International | Jul 20 2009
By Greg Peel
I suggested in last week’s China: Global Saviour Or New Bubble? that Australia would not want to look a gift horse in the mouth. An annualised quarterly GDP growth rate of 7.9% for the emerging economy is very encouraging for Australian commodity exports, and thus the Australian GDP and unemployment rate. A cynic might suggest Chinese authorities had “forecast” 8% growth in 2009, and had thus provided a commensurate result. But if 7.9% is real, Australia can only hope the dream continues.
But economists across the globe are looking at the most recent Chinese data with astonishment. In the first half of 2009, domestic lending hit 7.4 trillion renminbi. That figure is 48% higher than the whole of 2008, and equivalent to 33% of GDP. In the US, credit markets are yet to return to any level of health despite six months of a zero cash rate and extensive quantitative easing by the Fed. Yet the world is already asking, what is the Fed’s “exit strategy”? When will the Fed reverse its easing and perhaps raise the cash rate in order to head off an inevitable surge in inflation stemming from too much stimulatory credit being fed into the system?
The Fed is not concerned just yet, although its last monetary policy statement hinted that an “exit strategy” was not far from the committee’s mind. While the deflationary pressures of excess business and household debt are still being unwound, and one third of all US production capacity is lying idle, the Fed does not yet fear inflation. It believes consumer spending, and thus the US economy, will recover but recover sluggishly. Consumer spending once represented 75% of the US economy.
China did not suffer from excess business debt, and certainly no excess household debt. There were no subprime mortgages and AAA-rated subprime CDOs being generated in China, nor credit default swaps or oversold bond insurance nor any of the other nasties created in the US. China’s GDP growth simply crashed from 13% to 6% because the US (and European) economy went into recession, implying an evaporation of the developed world consumer export market for China. At the height of the boom, China’s export industry represented about 65% of GDP growth. Chinese consumer spending was also on the rise, but from a very low base. When the developed world went down, so did China.
But China went down with a massive trade surplus, and a billion workers with their newfound jobs on the line. China thus turned inward and exploited its unique position to grease the economic wheels from within. Some US$600bn of fiscal stimulus was announced and monetary policy was rapidly loosened to provide the astonishing lending growth number above. China’s competitive provinces are now engaged in a fierce construction race. Dormant steel factories are firing up again. Workers have new jobs. Money is flowing back into Chinese pockets.
And thus China is once again facing the spectre of inflation. At the peak of oil and food prices in 2008, Chinese headline inflation reached 8%. Following the crash of the export market, Chinese inflation has since fallen to slightly negative. The bulk of this fall is accounted for by 2008’s big drop in commodity prices.
The above chart comes from DBS Group Research. DBS analysts ask the question, as apparently has China itself lately, as to whether government stimulus will lead to a real increase in economic output (“real” GDP growth) or simply a return to runaway inflation (contrived growth). The surge in Chinese inflation during the previous boom years began in 2004 – twelve months after loan growth peaked in 2003. But the GDP growth rate of 10% in 2003 was actually not improved upon in 2004.
Will China soon need its own “exit strategy”?
While CPI inflation is yet to provide evidence of having turned, there’s little doubt asset prices are on the increase. Domestic-only share prices in China rose 60-70% in the first half of 2009. Property prices stopped falling, and major cities have now seen three consecutive months of price increases. But then if you break down the CPI number, it turns out that food prices have actually risen 5% (annual) between January and May. As DBS suggests:
“The resilience of food prices may be a sign of latent inflation risks.”
So why should Australia be worried? If China wants to overstimulate its domestic economy while the developed world still struggles under the weight of massive credit unwinding, who are we to argue? Benefits can only flow.
The answer is that apart from looking back at its own experiences in the nineties and noughties, China need only look to neighbouring Japan – once also an “emerging” economy – for a history lesson. Japan allowed its economic miracle to run riot to the point that in 1990 it suffered massive stock and property market bubble-and-busts. Over two decades, Japan has never recovered. Australia can only be happy that China came along to replace Japan as the emerging market super-buyer of our commodity exports. But Australia can’t be happy if China also blows it.
DBS notes that China has been slow in the past to make necessary monetary policy adjustments, preferring to wait for “strong justification”. The authorities may have gained a lot of experience over the past decade, such that responses might now be a little more expedient, but DBS does not think now is the time to overreact. While China waits for the developed world to get back on its feet, and to start demanding Chinese imports once again, the authorities will likely choose economic growth at the risk of inflation. Only when the developed world shows true signs of recovery will monetary policy shift from its current super-stimulative state.
Thus DBS does not expect the astonishing Chinese numbers of the first half 2009 to change much in the second half. This is good news for the rest of the world and particularly for Australia. The analysts expect asset prices to continue to rise and CPI inflation to spin around some in early 2010, climbing from below zero to 3% annual in 2010.
In the meantime, DBS expects senior officials to offer more frequent verbal warnings about the pace of stimulated growth while at the same time China will sell more short-term bills to banks to “mop up” excess liquidity. The analysts don’t expect any change in policy ahead of 60th anniversary celebrations beginning October 1. “The real risk of tightening will come some time in the first half 2010,” says DBS.
Which, at a time when Australian unemployment is rising (quietly) and bad debts are growing (not quite so quietly), is welcome news. Australian government stimulus packages such as cash hand-outs and housing grants have either expired or will expire, leaving only debt-funded domestic infrastructure stimulus to carry the can. Without China’s support, positive GDP growth in Australia will be a struggle. Already the big drop in annual bulk commodity prices is threatening to send Australia’s GDP growth into the red once more.
And annual price negotiations for Chinese iron ore imports are now long overdue. As the shenanigans continue, chances are the big players will opt to either abandon annual contract pricing altogether and trade only on a spot basis, or perhaps settle for quarterly price negotiations. China can throw everyone in gaol, but it can’t drive its own infrastructure stimulus without iron ore. Something has to give, and Japan and Korea have long ago set their prices. Were China to capitulate and settle for equivalent prices, Australia would still take a big hit to its bottom line. But then there’s 2010 price negotiations.
In the meantime, Australia will put up with Chinese inflation. At least until it begins to spill over and the RBA is forced to begin a new tightening cycle.