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The Crumbling of China’s Export Market

David DuByne
November 15th, 2008

The Olympics have come and gone, and the promises by Ministry of Finance government spokesmen that the Chinese economy was set to grow healthily and steadily after the summer Olympic Games and that a post-Olympic economic downturn was highly unlikely need to rethink their official statements. Even today after the $500 billion dollar rescue package from the Chinese government the National Bureau of Statistics (NBS) reiterated “China's economy is in good shape despite the changing economic environment, and it will maintain stable with relatively fast growth. We should be confident about the country's economic outlook."

Rosy scenarios now fly around the daily news that even in the worst of global economic times China will be minimally affected. The fundamentals of China's economy are sound, the central government is in total control and if a problem occurs, the solution is already unfolding. The National Development and Reform Commission will continue efforts to expand domestic consumption amid the global economic uncertainty and People's Bank of China says “there is still room to tap more domestic consumption.” The Ministry of Finance reiterated “A high savings ratio can stimulate demand when economic recession occurs. China's economy is therefore cushioned against the worst of the disaster.”

With all of this positive news; who should be worried? My answer: Anyone that understands the ripple effect, that’s who! The leaders say one thing to pacify the people while on the streets another world exists. I want to delve into the beginnings of a disintegrating China.

I sat in disbelief reading today’s Shenzhen local paper stating that Some 9,000 of the 45,000 factories in the cities of Guangzhou, Dongguan and Shenzhen are expected to close down in the next three months according to the Dongguan City Association of Enterprises with Foreign Investment estimates. Those closures would see up to 2.7 million jobs cut as overseas demand for consumer goods and clothes fades, that’s more than 50,000+ a day if you believe official figures, which I do not, and I believe number is actually higher. The association says that, by end of January, demand will shrink by 30 per cent, and these are just mainland factories. The Federation of Hong Kong Industries said that about 25 per cent of the 70,000 Hong Kong-owned companies in southern China "could go to the wall by the end of January". Yet on the very next page I read an article quoting the Ministry of Commerce as stating “Although it is likely to cause a decline in China's external demand, our stock market and financial system will not be fundamentally affected.”

I can understand the flip-flopping stories as a means to keep a population from panicking, after all the Shanghai A-shares have declined more than 60% from their bubbly peak at the beginning of the year. The Hang Sang in Hong Kong and the Shenzhen indices are not doing much better. Real Estate prices have slipped 20% in the last six months, all of the recent factory closings with many more to come and this is just the beginning of a prolonged feedback loop.

The central governments plan to reverse a foreign trade decline is to increase domestic consumption, restructure industry and boost innovation to change its economic development mode, that’s fine but first you need to have an expanding domestic economy in order to do that.

Priority Number One: Number one on the priority list is domestic unrest caused by factory closures and owners declaring bankrupsy, thereby avoiding the troublesome task of paying the employees. In the last three weeks Dongguan Weixu Shoe Company collapsed and laid off 2,000, Chong Yik Toy Company shut leaving 1,000 payless and the largest; Smart Union locked its gates on 7,600 workers. Protesters descended on government buildings in Dongguan where hundreds of police were called out to quell violence. So far local public funds have been used to cover the back pay owed to workers, $ 7.6 million dollars so far. This was to cover three factory closures, imagine the bill when factories close across China in the tens of thousands. By the time you read the article “Govt foots collapsed shoe firm's wage bill”, from Xinhua News Agency a thousand more factories will have closed along the east coast.

"Big deal", you say. "The workers are paid and will return to the countryside where they can grow vegetables." That is true, but the few thousand RMB in their pockets will run out after a few months and with very few other opportunities to secure an income, China’s stability is in question. These workers originally came to the city to support the family by sending back money every month, now they are returning to the countryside by the tens of millions across China. My question is, "When the money runs out what will they do?" I’m sure crime and violence will skyrocket; to what degree I can only guess; but most importantly to what degree can security be guaranteed by the central authorities outside the cities?

If there is a repeat of anything like the Cultural Revolution where 40 million starved to death and family members turned on each other, it will become a society restructuring event. China is quite different compared with the 1960s as the current pollution problems have made 98% of water sources above ground unusable and the amount of arable land has shrunken dramatically as factories and cities now cover what was once farmland.

These bankruptcies and massive layoffs are not just single events in isolated locations; it is beginning to happen countrywide. The lag time between the events of the western banking system and the fallout here is approximately two months. With that said more trouble is on the way. If there is no contingency plan by the communist party for the global downturn within their own society and if they are reacting to each event rather than planning for such events; than the China we have seen over the last ten years will be an entirely different place in another two.

