China's latest tool to calm investors is a raft of cheerful GDP figures. The trouble is, they're looking a bit too cheerful.
Beijing's attempt to get away with 7 percent growth in the second quarter fell flat with traders, who drove Shanghai stocks down 3 percent on Wednesday. You can just picture President Xi Jinping's men gathered around a stock spreadsheet wondering what went wrong. Let me save them the suspense: China's irrational stock rally is reaching its natural end.
There are two reasons the latest burst of GDP creativity didn't work. First, the Goldilocks nature of yesterday's numbers -- good enough to suggest the government's stimulus moves are working, but not so stellar that they would reduce speculations that more are on the way -- raised red flags among investors. Everything from commodity prices to electricity usage to export statistics in neighboring countries suggested China's economy was decelerating, so markets were incredulous at Beijing's suggestion otherwise. (It didn't help matters that the government reported that also grew a tidy 7 percent during the first quarter, too).
Second, this week's events confirm fears among investors that Xi, 32 months since becoming China's president, is still putting growth ahead of economic reform. There's no end in sight to the dominance of state-owned enterprises; the financial system remains tightly controlled; shadow banks are running amok; and China is even less transparent than it was in the days of predecessor Hu Jintao (which is saying something).
Instead of the economic glasnost Xi pledged (heralded as the "Chinese Dream"), Beijing is papering over the country's many cracks. First, it accelerated the growth of a debt bubble that added $20 trillion of credit between 2009 and 2014. Next, it engineered history's biggest equity rally to help companies raise capital and make households feel richer. Now, in hopes of keeping those bubbles inflated, Beijing is deploying statisticians to calm investors' nerves.
China's growth "partly reflects an unsustainable surge in financial sector activity that will prove short-lived," says Julian Evans-Pritchard, China economist at Capital Economics. The other part reflects unsustainable jumps in fiscal-spending activity among regional governments all vying for Xi's favor by boosting national growth. All the while, says economist Li-Gang Liu of Australia & New Zealand Bank, "deflation risk remains elevated."
Meanwhile, per capita disposable incomes reportedly rose 10.5 percent from a year earlier to $1,562 in the first six months of the year. "This number would indicate a relatively solid Chinese labor market in the first half of 2015," says economist Bill Adams of PNC Financial, "but seems inconsistent with sluggish growth in the cyclical drivers of labor demand: investment, industrial production, and construction activity."
Even if China isn't fudging its household earnings stats, they wouldn't hold up in the face of Xi's promised economic reforms. Any effort to create a vibrant private sector will require tossing millions of state-owned-enterprise staffers out of work. (In the late 1990s, remember, then-Premier Zhu Rongji slashed 40 million jobs from SOEs -- and the sector still dominates China's economy.)
China's overdue reform program will inevitably mean markedly slower economic growth in the short term. Prominent economists including former U.S. Treasury Secretary Lawrence Summers suggest China's revised growth rate would be about 4 percent.
In other words, as long as China's longer growth stays near 7 percent, investors will suspect Xi's team isn't doing enough to modernize the economy. They will assume, not unfairly, that Beijing lacks the confidence to allow markets to rise and fall by their own volition. The government ought to keep that in mind the next time it thinks it can fool the world with a good GDP headline.
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