The Good

• Manufacturing output: up by 12.3% year on year, better than last month’s 10.8% and higher than consensus. 
• Steel output: up 29%
• Auto production: up 90%.
• Urban fixed-asset investment: up 33.0% for the first eight months of the year, which slightly exceeded already-high estimates of 32.5%.
• Retail sales: up 15.4%.
• Net new lending: was RMB 410 billion, less than half the monthly average this year (RMB 1,105 billion).   This was higher than anticipated by about 110 billion. 
• Consumer Prices: fell 1.2% last month from a year earlier. 
• Producer Prices:  fell 7.9% compared with a record 8.2% fall last month.

Commentary:  One very interesting contradiction arises between the production/consumption numbers vs. the inflation data.   Consumption and production are up but inflation is down.  Typically, supply becomes constrained and prices rise which leads to increased production.   If there is an increase in retail sales that tends to put pressure on consumer prices.  This data is consistent with overproduction.  The Chinese measure retail sales from the point of shipment from the manufacturer to the retailer.  There could be a good bit of government mandated channel stuffing here.  This is consistent with some anecdotal reports of washing machines being distributed to small villages that lack electricity.

The output figures should also be viewed with the consideration that last August, during the Olympics, many factories were closed to clear air pollution so that this number may not be as impressive as it seems.    The high Urban fixed-asset investment suggests that it is the only significant driver of growth in China after the collapse of the US consumer. 

The Bad

• Exports: down 23.4% YOY
• Imports: down 17.0% YOY
  • Crude-oil imports: fell to 18.47 million metric tons in August, or about 4.37 million barrels a day- down 5.9% from July’s record high of 4.64 million barrels a day.
  • Iron ore imports: fell to 49.68 million metric tons, down 14% from July’s 58.08 million metric tons
  • Copper imports: fell to 325,000 metric tons, down 20% from July’s 406,600 metric tons.

Commentary:  The drop in both exports and imports was higher than anticipated and were definitely bad news.   It suggests that any recovery to the world prior to 2008 of US consumer driven export GDP growth is far from China’s reach.   The data above has significant import with respect to world commodities prices.  China, the world’s second-biggest oil consumer, imports more than half of its oil demand.  Despite the drop, August’s oil imports level is still the second highest monthly number but it may signal that China is backing off of oil stock piling.   It will be very important to track China’s rate of oil importation because it acts as the marginal consumer.  If Chinese consumers rapidly adopt the use of automobiles that should put significant pressure on world oil consumption over time. 

China is the world’s biggest consumer of iron ore and copper.  I think the massive reduction in these imports suggests that China is backing away from its stockpiling of those minerals.  Additional data suggesting a reduction in China’s consumption of industrial mettles and oil could lead to significant pressures on world commodities prices and perhaps a rally in the dollar and a world stock market correction.  Because the Chinese have such a significant influence on industrial metals prices they may be reducing their consumption to intentionally put pressure on producers.  This could give them more leverage with players such as Rio Tinto in negotiating long term contracts. 

Conclusion:  The green-shoots crowd will look at the economic numbers, with the exception of the trade data as all positive and suggest that China is on track to recovery.  For them, the great risk to China was that the global contraction in demand would result in terrible damage to China’s export industry and, with it, would cause factory closings and soaring unemployment.  Rising unemployment would lead to a collapse in consumption.

The purpose of the stimulus package is to provide a stop gap against economic contraction and with it the possibility that the economy would fall into a feed back loop in which rising unemployment would cause a contraction in Chinese consumption which, when added to the contraction in foreign demand for Chinese exports, would lead to yet more unemployment.  In that sense, at least for now, the stimulus has proven to be a great success.  Chinese growth has slowed, but by a lot less than expected, and unemployment is apparently manageable.

Nonetheless, the Chinese vulnerability and addiction to US consumption remains because Chinese stimulus cannot indefinitely provide jobs to migrant workers to build washing machines to be delivered to electrically challenged rural villagers.  China must develop a more balanced approach in which Chinese consumers effectively take a larger share of China’s production.   This imbalance exists in large part because China is overly reliant on investment for its growth.  China has probably the highest investment rate ever recorded for a large economy, and for years there has been widespread concern that much of this investment was misallocated. 

This misallocation occurs because the cost of capital is artificially so low.  Capital costs are driven down because Chinese households are forced to earn a miniscule return on their significant savings.  Those low capital costs are what allow State Owned Enterprises (SOEs) to show profits because the Government allows them to borrow at below market interest rates.  If China had reasonable interest rates, in other words, (and in fact there were negative real rates for much of the recent past), SOEs would on average would consistently lose money.

With the recent surge in government financed investment (including government mandated bank lending), the new stimulus investment will be of an even lower quality than the older investment, with very low or even negative expected returns.

This is why Chinese growth must become more reliant on rising consumption rather than on rising investment, much of which is certain to be unprofitable.  The current path of ever increasing government investment requires a large trade surplus to absorb the difference between what China consumes and what it produces, but foreign consumers (most notably the US) will not absorb the balance as they have in the past.  China is trying to plug the gap by a surge in government-financed investment, but this is likely only to increase capacity and widen the gap in the future.

So the August data suggests that while China is growing, it is actually more reliant, not less reliant, on investment.  What is worse the very poor import numbers suggest that in spite of high retail growth figures, consumption growth in China is still quite sluggish. 

The August numbers confirm that the stimulus package is boosting production solely because of government-financed investment, and that a serious misallocation problem will result in more future pressure on Chinese households to foot the bill via low wages and poor interest returns on savings.  The export numbers show that China’s external accounts continue to deteriorate, and it will take more than simply an end to the global crisis to return to the good old pre-2008 days.