2015-01 Relative Price Trends

 

Consumer prices increased 0.80% year-over-year in January.  Purchasing prices decreased -5.20% over the last twelve months.  This adds another month to China’s contraction in the structure of production, which has now lasted 38 months.

This year’s January data is impacted by the fact that last year’s Lunar New Year was in January, but this year falls in February.  The Lunar New Year in China is a time of pent-up consumption as much of the migrant population returns home and spends time off with family.  We can hope that consumer price increases continue to decelerate into negative territory so that this year’s Lunar New Year is less expensive that last year’s for all of the people that saved money throughout the year.  Ideally, the price of everything would fall to five mao.

Most of the analysis done after the release of this data by very well-paid people has been advocating more of the same.  Ms. Xiaoping Ma of HSBC said “We still don’t see any positive effects of the stimulus measures put through at the end of last year. Obviously, policy makers need to do more.”  Dariusz Kowalczyk said “There are very strong arguments from all directions of a need for monetary easing.”

These price trends are not happening for unexpected reasons that only central banks can fix with knee-jerk reactions.  The real root cause of this downward cycle was only partially mentioned in the Wall Street Journal article that quoted the above economists.

"Falling prices can also make debt more difficult to repay, a big issue in China where local companies are saddled with huge liabilities assumed after the 2008 global economic crisis. Fitch, a global ratings agency, estimates that the stock of debt—mostly corporate—in China’s economy had risen to 242% of gross domestic product by the end of 2014, up from 217% a year earlier."

The cost of debt in the future is not important if there had not have been so much debt built up in the past.

An Introduction

The most common understanding of a recession is a contraction in overall economic activity. A different way to view economic expansions and contractions is to determine the relationship between consumer goods and the higher orders of production. Relative increases in higher orders of production indicate the business cycle is in the expansion phase. Relative increases of consumption indicate the business cycle is in the contraction phase. The mainstream and alternative view of business cycles often align, but the alternative understanding of business cycles allows for a better understanding of changes happening within the economy.

Since the Chinese economic reforms that began in 1978, China has never experienced a contraction in overall economic activity. Gross domestic product, as it is officially reported, has never decreased from one year to the next over this period. However, research into the structure of production reveals that China has experienced multiple periods of expansion and contraction.

The purpose of this blog is to be a source for an alternative view of Chinese economic indicators to both reflect on business cycles in the past and the business cycle as it unfolds in the present. Posts on this blog will consist of reporting on main economic indicators as they become available, links to news stories on current events, and special articles on economic or financial events in the past. Two main economic indicators will be referenced to determine the status of the business cycle. The first indicator will be the relationship between purchasing prices and consumer prices. The National Bureau of Statistics publishes these monthly. The second indicator will be the relationship between equity returns in the consumer goods industry and the materials industry. These can be tracked by the Global X China Consumer ETF (CHIQ) and the Global X China Materials ETF (CHIM).

A consumer price index is available back to January 1987. A purchasing price index is available back to October 1996. With these two data sets we can compare the relationship between purchasing prices and consumer prices back to October 1996.

From the start of our dataset until September 1997, China was in a state of contraction. This would correspond to the Asian Financial Crisis, which according to official statistics, China avoided. The production structure began expanding again only during the three months of quarter four in 1997. However, it soon began contracting again as the decline in purchasing prices outpaced the decline in consumer prices. This trend began in January 1998 and continued for almost two years until November 1999. Although gross domestic product did not decrease during the Asian Financial Crisis, it seems China’s structure of production was not immune from it.

Between December 1999 and March 2001, the production structure began expanding again for almost five quarters. The length of this expansion was shorter than the following period of contraction starting in April 2001 and lasting six quarters until September 2002. This corresponded to the establishment of asset management companies to deal with non-performing loans in the state-owned banking system.

The following period of expansion lasted for almost five years until May 2007. This corresponds to the economic boom fueled by artificially low interest rates throughout the world. China’s production structure contracted for six months, starting in June 2007, similar to when the rest of the world began experiencing the effects of economic recession. Unlike the experiences of the rest of the world, China experienced a period of expansion between December 2007 and November 2008. This was followed by another twelve months of contraction.

Most countries officially exited the recession in 2009, which is the same time China’s production structure re-entered a period of expansion. This lasted until November 2011. Interestingly, between December 2011 and the end of this data set, China’s production structure has been in a period of contraction. This is the opposite of the signals that gross domestic product statistics are sending. Unfortunately for savers, in addition to this being the longest period of contraction, it is also the only extended contraction during our period that the rate of change in consumer prices has not entered negative territory.

An exchange traded fund tracking the consumer goods industry (CHIQ) was launched in December 2009, followed by one tracking the materials industry (CHIM) in January 2010. We can use these to compute 12 month growth rates beginning in 2011.

This dataset begins with China in a period of expansion, similar to our previous indicator. The growth in earnings from CHIQ began to exceed that of CHIM in May 2011. CHIQ increased by 19.12% while CHIM only grew by 17.81% that month. In June 2011, CHIM outpaced CHIQ by growing 20.78% against CHIM’s 14.00% over the previous 12 months. Soon, both began to experience double-digit negative growth, although the decline in the materials industry outpaced that in the consumer goods industry. This period of contraction continued until May 2014. Although the consumer goods industry recovered during the later part of this period, the materials industry was in negative territory almost every month.

Unlike the relative price index trend indicator examined above, the relative equity earnings trend indicator showed China’s production structure in a state of expansion starting in June 2014. We are most likely seeing a drop in consumption in order to finance higher orders of production.
Why am I starting this project now? Because 2014 was the first year in 20 years that the Chinese yuan depreciated against the U.S. dollar. It is a sign of bigger things to come.

The expansions and contractions in China’s structure of production that are revealed by these indicators correspond to regional or global recessions, such as the Asian Financial Crisis or the Great Recession. However, gross domestic product, as officially reported, has expanded every year since economic reforms began. Eventually, we can expect fluctuations in China’s gross domestic product to correspond to changes in the structure of production. This means that China’s gross domestic product will also experience a decline. Considering that both of these indicators have experienced the longest period of contraction seen so far during this period, China will most likely experience negative gross domestic product growth in the very near future.