Rebel Traders – Analysis Without The Hype

Japan is one of the world economies that relies heavily on having great exports to compensate the costs it faces with having had to cope with a high public and corporate debt during the “lost decade”.

It is also often a bellwether of the global economy, as many of its high-end technological products need a buoyant market for people to consent those types of investment.

And after a transient effect, due mainly to stimuluses, the recession seems to be catching up with the economy in Japan as everywhere else. In August, Japan’s exports fell by 36 %, while the imports also sharply contracted. As the crisis deepens, layoffs have also picked up pace in Japan, thus compounding the issue in some measure.

The ill tidings from Japan bode ill for China, whose economy is largely dependent on exports and who dedicated a great part of its stimulus to increase its capacity and infrastructures. A Chinese slump can be indirectly predicted to be soon in the books by the fall by 27.6 % of Japanese exports to China.

As the effect of the aids start to dissipate, the woobly global economy is now obliged to “walk on its own feet”, and the hope of the Keynesian policies adopted so far, is that the extra government spending will allow the economy to feel new economic “blood” flow into its veins.

So far, that seems uncertain, as a number of structural issues have not been addressed, among others the “hidden debt” in the books of the US banks.

Japan’s exports tumbled 36 percent in August — with car shipments falling by half — and imports also contracted sharply, the government said Thursday, showing the world’s No. 2 economy remains mired in a deep slump.

Declines in automobile and steel exports were especially pronounced, the Ministry of Finance said. Exports fell for the 11th straight month to 4.5 trillion yen ($49 billion).

“We are not seeing an improvement in exports due to a continued slump in global demand,” said Hiroshi Watanabe, an economist at Daiwa Institute of Research. “Japan’s exports were particularly hit hard by stagnant demand in Asia and China.”

Imports, meanwhile, dropped 41.3 percent from a year earlier to 4.3 trillion yen, reflecting weak consumption within Japan, where the jobless rate is at a record high as companies shed workers. Consumer finance company Aiful Corp. said Thursday it will cut 2,000 jobs, or about 44 percent of its work force.

The incoming government of Prime Minister Yukio Hatoyama is seeking to boost consumption and help households with a range of consumer-oriented proposals, including cutting tolls on highways and giving families with children $275 a month through junior high.

But critics say the Democrats, who unseated the long-ruling conservatives in last month’s election, don’t have any clear strategy to achieve long-term economic growth.

Japan’s economy managed to climb out of a yearlong recession in the April-June quarter, growing at an annual pace of 2.3 percent. But with the jobless rate at a record 5.7 percent, growth prospects look murky.

The trade figures showed that the monthly trade surplus, or the amount exports exceeded imports, came to 190 billion yen.

Auto exports in August plunged a staggering 50 percent, while shipments of steel products dropped 43.3 percent, the ministry said. Exports of light oil products fell 59.9 percent due to faltering demand in China and Vietnam, it said.

Japan’s U.S.-bound shipments declined 34.4 percent to 713.1 billion yen, marking the 24th straight month of year-on-year decline. Among exported goods to the U.S., metal products nose-dived 82.2 percent.

Exports to Asia tumbled 30.6 percent to 2.6 trillion yen. Japan’s exports to China were down 27.6 percent.

Japan’s exports to the European Union dropped 45.9 percent to 514.3 billion yen.

It was mentioned on several web sites (among which the Rebel Traders one) that Shipping had its own graveyard, somewhere in Malaysia, where superfluous ships were sent to expect the economic recovery. The phenomenon of overcapacity in shipping (we saw in a previous post that overcapacity had  a direct negative influence on the Baltic Dry Index) is best reflected in what Caijing sees of the Chinese shipbuilding industry. With years of frugality ahead, overcapacity will soon become an issue for China, from all points of view, unless it manages to focus its efforts on creating an internal market.

Chinese shipbuilders’ order books have improved somewhat since June, but many yards are still operating below capacity, according to official statistics released on Sept. 16.

About 89 percent of all orders received in the first eight months, or 9.8 million deadweight tons, were placed between June and August, the Ministry of Industry and Information Technology said in a Web site statement.

