-- China is considering a 370 bln yuan ($54 bln) post-Olympic stimulus package to keep the economy rolling along. With much of the rest of the world slowing, China is seeking to offset any negative fallout with 220 bln yuan in government spending and 150 bln yuan in tax breaks. While details of the plan have yet to be announced, the proposal has been approved by the central finance planning team.
As discussed in yesterday’s report, the Chinese economy got a considerable boost as a result of government spending on infrastructure improvements in the run-up to the Olympics. Along the way, China attracted significant amounts of foreign investment. Yet the Shanghai Stock Exchange has fallen by more than 50% this year.
With western economies slowing rapidly, there is understandably less demand for Chinese manufactured goods. China is also abundantly aware of the fact that they are very dependent on that demand for job creation. President Hu Jintao is faced with the daunting task of creating 10 million new jobs each year in the face of waning overseas demand for goods manufactured here.
Industrial production slowed to 14.7% y/y in July, a 17-month low. That was down from a 16.0% pace in June and 18.0% in Jul-07. A government effort to reduce pollution in Beijing by curtailing industrial activity probably was a contributing factor to the slowdown, but waning exports are a factor as well.
Chinese exports were growing by as much as 30% y/y as recently as two years ago. While export growth in Q1-08 was still an impressive 10%, the trends in both exports and industrial production are understandably troubling to the government. They raise some doubts about the government’s ability to generate those 10 million new jobs.
GDP growth in Q2 was already down to 10.1%, from 10.6% in Q1. The outlook suggests that growth for 2008 could fall below 10% for the first time since 2002. With western economies floundering, where might China look to generate the necessary growth to keep the economy afloat?
The proposed stimulus package will certainly help, but in reality 370 billion yuan is a mere drop in the bucket. The overall Chinese economy makes for a rather large bucket: GDP in 2007 was 24.7 trillion yuan.
The more obvious answer is that they will look inward and seek to stimulate domestic demand. Such a move will also allow China to insulate itself to some degree from external demand shocks. The annualized growth rate for retail sales surged to a record 23.3% in July, a pretty strong indication of the resiliency of the Chinese economy.
With a population of 1.3 billion and a middle class that is expected to grow to 600 million over the next 17 years, the potential for domestic growth is absolutely staggering. Last year, only 38% of China’s GDP came from domestic consumption. Meanwhile, in the US, fully 70% of GDP is derived from consumption. Once again, the potential here in China is very obvious, but so are the challenges.
The PBoC will be forced to walk the thin line between price risks and generating enough growth to keep the economy growing and creating jobs. No matter what they do, there is going to be upward pressure on prices as domestic demand for just about everything continues to expand.
Growing domestic demand in China is going to continue to attract strong foreign investment. Fixed asset investment accelerated 27.3% in the first seven months of the year. Such a number, combined with an increase of 25.3% in government investment for the same period, will go a long way toward offsetting any setback in exports.
Nonetheless, exports will still be a mainstay of the Chinese economy. This will challenge the PBoC’s ability to keep yuan appreciation in check. With persistent upward pressure on input prices for manufactured goods, managing exchange rates may be the government’s best hope for keeping their export prices attractive.
The trajectory of the yuan is already a delicate trade issue. Many countries, including the US, believe that the yuan must be allowed to rise significantly to be in line with China’s fundamentals and to curtail any unfair trade advantages.
However, if push comes to shove on trade, China holds the all-important trump card over the US. China finances a major portion of America’s debt. They own nearly 20% of outstanding treasury notes. Only Japan owns more. Any hint that the Chinese might start divesting themselves of US debt instruments would send the dollar plunging.
A competitive devaluation of currencies might be the end result, which could sharply accelerate global inflation. The more self-reliant China becomes, the more vulnerable the US becomes.
Gold is the classic hedge against the inevitable inflation that will result from persistent growth in China. In addition, any moves by China to scale back on US treasury purchases, or worse yet, selling of their current holdings, would give gold a considerable boost as the dollar resumes its long-term slide.