Further signs of China's slowing property markets

China's official housing index now shows home price appreciation slowing faster than some had anticipated.

Source: Investing.com

Other indicators are also pointing to weakness in China's housing markets. For example the number of cities with falling prices has spiked sharply.

Source: Scotiabank

Furthermore, the steel rebar futures in Shanghai - an important real-time indicator of construction demand - remain under pressure.

Jan steel rebar futures in Shanghai (barchart.com)

Related to the trends in residential housing, China's commercial floor space and the number of commercial buildings sold has declined materially recently (based on official reports).

Source: National Bureau of Statistics

There is no question that Beijing has the wherewithal and the will to support the housing market should things unravel faster than the government likes. Nevertheless, given how pervasive property markets are in the nation's overall economy, concerns among global investors are rising with respect to China's housing slowdown.

Scotiabank: - On the theory that where there’s smoke there's fire (and it’s not just because I’m BBQing), weak company financing and concerns surrounding potential defaults in the shadow banking sector coupled with — and likely driven by — further evidence of falling property prices will only amplify the concerns.

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5 indicators pointing to persistent economic weakness in China

China continues to pose a significant risk to global economic expansion. The country is close to becoming the world's largest economy and a further slowdown will be felt worldwide. From the Eurozone to South Korea, major economies are carefully tracking developments in China and the extent to which their own economies may be impacted. So far key economic and market signals from the nation point to an economy that remains in the doldrums. Here are the latest indicators:

1. The unofficial manufacturing PMI shows that the manufacturing sector is still contracting.

Source: Markit/HSBC

HSBC: - The final reading of the HSBC China Manufacturing PMI stabilised at 48.1 in April, up slightly from 48.0 in March, and revised down from an earlier flash reading of 48.3. The latest data implied that domestic demand contracted at a slower pace, but remained sluggish. Meanwhile, both the new export orders and employment sub-indices contracted, and were revised down from the earlier flash readings. These indicate that the manufacturing sector, and the broader economy as a whole, continues to lose momentum. Over the past few days, Beijing has introduced more reform measures which could support growth by inducing more private sector investment. We think bolder actions will be required to ensure the economy regains its momentum.

2. Property price correction is looming and investors are becoming jittery - both domestically and abroad. The recent yuan depreciation (see Twitter post) has exacerbated the situation. Concerns over property developers running into financial problems are rising, particularly as credit tightens.

Want China Times: - The one-way movement of the renminbi in recent years has boosted yuan-denominated assets and lowered the cost of overseas lending among Chinese real estate investors, with the former attracting the inflow of foreign capital into the country's housing market and the latter making it more convenient for the companies to raise funds overseas.

But the sudden depreciation of the yuan has prevented international money inflows into China's housing market and has reduced yuan-denominated house prices. It is hard for real estate developers to raise funds with the rising cost of overseas lending. Therefore, a change in the current financial condition will naturally trigger a cyclical adjustment in housing prices.

3. Related to the issue above, industrial commodity prices in China are still depressed - unable to sustain a recovery after the sharp declines back in March. This does not bode well for industrial demand.

Steel rebar June futures (barchart)

Iron ore June futures (barchart)

4. The rate swap curve remains inverted, which is never a good sign.

Source: Chinamoney

5. The Shanghai Composite Index is once again toying with the psychologically important 2,000 level. If we move below that level and stay there, concerns over China's economic trajectory will rise further.

The Shanghai Composite Index (source: Bigcharts)

China's government is pushing through some fiscal stimulus to give the economy a boost. The focus these days is on rail infrastructure investment.

China News Service: - China's national railway operator has raised its fixed-assets investment target to more than 800 billion yuan ($127.2 billion) for 2014, which is part of the country's efforts to stabilize growth through infrastructure construction, experts said Saturday.

But will it be enough?

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From our sponsor:

Xu Shaoshi says all is well with China's economy

China's propaganda machine went into full gear as it sets its sights on foreign economic forecasters who are continuing to profess slower economic growth for the nation. Is the West is picking on China again? Creating all this negative publicity?

