Reality check: economy of China

china

First thing first: no countries can grow at a double-digit pace forever.

China, the world’s second largest economic power, seemed to (probably) have learned hard lessons from the recent stock crash that is taking place in the last two months: there are no expected circumstances. No matter how many trillions of dollars the government has been pumping in to support the ailing stock market indices, the money is still lost. And now, more than 5 trillion US$ (pretty much the annual output of Japan’s economy) have all but evaporated from the country’s stock markets in Shanghai and Shenzhen.

The recent crash sparked numerous discussions worldwide about the real situation happening in China’s economy. Google ‘China economy’, and most likely the keywords are overwhelmingly negative; many users even question if the economy is none other than a ‘gigantic Ponzi scheme’. And what makes economic risks in 2015 particularly very distinct – and also unprecedented – from the previous crises in 1998 and 2008 are that the problems are three-fold:

  1. There is uncertainty among US Federal Reserve whether to increase interest rates or not – the first time since 2006. Given that the central bank has pumped more than 4 trillion US$ from 2008 up to the end of 2013 into global financial markets, US economic recovery gradually reverses the quantitative-easing policy, posing countries with massive short-term capital inflows at significant risks.
  2. China’s economic slowing-down ‘exacerbates’ the matter. As the world and China increasingly co-depend on each other – especially in international trade, any economic problems inside the country will translate as bigger problems for global economy as well. If, in case, US Federal Reserve decides to increase the interest rates, this will impose increasing burdens for, plainly speaking, a whole lot of people worldwide – especially companies with bonds and debts denominated in US dollars.
  3. The slowing global economy also pushes commodity prices to unprecedentedly low levels; oil prices continue to linger between 38 and 40 US$ per barrel, the lowest since 2009. Dozens of currencies depending on oil incomes have seen their values significantly decline (Nigerian naira, Saudi Arabian riyal, Malaysian ringgit, Zambian kwacha being the biggest casualties), and in fact, most of the currencies whose commodity exports depend on China’s economy are actually plummeting in values.

Given the tendencies for mass media to make any stories overblown, let us do some reality checks on what is actually happening with Chinese economy in brief points below. Some are indeed alarming, but others may be more soothing, so a delicate balance of views has to be considered. These are the things we need to know:

Soothing: China is different from Greece, and its manufacturing output remains huge

With the country expected to have domestic output at over 11 trillion US$ this year, industry-related sectors account for approximately 45% of the GDP composition, slightly larger than those provided by services-related economies. Even though labor costs are increasing very rapidly in recent years (hint: GDP per capita was already 7,500 US$ last year), China’s manufacturing output remains huge, particularly in coastal regions. Initially, there were worries that Greece’s rejection of financial bailouts would result in a blow on Euro values, and therefore spell a trouble in global economy, until China’s stock market crash took its turn as another headline.

Alarming: China has a bad-debt problem

On paper, and on most statistics offered by CIA World Databook, IMF, and World Bank, China’s external debt and public level debts stand at approximately 25-35% of total GDP. But there is one huge caution: debts generated through ‘shadow banking’ (financial institutions that are not listed in the government records) are not counted in the process, and that is an alarming sign. In fact, much of this debt, whether clean or not, is mostly used to fund projects that turn out to resemble more like ‘white elephants’, say, ghost cities. While estimates provide that the actual debt-to-GDP level for China is more than 280% (which may be true), we truly have no idea how much debt the country has accumulated since the beginning of economic reforms in the last almost four decades.

Alarming-soothing: Some portions of these ‘bad-debt’ amount are actually overwritten

Accounting, no matter how tedious it is, sometimes can have its own magicians. This is particularly the case for Chinese state-owned enterprises that build numerous projects overseas – and end up losing money. The question is, do they actually lose the money, or does the money go ‘somewhere else’? Another controversy is overstating debt amount in order to reduce taxes paid, or even to avoid paying taxes at all. While there has been little research about this area, more works need to be done in the future to understand further about such accounting magic tricks.