New vessel orders in the first eight months fell 82 percent year-on-year to 10.98 million DWT, compared with a 96 percent drop in the first five months to 1.18 million DWT.

However, the rebound was insufficient, considering that the country’s major shipbuilders have combined production capacity of 60 million DWT annually.

Domestic shipyards have been under growing pressure as new orders plunged and the order backlog decreased, the China Shipping Industry Association said in an August report. The association said most order backlogs could be depleted by end-2010 or in the first half of 2011.

Some shipbuilders began to operate below capacity in the second half, it added.

Conditions will remain very difficult for the global shipping industry in the next two or three years, the association said.

Zhang Jing, chief researcher at the China Shipping Industry Research Institute, said on Sept. 14 that there had been no signs of a rebound in industry fundamentals.

Andy Xie, whose insights we have often referenced in our chronicles is back with an analysis of the failure of Keynesian economics in Japan on Caijing.

As previously mentioned in two posts, Andy Xie firmly believes in a second dip taking place somewhere next year in Anglo-Saxon economies.

Before delving more ahead, that specific distinction warrants by itself more attention, as to the foundations of the US or British economies. It is true that they have been based on sand in the form of dangerous credit expansion and a housing market bubble. Something similar to what is happening in China, with the addition of a huge bailout that was partially rerouted towards the stock markets and commodity assets. You can read the full article here.

For Xie, exports were one of the major motors of the Japanese economy (not unlike China).

Anyone who doesn’t believe in the harm of a financial bubble but does believe in Keynesian stimulus magic should visit Japan. A likely dip for the Anglo-Saxon economies next year will underscore these truths. The same goes for anyone who thinks China’s latest real estate bubble, asset borrowing and shadow banking system are worthwhile substitutes for real economic growth.

The world including China can learn a lot by looking at what’s happened to Japan, and what’s in store for DPJ. Since Japan’s stock market bubble burst in 1989 and the land market popped in 1992, the LDP government has run up debt equal to nearly 200 percent GDP in hopes of reviving the economy. And its economy has stagnated.

The burst of the global credit bubble in 2008 brought down Japan’s export machine. That was its only hope. Now, of all OECD economies, Japan’s looks most like a depression. Its nominal GDP declined 8 percent in the first quarter 2009 from the year before. Although its economy rebounded a bit in the second quarter, nominal GDP for 2009 is still expected to decline substantially and will likely be lower than in 1993.

Despite the difference in the return on assets between Japan and the US, it might almost instinctively be understood that Japan was mostly basing itself on “real” economy, whereas the US corporations were using financial engineering to achieve the higher return.

U.S. return on asset (ROA) was twice as high as that in Japan. But, in hindsight, higher ROA in the United States was mostly a bubble phenomenon. Much of U.S. corporate profitability was due to financial engineering. In one aspect, the export performance of Japan’s corporate sector has done very well — much better than its U.S. counterpart. Japan’s exports doubled in yen terms between 1993 and 2008, and the sector’s share of GDP nearly doubled to 16 percent from 9 percent, even though the yen remained strong during the period. The performance of Japan’s export sector shows its inefficiencies elsewhere were largely due to shortcomings in the system.

Where it starts getting very interesting, it is in the policies pursued to stimulate recovery in Japan from the 1980’s onwards, after the country fell prey to a burst real estate bubble: rates at zero and… abolition of mark to market! Sounds familiar?

The consequences of running high deficits and trying to maintain the bubbles has been of maintaining a very high cost of living, thus putting a pressure towards limiting the birth rate and ultimately compounding Japanese economic issues.

This strategy was flawed in three aspects. First, even as the corporate sector earns profits to pay down debt, the government’s debt is rising. At best, it is shifting corporate debt to government debt. In reality, government debt has been rising faster than private sector debt has been falling.

Second, economic efficiencies don’t increase in such equilibrium. Existing resources in the zombie sector are essentially unproductive. Bankruptcies improve efficiency by shifting resources from failing to succeeding companies. When rules are changed to stop bankruptcies, efficiency is sacrificed. Worse, incremental resources are sucked up to pay fiscal deficits used to prop up zombie industries. Japan is thus trapped in equilibrium of low productivity.

