary function of this anticipated growth comes primarily from a mathematical contribution resulting from an increase in net exports. From the Bundesbank's most recent monthly economic report:

According to provisional figures from the Federal Statistical Office, in May the foreign trade surplus was up by 30.2 billion on the month to 39.6 billion. After adjustment for seasonal and calendar effects, it rose from 39.0 billion to 310.3 billion. The value of exports rose slightly by 0.3%, while the value of imports declined by 2.1%. If April and May are taken together, seasonally adjusted nominal exports were 5.1% below the average for the first quarter of 2009. Of this, 0.6 percentage point can be attributed to export prices. Imports were down as much as 8.4%, with 1.7 percentage points due to market prices.

So basically, we are seeing voodoo mathematics which indicate sovereign economic improvement as a result of declining world trade. This is even more obvious by looking at a time series of US net exports, where a disproportionate collapse in imports has made it seems that the US GDP is also improving.

Yet while Germany (and thus the Eurozone) and the US are basking in the temporary glow of mathematical bliss, gulped up by eager momo quants who have the attention span of only the first 5 letters of any headline before lurching with millions of bids, this changes nothing on a global scale where all trade flows are net neutral, and the traditional net exporters are getting pummeled: we demonstrated the collapse in Japanese exports, historically one of the strongest positive trade balance countries. The simple math is that what is good for the US and the Eurozone is bad for Japan. 

Yet the real wild card is China, where estimates for export decline approach the 20% mark, after a prior year increase of 20%. This is a huge hit to the Chinese economy and is the primary reason for the $1.1 trillion in increased lending, whose primary purpose is to spur replacement demand with traditional export partners reeling.

In essence what is going on, is that the brief pick up in German and US GDPs on the trade balance side, are being facilitated exclusively by the credit bubble in China. By dint of China being able to recognize GDP at production instead of expenditures (like normal Western countries), China is now trying to back fill into the trade void left from the collapse of Western economies by promoting the same kind of irresponsible lending (and borrowing) that lead the US economy to its current sorry state. This will eventually end very, very badly.

Two conclusions: i) the bubble is unsustainable and recent overtures by the Bank Of China indicate that they are aggressively attempting to rein it in; however as the amount of liquidity let loose primarily in the equity capital markets is staggering, on par with the balance sheet expansion by the Federal Reserve, this will prove to be a nearly impossible task; ii) as this replacement demand is shut off, the tremors in trade flows will exacerbate the temporary respite that the two main non-Chinese economies have been experiencing, and not only will the velocity of exports over imports decline, but the bigger question of how the collapse in Chinese capital markets (and the real estate bubble) is yet to be answered. All this, of course, also means that the temporary period of abnormal increase in the US equity markets will be aggressively tested as flush global liquidity will be promptly mopped up beginning over the next 2 months, with the expiration of QE and a major shift in Chinese lending policy.

As everyone knows, the S&P 500 is up 50% + not on any improvements in fundamentals, but merely as a function of excess liquidity driving markets higher, which in turn generated temporary increases in confidence, feeding a closed loop of confidence and market increases. Yet, the US consumer is down for the count, and while it is this primary factor for US growth the the Fed should be tending to, Mr. Bernanke is more concerned about keeping mortgage rates artificially low in order to perperuate the credit bubble as long as he can. As we have seen over the past year, credit bubbles do not go away by themselves, and inflated asset bubbles tend to pop. Regardless of how much cash one can throw at the problem, and how much pain the formerly proud US Dollar can take.