Still, we don’t actually know how much China owes the world, and most importantly, its own people.

Soothing: Even at an annualized growth rate of 7% this year, China already ‘grows pretty fast’

Even both President Xi Jinping and Prime Minister Li Keqiang acknowledge that fact. The premier, in particular, emphasized that the economy has entered a new normal, and the world has to accept the reality that China, indeed, can not grow at an astronomical pace forever. With increasing labor costs, China will have to move its factories, one by one, to other emerging markets, and upgrade its economic composition to be based more on services and domestic consumption. China’s appetite for natural resources is also gradually declining, and indeed, the slowing economic growth should be a positive thing to celebrate for environmentalists: they are doing really hard to reduce emissions of carbon dioxide, one side effect resulting from the country’s rapid-fire growth in the last 30 years.

Furthermore, with growth rate at 7% this year, China actually still increases 700-800 billion US$ to its annual output, and that quadruples the amount of real GDP produced by India in 2015, for the first time ever the fastest-growing economy in Asia (with an annualized growth rate at 7.5%).

Alarming: Nobody really knows how the government measures economic growth rate

On theory, economic growth is measured through increase in inflation-adjusted market value of the goods and services produced within a certain time period (usually one year). The real problem here, nonetheless, is not about the definition, but WHAT classifies (or constitutes) as the components of growth by the government. Building buildings is one thing, but do they house people? That’s another thing worth concerning about.

Alarming-number two: China’s gross fixed capital formation is actually increasing, not declining

To get you acquainted with this economic term, gross fixed capital formation is, in simple terms, ‘investment’. Something that requires us to spend money in building fixed assets, such as factories, houses, equipment, infrastructure, or anything that can’t be moved (but destructible). While it is necessary to increase the percentage of gross fixed investment at times of rapid economic growth, no economies can incrementally add up the figures forever. There is always laws of diminishing returns: if you invest too much, you end up losing money. And that is what China is actually experiencing.

In 2008, during the height of global financial crisis, China’s GFCI was already approximately 40% of the country’s GDP, among the world’s highest. The almost 600-billion-dollar stimulus package introduced in 2009, intended to boost domestic consumption to support economic growth, was ironically channeled to numerous investment projects instead, many of which are simply unprofitable. That’s why one sees empty cities, little-used highways, and losses-generating projects overseas, when in fact many people in China are still struggling to gain access to basic infrastructure, particularly in hinterland areas. By 2012, the gross fixed investment was already 46%, and it is estimated that by this year, the rate is approaching 50%, an increasingly unhealthy level.

Soothing: ‘stock market crash’ may be an overblown title

Even until mid-2014, the average indices for Shanghai Stock Exchange remained below 2,000. It was only after Chinese government decided to allow financial liberalization that tens of millions of investors, many of whom used financial loans, placed them on companies’ stock prices. In less than one year, the scores shot up to more than 5,500, an astronomical pace so markedly Chinese form of ‘rapid-fire growth’, that when it dropped starting from June, it dropped catastrophically.

Yes, the stock indices are now below 3,000, but honestly speaking, that is still significantly more than the indices were last year. While government intervention was, admittedly, very heavy, including ‘persuading’ (or forcing?) managers of companies and state-owned enterprises to buy up stocks to withhold the drop in stock prices, that couldn’t do much to reduce the impact. After all, stock index is one unpredictable thing by its own. If the government is committed to financial liberalization, the government should regulate investors so as not to excessively use loans to buy stocks, but not to withhold the drop in stock prices.

Alarming: China’s currency depreciation is not going to help its exports

Shortly after the ‘stock market crash’ and the resulting free-fall of currencies worldwide, China’s central bank took an unexpected turn it has barely done since early 2010s: devaluating the yuan at over 3%. It sends even further shrills to currencies worldwide, delivering a dramatic drop for currencies whose exports increasingly rely on China’s economic strength, such as Taiwanese dollar, South Korean won, Indonesian rupiah, and South African rand.