Third, a long period of stagnation could worsen irreversible social change. A falling birth rate, for example, is one consequence that is wreaking havoc on the Japanese economy. Japan’s post-bubble policy was to let property prices decline gradually. Hence, living costs also declined gradually. On the other hand, the economy stopped growing, which caused income expectations to quickly adjust downward. The combination of high property prices and low income growth rapidly pushed down Japan’s birth rate. As a consequence, Japan’s population is declining two decades after the bubble. The rising burden of caring for the old will lower Japan’s ability to pay for anything else.

Legacy of the failed policies of stimuluses: Japan’s corporate indebteness is of about 180 % of GDP even if the households are “only” leveraged at 69 % of the GDP. Of course, the Government’s debt is one of the highest in the world at 194 % of the GDP (still some way to go for the US before becoming nipponized).

For Andy Xie, the Japanese experience prefigures what will happen to the US next year:

As the global economy is again showing signs of growth in the third quarter, most governments are celebrating the effectiveness of their policies. Yet Japan’s experience forces us to pause: Its economy experienced many such growth bounces over the past two decades, but was unable to sustain any of them. The problem was Japan only used stimulus, not restructuring, to cope with the bursting of its bubble. After the demise of any big bubble, serious structural problems that hamper economic growth remain. Stimulus can only provide short-term support that makes structural reform possible. When policymakers celebrate the short-term impact of stimulus and forget structural reforms, economies slump again. I think the Anglo-Saxon economies will dip again next year.

He sees the only solution in restructuring at the same time as stimulating. Bankruptcy, from that point of view is an essential tool as it refocuses resources on more efficient companies, rather than on the failing companies.

Andy Xie concludes by exploring some avenues and necessary restructuring for China, but in my view, many of his comments could be transposed to the US:

A bubble rises when there is excess money supply. Is the current, excessive monetary growth due to demand or supply? We can argue that point forever. When the former chairman of the U.S. Federal Reserve, Alan Greenspan, said a central bank couldn’t stop a bubble, he meant money demand would rise regardless of interest rates. I disagree. If a central bank targets monetary growth in line with nominal GDP growth, a big bubble can’t happen. Aside from central bank failure, then, the most important microeconomic element in a bubble is the shadow banking system.

Regulators limit what banks can do by imposing capital requirements. The international standard is 8 percent of total assets, but banks can use accounting tricks to minimize their requirements. But a big accounting loophole can lead to disaster. For example, the loose restrictions on off-balance holdings were major factors in the global credit bubble. Most regulators are now tightening accounting rules for capital requirements.

Shadow banking is a less noticed but more important factor in creating bubbles. Most analysts compare it to the hedge fund industry, which provided leverage for financial speculators with little capital. The shadow banking system is much more because industrial firms engaging in financial activities are more important. Entities such as GE Capital and GMAC provided massive leverage to asset markets with little capital. A shadow banking system is essential to a big bubble.

China’s corporate sector increasingly looks like a shadow banking system. It raises funds from banks, through commercial bills or the corporate bond market, and then channels the funds into the land market. The resulting land inflation underwrites corporate profitability and improves their creditworthiness in the short term.

We all know with what caution Chinese numbers must be taken. However, there generally is a measure of truth in them, even if positive evolution are exaggerated and negative evolutions downplayed. At the very least, they give an idea of the general trend.

And so far, it would seem that the Chinese economy is succeeding in walking that thin line between the stimulus excesses and developing an internal demand.

As some observers tend to believe only year on year numbers as being valid comparisons, the factory output increased by 12.3 % from August 2008. In addition, in what would seem to indicate a success in developing an internal market, the Chinese retail sales jumped by 15.4 % in August, Y/Y, these numbers being adjusted for seasonal distortions (China’s new year holiday affecting the calculations).

At the same time, however, exports fell more than estimated by 23.4 % Y/Y in August.

However, the whole progress is expected to pull the Chinese GDP back up to 9.5 % on a yearly basis, and to pull ahead the whole Asian region.

