World Economy

Gauging China’s Economy

Gauging China’s EconomyGauging China’s Economy

In what will do little to appease growing concerns over the health of China's economy, the total volume of goods transported by China's national railway network plunged by over 10% last year, the largest annual decline on record.

According to Reuters, citing the Chinese business magazine Caixin, the volume of railway cargo declined by 10.5% to 3.4 billion tons, following a fall of 4.7% in 2014.

Railway cargo, along with electricity production and bank lending, is used by many analysts to gauge the true health of the Chinese economy.

In 2007, Chinese Premier Li Keqiang, then party committee secretary of Liaoning, said the figures for gross domestic product in his province were unreliable, telling a US ambassador that he preferred to look at alternative metrics, such as railway cargo, to determine what was really happening in the economy.

While the collapse in cargo volumes points to a significant slowdown in the Chinese economy, the view offered by the Chinese government is different.

Increase in Green Energy

In October, China's state-run People's Daily newspaper said falling freight rail volumes were not due to declining economic activity, but rather to an increase in green energy production reducing the need to haul coal across the country.

"The percentage of green energy consumed in China has increased in recent years," the newspaper said.

"Eco-friendlier sources such as hydro, wind, nuclear, and natural gas made up 16.9% of total energy consumed in 2014, a 3.5% increase compared to 2010. The development of new energy has reduced demand for both thermal power and coal."

Coal volumes transported by railway fell by 11.4% from January to August, leading to a 6.1% drop of overall railway freight, the newspaper said.

Whether true or not, or somewhere in-between, the view presented by the government is unlikely to fill many China watchers with confidence.

Price Gyrations

Turbulence in Shanghai stocks has global investors on edge though really it's the Chinese currency they need to be watching to assess the risk of a full-blown contagion.

The reason is simple. Share ownership is still a small part of Chinese household wealth. Price gyrations–like the 7% drop in the CSI 300 index Monday–do affect market valuations globally. But beyond short-term jitters, the sharp declines don't mean much. Mostly, they're a reflection of pent-up selling pressure, such as the impending removal of a ban on major shareholders' equity sales. To a more limited extent, they're a handy barometer of investor despondence over authorities' seeming inability to stabilize GDP growth at anywhere near their stated 7% target.

Shock Devaluation

But just how that weakness in Chinese demand might reverberate through neighboring Asian economies–the most likely starting point of any contagion–is the more important story, one that's better told by the 5% drop in the yuan against the US dollar since just before last year's surprise Aug. 11 devaluation.

To see why this slide matters, consider the 800-odd non-Chinese, non-financial companies in Asia that, according to their filings, garner 80% or more of their revenue from China, Europe or America.

This motley group of Asian exporters includes Australian commodity companies such as Fortescue Metals, Singapore-based smartphone casing fabricator Hi-P International, nearly all Indian software services companies, and Hartalega Holdings, a Malaysian maker of latex gloves.

Focus next on these exporters' combined annual net profit, which rose from $40 billion in 2010 to $50 billion in 2013, but has since slumped to a little less than $45 billion.

Competing against Chinese rivals who have the advantage of a weaker currency could push some of them out of business, and force many more to fire workers and cancel investments. The more the yuan weakens against its trading partners' currencies, the greater the risk that weak corporate profitability will infect the region's banking systems.

This is how the 1997 Asian crisis unfolded, following a 1994 devaluation in the yuan. And while the region's banks are generally better capitalized than they were back then–with India being a notable exception–it's once again the most obvious way panic could spread quickly through other parts of the continent.

The natural corollary of such a crisis of confidence will be capital outflows, and a sharp depreciation in Asian currencies.