Tuesday, August 11, 2009

Chinese GDP Growth and Electricity Consumption

Investors have recently been questioning, with intensifying rigor, the validity of the Chinese government's reported GDP figures. The most official - and amusingly flagrant I might add - challenge to the Communist Party's claims of >6% annualized growth was the recent IEA report titled "Another Chinese Riddle". That report, as well as my analysis thereof, can be found here.

In the aforementioned report, one of the more compelling pieces of evidence offered in support of the argument that China overstates it's GDP is that there has been a divergence of the relationship between Chinese electricity consumption and reported growth. Because nearly all significant value-adding economic activity requires the use of electricity, the logical - not to mention historically supported - conclusion is that GDP and electricity consumption should be positively correlated variables having a relatively high r-squared value. (The only exception I would grant for this argument is that maybe, during a spectacular leap in technological advancement, this relationship could be disrupted by new machinery/methods of production that required substantially less electricity to perform the same - or greater - tasks. Needless to say, once this technological advancement was complete (for the time being of course), the relationship between electricity and GDP would simply re-balance itself in the form of another equation that would, in all likelihood, demonstrate the same properties as the original relationship i.e. positive, high r-squared value. This exception does not apply to the current topic however, as China has experienced no "leap forward" in terms of technological advancement over the past 12 months.)

That being said, a piece of analysis from Deutsche Bank's Norbert Walker, titled "Electricity consumption and Chinese GDP - tenuously linked" , has caught my eye as well as my attention. Mr. Walker begins his research note by questioning - as his title would suggest - the existence of a correlation between Chinese macro economic growth and electricity consumption. He even goes so far to say that this relationship "may prove to be fallacious on closer inspection". At this point, as an open minded reader, I am looking forward to a more nuanced version of Mr. Walker's argument; presumably these details are found below the title and bold-typed abstract-ish statement.

Norbert proceeds to explain that 2/3's of China's electricity consumption can be attributed to the industrial production of steel, aluminum and cement. Therefore, concludes the gentleman from DB, the drop in electricity can easily be explained by accounting for the significant drop in Chinese exports over this same period of time. But isn't that exactly the point Mr. Walker? As if this logical leap was not enough, the author further goes on to state that:
"Therefore, the first idea that declining Chinese electricity consumption was a leading indicator for a fall in Chinese GDP has to be dismissed"

Perhaps I have missed something, but I'm fairly certain that nobody has ever accused electricity consumption of being a Leading indicator of GDP. In fact, it is the most obviously Concomitant indicator known to man: Once power is cut to the machines, they are no longer producing anything. To say that electricity is a leading indicator is to assume that something can occur after the electricity has stopped being consumed, albeit only for a short while because it's not lagging too far behind is it?

Ultimately, I was surprised that a professionally produced article would contain two logical twists, a turn, and end up never addressing the claim that it originally sought to dispel. My suspicion is that the Chinese growth story is one that "stock-peddlers" and others who stand to benefit economically from widespread buying of US equities, literally require that the Chinese Growth Riddles be true in order to justify equities in general. No legitimate argument can be made for US consumer growth, so the Chinese (or Brazilian, Russian, Indian) consumer is hailed as "he who will justify the trading of US stocks at high multiples relative to their earnings". Just my theory. Sphere: Related Content

No comments:

Post a Comment