Output at the nation’s factories gained 12.3 percent from a year earlier, the most since August 2008, the statistics bureau said in Beijing today. Local-currency new loans were 410.4 billion yuan ($60 billion), up from 355.9 billion yuan in July, the central bank reported.

(…)

Economists had forecast an 11.8 percent gain in industrial production, according to the median of 15 estimates in a Bloomberg News survey. New loans were projected to total 320 billion yuan, a separate survey showed.

Retail sales climbed 15.4 percent in August from a year before, the most for the year after accounting for seasonal distortions caused by the lunar new year holiday, statistics bureau data showed today. The median estimate was for a 15.3 percent advance.

Despite this rapid progression, so far, there appears to be no hint of inflation, as the Chinese CPI and PPI both declined, respectively by 1.2 % and 7.9 % Y/Y. However, inflation stays at the heart of the preoccupation of the Chinese authorities.

China’s consumer and producer prices witnessed a fall in August, generally consistent with market forecasts. Consumer prices fell 1.2 percent year-on-year, 6 percentage points lower than the fall in July, the first consecutive seven months of decrease since 2003, according to the data released by the National Bureau of Statistics on Sept. 11.

Producer Prices were down 7.9 percent, 3 percentage points lower than the decrease in July, having reversed a widening fall since December 2008.

In fact, M2, the measure of Money supply which reflects the money in circulation*, appears to have risen to over 57 Tn Yuan, a huge amount which allows for some worries in the Chinese government on its capacity to handle inflation when all this money starts flowing back in the economy.

China’s central bank said M2, the broadest measure of money supply, increased to 57.67 trillion yuan at the end of August, up 28.53 percent from a year earlier. The growth rate was slightly higher than the 28.2 percent forecast by 20 economists surveyed by Caijing. The growth rate in August was also higher than 28.42 percent at the end of July, the People’s Bank of China said in a statement on its Web site on Sept. 11.

A Chinese version of the American problem in the months ahead. For now, the government is only happy that it can find some jobs for the huge Chinese jobless population.

*M2: Equals M1 + savings deposits, time deposits less than $100,000 and money market deposit accounts for individuals. M2 represents money and “close substitutes” for money.^[13] M2 is a broader classification of money than M1. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. M2 is a key economic indicator used to forecast inflation (from Wikipedia)

Update: as some readers seem to have an issue with Chinese numbers and confront them to the stats on power usage (stats released by the same governmental agencies they don’t trust, by the way), it is worth pointing out that the Chinese power demand rose by 6 % in July.

In what should be one of the largest periods for the Chinese exports it is actually one of the worst. This is the peak time for worldwide retaillers to be receiving goods from China for the upcoming holiday shopping season.

Either retailers are waiting for the last minute to determine what (and how much) they will commit money to, or they just don’t see the demand to justify ordering large quantities of goods.

Just released were the figures for August 2009:

(CH) CHINA AUG TRADE BALANCE: $15.7B V $13.6BE ($10.6B PRIOR)

- Exports Y/Y: -23.4% v -19%e (-23% prior)
- Imports Y/Y: -17% v -10.5%e (-15% prior)

The terrible hits that took place the last few months on the global economy took an especially heavy toll on the emerging countries’ economies. The Chinese powerhouse namely, took a severe hit on the front of jobs, sparking hence some social tensions which we mentioned in our past chronicles.

It appeared that a universitarian research institution gave some amount of clarity on the extent of the phenomenon. The Chinese Academy of Social Sciences (CASS) revealed that, in its estimation, about 41 million persons lost their jobs due to the downturn. For those Americans who think they have been badly hit by the recession, it is worth noticing that for the CASS, 40 % of the global layoffs took place in China. For the CASS, better orienting the stimulus package could have created up to 72.36 million jobs, in contrast to the 51.35 million which could be created by the infrastructure-oriented current Chinese stimulus, as reports China’s Economic Review.

