“But nothing is normal in China anymore.”
Hard-landing gurus have been predicting an imminent end of the China bubble for years. A “hard landing” would be the optimistic scenario. The other scenario would be a crash-and-burn. But to their greatest frustration, there was no hard landing, or a soft landing, or any landing for that matter. China just kept on flying.
Fueled by an enormous credit bubble and monetary propellants, it kept adding to entire ghost cities, industrial overcapacity, and the most breath-taking infrastructure build-out the world has ever seen. Global demand for its products faded as labor got more expensive, but the 1.35 billion increasingly moneyed Chinese consumers discovered splurging on smartphones, cars, luxury goods, and a million other things. The China bubble stayed aloft, despite all the cracks appearing here and there.
But now it’s running out of air.
The car business in China has been the most phenomenal growth party in the world: in two decades, it went from nearly nothing to 20 million passenger vehicle sales per year. Every global manufacturer elbowed into it with multi-billion dollar investments. It’s a big part of the Chinese economy, impacting retail sales, manufacturing, and investment in fixed assets as plants, distribution centers, and dealerships are built. It adds to transportation as these cars are shipped from the plant to dealers across the country. It adds to services such as finance and insurance.
But the party has been running out of booze. In April it just about stalled at a dreadfully tiny year-over-year growth rate of 3.7% when the industry is counting on a 9% increase for the year and is building out capacity to accommodate much more. Hence what automakers dread: price cuts.
GM and Volkswagen, which between them control 30% of the Chinese market, kicked it off. Prices of VW models will get cut by $800 to $1,600. GM is slashing prices of Buick, Chevrolet, and Cadillac models by $1,500 to a juicy $8,700.
“In this market, price wars are normally started by Chinese automakers trying to compensate for a weak brand image and obsolete technology,” wrote Yang Jian, managing editor of Automotive News China. “But nothing is normal in China anymore. This time it’s global brands – not the domestics – that are launching a price war.”
The problem is that “economic growth and premium-brand vehicle sales are highly correlated,” Jochen Siebert, head of JSC Automotive, a consultancy with offices in Shanghai and Stuttgart, told Yang Jian. The economy may be much weaker than official estimates indicate, Siebert said, citing steep drops in railway freight transportation and electric power consumption. In that case, he said, demand for passenger vehicles, especially luxury cars, will deteriorate further.
And that seems to be playing out. Fathom Consulting via Thomson Reuters’ Alpha Now, reported:
The most recent update of Fathom’s China Momentum Indicator (CMI) points to a further setback for China’s economy, with the March release suggesting that growth could be as low as 2.5% over the next year or so. This implies a much faster pace of deceleration than that reported by the official data. Notably, until early last year, our measure of China’s economic growth rate tracked that reported by the official data. The two now diverge wildly.
The CMI’s components are in bad shape.
Freight railway volume plunged in February to a level not seen since early 2009 and is down 24% from its peak at the end of 2014. Volume ticked up in March but only to a level first seen in 2010, and remained nearly 10% below a year ago.
Retail sales grew, unlike some of the other indicators, but at the slowest year-over-year rate since 2006. Industrial production grew 5.9%, compared to an average pace of 14.5% during the 10 years before the financial crisis. And electricity production, which is part of industrial production, fell year-over-year.
And this after three rate cuts by the People’s Bank of China over the last six months. Fathom:
Worryingly, evidence to date suggests that the PBoC is losing policy traction – with rate cuts failing to properly feed-through to market rates. This will inevitably complicate the transition away from shadow-based financing to bank lending. As a consequence, the stock of nominal bank loans – the third indicator used to calculate the CMI – rose by just 1.4% between February and March.
Total social financing, a measure developed by the Chinese authorities to capture the total stock of credit extended to non-state entities, has fallen to a six-month low. Evidently, the monetary loosening that has been undertaken by the PBoC has been insufficient to stimulate enough lending through official channels to offset the state-induced contraction in shadow-financing.
