China's Trade Statistics

China’s Trade Statistics: Booming Asia
by Dr. Kurt Richebacher

“The point is that the large direct investments from the industrial countries grossly distort the trade picture. In China’s trade statistics, these foreign direct investments show as imports of goods. But these imports involve no payments on the part of China.”

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In assessing the world economy’s prospects, it is necessary to pay increasing attention to the development in China. Together with the United States, it has become the locomotive of the world economy. But that is only true for the Asian economies, including Japan. During 2003, no less than 58% of China’s imports of goods and services came from Asia, as against 8% from the United States and 13% from the European Union. In short, China is running a big trade deficit within the region.

In the case of Japan, exports to China accounted for 32% of total export growth in the course of last year. In the case of Korea, the share was 36%, and in the case of Taiwan, it was even 68%. The booming trade surplus with China was the spark that powered Asia’s nascent cyclical recovery last year

But this trade deficit with the Asian countries has been more than matched by trade surpluses earned with the United States ($88 billion in 2003) and with the European Union ($29 billion).

China’s Trade Statistics: U.S. Trade Balance

During the first half of 2004, China’s U.S. surplus was up to $137 billion at annual rate. Overall, China had a trade surplus of about $29.6 billion in 2003.

While the overall trade balance did not change significantly during 2001-03, there have been significant shifts in regional trade balances. China’s trade balance with the United States and the European Union is rapidly rising, but are being more than offset by rising deficits in Asia.

We wonder, however, how much of the export to China from America, Europe and Japan, reflects direct investments of firms of these countries expanding their operations to China, in order to take advantage of rock-bottom labor costs and strong future demand growth.

Now comes an interesting point. Given capital controls and a modest overall trade surplus, one would think that large inflows of foreign exchange are possible. But the point is that the large direct investments from the industrial countries grossly distort the trade picture. In China’s trade statistics, these foreign direct investments show as imports of goods. But these imports involve no payments on the part of China.

The result is that China, regardless of capital controls, enjoys a huge net inflow of foreign exchange. In 2003, the central bank’s foreign exchange reserves increased by $116.8 billion, to $403.2 billion, against a trade surplus of only $29.6 billion. Until April 2004, these reserves had further risen to $449 billion.

For good reasons, China’s economic performance is admired around the world. Its real GDP growth has recently been around 9% per year, even after 12% in prior years. More remarkably, no less than 47% of China’s GDP has been devoted to capital investment.

An existing chronic trade surplus suggests, on the other hand, that this ferocious investment boom is fully covered by private domestic saving. The government is running a deficit of close to 3% of GDP.

Fearful of overheating inflation rates and structural distortions, the Chinese authorities have taken action to slow economic growth. Whether or not they will succeed in managing a soft landing has become one of the great themes being pondered and discussed around the world.

With exports and imports both soaring at annual rates of around 40%, the Chinese economy has suddenly gained outstanding importance in the global economy. Clearly, it has become the locomotive for all of East Asia, running substantial trade deficits with them. These have their main counterpart in the large trade surplus with the United States.

China’s Trade Statistics: China’s Locomotive

But China’s locomotive, in turn, is the U.S. economy. The pull is taking place through two channels: trade and soaring dollar flows to China. During the past two years, U.S. imports from China have sharply accelerated, rising at an annual rate of 18%, in nominal terms. The “real” increase is undoubtedly much greater, since the average price of imports from China has been falling. Over the same period, imports from other countries have increased at a much slower rate of 3.5% – a rate that is broadly in line with recent U.S. GDP growth.

Our particular focus, though, is on the escalating monetary linkage between China and the United States. That is the linkage where, as a rule, the problems loom. Here, too, the year 2000 marks a drastic rupture. Up to then, the dollar reserves of the Bank of China had been increasing modestly, from $105 billion in 1996 to $165.6 billion in 2000. But during the following 3 1/2 years until April 2004, they soared to $449 billion. Particularly in 2003, China’s central bank became a big dollar buyer at a fixed exchange rate.

This had sweeping monetary consequences. Domestic bank credit surged by 83%, compared with an increase by 49% in the prior three years.

Yet more recently, there has been a pronounced slowdown, apparently implemented by more drastic administrative measures.

For us, today’s China is the parallel to Japan in the late 1980s. The runaway bubble in building and business fixed investment threatens to leave behind collapsing property prices, vast amounts of excessive industrial capacity and lots of bad debt. Yet there are some important differences: First, the investment excesses vastly exceed those in Japan, implying even more extensive malinvestment; second, there is a property bubble, but no stock market bubble; and third, the government owns all banks.

Virtually through all of Asia, governments have tied their currency at a fixed or quasi-fixed rate to the dollar. With their foreign trade generally in surplus, the central banks have for years intervened heavily in the exchange markets to prevent or limit the appreciation of their currencies against the dollar.

