China's cycle is turning up

This week’s blog will focus on the patterns in China’s economic cycle. China has not suffered a recession in recent history, at least on the official data, but it has gone through three big cycles, in the 1990s, early 2000s and since 2009. These align broadly – but as we shall see, not exactly – with the US. Within those big cycles there were mini cycles with recent troughs in Q3 2012 and Q3 2015. I suspect, a new trough will be recorded in either Q4 2018 or Q1 2019.

First, lets look at the big cycle. After Deng Xiaoping’s opening from 1978 onwards, China grew very fast in the 1980s before slowing during the 1990s. This slowdown was partly inevitable after such a surge, but also reflected policy as the authorities, under Jiang Zemin, worked to bring down inflation and implement policy reforms, including closing many loss-making state-owned enterprises. Growth was at its weakest from 1998-2001, partly because of policy and partly influenced by the world recession in 2001. Then growth took off again, powered by exports initially, with the help of WTO membership, and later by a domestic investment boom.

When the US led the world into a recession in 2008-9 China was hit hard, then rebounded quickly following a massive fiscal and monetary stimulus programme. But growth has been slowing again since 2010. Over the last 20 years China has become much more important in the world economy and therefore its cycle has more influence on other countries. At the same time its increased openness to the world means that it also is more susceptible to economic influences elsewhere, primarily from the US and EU.

Official GDP data show the big cycles clearly enough but it is hard to see the mini-cycles. The mini-cycles in the last 10 years seem to be due to a combination of domestic policy and foreign influences. After the stimulus splurge in 2009 the authorities realised that they must pull back, which they did by tightening credit. This, together with the effects of the euro crisis, caused a slowdown in 2010-11. By then, China’s exports to the EU exceeded those to the US and Europe’s double-dip recession caused by the euro crisis hurt.

The response in 2012 was to ease up on austerity and encourage renewed growth. It is hard to see that in the official GDP numbers but it is pretty clear from the Li Keqiang activity index. This is an index named after China’s Premier who is (officially) number two after Xi Jinping. Li Keqiang reportedly commented in 2007 that he doubted the GDP figures and preferred a simple activity index composed of 3 indicators (railway freight, bank lending and electricity output). I doubt that this index is any more reliable than the official GDP numbers in giving us the level of GDP growth, especially recently, but it has not been smoothed like GDP so it is more useful for seeing the mini-cycles.

After a strong pick-up in 2013 China’s growth faded again, this time mainly due to domestic policy. The authorities were increasingly concerned about the growth of debt and knew they had to slow it down by slowing public investment and restricting credit. But by 2016, exacerbated by slower growth in the US and Europe (partly in response to China’s slowdown but also influenced by an inventory cycle), the government realised China was too weak and so once again there was a big stimulus.

The mini-cycles can also be seen in the pattern of Total Social Financing. This is an official number which tries to measure total lending in the economy. It is measured in Renminbi so naturally grows over time but (when smoothed as a 12-month moving average) it shows clear retracements in 2010-11 and then renewed expansion in 2012.

Again, a word of caution on the numbers here. Whenever the authorities try to squeeze credit there is a real effect and a statistical effect. The real effect is that credit actually does get squeezed somewhat. The statistical effect is that financial institutions find a way to keep credit going through innovations in the shadow banking system that are not immediately captured by the TSF statistic. As elsewhere with financial statistics, the statisticians are always running to catch up, so it is unlikely credit actually fell as much as the data suggests. But it was at least crimped.

Another data series that shows the mini-cycles is industrial production but here we have to allow for the fact that IP growth is on a declining trend. When the authorities pulled the stimulus levers in 2012 and again in 2017, IP stopped falling but didn’t really pick up. In part this reflects one of China’s key problems, the overcapacity in the industrial sector which is bearing down on new investment. And in part it is due to the declining importance of manufacturing.

Another good series to see the mini-cycles is house prices. Shanghai prices for example surged in 2013 and 2016-17 and declined in 2015 and 2018. This pattern reflects both the credit cycle and specific controls on housing finance, another lever the authorities use to influence the economy.

The 2016 stimulus faded in 2018 and the new slowdown has occasioned yet another stimulus which should kick in during 2019. Estimates suggest that the fiscal stimulus planned this year adds up to about 4% of GDP and it is accompanied too by monetary easing. So, we should be off to the races again for a year or two of stronger growth.

That said, the strength of the pick-up depends on how much of the fiscal stimulus actually going into spending. There are already anecdotal reports of local authorities using some new borrowing to pay off old debt. And the tax cuts for consumers could be saved. With the stock market down 25% from the first few months of 2018 and, more importantly, house prices weak, consumers may be reluctant to raise spending. That said, the official indices of consumer confidence are exceptionally high currently, in fact higher than any registered since the early 1990s.

My guess is that business investment spending will be hard to galvanise but at least some of the new infrastructure spending will happen. And if consumers step up, which they probably will to some extent, expect stronger consumer spending. We are into the lunar New Year hiatus now, with January and February data telling us nothing. But by the spring, assuming the trade war is resolved as looks increasingly likely, the data from China will start to look better. The bottom line is, don’t worry too much about China’s growth this year.