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

Russian GDP Continues to Contract at Double Digit Pace

The Russian Federal Statistics service reported Q2 GDP figures today, which aside from proving Joe Biden to be a prescient economic seer (he described Russia's economy as "wilting" just a couple of weeks ago) , showed the country's gross domestic product contracting at an annualized -10.9%. As illustrated by the chart above, Russia's international reserve position has stabilized over the course of the year as oil prices have hovered in the $70/bbl range. Furthermore, despite Russia's vocal assertions that it is in favor of special drawing rights (SDR's) as a way of diversifying away from USD exposure, gold seems to have been a primary beneficiary of reserve re-balancing. Russian gold holdings are still too small to make a significant visual chart impact, but they have increased the value of gold in reserve by $2.5B or ~17% since the start of the 2009.

We suspect that Russia has reached a critical point of sorts with regards to the contraction of it's domestic economy, and it's stated international reserve position. Unless these double digit annualized GDP contractions moderate substantially, Moscow may come under political pressure from an unruly populace to extend or create social benefit programs. Such a move would necessitate the use of the country's reserves for funding, as the price of oil is currently at a level which is barely sustainable to run the government's primary functions. Obviously, this all assumes that the global economy does not perform a double-dip; pushing oil prices further down, and compelling Moscow to deplete it's international reserves further. Sphere: Related Content

GDP Falls Less Than Expected On Government Expenditures

The Commerce Department's Bureau of Economic Analysis released it's advanced estimate of gross domestic product (GDP) figures this morning which indicated that the economy contracted less than expected in the second quarter of 2009. The 1% annualized second quarter decline will likely be celebrated, as it is a departure from the ~6% annualized declines the economy experienced in both the fourth quarter of 2008, and the first quarter of the current year. The story behind the numbers is however, no cause for celebration.

The true health of the economy- broadly defined by us as the ability of the private sector to maintain capital expenditures, create jobs, and service it's debt related obligations- has seen virtually no improvement, and in fact has continued to deteriorate throughout the current quarter. What is evident though, is that Government expenditures-a dollar amount that contributes to GDP in the same manner as private investment - have been propping up our largely wilted economy. From the Commerce Department's press release:

"Real federal government consumption expenditures and gross investment increased 10.9 percent in the second quarter, in contrast to a decrease of 4.3 percent in the first. National defense increased 13.3 percent, in contrast to a decrease of 5.1 percent."

The trend towards increased Government spending is illustrated by the chart above, which takes a handful of the categories that contribute to GDP and compares the dollar value of those contributions from 2004-2008. It's obvious from the chart that Government spending is not only resistant to recessions, but that it somehow strengthens during a decline! Now, Government spending is not the same as economic activity generated by the private sector; for the most part because Uncle Sam's expenditures are not naturally allocated towards the most efficient available opportunity, as is the case with private investment. Rather, the federal government's dollars are doled out primarily via political considerations. One would expect this wastefulness to be magnified during a recession, where the number and magnitude of profitable investments is on a decline, while the Government's absolute dollar expenditures are rising. Such levels of spending will serve to create the illusion that the economy is bottoming, recovering etc., all the while the plight of the average individual continues to deteriorate. Sphere: Related Content

IEA Report Questions Chinese GDP Figures

In the May 2009 edition of the International Energy Agency's "Oil Market Report", a bit of refreshing skepticism is found with regards to the Chinese Government's reported GDP growth statistics. The story of magnificent Chinese growth has seemingly rendered a large segment of the investment community unable to assess China from a critical standpoint. Our official explanation for this behavior is that it allows stock market bulls to justify US stocks on the theory that demand from China will offset weakness here in the US. After all, how can you argue against the prospect of a billion or so customers just waiting to add to US corporation's bottom lines? Well, the IEA's report does just that, with a special section entitled Another Chinese Riddle: How Reliable Are GDP Figures? The report challenges Beijing's reported Q1 6.1% (year over year) GDP growth. The IEA notes that China's weak oil demand - down 3.5% year over year - in addition to newly released electricity demand figures, are completely inconsistent with the reported level of GDP growth. Throw in the fact that Chinese trade volumes contracted by 20% (Q1 year to year), and a huge question mark starts to emerge.

The fact that the Chinese government would consider misrepresenting it's growth figures should not be a surprise to anyone. The Chinese Government smells Western blood in the water, and has already demonstrated opportunistic tendencies towards increasing it's international profile. Besides, if the United States government is willing to create jobs out of thin air (Birth/Death model), why should we be surprised at similar behavior from an autocratic regime?

IEA May Oil Report Another Chinese Riddle Sphere: Related Content