Tom Holland / South China Morning Post
A look at the figures shows the mainland is paying the price for having severe industrial overcapacity amid suppressed domestic demand
The cynical explanation for the rash of anti-Japanese demonstrations that spread across China this week is that Beijing encouraged the protests, or at least allowed them to go ahead, in order to take people’s minds off what is going on at home.
And what is going on at home is not just an unseemly power struggle ahead of the approaching leadership transition, but an uncomfortably hard landing in China’s domestic economy.
Behind China’s slowdown lies the enormous investment boom of the last few years.
On one hand, headlong investment has created severe overcapacity in a swathe of industries, overcapacity that is now weighing on prices.
On the other hand, government efforts to rein in runaway property prices have suppressed domestic demand.
The result of this simultaneous supply glut and demand deficit has been an abrupt swing from rising prices to deflation.
The switch doesn’t show up in consumer price inflation, which edged up to 2 per cent in August from 1.8 per cent the previous month.
But considering that household spending makes up only 35 per cent of China’s economy, consumer prices are the wrong measure to look at.
With fixed investment and exports together equalling 73 per cent of gross domestic product, the corporate goods price index is a better indicator of what is really happening on an economy-wide scale.
And this shows the rate of inflation collapsing from 9.7 per cent last summer to minus 3.7 per cent in July this year.
Meanwhile, wages are still rising at double-digit rates (see the first chart).
Part of the increase is justified by gains in productivity, which is reckoned to be improving at a rate of around 5 per cent a year. But that still leaves unit labour costs rising at an annual rate of 6 per cent even as factory-gate prices are falling.
The result is a severe squeeze on corporate profit margins, which is discouraging private sector investment.
The conventional response would be to cut interest rates. But with China already facing capital outflows and the banks struggling to attract depositors – the growth rate of corporate deposits slumped to single digits in August from 73 per cent a year earlier – room to reduce rates is limited.
As a result, China’s real borrowing rate – that is the borrowing rate minus the inflation rate – now stands at a crippling 9.7 per cent.
The consequence has been a sharp slowdown in economic growth.
Again, this hard landing doesn’t show up in the official figures for real growth, which indicated a healthy 7.6 per cent year-on-year rate of expansion in the second quarter of the year.
But according to Charles Dumas, chairman of economic consultancy Lombard Street Research, this number is not be trusted because Beijing only publishes an isolated figure for the growth in real GDP without releasing any data about the level of real GDP to support it.
Working with the only hard numbers the government does publish – the level of nominal GDP – Dumas has constructed an economy-wide deflator in an attempt to derive China’s true rate of real GDP growth.
According to his analysis, China’s real quarter-on-quarter growth rate sank to 0.4 per cent in the second quarter of the year (see the second chart). That equates to an annualised growth rate of just 1.6 per cent – a hard landing by anyone’s standards.
Activity should pick up slightly towards the end of the year in response to renewed stimulus efforts.
But Dumas warns that growth is likely to slacken off again next year when consumer spending – now growing strongly thanks to generous wage increases – falters once shrinking corporate margins slow the pace of pay rises.
Perhaps the cynics should look out for another outbreak of nationalist outrage come the new year.