Second Tier: The second order of business will be restructuring to a non-export driven economy for the next three years until the world works itself out of this financial mess. The only one to speak out so far against the grain of positive news is Fu Ziying, Vice Minister of Commerce, who with some common sense said “It would be more difficult to maintain stable export growth next year because of the global financial turmoil.” As I stated before most of the fixes for the slowdown seem to revolve around expanding domestic demand, which is the catch 22; demand for exports slows, so if citizens have no job and less money selling them goods and getting them to spend won’t work. These pipe dreams of China's economic flexibility and macro-control guaranteeing economic stability is exactly that, a dream.

I think a message is beginning to get through with this unfathomable event requiring Government Agency spending be frozen in 2009, halting the average annual 5 percent increase of the past five years. The Ministry of Finance said on Tuesday. "The budgets for next year should be capped at the same amount as this year's and every project would be looked at"

Agency spending includes staff salaries, lavish gatherings and official state business. Expense budgets of all 107 central government agencies will be analyzed and related departments asked to tighten their budgets.

Wang Chaocai, vice-president of the ministry's research institute for fiscal science, said “The spending freeze will be achieved by reducing the number of meetings and conferences, reception activities and business trips, and by cutting transport costs.” This truly astonishing in the land of showing off wealth and status, that’s like asking the Emperor to reduce the party and banquet budget during the Tang Dynasty, unthinkable unless there is a crisis.

The way I understand it, each department is compartmentalized and deals with that departments business only, the idea of ripple effect is not widely understood in China even at the highest ministry levels. Exports directly effect factory production and workers loose their jobs, that is widely understood. Trying to explain that the copper mine in Jiangxi will need less workers and that leads to lower need for rail transport, which leads to a reduction of rail cars and that industry, plus the maintenance crews and repair parts involved to keep it all running, this is a bit more difficult task. How about the food vendors at the factory gate, the nearby stores and delivery drivers who drive fewer miles and buy fewer tires. There is less vehicle maintenance which requires far fewer mechanics and spare parts to keep the transportation network by road moving, which is also its own separate industry. This example filters right through ports, construction, real estate, logistics etc… and it’s all based on producing or transporting something for manufacturing, export and indirectly imports.

Power generation is one of the biggest industries in China, and according to the China Electricity Council “power demand in August fell 5.8% from the slowdown in export-oriented consumption along coastal areas.” This directly connects to China’s largest steelmaker, Baoshan Iron and Steel and the nation’s biggest aluminum producer Aluminum Corp of China cut prices for December by as much as 20% in a bid to attract more orders amid a slowing economy, and are considering further cuts because of falling metal prices and weak domestic demand.

Premier Wen Jiabao said on Saturday that fiscal revenue in the fourth quarter of this year will continue to drop after falling from more than 33 percent in the first half to 10.5 percent in the third quarter. The World Bank followed with a downward revision for China’s GDP growth next year at 7.8% or lower on reduced spending in consumer markets.

As many areas of the world enter a recession 7.8% sounds great, but in China the working age population is still growing, China needs at least 8% growth to maintain the current employment rate. Where will the three million new college graduates find work this year, after all they are fighting with the surplus of five million diploma holders that still have not found work over the last two years.

Third Time is a Charm: The third obstacle will be restoring confidence in the average citizen’s mind. As the cycle of distrust between employee, supplier and factories intensifies, factories may close because workers leave for fear of not being paid; suppliers will not deliver unless paid cash on the spot at delivery, no more credit. This cycle will lead to an exodus of workers from coastal provinces; I firmly believe that Shenzhen a city of between 10-14 million depending on statistics will shrink to around six million by the late part of 2009.

In a reactive approach as situations occur around the mainland, there have been several new laws introduced, The Communist Party of China (CPC) issued a landmark policy document on October 20 allowing farmers to "lease their contracted farmland or transfer their land use right to boost the scale of operation for farm production and provide funds for them to start new businesses.” This is the first firm confirmation that tens of millions are going back to the countryside.

The Ministry of Finance shortly there after on October 28 announced that the property contract tax had been lowered to 1 per cent from 3 per cent, on purchases of properties that are smaller than 90 square meters. Also, the down payment requirements will be lowered to 20 percent, from 30 percent. Real estate was where a lot of “new” money came from in the last ten years. Spending was up because property values were up, just as in the US from 2000-2007.

Starting from November 1, the Ministry of Finance said in a statement “The government will raise export tax rebates for 3,486 products including textiles, clothing, furniture and toys. The tax rebate was raised from 11 to 14 per cent to help exporters cope with lower demand” which is a stealthy way to boost container loading since cargo volumes are down 20-50% depending on the port.