People's Daily: - Among a number of foreign investment banks and international media, prophets of doom on the Chinese economy have begun to find their voices once more.

How should we view this negative publicity, and what is China's current economic situation? On March 5, Xu Shaoshi, head of the National Development and Reform Commission made clear that the Chinese economy has made a good start to the year and that future prospects are favorable. On the sidelines of the "two sessions" - the annual sessions of the National People's Congress (NPC) and the Chinese People's Political Consultative Conference (CPPCC) - reporters interviewed NPC deputies and CPPCC members.

Are the Western analysts just "prophets of doom" hyping up the China-slowdown story? While a severe recession in China remains an unlikely outcome, there is no question we are seeing PRC face some serious headwinds.

First of all it is well known that many of China's insiders, analysts working for Chinese organizations, seem to be just as bearish on China's economic expansion as their counterparts abroad. Moreover, key economic data continue to indicate that growth is below expectations - see the latest export figures for example. And while one could debate the veracity of such data due to seasonal effects and other biases, it's harder to argue with the markets. Commodities that are sensitive to China's industrial demand, particularly iron ore (see chart), steel (see chart), and copper (chart below) have been hit unusually hard. Clearly something is wrong here.

China's authorities certainly have the wherewithal to stabilize growth through either fiscal or monetary stimulus. They've done it before. The central government however has been trying to wean the country from both in order to contain the buildup of market bubbles in areas such as wealth management ($6 trillion shadow banking balance sheet), corporate credit, and real estate. And if all was well with the nation's economy, Beijing would be staying the course here.

Lately however China's central bank has become quite accommodative. It stopped appreciating the yuan - in fact the currency has been allowed to depreciate (see chart) to help the nation's exporters. It is also allowing short term rates to decline. Some of that decline is due to falling demand, as banks pull back on lending into certain sectors. Partially it is the result of PBoC injecting liquidity via unsterilized dollar purchases (yuan sales). Whatever the case, the outcome is a sharp decline in interbank rates - a loosening monetary stance.

1-week and 2-week SHIBOR

One could debate the reasons for each of these trends. But taken as a whole, it is hard to argue that it is business as usual in China - even if Xu Shaoshi made it perfectly "clear that the Chinese economy has made a good start to the year and that future prospects are favorable."

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China's credit markets under pressure

China's corporate sector has been hit with escalating credit problems. Here is the latest:

1. Shanghai Chaori Energy Science and Technology is about to miss a coupon payment on its bond (see story).

2. As a result, Suining Chuanzhong Economic Technology Development and 2 other companies scrapped their bond offerings - demand for new issue corporate bonds has dried up.

3. Secondary corporate bond trading has also slowed materially. This is fairly new for China since it has never really experienced large scale credit problems in its nascent bond markets.

4. There are indications that banks are cutting back lending as a result. In particular lines have been cut to natural resource wholesalers, traders, and importers (iron ore, steel, cement, etc.). These borrowers in turn are forced to sell inventory that is ofren used as collateral for these loans. Inventory sales depress prices of some of the raw materials, generating further losses for these businesses. This is compounded by the nation's slack industrial demand, with steel mills now running at 50-70% of capacity.

Iron ore April futures contract (source: barchart).

5. With banks cutting back on lending, demand for interbank funding fell materially, sharply lowering China's money market rates. Both 7-day repo and the 1-week SHIBOR are at lows not seen in quite some time. While lower money market rates are good for banks, at this point there is ample liquidity in the system with far less demand.

7-day repo rate (source: chinamoney)

1 week SHIBOR

These developments are quite negative for China's economy. Confidence in the nation's credit markets - both bank lending and corporate bonds - has taken a hit. It remains unclear however just how pervasive these problems could become - some think this is just the tip of the iceberg (see story).

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From our sponsor:

4 signs of economic slowdown in China

The thesis of China facing weaker nearterm economic growth is widely accepted at this point.  Moreover, the slowdown in the nation's manufacturing sector this month (see chart) has provided some support for this view. But as we have seen in recent years, it could be a temporary correction related to some seasonal patterns. Given the difficulty in obtaining reliable data out of China, what other evidence do we have that the nation's economy is actually slowing? Here are four signs that seem to support the "slowdown"  thesis.