Fathom developed its own index of non-performing loans, a mega-problem in China after years of malinvestment in overcapacity and projects that will never be able to pay for the debt that had been incurred to build them. Fathom’s index pegs non-performing loans at 21% of GDP for 2015, while the official NPL ratio is an “implausibly low” 2% of GDP. And it observed:
Interestingly, even they could not deny the recent economic deterioration with the value of non-performing loans registering its biggest quarterly jump on record in the first quarter of this year.
Fathom’s overall China Momentum Indicator used to track the official GDP growth rate fairly closely. But last year, it began deviating sharply as the official growth rate clung stubbornly to the 7% range. And now, while the official rate is still 7.0%, Fathom’s CMI plunged to a new low of 2.5%. This “growing wedge” between the CMI and official statistics shows that China entered a hard landing, according to Fathom, at the beginning of 2015. And this (yellow line) is what a hard landing looks like:
#China‘s Momentum Indicator plunged to new depths meaning further setbacks for the economy: http://t.co/6BGZnBYMws pic.twitter.com/Rh7HY3SOQ1
— Alpha Now (@Alpha_Now) May 14, 2015
Fathom warns that the PBoC’s current process of “cautious monetary easing” won’t be enough to overcome China’s “mounting economic woes.” So when the PBoC spoke of “big downward pressure,” it wasn’t kidding. Read… China Downturn Hits US Automakers
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China experienced incredible blistering economic growth since the mid 90’s. This was in part due to the plenty of young workers willing to toil in the factories for pittance and loose lending practices to SOEs (state owned enterprises).
Great recession of 2008 was a shock to the comrades in charge and they spent like drunken sailor to maintain the high growth and ended up mislocating the capital in certain sectors dominated by the capital intensive SOEs (steel, aluminum, car, cement, bridges/roads to no where, highspeed rail, etc). Local governments got taste of captialism and borrowed heavily to build mini Taj Mahal city halls and grabbed peasant’s land and sold to the developers. Folks speculated in RE flats as a store of value with ghost towns popping up all over China. Now there are strains in the financial well being of the small to mid size companies who got funding thru the non-regulated shadow banking and the developers are facing head winds with some going BK.
Folks – this could be the start of unraveling of bad debts in a country where lending is dictated via connections and rampant corruption. So what is BoC to do? QE of course but alas it didn’t work in Japan, US and EU, and alas what can happen if the global growth engine lands harder than expected?
The Communist Party can do anything it wants to keep the China economy growing. A crash and burn scenario is not going to happen. Slowing growth and a limited temporary recession the worst case scenario. Modern central banking monetary policy will be applied to stem a crash. Same as being applied in Japan and EU. Remember there is only One political party in China and these people want stay in power at any cost. So they can apply as much monetary economic engineering to a slow down as they deem necessary.
I agree with this. I am going to argue with the numbers, because it may actually be worse, but so what? The Chinese government can play this game even longer than Western CBs in my opinion. The only thing that may upset the cart is if capital flight becomes too obvious, but if the government gets in front of the corruptors fast enough, capital will stay in the country and this thing can go on for quite some time yet.
I meant “I am not going to argue with the numbers”
All hail the central planners then. They have found the magic formula, the road to Nirvana.
I’ve noticed that items I bought last year which were made in China are now being made in Vietnam, Thailand, and Sri Lanka. Looks like the TPP is already in action.
China can’t crash and burn? I don’t get it. Let’s see. The Soviet Union starved 30 million people to death. Circa 1960 China had a famine and Chairman Mao slaughtered the intellectuals in the Cultural Revolution. Such a reactionary event can happen again in an economic contraction – they’re COMMUNISTS!
A lot of people seem to have conveniently forgotten that “THEY’RE COMMUNISTS” part. I too think that is important. Not that it will stop the money movers. A deal with the Devil? What’s he offering?
