Eye on China: Statistics tell tangled tale

Something curious is happening in China: Investors are beginning to take a closer look at China's government statistics. I believe such a questioning attitude by investors tends to be a precursor of a China slowdown.

When everybody is making money in China, nobody is really bothered about government statistics. Sure, they may appear incomprehensible when looked at closely, but there's no obvious harm done when you are raking in profits.

But when investors' antennae start twitching out of some sixth sense that not everything is right, they turn to government statistics for reassurance. Given the confused nature of those stats, that can be hard to come by.

Chinese statistics have always been suspect. In fact, they are outrageously bad, with even the docile local media occasionally poking fun at the politically motivated research of the National Bureau of Statistics.

Foreign observers who have always distrusted the foundations of China's economic growth - such as Joe Studwell, author of The China Dream - get especially vicious in their criticism when China enters a downturn. Indeed, at such times their criticisms appear brilliantly apt. That is, until the next business upturn and people go back to making money hand over fist.

The recent perplexity about China's economic growth is related to fixed asset investment (FAI). FAI is the value of investment that goes into fixed assets such as office and residential buildings and machinery.

At more than 50 per cent of GDP, FAI appears to be a shockingly large part of the Chinese economy; indeed it's a level that no other country has ever come close to.

This upsets people. How can such a large volume of FAI be sustainable? High FAI is reflected in the output capacity of the economy. But adding capacity works only when there is sufficient consumer demand to absorb the output.

If there is no matching consumer demand, adding to output can lead to a collapse in company profit margins, vicious price competition and tumbling prices.

Ultimately, it can lead to deflation. Once an economy enters a deflationary spiral it's hard to stop. People acquire the mindset that everything is going to be cheaper tomorrow, so they put off acquisitions.

Deflation also creates the phenomenon of high real interest rates even if nominal interest rates are close to zero. That's because the real value of money is actually going up, meaning that repaying money in the future will be more expensive than now, so people also defer borrowing.

The high levels of FAI compared with consumer demand (equally hard to calculate but definitely not growing as fast as FAI) in China, therefore, appear to signal that something is seriously amiss.

Western economists working for investment banks have come up with some ingenious explanations for why growth should continue to be strong.

For a start, they argue that FAI is not as high as it first appears. The most important reason for the high ratio is that Chinese statisticians include cars and property transactions, Western economists have concluded. Including these items is not common in the West, where they are usually classed as consumption.

Also, it's likely that Chinese statisticians tend to be too conservative in how they measure the size of China's GDP. Like many developing countries, China's GDP is far larger than the headline figures because of the huge contribution from the grey and black markets.

That's all well and good. But the consumption element of FAI is weakening, with car purchases down as a result of tighter lending guidelines and property buyers being squeezed by a raft of measures intended to cool overheating at the beginning of the year. China's core consumer price index is also barely above 1 per cent in positive territory.

So how sustainable is China's GDP growth, really?

Well, economists have another theory. They argue that China's looming demographic disaster (a baby shortage caused by the one-child policy) is going to put pressure on wages, and we are not talking pressure on skilled labour (which already exists) but un-skilled labour - the bulk of the population.

When 900 million peasants finally get more than the tiny cash amounts they get now, they can contribute to consumption and, hence, stimulate and balance China's growth.

It's a decent theory, although the supply of cheap labour from inland China to the coastal cities shows no signs of slowing. One obvious flaw in the theory is that, at least when I was travelling down the Chinese coast a few years ago, it was clear that peasant families didn't seem interested in birth control. The people I met all had several kids.

So perhaps, despite even the best arguments of the economists talking up China, the country is indeed heading for the sharp slowdown the pessimist have so long been predicting. But the truth is, nobody really knows.

If you are a businessman, all you can do is cross your fingers and hope for the best.

* The writer remains anonymous to protect his position in China.