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China's Economic Crisis

China Experiences a Slowdown

By
Friday, July 26th, 2013

As was anticipated last week, the Chinese government has announced it will stimulate its slowing economy. But although China has a large enough wallet to dip into, it is not going full-out, opting for a more targeted approach.

ChinaWill this be enough to prevent China’s economy from tanking? Its ability to negotiate this landing will have an impact on the rest of the world, for if China goes down hard, the quake it unleashes could crumble the West’s already weakened foundations.

Sharp-Shooting, Not Spraying

China’s economic slowdown has reached the government’s line in the sand, with Q2’s GDP coming in at an annualized 7.5%, squarely on the government’s GDP target, which it has promised to maintain.

On Wednesday, Chinese officials announced what all were expecting: a stimulus package. But unlike the last purse delivered back in 2008 worth some $600 billion, which pretty much blanketed the entire economy, this time the Chinese government is sniping at just specific targets – aiming at job protection, exports, and infrastructure. Officials believe the worst of the slowdown is over and that only a little lift is needed to make sure GDP does not cross below that 7.5% line.

The three main objectives of this newest plan will target:

  • Small business: by eliminating all value-added and operating taxes on small businesses with less than $3,250 in monthly sales, which is expected to assist more than 6 million operations employing tens of millions of workers.
  • Export businesses: by reducing licensing and administrative requirements, canceling inspection fees on commodity exports, and simplifying customs procedures on manufactured goods to reduce the costs of exporting.
  • Railway infrastructure: by providing additional financing for railway projects, including permitting more private investment through bond products.

Economist Lu Ting at Bank of America Merrill Lynch calls it a “mini-stimulus”. “It’s quite small but it’s on the supply side, and that’s more efficient,” quotes The Financial Times.

The Chinese government is also focusing on maximizing the return on monies spent, recently banning the construction of new government buildings for the next five years, opting instead to invest those funds in projects that will contribute toward growth.

“We must really use our limited funds and resources for the development of the economy and the improvement of people’s lives,” the State Council declared.

Focus Must Be Jobs

The Chinese government’s efforts to keep its economy humming is of keen interest to the rest of the globe. At more than 19% of the world’s population, with hundreds of millions transitioning from the lower to middle classes, China has been a lifeline to floundering nations desperate for someone who will consume their resources and products.

For decades leading up to the close of millennium, China was selling to the world, raking in billions each year from low cost merchandise. Yet as Chinese policy slowly opened up, greater freedoms in property ownership and business creation fueled the largest upward mobility in the history of civilization.

Suddenly, the world was selling to China, from commodities such as metals and energy, all the way up to high tech products and equipment. And the ones doing the heavy lifting for the benefit of all those economies selling to China have been Chinese consumers.

For this reason, the world is keenly interested in how China navigates its shallow waters. The focus must remain fixated on Chinese jobs. As long as the Chinese keep earning, they will keep buying. And as long as the Chinese consumer keeps buying, the world will have held on to a major customer of its resources and technology.

China Slows the World

In the meantime, the slowdown in China has already cost its trading partners. Although Japanese exports to China are still rising, they are not rising as fast, slowing from a gain of 8.3% in May to a gain of only 4.8% in June.

China’s purchases of American products are also slowing, with Apple (NASDAQ: AAPL) reporting Q2 earnings from mainland China as 43% lower than Q1’s, and 14% lower than last year’s Q2.

As China consumes from 30 to 50% of the world’s copper, iron ore, and coal, much of the rout in commodity prices can be attributed to the Chinese slowdown. As Alexandra Knight, economist at National Australia Bank, informed Reuters, “It adds to the concern about the outlook for demand, and brings into question just how strong Chinese commodities demand will be.”

It seems the run up enjoyed by Western miners and manufacturers over the years was due to China’s running a little too far ahead of itself. China may have miss-measured its internal growth, much like a town building more roads and houses than its families needed. China overbuilt.

“China cannot change its weak economic growth situation due to still weak external demand and overcapacity problems,” Wang Jian, a senior researcher with the China Society of Macroeconomics, advised Reuters.

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Disaster Will Be Averted

But such is not the case everywhere in China. It may have an overcapacity in some industries, even in office space in its major cities. But its smaller cities have barely been touched, with infrastructure still sorely underdeveloped.

This is the government’s focus now. It is letting up on expanding with a view to the outside world and global trade, and instead focusing on growing internally as it develops its own domestic market by creating jobs and increasing its population’s personal wealth.

We can expect, then, that China will indeed make good on its assurance to keep its GDP from falling below that 7.5% target. After all, it has an awful lot of cash it has earned over the years from selling to the West, which it is not afraid to spend now.

Given the Chinese government’s resolve, there is no reason to believe that 7.5% growth cannot be sustained in China. Neither is there any reason to believe that the Chinese consumer will stop buying. As just one example, even though Japanese exports into China grew by a slower pace in June than in May, they were still higher in June than they were in May.

China’s insatiable appetite for the world’s resources will once again fire up our mines and pump up our oil wells. There may yet be another year or two of sideways movement in commodities, especially the base and precious metals. But now that resource producers have trimmed off their less productive operations, they are leaner, meaner, and better positioned to start turning profit going forward.

The second half of the year is historically profitable for commodities and their producers. Miners should post some nice numbers at the end of the year, and investors who have stayed with a reasonable allocation of 5 to 15% in commodities should likewise see some equally nice statements then too.

Remember that continually adjusting the allocation according to your chosen percentage will lock-in profit as you increase your position at cheaper prices and trim your position at higher prices. Even in a sideways market, you will still have opportunities each and every month to buy a little on the dips and sell a little on the rebounds. Just over the past 4 weeks alone, gold has swung from just under $1,180 to $1,350, a gain of 14% in just one month. Now who wouldn’t be happy with that?

If you stick to your allocations and refrain from a heavy reliance on margin, you can make money in commodities, even with a slowing China.

Joseph Cafariello

 

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