Even the bank’s recipe-as-usual policy to reduce currency values to boost export is already an outdated move given the changing face of global economy today: China has had more trade agreements in 2015 than it was back in 2008, when their trade policies back then were largely protectionist. While it will increase its export volume, it will not be significant. The most important thing, instead, is to focus on its own 1.4 billion people as potential consumers, and that is where Chinese government needs to pay attention to.

Furthermore, China also ‘suffers another blow’ after surrendering the ‘fastest-growing economy in Asia’ title to India: it now relinquishes the ‘world’s largest trade-surplus’ title to Germany; while China records the volume a little above 200 billion US$ in 2014, Germany put in more than 270 billion US$ in the same year. German model of capitalism, which focuses on ‘hidden champions’ and mittelstand, is slowly winning.

 

BONUS: Oliver Wyman, a respected consultancy firm, has previously forecast that a ‘2015 financial disaster’ will occur back in 2011, and now, what currently happens largely echoes what the analysts had predicted 4 years earlier. Read the full report, and understand things better, by clicking on the link here.

Dilip Ratha: the hidden force in global economics – sending money home

globalization

 

Globalization, like it or hate it, has brought tremendous impact to global economy, either on the very macro level – as often discussed in global forums, or in the deeply micro level – as shown by the restless dedication put forward by hundreds of millions of people who move outside their home countries, to pursue either personal goals or dreams, or to help their families and beloved ones thriving. With nearly 250 million people now living outside their national borders, as many as 180 million of them originate from less developed countries, and most of them, while being overlooked by bulk of international economists, are the economic lifeblood for their home countries. India, counting its millions of migrant workers in Middle East and Western Hemisphere alone, receives the world’s largest amount of remittance, currently reaching 72 billion US$ as of 2014, three to four times the amount of its IT export. Egypt itself receives 18 billion US$, three times the revenues obtained from Suez Canal. Both Tajikistan and Somalia respectively account their remittances into nearly 40% of their overall GDP. While the next time you see a migrant worker toiling hard in a construction site in an otherworldly city, or cleaning up their masters’ flat, do not, for ever, underestimate their labor: they bring a staggering amount of 415 billion US$ back to their countries each year, excluding another half a trillion dollars in their personal savings. The amount of money highly enough to make sure children go to schools, families receive adequate healthcare, and help their beloved ones in setting up small-scale businesses. It’s even three times the amount of international aid; a charity concert will do unforgivably small compared to the contribution of these migrants.

In this brilliant TED talk, Dilip Ratha, himself one of the migrants hailing from India, and now a development economist based in US, wants to talk about one of the world’s largest, and most thriving, sectors, thanks to globalization, and also one of the most overlooked, all with its bureaucracy problems, mismanagement, and even remittance abuse by labor agencies across the globe.

Listen to his talk, and let us think deeper.

 

How Do You Say ‘Kimchi’ in Kinyarwanda?

korea in rwanda

 

Inspired by South Korea’s economic success, Rwanda, now under the leadership of strongman Paul Kagame (a.k.a. Africa’s Lee Kuan Yew), wants to emulate its experience. And here comes a Korean engagement in one of Africa’s fastest growing markets, not simply in terms of financial aids and project assistance, but also in foreign direct investment, and later on, a gradual emigration of Koreans to the country to set up new businesses and empower local population.

Read the full article in Foreign Policy.

 

Excerpt:

 

To whatever degree that South Korea’s expanding Africa footprint has been informed by its own successes, the process also exposes some of the Korean growth model’s limitations. Aside from several oil and mining deals, much of Korea’s activity in Africa, including a major push by Samsung into the mobile phone market, can be linked to increasingly saturated consumer markets, and therefore limited growth potential, at home. From a workforce perspective, too, Korea’s hierarchical office culture and lengthy working hours have raised the attractiveness of overseas business and aid assignments. Jeong Jun-ho, chief strategy officer of Olleh Rwanda Networks, the KT-Rwandan joint venture, says he volunteered for his placement largely because it meant he’d have more time with his family. (He relocated with his wife and children.)

