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STRATFOR.COM Global Intelligence Update August 19, 1999

China Battles Deepening Economic Depression

Summary:

China has announced that it is placing caps on the production of a range of consumer goods, after price floors and export subsidies failed to halt plummeting prices. Plagued by declining consumer confidence and abysmal domestic demand, China is turning to ever more radical moves to battle its economic depression. It is running out of options. Devaluation is clearly next on the table, but beyond that there remains only the more draconian steps of direct state control, with the accompanying purge of "economic criminals."

Analysis:

In an effort to halt plummeting prices, China's State Economic and Trade Commission announced a ban on all new projects, involving the manufacture of a broad range of consumer products, Xinhua news agency reported on August 18. The ban would begin on September 1, and includes products ranging from video compact disk players, microwave ovens, refrigerators, and air conditioners, as well as bicycles, toothpaste, plastic bags, candy, salt, apple juice, and liquor. China's domestic market is stagnant, with citizens worried about looming unemployment stashing their money under mattresses rather than spending it. With a glutted market, China's producers are slashing prices, thus threatening to make those unemployment fears come true by driving themselves into bankruptcy. Beijing has already attempted to slow the deflationary spiral, imposing price floors on some products.

China is stuck in a crisis of overproduction and underconsumption. Consumer confidence has collapsed, and with it domestic demand. Meanwhile, despite generous tax subsidies on exports, China has been unable to export its way out of the crisis. Beijing is not done trying. According to an August 18 report by Xinhua, China's Eximbank will give priority in issuing credit to the export of new materials and new high technology, including machinery and equipment, consumer electronics, and textiles. The bank will reportedly ease its lending standards, loaning to large and medium -sized state-owned enterprises that are currently operating with "temporary losses," and contemplating offering no-guarantee loans to large conglomerates with good credit. Additionally, Xinhua quoted Eximbank president Yang Zilin as saying the bank would give priority to infrastructure projects and to central and western China in the distribution of loans from foreign governments.

China has also announced it is placing an embargo on any further construction of luxury apartments, hotels, department stores, and office buildings. The decline in demand extends to real estate, and China is facing a glut in that market as well. According to the Associated Press, the once booming coastal city of Shanghai has office-vacancy rates of up to 70 percent. The boom that has dotted Shanghai's skyline with cranes and new buildings has gone bust, and if Shanghai cannot attract business tenants, China's interior can only be in full economic reversal.

Despite rosy estimates of economic growth, China is in a depression. If it can not sell the products it is producing at home or abroad, even honest accounts of growth in industrial production point to nothing but the sickness of China's economy. Letting market forces reconcile themselves is unacceptable to the Chinese government, which is terrified at the social unrest that could be unleashed by high unemployment. Chinese President Jiang Zemin, currently on a tour of troubled SOE's in northeastern China, has called for the development of those enterprises. Rather than release these large employers to their market-driven fates, Jiang has ordered that they be propped up.

The Eximbank's loan targets mark a continuation of de facto devaluation, subsidizing exports and pumping money into infrastructure. The bank is also distributing money to China's economically lagging central and western regions, rather than to centers of economic growth on the coast. Priority in Chinese economic decision-making has all but abandoned Western market strategies, and has been given over to maintaining social stability.

Price floors have not boosted consumption. Tax subsidies have not boosted exports. Production ceilings are now in place, though layoffs are out of the question. Exports are being further subsidized by loans all but expected to fall victim to default. And devaluation looms on the horizon. This option, recently supported by Asian economic iconoclast and Malaysian Prime Minister Mahathir Mohamad, who is currently meeting with senior leaders in China, offers the possibility of generating inflationary pressure - pumping more money into consumers' hands. It could also make Chinese exports more competitive. The likely outcome, in a time of economic instability and fear, is that more money will be hoarded.

China is running out of options. If devaluation does not work, there is still the potential for internal currency controls - an option potentially catastrophic for China's foreign joint venture partners and foreign companies registered in China, using Chinese banks, and trading in yuan. And along with greater state control, there is the opportunity for recriminations. China has already declared war on corruption, prosecuting some 244,000 "economic crimes" in the first half of 1999 - a 28.6 percent increase over the first half of 1998. Beijing's piecemeal attempt at economic reform without social disruption has failed. Now comes the crackdown and an attempted return to central control.

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There is no guarantee that the stuff "in the pipeline" already will stay priced-cheap either. The Walmart cheap prep period is drawing to a close. Don't overextend yourselves financially-just keep this news in mind while making future purchasing plans. Have you got all of the basic stuff yet? If not, then get a move on.

-- Jeremiah Jetson (laterthan@uthink.y2k), August 19, 1999

Answers

Er. The way I read this, it is saying that it is domestic consumption of goods *within* China that has slumped, and prices have been slumping along with consumption. If the plan to limit production goes into effect, it will not affect the amount of goods for export in any way, and it is meant only to halt the decline of prices *within* China, not raise the price of exports.

You see, raising the price of exports would slow down the rate of exports and the rate at which China earns foreign exchange. They don't want that! Their exports are already hurt by competition from now-cheaper goods from Korea and Thailand.

The reason why China is considering a currency devaluation is to boost their exports by making their exports cheaper. It would also raise the price of imports, cutting back on the rate of importation. This means *more* cheap goods flowing from China to the world, not less.

Why devaluation of the yuan is bad for the USA is that it stiffens competition among the Asian nations for market share and may set off another round of currency devaluations in other Asian nations, and consequently would make it near impossible to earn enough foreign exchange to pay back huge loans to US banks, Japanese banks, and other western creditors.

I think you are drawing the wrong conclusions, but this is definitely not great news for the world.

-- Brian McLaughlin (brianm@ims.com), August 19, 1999.

and i say to mmmmyself, WHAT A WUNNER-FUL WORLD.

-- ALL WILLBE SHAKEN, (dogs@zianet.com), August 19, 1999.

"China is stuck in a crisis of overproduction and underconsumption. Consumer confidence has collapsed, and with it domestic demand. Meanwhile, despite generous tax subsidies on exports, China has been unable to export its way out of the crisis."

"If devaluation does not work, there is still the potential for internal currency controls - an option potentially catastrophic for China's foreign joint venture partners and foreign companies registered in China, using Chinese banks, and trading in yuan."

My point is that if the companies in China that pump all this stuff out to us for dollars can't make a profit, pay their debts, or just continue to otherwise stay in business (even with subsidies) because of an internal depression and/or hyperinflation, then they will drop out of the picture and exports will continue to stagnate while demand here continues to skyrocket (look at our latest trade statistics). Maybe the other asian nations will take up the slack if their recoveries take hold and maybe they won't. Y2K could throw a monkey wrench into their (Malaysia, et al) plans. Also, the QUALITY of the goods may well drop because of their internal problems for any number of reasons.

-- Jeremiah Jetson (laterthan@uthink.y2k), August 19, 1999.