| HSBC Flash China Manufacturing PMI Improves in December; Has China Turned the Corner? Posted: 13 Dec 2012 10:38 PM PST The HSBC Flash China Manufacturing PMI™ report shows Operating conditions continue to improve in December. Key points
- Flash China Manufacturing PMI™ at 50.9 (50.5 in November). Fourteen-month high.
- Flash China Manufacturing Output Index at 50.5 (51.3 in November). Two-month low.
Data collected 5–12 December 2012.
Commenting on the Flash China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC said:
"As December flash manufacturing PMI picked up further to a 14 month high, it confirmed that China's ongoing growth recovery is gaining momentum mainly driven by domestic demand conditions. However, the drop of new export orders and the downside surprise of November exports growth suggest the persisting external headwinds. This calls for Beijing to keep an accommodative policy stance to counter-balance the external weakness, provided inflation stays benign." Has China Turned the Corner? Before anyone gets excited by this 14 month high (barely above contraction), please consider a few comments by Michael Pettis at China Financial Markets. The comments via email are from December 6, following the last full PMI report but prior to this flash report. Following many months of gloom – and seven consecutive quarters of declining growth – the Chinese stock markets are permitting themselves a frisson of excitement after China's official manufacturing PMI rose to a seven-month high of 50.6 in November, from 50.2 in October. The higher PMI was propelled (unfortunately, I think) by a surge in construction activities. Infrastructure investment was also strong.
The HSBC China manufacturing PMI, which is more heavily weighted towards smaller companies, also rose, to 50.5 up from 49.5 in October, but not without dire warnings from smaller companies that the outlook continues to be, for them, very poor. Orders are generally up, but not enough to reduce inventory, and it is the big companies, not the small ones, who seem to account for all the improvement in the two PMIs.
Still, the overall numbers were stronger than they have been for most of this year. "We believe that China's near-term outlook remains positive as the political uncertainties have dissipated after a smooth leadership transition," ANZ said in their subsequent research piece. "The much-feared 'hard landing' has been averted," IHS wrote in their own research piece. "Economic activity is back, and growth has bottomed out."
I don't think, however, that we should get overly excited. The economic slowdown in China has not bottomed out except in the very short term, and pretty much as I (and many of my fellow skeptics) had expected. It was obvious all year that the political transition was going to be tough and that there would be strong opposition to reforms that the leadership is pretty serious about wanting to implement (about which more later). In that case, and as I have been writing since early this year, I expected that Beijing would once again step on the investment accelerator to create some good feeling within which the new leaders can more easily manage the process of consolidating power.
As I see it, the length of the upturn will give us a sense of how difficult the process of consolidation will have been. If we see investment start to flag in the late first quarter or early second quarter of 2013, and with it growth drop sharply, this would suggest to me that the leadership is in firm control and determined to begin the adjustment process as quickly and forcefully as possible. If investment and economic growth continue strong through the end of 2013, I would be a lot more pessimistic about the pace of the adjustment and more worried about the possibility of a debt problem). The better the numbers over the next year, in a sense, the worse the medium term outlook.
No one should doubt, in other words, that this "bottoming out" is very temporary and most certainly not a bottoming out in any meaningful sense (and in fairness both IHS and ANZ, who are quoted above on the subject of "bottoming out", warn that this may be temporary). Growth in China in the short term can only occur with a surge in investment, and by now we should all be worrying about the longer-term consequences of more investment.
On that very subject the IMF's Il Houng Lee, Murtaza Syed, and Liu Xueyan have published a very interesting and widely noticed study called "Is China Over-Investing and Does it Matter?" In it they argue that there is strong evidence that China is overinvesting significantly. According to the abstract:
Now close to 50 percent of GDP, this paper assesses the appropriateness of China's current investment levels. It finds that China's capital-to-output ratio is within the range of other emerging markets, but its economic growth rates stand out, partly due to a surge in investment over the last decade. Moreover, its investment is significantly higher than suggested by cross-country panel estimation.
