New Normal

Just over three weeks ago, in his keynote address to the Global Corporocracy at the so-called ‘Summer Davos’ meeting in Tianjin, Li Keqiang firmly stated that:  ‘…we [have] focused more on structural readjustment and other long-term problems, and refrained from being distracted by the slight short-term fluctuations of individual indicators.’

He went on to downplay the fetish for the 7.5% GDP number, saying that ‘…we believe the actual economic growth rate is within the proper range, even if it is slightly higher or lower than the… target.’

As if that were not clear enough, Finance Minister Lou Jiwei rather spoiled Madame Lagarde’s infrastructure orgy at the Sep 20th weekend G20 meeting in Australia when he pointed out that China had already tried the very approach which his Western peers are itching to undertake – and which they hope can be financed by a grab at their citizens’ private pension funds.

Lou pointed out that while the programme may well have provided a short term fillip to ‘growth’, it brought environmental damage, capital misallocation, and dangerously increased indebtedness in its train. As if that were not enough of an ‘ice bucket challenge’ for his audience of panting Keynesians, he reiterated Li’s diagnosis that his government’s macro-economic policy would ‘continue to focus on the general objectives, in particular to maintain employment growth and price stability’ and that [emphasis added], ‘policy adjustments will not change on a single economic indicator’.

However determinedly deaf certain Occidental wise monkeys were to this pronouncement, Lou’s local market traders certainly took the words to heart: rebar, rubber, and iron ore fell 4% to major new lows in the Monday session, while a whole range of metals, petrochemicals, and others dropped 2% or more. If the impending Golden Week holiday may have been enough to discourage any further initiative selling of the metals over the succeeding few days (steel, iron, rubber, and cotton were NOT similarly spared), nevertheless the verdict was clear: the pain would continue.

Li himself seemed to be resolutely sticking to his guns. In the two policy announcements he has made since his big speech, he has continued to tinker with microeconomic reforms (e.g., liberalizing delivery services) and to enact fiscal measures (notably the introduction of  a series of accelerated depreciation measures aimed both at alleviating the current tax burden and at encouraging SMEs to undertake a little more capex in future). Nowhere is there any hint that the regime’s nerve has failed or therefore that the spigots are about to be opened once more.

The latest kite to be flown on this account is the speculation raised by the WSJ that PboC chief Zhou Xiaochuan will be ‘retired’ at the upcoming autumn plenum. Though no confirmation of any sort has been forthcoming so far, we have already been subjected to no shortage of punditry as to the whys and wherefores of the supposed move.

Chief among these have been somewhat conflicting conspiracy theories that his expulsion would represent variously a reassertion of its influence by the factions so far largely being steam-rolled by Xi and, in almost exact opposition to this, a move by Xi to ride himself of a turbulent monetary priest who – wait for it – has proved too reluctant to swamp the ailing economy with the massive amounts of liquidity Xi has now decided is necessary in complete contradiction of the programme he and his team have been pursuing!

Though we have no special insight into this matter, it does strike us as unlikely that Zhou is suddenly now regarded as an enemy – this is, after all, the man whose gravitas and reputation for calm confidence was deemed so valuable to the incoming administration that it deliberately bent the rules concerning the mandatory retirement of top officials in order to keep him in his post. It seems far more probable, therefore, that if the personnel change is indeed to be affected – and the fulsome encomium to this ‘wise old sage’ which was carried in all the main outlets over the weekend rather diminishes the prospect – his baton would be passed on to someone of like mind. Several commentators have already noted that this may well be the case if the go-to man tipped to be his successor, Guo Shuqing, actually does get the nod.

Whether the incumbent stays or goes, however, the very fact that the mere rumour of his departure was enough to have the stimulus junkies drooling that their itch for the next fix would soon be assuaged is revealing of the parlous state to which we have all been reduced in our QEternity, Goldilocks world of an utter reliance on the foibles of central bank heads to determine where we should place our next bets, to the exclusion of all other factors.