Up to 41 million workers in China have lost their jobs in the global economic downturn and 23 million remain out of work, the South China Morning Post reported, citing a report by the Chinese Academy of Social Sciences (CASS). The layoffs far exceed government estimates, CASS said. Last month the Ministry of Human Resources and Social Security said that just 16.5 million people had lost their jobs due to the downturn: 9 million urban residents, 3 million college graduates and 4.5 million rural migrant workers. Many of the layoffs were triggered by collapse of the export sector at the end of 2008. CASS estimated that approximately 40% of the global redundancies from the downturn were in China. It added that Beijing did not make employment a priority in its US$586 billion stimulus the package. The current focus on infrastructure projects is expected to create 51.35 million jobs. However, if the stimulus package was reorganized to make employment a priority, it could create up to 72.36 million jobs.

Unofficial estimates have put the current job losses in China at around 74 million, hitting mainly migrant workers. The Chinese government was on the offensive after the CASS report. Yi Weimin, the Chinese minister for Human Resources announced that 95 % of migrant workers had a job in August.

Government data shows that 95 percent of migrant workers had jobs last month, which was on par with the percentage working last year. And a recent shortage of labor in the Yangtze River Delta and Pearl River Delta areas, both economic heartlands, underlines the recovery of the economy and the creation of new jobs, the official said.

Of course, what Weimin did not say was that many migrant workers do not register in the unemployment statistics, simply because they return to the country, a situation which may trigger social unrest, a possibility to which the authorities have been alert, as incidentally confirmed by the minister:

The worst-case scenario we prepared for earlier, in which migrant workers who lost their jobs might turn up protesting, did not take place. “And college graduates are also quite stable, with sufficient employment measures in place,” the minister told.

The budding recovery relaxes a bit the pressure on the Chinese authorities, but the alert is still present. Unless there is a relapse of the US consumer into the very habits that created the crisis in the first place, the export sector on which China is strongly dependent for its job creation may not be as buoyant as in the past.

Sphere: Related Content

Recent worldwide “green shoot” stats have given grounds for people to call in a rapid recovery, some even asserting that it would be “explosive”. However, a look at statistics around the globe testify rather to a more subdued economic recovery. Indeed, an investigative article by two journalists of Caijing sheds some clearer light on the economic “recovery” clamored by Chinese authorities. The few extracts posted below should incite you to read the full article…

The journey began in Jiaozhu, the largest export town in Shandong Province. Jiaozhu’s economy officially posted a 5 percent increase in exports year-on-year during the first quarter 2009, at a time when exports nationwide were plunging. But by the second quarter, the statistics confirmed that local business had slumped.

(…)

Down the coast in Zhejiang Province, the situation is just as harsh. According to a survey of major trade companies in late June by the provincial Office of Commerce, 64 percent of Zhejiang exporters reported fewer orders, 18.5 percent saw no change, and 18 percent said orders had increased from last year’s levels. Those results reflected only a slight improvement since a similar survey conducted in May.

A different picture emerged farther south in the Pearl Delta city of Dongguan, Guangdong Province, where waves of migrant factory workers left several months ago.

Wen Zhimou, deputy secretary of the Taiwanese Investment Enterprises Association of Dongguan, said it’s hard to say whether exports have substantially turned for the better in the Pearl Delta in recent months. He said many company orders follow seasonal patterns, and not all manufacturers can expect a stable flow of orders.

But Wen said the chamber’s membership roles have shrunk. Of the 3,100 Taiwanese-investor companies registered in Dongguan, up to 700 have not paid their membership fees, which could mean they’ve suspended operations.

In an interesting development,  the Financial Times reports this morning that Chinese exports have overtaken German ones.

China exported 521,7 Bn $ during H1, compared to 521,6 Bn $ for Germany during the same period. The comparison in exports stops there because, unlike China, most of the German production is focused on capital goods and heavy equipment.  The expenditure on these materials are generally considered by economists as advanced indicators for an economic recovery as they are indicators of a return of confidence in businesses.

China’s exports narrowly edged ahead of those from Germany in the first six months of the year, new figures showed on Monday, in a fresh sign that the latter’s status as the world’s leading exporter is at risk.