1. For the first time China's "insiders" are calling for weaker growth:

WSJ: - China’s state media have long accused foreign analysts of being too bearish on the Chinese economy. Those analysts looking in from the outside are often said to be too eager to be “chanting decline”—chang shuai—when it comes to the economy’s prospects.

This time around, China’s own economists seem to be chanting a pessimistic tune about growth prospects. Perhaps they are not quite as negative as those pesky foreign counterparts—who according to at least one report China’s state media are being told to avoid—but they are increasingly outspoken about slowing growth and rising financial risk.

“We are now in a painful stage,” economist Wang Luolin told a seminar this week. “Let’s not try to dress things up,” said the consultant to the Chinese Academy of Social Sciences, a government think tank.

Yu Bin, a senior researcher at the influential Development Research Center under the State Council, took a similarly pessimistic view.

“The fact is, China’s economic growth is facing substantial downward pressure,” he said. “I don’t think we should get our hopes up for this year’s growth.”

2. The nation's central bank has once again halted the currency appreciation. The authorities tend to do this during periods of economic uncertainty in order to provide some support for China's exporters.

Chart shows USD appreciating against CNY (Source: Reuters)

3. Australian coal prices have been under some pressure - mostly due to mediocre demand from China.

Australian thermal coal price (source: Ycharts)

Similarly iron ore price has been weaker recently, with China having stockpiled massive amounts of the commodity (inventories at highest level since 2010). This could be an indication of slack in industrial demand.

4. Perhaps the most significant indicator of slowing growth in China is the decline in longer term interest rates combined with an inverted yield curve.

Why is the yield curve inversion (short term rates higher than long term rates) so important to watch? In many countries an inverted yield curve is often a harbinger of an economic slowdown. Just to put this in perspective, here is what the US yield curve looked like in the middle of 2007 (about six months before the start of the Great Recession).

Of course nobody is calling for a major recession in China, but a slowdown looks increasingly likely.

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From our sponsor:

Watching the 'China taper'

Chicago Tribune: - "Emerging markets should be much more concerned about the 'China taper' than the Fed taper" -  Crossborder Capital Managing Director Mike Howell.

Indeed, while the rate of US taper is modest and reasonably well defined, signs point to slower economic expansion in China. And even in the near-term there is little visibility on that country's growth. The January HSBC services PMI print this morning was quite weak. One of the explanations seems to be that services have slowed due to Beijing forcing government officials to go easy on the extravagant "entertainment" that has become so prevalent in recent years (see post). Once that is dealt with things should improve? Perhaps.

Hongbin Qu/HSBC (published by Markit): - The slower expansion of services activities in January reflected soft manufacturing growth and the impact of Beijing's latest measures to curb official extravagance. As business sentiment remains stable, we expect services growth to bounce back a little in the coming months. Yet a meaningful improvement relies on stronger growth of manufacturing sectors and the implementation of reforms to boost service sectors.

Source: Investing.com

Other measures from China are consistent with slower growth as well.

Reuters: - A similar services PMI released by the China's statistics authority earlier this week showed growth in the sector sagged to a five-year trough in January as business confidence retreated to four-year lows.

Two separate PMIs for China's factories also showed manufacturing growth slipping to six-month lows in January.

Analysts polled by Reuters believe China's economy will grow 7.4 percent this year, far ahead of other major economies but still its worst performance in 24 years.

The trajectory of emerging as well as many developed economies going forward will depend on whether we see an uptick in China's economic activity after the holidays. For now the global equity markets remain skeptical.

Source: Ycharts

• ^DJWO - Dow Jones global equity index
•   IEMG - Core emerging markets
•   FXI - China's large cap shares

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From our sponsor:

An explanation for persistent weakness in China's stock market

There have been numerous theories attempting to explain China's stock market's lackluster performance in recent years.

