Workers distribute packs at S.F. Express in Shenzhen, China, on Nov. 11, 2013. Private companies in China have stopped to invest in further expansion in 2016. (ChinaFotoPress/ChinaFotoPress via Getty Images)Workers distribute packs at S.F. Express in Shenzhen, China, on Nov. 11, 2013. Private companies in China have stopped to invest in further expansion in 2016. (ChinaFotoPress/ChinaFotoPress via Getty Images)

Previously the engine of relatively efficient growth, it looks like the private sector has given up in China. Investment by private companies went negative in June and decreased another 0.6 percent in July. That’s right, negative growth month over month, something completely unfathomable during the boom years of above 20 percent growth just a few years ago.

“We believe private [investment] slowdown is more structural this time, dragged by weaker investment return and falling business confidence amid limited reforms and deregulation. Strong State Owned Enterprise (SOE) investment is unlikely to fully offset the weakness, instead, it could create more excess capacity and deteriorate capital returns,” the investment bank Morgan Stanley writes in a note.

For the first half of 2016, private investment is only up 2.4 percent over the year. This is worrying because the private sector is responsible for most of China’s real economic development and relatively efficient capital allocation. 

The government will try to coopt the private sector into spending through monetary and fiscal policies.

— Viktor Shvets, global strategist, Macquarie Securities

To balance the decline in private investment, the state used SOEs as countercylical fiscal policy instruments. SOE’s share of investment in fixed assets rose 23.5 percent compared to the first half of 2015. Because of inefficient investments from years prior, overcapacity, and mounting defaults, Morgan Stanley thinks this is ill advised. 


(Morgan Stanley)

(Morgan Stanley)

Morgan Stanley notes that private companies are avoiding sectors such as mining and steel, which are plagued by overcapacity. But they also cannot invest in the service sector as they please because of high entry barriers and too much regulation.

Private investment outside of manufacturing—read services—declined 1.1 percent in the first half of 2016 over the year, compared to 15 percent growth in 2015. SOEs, on the other hand, boosted investment in services 39.6 percent.

So much for a successful rebalancing to services, which has been considered a linchpin of the effort to reform the Chinese economy. It’s happening, but at the behest of the state.



(Morgan Stanley)

(Morgan Stanley)

Overall, there just aren’t enough good investment opportunities around and the borrowing costs for private firms are as high as 15 percent, much higher than the return on assets. Unlike their state-owned counterparts, private companies actually try to be profitable—and they don’t see profits in China’s slowing economy.

In addition, the lack of progress in the much-touted reform agenda hurts business confidence and financial visibility. Zhang Qiurong, who owns a specialty paper business told the Wall Street Journal: “The economic outlook is really grim. You have to survive, that comes first.”

Mr. Zhang’s feelings are reflected in the China Economic Policy Uncertainty Index, which has been increasing steadily in 2016, almost reaching the record levels of uncertainty seen during the last handover of Communist Party leadership in 2012.

The economic outlook is really grim. You have to survive, that comes first.

— Zhang Qiurong

The result of the uncertainty? Companies are stashing money at the bank and just won’t spend and invest it. 

“Despite loads of liquidity pumped into the market, enterprises would rather bank the money in current accounts in the absence of good investment options, which is in line with record low private investment data,” Sheng Songcheng, head of statistics and analysis at the People’s Bank of China said earlier this year. Cash and short-term deposits at banks grew 25.4 percent in July.

To counter concerns of crashing private investment in China, the regime promptly announced private-public partnership (PPP) investment programs worth $1.6 trillion and spanning 9,285 projects, first reported by Xinhua on Aug. 15.

“The government will try to coopt the private sector into spending through monetary and fiscal policies,” says Viktor Shvets, global strategist at Macquarie securities.

The problem is that this strategy is unlikely to work. 

“The impact of PPP on China’s investment growth is likely to be limited, considering the small share of PPP projects in execution (less than 0.5% of total [investment]), the still low participation ratio by private investors … International experience shows that private financing of public investment entails large fiscal risks in the absence of a good legal and institutional setup,” writes Morgan Stanley. And a good legal and institutional set-up is not what China is known for.

If the PPP and short-term monetary and fiscal stimulus won’t work, China actually has to deliver on reforms to get the private sector to spend again. 


Read the full article here

Local Chinese residents walk on a flooded street in heavy rain in Wuhan, central China, on July 6 2016. (Wang He/Getty Images)Local Chinese residents walk on a flooded street in heavy rain in Wuhan, central China, on July 6 2016. (Wang He/Getty Images)

Chinese president Xi Jinping seldom comments directly on the economy. Instead, he lets his premier Li Keqiang do the talking. Or Xi speaks through one of the regime’s mouthpieces like People’s Daily or Xinhua.

On July 21—only one week after China published unexciting GDP figures—it was Xinhua who came out with a commentary on how important reform is for China and that there is no alternative to short-term pain and long-term gain.

“China must push through reform, for there is no plan B,” the mouthpiece states.

The article is just a Xinhua commentary and didn’t cite an “authoritative person” like the People’s Daily usually does, but given the amount of control Xi personally exerts over the media, it probably had his blessing. 

Piecemeal solutions no longer work.

—  Xinhua

The article espouses the reform narrative we have heard previously: market reform, sustainable growth model, innovation, consumer spending, supply-side structural reform, cutting red tape etc. So we can assume that Xi and his premier still stand behind the reform agenda.

“What is called for is not temporary fixes: My government has resisted the temptations of quantitative easing and competitive currency devaluation. Instead, we choose structural reform,” Xinhua quotes premier Li Keqiang. 

Reality Check

The problem, as it is the case so many times with Chinese media and utterances from the Communist Party, is that the claims don’t reflect reality.

With respect to temporary fixes, China just created a record amount of credit in the first quarter, amounting to $712 billion in new loans. These loans did not go into the private sector as Li claims but broadly speaking boosted investment by state enterprises.

Chinese ship-builders, for example, reported a surge in orders by volume of 44.7 percent from January to June this year compared to last year. Private investment on the other hand only grew 3.9 percent in the second quarter of 2016, whereas total investment rose 9.6 percent.

“State Owned Enterprises (SOE) continue to invest in the overcapacity industries, which suffer from slower growth in production,” writes the investment bank Natixis in a note.

However, judging from the Xinhua piece and others before, the regime clearly recognizes the problems: “Problems facing China’s economy, including a troubled property sector, industrial overcapacity, rising debt levels and the lack of new growth engines, are all connected with each other and piecemeal solutions no longer work. The only way to restore vitality to the economy is to push through reforms.” They aren’t happening.

Instead, central bank officials are calling for fiscal deficits of up to 5 percent to support the economy and they admit traditional monetary stimulus is not working anymore. 

“Despite loads of liquidity pumped into the market, enterprises would rather bank the money in current accounts in the absence of good investment options, which is in line with record low private investment data,” Sheng Songcheng, head of statistics and analysis at the People’s Bank of China (PBOC) said recently.

You can have a good old financial crisis without having the 1997–1998 Asian foreign debt issue.

