Washington is wrong about China’s economy
David P. Goldman
May 30, 2019
Americans want to believe that their economy is doing well and that China’s economy is doing badly, as President Trump keeps saying. One shouldn’t blame Trump for this – underestimating competitors is America’s national pastime.
A recent embarrassing example was a report by Wells Fargo analyst Roger Read featured on CNBC, claiming that a fall in the growth rate in China’s diesel consumption “is most likely tied to economic factors and the effects of the tariff ‘war’ with the US.”
As physicist Wolfgang Pauli once said, this isn’t even wrong. The fellow from Wells Fargo failed to observe that China’s rail traffic is growing 10%, year-on-year, which is also the rate of expansion of China’s rail network. The more China ships by rail, the less dependent it is on diesel trucks.
The relationship is robust statistically (I’ll spare you the econometrics, which show that lagged values for changes in diesel demand predict changes in rail traffic). The analyst also failed to observe that heavy truck sales reached an all-time record in March 2019, driven by vehicles powered by natural gas.
China’s economy is becoming more efficient, shifting away from costly (and polluting) diesel fuel to more energy-efficient and cleaner railways and natural-gas-powered trucks. The notion that the tariff war might have caused diesel demand to drop in China is silly. Only 5% of China’s manufacturing is sold to the US, and most of that is consumer electronics and similar goods with a very low ratio of weight to value.
This sort of thing hardly would be worth the mention, except for the sad fact that a distorted view of China’s economic vulnerability contributes to American miscalculation in the present trade war. I am an American, and if there is a trade war, I want America to win it – but this sort of self-consoling delusion leads to humiliation rather than triumph.
By the same token, President Trump, and the China hawks in general, point to supposedly strong economic performance in the United States as evidence that Washington has the upper hand in trade negotiations. Again, that is a self-consoling delusion with dangerous consequences.
The final US GDP report for the first quarter shows the weakest growth since 2013. Final sales to private domestic purchasers at an annual rate of just 1.2%. That measures what Americans sold to other Americans. The headline GDP growth number of 3.1% is inflated by quirks of national income accounting.
How do we get from a 3.1% headline number to an underlying growth rate of just 1.2%? Of the 3.1% headline growth, 1% came from a reduced trade deficit. Imports fell sharply in the first quarter, and the deficit fell, but imports were lower because growth in retail sales fell sharply. The rate of change of imports to the US depends on retail sales.
Another 0.6% of the 3.1% came from an increase in private inventories. That’s not necessarily good news either; inventories might be rising because demand is weaker. And another 0.4% came from higher government consumption.
That begs the question: Why are retail sales barely growing despite robust increases in employment?
The first reason is that although more people are working, they are working fewer hours. Year-on-year growth in total hours worked (total employment X average weekly hours) shows the same decline that we observe in the purchasing managers’ index.
The second reason is that banks are tightening conditions for consumer credit. Credit card interest rates are at an all-time high although term yields are close to all-time lows. That simply means that banks are rationing credit.
Total credit to consumers (apart from home mortgages) is shrinking in real terms, if we take into account the shrinkage in home equity loan balances outstanding. During 2018 the combined rate of increase of revolving credit (mainly credit cards) and home equity stood at around 4.5%, but now has fallen to about 1.5%, or less than the inflation rate.
It matters little in the big picture whether China grows at 6% or 4% this year, to be sure. More important than the tariff war is the tech war. Washington doesn’t appear to have considered that the leading US chip designers depend on the Asian market. Intel makes 20% of its revenue in each of China, Singapore and Taiwan. Qualcomm makes 52% of its revenues in China and another 16% in South Korea. Nvidia makes 38% of its sales in Taiwan, 16% in China and a further 15% in the rest of Asia.
Huawei has not only leapfrogged its competitors in 5G broadband technology. It has designed its own line of Artificial-Intelligence enabled processors that compete with America’s best products. It very well may have the capacity to price its American competitors out of the critical Asian market. In a full-blown tech war, the US cannot be sure that China would not emerge with a dominant position in semiconductors.
Every indicator we examine – gross domestic product, purchasing managers’ indices, retail sales, consumer credit, total hours worked, and capital investment – points to an economy growing at slightly over 1%, not the 3.2% that the US administration has bragged about.
If the Administration places a 25% tariff on $570 billion of imported Chinese goods, that will take another substantial bite out of consumer demand. In that case, slow growth might turn into recession, imperiling Trump’s re-election prospects for 2020.