 China Stock Market (SSE Composite) - source: Tradingeconomics.com

One of those explanations focused on the need for reform. Once the economy and the markets undergo some key reforms, the market will take off. At least that was one of the theories. So now that some major reforms have been announced (see story), why hasn't the market responded? Donald Straszheim of the ISI Group wrote a comment this weekend that provides a hint...

ISI: - This week, PM Li said that China has entered a transition period - from 'high growth' to 'medium-high growth'. He's got the direction right. Li also indicated that China is losing its competitive edge in low- and medium-level (tech) products. He's right, sharp wage gains are eroding the Middle Kingdom's competitiveness. His solution - China must rely more on technological innovations to drive future growth. Unfortunately, innovation is and will remain, we believe, China's weak point. In other words, if innovation is China's future - that future is grim. China is a technology adaptor; it is not an innovator. Li made the above remarks at an annual government-sponsored meeting which highlights major accomplishments (and makes monetary awards) in the science and technology arena.

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From our sponsor:

Reduction in fiscal stimulus creates tight monetary conditions in China

China's short-term rates have spiked again. In a replay of this summer's liquidity squeeze (see post), term money market rates (SHIBOR and repo rates) have risen across the board. The PBoC had to inject liquidity to stabilize the situation.

WSJ: - The People’s Bank of China said Friday it had been forced to inject more than 300 billion yuan (US$49.2 billion) into China’s money markets over a three-day period after the interest rates banks charge each other for short-term loans surged to 8.2%. The injection helped bring down rates to 5.6% by Monday morning.

Last week’s levels were the highest since June’s cash squeeze sent short-term rates soaring above 28%. Then, China’s lenders were caught in a credit squeeze caused by a combination of factors, ranging from lower capital inflows and seasonal tax payments to a mismatch between banks’ short-term funding and longer-term lending. The PBOC let the problem fester before stepping in, to teach banks a lesson.

Source: China Foreign Exchange Trade System & Nation Interbank Funding Center

The explanation this time around seems to be reduced government spending. The banks and the economy as a whole rely on seasonal fiscal stimulus, which is not nearly as potent this time around. Reforms focused on reducing "unnecessary" government spending are being put in place.

WSJ: - Those seasonal factors have come into play now as well. But “the recent rate spike is, to a large extent, a reflection of the government’s tighter stance on spending,” Citigroup economist Ding Shuang said.

The Chinese government usually draws down fiscal deposits — the amount of funds the government keeps in the financial system—more quickly in December, as it speeds up spending and fiscal disbursements before the end of the year, UBS economist Wang Tao said in a recent note.

That boost in government spending adds liquidity to the banking system, and the PBOC normally withdraws liquidity at the end of the year to offset the inflows. This time, though, the government’s tighter fiscal policy means year-end spending has been restrained, Ms. Wang said.

China’s Communist Party has launched a campaign this year to crack down on unnecessary government spending, from official banquets to investment projects. Even budgeted investment projects that are deemed unnecessary won’t get funding, Citigroup’s Mr. Ding said.

Withdrawal from years of stimulus is bound to have its side effects. And tight monetary conditions are likely to be just a part of the overall impact.

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From our sponsor:

China's short-term rates spike to multi-year highs; SHIBOR and repo curves become inverted

China's interbank rates have unexpectedly spiked last week as the SHIBOR curve (China's LIBOR equivalent) became highly inverted. Given that there have been no indications of a change in policy by the PBoC (the central bank), there is only one thing that can cause such a move: a liquidity squeeze.

Source: Shanghai Interbank Offered Rate

China analysts point to a number of possibilities for this spike, including some action by the authorities to curb FX speculation or other trading activities. The best explanation however was that a panic ensued among China's banking institutions due to a rumor that several banks were about to fail. This rumor, though unverified, caused banks to cut lending to each other, creating a liquidity squeeze. The squeeze was exacerbated by China's markets being closed this Monday through Wednesday for the Dragon Boat Festival and liquidity already being tight coming into last week.