This deviation has been accumulating over the last decade, and at nearly 10 percent of GDP is now larger and more persistent than experienced by other Asian economies leading up to the Asian crisis. However, because its investment is predominantly financed by domestic savings, a crisis appears unlikely when assessed against dependency on external funding. But this does not mean that the cost is absent. Rather, it is distributed to other sectors of the economy through a hidden transfer of resources, estimated at an average of 4 percent of GDP per year.
The article is well worth reading because it makes a very strong case, perhaps a little late, for what many of us have been arguing for the past seven or eight years. China's investment rate is so high, we have argued, that even ignoring the tremendous evidence of misallocated investment, unless we can confidently propose that Beijing has uncovered a secret formula that allows it (and the tens of thousands of minor government officials and SOE heads who can unleash investment without much oversight) to identify high quality investment in a way that no other country in history has been able, there is likely to be a systematic tendency to wasted investment.
How much would growth have to slow?
One of the implications of the study is that households and SMEs have been forced to subsidize growth at a cost to them of well over 4% of GDP annually. My own back-of-the-envelope calculations suggest that the cost to households is actually 5-8% of GDP – perhaps because I also include the implicit subsidy to recapitalize the banks in the form of the excess spread between the lending and deposit rates – but certainly I agree with the IMF study that this has been a massive transfer to subsidize growth.
This subsidy also explains most of the collapse in the household share of GDP over the past twelve years. With household income only 50% of GDP, a transfer every year of 4% of GDP requires ferocious growth in household income for it just to keep pace with GDP, something it has never done until, possibly, this year.
The size of the transfer makes it very clear that without eliminating this subsidy – which basically means abandoning the growth model – it will be almost impossible to get the household and consumption shares of GDP to rise if China still hopes to maintain high GDP growth. The transfer of wealth from the household sector to maintain high levels of investment is simply too great, and this will be made all the more clear as the growth impact per unit of investment declines.
Another implication of the IMF study is that to get into line with other equivalent countries at this stage of its economic takeoff, China would have to reduce the investment share of GDP by at least ten percentage points and perhaps as much as twenty. Aside from pointing out that the sectors of the economy that have benefitted from such extraordinarily high investments are unlikely to celebrate such a finding, I have three comments. First, after many years in which China has invested far more than other countries at its stage of development, one could presumably argue that in order to get back to the "correct" ratio, investment should be lower than the peer group, not equal to the peer group. In that case investment has to drop by a lot more than ten percentage points.
After all if China's deviation from the experience of other countries is meaningful, then after a few years of substantial deviation, it cannot be enough for China simply to return to the mean. It must come in lower than the mean for a few years so that on average the deviation is eliminated.
Second, even if China had kept investment at the "correct" level, as measured by the peer group, this would not imply that China has not overinvested. I haven't been able to dig deeply into the comparison countries, but the study does list them, and a very quick glance suggests that many of these countries, after years of very high investment, themselves experienced deep crises or "lost decades".
This implies to me that these countries themselves overinvested, and so even if Chinese investment levels were not much higher than that of the peer group (and it was mainly in the past decade that Chinese investment rose to much higher levels than that of the peer group, and not in the 1990s, exactly as we have been suggesting using more qualitative measures), this could nonetheless be worrying. China would still have a difficult adjustment for the same reasons that many if not most of the peer group countries also had difficult adjustments.
The average number driven by the peer group sample, in other words, is not in itself an "optimal" level of investment. It might already be too high. That Chinese investment levels have been so much higher than theirs is all the more worrying.
My third point is more technical. If Chinese investment levels are much higher than optimal (assuming the peer group average is indeed optimal), of course the best solution for China is immediately to reduce investment until it reaches the right level. The longer investment rates are too high, the greater the impact of losses that have eventually to be amortized, and the worse off China is likely to be.
