Following Wednesday’s ‘Smart Future’ article, I had a lot of very insightful feedback and pertinent questions. A couple of exchanges in particular were very rewarding, as it helped jog my thinking further as well. I thought it would be useful for the readers of the blog to get a taste of it, so I am reproducing extracts of it here. The gist of many of the Qs were: So why the declining export/manufacturing in China? Is it that it is being out-competed? What about their markets still being healthy, unlike the EU? Isn’t the US still the world’s consumer? And how come the markets reacted so sharply?
My responses covered 4 main areas, (apologies in advance as they may not be very well ordered):
- A Tricky Rebalancing – Domestic Consumption
Chinese authorities, over the last couple of years, have been placing heavy emphasis on the rebalancing effort – a lot to promote domestic consumption. So even the incentive structure for firms and households, a whole host of measures to boost retail ownership of shares/create a domestic class that owns shares (similar to what happened with the mortgage market in the US, and giving “N.I.N.J.A.” loans), boosting loans for for home ownership etc. So, why am I saying this? – Yes, China is primarily an export manufacturing based economy, but China has put heavy efforts on shaking that up – trying to pivot more towards consumption.
This means that China needs the domestic consumption to be really vibrant, which it hasn’t been. Yes, a lot of ultra-rich are buying up a significant share of luxury brands, but the broader consumption rebalancing hasn’t happened yet.
Moreover, manufacturing activity (remember the weak PMI data is not just about export manufacturing, it is manufacturing/factory activity in general) hasn’t been helped by this somewhat soft domestic demand.
- Rising Industry Costs, “China Flight” and “Re-shoring”?
The rebalancing in terms of geography also hasn’t gone super smoothly – a lot of the previously-low-cost factory hubs along the coast have seen factories leave and begun locating in Cambodia, Laos, Vietnam, Myanmar. Just this week Foxconn (a huge employer in the past, in the zones along the coast) have announced they will be setting up a number of plants in India! So there is a ‘China flight’ of manufacturing.
So, there is some element of China being out-competed in the areas it was most comfortable in, and had seen very steady and “easy” export growth in the past. Some of those have been won over in the countries mentioned above. The rebalancing towards more value added and innovation driven products is taking some time. Moreover, new technologies are seeing the beginnings of “re-shoring” taking place – i.e., manufacturing that had previously located to China due to cost advantages, now seeing opportunities to have the same price point by producing closer to home. Even in Eastern European countries. Technology (like additive manufacturing) is making it easier and cost-feasible to re-shore. Admittedly, this is not happening at a huge pace, but enough to show up in the export performance out of China.
Yes, the US is still the big consumer, but all of that is not coming from China as much as it used to. People may say a lot about Obama but he has managed to rekindle American manufacturing again. And of course one big factor contributing to American domestic manufacturing revival – ENERGY! Substantial new manufacturing has emerged due to energy costs being affordable again for manufacturing at home (Shale gas/oil, etc). There is data on the recovery of US manufacturing due to the energy revolution. Some industries that were earlier offshore (for e.g. in China) have become highly feasible at home once again.
- Reasons for Panic? Asian Supply Chain Integration with China + “Hamfisted” Reaction by Authorities
Another key reason for Asian stocks reacting so violently also is because of the massive vertically integrated supply chain linkages between China and East and particularly South East Asia. Asian regional supply chains have been the most dynamic driver of world trade over the last decade, and mostly linked to China’s dynamism and export performance. So any sign of weakness there, would worry the Asians.
One other possible reason for the recent panic is actually the optics, and less to do with the fundamentals, I think. And that is – the ham-fisted, clunky way in which the Chinese authorities dealt with the multiple crises of the last couple of months. Firstly, the stock market collapse and suspension of trading of nearly 1400 firms back in July. It was v similar to the collapse of the mortgage market in the US back in 2006/07. It was a bubble (read the Economist of June), and Chinese authorities should have let it burst. Instead it tried in vain, by throwing all types of cash at it, to revive. And didn’t work. And investors thought of it as ham-fisted and messy response. Then came the stock market turmoil last week. Same thing happened. And again with the sudden Yuan depreciation – sending a signal of export weakness. Etc etc. Basically, I think investors aren’t confident about the ability of the Chinese economy to handle market volatility, and PBoC etc aren’t doing a good enough job of communicating. Remember, Chinese authorities are very new to the idea of “China is able to move global stock, oil, and commodity markets”. They have unofficially said this too – “we didn’t expect that global markets will have such an adverse reaction to our moves!”. Unlike a US Fed Chair who knows that even if he or she pauses too long before answering a question on rates, markets will interpret that and drive behaviour.
- Other explanations + hear-say
There are also some other things I have heard from counterparts in Chinese institutions, I have also seen mentioned in some articles, but I don’t know too much about to be able to say anything decisive:
- Apparently the PBoC had hired a lot of foreign returnees – attracted back dozens of hot shot bankers and economists who were working overseas. However, in recent weeks and months, over 20 of the best ones had left, disillusioned with probably the different style at PBoC than what they are used to in the West, plus not getting the comparable high salaries they were promised when they were invited back.
- Summer storms – some evidence of summer storms affecting key factory hubs of Guangdong and Jejiang affecting production. So this contributed to weak factory data.
- A lot of companies who were manufacturers were also investors on the stock market, and saw massive losses, and this seeing them scale back their activities.