— Willem Buiter, Citigroup

Willem Buiter, the chief economist of Citigroup says China needs to recapitalize the banks and go through a round of central bank financed deficits to clear up past excesses. He thinks China won’t avoid a financial crisis otherwise:

“Unless they are willing to go for Chinese helicopter money, fiscal stimulus targeted mainly at consumption not at investment. Yes, some capital expenditure like social housing, affordable housing, yes, even some infrastructure. But organization supporting infrastructure, not high-speed trains in Tibet. It has to be funded by the central government, the only entity with deep pockets, and it has to be monetized by the People’s Bank of China.”

Debt Semantics

Speaking about debt and a financial crisis, naturally, Xinhua has a differing view: “Most of China’s debts are domestic, and its debt levels are within control and lower than other major economies. A moderate deficit level (2.4 percent in 2015 and a target of 3 percent for 2016), large household savings and massive foreign exchange reserves strengthen the country’s ability to endure risk.”

Forget about the fact that central bank officials are already calling for a 5 percent deficit, Standard and Poors just released a report warning about China’s dangerously high debt levels. “The downside risks are material, especially if Chinese authorities lose their grip on rebalancing the economy,” it states. 

china debt

Foreign exchange reserves have decreased from $4 trillion in 2014 to $3.2 trillion now. Hedge fund managers like Kyle Bass of Hayman Capital think the crisis threshold is at around $2.5 trillion. 

“They are so far ahead of the world’s excesses in prior crises, we are facing the largest macro imbalance in world history,” he told RealVisionTV.  

Willem Buiter says the debate of external versus internal debt is largely meaningless: “You can have a good old financial crisis without having the 1997–1998 Asian foreign debt issue.” 

Both Kyle Bass and Buiter see a further devaluation of the Chinese currency as highly likely. “The Chinese government wants a devaluation, they just want it on their terms. In the next two years, this is happening,” says Bass.  

One thing Xinhua gets right: The days of double-digit growth are over. “To be sure, China’s economy cannot, and should not, repeat its past growth record. It may be on a bumpy journey, but will maintain a slower, but stable growth.” Which is the best the country can hope for. 

Follow Valentin on Twitter: @vxschmid

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Chinese workers prepare stuffed toys at a factory in  Zhejiang, China, September 17, 2015  (Kevin Frayer/Getty Images)Chinese workers prepare stuffed toys at a factory in  Zhejiang, China, September 17, 2015  (Kevin Frayer/Getty Images)


Any kind of improvement will have to start somewhere. For the Chinese economy, the starting point is the second quarter of 2016, at least according to the data experts at China Beige Book (CBB).

Every quarter they survey thousands of Chinese companies and ask them whether their revenues went up, whether they are hiring or not and what they think of the future.

The results are a much better representation than official data, which often follows CBB’s lead a quarter or two later.  

Transport construction followed its worst performance ever in Q1 with its largest improvement ever.

—  China Beige Book

So after a pretty bad first quarter, CBB says most indicators improved in the second quarter, although activity is roughly flat over the year. In most cases, less than 50 percent of survey respondents report an improvement in sales, hiring, capital expenditure, or bank lending.

So the results hardly represent a booming economy, but are much better than the below 40 economy from the first quarter.

“The rebound constitutes a performance roughly echoing that of a year ago—profits and capex were moderately better than the second quarter of 2015, revenue and wage growth were similar, and output, new domestic orders, receivables, and payables all weakened over the past year,” CBB states in an advance release of its report

The problem: The report for the second quarter of 2015 looked similar, only for things to get worse later.

But let’s focus on the improvements first, which in most cases confirm official data throughout the second quarter.

Fiscal Stimulus

After the central government made it clear it would turn on the spigots of fiscal stimulus and targeted a 3 percent deficit for 2016, it followed through.

According to CBB, one of the prime targets for fiscal spending is the transportation sector, which is largely controlled by the government directly or State Owned Enterprises (SOE).

“Transport construction followed its worst performance ever in Q1 with its largest improvement ever, a reversal which is difficult to explain except by citing (effective) government action,” states the report.

So revenues improved at 59 percent of the transportation construction companies surveyed, which is 43 percentage points higher than in the first quarter.

New data from our 3,000-firm survey is still more optimistic, showing Q2 capex recovering sharply from first-quarter weakness.

—  China Beige Book

Transportation revenue in general improved at 57 percent of the firms and most companies (63) forecast higher revenues in the next six months. Also of note, 51 percent of steel companies reported higher revenues, possibly connected to the increase in transportation construction.

Another favorite for government stimulus is real estate, it also improved. Half of the firms reported increases in revenues this quarter, an improvement of 23 percentage points. It’s interesting to note that the best performers came from the less loved Tier 3 cities.

This fits the narrative of the official data which reported vast price increases and volume increases. Residential real estate construction lagged at 43 percent, hardly surprising with 18 million of unsold units still on the market.

(Capital Economics)

(Capital Economics)

Services Up

The service sector also showed some real gains, a feat many have been waiting for in the China rebalancing story. Revenues for service sector firms increased in 57 percent of the cases, a boost which is likely disconnected from government stimulus and fits the rebalancing story from manufacturing to services.

“This is a difficult performance to replicate, but it’s exactly what services must do in order for overall growth to be maintained as excess manufacturing capacity is addressed, states the report.”

Media, restaurants, healthcare, and IT all did well.

The Below 50 Economy

The rest of the economy is the below 50 economy. Better than last quarter, but less than half of firms are making serious headways. Capital expenditure, manufacturing, retail, commodities, and residential real estate construction all fall into that category, broadly echoing official data.

CBB notes that private investment has not decoupled from public sector investment and should see a rebound soon. Most official data shows a big drop in private investment whereas state investment is rising.  

“New data from our 3,000-firm survey is still more optimistic, showing Q2 capex recovering sharply from first-quarter weakness,” states the report. “Private firms led the way in Q2.”

Despite the overall positive report, some dark spots still remain. Only 37 percent of companies are hiring more people, especially private firms. The labor market remains right, especially unskilled labor supply only improved at 29 percent of companies, confirming official data that migrant workers are not leaving the countryside anymore.

(Capital Economics)

(Capital Economics)

Coal companies did particularly bad in the commodities sector, with only 33 percent of companies showing an improvement. Exports for the whole of the manufacturing sector improved at only 34 percent of companies.  

Bank lending to companies is also not happening, despite China’s record credit binge in the first quarter. Borrowing increased at only 17 percent of the companies, as application for loans increased at 37 percent and availability of loans increased at 33 percent. Almost a fifth of all loan application is rejected, according to the bankers responding to the survey.

Almost a fifth of all loan application is rejected, according to the bankers responding to the survey.

Because firms are not demanding new loans, interest rates also dropped across the board (bank, bonds, and shadow loans) and remain near record lows, one reason why the yuan was under constant pressure in Q2.