If you know a few Chinese businessmen, you’ll be struck by how differently they view their own country.
Westerners are almost invariably in awe of the so called Red Capitalist model. They guzzle down without questioning the impossible numbers originating from Beijing and tend to shrug away data (industrial overcapacity and underperforming loans being the most worrisome) which doesn’t fit in their preconceived pattern.
I think this stems by how, in general, Westerners have always admired centrally planned economies because they never lived in one (until very recently). I saw exactly the same infatuation back in the days when the USSR regularly released her steel and cement production figures.
The Chinese are different. Their ebullient behavior doesn’t betray the blind faith and naive optimism typical of Westerners. We like to imagine China as populated by otherwordly mystics and firebrand Maoist ideologues but in reality the Chinese are the most down-to-earth, pragmatic people around. And they are deeply cynical and distrustful of their government.
Their behavior is driven by a very simple rule: “make money and enjoy it right now because you never know what Beijing will come up with tomorrow”.
Hence make a killing in the housing sector and buy a Ferrari. Housing is grinding to a halt? Switch to stocks damn right now and get an Ukrainian mail order bride (I don’t want to sound sexist, but it’s a big thing in China right now).
For the Chinese, be them well connected Party members with almost unlimited access to credit or street peddlers gambling their savings on the Shenzen Small Caps Index, time is everything. You have to get into the party as soon as it starts because you never know when Beijing (or the natural, unescapable laws of economics) will take away the punch bowl. That’s the reason of the herd-like behavior we’ve seen in housing and now the financial sector.
The central planners in Beijing may have the illusion of being in control, but all they can do is reshuffle the chairs to push their own people into one bubble after another by playing upon the almost physiological need to make as much money as possible in a very short time.
Problem is, housing in China, probably the most egregious bubble in the history of mankind, is in very deep troubles. It will take years just to liquidate malinvestment in the sector, provided China doesn’t go the same route as Europe and the US and doesn’t leave a stone unturned to stop the bubble from deflating.
All that’s left now are the stock markets.
How long will they last?
By borrowing a page from our Chinese friends, it only needs to last long enough for me to sell my holdings.
Yes, I confess I got into the Shanghai stock market before this stampede started. I got the local equivalent of blue chips: big State-controlled banks, big telecom companies etc. I may not have made a killing but my gains have been very conspicuous, especially given the small sum I originally invested.
But now those blue chips have followed exactly the same pattern as they do all over the world: they got too expensive and flatlined. The chances of them soaring again are very slim: the hot thing in China right now are the relatively cheaper small caps, and there’s no chance in Hell I am getting into such a volatile market.
Time to get out before they start sliding down.
It was nice knowing you China and thanks for the rice.
I tend to believe that economic fundamentals will trump at some point. An economy cannot keep printing money above a related level of goods and services without inflation showing at some point. The thing all modern fiat economies have going for them in this regard is they are so large. Huge really. So the ‘reservoirs’ to retain that inflated money are big. The stock market is one such ‘reservoir’ that governments actively promote for use.
All this, be it as it may, economic fundamentals will assert themselves. We just don’t know when.
When I think of China I always envision line after line of people with a basket of dirt, all shuffling forward to drop the basket in the same way to construct a railroad bed or new dam (maybe the Great Wall)….all at the point of a machine gun toting soldier.
This isn’t communisim. It’s someting else. It’s Chinese.
The Emperor and the Mandarins never went away.
Just like the Tzar and the Boyars they simply keep changing hats and names.
Each new bunch, eviler, and even more corrupt than the last.
Current human population levels, and the current consumerism based capitalism are both unsustainable.
The questions are: who does the culling, how, and of whom.
China structured as it is, is one of the states ready to survive such a situation, perhaps even instigate it.
Well it’s nice to know I’m not going mad. Too many people confuse power with control. Both Caesar Augustus and Napoleon admitted before they died that they controlled nothing.