Then there are entrepreneurs like Shin Ji-yoon, who was driven to Africa in part by the influence of Korea’s chaebol, which, despite playing an essential role in driving the country’s growth, are increasingly blamed for inhibiting small and medium enterprises, discouraging entrepreneurship, and stifling innovation. “In the United States, everybody can be an entrepreneur and if they fail, oh OK, they can do another business,” Shin, 26, says over coffee at Rz Manna, a Korean-style cafe and pastry shop that he and five university colleagues opened in Kigali, Rwanda’s capital, last year. “In Korea, if I fail the first time, everybody will say, ‘You’re a loser.’ And if I succeed, and I invent a really good thing, a big company will just come and take it over.”

Rethinking China’s economic growth

beijing

 

An in-depth analysis that explains why China may, if not trying to reform its already questionable economic system, parallel Japan in terms of ‘boom-and-bust’: a long period of rapid, heated, oftentimes double-digit growth (lasting for two or three decades), followed by real estate bubble, overproduction, and over-reliance on banking loans, which culminate into lengthy times of economic drag.

Read the complete analysis in Mauldin Economics.

 

Excerpt:

 

Although John and I spend hours every week searching for the truth in a murky stream of official and unofficial reports, we always reach the same conclusion about the People’s Republic: There is really no way to know what is happening in China today, much less what will happen tomorrow, based on widely available data. The primary data is flawed at best and manipulated at worst. Sometimes the most revealing insights lie in the disagreement between the official and unofficial reports… suggesting that official data is useful only to the extent that we think about it as state-sanctioned propaganda. In other words, it tells us what Chinese policymakers want the world to believe.

This shortfall in credible and actionable data from one of the global economy’s largest and most interconnected members leaves us with more questions than answers – especially in the presence of a massive Chinese credit bubble, with clear signs of overinvestment and unsustainably high debt-service ratios. These are troubling signs for all investors, in every asset class, everywhere in the world today… and everyone should be paying close attention.

(I should note that John has access to a massive amount of research from a very wide variety of both traditional and nontraditional sources… and I say that after having extraordinary access myself as the portfolio strategist for an $18B Texas money manager. I am seeing and reading things every day that I could only imagine before, and the information flow is addictive. John’s sources give us a big, if sometimes overwhelming, head start on thinking through all the implications for investing around the constant collisions of macroeconomic forces. While we legally and ethically cannot share some of the best research we see, we can share a lot of the core ideas and do our best to give you a head start, too. That’s what this letter is about.)

China’s fearsome future: ghost cities

ghost city

 

Spanning over three decades since its limited market reforms in 1978, China has seen a dramatic rise in GDP growth unprecedented in any scales before. It was still one of the world’s poorest when it decided to open up, with GDP per capita little more than 100 US$; as of today, it is, having defeated other ages-old industrial powers like Japan, Germany, France, and United Kingdom, the world’s second largest economy, with GDP values now gradually threatening those of the United States.

Okay, calm down, Washington, Beijing’s not gonna reclaim your throne that soon.

Since 2012, though, China has already experienced a slowing down, and, apparently, many of the by-products resulting from its overheating growth are now being felt across the whole country. Overproduction, property bubble, and environmental destruction, these are only a handful of negative consequences the country’s over-rapid growth has caused.

And property bubble, in particular, despite the country’s increasingly growing middle-class strata, has become a tremendous headache for the central government themselves. For this reason, the costs being paid are highly painful: ghost cities are mushrooming elsewhere. Imagine scenes of skyscrapers, shopping malls, office towers, and government buildings, and there are barely any persons living inside. They are plain dead concrete structures, with a complete void surrounding everything.

Ghost cities, in short, are merely tips of a huge iceberg, of something deeply going wrong with Chinese economy.

 

See the full photographs in Business Insider, and be ready to get yourself surprised.