Reuters: - Early Friday, rates skyrocketed from already-high levels the previous day. Rumours that several mid-sized banks had defaulted on interbank loans added an element of fear to an acute liquidity shortage related to a coming national holiday and a slowdown in capital inflows. The rumours couldn't be verified.

The stock market tanked in response.

Shanghai composite

It is thought that the PBoC has stepped in on Friday afternoon to ease liquidity conditions. The spike in short-term rates was not limited to SHIBOR, as the repo rates (secured lending) have been on the rise in recent days as well (with the repo curve now also highly inverted).

Reuters: - The weighted-average one-day repo rate closed at 8.68 percent on Friday - the highest since October 2007 - from 6.15 percent on Thursday. It's extremely unusual for the one-day rate to move higher than the seven-day rate.

Dealers said the central bank had likely conducted short-term repos with selected banks, who were then able to transmit funds to the rest of the market.

Even the one-year government-issued bill rate spiked, indicating that the short-term liquidity concern has spilled over to some longer term instruments.

Source: Investing.com

This is a dangerous development, particularly when China is already struggling with a relatively weak (by historical standards) growth. While the nation's PMI numbers indicate an ongoing expansion on the whole, it is quite a slow one.

A spike in short term rates could dramatically dampen bank lending and slow growth even further. A prolonged spike could even put China into a recession. Many are hoping that the PBoC will deal with this issue aggressively by injecting more liquidity into the banking system in order to reduce the risk of a major credit contraction.

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From our sponsor:

Is China's anti-corruption campaign responsible for global commodities sell-off?

Commodities came under severe pressure yesterday, in part driven by some negative news out of China, the world's largest single consumer of natural resources.

CRB Commodity Index (Bloomberg)

The nation's GDP growth rate came in below expectations.

Source: Econoday

Anecdotal evidence suggests that some large hedge funds were forced to unwind commodity holdings across the board. This latest move has been extraordinarily painful for investors, who are left scratching their heads in trying to understand the fundamentals. Many point to China's lackluster industrial production as the cause for this weaker than expected growth. But there is a new theory emerging to explain China's negative surprise. Some analysts believe that the latest anti-corruption campaign is having a chilling effect on the nation's economy.

Worried about being accused of spending excesses, local officials have cut down on extravagant parties and gifts used to entice (and essentially bribe) central government bureaucrats. Restaurants and luxury goods have been hit especially hard.

Global Post: - Since the end of last year, Xi has spearheaded a drive to curb officials' notoriously lavish dinners and high-end gift-giving. At a Party meeting in December, he called for new regulations that require cadres to cut back on liquor, flowers and extravagant banquets. Some provinces even banned the use of red carpets to greet visiting officials.
...
"Abalone, baby birds, sharks, big prawns, sea cucumbers and geoduck clams are just some of the creatures who can breathe easier, for a bit at least," says Bill Bishop, a commentator in Beijing and author of the influential Sinocism newsletter. "But [food and beverage] businesses should expect more pain."

Can a slowdown in these sectors really have a significant effect on China's overall growth? Some economists are convinced that the impact is quite real and is indeed responsible for slower growth.

Bloomberg: - “The anti-corruption action by Xi is creating unprecedented phenomena, including an absolute fall in high-end restaurant sales,” said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong, who previously worked for the European Central Bank. “It’s certainly a big factor dragging down short-term growth.”

And that in turn could be a big part of the story behind the latest sell-off in commodities.

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From our sponsor:

China's drawdown of iron ore and steel inventories

This summer we saw massive builds of iron ore (see post) and steel inventories in China. That drove domestic prices to new multi-year lows (see post).  With China's economy beginning to stabilize (see post), these inventories are now declining.

Source: DB

Source: DB

According to Deutsche Bank, the restocking of these inventories should increase production and result in moderate price increases for iron ore. This is by no means a start of a new commodity boom - the market remains well supplied.

DB: - We expect that steel production rates in China could rebound into the end of the first quarter and potentially approach the 2.1mt/day level during the year. We expect that this in addition to a modest restocking event should help to push iron ore prices higher into mid-year.