But it will be very hard for China to bring investment down as a share of GDP by ten full percentage points very quickly. Let us assume instead that China has five years to bring investment levels down to the "correct" level, and let us assume further that the "correct" level is indeed ten percentage points below where it is today. Both assumptions are, I think, dangerous because I am not convinced that an investment level of 40% of GDP is the "correct" level for China going forward (I think it must be much lower) and I don't think China has five years to make the necessary adjustment without running a serious risk of a financial crisis.
But let us ignore both objections and give China five years to bring investment down to 40% of GDP from its current level of 50%. Chinese investment must grow at a much lower rate than GDP for this to happen. How much lower? The arithmetic is simple. It depends on what we assume GDP growth will be over the next five years, but investment has to grow by roughly 4.5 percentage points or more below the GDP growth rate for this condition to be met.
If Chinese GDP grows at 7%, in other words, Chinese investment must grow at 2.3%. If China grows at 5%, investment must grow at 0.4%. And if China grows at 3%, which is much closer to my ten-year view, investment growth must actually contract by 1.5%. Only in this way will investment drop by ten percentage points as a share of GDP in the next five years.
The conclusion should be obvious, but to many analysts, especially on the sell side, it probably needs nonetheless to be spelled out. Any meaningful rebalancing in China's extraordinary rate of overinvestment is only consistent with a very sharp reduction in the growth rate of investment, and perhaps even a contraction in investment growth.
In fact I think over the next few years China will indeed undergo a sharp contraction in investment growth, but my point here is simply to suggest that even under the most optimistic of scenarios it will be very hard to keep investment growth high. Either Beijing moves quickly to bring investment growth down sharply, or overinvestment will contribute to further financial fragility leading, ultimately, to the point where credit cannot expand quickly enough and investment will collapse anyway.
This is just arithmetic. The extent of Chinese overinvestment – even if we assume that it has not already caused significant fragility in the banking system and enormous hidden losses yet to be amortized – requires a very sharp contraction just to get back to a "normal" which, in the past, was anyway associated with difficult economic adjustments. It is hard to imagine how such a sharp contraction in investment will itself not lead to a sharp drop in GDP growth. Michael Pettis, one of the brightest minds on trade issues, especially China, will be speaking in Sonoma California on April 5, 2013. Click on the image below for details. "Wine Country" Economic Conference Hosted By Mish Click on Image to Learn More  |
| EU Punts on Creating Timetable for Fiscal and Banking Unions Posted: 13 Dec 2012 03:56 PM PST Those looking for a step in the right direction today can find it in the Financial Times Live Blog which announces "EU drops timetable for creating eurozone fiscal and banking union". EU heads of state and government have started gathering in Brussels even though their summit isn't scheduled to begin until 5pm. Last night, however, Herman Van Rompuy, president of the European Council, circulated a final draft of the summit communiqué, and we got our hands on it.
The 12-page document differs from a version circulated last week in several significant ways – most notably completely dropping a timetable for creating a fiscal and banking union in the eurozone.
Van Rompuy's pet idea of getting eurozone countries to commit to signing binding contracts with Brussels on economic reform programmes – essentially forcing upon all euro members the kind of detailed plans now only agreed with bailout countries – has also been significantly watered down. In the original version, EU leaders would have explicitly endorsed the idea. In the new version, they are simply cited as an idea that "could" enhance ownership of reform programmes.
Rather than come to any conclusion on the issue, the draft says it will be addressed again at a March summit "after an informal process of consultations with Member States".
