In the Face of Money Printing, Chinese Consumers Stop Spending

In the Face of Money Printing, Chinese Consumers Stop Spending

Due to the trade war, the Chinese have turned to quantitative easing to solve the problem. China now faces a population who has reduced spending (or may be unable to) at the gain of industries who are expanding quickly and exporting aggressively. This article explains it all. I would recommend reading the One Belt One Road article as well, as it will provide more context to this article.

China’s economy has begun to slow down (Bradsher, 2019). This is a natural part of China catching up the U.S. in terms of technology, meaning that the easy growth of simply adopting existing technology, rather than inventing it, is running out. New growth will have to be made through new technological break-throughs.

China has turned to two methods; heavy infrastructure projects and monetary expansion. As seen in my previous article, here, we can see that Chinese exports of steel, while high, has decreased even as supply increases. This increase in domestic consumption of steel is the result of the increased public expenditure.

Even as you walk around Beijing today, you will find massive amounts of public works undertaken. Trees are being uprooted and replaced. Flowers are being planted across the city. Painting is covering the land. Buildings, trains, and other constructions works have taken the city by storm. Below is a photo I’ve taken of a river in the city being torn apart and rebuilt.

Source: Shepherd, 2019*

In terms of monetary expansion, according to Stevenson (2019), China has released hundreds of billions of U.S. dollars into the Chinese economy to shore up the flagging economy after the trade war began. They have also allowed local provinces to have government backed bonds to produce infrastructure deals as quickly as possible, as well as heavily encouraging financial services to be more generous with their lending (Shidong, 2019). From the Federal Reserve Bank of St. Louis (2019), we have China’s M2 (Money Supply) figures measured in RMB:

Source: Federal Reserve Bank of Saint Louis, 2019

Source: Federal Reserve Bank of Saint Louis, 2019

Why does this matter? Because if we take the following figures from the above, we have Table 1:

Source: Federal Reserve Bank of Saint Louis, 2019

Source: Federal Reserve Bank of Saint Louis, 2019

We can see from the above that the amount of money that greater and greater amounts of money have been printed over time, but since Xi has come to power, his government has been printing below the average percentage of money. We can also assume that China will have to print an additional 24RMB trillion to maintain the ten year average, or 20RMB trillion to maintain Xi’s average.

We can see in Table 2 a decrease in the growth of the economy over the past 10 years:

Source: Trading Economics, 2019a

Source: Trading Economics, 2019a

This is interesting as, despite the shrinking growth, Chinese industry has been increasing by more than GDP growth (8.5% year-on-year; more on that later) in March; meeting demand from this increased government spending. Public investment rose (from 5.5% to 6.7%) and crowded out private investment (6.4% from 7.5%) since March. Exports increased by 0.9%, while imports decreased by 4.4%. The economy grew 1.4% this quarter, versus the expected 1.5% (TradingEconomics, 2019a).

Testing the Loss of Spending

There is a simple formula we can also use:

MV = Nominal GDP

Let me explain how the above formula works:

(M)=Money Supply. How much money is in the economy.

(V)=Velocity. How quickly money is moved around the economy, through spending and lending and saving.

Nominal GDP = Real GDP times Inflation = How much does the economy produce, invest, export, import, spend, etc.

Therefore, we can assume:

∆M * ∆V = ∆Nominal GDP

Chinese statistics are unreliable and man-made according to Chinese Premier Li KeQiang (Minter, 2014). As such, we shall not be measuring the actual numbers, and the results given will not be accurate enough to rely on. However, we can measure the general trend of numbers given, and the general direction that China is moving in; these are the officially approved figures provided by the Chinese government itself.

So, we take the figures from Table 1 and Table 2, and we find the following results:

Source: Self

Source: Self

Note: This is not to be a perfect estimation of the velocity of Chinese money. But it is a rough estimation of the general trend in behaviour.

Combining both of the estimates, we can create a rough range for the velocity of China ranging from 1.08-0.93 in 2011 to 0.46-0.44 in 2019. We can see that Chinese money is not moving; people, banks, and businesses are holding their money now, and so it will require greater and greater amounts of stimulus from quantitive easing to get the same results of growth. Recent policy has used that greater amount of money.

We can also see that consumers initially became more confident since President Xi took power; rising from 0.595 to 0.605, before issues in 2016 dropped the Chinese economy. We can see that the economy has been slowing down in general, however.