Read the full article here

Financial markets usually take a shorter term view and focus on things like quarterly economic growth, the exchange rate, as well as capital flows—especially when it comes to China recently. 
Every once in a while, it’s good to focus on some longer term indicators, which will shape the economy for the next decades, like population growth and the availability of workers.
Case in point: Every year the National Bureau of Statistics (NBS) in China puts out a report analyzing the status of migrant workers and just released the one for 2015.
There are major demographic shifts underway, including that the working age population has peaked. , Capital Economics

Because migrant workers usually work without formal contracts and in very economically sensitive segments like construction and manufacturing, changes in wages and employment provide a good snapshot of where the overall job situation and economy are right now.
Longer-term trends in worker migration describe the potential for the economy to increase productivity per worker, as they move from lower value-added jobs like farming in the countryside to higher value-added jobs in the city. This was big in China over the last 20 years.
Capital Economics
Chinese migrant workers make up 277 million or one-third of China’s workforce. Some of them actually don’t move from their home province and just work in different jobs from agriculture in their home provinces. They are still classified as migrants because of China’s hukou registration system. Some of them move to another province in China to try their luck to build a better future. 
For the short-term, the report confirms that the Chinese economy is getting worse, as other on-the-ground surveys confirmed throughout 2015 and the first quarter of 2016.
Wage growth slowed from 9.9 percent in 2014 to 5.6 percent in 2015 on average, with manufacturing and construction showing the biggest declines.
The number of workers not paid on time increased to 2.8 million during that period, the bulk of them coming from those two sectors. On average, they will have to do without three months’ pay for the foreseeable future.
For the long-term view, the trend of migration from the countryside to the cities, which contributed to China’s fast economic growth for the last 20 years is probably over.
The pool of surplus workers in the countryside has now all but dried up. , Capital Economics

“There are major demographic shifts underway, including that the working age population has peaked,” research firm Capital Economics writes in a note to clients.
The net increase in migrant workers peaked in 2010 at around 12 million; last year they only increased by 3.5 million. According to Capital Economics and other researchers, China has reached the Lewis Turning point—the move from the countryside to cities is over.
The Chinese regime wants to increase the number of people with urban hukou to 45 percent by 2020 from around 35 percent in 2014. It may succeed because of a bureaucratic trick. 
Capital Economics
“The government has been granting more urban hukous to migrant workers since 2010. Once migrants have an urban hukou they are reclassified as urban workers and removed from the migrant data,” Capital Economics states.
This is positive for the statistic, but does not change the economic reality on the ground, as only migrants who already live in the cities can get the urban hukou.
The population still left in the countryside is staying put as the wages for agricultural work have risen and the country faces shortages of important food items, such as pork. 
“The pool of surplus workers in the countryside has now all but dried up. Rural wages are rising rapidly making it harder to entice them to go elsewhere,” writes Capital Economics.
Urban Benefit
Consulting firm McKinsey, however, is going against the grain and suggests Chinese consumers aged 15-59 and living in cities will increase by 100 million by 2030.
“By 2030, the number of consumers in this segment will grow by 20 percent. … Their average per capita consumption is expected to more than double from $4,800 per person annually to $10,700. By 2030, this group will spend 12 cents of every $1 of worldwide urban consumption,” McKinsey states in its Urban World Global Consumer Report without saying how it obtained the data or its estimates.
According to the chart below, McKinsey expects the population aged 15-59 to keep growing in most urban areas in China. 
The projection comes despite the fact that this age group declined by almost 5 million in the whole of China in 2015 according to official data, and other institutions like the World Bank, expect the working age population to decline another 10 percent by 2040.   

Read the full article here

Not a day goes by without talk and commentary about China’s debt situation. Yesterday, it was Société Générale’s Yao Wei sounding the alarm bell, this time it is Paul Krake from View From the Peak investment research.
“We had a false start in a rebound in Chinese economic in the first quarter of the year … The Chinese leadership is very concerned about the current debt dynamics in China,” he said in an interview with RealVisionTV. 
Activity rebounded a bit during the first quarter, thanks to a record amount of new debt, but this stimulus is already wearing off again and Krake thinks the Chinese regime won’t engage in continuous stimulus and debt expansion. 
“Any thoughts or hopes of a large credit-fueled stimulus from Beijing is barking up the wrong tree. As a result, aggregate demand globally is going to be poor.”
(Visual Capitalist)
And even if China succeeded in changing its economy from capital investment to consumption, the transition will take a long time, slow down Chinese growth and hurt other emerging markets.
“Unfortunately for China and more unfortunately for the world is that no one outside China wins in a world dominated by Alibaba and Ping An insurance. Brazil doesn’t care if the Chinese buy more insurance policies. Indonesia doesn’t care if more Chinese are going to the movies or buying stuff online. The emerging world is still very much dependent on Chinese fixed asset investment and that is in structural decline.”
Nevertheless, Krake thinks the Chinese regime has means and ways to manage a debt crisis, similar to Société Générale’s analysis of a possible debt restructuring.
“We are not in a crisis mode. China has a lot of debt and we all know that,” he says. But: “The Lehman- style moment that many are espousing is not going to occur.”
The same goes for the management of the currency, where many speculators are betting on a large one-off devaluation of the yuan. 
“I don’t really see a one-off disorderly devaluation of the yuan coming. The Chinese have plenty of policy tools, both draconian and market related, to stem the flow of capital flight.”
These tools don’t change his opinion on whether the world should buy China now or not: “China is broadly uninvestable.”

Read the full article here

By now most people have realized that China is, one, addicted to debt and, two, its debt addiction is not sustainable.
Any country investing around 50 percent of GDP in infrastructure and productive assets over a decade or so will run into overcapacity problems. Overcapacity simply means there is infrastructure and factories to make things, but nobody is consuming them.
No, or not enough consumption means no cash flow and if the projects are debt-financed this creates a payment problem.  
It is impossible to avoid deterioration in the efficiency of credit allocation with the pace of debt growth that China has seen. — Wei Yao, Société Générale

China fans—until recently—have brushed this argument aside saying that the country is growing very fast and will one day be able to use this infrastructure. Furthermore, the totalitarian communist regime could always bail out everybody.
There are still some people who believe China will escape its 300-350 percent debt to GDP load and decreasing debt efficiency without much of a crisis.
This optimistic scenario is unlikely to happen according to Société Générale’s chief China economist Wei Yao. She thinks China has to restructure one way or another and presents some more realistic albeit unpleasant outcomes.
(Société Générale)
“It is impossible to avoid deterioration in the efficiency of credit allocation with the pace of debt growth that China has seen. In our view, the reason that China has so far avoided a banking crisis is because it remains a relatively closed system,” writes Yao.
The main problem, according to Yao, are the State Owned Enterprises (SOEs), which have the most debt (127 percent debt to GDP), worst profitability (3.4 percent of GDP), and worst return on assets (smaller than 2 percent). More than a quarter of the industrial SOEs are consistently loss-making.
Total losses in the banking sector could reach $1.2 trillion, equivalent to more than 60 percent of commercial banks’ capital, 50 percent of fiscal revenues and 12 percent of GDP. — Wei Yao, Société Générale

Given their track record, Société Générale estimates about 18 percent of SOE debt could go bad, leading to total losses of around $800 billion. Losses to the Chinese banking system because state banks own most of SOE loans and bonds.
The Communist Party ultimately controls the whole banking system either outright or through the state organs. And it’s CCP officials who benefit most from corruption. “The bankers, whose primary allegiance is to the Party rather than to their institutions, still have little choice but to support local government projects,” Mark DeWeaver wrote in his book “Animal Spirits With Chinese Characteristics.”
(Société Générale)
So Société Générale thinks that”all in all, SOE debt restructuring could jeopardize 50 percent or more of the banks’ capital base, which—if it materializes quickly—would almost certainly knock China’s banking sector into a systemic crisis.”
While these words may sound shocking to the uninitiated, it is nothing we haven’t seen before. China had to bail out SOEs and banks in the late 1990s when 30 to 50 percent of all debt went bad.
In the late 1990s, the government completely bailed out the SOEs and the banks, but this is unlikely to happen again.

