“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.
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:
— 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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