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China’s Economy Slides—and Capital Flees

In a few days, China’s official National Bureau of Statistics will report the results for both September, the last month of the third calendar quarter, and the quarter as a whole. Analysts generally expect growth of gross domestic product will fall slightly from the second quarter’s 7.5 percent. Bank of China, one of the country’s Big Four state banks, predicts the economy will expand 7.3 percent.

In reality, growth is far less than that. Especially indicative is electricity consumption, often viewed as a proxy for the economy as a whole and widely considered to be the most reliable indicator. Electricity was up 5.9 percent in June from the same month in 2013, up 3.0 percent in July, and down 1.5 percent in August. Notice a trend?

Some analysts are fond of saying that electricity is no longer as indicative as it once was because it tracks manufacturing and manufacturing is no longer the biggest sector of the economy, having been narrowly eclipsed by services, now about 46 percent of GDP.

The service sector, however, does not appear especially robust. For one thing, freight and logistics services are directly related to the deteriorating manufacturing sector. Moreover, construction, a big prop for services, looks like a disaster in the making. For the first eight months of the year, construction starts were down 10.5 percent.

Retailing, a big hope for optimists, looks to be in trouble. Stagnating consumption is evident from private surveys and, among other indicators, falling imports and negative same-store sales for retailers. In Walmart’s second quarter, the retailer’s international division had same-store sales growth in every country except China. Other major retailers also saw falling same-store sales in China during the quarter.

And it appears unlikely that there will be a significant pickup in consumption this year. Employment growth is probably now no better than it was last year: 0.36 percent, according to China’s Ministry of Human Resources and Social Security.  Moreover, the downturn in housing values—month-on-month prices declined in August for the fourth-straight month—will soon hit retailing hard because, for example, furniture and home appliance purchases will inevitably fall. Sales volumes for homes are also swooning across the country.

Exports are the one bright spot for the economy, but exports can no longer carry the entire economy.

Put all the factors together, growth this year will be less than in 2013. In 2013, growth was probably no more than 2.2 percent, not the 7.7 percent NBS reported.

The last Chinese recession, according to NBS, was in 1976, the year Mao Zedong died. What happens when the Chinese economy falls into recession this time?

For one thing, money will flee China faster than it does now. Many may think the sale of the Waldorf Astoria to a little-known insurance company in Beijing is a result of China’s strength—Hong Kong’s South China Morning Post called the record price “a clear sign that economic power is shifting away from the West”—but it looks more like a capital flight play. Why overpay for a slow-growth asset in need of substantial renovation if the prospects in China are so strong?

The truth is that the US looks like a much better bet than China. So the Chinese are bailing out of their own country, buying unloved assets like a slumping theater chain, AMC; a stodgy pork company, Smithfield Foods; and perhaps the riskiest bet in America, buildings in downtown Detroit. Why do we suspect this is capital flight instead of bargain hunting? A recent Barclays study shows that a stunning 47 percent of China’s rich plan to leave their country within five years.

The Chinese economy is based on several deeply flawed premises, but it has worked because the Chinese and foreigners believed that central government technocrats could create growth indefinitely. When they no longer have that confidence, money will flee fast, as it is starting to do now.

No economy can sustain itself in the face of accelerating and prolonged capital flight. And in a country where political discontent and social antagonism already appear high, it is not clear the one-party state can survive long-term economic distress. The Chinese now believe that high growth is normal, and they will probably not react well to a long Chinese downturn.

There is an assumption that China will own the 21st century, but it is just as possible that the country has progressed as far as it can within its existing framework. “This is a period of historic change in China,” noted Mark Schwartz in March. “There haven’t been many periods in history as exciting and as fascinating as this.” The chairman of Goldman Sachs Asia Pacific is absolutely correct—but perhaps not in the way he was trying to convey. 

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