So bailing out the SOEs will also involve bailing out the banks as well. Nobody likes bail-outs, but Société Générale has some suggestions how to minimize the damage.
First, the so-called “zombie companies” should be closed down systematically and the debt written off. Given the magnitude of the bad loans, however, the banks cannot shoulder that cost alone, a cost which is going to be higher than just the bad SOE debt.
Because of some knock on effects and some private sector problems, “total losses in the banking sector could reach $1.2 trillion, equivalent to more than 60 percent of commercial banks’ capital, 50 percent of fiscal revenues and 12 percent of GDP.”
Restructuring Options
In the late 1990s, the government completely bailed out the SOEs and the banks, but this is unlikely to happen again.
“Previously, the government—also the sole shareholder of China’s banking sector at the time—picked up the lion’s share of the bill, and it received significant help from solid economic growth in the 2000s. This time, not only will that same split be hard to achieve—and it should not be replicated—but future economic growth will not be as helpful either,” writes Yao.
Aside from forcing banks to exchange bad debt for an equity stake in the troubled company, which is a short-term fix, banks will have to use up their existing capital base and also raise new money from private investors.
The central government would then issue new bonds (currently only 15 percent of debt to GDP are in the form of government bonds) to the tune of 10 percent of GDP.
The bottom line is that the government bail-out program could be designed in a way to greatly limit its impacts on currency and capital account stability. — Wei Yao, Société Générale

“The new [bond] supply would be equivalent to 3-9 percent of GDP, 12-35 percent of fiscal revenues and 20-60 percent of outstanding [bonds]. In addition to bank recapitalization, the government would have to provide fiscal support to address unemployment pain and other social effects. The total fiscal bill would probably be considerably more than 10 percent of GDP.”
The People’s Bank of China (PBOC) could play a role by either doing Quantitative Easing (QE) and buying up some of the bond supply or by using up its foreign exchange reserves to make up for the banking losses. It would have to because the Chinese bond market is not liquid enough to just double in size within the space of a year or so. 
Both options are not without problems, however, as QE would put further pressure on the already brittle currency whereas the selling of foreign exchange reserves would put deflationary pressure on the already deflating manufacturing economy.  
In the best case scenario, those two factors could offset each other.
“The bottom line is that the government bail-out program could be designed in a way to greatly limit its impacts on currency and capital account stability. Such designs seem

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On the surface, things are quite straight forward: China has been growing fast thanks to a historic expansion in debt and recently failed to transition its economy from investment in things that don’t move to consumers who move around and buy stuff.
It has taken the market quite some time to come to that conclusion as most people thought the central planners in Beijing were invincible. Now, the sentiment is more negative, despite another ramp up in debt and investment to stabilize the economy in early 2016.
Investment bank Macquarie, however, goes against the grain and says China’s debt problem is misunderstood and there is untapped potential in the Chinese economy.
First of all, Macquarie states the debt is not the problem: “Focusing on debt misses the main point: debt under state capitalism is different from that in market economy,” it states in a report.
State capitalism in China’s case means China controls who lends and who borrows by owning most of the banking system as well as the State Owned Enterprises (SOE). It also writes the accounting rules and can tell banks to roll over debt indefinitely. China’s banking system was bust at the end of the 1990s and the regime swept the problem under the rug by setting up bad banks and using accounting gimmicks to forget about the problem.
In principle, the regime could do this again, although it likely won’t get away scot-free this time. “The hope, again similar to the 1999 crisis, is that nominal growth will grow enough to reduce the debt to GDP ratio to a manageable proportion. However, given the environment of slow growth amid collapsing productivity, such a strategy could instead lead to the scenario of Japan’s ‘lost decade’,” the Institute of International Finance states in a report.
Declining capacity utilization rates are only one indicator that a lot of capital and labor was wasted and therefore won’t generate much nominal GDP growth in the future without further increasing debt.  
Another thing has changed from 15 years ago: China doesn’t control its depositor base as tightly as before. Chinese savers, who are the ultimate lenders in the Chinese economy, were mostly confined to saving money in the form of bank deposits. And although bank deposits still make up the majority of savings, Chinese savers have used the liberalization of the financial system to get money out of the country.
Even the state controlled companies (who can also be savers, depending on the sector and company) have ramped up overseas investments, contributing to the  $676 billion in outflows in 2015. Macquarie also notes “foreign asset accumulation is more of a concern,” now and that outflows have a significant impact on China’s monetary policy.

As for the positives, Macquarie buys into the themes of further urbanization as well as increases in productivity, consumption, and services. The key point according to Macquarie, which may indeed be missed by the markets, is that more than 56 percent of the population lives in the cities, but only 40 percent have been properly registered under the Hukou residency system.
It also notes that China’s top four cities contribute less to the country’s GDP than either London or Tokyo, which is why there is further upside. And while most observers agree that a reform of the Hukou system would liberate millions of Chinese others doubt the service and consumer revolution that Macquarie thinks is going to happen just because it churns out more college graduate than everybody else.
“Sheer numbers of graduates are not translating into talent that can turn ideas into scalable businesses,” Eric Roth, head of Mc Kinsey’s Global Innovation and Growth Practice, wrote on the company’s blog.
“Chinese companies have an abundance of structures and processes, but suffer from the inability to translate these into an increased stream of value-creating innovation.”

