China’s growth an accounting miracle

Now we are learning how China has achieved its "miracle growth." The country showed positive GDP growth while its electricity consumption declined in the beginning of 2009.

China Growth – No Miracle

I hope you are enjoying the last month of summer.  I’ve gone fishing twice this month – caught absolutely nothing.  Actually I don’t think I’ve caught a single fish over the last five years.  But I’ve been mainly reading, listening to music and drinking beer while I was fishing.  So the fish probably did not take me too seriously.   I’m taking the wife and kids to Steamboat this weekend.  We had a lot of fun there last year, thus I’ve been waiting for it since.

China’s growth an accounting miracle

Now we are learning how China has achieved its “miracle growth.” The country showed positive GDP growth while its electricity consumption declined in the beginning of 2009 – creative accounting that makes Enron’s accountants appear as dilettantes. A paper published by John Makin at American Enterprise Institute explains it well:

“Once China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public works spending. It is important to understand that the disbursal of funds is recorded as GDP growth. So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers. Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed. In fact, the funds go out to the state-owned enterprises and provincial governments and may be held until actual projects are identified and undertaken.” (Emphasis is mine.)

But wait, it gets worse:

“…Ambitious planners count shipments [consumer products] as retail sales while end-use demand may be absent. In such cases, the “sales” are made to happen by virtually giving away the products that have already been produced and counted as GDP growth.”

I am not convinced if China will have inflation in the long-run. It appears that deflation is a more likely scenario as China is ridden with overcapacity – the country was geared for much higher global growth. I can, however, see inflation erupting in a very short timeframe as money has been thrown at the consumer/companies, and we are seeing this in the stock market and real estate. But in the long run, inflation appears an unlikely outcome: overcapacity and slower demand from the US and Europe will force Chinese producers to cut prices to increase utilization and stimulate demand.

Lately, we’ve started hearing whispers of the Chinese renminbi contending for the status of the world’s reserve currency. On the surface it more or less makes sense. The US is struggling and Europe has structural problems. John Mauldin correctly put it, “EU was designed for prosperity not for adversity.” It will be hard for the EU experiment to survive in the long run. But that’s a topic for a different discussion.

China on the other hand is chugging along. I heard (though not confirmed) the Chinese stock market now has a greater market capitalization than Japan’s. Though the Chinese economy has the size of a global currency contender, it lacks one not-so-little element that the global economy will require for renminbi to become the world’s currency – political stability. We forget that China is still not a democracy. I am not sure what to call the political system of the People’s Republic of China but I don’t think it’s the “people’s” nor is it a “republic.” The rule of law is a nascent concept in China. Something is only legal if the government thinks it is legal.

And finally, I’m sure China doesn’t want the renminbi to be the world’s currency as it would drive up the value – a suicide for an export-based economy.

P.S. I highly recommend you read Peter Drucker’s paper called Managing Oneself – it is terrific. I’ve read it the first time about six years ago, had a huge impact on my life.

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