The decline in China’s electricity consumption growth highlights the remarkable slowdown underway in its Old Normal economy, as the chart shows:
- Consumption growth took off in 2009 under the influence of the stimulus programme
- It rose 6.5% in 2009, and then accelerated further in 2010 when it was up 14.7%
- 2011 growth stayed at double-digit level – meaning consumption was up by more than a third compared to 2008
- It then slowed to 5.5% in 2012 and 7.7% in 2013, before new President Xi introduced his New Normal policies
- Growth fell to 3.8% in 2014, and was barely positive in 2015 at just 0.5%
These developments mirror those seen for commodities such as oil and metals, and for polymers, during the stimulus bubble. The problem was that then-President Hu and Premier Wen panicked at the start of the financial crisis in 2008, due to the job losses being caused in China’s export factories. Fearing major social unrest, which could lead to the end of communist party rule, they doubled lending to $20tn in 2009 – 4x China’s GDP of $5tn. And they kept their foot on the accelerator till they left office in 2013, by when annual lending had reached $28tn.
Temporarily, China’s demand appeared to rescue the global economy. And at the same time, the story spread that this was due to a previously hidden secret – that China had somehow become “middle class” by Western standards, without anyone really noticing. In reality, of course, average incomes were still only $5k/year in 2015.
But no country, not even China, can continue lending at such a rate. Its interest bill in 2015 was $1.7tn – almost equal to India’s GDP. And not only was much of the money wasted in building ghost cities and property speculation, but it also boosted corruption and pollution. Such a vast lending bubble created easy pickings for corrupt officials. And pollution rose to intolerable levels, as 2/3rds of China’s electricity production is based on coal.
Thus Hu and Wen’s 2008 panic ended-up by 2013 in creating an existential threat to continued party rule, as ordinary Chinese suffered the after-effects of the stimulus policy on a daily basis.
This is why President Xi had no choice but to cut back on stimulus, and abandon the idea of further growth in the Old Normal economy. But just as China still suffers from the legacy of pollution and corruption, so the global economy is still suffering from the vast supply gluts created in energy and mining markets, as well as chemicals and polymers:
- These gluts are actually getting worse, rather than better, as lead times mean that companies are still planning to bring new capacity online in the 2016-2018 time-frame
- And continued government stimulus policies outside China mean that companies and investors still find it easy to fund these “white elephants”
The story of China’s electricity consumption boom, and its recent collapse, will be a case study for future historians on the chaotic conditions created by the stimulus policies. For us, living today, it creates a more immediate issue – namely how to manage the supply gluts that they have created.
Business models will have to change as a result, as they are creating a paradigm shift in the global economy. Today’s supply-driven business models, based on the “build it, and they will come” principle, will have to be replaced by a new model focused on securing customer commitments to buy.
‘Bad news’ seems to have become ‘good news’ as far as China’s economy is concerned. In the past, most analysts simply ignored the possibility of a major slowdown. Now that the slowdown is underway, they still ignore it – this time, because they are sure further stimulus is just around the corner.
But time passes, and the lending data still points in a downwards direction, as the chart above shows:
- Shadow lending is now just a quarter of total lending, less than half the previous ratio (red area)
- This was the area the government wanted to squeeze, as it had created the property bubble
- Official lending has been maintained at previous levels, but not increased (green)
- This is essential as the government needs to keep liquidity in the banking system
Ironically, the analysts are in fact right, for the wrong reasons. It is actually very good news that China has stopped trying to create ‘wealth effects’ via stimulus and an unsustainable property bubble. As the editor-at-large of China Daily explained recently:
“Here’s why Chinese banks are reluctant to lend even though the central bank has cut both the interest rates and banks’ reserve requirements: Their clients－mostly those on the corporate level－are besieged by more and more difficulties in the market and are less and less able to pay back their borrowings Local housing developers cannot sell all the apartments they have built.”
A new investigation by the New York Times confirms his conclusion:
“Despite recent signs that housing prices are stabilizing, a backlog of unsold homes and unleased shops means that builders simply are not doing much building“.