Read the full article here

Let’s start with the facts: During the first quarter of 2016 and during a time when the Chinese economy stared into the abyss, the Chinese financial system created $712 billion in new loans. This is the highest amount of loans created on record, even higher than in 2009, right after the financial crisis.
Because China has one of the highest debt loads on the planet (346 percent of GDP according to Rabobank estimates—others estimate as low as 250 percent), analysts are sounding the alarm bells.
If China’s new loans were a whole economy, it would be bigger than Indonesia and the Netherlands. (Royal Bank of Scotland)
“China has engineered yet another credit boom to arrest the sharp drop in growth,” writes Marcus Wright of the Royal Bank of Scotland. What he means with “yet another” is the previous record build up in debt after the financial crisis which went almost exclusively into projects with little or no economic value. This is why the analyst calls the increase in debt a move “further away from what is desired.”
After all, even the Chinese regime admitted it needs to reduce investment spending, cut overcapacity, and rebalance the economy toward more consumer spending. So what about the record increase in debt in the first quarter? Not to worry, says Xinhua, the regime’s mouthpiece in an editorial published May 2.
“China will not resort to large stimulus measures; policymakers are more than aware of the consequences of such a short-sighted program,” it says, adding that “fears are unfounded” and that “this rapid increase in loans is temporary.”
The ramp up in debt is reminiscent of the financial crisis (Royal Bank of Scotland)
Note that Xinhua speaks of stimulus in the future tense, as if the increase in debt wasn’t stimulus that already happened in the first quarter and as if banks were somehow independent of the central government. Because the central and local branches of government own most banks in China, almost any increase in debt is equivalent to official government stimulus, as Mark DeWeaver demonstrated in his book “Animal Spirits With Chinese Characteristics.“
Christopher Balding, professor of economics at Peking University had this to say about the Xinhua editorial: “I think you guys already missed that off-ramp,” he commented on Twitter.
Further evidence he may be right and Xinhua may be wrong: The fiscal deficit. China usually runs deficits of about 1 percent, with notable exceptions during the financial crisis, when it approached 3 percent. This year, the regime is targeting a deficit of 3 percent or more, making it the highest in 34 years.  
(Royal Bank of Scotland)
Again, Xinhua thinks this will all be productive investment in the long-term: “However, instead of being channeled to investment projects with short-term impact on GDP, as was the case back then, the lion’s share of the current new loans ended up funding long-term programs, supporting small businesses, and facilitating consumption, such as housing.”
We all know accurate statistics isn’t exactly China’s strong point, but counting housing as consumption is a novelty even the National Bureau of Statistics would have a bone to pick with.
Also not consumption is what Xinhua lists as “the start of numerous infrastructure projects,” and the systematic stockpiling of commodities.
Instead, the Royal Bank of Scotland thinks China has exactly the same problems as before and has abandoned the rebalancing objective to keep the economy from crashing.
“The economy remains beset by: an excessive reliance on investment driven growth; a structurally low share of GDP going to household incomes; overcapacity in key sectors; hidden non-performing loans in the banking sector [and] ad-hoc, reactive policy-making that fails to address the underlying distortions in the economy.”
Or in the words of famous psychologist Abraham Maslow: “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.”

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Every economy has themes. For the Chinese economy, the only theme up until recently was rapid growth. First because of exports, then because of investment in infrastructure and factories.
The Chinese economy of 2016 has many different themes. One theme is an unprecedented economic slowdown, reflected in official numbers and much worse in unofficial estimates. But then there is the theme of rebalancing. The old economy of manufacturing, investment, and exports is slowing down but the new consumer and services led economy is supposed to take over the baton.
With official sector data notoriously unreliable, China analysts get conflicting messages and don’t know which theme is actually happening. To shed light on this murky situation, Leland Miller and his team at the China Beige Book (CBB) interview thousands of companies and hundreds of bankers in China each quarter to get an accurate gauge of the themes prevailing in the Chinese economy.
Led by rising layoffs at private firms, first quarter job growth took another notable hit.— China Beige Book

CBB collects data from thousands of Chinese firms every quarter including some in-depth interviews with local executives. Although the CBB does not give definitive growth numbers, it logs how many companies increased their revenues or how many laid off workers, for example.
Labor Weakness
The most interesting finding of this quarter’s report is that the labor market is finally reflecting the weakness in the general economy. This hasn’t been the case throughout the slow-down, which started in the second quarter of 2014 according to the CBB data.
“Led by rising layoffs at private firms, first quarter job growth took another notable hit, sliding to a new four-year low. Expectations of future hiring have also taken a dive,” states the report. Only 23 percent of respondents said they were hiring, with 15 percent of companies said they are firing. China has announced it will lay off millions in the moribund steel and coal sectors of State Owned Enterprises (SOE). However, the CBB survey indicates it was mostly private companies which didn’t want to hire more workers.
Only 28 percent of the companies said they will hire in the near future. Another interesting development is the slowing growth in the country’s supply of skilled and unskilled labor. The constant flow of rural workers to the cities dramatically increased productivity over the last 20 years and provided China with a low-cost labor advantage. However, many analysts now estimate that the Lewis Turning Point has been reached and China’s working age population is declining. The CBB report confirms this thesis, as only 33 percent and 24 percent of the companies reported growth in skilled and unskilled labor.
The good news: Profit growth stabilized overall and didn’t further deteriorate compared to last quarter, although the report notes this may be due to cost cutting and layoffs.
Old Economy
Capital expenditure increased at only 33 percent of companies, a record low in the 5-year history of the CBB. Again it was private companies leading the way here, whereas SOEs tried to budge the trend. Another part of the old economy—manufacturing—continues to deteriorate, especially when compared to the first quarter of last year. Only 42 percent of companies reported revenue gains, which technically means the sector is in recession. 
Collectively, our data show that that firms first stopped borrowing, then cut spending, and now are becoming allergic to hiring. — China Beige Book

Most notable here is the textile sector, which has lost competitiveness due to higher wages. As a consequence, multinational companies relocate their production elsewhere in Asia or even back to the United States. The number of companies reporting gains crashed by 31 percentage points to only 24 percent compared to last year.
The last part of the old economy, the manufacturing export sector, is also very weak, with only 27 percent of companies reporting revenue gains.
The CBB cautions that any kind of monetary easing, like the Reserve Requirement Ratio cut earlier this year, is not having its intended effect. Only 16 percent of companies say they are borrowing money. Again, contrary to the People’s Bank of China’s (PBOC) easing effort, interest rates at banks and shadow lenders increased, presenting an interesting paradox. The central bank eases credit conditions, firms do not wish to borrow, and yet interest rates are on the rise. Unfortunately, the CBB doesn’t explain this phenomenon but succinctly summarizes the current state of affairs like this: 
“Collectively, our data show that that firms first stopped borrowing, then cut spending, and now are becoming allergic to hiring.”
The PBOC has been cutting reserve requirements but the CBB days it didn’t help much (Natixis)
So what about the new economy? Services, consumption, retail?
“Revenue growth in retail and services each slowed again in the first quarter, a rebuke to those analysts who optimistically repeat the mantra of ‘two-tiered economy’ in lieu of compiling relevant data.” So no, at least for now, even though e-commerce companies reported gains.
The worst performers in retail were textile and furniture and appliances. The China watchers who speculated the home furnishing section would take a hit because of a slowdown in property were right. 
Services presented a mixed picture, with 47 percent of firms saying their revenues increased, which is down from 48 percent compared to a year ago and not enough to take over from the old economy.
Within the service sector, China shows a remarkable similarity to the United States: The strongest subsector was healthcare.
As for the property market, residential is still under pressure but commercial property showed a rebound compared to the last quarter.
“Talk of a property rebound was also accurate only on the surface, in light of sharp differences by city size, region, and commercial (soaring) or residential (plunging) orientation,” the report states.
With respect to the official data rebound in prices and record volumes of used homes transacted in residential real-estate, the CBB survey poses more questions than it answers. Or maybe we should just trust the data on the ground and not the officially reported ones, as Andrew Kollier of Orient Capital pointed out: “I don’t trust the official figures of a rebound because