It strikes us as rather ominous that these dollar purchases by Asian central banks have multiplied since 2000, due to an escalating U.S. current account deficit. During the second quarter of 2004, this U.S. deficit amounted to $664.8 billion at annual rate, after $588.8 billion in the prior quarter and $411.5 billion in 2000. That is an increase by more than 50% in just three to four years. It is ominous in our view because U.S. domestic demand has slowed, while Asia has sharply accelerated growth.

In 2000, the central banks of emerging Asia acquired $52.5 billion. In 2003, it was more than five times that amount – $263.9 billion. As already mentioned, the dollar reserves of China’s central bank soared between 2000 and April 2004 from $165.5 billion to $449 billion; that is, by $283.5 billion. This compares with an increase during the prior three years by $25.6 billion, to $165.5 billion.

The decisive difference between the two areas, obviously, is that the Asian economies get their growth dynamic from saving and investment, while the U.S. economy gets it from consumption and “wealth creation” through asset price inflation. Importantly, both sides appear manifestly satisfied with the net economic result on their part. We think both sides neglect the horrendous longer-term costs of their policies.

Asia and the Fall of the Dollar:

It is often argued that the Asian central banks will bring on huge losses when the dollar finally falls. For sure, the banks know that. But they do not care about these future currency losses. In their view, they are grossly outweighed by the inherent current gains through higher economic growth. That is, of course, precisely what Japan’s policymakers thought when they obliged their central bank to prevent an undesired yen appreciation with massive interventions.

Really, the key problem with the large-scale dollar purchases by central banks is that they pay for them by creating liabilities to the commercial banks in the form of deposits, generally referred to as bank reserves or high-powered money. Availability of bank reserves tends to set the limit on overall lending by the banking system.

Bearing no interest, the banks want to get rid of reserves in excess of requirements by increasing lending. In this way, rising bank reserves generally spark off a general process of accelerating credit and money growth. Typically, banks in many Asian countries have embarked on rampant credit inflation with two macro characteristics: an investment boom accompanied by asset price inflation.

Basic to all Asian countries is one macro problem – too much personal saving and too little private consumption. It is, by the way, also the key problem of the Eurozone, though on a more moderate scale. Although continental Europe is investing a considerably higher share of GDP than the United States, it falls short of the high rates of personal saving. The French and Germans save on average around 11% of their disposable income.

In the United States, this rate lately is close to zero. As a matter of fact, it is also substantially negative in Australia and New Zealand and very low in England. As a rule, strong economic growth arises when investments exceed savings, while weak growth arises when savings exceed investments. Paradoxically, the United States has solved the growth problem by equilibrating record-low investment with record-low national saving.

One could say that this “division of labor” between overconsuming and overproducing countries solves the problem on the international level. But it is all about sustainability.

The U.S. Economy:

The bullish consensus in America assumes that central banks in general, and the Greenspan Fed in particular, joined by highly flexible and efficient markets, are sure to cope with all problems. For sure, the experience of the past two to three years encourages their belief.

This view overlooks two things of crucial importance: first , that the policy excesses in America – and some other countries – during the past few years have resulted in a grossly distorted, artificial and fragile recovery; and second, that under persistent excessive monetary looseness, growth-impairing imbalances in the U.S. economy have tremendously festered. Think of near-zero personal savings and record-high debts, the ballooning twin deficits and poor profit performance.

Of course, the U.S. economy has been the locomotive for the rest of the world for years, but what this actually has reflected is definitely not economic strength, but unprecedented American credit and debt excess, accommodated by buoyant foreign purchases of U.S. assets. Internal American indebtedness since 2000 has surged by $8,211.3 billion, or 31%. External net indebtedness almost doubled to around $3,000 billion.

Among the industrial countries, the economic news is generally disappointing prior high expectations. The U.S. economy in particular shows a more pronounced slowdown. Recognizing the main causes in developing poor profits and personal income growth, we regard this slowdown as definite and prone to worsen.

Both the resurgent U.S. bond market and the sputtering stock market apparently do not concur with Mr. Greenspan’s “soft patch” appraisal that the U.S. economy’s ills are transitory.

It was in particular the surge in the employment numbers through the phony “net birth/death” computer model, accounting for two-thirds of the reported increase, which has created false optimism about the U.S. economy.

Related Articles on China’s Trade Statistics:
Treading Carefully in China

China’s Foot on America’s Throat

The China Factor and the U.S. Dollar

Respected International Banker, Economist and Author

Dr. Kurt Richebächer’s articles appear regularly in The Wall Street Journal, Barron’s, the US edition of  The Fleet Street Letter and other respected financial publications. France’s Le Figaro magazine did a feature story on him as ‘the man who predicted the Asian crisis.’