Giving this crowd some brief hope, the PboC did in fact adjust the repo rate lower and also offered (in its usual, frustratingly opaque manner) a CNY500 billion injection of funds to the five biggest state-owned banks even though this may have been no more than a partial offset to the ongoing lack of foreign exchange accumulation – of especial significance now that the CBRC has clamped down on end-period deposit hunting – and/or a timely assist aimed at preventing the IPO flood from dampening a rekindled enthusiasm for stocks.

The realisation that the country’s current afflictions might not be susceptible of alleviation in the time-honoured Yellen-Draghi fashion seems to be spreading. With the capital market queue for bank refinancing now said to stretch to CNY600 billion and with the count of bad and doubtful loans rising rapidly (if still hugely understated), the lenders seem to have a somewhat different focus than that of showering credit on each and every would-be borrower.

Nor are borrowers beating down their doors, at least according to the results of the central bank’s latest quarterly survey. This has loan demand falling below the lows of 2012, so no wonder the monthly data dump shows the pace of increase in yuan loans on bank books dropping to the lowest levels of the past eight years. No wonder either when, as CASS academician Yu Yongding told an audience at Tsinghua University, a recent NBS survey found that lending rates for the average SME was no less than 25.1% annualized.

The combination of usurious rates and burgeoning liabilities (especially accounts receivable which are up more than 14% yoy) means that financing costs for SOEs are rising at a rate of 16.7% p.a. (as the MOF tells us), while those for joint-stock enterprises are growing 14.4%, and for the usually more profitable HK, Macau & Taiwanese owned-firms at no less than 27.2%, so says the NBS. The Chinese Enterprise Confederation also reported that the top 205 state-owned manufacturing companies’ income margin was a mere 1.8% this past year, while that for their 295 private counterparts was a less than stellar 2.8% (for comparison, over the past 4 ½ years, US manufacturers have returned an average of 10.6¢ pre- and 8.7¢ after-tax on each $1 of sales).

Would you be borrowing more in a decelerating economy if these were your business metrics?

Reflecting all this on the macro side, Want China Times reported that, with several Chinese provinces finding it ‘hard’ to reach their GDP numbers, voices are being raised in favour of a lowering of the goalposts (the message naturally being far more important than the medium in Leninist thinking).

Recall here that the official spin keeps emphasizing both the long-term nature of the shift to the ‘New Normal’ (which one unnamed cynic dared to translate as ‘recession’!) and continually pleads the medium-term difficulties associated with the ‘Three Overlay’ constellation – viz., the problems of changing the emphasis from the quantity to the quality of output; the ‘structural’ shift away from investment and toward consumption as the focus of future development; and the tribulations of eliminating (‘digesting’ in Newspeak) some of the excess capacity and crippling debt levels built up during the ‘stimulus’ the Party unleashed in the attempt to combat the effects of the financial crisis.

Significantly, at the grandly titled ‘2014 Co-prosperity Capital Wealth Summit’ held on Sunday, former NBS chief economist and State Department advisor Yao Jingyuan opined that this baleful cyclical conjunction would last for another three to five years. Simultaneously, Shengsong Cheng of the central bank pointed out – in what may be the first serious attempt at disassociating the regime from its previous expectational anchor – that if China were to grow at no more than 6.7% p.a. over the remainder of the decade, the desideratum of doubling the size of the economy over the whole of that ten year stretch would still have been achieved. It would also seriously embarrass many of the Sinomaniacs’ determinedly bullish projections.

As Want China Times also wrote, besides the growing shortfalls in Jiangsu, Shandong, Shanxi, Heilongjiang, Hunan, and Guangdong provinces, Shenzhen is labouring under the burden of a fall in two-way trade volumes of 28% over the first seven months of the year in addition to a 60% plunge in newly constructed real estate.

As 21st Century Herald has pointed out, the upshot has been that many local governments are trimming outlays, dipping into reserves, and even indulging in asset fire-sales in order to stem the fiscal haemorrhage. Even then, in order to meet revenue goals, resort has been made to a neat, fraudulent round-robin whereby local businesses borrow the money with which to pay fictional taxes and then recoup the outlay in the form of phony subsidies, rebates, and contracts. An official at one northern city admitted that up to 15% of his authority’s budget consisted of such shenanigans but that in certain county governments the padding amounted to 30% of the total. No wonder the expansion of bank balance sheets is having so little effect on genuine activity.

