Saturday, December 13, 2008

Don’t Worry About China’s Exports. Worry About FDI


The last week has confirmed a number of the fears I had when first looking at the global economic ripples that China was exposed to.

It was abundantly clear early on that consumers in the west were going to tighten up and that this would filter back to China through exports at some point. Confirmed yesterday, this is a process that I think many were prepared for already, and I am quite happy knowing that the falloff was only2% from last year’s level. It is simply amazing.

Where I was concerned 2 months ago, was FDI.

Simply put, while the focus on the financial crisis has been for the most part on the mortgage credit, and to some degree the access of firms to trade credit instruments, the credit needed to fund capital investments has not really been discussed.

Funds that firms use to expand their geographic presence, invest in equipment, buy land, build factories, and fund R&D - capital investments - are funds that the Chinese economy have benefited greatly from (as a trip to Suzhou will clearly prove).

For me, a 36.5% falloff in FDI has one message and two impacts

The message - the credit seizure we have been witness to has forced large and medium sized firm to move to making decisions without credit, and these firms do not have the confidence to make further investments in the Chinese economy.

Note 1 - when I say “these firms”, I mean manufacturers do not see the business case for a new factory in China and I mean that real estate funds do not see the case for investment in China’s buildings

Note 2 - When I say “do not have the confidence”, I mean at this time. Investors are waiting for the bottom of the market and manufacturers are waiting for credit to turn back on. When these events occur, the situation will change.

However, until the turn around occurs, there are two significant impacts that I can see:

1) As the manufacturing sectors come off, the economic reverberations will run deep into the population.

Lay offs are already occurring in some sectors (hiring freezes are in many more sectors) - but the situation will continue to roll down hill as suppliers begin to cut back, as logistics firms no longer need to hire warehouse workers, as independent truck drivers sit idle.

Which will further roll down to those industries that support them.

2) With the manufacturing sector coming off, a lot of cities are going to tighten their infrastructural investment.

this is an area that I think has still yet to be analyzed. Many decoupler economists used to point to the level of government investment in the economy as the reason why China could sustain a decoupling of the economy, but no one has pointed to the cities of Suzhou, Tianjin, Shantou and said that the vast majority of the money in those economies was for the foreign based economies. that the investments made in those cities would attract foreign investment into the economy, which would in turn grow the economy.

So, while the central party has announced their stimulus package, which was heavy on infrastructure, the question then becomes (1) will the local governments build anything with the money they are given, or hoard the cash to weather the short term issues they are going to be facing and (2) are these investments going to bring returns, or will the investments simply result in a large number of wasted money that could have been put into programs that would have supported the populace long term.

For me, these are the concerns I have going forward because it is a cycle. None of these events or actions are disconnected, much less decoupled, and with firms showing they are unwilling to invest in the Chinese economy unleveraged, my concern is that this increases the likelihood that we will see a large portion of the Chinese stimulus sit idle as a result. Local governments are notorious for hoarding when they are uncertain, and I just cannot see how this will change until they are comfortable giving up what they may feel is their last lifeline.

Following this line, I have a post on consumers in process. I simply do not believe China’s consumers will be the consumers of last resort, and I think the economists who are pushing that line are simply trying to squeeze water from a rock.


In a speech former US Ambassador to China, Amb Stapleton Roy thinks that China’s future is bright and US should learn to deal with it.