Volume 62, Number 3
China announced their GDP grew 8.9% over the four quarters of 2011, and at an 8.2% annual rate in the final quarter of the year. Nominal GDP grew 17.0% during the four quarters of 2011. As McVean Trading decomposes the data, implied inflation slowed sharply in the fourth quarter to a 5.6% annual rate from 9.1% in the third. Despite all the clamoring about food based retail inflation, the broader GDP deflator was up at a 7.4% annual rate in the second half of the year after a 7.3% annual rate in the first half. Inflation in 2010 was at a 6.6% annual rate – right in line with the average of the past eight years.
China’s high inflation rate remains a consequence of its managed foreign exchange rate policy, as it boosts money supply by buying dollars with newly created yuan to limit the rise in the value of its currency. The invisible hand is smarter, however, and pushes up prices in yuan to compensate. The need for money creation should ebb in 2012 due to a narrowing trade surplus, reduced inflows of foreign direct investment, and more hot money trying to move out of China than is coming in. Inflation has traditionally lagged behind growth in China as the authorities are slow to rein in lending. Continued restrictions on property may sustain the slowdown in inflation this year. A recent announcement indicated major banks will be allowed to increase loans 5%, but another announcement indicated the government wants a more even pattern of distribution through the year. Historically, almost 40% of loans are made in the first quarter – despite limited economic activity due to the New Year’s celebration. This year, the government wants 30%, so even if annual loan limits are expanded the first half may remain tough. This only adds to the concern sparked by Premier Wen’s recent speech warning about a difficult start to 2012 due to slow external demand. Bottom line, many indicators suggest rapidly slowing inflation at the start of the year in China, allowing for growing stimulus throughout the year as the Hu and Wen leadership transitions to the Xi and Li era starting in 2013.
Examining China’s Trade Gap
China’s shift to a consumer led economy has long been a dream of foreign marketers – mostly American — wanting to cash in on the vast new demand. However, the boom in Chinese exports has, in large part, been a response to foreigners – largely Asian – utilizing the country’s cheaper labor to maintain their share in America’s consumer markets. Japan first launched its mercantilist attack on American shores in the 1970s as soaring gasoline prices made cheaper cars (and everything else) a necessity to maintain lifestyle. However, as the yen began to appreciate rapidly in late 1985, Japan began to seek out cheaper labor across Asia. Over the next decade, South Korea, Thailand, Malaysia, Indonesia and others all saw rapid inflows of capital, which eventually culminated in the Asian crisis starting in Thailand in July 1997.
The third wave began in 2000, as Japan shifted its focus to China, rapidly increasing its exports to that nation as Chinese accession to the WTO opened the door to the world for its exports. It is noteworthy that Japan’s export numbers show a clear decrease in the share going directly to the US from 1986 to 1996 as they shifted production bases into Asia – but no change in their traffic to Europe. In the post-2000 phase, as Japanese production shifted into China, though most of the effect was to reduce share directly to America, exports directly to Europe fell by 7% as well reflecting the power of WTO access. Clearly, part of the shift in Japanese exports to China was due to that country’s rapid growth, but before 2004 (after China’s export share had already risen by 7%), China’s economy was still just $2 billion compared to $12 billion each in Europe and the US. Most of the shift had to be for re-export.
Moreover, the pattern is the same in South Korea and Taiwan, both Newly Industrialized Countries that benefitted from the second wave of Japanese exports to America. Starting in 2000, China’s share of South Korean exports explodes from 10% to 25% over the next decade. The share to America collapses from 21% to 10% — yet the shares going to Japan and Europe, both developed countries competing with the US for the same type of imports, decline far more slowly. Indeed, though Europe and the US had similar sized economies growing at about the same rate during this period, Europe’s share doesn’t fall until after 2008 – when the US recession (pre-Lehman) cause South Korea to refocus its exports. In Taiwan, we cannot break out the detail on Asia, but it is clear the Asian share came largely at the expense of the US and only slightly from Europe – and all of the decreased European share coming after China’s access to the WTO.
All of the analysis so far is based on Japanese, South Korean and Taiwanese data, but China and America’s own statistics confirm the trends. China’s trade surplus surged from less than 2% of their GDP in 2003 to almost 8% in 2007. It was still hovering around 7% of GDP in early 2009, just after Lehman (which collapsed imports), and their trade gap peaked at $312 billion. Since then, China’s trade gap has returned to just 2% of GDP, but given the much larger size of their economy, that now represents $157 billion. Though exports have grown at a 12% annual rate since 2007, imports have grown much faster 16% reflecting China’s faster domestic performance. At the peak in 2007, exports accounted for 35% of GDP with imports representing 28%. The best estimates at that time were that roughly one-third of imports were for domestic consumption (10% of GDP), thus the Chinese value added in exports amounted to 18% of GDP (36% of GDP export value – 18% of GDP import value). Assuming that imports for domestic consumption have remained at a steady 10% of GDP (and that is likely on the low side given the rapid growth in commodities demand), with exports now at 26% of GDP and imports at 24%, the value added would be just 12% of Chinese GDP. That would be roughly in line net exports from with the US and Europe.
