China is not rebalancing a) yet, or b) enough | FT Alphaville

China is not rebalancing a) yet, or b) enough

Answer according to your view on the very important question of China’s economy rebalancing towards a higher consumption-to-GDP ratio.

The debate isn’t really about whether China needs to or will inevitably rebalance, but whether it already has begun to do so. A note from Barclays Capital by Yiping Huang made the case that household consumption as a proportion of GDP is already beginning to rise.

With the murkiness of China’s economic data, it’s hard to say for sure.

We went through some of Michael Pettis’ arguments that China probably isn’t rebalancing much, if at all, in the earlier posts. Pettis was travelling at the time so in his latest newsletter he looks at it in more detail. Here are a few excerpts:

Is the household income share growing?

We just don’t know.  Contrary to Huang, however, I believe it is probably still declining because I don’t see enough of a reversal in the three great mechanisms that repress household income growth in order to generate GDP growth (the undervalued currency, relatively low wage growth, and most importantly, repressed interest rates) to suggest otherwise.  To me, high rates of GDP growth are not compatible with a reversal of the subsidies that flow from the household sector to the producers of GDP, and so as long as growth is high it is hard to see how household income growth could have outpaced GDP growth.

I also think that given the huge increase in investment over the past three years and the slight decline in GDP growth, mitigated in part, it is true, by the contraction in the trade surplus, it is unlikely that the consumption share of that GDP growth could have increased.  This would have implied a very large rise in consumption, and except for the very questionable retail sales figures, which are easy to manipulate, it is had to see much evidence of that.

Huang also pointed to data suggesting that there was more income and more consumption than official data reported. But Pettis says this doesn’t build the case either, because it’s the ratio of consumption-to-GDP that’s important, not the nominal amount — and in any case, the unreported income and consumption are probably concentrated among higher earners, who tend to consume lower ratios of their income than the general population.

And this is the argument, in a nutshell (emphasis ours):

At any rate one way of thinking about the consumption share of GDP is to remember that consumption is equal by definition to GDP minus savings, and savings is equal, also by definition, to domestic investment plus the current account surplus. Since China has an extremely high investment rate, and this has shot up over the past three years – the period during which Huang suggests the consumption rate may have increased – if it has risen by more than the decline in the current account surplus, then savings have probably increased as a share of GDP, in which case the consumption share will have had to decline.

Finally, another point that we haven’t heard that much about before:

Before you look at the actual numbers (if you trust them), I have to add a complication. Any reduction in the current account surplus must be adjusted for any increased stockpiling of commodities. Commodity stockpiling artificially lowers the current account surplus by converting what should be a capital account outflow into a current account inflow. It is a way to export savings, and not a form of domestic consumption.

Which is interesting, considering that a) we can be fairly certain there’s a lot of stockpiling going on, and b) some of it (in iron ore, at least) wasn’t even being counted until mid-2011.

Related links:
Pettis on Europe and China – Calculated Risk
China Enters The Danger Zone, SocGen Presents The Four Critical Themes – Zero Hedge