By John Richardson
THE blog, a bit like Wile E Coyote who always fails to catch Road Runner, has been amazed in recent weeks at certain people in the chemicals industry who, in public at least, fail to grasp the complexities confronting China’s economy in 2012. We wish that our experience would, at least for some of the time, triumph over hope.
It seems as if the attitude is that “last year was an exception and everything will therefore be back to normal in 2012.”
This is based on the assumption that the government will further relax credit conditions following its 50 basis-point cut in bank-reserve requirements in late 2011. A total of a further 200 basis points are forecast to be cut from reserve requirements by the end of this year, although economists expect interest rates will remain unchanged because of the danger of resurgent inflation.
The worst of possible outcomes also seems to have been been ruled out in the assumption that chemicals demand growth will rebound strongly in 2012 – i.e. a severe, new global recession driven by problems in Europe.
Let’s firstly deal with the argument over the easing of credit.
Further reductions in reserve requirements would certainly be welcome, as would more targeted measures to help China’s struggling small and medium-sized enterprises (SMEs), which make up the bulk of the country’s chemicals and polymer buyers.
But a rebound in inflation to above the government’s target of an annualised increase of a maximum of 5%, remains a significant threat.
Interestingly, the country’s official purchasing manager’s pricing sub-index for December increased to 47.1 from 44.4 in November.
This was ignored by government officials, who preferred to instead focus on the fact that the index also showed that manufacturing activity narrowly avoided a contraction – rising to 50.3 in December from 49 in November (below 50 being a contraction).
The crucial question, though, is “at what cost?” Monetary easing has evidently already fed-through to producer pricing, thereby perhaps adversely influencing consumer pricing.
Controlling inflation remains a crucial task for Beijing in order to maintain social stability, particularly in a year when a leadership transition will take place.
Communist Party leaders, led by President Hu Jintao, are expected to retire by November in a once-in-a-decade leadership change that could, as Jeremy Page writes in the Wall Street Journal, “paralyse decision-making”.
The retiring leaders will be anxious to protect their own legacies – while making life relatively smooth for the new incumbents – by not taking any drastic decisions.
Hence, moderate credit easing could well be the order of the day, in order to avoid re-inflating the real-estate asset bubble that has been a significant source of social disquiet among China’s “sandwich generation”.
A “steady as she goes approach” might, as a result, be the approach for 2012. This would leave the task of tackling systemic longer-term challenges confronting China to the next generation of leaders.
These problems include huge local government debt, rising labour costs, and reducing the economy’s dependence on exports, which we will examine in a blog post tomorrow.
The worst of possible outcomes
The steady as she goes approach assumes that either a collapse in the Eurozone can be avoided or short of a collapse, Europe’s own version of political paralysis is enough to drag the world into a severe recession.
Europe’s crisis is already having a severe effect on China.
Gordon Chang, the famous China sceptic, claims that China’s exports and imports were flat in November, when government stockpiling of cheaper commodities was discounted.
Electricity output growth, a key measure of overall economic activity, was at a ten-month low in November.
Only 34% of China’s economy was driven by internal consumption in 2010, which suggests that in the short term there is little that Beijing can do in the event of external trading conditions getting worse – other than blind panic.
This is where we should be really worried.
If the world enters a severe recession, China’s leaders might be forced to engage in an all-out trade war in order to protect manufacturing job, thus, hopefully, keeping a lid on social unrest.
Chang argues that the number of public demonstrations rose from 70,000 in 2005 to approximately 280,000 in 2010 – way above the official figures of 80,000-100,000.
The last thing the government needs is tens of millions of angry factory workers taking to the streets, in a year when it is trying to sell to the public the concept of a smooth transition of political leadership.
But, of course, as the Great Depression proved, protectionism doesn’t work.
If China were to, for example, competitively devalue the Yuan, increase export tax rebates for exporters, or go soft on new environmental regulations that have undermined the competitiveness of low-end manufacturers, the West would respond with trade barriers. This would make the macro-economic climate for China, and everyone else, even worse.
And so to assume that China will inevitably return to strong chemicals demand growth in 2012 is one heck of a big and harmful assumption.