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From our sponsor:

Positive numbers out of China providing some support to risk assets

Risk assets are surprisingly stable at the open on Sunday night, in spite of the news out of Europe (see post). Key development providing support to markets is the positive economic news coming out of China. Here are some of the recently released indicators:

1. Inflation rate seems to be at the lowest level since early 2010.

Source: Tradingeconomics.com

2. The official manufacturing PMI shows expansion  - quite modest, but expansion nevertheless (>50 = expansion, <50=contraction)

China (official) Manufacturing PMI, seasonally adjusted (source: Li & Fung Research Center)

3. Services PMI is also shows some signs of life.

Source: Markit/HSBC

4. Industrial production is up some 10% YoY. Not great relative to recent history, but still an improvement.

China Industrial Production YoY

5. The equity market, which has become too scary for retail investors (see discussion), had its biggest rise in 13 months.

The Shanghai Composite (source: WSJ)

Clearly there are still some major problems. For example a "wealth management product" sold at a branch of Huaxia's Shanghai Branch defaulted last week. There is certainly more to come (see this story). People have been talking for some time now about China's shadow banking and Huaxia's product should be a wake up call.

There are also problems with the property bubble, as housing now grinds higher for a sixth straight month. So much for making housing cheaper.

In spite of these issues, at least for now it looks like China has been able to avoid "hard landing" and is beginning to show some recovery.

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From our sponsor:

China's coal inventories rise as power usage declines; rebound expected

Thermal coal inventories at China's power plants continue to grow. This is an important leading indicator that analysts look to in order to understand inflection points in power demand and ultimately output growth.

Source: CS

The question of course is how to reconcile this with somewhat stronger indicators coming out of China these days. For example the official manufacturing PMI from October shows a slight expansion.

China Official Manufacturing  PMI (source: Fung Group)

But with the Markit/HSBC PMI indicating a slight contraction (see chart), the data is still mixed.

According to Credit Suisse, 75% of the increases in thermal coal inventory can be attributed to continuing relative weakness in China's Industrial production growth. China's official media seems to agree with this assessment, at least through September.

Xinhua - China's power consumption growth slowed further in September as factory activity and industrial output posted weaker increases amid the economic downturn.

The country's total electricity consumption grew only 2.9 percent from a year earlier to 405.1 billion kwh. The growth was 0.7 percentage point lower than that of August and 9.3 percentage points lower than that of September 2011, according to data from the National Energy Administration.

Source: tradingeconomics.com (click to expand)

However there is another factor at play that is contributing to high coal inventories. It is China's partial shift in sources of power generation away from coal toward hydroelectric power generation.

Source: CS

CS: - This soft thermal generation, as it has been all summer, was driven by a combination of weak IP [Industrial Production] – which accounts for ~75% of power demand – and the continued outperformance of hydro.

China's officials claim of course that the decline in electricity usage is temporary and, as Industrial Production picks up, so will power usage.

Xinhua - China's power consumption is expected to rise 4 percent to 6 percent year on year in the fourth quarter as the country's economy is stabilizing, the China Electricity Council (CEC) said on Tuesday.

That will bring electricity consumption in the entire year to 4.94 trillion kilowatt-hours (kwh), up 5 percent from a year earlier, the CEC said.

The country's total installed power generation capacity will hit 1.14 billion kilowatts at the end of this year, the CEC said.

Power demand and supply will be balanced because there are abundant coal stocks in most thermal power plants and hydropower plants, according to the CEC.

If that's the case, we should see thermal coal inventories begin to decline this quarter. Total coal inventory level remains a good indicator of China's industrial output growth, but one needs to take hydroelectric power usage into account in this analysis.

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Has China's Q3 GDP been grossly overstated?

Here is an interesting interview with Gordon Chang, who believes that China's GDP growth in Q3 has been grossly overstated. In his opinion the number should be closer to zero.

His view is based on slow growth in electricity production across China as well as consistently weak PMI numbers. The HSBC PMI has been showing a mild contraction every month throughout 2012.