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The good news first. The slowdown in the Chinese economy and lower commodity prices mean more money for the consumer in the West.
“What happens to the overall world economy depends on whether the boost to income and spending of the consumer will outweigh the hit to the income and spending of the producers,” says Diana Choyleva, chief economist of Lombard Street Research.
While mining companies like Anglo American PLC and commodity traders like Glencore PLC are suffering, consumers are enjoying lower prices, especially regarding gasoline.
U.S. disposable income has gotten a boost from low commodity prices (St. Louis Fed)
But while consumers in the European Union have spent most of it according to Choyleva, consumers in the United States are staying put because a big chunk of their savings is tied up in the stock market.
“The longer financial market volatility continues, the more likely it is that the American consumer will continue saving the real income gains and not spend them,” says Choyleva.
Good for China
The same is true for China. Take money away from the producers and put it in the consumer’s pocket. A devaluation of the currency could help this process, says Choyleva.

“An open capital account and weaker currency will produce higher domestic interest rates. It’s exactly what China needs in order to move toward higher consumption,” she says. Because most of Chinese household savings are in interest bearing deposit accounts within the banking system, higher rates mean higher income and thus higher consumption.
Lower Chinese investment by producers and the government, on the other hand, would enable Western businesses to pick up the slack and increase business investment.
Given where debt-to-GDP is at the moment, it actually has at most one or two years to do the wrong thing before it blows up.— Diana Choyleva, Lombard Street Research

As for higher import prices because of a weaker currency, Mrs. Choyleva says this is nothing to worry about because China doesn’t actually import a lot of consumer good but rather commodities needed for investment.
Bad for China
However, it looks like Western central banks aren’t letting China get away with this strategy. “It would have been much better for them to let the currency go in a one-off fashion. But of course, that would be like a red rag to the bull; whether it’s the Japanese bull or the American bull,” says Choyleva.
The Bank of Japan has recently reiterated its aggressive stance on monetary easing and even told China to implement stricter capital controls to stem capital outflows and prevent a depreciation.
“We are in the midst of a currency war. It’s quite clear that if every major central bank in the world tries to devalue its way out of trouble, no one will succeed, unless of course, we find life on Mars,” says Choyleva.
It has in the past, when its run into these hurdles, tried to go through one last, great surge of lending.— Evan Lorenz, Grant’s Interest Rate Observer

Evan Lorenz of Grant’s Interest Rate Observer thinks a sharp Chinese devaluation would definitely make in onto the U.S. election agenda in 2016.
“It would be a political catastrophe right now. We’re in the middle of a U.S. election right now. China has already become an election issue. I have to imagine that the Republican front-runner Donald Trump is going to make China headline news until the election in November should they devalue 10-15 percent. That may lead to trade sanctions or some problems for China down the line,” he says.
Ugly for China
Evan Lorenz has a more pessimistic view on the whole China rebalancing story. “It does seem like China’s overinvestment bubble is starting to pop with bad repercussions for China and the rest of the world,” he says.
He says China has a massive debt problem (240 percent of GDP officially), which is impossible to solve without dramatically slower growth. The regime has recently set a target of 6.5 percent to 7 percent, but Lorenz thinks this won’t be achievable.

“It’s unclear whether it’s going to be 0, 1, 2, or even -1 percent but I do expect lower growth,” he says. The real problem, however, would be for China to inflate another bubble to counter slow growth.
MORE:China Boosts Debt in December, the Market Doesn’t Buy ItChina and Greece Show Not All Debt Is Created Equal
“If the authorities throw money at the problem, forget reform, maybe we will have a short-term relief rally. Given the alarming pace of increase in debt in China, given the investment excesses of the past, given the lack of structural reform in places like Japan and the Euro-area, then it’s very unlikely that this will be a healthy and long term improvement. On the contrary, the fallout from that sort of policy would be much worse,” says Mrs. Choyleva.
“It has in the past, when its run into these hurdles, tried to go through one last, great surge of lending and we saw that around the transition of CCP chairman Xi Jinping in the last Congress of 2012,” says Lorenz.
It seems China is following this “great surge” policy in 2016 as well as it has created more than $1 trillion in total debt financing until the end of February, a new record.
This will not end well, according to Mrs. Choyleva: “China doesn’t have another ten years to be blowing up bubbles and kicking the can down the road. Given where debt-to-GDP is at the moment, it actually has at most one or two years to do the wrong thing before it blows up. The positive take on this is that it still has the funds to clean up the excesses now if it does the right thing.” If it does the right thing.

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China allowed the world to catch a breath on Friday. Chinese stocks rose 2 percent and the central bank fixed the currency a tad higher. Global stocks are more or less unchanged.
After a week of complete market chaos, this is a welcome break, but won’t change anything in the long-term says James Rickards, author of “Currency Wars” and “The Death of Money.”
“The Chinese are communists and they don’t know anything about capital markets. Putting communists in charge of capital markets is like giving a loaded gun to a three-year old,” he told Canadian broadcaster CBC.
He says their biggest mistake was to shock the world by devaluing their currency last August. “You never shock the system, you always let people know what’s coming,” he said. At that time, the move came as a complete surprise and shook the world’s belief in Chinese central planning.
Since then, the Chinese authorities have learnt their lesson-although a bit late-and are sending signals the currency has further to drop.
According to Reuters, the central bank stated on its website on Friday, Jan. 8.
“The central bank also said it would make the yuan more international, keep the currency basically stable, further improve the currency formation mechanism and deepen reforms of the foreign exchange management system and financial institutions.”
Translated, this means the yuan will depreciate further against the dollar. China has a restricted set of choices, according to the law of the impossible trinity:
1. Have an open capital account2. Have independent monetary policy3. Have a stable exchange rate
At any given time, only two are possible and Rickards says China will chose an independent monetary policy and an open capital account, similar to most developed markets. “They have to devalue the currency. They are not going to close the capital account, there is too much pressure from the International Monetary Fund. They are not going to give up independent monetary policy. They are not going to raise rates to stop the capital outflows, so they have to devalue the currency,” he said.
As for the transition to a consumer economy, Rickards thinks it will take longer than people expect.
“I am not so sure the demand is there. There are a lot of Chinese people, but their income distribution is widely skewed. They have a sort of middle class of 200 million people out of a population of 1.2 billion, but those people are practically eating bark of the trees, they are pretty poor,” he said.
“Those who do have some money, a lot of them sank the money into overvalued assets like real estate and stocks, so they are taking a beating. This transition to the consumer driven economy, we are talking something that will play out over 5 or 10 years, it is not going to rescue the situation today. China’s growth has hit an air pocket, it is going to go down a lot.”