Chinese consumers are also spending less: this could be due to increased caution from Chinese consumers (Hancock, 2019), or it could be due to the fact that Chinese consumption may simply be tapping out; phones sales are down, decries the Chinese, but everyone has a phone. Do people really need to purchase a second, expensive phone each year?

Chinese consumers are also decreasing their purchases of cars (Hancock, 2019), which is one of China’s best industries; again, how many cars do you need? Cities are already crammed to breaking point with cars. As such; car industries in China are reducing investment (Hancock, 2019).

The usual method of increasing consumption is to reduce taxes; but Chinese consumers pay little to no income tax (Hancock, 2019). You can’t reduce past 0% (well, you could subsidise, I guess, but don’t expect it). It seems that the youngest generation in China consumes far more than their elders, consuming 15% of household spending (the U.K.’s and U.S.’s equivalent only spends 4%), but it takes time for that generation to take on the burden of consumption (Hancock, 2019). There is also the looming ageing population that is sure to cut that consumption to the bone, with one adult supporting up to 2 parents and up to 4 grandparents each, as well as their own children.

An Alternative Interpretation: Real GDP Growth

There is another alternative; it is considered as given that velocity is not mobile (people do not change ingrained spending habits as a rule); that it is cultural and not easily changed. If this is the case, then perhaps there is another alternative. Assume that velocity is unmovable:

MV = Nominal GDP

If V cannot move, then as M increases, so must Nominal GDP. Nominal GDP is made up of two parts; inflation and real GDP. 

If we take 2018 to 2019, we know that money supply increased by 13% according to Table 1. If velocity is indeed unmovable, then Nominal GDP must have increased by 13%.

As we know in Table 2, Nominal GDP increased by 6.4%. The Chinese government has also shared the inflation rate below (TradingEconomics, 2019b):

Source: Trading Economics, 2019b

Source: Trading Economics, 2019b

So the official inflation rate is around 2.7%, ranging from 2.9% down to 0.7%. We shall take all of these values of inflation from the Chinese government. We can then make this formula to find the true growth in real GDP:

Screenshot 2019-06-14 at 23.52.42.png

M remains the money supply. I is the inflation rate, and Y is the real value of GDP. ∆ represents “the change in”. Now we could do the same for finding a new value for inflation (which would be around 2%, lower than the given government numbers). Carrying on with real GDP.

(Best case if extremely unlikely scenario) Assuming that 0.7% inflation (extremely rare, only happening twice in over 5 years) is the true inflation rate, then real GDP growth would be 18.6%.

(Current scenario) Assuming inflation is 2.7%, then real GDP growth would be 4.8%.

(Worst case scenario) Assuming inflation is 2.9%, then real GDP growth would be 4.4%.

There are actually even worse case scenarios. A report found that Chinese food prices had a 7.1% inflation in one month (Tan, 2019); this could mean that in terms of people’s livelihoods, real GDP growth for the common people buying goods was 1.8% during this month, and maybe every month.** It seems that this has been confirmed by independent researchers a few months later.

If Chinese people are having less and less purchasing power relative to other countries, we would see a decline in imports as they would have less growth in purchasing power either from increasing food prices taking additional disposable cash, or from a weakening currency and a lack of real growth in their wages. In fact, if inflation was 2.7%, but commoners had growth of around 1.8%, there would be a retraction in their buying power. During the trade war, when imports from U.S. were stopped, some believe that pork price inflation alone was at 40% y.o.y. Let’s consider the imports of Chinese citizens (Lawson, 2019):

Source: Lawson, 2019

Source: Lawson, 2019

As we can see, imports have dropped. China has announced a massive trade surplus in May; A trade surplus can be made larger by either exporting more, or importing less (Lee, 2019). This can represent the strong exporting component of the One Belt One Road exporting of Chinese goods, but it also represents the massive drop in importing. In fact, Chinese imports fell by 8.5% in May (Lee, 2019). Naturally so, in the face of rising tariffs.

The Rise of Industry

This does have an interesting parallel; industry inflation (Producer Price Index) was 1.7%, meaning that would have 7.6% growth. This would mirror China’s excellent reports of industry growth, export growth, and a strong stock market would reflect that as the companies would be benefitting from having only 1.7% inflation with 7.6% growth, leading to significant growth. This sounds perhaps made up; Citic Securities placed an estimate of 8% for infrastructure companies after Chinese government help (Shidong, 2019). Meaning that I am only 0.4% off in my estimate from China’s largest publicly traded brokerage.