China PMI (Source: HSBC/Markit)

He also points to an increasing risk of social unrest in China - which hasn't been covered by the media. This stems directly from the slowdown and the wealth inequalities that have developed in the country in recent years.

YF: - Another area of concern for Chang is the potential for unrest. While the saga surrounding workers at the Foxconn factories where Apple gadgets are made has been well covered, Chang says it barely touches on what is happening on a broader scale.

"Across Chinese society, the one factor that people always talk about is the anger," he says. But the reality is that the central government in Beijing no longer produces statistics on uprisings and protests, which by his estimates are now probably occurring at a rate that is ''north of 200,000 per year."

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China can't break dependence on the US, as America once again becomes China's largest export market

The recent spike in China's exports took many by surprise. According to the official sources, China's exports in September grew by some 10% from a year earlier - about 2% higher than expected. A great deal of that increase came from iPhones, iPads, Android phones, and other popular electronics orders.


Scroll to see expors by month (Source: tradingeconomics.com)


One fact that some analysts have overlooked however is that the key driver of China's export growth (and ultimately the GDP growth) continues to be the US.

Xinhua: - During [the Jan.-Sept (YTD)] period, trade with the European Union, China's largest trade partner, fell 2.7 percent year on year to 410.99 billion U.S. dollars, the figures showed.

... China's trade with Japan dipped 1.8 percent to 248.76 billion U.S. dollars, faster than the 1.4 percent decline recorded in the first eight months

Trade with the United States, the country's second largest trade partner, increased 9.1 percent to 355.42 billion U.S. dollars.

In fact in Q3 (for the first time in years) the US has once again become China's largest export market - now larger than exports to the EU.

China monthly exports to the US and the EU (Source: China Customs; NSA; USD MM)

China's dependence on exports to the US has largely become entrenched in the past decade, as the US rapidly shifted its Asian import portfolio from being dominated by Japan to largely concentrated in China.

Source: Barclays Capital

With Japan's and the EU's growth stalled, China's recovery is now even more linked to the success of the US turning its economy around. And with the US growth potentially stabilizing (see discussion), investors have turned somewhat bullish on China.

CNBC: - What a difference a quarter makes. After months of jitters over a possible hard landing in China, market watchers are quickly turning optimistic on the outlook for the world’s second largest economy following a spate of reassuring data this week.

But any hint of an economic slowdown in the US, and the "months of jitters" will return. As much as China has tried to shift more of its economy to domestic consumption, at least for now it is still heavily dependent on making iPhones, etc. for the US markets. China certainly can not afford to see a disruption in its export sector. That's why it shouldn't come as a surprise that Beijing is keenly interested in the outcome of the US elections (see discussion).

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Stresses in China's manufacturing sector point to further economic slowdown

The latest Foxconn incident (see video below) is raising more questions about China's manufacturing sector's ability to grow. It is becoming difficult to see how China's overall economy can expand at projected rates with such uncertainties around manufacturing.

WSJ: - The riot raises questions about the sustainability of China's vaunted manufacturing machine. And it poses a challenge to the government that is struggling to satisfy the soaring expectations of a new generation of Chinese workers who came of age in an era of double-digit economic growth and are less willing than their parents to make personal sacrifices for their country...

We are now seeing clear signs of strain faced by China's high tech factories as they attempt to squeeze more production out of their thin margins (discussed here) - and hitting bottlenecks in the process

FT: - [Foxconn] is the sole assembler for the iPhone 5 this year, with 80-85 per cent of shipments next year as well, according to analysts at Barclays. At an estimated $8 a phone, that workload brings in revenue, but has also put the company under strain. To handle Apple’s demands, Citi analysts estimate, Hon Hai must increase headcount at its Zhengzhou iPhone factory from 150,000 workers in June to 250,000 in October.

The relentless selloff in China's domestic stock market is reflecting this uncertainty in manufacturing growth (as well as the renewed volatility in Europe). The Shanghai Composite Index hit a new multi-year low this morning.

