The simplest explanation for the tight correlation between US and Chinese imports would be a fairly synchronized downturn in both the US and China. That would explain why both countries are importing substantially less – and both are experiencing larger falls in their imports than can be explained by the fall in commodity prices.
Other explanations are obviously possible: About ½ of China’s imports are for re-export, so a large share of the fall in China’s imports is a reflection of the fall in China’s exports. And China may import more commodities than the US, and thus falling commodity prices (though there are limits here: the US imports a higher share of its oil than China does) may have a bigger impact on the data.
Another of the Economist’s arguments – namely that the size of the fiscal stimulus has been unduly discounted — is more persuasive. Consider that a mea culpa, as I have argued that the large size of China’s announced stimulus overstated China’s true stimulus. China’s headline deficit of 3% of GDP just isn’t that impressive, and the swing in the government’s fiscal balance was far less than the announced size of the stimulus.
And consider the possibility of non-performing loans as a result of Chinese huge increase in lending starting in January 2009:
China’s state banks before the current crisis were a bit like the US Agencies before the August subprime crisis. At the peak of the housing boom, the Agencies’ ability to grow their portfolio was constrained (as a result of past accounting irregularities and the like). Their market share was falling. After the subprime crisis curbed private label securitization though, Washington lifted curbs on their activity, and they responded. Similarly, the state banks ability to lend was constrained by lending curbs and a rising reserve requirement at the peak of China’s boom. When the curbs on their lending were lifted, they responded, and in a big way.
The increase in their lending in the first quarter is staggering. The state banks are a far larger part of China’s financial system than the Agencies are in the US, so the expansion of their lending seems to have had a macro impact. Wang Tao of UBS has produced a graph that shows that the increase in bank lending in the first quarter looks a lot like the increase in late 2002 and 2003. That blowout eventually led to an uptick in inflation, and then to a decision to curb the state banks’ lending growth.* The current blowout looks bigger. As a result, y/y investment growth in China in q1 was around 30%. That is huge. It presumably reflects a huge rise in public not private investment. It likely will have a future fiscal cost. The likely losses on these loans probably can be thought of an additional form of fiscal stimulus.
And back in January, Chinese blogger Michael Pettis reiterated the possibility of the recession lasting longer than a year, and the implication this would have on these new Chinese loans:
China has to make an adjustment from an economy overly dependent on exports to one more focused on domestic consumption. This adjustment was never going to be easy and there will definitely be a significant cost. Every other country in history that I can think of that successfully made the adjustment only did so with great difficulty, in the throes of crisis, and over decades. My worry, which I started discussing a few months ago, is that in their desperation to reduce the combined cost of the transition and the global slowdown — instead of forcing the transition during good times they waited until they were forced into it during a crisis — policymakers are going to throw everything they have against the resulting slowdown, including out-of-control bank expansion. While this may reduce the extent of the slowdown this year, as Dong Tao points out, it does so at the risk of creating much deeper instability in the banking system.
If the global crisis lasts only a year, this all-but-the-kitchen-sink strategy will probably have turned out to be a good one, but if, as I suspect, the crisis is going to last two or three years or more, weakening the banking system so early in the process may create much greater risks for China in the future. Piling up loans in such an undisciplined way and having the banks bear most of the heavy lifting in the fiscal expansion plans is good only if it does not result in a sharp rise in non-performing loans. That, most of us would agree, and Victor Shih has been especially worried about this possibility, is unlikely. If it does result in surging NPLs, however, in the near future policymakers will be seriously constrained in their ability to fund more expansion and may even find themselves caught up in a monetary contraction as bank portfolios go bad. The monetary side of policy making in China continues to be, in my opinion, the most difficult and uncertain part of the process, and I think it pays to be cautious.
This post was from January. Here we are in May, and I think its safe to say at this point the world economy has on deteriorated since the beginning of the year. As far as I am concerned, there seems to be no good economic news in sight. China is going down!
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