These measures are like a doctor treating the symptoms of a patient, not treating the cause of the disease. The trend of shrinking foreign demand is unlikely to reverse, and the new policies are to create domestic consumption and encourage spending. Disposable income from the real estate and manufacturing sectors has dried up in the country. You cannot spend something that you do not have.

Trade Fairs and the Future: Trade fairs throughout China set the tone for the following year’s production and export market, the largest in the country being Canton Fair in Guangzhou, concluded November 06. The number of buyers from Europe and the United States dropped by more than 30% from last year's levels. Trade volume at the annual event dropped by about 15%-17% from last year amid global recession worries.

The Yiwu International Commodities Fair and China-ASEAN Expo reported similar results. These shows are a showcase of Chinese Commodities focusing on Machinery & Equipment; Electronics & Electrical Appliances; Building Materials & Household Ware; Agricultural Materials, Produce & Foodstuffs.

The downward trend is obvious, and now manufacturers are trying to save themselves, with decreased orders, rising production and labor costs, manufacturers are cutting more corners wherever possible.

As well as cutting staff, companies are trying to use energy and raw materials more efficiently, and seeking out alternative, lower-cost suppliers. From my own experience, Chinese firms already seek out the lowest cost supplier and purchase one-off lots to reduce costs; I really don’t see how they could achieve cost reduction using this method. One unique approach is promoting and selling products online, a virtual store with no office rent to cover and downsizing the office into your own apartment is another tactic.

Just as overseas and domestic demand slacks off, I wonder when the multinationals will start trimming their China office staff as a way to save money in the head office abroad.

Economic Fallout: The fall-out will be highly concentrated in provinces such as Guangdong, Zhejiang, Jiangsu, Shandong and Fujian all the way up the east coast stretching back the production and supply chain to the Special Economic Zones (SEZ’s) in the western provinces. Nothing will go untouched as this export driven economy is a tight spider web of endless links to supply the greatest economic growth in history, and now perhaps the greatest reversal.

To an unprepared reactive country the crisis will come in many ways that are not directly financial but societal as well. The question is not whether the crisis will come to China, but rather how China is prepared to deal with it.

As I read in a recent blog, “China has been a country littered with crises of large scale. They have dealt with crises before like the Cultural Revolution which ripped the fabric of society, several famines and the Japanese invasion in the last century.”

That was then this is now. Around Guangdong Province impromptu protests by disgruntled workers left jobless and without pay are becoming more common; they have resorted to petitioning local government officials for back pay because they have few other ways to be compensated. They will complain more and they will protest at local government offices, you will see more demonstrations and picketing. In the last few years riots related to land grabs, bank failures, forced relocation and protests to close polluting factories were estimated at 70,000 last year, now add in this new “wave” of social movement and anything is possible.

Chinese Crude Demand: Just when you thought there may be a let-up in Chinese oil demand because of the slowing global economy! Think again. This China Daily article, “Calls to pump up nation's oil stockpile,” states that the country should take advantage of the record drop in global crude oil prices to build up more reserves. “Compared with the highest prices in July, crude oil prices have dropped by 50 percent. We should take advantage of the low prices to build more oil reserves.”

If you have been asking yourself throughout this article, why don’t they just spend part of their two trillion dollar foreign currency reserve to keep things going, keep in mind Chinese currency reserves are 80% US dollars and 20% Euros and the government can’t purchase items priced in different currencies at will. They would first have to sell dollars and then re-buy another currency, and that’s bad for China. If the dollar drops than the effect will be intensified as fewer US orders will come in. The most obvious choice is to buy something useful and already priced in US dollars; I think you know the answer.

Restructuring the Future: The parallels between China’s precarious social and economic future based solely on exports and our own societies entirely dependent on fossil fuel as a driver for growth are striking. China now needs to focus on what’s beyond expanding its economy through exports and manufacturing, while all of us need to focus on what’s beyond growth in a crude oil based economy. Peak oil is occurring now, the economic repercussions are a symptom, China is affected, the world is affected, we are all affected. Now the emphasis needs to be more on what to do after the peak.

We have come to the end of the line in terms of endless economic growth based on cheap, readily available crude oil, China has come to the end of their growth in this phase if industrialization for the same reason. The world has been the economic driver for China and China the economic driver for the world, both were based on cheap energy and disposable income derived from cheap energy, that time has passed. We need to find ways to be proactive for the future instead of reactive. My gut feeling is that within 3-6 months we will begin to see events on a level no one has anticipated. When it becomes impossible to find work in China during the “economic miracle” we will have truly entered the end of the age of oil.

David DuByne
November 15th, 2008

Until recently, David DuByne taught business English in Chongqing, China - near the epicentre of the earthquake. He has returned to the United States. His website - Dave's ESL biofuel - is devoted to bio-fuel and oil depletion.

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