Further to the regional tale of woe, the local stats bureau made it known that even mighty Shanghai’s industries saw an actual drop in the value of output of 2.5% yoy in August, figures which represent a truly stunning reversal from June’s +7.1 gain and the first half’s overall increase of +4.4%.

Meanwhile, the CISA reported that implied steel consumption has failed to grow so far this year for the first time in the new millennium. No surprise then that rumours continue to swirl about the possible CNY10’s of billions involved in the potential bankruptcy of Sinosteel. Likewise, Reuters reported that ‘sources at the country’s major oil companies have predicted that China’s diesel consumption is set to post its first decline in more than a decade.’ How much of even that is real demand is another moot point given that SAFE has just announced the identification of $10 billion in fake cross-border transactions in a scandal which has progressively widened out from the initial Qindao port incident to encompass no less than 24 separate provinces and cities thus far.

Globally, the impact is being felt in the bellwether chemical industry.  As the American Chemistry Council noted, there was a ‘worrying’ slide in operating rates during what is typically the seasonally strong second quarter.  Things have not improved much since. Q2.   The ACC showed Germany dropping from 4.8% growth in February to a fall of 3.5% in August.  India crashed from +12.9% in January to +3.4% in August. Japan fell from +9.2% in March to just +0.8% in August. Mexico went from 1% growth in April to -2.8% and Russia slowed from +4.2% in January to -10.4% last month.

Only one major country managed to maintain a relatively strong growth level. You may not be surprised to learn that this stalwart was China, where output peaked at +11.1% in April, was still a strong +8.8% four months later. Why the anomaly? No real mystery: the country has swung from being a net importer of bulk chemicals to being a net exporter, much as it has in refined oil products and also in some metals. No-one dare utter the word, ‘dumping’!

All of this is a sharp contrast to the first stages of Chinese expansion when the country purchased large quantities of raw and semi-processed items – without much regard to their cost – either to employ them in building out its own industries and infrastructure (as Mr Lou pointed out) or to incorporate – along with a range of other bought-in, more sophisticated components – into finished-goods exports bound for Western consumers who were borrowing a goodly portion of the necessary invoice amounts.

Nowadays, many of those foreign customers are either unwilling or unable add any  more to their slate, while the prevailing quest for China’s factory owners is to find some way of more profitably utilising some of the vast overcapacity they have built up in the interim.

One consequence is that, even allowing for possible distortions in the data, it is clear that things are running no where near as hot as they once were. Taking the five years to the peak of the last cycle, Chinese industrial corporations enjoyed compound annual revenue growth of over 25% and profit growth of 37%. Fast forward and since the end of 2012, earnings growth and – perhaps even more tellingly – revenues are up by a much lesser 10% or so. Not a basis on which to be too gung-ho on further capital outlays, nor one in which double-digit rises in wage costs can continue to be blithely accommodated.

At the largest of scales, evidence of this change can also be found. During the whole of the two decades before Crash, world trade volumes rose at 7.2% a year, compounded: since the start of 2011, that pace has slowed to a tardy 2.0%, meaning that now, some six years on from the Snowball Earth episode, we are only at three quarters of the level we would have attained had the crisis not intervened. And, as we know, all this is closely related in a complex web of cause-and-effect to the rate global money growth. That latter is facing its own challenges given that the ongoing steep rise in the dollar reduces the effective global heft of the monies being emitted by just about everyone other than the Chinese themselves with their similarly-soaring currency.

In passing, economic turmoil may be one thing with which the leadership has to contend, but the upsurge of violence in Xinjiang – where up to 50 people were reported killed during a bomb attack on two Luntai police stations – and the rather more peaceful, if no less weighty, street protests in HK – with their uncomfortable echoes of East European ‘Colour’ revolutions – are another matter entirely.

All told, the Chinese CCP and its new leaders have some sizeable challenges to overcome in the months ahead.