Blog Spotlight: Capital Chronicle

Another edition of our new series:  Blog Spotlight.

We put together a short list of excellent but somewhat overlooked
blog that deserves a greater audience. Expect to see a post from a
different featured blogger here every Tuesday and Thursday evening,
around 7pm.

Next up in our Blogger Spotlight: RJH Adams (known as Rawdon) of Capital Chronicle. Rawdon was raised in a tiny emerging economy, and his professional life began as a dogsbody at the UK’s economics and finance ministry, HM Treasury. He subsequently moved to the finance functions of multinationals Xerox (UK) and General Electric (France) learning from the inside what making quarterly numbers really involves. In 2000 he left and co-founded an investment vehicle. He lives in the French Alps splitting most of his time between raising three small occasionally charming children and reading about economic development and investment."

Today’s focus commentary:

*On the first day of Christmas My True Love gave to me a Highly Coupled Economy*

Will China’s domestic demand play its proscribed role in the soft-landing “decoupling” scenario when/if American consumption demand falls along with GDP output in the next slowdown?

Much of the Chinese economic public relations image rests upon only seven of its cities whose combined population is 306 million souls*. Six of these cities are highly urban and have grown thanks to massive infrastructure and/or capital intensive investments. With nearly 40% of industry state-run that is not unexpected; and at least in urban centers it can be said that a form of consumption demand exists.

Nonetheless, aggregate domestic distribution of goods has fallen since 1998; and the internal consumption market is, unsurprisingly, extremely fragmented. In rural China – 50% of the population – incomes are falling and are about 30% of the national average (which is $1,500 annually or $5,900 on a purchasing power parity basis). There are just too many farmers for what fertile land is available.

The famed Chinese gross export sector – 40% of GDP – also has an unexpected characteristic: 90% of it arises from the efforts of foreign owned firms, revealing a striking lack of presence of Chinese enterprises and thus a greater independence of action from central government.

Exhibit 1: Foreign share of Chinese exports, 1998 – 2006

(Image courtesy of La Caixa bank)

If, therefore, “decoupling” means weathering the storm of a moderate American recession China could limit the damage thanks to its massive public spending outlays. Although one impetus behind these is ending with the preparations for the 2008 Olympics they are still a formidable mitigating factor to declines in private consumption, private investment and net exports.

However, if “decoupling” means being able to laugh off a significant US hit and go on contentedly thanks to a diversified and balanced economy it becomes a different game.

The US is China’s single largest export destination: a significant American downturn will deliver a body blow to domestic Chinese urban employment and – by extension – incomes and private consumption.

Economic sustenance via government spending becomes a timing issue in this event, until domestic private consumption recovers once the US starts buying again. That does not look particularly problematic until the existing issues of Chinese over-investment and over-production in several key sectors/industries are taken account of. Some of these are already over-staffed and building inventory (steel comes to mind), and that cannot continue indefinitely.

China may be a great new market (and so it’s been said for over 400
years) but investment–led internal demand hand in hand with great dependence on exports has limits. The balance of probability says these will be exposed in the event of a significant US downturn.

As for decoupling, they may actually be considering proposing.

*Shanghai, Beijing, Tientsin, Guandong, Zhejiang, Jiangsu and Shangdong

Sources:

World Bank; UN Development Programme; La Caixa bank’s monthly report for November 2006