Guangdong Province has always been China’s export powerhouse since it was set up as a special zone by Deng Xiaoping in 1978. In 2003, Guangdong accounted for 10% of Chinese GDP and 33% of exports. Its trade surplus of $22 billion was more than the surplus for the entire nation. The success of Deng’s export strategy caused other areas to compete with Guangdong, especially in the Yangtze River Delta in areas like Suzhou where Taiwanese electronics manufacturers concentrated. By the peak of the Chinese export boom in 2007, Guangdong accounted for just 40% of China’s trade surplus. However, since Lehman, the latecomers to the export boom across China have refocused on domestic production, aided by the record $1.4 trillion stimulus in early 2009. Still the country’s most export dependent region, Guangdong’s $126 billion trade surplus again accounts for most of the whole country’s total. Throughout this period, Guangdong’s exports have exceeded 60% of its GDP and re-exports over 20% of GDP. However, Guangdong has steadily shifted from low end manufacturers like toys, textiles and footwear to more advanced products like electronics and chemicals. Auto manufacturing is also a big growth industry, but primarily for domestic consumption (though exports of auto parts is a growing industry.) Bottom line, Guangdong’s story has long been different from the rest of China’s, but because it is where many foreign visitors spend their time it has distorted the world’s view of China.
Finally, the US statistics themselves show that China is primarily a replacement for the rest of Asia as an export base. As the Chinese share of the US import market has gone up, the share from Japan and the Newly Industrialized Countries has gone down. Over the past three years, as Chinese labor has started to become more expensive, the penetration from China has leveled off and the decline from Japan and the NICs has slowed or ended.
Looking at the wider picture of US exports, it is clear that what is selling in the US is not “Chinese,” but “cheaper”. Just as China has been replacing more expensive Japan, Eastern Europe and Latin America have been replacing Europe and Canada. US imports from the developed world have been dropping steadily over the past decade as lower cost labor from the newly freed communist countries and resurgent commodities producers has lifted the share of imports from the Emerging Markets. Some of this is due to increasing commodities prices, a byproduct of the rise of the Emerging Markets. However, the simpler reality is that flat to declining buying power for American workers has increased their appetite for lower cost imports to maintain their living standards – just as in the 1970s. The feedback loop is obvious as America continues to lose manufacturing jobs, and the bulk of new jobs are in services, where imports have a harder time competing.
So what is the next step in this inexorable process of the invisible hand shifting global production to the lowest cost producers? That depends on what you think about currencies and relative labor costs. The yen is still rising against the dollar, and even faster against the Euro now that its major competitor for finished products also has a banking system that is on the ropes. Even if the yen were to retreat from recent highs, we would expect Japan to continue shifting production into lower cost areas for some time. Although the Renminbi is now 22% higher versus the dollar than in 2005, it is still 11% cheaper relative to the yen. The shift into China should continue, but rising oil prices may shift some production to Mexico as proximity trumps currency. Meanwhile, a stronger US dollar, due to greater world insecurity, will not slow the pace of US manufacturing moving abroad or US consumers’ demand for imported goods. Both European and Japanese manufacturers are shifting some high value added products back to America. In Japan’s case, this is to take advantage of labor cost differentials in products that they cannot or will not shift into Asia (due to fear of intellectual property rights infringement or lack of sufficiently skilled labor.) For Europe, the shift may have more to do with supply line security, as they fear a Lehman type stop may be lurking. Regardless, the broader ongoing shift of global manufacturing to the Emerging Markets is likely to continue as those nations gain in sophistication of labor skills. Currencies matter, but productivity gains may matter more. While productivity growth has slowed in the developed world to roughly 2%, it is still bordering on double digits in China and other Emerging Markets as they simply adopt and adapt technologies that already exist in the developed markets.
From an American perspective, the best thing that can happen for jobs is a rapid rise in the value of Chinese/Emerging Markets labor, which makes it less desirable for developed countries to shift their production to them. China’s own demographics, with slower growth in its work age population, are a challenge – however, even more rapid growth in cheap labor from populous India, Indonesia, Turkey, Egypt etc., suggests that turning back the clock to American manufacturing dominance is unlikely. Rather than reclaiming old markets lost when our comparative advantage disappeared, the US needs to concentrate on winning the lion’s share of growing markets like health care and finance, where the world’s rapidly aging population spends more of their money. Indeed, US exports of energy, agriculture and natural resources are among our fastest growing industries as the growing Emerging Markets drive up prices, both because their own production costs of commodities are becoming more expensive, and because with rising incomes they are demanding more of these resources. Bottom line, China’s export boom was not an anomaly of mercantilist policy, but merely a concentrated example of the invisible hands ongoing process of leveling the playing field between the developed economies and Emerging Markets. We expect this process to continue at a rapid pace, whether China is the prime beneficiary or not. It will remain the key driver of international economic policy and trade – and commodities demand – for many years to come.
Dear Clients and Friends,
On February 8th, 2012, the Global Interdependence Center, in conjunction with the University of Memphis Fogelman College of Business and Economics, will present a full day conference “Food and Inflation: Truth and Consequences.” McVean Trading is proud to be a sponsor of this event, which features speakers from the Federal Reserve and industry experts from the agricultural community. The conference is followed by an open bar reception and dinner, in conjunction with the Economic Club of Memphis, featuring Dennis Gartman, editor of the Gartman Letter, as the evening’s speaker. Registration to the conference and dinner is open to the public at the Global Interdependence Center website:
Registration includes a one year membership in the Global Interdependence Center, which hosts a series of events in the US and abroad on topics of importance to the financial services industry. McVean Trading hopes that many of our clients and friends will take advantage of this exciting and timely opportunity to attend and debate with the experts on the key issues facing the agricultural industry and the economy today.
Looking forward to seeing you soon in our hometown,
McVean Trading & Investments, LLC