China’s construction market came to dominate the economy under the stimulus programme. Now other key data are confirming the slowdown, with electricity consumption up just 1.6% in May, as the chart above shows. This takes us back to the pattern in early 2009, before the stimulus programme began to have its full impact. And it reflects the policy statement made at the end of 2014:
“China’s economy has entered a “new normal” of slower but higher-quality growth. From top leadership to small-business owners, the “new normal” status has become the new consensus.
“The popularity of the catchphrase marks a shift in mindset of the Chinese people – lower growth is likely to continue for a while and is not a sign of failure, but a lack of reform can be fatal to long-term sustainable growth. For policymakers, they are less worried about missing official growth targets, but rather hold fast to the belief that giving up growth spurts for stringent reforms will eventually pay off.
“A nationwide acceptance of and disenchantment with growth figures will help build a stronger economy — slower growth but lower unemployment driven by innovation and services industry, compared with high growth and high unemployment in an economy led by investment and exports in the past.”
China’s new leadership made it clear on taking office that they would not continue with stimulus policies. They knew they had to change course, and move away from the investment and export-led focus of the past. But most analysts have continued to wear their rose-tinted glasses and have ignored the changes underway.
It may be a painful awakening, when the reality of China’s New Normal policies finally forces them to accept this has been wishful thinking.
More and more evidence is emerging of the major slowdown now underway in China’s economy.
China’s leadership have warned this would take place since they took office 2 years ago. And they have reinforced the message in recent months with their focus on explaining the move into the New Normal and its consequences.
A major interview last week in the Financial Times with Premier Li Keqiang confirmed the outlook:
“China’s turbocharged economy is growing at its slowest pace in a quarter of a century and is expected to slow further, the ruling Communist party is engaged in a sweeping anti-corruption purge and the country’s leaders are trying to clean up decades of rampant industrial pollution.”
Li was also quite clear about the problems that China sees with the West/Japan’s addiction to stimulus and Quantitative Easing (QE):
“Chinese leaders like to use metaphors in their speeches and Mr Li was most lyrical in explaining his concerns about quantitative easing and the US Federal Reserve’s plan to end unconventional monetary policy.
“It is quite easy for one to introduce QE policy, as it is little more than printing money,” he says. “When QE is in place, there may be all sorts of players managing to stay afloat in this big ocean. Yet it is difficult to predict now what may come out of it when QE is withdrawn.
“He warns that most countries have not yet undertaken the necessary structural reforms to address the root causes of the global financial crisis and compares the world economy to a patient on an “IV drip and antibiotics” who has not been allowed to strengthen their immune system to recover on their own.”
The chart above of one of Li’s favourite indicators for the economy confirms his message:
- It shows electricity consumption in Q1 from 2008 onwards
- Consumption fell 4% in 2009 after the crash, but then grew rapidly following China’s major stimulus programme
- It jumped 24% in 2010, followed by 10% in 2011, 9% in 2012 and 4% in 2013
- After the new leadership took over in March 2013, it grew 6% in 2014 and then just 1% this year
Other key indicators such as total social financing are also weak. Lending fell 2% in January/February versus 2014, after a 5% fall during the whole of 2014.
Unsurprisingly, China therefore cut its reserve ratio yesterday, aiming to shore up the country’s banking system. But it is clear this was not meant to be seen as a repeat of 2009′s massive stimulus. Thus Li highlighted in his interview:
“Since the fourth quarter of last year we have made fine-tuning adjustments to our fiscal and monetary policies but these adjustments are not a QE policy. Instead they are targeted regulatory steps and they have paid off.”
Of course, there are no guarantees that China’s New Normal policies will succeed in tackling the problems created during the ‘lost decade’ from 2003-2012. As the BBC reported a year ago, the stimulus programme
“Has now left the Chinese economy with huge debts and questions over whether much of the money can ever be paid back….it is now headed into the third wave of the global financial crisis which began in 2007/8 – the first wave was the Wall Street and City debacle of 2007-08; the second was the eurozone crisis.”
As Li warned China’s parliament last month:
“This is not nail-clipping. This is like taking a knife to one’s own flesh. But however painful it might be, we are determined to keep going until our job is done.”
