The China slowdown.

To over a year of cross-calling by every major institution on the planet sounding the horn of optimism on China, to now deluded naysayers saying to everyone how hard its economy will land with a ‘hard impact’, these massive deviations in forecasts say much more about what the forecasters are missing than what they actually say. .
In 2012, Goldman claimed it would see Chinese growth go above 8% and ‘almost certainly’. Now, in 2013, Goldman claims it might be under 7%. That 1% difference is quite a lot. While 8% was, at one point, the base case – the bottoming of growth – now 7% is considered to be the magic number the Chinese Politburo is trying to target.

Overall, there seems to be a lot of confusion when it comes to analyzing China’s economy, not in some facile way of seeing it as becoming the #1 economy, or as a communist state, but simply as it is – where one part of the ship is squeaky clean and the other is simply full of holes.

One way of putting this is the old adage which we seem to forget: a larger economy stops growing as quickly as small one. China, now the 2nd largest economy in the world, which people also seem to forget, bases its economic vitality on the West’s ability to continue consuming and buying its products rather than its ability to have its consumption stimulated through China’s low-cost exports.

So what areas are we frequently missing when we ask why the China’s economy will probably grow at 7.5 this year and stagnate at that number for another year? If it’s not a cyclical thing then it must be secular. Well here’s a few tips:

1. According to recent data, Chinese YoY% exports grew at 14%. According to HK data, YoY% growth was just 4%. If China’s economy can grew 10% higher than HK, either this says a lot about China’s ability to coordinate its fiscal stimulus programs better than the US, superior crisis-management, or HK’s economy is tanking. However, Hong Kong’s economy is certainly not tanking. It’s one of the few developed areas of the world to have done significantly better as the crisis went on.

So what happened? Well, in order to obtain dollars, local exporters charged themselves higher amounts by faking receipts and then returning them to the local PR China Bank – obtaining a higher amount of dollars when they cash these receipts in change currencies from their US buyers and invest it abroad. Unfortunately, this level of thrift has been so great that it actually reduces China’s YoY% export growth to make it level as Hong Kong’s.
The conclusion: significant corruption exists at the mid-sized business level and at local government

2. The stimulus. The stimulus we all heard about in 2012 never really amounted to anything. Like most Keynesian stimuluses, it’s mostly about keeping aggregate demand at a stable level, maintaining low levels of unemployment, and the rest. However, this usually works in a closed economy – but China is no longer a closed economy – which it was when the last stimulus of this kind came into effect in the early 2000s. Additionally, massive regulation, very low capital controls, and opaque governance meant high levels of corruption. Much like FDR’s New Deal, which given that China’s economy still has a relatively large agrarian population is a fair comparison, it wasted incredible amounts of money because it lacked the institutional infrastructure to reallocate unproductive capital from loss-making industrial areas to wherever else that could be put to use. So, the stimulus flopped like a layered pudding does when it hits the wall and sticks to it.

3. Giving up on being an export-powerhouse, China’s new leaders now recognize that it cannot be a sustainable country without a large consumer economy and consumer base – consuming Chinese products by Chinese consumers. There are a few issues they’re addressing in the new 5-Year Plan. One, of course, is maintaining its domestic industries by enlarging its consumer class, making them invest their savings and not speculate with it in anything but the property market. The other is reducing the consumer funding gap (deposits minus liabilities, essentially how indebted consumers are and how much it costs to fund their debt).

China’s consumers are some of the few to actually not be in debt to their banks. However, by keeping so much money in their interest-making deposits they actually sap strength of China’s economy because these deposits-subsides were originally for incentivizing the country’s banks to loan money, which in turn consumers were suppose to use to buy their first homes or maintain stable consumption. However, neither materialized. Consumers instead used it to buy their second homes by bundling money together and actually decreased their consumption over time by either using the proceeds to buy products abroad or smooth consumption by making long-term investments in gold and the like.

What do you guys thinks, how will China’s economy perform in the coming year?