The Shanghai Stock Exchange Composite Index (Bloomberg)

China's official news has little on the incident in Taiyuan, but the authorities are clearly preparing the population for weaker growth ahead. As discussed about a year ago (see post), the impending slowdown will increase risks of social unrest and possibly additional production disruptions. That in turn will hurt confidence and investment, as the economy will become increasingly dependent on government stimulus.

China Daily: - China's economic growth is likely to slow for its ninth consecutive quarter in the period from July to September, top policy advisers said on Tuesday.

If their predictions prove true, the government may find itself taking "remarkable measures" to combat the slump, they said.

Zheng Xinli, deputy head of the China Center for International Economic Exchanges, a government think tank, said China’s economic data for August has turned out worse than expected and the economy’s prospects remain gloomy. Amid those circumstances,the country’s GDP is unlikely to grow at a faster pace in the fourth quarter.

"The urgent need right now is to clarify what are the most effective ways to boost domestic demand," Zheng said.

Source: Reuters

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China's shifting demographics and their impact

China's changing demographics now pose risks to global economic output for the simple reason that the nation is currently responsible for about 40% of world's GDP growth.

Global GDP growth (Source: DB)

It is therefore important to understand what is driving China's population dynamics (h/t @Frances_Coppola). Here are some facts (also discussed in some detail here):

1. China's population is ageing.

BBC: - Chinese women are having fewer children, but having a smaller generation follow a boom generation - and longer life expectancies - means that by 2050, it is expected that for every 100 people aged 20-64, there will be 45 people aged over 65, compared with about 15 today.

2. Ageing population is expected to have a negative impact on China's labor force growth.

Source: DB

3. Declining labor force will limit economic growth.

DB: - Over the medium term the country will be faced with a more hostile demographic outlook, as labour force growth turns negative [above]. Alongside weaker western world growth, this will help to explain why Chinese growth will moderate from 10-12% to between 7-9% over the next few years.

4. Some argue that the slowdown will be more dramatic and may even result in social unrest.

BBC: - The rapid ageing process will also bring with it political difficulties. The legitimacy of Chinese communist party as a ruling group of the country since the Tiananmen Square massacre in 1989 has been based on its maintaining rapid economic growth.

An economic slowdown could prompt challenges to party's legitimacy.

Existing disadvantaged social groups, such as migrant workers and pensioners, especially those in rural areas, will be most severely affected, and the social unrest sometimes experience in China now could become increasingly common.

5. It seems that China's one-child policy is not necessarily the cause of declining birth rates (although Beijing is convinced that it is). Many will find this surprising, but the decline in fertility may have continued at the same or even sharper pace without this policy (as it did in other nations).

BBC: - China had a remarkable success in fertility reduction in the 1970s, before the introduction of the one-child policy: China's fertility dropped from 5.8 children per woman in 1970 to 2.7 in 1978. The model suggests that fertility would have continued its decline without the one-child policy, and possibly would have declined even faster.

This last point seems to be counterintuitive, but one explanation could be that the policy caused anxiety among the population, which prompted many to have children at an earlier time. There was a decline in age at first marriage and age at first childbearing in the 1980s.

6. The one-child policy however had negative "unintended consequences". They included "forced abortions, sterilisations and sex-selective abortions, which have skewed China's sex ratios; the latest census figures suggested nearly six boys were born to every five girls" (BBC). The skewed sex ratio (119 boys per 100 girls born in 2012) is a dangerous development that could result in social unrest.

7. Population ageing was caused not just by lower birth rates but by a "significant increase in the country's life expectancy. People are living longer life thanks to significant improvements in living standards, including improved nutrition, access to education and medical care" (BBC).

8. However China is not prepared to handle (and fund) the rapid growth in the elderly population.

Source: BBC

BBC: - You can glimpse what China faces in 20 or 30 years in one of the few hospices in Beijing. The elderly and dying are lined up in basic wards, some tied to their beds, some hardly moving at all. All have the illnesses of an ageing population.

These facts are not simply an academic curiosity. Given how uncertain global economic growth trajectory has become, some of these changes in China will be even more impactful going forward.

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