 

Bonus: you can view GIFs here to see how spectacularly Chinese cities have grown in the last three decades (although some of them end up completely empty), still in Business Insider.

Even more bonus: Chinese developers, indeed, once built a huge metropolis in Angola, one of the country’s closest African oil trading partners, only to find out the whole city was completely uninhabited. See the pictures in the same website here.

What failed Mitt Romney?

mitt romney

 

 

The story of how the presidential candidate, despite his decades-old expertise in business consulting and economic analysis, failed the election of 2012 against Barack Obama.

Hint: looking back at your past success was not always a guarantee you could win support among your voters.

Read the full article on Bloomberg Businessweek, originally published in November 2012.

 

Excerpt:

 

By the time Romney left Harvard in 1975, a wave of entrepreneurialism was changing how businesses were run. Large but poorly performing companies, undervalued by a nervous market, saddled with expansive bureaucracies and expensive labor issues, struggled to compete, and became easy targets for mergers and consolidations. Panicked executives turned to firms like BCG for answers, and Wall Street opened up to new kinds of people.

“It was a time of great foment and thinking about strategy,” says William Sahlman, a classmate of Romney’s and now a Harvard Business School professor. “American business hadn’t really had to compete for a long period of time. That whole period was the origin of the shift in the economy toward knowledge workers and gave rise to a meritocracy where anybody who was really smart could get a job and do well.”

Romney had plenty of connections to the old pedigreed world. But his acumen, more than anything else, brought him success in the new one. Working with CEOs, strategic consultants guided businesses through corporate successions and transitions, focusing them on doing a few core things well. If a company was underperforming, a good consultant could figure out why and advise on which divisions to shed. If a new product was under consideration, he—and it was then almost entirely men—could study the market and the competition to determine how, when, and where to launch it.

To an almost unimaginable degree, given their age and experience, consultants still in their twenties and thirties reset the course of major American businesses (including Chrysler), helping many CEOs twice their age survive by forcing them to confront the realities of a new marketplace. A colleague of Romney’s from this period, seeking to convey the challenge consultants faced, says that Chrysler executives firmly believed people would continue to buy Chryslers because they had always bought Chryslers. Consultants found that this was a common tendency among executives: the belief that past success was a strategy for the future. Romney shone as someone possessed of both the analytical ability to find the right answer and a presence that inspired trust in more experienced executives.

Myanmar’s crony capitalists

cronyism in myanmar

 

 

Firstly, we have to acknowledge that Myanmar has opened up since 2011 with the reforms it is undergoing through. The government, led by Thein Sein, has initiated the release of a few hundred political prisoners – most notably, the country’s icon of democracy, Aung San Suu Kyi – and even allowed the opposition a substantial number of parliamentary seats in election. Economic growth has, step by step, shown signs of booming, with foreign investors – not only China’s behemoth corporations – putting forward billions of dollars in this new emerging market. Commercial sales and other trading activities are rapidly growing, largely thanks to the domino’s effect the opening up has engendered.

Nevertheless, the upcoming challenges Myanmar is facing, as a consequence of its previous decades-old military junta rule, remain huge challenges, and given the opening up that occurs, will even be more insurmountable. Internal instability, as shown by the military’s continuing battles against ethnic insurgents, continues. Religious violence has reached a new level of extremes, as displayed by ongoing Buddhist-Rohingya conflicts. Despite loosening rigidity in parliament – opposition is now offered seats there, bulk of the major political and governmental bodies remain under military control.

And now, a new economic problem: the strengthening of its crony capitalists.

A handful of individuals, having been the junta’s main partners in economic development, continue to dominate Burmese economy, and thanks to the opening up, become even stronger as their main role increases: being the joint partners for foreign investors. Despite the flourishing economic boom now taking place in the country, income inequality becomes another point of concern; it is feared that the growth will mostly benefit the cronies, and without further reforms in economic structure, such problem will pose a threat to the country’s uneasy stability in the future.

Watch the slide show, displaying the obvious signs of Myanmar’s cronyism, at Al Jazeera.