Similarly, Van Rompuy seems to show somewhat less ambition towards creating a eurozone budget, once one of the cornerstones if his reform plans. In the previous text, he explicitly talked about creating a so-called "fiscal capacity" sometime after 2014. Now, that language is removed entirely, and the draft says any discussion of "a shock absorption function" – the new, more limited eurocratese for what was once a eurozone budget – are to be put off indefinitely:
"These issues will take more time and will require in-depth consultations with the Member States." Even though José Manuel Barroso, the European Commission president, has vowed to introduce plans for an embryonic eurozone budget sometime next year, Van Rompuy's draft suggests it won't be taken up until "after the election of a new European Parliament and the appointment of a new Commission" – which will not happen until the end of 2014. Baby Steps This is a step in the right direction, but only a baby step. What's really needed is a plan and timetable to dismantle the eurozone. Don't count on that any time soon. In fact don't count on it ever. Regardless, a eurozone breakup is in the cards anyway. This baby step, although it will not lead to plans to do what is necessary, is nonetheless symbolic of the insurmountable problems to get agreements from all the players. The structural problems and unemployment are so bad now, that even if the key players agree, some politician will eventually stand up, proclaim debts and the treaty null and void, and be elected. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Small Business Owners Cut Capital Expenditures, Plan to Cut Even More Posted: 13 Dec 2012 11:01 AM PST According to the latest Gallup survey, Small-Business Owners Pull Back Capital Spending Plans. Moreover, net capital spending by small businesses declined over the last year as well. Here is the question Gallup asked " Over the next 12 months, do you expect the amount of money your company allocates for capital spending -- such as computers, machinery, facilities, or other long-term investments -- to increase a lot, increase a little, stay the same, decrease a little, or decrease a lot?" U.S. small-business owners' net capital spending intentions for the next 12 months plunged to -14 in November, the lowest level in more than two years, according to the Wells Fargo/Gallup Small Business Index. This is down from net capital spending intentions of -1 in July and suggests the nation's small-business owners are likely to pull back on their business investments even more, given their negative expectations for the next 12 months.
The -14 November score is based on 20% of small-business owners saying they expect to increase their capital spending over the next 12 months and 34% saying expecting to decrease their capital spending. The 20% "increase" reading is down from 23% in July and the lowest level since July 2010. The 34% "decrease" reading is the highest since July 2010. In the current survey, 45% of owners expect no change in their capital spending.
The current negative net capital spending intentions mark a significant shift from the positive double-digit scores seen prior to 2008. Positive net spending intentions reflect how small-business owners usually expect to grow their businesses and take advantage of advancing technologies to help them do so. However, this has not been the case since the recession and financial crisis of 2008-2009, with net capital spending intentions reaching a low of -23 in November 2008. Small-business-owner capital spending expectations were slightly positive during the first two quarters of 2012, before turning neutral in July, and then plunging in November. The last time net capital spending intentions were lower than they are today was in July 2010, at -20.
Owners' Net Capital Spending Down Over Past 12 Months
The survey also asks small-business owners to report on their capital spending over the past 12 months. In November, more owners reported decreasing their capital spending (40%) than increasing (18%) it, resulting in a net capital spending score of -22. This is down from the -11 of July and the similar prior two quarterly measurements of 2012. Net capital spending over the past 12 months is now about where it was in October 2011, at -24.
The 18% of small-business owners who in November reported increasing their company's capital spending over the past 12 months is about the same as the 19% who voiced the same opinion a year ago. Similarly, the 40% reporting a decrease in capital spending over the past 12 months is just slightly lower than the 43% of October 2011. These numbers suggest that small-business' owners reported capital spending has not matched their expectations, even as capital spending intentions have deteriorated. Positive Spin Gallup attempted to paint this in a positive light noting an "enormous level of pent-up demand for such investments and a potential for explosive capital spending by the nation's small businesses whenever the U.S. economy can return to a sustainable growth path that permits owners and lenders to grow their companies." When is that? I suggest no time soon. The US is back in recession or certainly headed there (take your pick). Regardless, given souring consumer attitudes coupled with a death of jobs except part-time jobs resulting from Obamacare artifacts, there is no reason for most small businesses to expand. Indeed, for most companies, expansion at this point would be suicidal. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Socialists Denounce French Actors Leaving France for Tax Purposes; California vs. France; Patriotic to Pay Excess Taxes? Posted: 13 Dec 2012 09:13 AM PST According to Socialist newspapers and politicians "to pay a tax is an act of solidarity, a patriotic act." Those leaving France because of its uncompetitive tax rate see things differently. Please consider Socialists Denounce Gérard Depardieu for Leaving France Gérard Depardieu, one of France's best-known actors, has been accused by the country's Socialist government of lacking patriotism after he moved to Belgium apparently in a bid to avoid the taxes for which France is also renowned.
