Niels Jensen Asks If Plunging Chinese Power Output Is Indicative Of A "Dramatic Economic Slowdown"

The latest letter by Absolute Return Partners' Niels Jensen is a must read for anyone still on the fence about the Chinese "thesis." With many prominent pundits pitching either side of the China bull/bear case, often times covering up weaknesses in their arguments with extended and superfluous rhetoric, sometimes it gets easy to get lost in the noise: here is where Jensen's ability to create signal shines through. Jensen starts off with the official revelation that Chinese GDP is a made up number, discussed previously on Zero Hedge. "In a leaked 2007 cable Li Keqiang, who is the favourite to become the next premier, confided that official Chinese GDP figures are “man made” and “for reference only” (surprise, surprise), and that one should rather look at alternative measures such as electricity consumption, rail freight volumes and bank lending, if one wants a true picture of economic growth in China." It is all downhill from there.

First, looking at trends in Chinese power output, indicates that the Chinese economy very likely fell off a cliff in 2010 despite what the fabricated GDP number was indicating:

Here is ARP's take on this collapse in the one metric that actually does matter:

Assuming the electricity stats tell the true story, and that the GDP numbers are ‘for reference only’ (remember, not my words!), China’s economy experienced a dramatic slowdown as 2010 progressed. Total power consumption (year on year) grew by a whopping 22.7% in Q1 last year but only by 5.5% in Q4. The slowdown in Q4 was in fact so dramatic that the power output dropped 6.3% quarter on quarter! There were some restrictions in place on the use of electricity in Q3 and Q4 which did have some impact, but those restrictions were dropped in November, so it cannot be the only explanation. This story is largely ignored by the sell-side banks, most of whom have no interest in offending their new pay masters

Yet while economic growth does not lead to revolutions, surging price inflation does. So what does China do? Pull a page straight out of the BLS playbook, and minimize the impact of food on CPI!

Turning to inflation, a similar picture emerges. According to the official stats, Chinese consumer price inflation moderated to 4.6% in December, down from 5.1% in November. However, anecdotal evidence suggests a much more serious problem, in particular in the largest cities, where actual inflation is running close to 20% according to my sources.

As I prepared for this letter I received an email from China specialist Simon Hunt, who notified me of the fact that the National Bureau of Statistics of China has just announced that the weight of food in the consumer price index has been reduced as of 1st January. In an emerging economy such as China, where 35-40% of disposable income is spent on food items, sharply rising food prices are actually likely to lead to food accounting for a higher percentage of overall disposable income, so the Chinese reaction defies all logic. There can only be one motive: to cook the books. The CPI numbers appear to be as rigged as the GDP numbers.

I don’t really know whether actual inflation is currently running at 8%, 10% or possible even higher. All I know is that it is a much bigger problem than the official numbers suggest.

Which is why, as we have been advising since October 2010, the easiest global central bank put is to push the accelerator on the rice trade. This, at least to China, is the end all be all, and why just like in Europe the bond vigilantes woke up just as it was made clear how insolvent the continent truly is, so shall the price of rice surge once it is made apparent to the entire world just how close to the edge China and its 1.3 billion really are.

And lest anyone believe that the PBoC was the only bank that did not engage in artificially stimulative QE, here is a chart from SocGen, via ARP, debunking that foolish notion:

Bottom line:

As a result of the above, the Chinese leadership currently finds itself in a bit of a pickle. On one hand, indications are pretty clear that the economy is at grave risk of overheating. On the other hand, the transition of power from current President Hu Jintao and Premier Wen Jiabao to the next generation of leaders is fast approaching. Although the National People’s Congress, where the new leaders will be officially instated, is not taking place until March 2012, the new power structure will almost certainly become apparent to the outside world at the next party congress, scheduled for October of this year.

Given the importance of this changeover and the significance the Chinese assign to not losing face, the leadership will do anything in its power to maintain the economic momentum until after the March 2012 congress. This increases the probability that the Chinese monetary authorities will fall further behind the curve in the months to come and make the landing so much harder when it ultimately happens.

While there is much more in the full letter below, the key focus is on items relating to commodity price inflation. It took cotton one month to jump 28%. This will make its way through the price chain and impact both Chinese margins and personal incomes, and eventually do the same here in the US. Then add all other commodities, and please ignore any stupefying explanations from the Steve Liesmans of the world how wheat prices surging is actually irrelevant for the price of bread.



No comments yet! Be the first to add yours.