The country simply has to take the pain of restructuring for the next couple of years, or instead risk suffering a ‘hard landing’ and possibly even economic collapse.
China’s reported 7.4% GDP growth for 2014 was the lowest in 25 years. But even so, it probably still overstates the true economic position. How could China possibly produce a final fiigure for GDP within just 20 days of 2015?
Electricity consumption, as Premier Li has advised in the past, is a far more reliable guide to the actual state of the economy. The chart shows how this has grown since 2008:
- Demand was 3.4bn kWh in 2008 (blue column), and grew 6% (red line) to 3.6bn kWh in 2009
- China’s massive stimulus programme in 2009 then caused it to jump 15% in 2010
- Growth remained at a high level in 2011, at 12%, but then began to slow
- It grew 6% in 2012 and 8% in 2013 as the transition to President Xi’s leadership began
- Newly-published data shows 2014 growth halved to just 3.8%, a clear sign that the economy was slowing sharply
The key to the slowdown is the vast demographic change now underway in China, due to the collapse in fertility rates over the past 40 years. As Yi Gang, deputy governor of China’s central bank has noted:
“China’s demographic situation and labor supply have fundamentally changed. The ageing problem will intensify and its impossible for China to sustain double-digit growth rate.”
One key issue is that the working population is now in decline. The number of people aged between 16 – 59 fell by 2.44m in 2013. Within 10 years, the total population will start to fall. The reason is that fertility rates collapsed from 6.1 children/woman in 1950 to just 1.1 child/woman in recent years.
This is nearly half the 2.1 replacement level necessary to keep the population stable over the long-term.
This fundamental issue has been disguised in recent years, as the total population was continuing to increase. But this was due to life expectancy having risen by 50% to 75 years over the same period.
In the short-term, of course, this lack of babies helped to increase economic growth rates, as it meant more women joined the workforce. But now China’s earlier demographic dividend is becoming a demographic deficit:
- Most parents have just 1 child, so there are relatively few children under the age of 25
- The rise in life expectancy is now delivering a vast cohort of people aged over 55 years
So China’s economy is now entering a new paradigm. It has fewer young people, but increasing numbers of older people. All those babies born before 1975 are now living a decade or more longer than their parents. And their incomes are very low, with average urban pensions just $330/month – and rural pensions even lower.
This creates many dangers for the global economy. Most policymakers are only just starting to recognise the far-reaching economic impact of today’s changing demographic profiles. But it also creates major new opportunities for those companies prepared to redesign their business models.
The blog got 54.8m results from Google when it entered the phrase “China GDP” this week. The only problem, seemingly unrecognised by most analysts, is that China’s GDP report is a completely fictitious number, invented by the leadership each quarter to suit its own narrative.
This sounds a bold statement, but it isn’t:
- China is the only country to declare its GDP figure only 2 weeks past the end of the quarter
- It is the only country that never revises its GDP figure
- It is also the only country where all the provinces routinely report GDP numbers higher than the national figure
The blog noted back in December 2010 that Li Keqiang, now China’s premier, had described the figures as “man-made and therefore unreliable”. Now the blog is delighted to see a new book, ‘Myth-busting China’s Numbers’, by Matthew Crabbe, highlights just how fictitious they are. As the Financial Times review notes:
“One of the first and most important points he makes is that in China’s Leninist system all information is political and can be designated a “state secret” at any time if the ruling Communist party decides it does not help to bolster the party’s own legitimacy and power.
“Crabbe also explains why data and statistics are so often manipulated by party cadres whose career advancement relies very heavily on them meeting various top-down targets issued by Beijing. This book is timed very well – just as the crowd of self-proclaimed China hands based all around the world has begun to multiply exponentially.
“The extremely important point he makes repeatedly is that it is impossible to understand what is happening in China by just looking at the data published by the government.”