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China is probably looking forward to the new year. A fresh start on Feb. 8, putting all the currency chaos behind.
This may well remain wishful thinking, as events are going from bad to worse—and Jan. 6 is no exception.
The Chinese yuan fell 0.6 percent—this is a lot for a big currency—to 6.55, the lowest level since March 2011. Traders dumped the yuan after China’s central bank fixed its value 0.22 percent lower, another official devaluation.
China first devalued the yuan in August of 2015 and then intervened with great force in the market to keep its value relatively stable, spending $255 billion of its foreign currency reserves by the end of November.
China’s foreign exchange reserves as of Nov. 30, 2015. (Bloomberg)
After the International Monetary Fund included China in its basket of reserve currencies in November as well, Beijing reduced the reserve burn and let the currency drift down gradually.
Beijing also gave the market a fair warning, as it said it would index the value of the yuan against a basket of currencies, not just the U.S. dollar.
The yuan’s value in U.S. dollars dropped in 2015, but it rose against the trade-weighted basket. This gives Beijing justification to further devalue against the dollar.
(Capital Economics)
“China is going to have to dramatically devalue its currency,” Kyle Bass, principal at Hayman Capital Management LLC., told Wall Street Week. He thinks the devaluation could be as much as 20 percent.

So investors took heed and are getting out of the yuan as fast as they can. After all, why stick around to lose money in a falling currency. The problem: This herd behavior leads to, you guess it, a falling yuan. 
And while Chinese regulators can stop them from wantonly selling the mainland currency (CNY) because of capital controls, nobody is stopping them from selling the freely traded offshore yuan (CNH), mostly traded in Hong Kong
READ about China’s two different currencies here
The CNH dropped 1.1 percent against the dollar, trading as low as 6.70, the lowest since September 2010. The spread between the mainland and the offshore currency also widened to a record 2.5 percent.
Capital Outflows
Behind the move in the currencies is the tectonic shift in capital flows. Up until 2014, China attracted capital, driving the exchange up. Now capital is moving out, driving the exchange rate down.
“You’ve gone from a period which you had this one-way bet—the currency was going to appreciate, capital inflows—to the reverse. Having a period in which your own residents want to diversify into something else,” says Harvard professor Carmen Reinhart.
She thinks China is facing “a significant internal debt crisis,” which is why domestic citizens and international investors are moving their money out.
READ Carmen Reinhart on China’s Debt Crisis
“You do have a shift in capital flows and in fact, that shift has also accelerated purchases of real estate in London, in Boston, in New York. You see that it’s not just Treasurys. We see that from China and we see that from Russia,” she says.
Bloomberg estimates as much as $367 billion of capital left China in last three months of 2015. Epoch Times previously estimated capital outflows of $850 billion in the first nine months of 2015, so the total could be more than $1.2 trillion, the same as Societe Generale’s worst case estimate. 
China’s big trade surplus is the reason it didn’t have to sell more foreign exchange reserves to keep the currency from collapsing. 
Why Devalue
There is nothing China can do against the capital flows per se, expect for completely reforming its economy.
It can intervene in the markets by selling its foreign currency reserves to stop the exchange rate from collapsing. For the onshore yuan, it can also enforce capital controls more strictly, which it has done, but that goes against the promised reforms. 
However, given only bad choices, managing a gradual devaluation in the offshore and onshore yuan is actually the best of the worst.
Past currency crises, like the British pound devaluation in 1992, the Asian financial crisis in 1997, and the recent Ruble crash, show the value of the currencies will always drop to its equilibrium level—no matter how much a country spends intervening in the market.

So if the currency has to drop, China can at least keep its large stash of foreign currency reserves, although cynics may then ask what good are they for after all. 
“The foreign exchange reserves are just that: they are foreign. They are not renminbi [RMB]; they are not money that can be brought to bear domestically,” says Fraser Howie, author of “Red Capitalism.”
A lower currency on the other hand will support the country’s export sector, which, thanks to rising land and labor costs, is not as competitive as it used to be. Kyle Bass thinks a devaluation will help China “come back to some level of competitiveness with the rest of the world.”
It needs to compete not to generate growth, as many think. Although the Beijing Academy of Sciences just estimated GDP will only grow 6.7 percent in 2016 (below the official target of 7 percent)—it is employment and public sentiment that matters most to the regime.
The export sector still contributes around 10 percent to total employment.
Gordon Chang, author of “The Coming Collapse of China” says: “Where you have people just sick and fed up, especially when the system is no longer delivering prosperity. When you have real serious economic problems, I think people are going to say, ‘I’ve had enough.’”
Until then, the yuan has a lot further to drop.

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The Chinese regime still has considerable power over the markets. After a 7 percent crash of the Shanghai Composite on Jan. 4, it managed to reverse another 3 percent drop on Jan. 5.
So in the very short term, all is well. In the long term and even in 2016, Bank of America sees big problems ahead for the Chinese economy.
According to their analysts the regime has to fight multiple battles at once and will ultimately lose to market forces.   
“We judge that China’s debt situation has probably passed the point of no-return and it will be difficult to grow out of the problem,” states a report by Bank of America’s chief strategist David Cui.
(Google Finance)
The report points out that a spike in private sector debt almost inevitably leads to a financial crisis.  China’s private debt to GDP ratio went up 75 percent between 2009 and 2014, bringing total debt to GDP to about 300 percent. Too much to sustain.
Western analysts often point out that China can handle it and that Beijing has found its own brand of state sponsored capitalism which can prevent a crisis from happening.
Cui shows this assumption is wrong from the start. China already went through all forms of debt crises (currency devaluation, hyper-inflation, and bank recapitalization) since the reform and opening up policies started in 1978.
(Bank of America)
“Banking sector NPL reached some 40 percent in the late 1990s and early 2000s and the government had to strip off some 20 percent of GDP equivalent of bad debt from the banking system between 1999 and 2005,” Cui writes.
(Bank of America)
He also writes that investors assumptions about how the Chinese regime runs the economy will face another severe test  in 2016. The assumptions were as follows:

GDP will keep growing fast
The yuan will appreciate against the dollar
The regime will support the stock market
No major company will default on its debt
The regime will prop up the real estate market

As of 2016, most of these assumptions are no longer true. In addition, market participants and the regime have made the debt problem worse by adhering to them.
This is “a classic case of short term stability breeding long term instability. It’s our assessment that the longer this practice drags on, the higher the risk of financial system instability, and the more painful the ultimate fall-out will be,” Cui writes.
For the coming crisis, Cui believes China will probably have to devalue its currency, write off bad debts, recapitalize the banks, and reduce the debt burden with high inflation.
And even if the regime wants to continue to deliver on the five assumptions, it won’t be able to, as they sometimes contradict themselves. For example, it is impossible to keep growth from crashing by printing money without further downward pressure on the currency.
So after the events of last August and after the International Monetary Fund finally included China in its reserve currency basket, the regime completely abandoned the stable currency objective and let the yuan drift lower.
Another key point Cui doesn’t mention but is important is reform. The regime promises reform and even follows through in some cases. But if push comes to shove, it resorts back to central planning to mold the market according to its needs, with less and less success.  
“It seems to us that the government’s policy options are rapidly narrowing—one only needs to look at how difficult it has been for the government to hold up GDP growth since mid-2014. A slow-down in economic growth is typically a prelude to financial sector instability,” writes Cui and predicts the Shanghai Composite to drop by 27 percent in 2016.

