China is set up for a big fall

The punderati has been especially kind to China. As the global recession takes hold, the conventional wisdom has moved from the largely debunked de-coupling of China to a story where China slows, but much less so than the west. But is that really how things will play out?

Marshall Auerback certainly thinks China faces some stiff headwinds, but he believes these are issues that can be overcome. Debt levels are extremely low and savings levels very high amongst the consuming masses there. Mark Mobius believes that the emerging markets generally are shortly due for an upswing. However, I would like to take a more pessimistic tack here.

You may recall that just yesterday I quoted from an Indian article which underlined the cratering of export demand for China. Let me add to those thoughts with the following analysis:

  1. The Chinese are highly dependent on manufacturing exports to maintain growth. Most of their growth in the last two decades has come from export demand subsidized by a cheap currency and massive numbers of relatively low wage workers.
  2. However, demand from the west is cratering because of the worst recession since the 1930s.  Because China’s export economy is geared to the west, this has had a devastating impact on export demand.
  3. As a result, the Chinese will need to switch to a focus on domestic demand. Where is this demand going to come from? Granted they have no debt. However, people don’t just start buying stuff in the middle of the greatest downturn in 75 years. Chinese people see these and must know that caution is warranted.
  4. Moreover, their residential property market has imploded as has the stock market. This too must work against the psychology of increased domestic spending as the wealth effects here are significant.
  5. And the banking system was already fragile. My general thinking would be there are huge hidden losses at Chinese banks as a result. Therefore, lending capacity has to be restricted going forward. I would not be surprised if we saw a reduction in the money multiplier in China as well.
  6. Ultimately, I would argue that the Chinese domestic consumer is not going to consume more.   In fact, they would need to consume a lot more given the GDP per capita of the average Chinese person in order to replace the lost demand from the West.  But, I believe they will consume less given the factors enumerated above.

I await more data from China. In the meantime, I remain skeptical but open to persuasion.

China’s industrial output growth stalls – Sydney Morning Herald
China ‘repeating US mistakes of 1930s’ –, India
The Great Crash of China – Far Eastern Economic Review
China’s Output Growth to Drop Further, Minister Says – Bloomberg
China: Industrial Output – Bloomberg
China Industrial-Output Growth Is Weakest Since 1999 – Bloomberg

  1. Sobers says

    China will be an economic (and social) disaster zone by late 2009. We may never know how bad it may get there. The Communist govt will suppress all evidence ruthlessly, and restrict Western media access. Any nation that is as export oriented at China is today will have horrendous problems when the demand for their manufactures just stops. Given the lack of social safety net in China it could be very ugly. But as I said, we will probably never know how ugly.
    Germany is in a similar but lesser situation. They will suffer most in Europe I think, but given they are a nation with a welfare system, not too excessively.

    1. Edward Harrison says

      @sobers, I would tend to agree with our views. It’s funny you should mention Germany. I see China as another East Germany, posting economic numbers for external consumption. The question is how real are they. In East Germany’s case we found out after reunification that the numbers were fake. Will the same be true in China? Only time will tell.

      I should point out that Marshall Auerback has a considered view greatly a odds with my own. See his recent post here:

      China can handle collapse of speculative inflows

      Let me know what you make of his argument and feel free to give him a piece of your mind! He and I disagree but he knows China quite well.

  2. wen O wen says

    Fake numbers every where.
    see Shadow stats . c o m etc.

  3. aheadofthecurve says

    Auerback is far behind the analytical vanguard where China is concerned (I recommend you read ), largely because he’s ignoring the export-led employment bubble that has burst. He can dismiss asset deflation as a bonus for employed Chinese, but he’s got nothing to say about the millions of unemployed and soon-to-be unemployed workers and students, most of whom are male and young.

    I hope the CCP has an answer for this that doesn’t involve blaming the situation on the West. Otherwise I think the German comparison is on-target and a dangerous proposition.

  4. John Creighton says

    Blaming other people is what politicians do to hide from accountability. We must not forget that the Chinese government fulled this imbalance by paging the Chinese currency against the US dollar at an artificially low rate.

  5. steven says

    Just wondering how many billions of $ Mobius has lost in the Indian and Chinese stock market over the past year and a half.

    1. Edward Harrison says

      @steven: and he is looking to put more billions at work. From where I sit the emerging markets look like a place to avoid at the moment because the full force of the downturn will hit the G7 first and fan out from there. You look at countries like Brazil, Russia, Argentina, South Korea, India, and China and you see places that are getting hammered by low commodity prices and are having severe foreign exchange turbulence. I anticipate this to continue for quite a while. Only time will tell about Mobius, but one wonders whether he has become a perma-bull on emerging markets.

  6. Mothman says

    Be careful quoting Indian articles in relation to China. They are invariably negative – INdia has a big brother relationship with China – and believes their economy (unweildy democracy, lack of infrastructure, less foriegn investment) is superior to China’s model. Even when the chinese economy was powering I never saw a positive article written by an Indian reporter.

    1. Edward Harrison says

      @Mothman, you make a good point. I agree with the story’s analysis however and that is much of the reason I presented it. However, it would not be unreasonable to believe the reporter had an axe to grind about China.


  7. Greg Norris says

    For readers' possible interest, here are links to two excellent reports assessing China's economic outlook:



    Best regards and thanks for a great blog,


    1. Edward Harrison says

      Thanks Greg. For some reason, those links don’t process. Would you send them again?

  8. Glen says

    It strikes me as odd how China will be able to shift their population into consumption mode when every asset class they have invested in has fizzled there by reducing their wealth. The other problem I see is that a large bulk of Chinese wages earners do not have the capacity to buy most of the goods they produce any way given their low wage rates. It's a flight of fantasy to think this can be done in 12 months when other nations have taken 20+ years to progress (regress?) to a consumption driven society.

    1. Edward Harrison says

      Glen, I agree with your skepticism 100%. On the other hand, the fact that Marshall Auerback and other pretty smart analysts have a more upbeat view on China keeps me from dismissing a quick rebound scenario. I do agree with Marshall that China will still be a much better bet for growth after the recession has eased. But, for now, I see most of the risk on the downside there. Mainly, I look at China like one might see a 1970s Korea or a 1960s Japan — and that means ty will overcome this recession eventually, but not without significant pain.

  9. Greg Norris says

    Hello Mr. Harrison,

    RE: Edward Harrison Says:
    December 27th, 2008 at 3:01 pm

    Thanks Greg. For some reason, those links don’t process. Would you send them again?

    Here are the two links again (apologies for the delay in re-sending them):


    Best Regards,

    Greg Norris

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More