We can expect any companies that would benefit from Chinese money being pumped into them; infrastructure projects, 5G networks, green technology are all good Chinese investments for both One Belt One Road and for Made in China 2025. More on One Belt One Road here; surely One Belt One Road would lead to massive benefits. 

The Shanghai stock market increased by 2.6% since Chinese government stimulus (Shidong, 2019).

Beijing Orient Landscape and Environment (green tech) increased by 10% (the daily limit)

China Railway Construction (infrastructure also being exported abroad for OBOR) increased by 6.7%

China Communications Construction (5G and telecoms) increased by 5.2%.

All special industries increased more than double, and sometimes nearly four times as much as the usual increase. Which is exactly what we would expect.

Not only that, but in the table on import and export above (Lawson, 2019), we find that exports have increased, especially exports to countries not the U.S.; yet more evidence of the importance of One Belt One Road for supporting Chinese business.

The Poorest Rich People

This is a massive problem for the Chinese economy. In 2017, Chinese consumption became 54% of Chinese GDP, when it was only 51% in 2011 (Hancock, 2019). In 2018, consumption of goods and services made up 76% of economic growth, when compared to 47% in 2013 (Hancock, 2019).

It must be mentioned; services are becoming a larger and larger part of consumption in China. Education is famously important, and people are buying services rather than goods now (Hancock, 2019). Not only that, but the Chinese are famous for saving, with a rate of 46% when compared to a world average of 25% (Balding, 2018).

This makes it seem that the Chinese are savers, and therefore have great reserves of money that the Chinese could tap into. This isn’t as true as some think.

Below is a graph outlining the expenditure of Chinese families (Hancock, 2019):

Source: Hancock, 2019

Source: Hancock, 2019

We see healthcare spending, education, bills, and cars are the main areas of increased spending.

Household spending is often in the form of mortgages; due to the perceived safety of investing in land in China, many people spend a large amount of their income in repayments; this drives down the total consumption of that family. I’ve heard stories of families who eat sparsely (spending less than $400 per month per family) on double income in the cities due to the pressure of repayments; known as “house slaves”. Su et al., (2019) explains it more clearly: The massive housing costs are driving the middle class consumption down; can’t buy goods when you’re buying a multi-million yuan house on an average wage of $1,500 per month. Economists agree that this is the vital reason for Chinese savings to be so high (Hancock, 2019). The problem has become so bad that household debt repayments now make 49% of the Chinese economy (Hancock, 2019); how can a nation so indebted be expected to consume?

Healthcare can take the form of two payments; either insurance (expensive; $1,500 per year per person for good insurance; assuming a family of 3, that’s $4,500 per family per year) or direct payments either for yourself or for a family member who has become sick and asked for financial assistance. In China, families will often provide private charity for the poorer members of family. Spending thousands of dollars for cancer is not uncommon, but is financially crippling.

Education is also expensive; a good primary school in Beijing costs $9,000 per year per child. A good university costs $2,500 per year in Beijing per child. Sending your child abroad to study, however, can range go up to $45,900 per year per child to go to Oxford, not including living costs.

Simply put; the Chinese may have savings, but they can’t spend it. It’s already spent. Chinese consumption has dropped to a marginal propensity to consume at 0.375 in 2014 (Su et al., 2019).

Source: Su et al., 2019

Source: Su et al., 2019

China’s massive economy is not well spread; the mean wealth of China may be $47,000, but the median wealth of China is $16,000. This means that the rich in China are so wealthy, and hold so many assets, that they pull the mean wealth to nearly 3 times the value of the median wealth (Credit Suisse, 2018). It also means that the average family doesn’t have nearly as much wealth as the mean amount of money. The bottom 50% of China holds less than 10% of the wealth (Hancock, 2019).

The top 10% of China holds more than 65% of all wealth in 2015 (Hancock, 2019). The Credit Suisse Report (2018) places the GINI co-efficient above 70%. All of this leads to an elite class who is able to consume massive amounts of luxury goods, but not normal or inferior goods (Su et al, 2019). The problem with this is that luxury goods does not provide jobs or wages to the poor, and many of these goods are foreign, leading to money leaving China, and creating further losses for the Chinese economy.

