China Looking Vulnerable

Ambrose Bierce, in The Devil’s Dictionary, defined an alliance as:

In international politics, when two thieves have their hands plunged so deeply into each other’s pocket that they cannot separately plunder a third party.

The corollary is that when your ally stumbles, you fall down too. China is learning that lesson the hard way. By pursuing a relentless mercantilist strategy, and becoming dependent on the US as a customer, it is sure to show lower growth as the US economy pulls back.

While a decline to a growth rate of 8% no doubt sounds plenty robust to Americans, that magnitude of reduction would create pressures within China, which has used rising prosperity to paper over domestic fissures. And while we have no insight into China, somehow that 8% figure, which is presented in an article below, seems a tad optimistic.

Two sightings from reader Michael, first on the general conundrum facing China, and a more specific one that suggests that growth is faltering. First, from the International Herald Tribune:

After living beyond its means for many years, America will have to rebuild its savings, so consumption will fall. Exports to the United States from China, Taiwan, Hong Kong and now South Korea are already weakening.

“I think this is a wake-up call for China,” said Stephen Roach, the chairman of Morgan Stanley in Asia.

Roach says that he expects U.S. consumption growth to halve – to about 2 percent – as debt burdens are pared.

As economic weakness spreads to Europe and Japan, the impact on China’s exports could cut its growth rate from about 10 percent now – already down from 11.9 percent in 2007 – to about 8 percent.

“It just underscores the fact that when you have a vibrant but very large export sector, when you have an external shock and you don’t have a lot of dynamism on the internal demand side, you have greater risks to growth,” he said…

But stoking domestic demand also requires changes that sometime shake the foundations of an economy – like scrapping deterrents to foreign investment in Japan, ending protection for favored groups in Malaysia or subjecting dominant companies to more competition in the Philippines and Hong Kong.

These are politically arduous tasks at the best of times. That’s why economists wanted governments to get cracking on them while the going was good.

Countries instead largely shirked the challenge, content to rely on export-led growth by holding down their exchange rates. Quite apart from hindering the needed rebalancing of the global economy, an undervalued currency acts as a tax on domestic demand, Hong Liang and Yu Song, economists who follow China for Goldman Sachs in Hong Kong, said in a report.

The result is evident in the case of China, where household consumption last year came to just 35.3 percent of gross domestic product – an unprecedented low in peacetime for a major country.

This means that a lopsided economy has scant domestic demand to fall back on as the global downturn deepens. “The real costs of China’s resistance to yuan appreciation are now becoming more apparent,” Liang and Song wrote.

So what is to be done?

In the case of China, Beijing must provide affordable health care and education and beef up its flimsy pensions system so people need to save for a rainy day. But setting up the administrative structures to ensure extra money is well spent takes time.

“My worry is that there are a lot of things that China can do to boost domestic consumption, including on the fiscal side, but none of these things are going to happen very quickly,” said Michael Pettis, a finance professor at Peking University.

From Reuters, “China buyers default on India iron ore deals“:

Chinese buyers of Indian iron ore are defaulting on import contracts and refusing to lift the ore unless the seller offers a discount on contracted prices, a top industry official told Reuters on Monday.

“Our exports are in deep red as there is no demand from China,” said Rahul Baldota, president of the Federation of Indian Mineral Industries and managing director of miner MSPL Ltd.

Chinese appetite for Indian ore has fallen despite rival Brazilian miner Vale’s demand for higher prices for the ore it exports to China — a move that initially cheered Indian suppliers.

Nearly 75 percent of India’s annual iron ore exports of about 100 million tonnes go to China, and shipments normally rise after the annual rainy season ends in September.

“The Chinese are backing off old contracts. They are saying either you reduce the price or we can’t take the shipments,” Baldota said. “I, myself, have had to suffer two cancellations.”

He said importers were willing to buy high-grade 63.5 percent iron ore at about $75 a tonne, about 45 percent less than rates of around $140 in June.

Sesa Goa, Dempo and Salgaocar from India’s western region and Essel Mining and the Rungta group of mines from the eastern sector are among the members of the Federation of Indian Mineral Industries.

Exports in the first half of September dropped to 1.99 million tonnes from 2.7 million tonnes in the same period last year. Shipments in August were also lower at 4.57 million tonnes against 5.39 million a year earlier, according to FIMI.

“If the situation continues like this, we will export only around 50 million tonnes in the year ending March. The problem has become severe in the last one month, though it was evident for the last three months,” Baldota said.

The China Securities Journal reported on Friday that Chinese steel mills would not import iron ore from Brazil in the near term, after Vale asked for the price hike.

Export demand for even low-grade iron ore, 57 to 60 percent iron content, which are shipped mainly from the western Indian state of Goa, is also flat.

“Hardly any exporter is doing anything even though our shipments usually start picking up around this time,” said Glenn Kalvampara, secretary of the Goa Mineral Ore Exporters Association.

This begs the question of whether China has suddenly decided to become a shrewd bargainer or whether the importers are retrading the deal due to a slump (in that scenario, they hope to break some deals). The latter seems a lot more plausible.