Chinese Excavator Sales Crash!

23 Jun

Earlier this month the Wall Street Journal carried an article headlined “China’s holes in the road”. The journal contented that a recent slump in excavator sales is a lead indicator of a hard landing in China’s GDP growth.

The headline figures are indeed stark. Year-on-year excavator sales in May were down 9.6%. What’s more, sales of heavy duty trucks declined 22.4% over the same period.

The WSJ’s conclusions are simply sloppy! These data points do not necessarily indicate (and should not cause!) a sudden and quick slowdown in GDP growth and fixed asset investment. Why?

• Sales in durable goods are naturally choppy, and a contraction in excavator sales in May comes off the back of a massive 20.8% growth in April. Heavy duty truck sales did decline in April too (-8.3%), but this also comes off the back of a strong March (10.2% growth).

• A limited period of falling sales in such goods will not have a significant impact on FAI growth, as the actual number of outstanding machines continues to grow. In addition, industry can increase utilization rates, and increase the lifespan of outstanding machinery.

• The Chinese authorities have been implementing a process of tightening. This leads corporates to allocate more of their cash to more immediate concerns like working capital.

• As for a reduction in excavator / heavy duty trucks causing a slowdown itself…well it only accounts for ~1.7% of China’s fixed asset investment, and a third of excavators are actually imported!

Looking at the economy from another angle – what is there supporting a soft landing?:

• Money supply is still supportive

• Social housing should fill the gap left by private real estate developers

• Healthy overall fiscal situation


Adam Smith In Beijing

13 Apr

A sophisticated insight into historical cycles, original interpretations of Adam Smith and Karl Marx, a breadth of foreign policy knowledge, and a knack for understanding human motivation. Late John Hopkins professor of sociology Giovanni Arrighi weaves these threads in his work Adam Smith in Beijing, and presents a case for the rise of East over West in the coming decades.

Arrighi opens by discussing the battle between capital and labour through the prisms of Smith and Marx. Smith differentiates between the natural and the unnatural path of economic development.  These two paths are best understood in Smith’s own words:

” According to the natural course of things, therefore, the greater part of the capital of every growing society is, first, directed to agriculture, afterwards to manufactures, and last of all to foreign commerce.  This order of things is so very natural, that in every society that had any territory, it has always, I believe, been in some degree observed…. But though this natural order of things must have taken place in some degree in every such society, it has, in all the modern states of Europe, been, in many respects, entirely inverted. The foreign commerce of some of their cities has introduced all their finer manufactures, or such as were fit for distant sale; and manufactures and foreign commerce together, have given birth to the principal improvements of agriculture. The manners and customs which the nature of their original government introduced, and which remained after that government was greatly altered, necessarily forced them into this unnatural and retrograde order. ”

Arrighi contends that the unnatural path leads to class conflicts as outlined by Marx, in which a relatively small class  gain control/ownership over production and financing, resulting in the creation of industrial states. To ensure a fresh supply of markets, and returns above the costs of capital, such industrial states are incentivised to military build up and imperialistic action. Concurrently, the flow of capital from lower return areas to areas with lower competitive forces leads to a wave of create destruction. Eventually, accumulation collapses under the stress of administrative costs, most notably military spending, and the state suffers a decline.

Arrighi argues that President Bush’s economic and foreign policy aims were the culmination of a neoliberal attempt at world domination, akin to the adventures of previously fallen empires (such as the British).  However the escalating cost of the Iraqi war/occupation, as well as loss of perceived total dominance on the battlefield in effect led to the unravelling of American hegemony. The point about costs is all important, as hegemony requires hegeMONEY. I was particularly struck by the differences the author highlights between the “US Empire” and the British. While the sun did eventually set on the British Empire they were able to prolong their rule by balancing their current account through raping overseas resources (primarily Indian), and using non-UK residents as army fodder (again primarily Indian). The US in contrast has no such resources.

An overextended US has left space for the East, notably China, to continue its steady rise. China by contrast followed Smith’s natural path of development – a large market economy managed by an active government. Some term this an industrious revolution, which leads to a large internal market, good supply of labour leading to a diverse skill base and economy, in which wealth is more widely dispersed. Natural development avoids the class distortions described by Marx.

It is this diverse and educated labour base that are well placed to continue a path of internal growth. Through China’s relatively stable/broader wealth creation and her influence on global financing, investment decisions and global power will continue to move from West to East.

I am not an economist by trade, but with a little effort, I found Adam Smith in Beijing very accessible. I’m sure an economist could find what to criticise, though from the point of view of a laymen I found the themes made common sense, appeared coherent, and provided me a valuable set of tools to judge global economics and its relation to foreign policy and power. From a layperson’s perspective my only criticism would be the one sided nature of the arguments. While I am also a sino-phile, I’m not blinded enough by my passion to assume that the road to greatness is inevitable. China will have to contend with other emerging powers (notably India), and will have to face issues such as human rights and democracy as well as environmental coherence.

All in all an intelligent and thought provoking read – go read it!

