China Slow Down - Reflecting on Jeremy Grantham's commentary

I just re-read Jeremy Grantham's October 23rd commentary (free download from http://www.gmo.com/). He is definitely a lot more bearish about China than most people. Increasingly more economists are coming out to argue for negative surprise in Chinese growth (See Roubini - 4 Nov 2008 - The Rising Risk of a Hard Landing in China: The Two Engines of Global Growth – U.S. and China – are Now Stalling and Brad Sester - 6 Nov 2008 - How severe a slump in China?). CLSA is now calling for China GDP dropping to 5.5% in 2009 from 25.8% in 2007 and estimated 19% in 2008.

I think that it is very important to consider China's growth since it is the final piece of the puzzle in the global "recession" story and is in both the world and China's (social unrest and jobs) interest to keep double digit growth. But since there is no way that Chinese export can escape from the global slowdown, unless China can magically boost domestic demand (how about more infrastructure projects... *), we are facing a complete global recession. Just the thought of that, I need to take a deep breathe.

How do we get out of such a hole? Can some of the smaller economies pick up the slack as developed countries scramble to lower their cost and further outsource their businesses in even less-developed countries? Will the governments spend enough to stop this slowdown? Will competitive devaluation of the currencies benefit anyone in the end?

We have a lot of questions! But not a lot of answers since there are simply a lot more moving parts when global economy is intertwined with global politics and globally diversified human behaviors.

I would like to close this post with quotes from Jeremy's October article (my emphasis in bold):


Like a Bear in a China Shop

I suggested last quarter that it was ridiculous to expect great financial and economic skills from the Chinese government, which is faced with the spectacularly complicated task of maintaining the highest economic growth rate in history. “Surely they will stumble,” I said. Well, the more I think about it, the more likely it seems that this is both the most likely and most dangerous disappointment (even shock) that awaits the current consensus.

Moving back to our armchair at 56,000 feet (don’t you miss the Concorde?), an amateur economist could summarize and simplify the Chinese economy as 39-37-37: an astonishingly large 39% of the GDP is capital spending, 37% is internal consumption, and an amount equal to 37% of GDP is exported. (These numbers do not sum to 100 as we are not using exports net of imports because we are concerned with the vulnerability of total exports to a weak global economy.) The U.S., in comparison, is 19-70-13, disturbingly on the other side of normal; 70% consumption compared with 57% in both Germany and Japan, for example, and nearly twice that in China. China’s mix is of course an utterly unprecedented one, and comes with great advantages in booming times. Now, however, we might ask: how do you stimulate the building of a new steel mill when rows of mills are sitting empty? How do you increase exports into a global economy that is not just slowing, but is unexpectedly very weak? And are they good enough at stimulating local consumption to have an impact on such a small percentage of GDP in the face of a negative wealth effect from declining stock and housing prices in their local market?

Simple old “Econ 101” thinking would suggest that their capital goods sector will have a bigger drop than the rest of the economy, and that export growth rates might slow from very large to even nil or worse. The one openended offset might be in Keynesian or Rooseveltian government spending, upping their already massive infrastructure spending by A LOT. (This is a specialized economic term.) And they will surely do some of that.


On balance I find myself more and more convinced that this is becoming our #1 disagreement with consensus. If we are right, it will be a very important and distressing surprise for global growth. The good news is that this is far from the “near certainty” of our recent views on housing, profit margins, and risk premiums. At best, if right, it is an inspired insight straight from the armchair. At worst, if wrong, an ill-researched hunch.

* a side note : middle east is also facing the same problem of slowing oil exports and the challenge to boost domestic demand.