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Western commentators complain that China’s 7 percent stock crash on Jan.4 is a  dreadful start to the new year.
Well, technically speaking, the Chinese still can hope their new year is going to be better than the old one, as it only starts on February 8.
Until then, it looks like it’s going to be downhill for the economy, stocks, and the yuan.
The Shanghai composite slipped 6.9 percent to 3296 on Jan. 4, triggering circuit breakers. The onshore yuan dropped 0.37 percent against the dollar.
(Google Finance)
Official GDP numbers come out on Jan. 19 but whatever the official number, it real growth won’t be good judging from data on the ground.  
Market commentators blame recent weak manufacturing data and new IPOs but analysts knew all of this beforehand.
In fact, if you look at any data coming out of China, whether it’s official or unofficial, all of it is pointing south. 
Research Firm Capital Economics compiled a chart book of important indicators for the Chinese economy based on official data, showing firmly established downtrends.
The currency will devalue further against the dollar because it has actually gotten stronger in trade weighted terms  in 2015 and that’s what China cares about.
This is the only reason why China launched a trade weighted index for the yuan, so it has a justification to devalue further against the dollar. 
(Capital Economics)
Official GDP growth slowed to 6.9 percent in the third quarter of 2015, but Capital Economic’s own activity proxy indicates growth of only 4 percent.
Electricity consumption, one of the best economic indicators is not growing at all. 
(Capital Economics)
Retail sales are still growing at 10 percent, but retail is not a large share of the economy and growth fell from a peak of almost 20 percent right after the financial crisis.
(Capital Economics)
Trade has collapsed, firmly trending down.
(Capital Economics)
Producer and commodity prices are deep in deflationary territory. Capital Economics is optimistic this will change soon though.
(Capital Economics)
Credit is still growing, but also trending down. Also, the ratio of output per unit of credit decreased dramatically over the years.
(Capital Economics)
Knowing all this, how can traders be surprised by weak manufacturing data? Hope dies last. 

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China ends 2015 with an economic win: The U.S. Congress approved a reform package to boost China’s voting rights at the International Monetary Fund (IMF) from 3.8 percent to 6 percent.
This win, however, is largely symbolic, similar to the inclusion of the Chinese renminbi in the IMF’s reserve currency basket (SDR), which happened in November this year.
In 2015, China gained prestige on the international stage while the economy at home had its worst year since reforms started in earnest in 1992.
International Prestige
In spite of being symbolic and far removed from the day-to-day action of global finance, the IMF’s endorsement of China as a whole is a big win Beijing pursued for years. The inclusion of the yuan into the Special Drawing Rights Basket (SDR) means the IMF thinks the currency, and by extension the whole Chinese political economy, is on par with the dollar, euro, yen, and pound sterling.
Why symbolic? Until China’s plan to replace the dollar with the SDR as the global reserve currency becomes reality, there are too few of the SDRs in circulation ($285 billion) to change the demand for the yuan as a reserve asset. Its use is also limited to member countries, who use it mostly for transactions with the IMF.
Also, the increase in voting rights doesn’t change the power structure at the IMF, since the United States retains veto power with 16.5 percent of total votes. However, it recognizes China’s efforts to build up an alternative power structure to the Bretton Woods financial system set up after World War II. China successfully launched its Asian Infrastructure and Investment Bank this year, convincing even staunch U.S. allies like Australia and the U. K. to participate.
The regime plans more reforms of the exchange rate, interest rates, as well as housing registration next year.

China also refined its efforts to compete in global gold trading and started several initiatives to gain control over global trade, like the Silk Road initiative, which plans to bring another U.S. ally, Pakistan, closer to China economically, as it opens up trade with central Asia and eventually Europe. China launched new clearing centers for the yuan worldwide, now the fourth most used currency in the world.
As part of the reforms to convince the IMF to give it more voting rights and include it in the SDR, China has for the first time since 2009 updated its official gold reserves, which increased more than 60 percent to 1,743 metric tonnes (1,921 short tons). It also lifted the cap on interest rates banks pay out to depositors to shift income to consumers, who are supposed to become the growth engine of the economy. It has somewhat liberalized its exchange rate compared to the dollar, although it is still closely managed. The regime plans more reforms of the exchange rate, interest rates, as well as housing registration next year.

Problems at Home
All these reforms move the economy away from a closed-off, centrally planned system to a real market economy fully integrated in the global financial system.
Alas, it may be too little too late and China is now chasing reforms it should have undertaken while the economy was still growing fast. Officially, China will grow at 7 percent in 2015, the lowest rate since 1990. Unofficially, growth has crashed to around 2 percent, with a marked deceleration in the fourth quarter.
In 2015, even the most optimistic analysts realized China’s investment driven growth model is over. Even more so than official data on investment, the plunge in commodity prices as well as producer prices in China suggest a severe slowdown, maybe even outright recession. This unexpected change in demand has left commodity exporters like Russia, Canada, Brazil, and Australia reeling and has wreaked havoc among international mining and commodity giants. They spent hundreds of billions building up their infrastructure to satisfy supposedly never-ending Chinese demand.
We will remember 2015 as a historic turning point for China—and the world.

The only debate still raging among investors and academics is whether the consumer or service sector can take over from manufacturing, investment, and exports. Although there are some signs of resilience in all of these sectors, a real rebalancing will take decades and will be painful, according to Peking University professor Michael Pettis. The consumer just doesn’t have enough income to make up for all the wasteful investment spending.
Wasteful investment spending has created economy-wide debt close to 300 percent of GDP: Debt that needs servicing. This year, reports about defaults and the inability of companies to service their debt have become more frequent, despite the efforts of the regime to provide monetary easing through lower interest rates and different accounting gimmicks, like the local government debt swap program.
Financial Markets
Too much debt and too little growth are the main reasons for the stock market boom and bust, as well as the shock currency devaluation in mid-August. Because many firms cannot service their debt loan anymore, the regime engineered a stock market boom, giving companies access to capital, which doesn’t carry interest and doesn’t have to be repaid.
This worked for a while, but because banks created the stock bubble with margin debt, it had to crash sooner or later, and eventually did in July. With the stock market bust, all asset classes in China were impaired and became uninvestable.
The real estate bubble had already burst in 2014. The fact the second half of 2015 was relatively better doesn’t make a big difference. The stock market had crashed and local government bonds or corporate bonds as of the beginning of the year carried the risk of default, something quite unknown to investors in Chinese companies.
A board shows the stock movements inside the Shanghai Stock Exchange in the Lujiazui Financial District of Shanghai on Sept. 22, 2015. (Johannes Eisele/AFP/Getty Images)
These factors worsened a trend, which probably started in mid-2014: capital outflows. Ever since China joined the World Trade Organization in 2001, it has accumulated trillions of dollars’ worth of foreign currency reserves, by running massive trade surpluses and attracting foreign capital. The country still has a trade surplus,

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