Chinese Science to Take Centre Stage

30 Mar

China was the birth place of the compass, the rudder, and gun powder. Today though one would think of China more as the work shop of the world than a Silicon Valley. Nonetheless, a new report by the Royal Society (the UK’s national academy of Science) highlights China as a scientific rival to traditional “scientific superpowers” such as the US, Western Europe and Japan.

You can  download the entire report from the following link:

In recent years China has overtaken both Japan and Europe in terms of its output of academic scientific publications. Over the years 1999-2003 China was the 6th largest contributor at 4% (25,464 papers in total, vs. 292,513 in the US). By 2004 to 2008 China had jumped to 2nd place reaching a commanding 10% of global output (184,080 paper in total, vs. 316,317 in the US). To reach that point, China had to grow output 18% annually over 1996-2008 (see graphs below – China is the bright red segment in both charts).


The report calls China’s rise up the rankings as “especially striking”, and attributes it to a 20% annual increase in R&D spend since 1999, reaching $100bn a year today (or 1.44% of 2007 GDP). China’s goal is to spend 2.5% of GDP on R&D by 2020. In 2006 China witnessed a staggering 1.5million science engineering graduates from its universities.

Some would say that size doesn’t count, but it’s the quality of the publications. That’s a fair point. Citations are often used as a means of evaluation the quality of a piece of research. Why? Peer recognition indicates the value the scientific community places on a piece of work. Chinese research accounts for 4% of global citations over 2004-2008, putting it in 7th place. Whilst the rate clearly lags the volume, China did not even register in the top 10 in 1999-2003, so the trend is still clear. In addition, The Royal Society does accept this is a rather crude and lagging indicator.

The report says that its findings are not simply about prestige, but are a barometer of a country’s ability to compete on the world stage.

We’ve spoken a few times about long-term changes in the make-up of the Chinese economy. As the country looks to move from being a cheap source of labour / the workshop of the world, increased R&D and scientific accomplishment are vital future drivers of not only growth, but a source of continued improvement in standards of living. This data shows that the Chinese are making all the right moves and setting themselves up to take centre stage.

Japan’s Quake – The Impact on China’s Economy

14 Mar

Let me start by expressing my deep sadness and sending my condolences for the disaster facing Japan.

Since 2007 China has been Japan’s largest trading partner. As such there is likely to be some level of economic impact. About 8% of China’s exports end up in Japan (China’s third largest export market), and about 12% of China’s imports come from Japan (China’s largest source of imports).  In addition, about 7% of China’s FDI comes from Japan. Let’s look at each of these issues (exports and imports) in more detail.


The pertinent question is whether the disaster will have a negative impact on Chinese exports to Japan. If history is anything to go by, Chinese exports might in fact increase. After the Kobe earthquake in January 1995 China’s exports to Japan increased by 65% yoy in 1Q95 (from 39% yoy in 4Q09). Exports increased to substitute for the loss of Japan’s production, and included goods such as metals, construction materials and prepared food.

Although the worst hit Japanese areas are not as industrially intensive as those hit in the 1995 earthquake, rolling power outages across the country to account for loss of electricity production (due to the nuclear power plant explosion) will have an impact on industrial production across the board.


The same question can be asked of imports. Will China’s imports from Japan suffer as a consequence of the current disaster? Logically, I would assume they will in the short-term. In 1995 China’s imports of Japanese vehicles, for example, crashed 77% yoy in 1H95 from an increase of 14% yoy the previous half.

As I mentioned, the current quake/tsunami devastated areas are less industrialized than those hit in 1995. This might mean that the impact on imports could be smaller this time, nonetheless the impact on the Chinese economy might be bigger this time around. Why?  China has become an assembly line for some major Japanese multinational companies in the past decade, accounting for the downstream production for many multi-national firms. As such, output disruption in the Japanese upstream (e.g. chips) presents a potential risk for Chinese production. Toshiba, for example, has NAND facilities in the damaged areas; they provide chips to the likes of Apple. However, while the impact could be felt for a number of quarters while plants are repaired / rebuilt, I believe the impact will be muted, as Chinese producers seek substitutes from other sources such as Korea and Taiwan.

A Question

Over the past few days grain prices have come down from recent highs. One driver is Japan. I would have thought that damage to Japanese inventory in the ports would have provided upside to grain prices. However, I’ve heard others argue that port disruption is causing concern that US exporters will be left with inventory, and as such prices of grains have softened. Clearly my initial thinking was incorrect as prices have gone down in the short-term, but does the argument for Japan impacting prices negative make sense? Let me know what you think.

Zai Jian

Is China’s Growth Slowing to 7%?

28 Feb

Yesterday Chinese Premier Wen Jiabao went online to answer questions posed to him by the public.