As Li and Crabbe note, one has to look at data for electricity consumption, bank lending or rail freight volumes to understand the real state of China’s economy. At the moment, given the problems with the shadow banking system, the blog is preferring to focus on electricity consumption as its key metric, as shown in the chart above:
- Electricity consumption is core to any economy, and reflects real-time demand as it cannot be stored
- 2009 data highlights the massive stimulus impact, with consumption up 22% in January-May versus 2008
- More recently, 2012 was up 6% versus 2011; 2013 was then up 5% versus 2012
- So far, 2014 is also up 5% overall, but April/May show a slowing trend versus Q1
This picture of a slowing economy is also confirmed by latest data for China’s oil consumption. Reuters report this was down 0.7% in May versus May 2013. They also note that China is now exporting fuel on a semi-regular basis, also suggesting a slow economy.
“Self-proclaimed China hands” may like to focus on GDP numbers, as it gives them the illusion of knowledge. The rest of us will be much more cautious.
No matter what the official numbers may say, China’s actual GDP growth may well head towards zero in the near future, as the new leadership continues to clean up the mess it was left.
There’s a lot of wishful thinking underway about China’s future growth. All the experts who told us that its growth was ‘inevitable’ and would never end, are now having to face the issue that clearly growth is now slowing fast.
Their response, of course, is to remain in Denial mode. They imagine that a magic wand will soon be waved to restore growth by yet another $trillion stimulus package. They simply cannot envisage a world in which China effectively went bankrupt.
But, of course, countries can and do go bankrupt if they can’t pay their debts. It just takes rather longer for them to run out of options. But as the blog described in last month’s Research Note, China is now very close to the end of the road with its $10tn+ lending bubble.
China’s new leadership appear to have recognised this reality. Certainly their new policies are the opposite of stimulus. And they give no sign of being about to reverse course at the first sign of trouble. Those hoping for a H2 recovery may therefore end up being very disappointed.
Though few have yet recognised it, China’s Bear Stearns moment took place last week with the $400m default of Zhejiang Xingrun Real Estate Co. Just as forecast in the Research Note, there was no panic in official circles. Instead Premier Li Keqiang confirmed more defaults would follow.
The problem for the experts is that they have grown used to following GDP estimates. But these are fundamentally flawed as an indicator. As the blog noted in December 2010, then vice-premier Li ’told the US ambassador that the GDP figure, for example, is “man-made and therefore unreliable“’.
Li suggested that a more accurate view of growth came from electricity consumption and lending levels – the 2 areas on which the blog has always focused. And new data for January/February electricity consumption provides further evidence that a major slowdown is underway, as the chart shows:
- Consumption rose just 4.5% in the 2 months combined (this avoids the issue of adjusting for Lunar New Year)
- Growth was 1 per cent less than the 5.5% seen in the January/February 2013 period
- Consumption growth since January 2009 seems likely to have peaked last September, when it was up 186%
As state news agency Xinhua commented:
“The slowdown was mainly attributed to sluggish industrial power use, which accounted for around 70% of the country’s total consumption, especially high energy-consuming industries like iron and steel, cement and petrochemicals”.
Lower consumption growth, and perhaps even lower absolute consumption, is almost inevitable. The reason is that 79% of its electricity production comes from coal-fired power stations – almost double the global average. And coal is one of the major causes of China’s current pollution crisis.
So it seems likely that part of the new strategy will be to take advantage of slowing growth to close some of the worst-polluting stations, along with iron, steel and other factories that contribute to the problem. Zero GDP growth for a period between now and 2018 should thus be a Base Case for anyone doing business in China.
Of course, the experts will still argue that another stimulus will come along and ‘kick the can along the road’ to enable further growth. But this argument fails to recognise that at some point, a road can run out. Far better to stop today, than disappear over the edge in a year or two’s time.
Benchmark product price movements since January 2013 are below, with ICIS pricing comments:
PTA China, down 27%. “The average operating rates of PTA plants in China stood at 65-68% for March, and are expected to decline to 57% for April”
Benzene, Europe, down 6%. “A raft of benzene and pygas exports out of the region in February was keeping availability balanced overall”
Brent crude oil, down 5%
Naphtha Europe, down 2%. “The naphtha arbitrage window to Asia has opened after weeks, giving European traders an opportunity to once again book cargoes to the region”
US$: yen, up 16%
HDPE US export, up 22%. “Producers maintaining price positions, but with prices unworkable in the global market,”
S&P 500 stock market index, up 27%