On Wednesday, Prime Minister Jean-Marc Ayrault weighed in, calling Mr. Depardieu's choice "rather pathetic."
"He's a great star, everyone loves him as an artist," Mr. Ayrault told the France 2 television channel on Wednesday, but "to pay a tax is an act of solidarity, a patriotic act."
To reduce the budget deficit and the country's debt, Mr. Hollande has put in place a 75 percent marginal tax rate for incomes above 1 million euros, or $1.3 million — a largely symbolic measure that will affect only a few thousand individuals, he has said — and has announced additional taxes that are expected to raise 20 billion euros next year.
Residents [in Belgium] pay no wealth tax and no capital gains tax on stock sales. In France, residents are required to pay a 0.25 percent wealth tax on assets valued at more than 1.3 million euros; those with more than 3 million euros in assets pay twice that.
Mr. Depardieu will by no means be the only Frenchman in Néchin, where he has reportedly bought a home. Néchin's mayor, Daniel Senesael, told the French news media that 27 percent of residents are French.
Bernard Arnault, the billionaire chief executive of the luxury group LVMH, was pilloried in the news media in September when it was revealed that he had requested Belgian citizenship.
Mr. Arnault said the request was not for tax purposes, but the left-leaning newspaper Libération featured a front-page headline that read, in polite translation, "Beat it, rich jerk!" (LVMH promptly pulled its advertising from the newspaper and Mr. Arnault filed a lawsuit charging the paper with public insult.)
On Tuesday, the newspaper featured Mr. Depardieu on its front page, along with an editorial deploring his "absence of moral sense" and insisting that the flight of the rich represents "a danger for democracy and solidarity." California vs. France California citizens have renewed reason to vote with their feet following massive tax hikes approved in the November elections. For a synopsis, please see Taxifornia Lessons. In case you missed it, the Bloomberg report $822,000 Worker Shows California Leads U.S. Pay Giveaway is a stunning, must see article on where those tax hikes will go (and it's not for the kids). The article is well worth a read in entirety, so I offer no snips. Patriotic to Pay Excess Taxes? Is it a sign of solidarity or stupidity to pay more taxes than necessary? Is it an act of patriotism to do something you disagree with or is the real act of patriotism to protest? While there may be other reasons influencing people's decisions to leave or stay, paying excess taxes for the sake of solidarity is complete nonsense. By the way, for all his bitching an moaning, Warren Buffet does not pay excess taxes either. In his case, since he feels so strongly about this, perhaps the patriotic thing for him to do would be to voluntarily pay extra taxes to write down the federal debt. In the case of California and France, the logical thing for taxpayers to do is "leave if you can", and there is nothing at all unpatriotic about such decisions. Indeed, for those who feel strongly that tax hikes are not the way to go, leaving in protest may actually be the patriotic thing to do. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Crazy Incentives in Welfare System; The Welfare Cliff; Welfare Spending Per Hour $30.60 - Median Income Per Hour $25.03 Posted: 13 Dec 2012 12:13 AM PST It's better to receive median welfare than median income according to a US Senate budget committee report Total Welfare Spending Equates To $168 Per Day For Every Household In Poverty. 
Based on data from the Congressional Research Service, cumulative spending on means-tested federal welfare programs, if converted into cash, would equal $167.65 per day per household living below the poverty level. By comparison, the median household income in 2011 of $50,054 equals $137.13 per day. Additionally, spending on federal welfare benefits, if converted into cash payments, equals enough to provide $30.60 per hour, 40 hours per week, to each household living below poverty. The median household hourly wage is $25.03. After accounting for federal taxes, the median hourly wage drops to between $21.50 and $23.45, depending on a household's deductions and filing status. State and local taxes further reduce the median household's hourly earnings. By contrast, welfare benefits are not taxed.