No More Mister Nice Buy

China makes up a massive amount of consumption on the planet; when the Chinese stop buying, the world economy slows (Hancock, 2019). There is also the crowding out effect; Chinese consumers do not have unlimited money, and you have both foreign and domestic brands fighting for the shrinking amount of money Chinese people want to spend. 

How important is China? Apple and General Motors both place China as the centre of their sales (Hancock, 2019). Multiple Hollywood films are made or broken by their inclusion into the Chinese market.

As global growth is slow and with the incoming trade wars, China cannot expect the world to become the consumers of Chinese goods (Hancock, 2019). This is yet another reason why China is on the poorer side of the trade war with Trump; finding customers is harder than finding suppliers. This is the reason why the One Belt One Road project has become so important to China.

Another reason that China cannot hope that other countries will pick up the check is the trade imbalances are becoming more and more politically unpopular (see Trump), and so China will have to either import more from those countries (reducing internal demand, and increasing unemployment) or export less (reducing external demand, and increasing unemployment). Regardless of the choice, a reduction in employment will lead to a slow-down of the economy (Okun’s Law).

Not only that, but the world may rely on China, but China isn’t entirely dependant on the world long-term. As China’s technology level increases, the Chinese will simply consume their own goods. For example, now China can produce Huawei phones, more and more Chinese will not be purchasing Apple or Samsung. As Made in China 2025 becomes a reality, the main import from the Chinese (luxury), will become a domestically produced good (Hancock, 2019).

The Trade War of IP

Su et al. (2019) explain that China has a ‘hot-market’ economy. When a good becomes popular, suddenly everyone must have it, and so demand is suddenly driven up. This is best done through technological innovation; as such, Chinese confiscation of IP allows for cheap technological innovation, which in turn drives domestic Chinese consumption greatly.

Should Trump manage to convince the Chinese to upload IP protection and stop ‘hacking’, China will lose IP development ranging from $180 billion to $540 billion; that’s free technological innovation greater than the amount that China exports to the U.S. in goods and services; of course they won’t agree to that (White House Office of Trade and Manufacturing Policy, 2018).

However, if China were to lose this IP, then China would lose all of that free innovation, and the hot market phenomenon that China relies on would disappear, causing problems for China’s now-mostly demand driven economy.

It is also worth noting that the latest data from the U.S. shows a weakening job creation in light of the trade war, meaning that the U.S. cannot sustain a trade war much longer than China (Lee, 2019).

What Now?

China could control and reduce the house prices to allow the mean income of the Chinese family to rise, and then in turn, be able to consume more due to lowering housing-costs/rising wages (Su et al., 2019).

Encouraging the Chinese to be able to consume more reliably and less erratically would also provide a steady consumption for the economy, leading to steady growth.

Higher consumption would also leads to lower public investment (Su et al., 2019). This would increase private investment due to a lessening of the crowding out effect of massive public investment. This in turn would be more efficient, and thus produce both economic growth and innovation for a lower cost.

We also see a massive reduction in one of two things: either the Chinese consumers have begun to drastically stop spending, or Chinese consumers are suffering heavily under the vast government spending as inflation far outstrips growth for consumers. A critique of my method may include that the method used is overly simplistic; yet the results mirror reality quite closely. My method proves that several indicators are misguided at best.

We could also see a massive slowdown in economic activity for companies, which seems unlikely due to the massive stock gains and exports they are enjoying; as such, this would lead evidence that the real GDP growth figures are not as high as expected. Companies who are part of infrastructure, tech and capital heavy industries, and OBOR are enjoying a particular boon under the current policies.

We can also see a Chinese population who are suffering under massive increases in food, healthcare, education, and housing prices; a mirror of the Chinese companies who are thriving in those industries.

Finally, we are watching the China Model in action; government supported and company focused quantitative easing based on producing for employment, keeping the economy moving, and One Belt One Road.


Additional Comments:

*That’s right, I have a camera phone.

**A quick thought experiment; if food prices increased by this much every month, food prices would increase by around 225% each year, which would be disastrous.


Bibliography:

In all articles, I provide as much information for sources as possible, including links. I encourage everyone reading this article to read deeper, and make their own conclusions. For students, links are here so they can read the original source themselves.

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