China exported goods worth $521.7bn (€364.9bn, £318.1bn) in the first six months of this year, while Germany’s total was $521.6bn, the Geneva-based World Trade Organisation reported.

Such export figures are closely followed in Germany, Europe’s largest economy, which has national elections next month.

Sales of its industrial products have largely powered the economic growth in recent years, and throughout the economic crisis the government of Angela Merkel, chancellor, has strongly defended the country’s export-driven economic model.

Germany has long been braced for the much faster-growing Chinese economy to assume its “world export champion” title.

However, the likely value of German and Chinese exports for the full year remains uncertain and will depend heavily on exchange rate movements in coming months. A strong euro would help flatter Germany’s figure. Germany’s export businesses have also shown signs of reviving in recent months.

“It is too close to say for the whole year and who knows for next year,” said Patrick Low, the WTO’s chief economist.

Germany’s exports were badly hit by the collapse in global confidence that followed the failure of Lehman Brothers investment bank last year.

But signs of a strong recovery have emerged. In June, the latest month for which data are available, German exports leapt by 7 per cent compared with the previous month. Nevertheless they were still 22.3 per cent lower than a year before.Chinese exports have followed a similar pattern.

The surge in exports helped explain why Germany was able to report a rise in gross domestic product in the second quarter, compared with the previous three months – meaning it emerged from recession ahead of the US, the UK and most of the other large European economies.

In turn, Germany’s rebound is helping lift the overall performance of the eurozone. Eurozone industrial orders surged by 3.1 per cent in June compared with the previous month, according to data on Monday from Eurostat, the European Union’s statistical office.

This comes as well in the wake of European statistics indicating a recovery in industrial production for June 2009: new orders for Capital Goods grew by 5.6 % in the Euro zone compared to the month of May 2009.

Nonetheless, this should not hide the continued degradation in the intermediate goods and durable consumer goods. And the further fact that most of these exports and orders were caused by internal stimulus.

Even in China, there stays cause for concern:the Chinese Prime minister warned that the lax credit policy would continue as long as the recovery is not firmly established, weak corporate profits testifying to continuing issues:

Premier Wen Jiabao has warned that the country still faces uncertainties despite signs of economic recovery, saying the government will maintain its macro economic policies.

In a statement on the government’s website, www.gov.cn, Wen said Beijing will ensure a sustainable flow of credit and a “reasonably sufficient” provision of liquidity to support an economy that is facing fresh difficulties.

Chinese Premier Wen Jiabao shakes hands with an enterprise chief during an enterprise meeting in Qingtian County, Lishui City, east China’s Zhejiang Province, on Aug. 22, 2009. Wen Jiabao inspected Zhejiang from Aug. 22 to 24. [Xinhua]

“There are still a lot of unstable and uncertain factors ahead and the economic situation ahead is still very grave, although both the world economy and the national economy are now making positive changes,” Wen said during an inspection tour to Zhejiang province from Saturday to Monday.

China has shown increasingly positive signs of economic performance, but the country’s economic recovery is still uncertain, Wen said.

“We can clearly see that the foundations of the recovery are not stable, not solidified and not balanced. We cannot be blindly optimistic,” he said.

The effects of some government measures might fade, while others will take time to show results, Wen said, who gave no other details of potential problems.

Beijing will stick to policies meant to boost domestic demand, maintain easy credit and promote efficiency, the statement said. The government is in the midst of a two-year, 4 trillion yuan ($586 billion) stimulus plan that is meant to insulate China from the global downturn by boosting domestic consumption.

Wen’s comments echoed his repeated recent warnings against complacency and assurances that Beijing’s stimulus spending and easy credit would continue. But they clashed with increasing optimism from financial analysts who say China is emerging from its economic slump.

China’s economic growth accelerated in the latest quarter amid Beijing’s huge stimulus spending but authorities have called for continued vigilance. They say weak corporate profits show that a recovery is not fully established.

During his visit to the coastal province, Wen inspected some private firms, a movement to boost the confidence of small- and medium-sized private companies.

President Hu Jintao said on July 23 that the country would maintain its macro economic policies, a week after the country reported a rebound in growth in the second quarter.