The diffuse and overlapping nature of federal welfare spending has led to some confusion regarding the scope and nature of benefits. For instance, Newark Mayor Cory Booker has recently received a great deal of attention for adopting the "food stamp challenge" in which he spends only $30 a week on food (the average individual benefit). The situation Booker presents, however, is not accurate: a low-income individual on food stamps may qualify for $25,000 in various forms of welfare support from the federal government on top of his or her existing income and resources—including access to 15 different food assistance programs. Further, even if one unrealistically assumes that no other welfare benefits are available, the size of the food stamp benefit increases as one's income decreases, as the benefit is designed as a supplement to existing resources; it is explicitly not intended to be the sole source of funds for purchasing food. Crazy Incentives in Welfare System Please consider Julia's mother: Why a single mom is better off with a $29,000 job and welfare than taking a $69,000 job. The U.S. welfare system sure creates some crazy disincentives to working your way up the ladder. Benefits stacked upon benefits can mean it is financially better, at least in the short term, to stay at a lower-paying jobs rather than taking a higher paying job and losing those benefits. This is called the "welfare cliff."
Let's take the example of a single mom with two kids, 1 and 4. She has a $29,000 a year job, putting the kids in daycare during the day while she works.
As the above chart – via Gary Alexander, Pennsylvania's secretary of Public Welfare — shows, the single mom is better off earning gross income of $29,000 with $57,327 in net income and benefits than to earn gross income of $69,000 with net income & benefits of $57,045.
It would sure be tempting for that mom to keep the status quo rather than take the new job, even though the new position might lead to further career advancement and a higher standard of living. I guess this is something the Obama White House forgot to mention in its "Life of Julia" cartoons extolling government assistance. Comments Several comments to the article were interesting. Here are a couple of them. Stinch writes ... Here is the truth about welfare from one who works in a PA welfare office. While welfare is designed to provide assistance to those who are at the lower end of the economic spectrum. The program was designed to supplement people's efforts in supporting themselves not being their sole support. Reality is that there are some that by no fault of their own will never be able to fully support themselves, but the number of people who could have supported themselves but due to poor decision making (and suffering the negative consequences of those decisions) only continues to grow. The truth is that welfare, though an assist for some is a trap for too many. There are some who escape the trap, and more power to them, but for most it is a trap. It is far too easy to become complacent and begin to rely on the system. There is little to no incentive to leave the system. I have seen too many people come through our doors ashamed to be asking for help, and years later are fighting to remain on the welfare rolls and seeking more. Without serious reform the future will only consist of more and more people receiving benefit and fewer and fewer paying more and more taxes to support them. Nesg83 writes ... I think there are some factual mistakes here although the broader point is well taken that there are moments due to benefit eligibility cutoffs where there is disincentive to gain the marginal dollar in income.
Just a few moments of googling found these mistakes:
1. The chart shows childcare benefits up to $45,000 or so. The Pennsylvania article for childcare credit shows a number well below the $45,000 shown on this graph (http://www.dpw.state.pa.us/forchildren/childcareearlylearning/childcareworkssubsidizedchildcareprogram/index.htm) when the actual number is cutoff at $38,000 and worker is expected to co-pay.
2. CHIP is likewise cut off around the $38,000 mark (http://www.chipcoverspakids.com/assets/media/pdf/complete_income_chart_2012.pdf) not the $45,000 or so shown here.
The calculation of cutoff for Medical Assistance (MA) at 133% of poverty level ($19,000 for family of 3) seems correct.
So I think the complaint implied here by the AEI is twofold (1) the general concept of benefits proportional to income, and (2) a mathematical problem where the use of eligibility cutoffs rather than gradual reductions causes points of disincentive. Point (1) is a political point I won't debate here but has many words of discussion elsewhere on this website, but point (2) is quite interesting to me as a mathematical kind of guy. The simple way to solve this is to use equations rather than eligibility limits, but that appears too complicated to most people (and we'd have other Facebook postings complaining about complexity of equations in the tax code). ... Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
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