He stressed a number of themes in his answers:

  • Firstly, and perhaps of concern for some readers, he set China’s growth projection for the period of its 12th 5-year plan (2011-2015) at 7%. We will come back to this point shortly.
  • Interesting for the current climate in the Middle-East, he stressed that he understands that the combination of inflation and corruption leads to social unrest. He specifically mentioned that institutional reform is the long-term answer, and acknowledged that the cause of much unrest is the concentration and unchecked nature of power. Interesting.
  • The Premier stressed that the stabilization of consumer prices were top on his list of priorities. He also mentioned that he expects household income growth to equal GDP growth, and wage growth to match labor productivity. In addition, he mentioned plans to raise wages for low earners, limit the top end of wages, protect legal incomes, and curb illegal incomes.
  • He promised to bring the property market under control. One thing he stressed was the supply side of the problem. The Government plans to build 36 million social housing units over the coming 5 years, of which 10 million will be started in 2011 alone. I’ve written about my skepticism of the curbing real estate in previous blog entries.
  • Personal income tax thresholds are to increase.
  • Premier Wen said he will enact currency exchange reform, and plans to move towards a more flexible managed floating rate against a basket of currencies.

So he appeared to say the right things. His message was balanced and socially aware. But what about this 7% projection? Are we to believe that the heyday growth is behind us?! Is this a sign of impending tightening measures? The short answer is no, and here’s why:

  • Firstly, the projection associated with the previous 5-year plan was… take a guess…7.5%! Over the previous 5 years growth was actually 11.1%. So the downward revision of 0.5% is actually small, and should be put in context.
  • Secondly, this is a projection, not a target, which makes it non-binding. Beijing does not make targets!
  • Beijing historically sets low projections to avoid disappointment.
  • Beijing often sets low projections as a minimum to reduce both excessive competition on the local level, and to minimize data manipulation.
  • In addition, we should not be shocked by this. Although 7% had never been announced as an official projection, the figure had been previously leaked in conjunction with the 12th 5-year plan.

Obviously the authorities are aware that the potential growth rate will gradually decline. Not only is the base for comparison getting tougher, but there are labor, resource and environment constraints too. So while I do believe growth over the coming 5 years will be above 7%, I have no doubt it will be below 11.1%. Perhaps 8.5% to 9.5% is a more reasonable expectation.

Feed the World

7 Feb

The US Grain Council says it ahs received information that points to Chinese demand for around 9m tonnes of corn imports in 2011. They claim that China is expecting to be around 10-15m tonnes short on corn inventory this year (using a 30% inventory/use as a target ratio).

Now the council is an industry body, and as such its findings might be somewhat optimistic. Nonetheless, directionally, and in terms of magnitude, demand anywhere near these levels would be nothing short of dramatic. Let’s put it in a little context….

  • Firstly, 2010 was a record year for Chinese corn imports at 1.3m tonnes since its 1995-6 season of crop failures. That puts the Grain Council’s estimate for 2011 7 times the recent record.
  • Secondly, in 2010 the global export market was around 92m tonnes. 9m is almost a 10% increase!
  • Thirdly, this 9m tonne figure is 9 times the USDA’s forecast of only 1m tonnes.
  • Finally, prior to 1995 China accounted for 0% of global soybean import demand. By 2010 it accounted for 63%. Perhaps corn is about to reach an inflection point.

There are ways to profit out of this. As we’ve discussed here before, demand for soft commodities has a positive impact along the entire value chain, especially when it comes to fertilizers. We all know that with growing food demand against a backdrop of limited arable land, there’s a need to improve yields to keep the world fed. That’s great for fertilizers.

At present farmer economics are the best they’ve ever been, and 2011 looks set to be a record year. Unlike the commodity bubble in 2008 though, fertilizer producers have been more sensible when it comes to pricing their goods this time around. Potash, for example, is in around US$450/t, while at this stage of the 2008 cycle is was about US$750/t. I believe that massive price increases in the last cycle pushed farmers to reduce their fertilizer inputs dramatically (as well as the global credit crunch!). Despite what analysts were being fed by the fertilizer industry about the integral nature of their products to global food security, we all learned that farmers can take “fertilizer holidays” with negligible reductions in their yields.

This time around though, I consider the more tempered price increases as a positive for the bottom lines of fertilizer producers. After all, the top line is comprised of both volume and price, and producers are more sensibly protecting their profits, by understanding the elasticity of their products.

I recently went to visit the CEO of a major global fertilizer company who said that this time they were not being greedy!

The upshot is, that in 1Q11 I believe fertilizer stocks (and general agchem) still have some way to go, but perhaps more importantly, their downsides are more protected.

Loads a Money!

12 Jan

Over 2010 the Chinese authorities applied multiple policy tightening decisions. Nonetheless, in December M2 increases 2.19%. Over 2010 China’s M2 increased 19.7%.

This is another indication of a dynamic I’ve discussed a number of times here at the Raven and the Dragon – the battle between a central bank and a booming economy. What do I mean? Early tightening policy is usually overwhelmed by a greater incentive to lend. This leads to greater levels of restriction. This cycles, until a sudden slowdown materializes.

In China the situation is complicated by the pace of foreign reserve growth in recent months. In 2010 reserves increases 18%, but growth in 4Q10 was a massive 43% on an annualized basis.

This illustrates the difficulty China faces in breaking the link between a build-up of reserves and local monetary growth. We know that China is starting to redirect the tanker, and decrease its dependence on export driven growth. Until a certain threshold is reached, this link will not be broken. Reserves are likely to continue to grow in th ecoming quarters.

The graph below highlights the huge growth in M2

PS – Here’s a definition of M2:

Zai Jian