China's Employment Index Falls to Five-Year Low

The highly credible HSBC/Markit Purchasing Managers’ Index (PMI) of economic demand in China reported that demand in China’s factories fell for a second month in a row and hit a seven-month low. 

Markit Research also reported that production turned negative for the first time in seven months, and hiring expectations fell to a new five-year low. Although the Chinese government continues to produce an array of rosy economic statistics each month, China’s industrial competitiveness seems to be fading fast. Coupling the production contraction with banking problems and a fall in the Employment Index to a five-year low, signs indicate the Chinese economy could soon be in crisis.

Markit Research compiles “flash” indicators each month for demand and operating conditions in China’s manufacturing sector. The report is based on survey responses from executives inside approximately 85%-90% of China’s most important factories. A Markit flash score above 50 means that activity is expanding, and a score below 50 means that activity is contracting. Although the final reports are not published for another two weeks, the Markit flash reports seldom differ from the final reports.

The Chinese Lunar New Year festival began this year on January 31, and most workers at this time go on vacation for two weeks back to their family homes. Consequently, economic activity during the Lunar holidays is an excellent indicator of the pace of domestic consumer demand. The purchasing managers’ index’s falling from a weak 49.5 in January to a seven-month low of 48.3 in February is a strong indication the accelerating contraction in demand is being driven by weak domestic consumption.

Former Chinese President Hu Jintao and Premier Wen Jiabao in 2010 published “Report on the Work of the Government.” This reported on the National Development and Reform Council (NDRC) that formed the basis of China’s Five Year Plan (2011-2015) to discard the economic model followed for the past three decades, which emphasized export manufacturing. Instead they recommended focusing the nation’s economic and development efforts into building a modern, consumer economy. 

The main features of the new policy orientation were as follows: converting China from being the “world’s manufacturer” to becoming the “world’s consumer,” upgrading its scientific and technological capabilities with an emphasis on innovation, expanding educational coverage, and improving the living conditions and increasing the wages of the people, especially those in the rural areas.

Over the next five years, China’s leadership encouraged “new measures” that included widespread property tax measures that resulted in huge amounts of agricultural land being released for housing development. State-owned-banks increased lending in just five years by $14 trillion to $15 trillion, twice the entire Chinese annual gross domestic product (GDP). As a result, housing prices increased in major cities like Beijing from an average of $1,150 per square meter to $11,400 per square meter. Condos that would have sold for $3,500 in 1994 now listed for sale at $833,000.

However, over the last six months, real estate demand and prices have been contracting in cities beyond the nation’s relatively wealthy “first-tier” metropolises such as Shanghai and Beijing. According to the Securities Times newspaper, housing developers in Hangzhou cut prices this week by an average 19% in a scramble to sell about 120,000 newly built apartments. The current inventory of new, unsold units exceeds the total number of houses offered for sale in the capital cities of Shanghai and Beijing combined. A study by Shanghai’s Tongji University said real estate markets have been especially shaky in the northeastern city of Harbin and the eastern commercial center of Wenzhou, where new-home prices have fallen monthly for more than two years.

The borrowing binge by China was not just restricted to state-owned lenders; China also has approximately $3.5 trillion in private “sub-prime” type loans made to individual speculators at up to three times the cost of bank loans. Many of these loans were made to shady business operators speculating on coal mines. As the price of coal has been cut in half over the last year, most of these loans appear insolvent.

Chinese banks over the last six months have been forced to borrow large amounts of short-term money as income from their loan payments has slowed. The Sunday edition of London’s Daily Telegraph published a story that “Currency crisis at Chinese banks could trigger global meltdown.” The article warned that short-term foreign currency borrowing by Chinese companies has almost quadrupled in just four years, to more than US$1 trillion. “Any substantial appreciation of the US dollar – and many analysts are indeed expecting gains this year – could open up a dangerous cross-currency mismatch, forcing Chinese borrowers to default and inflicting shattering losses on international lenders.”

According to Beijing’s State Administration of Foreign Exchange, at the end of 2013 China had foreign liabilities of a thumping $3.85 trillion, roughly 40 per cent of its gross domestic product. The bulk of those liabilities consist of $2.32 trillion of highly illiquid inward foreign direct investment in plants and equipment. Another $374 billion is foreign investments in China’s stock and bond markets that could be sold at any time. However, that money may be locked up, since China’s qualified foreign institutional investor program strictly limits the size and frequency of money that can be withdrawn from the country.

The HSBC/Markit Purchasing Managers’ Index contraction to 48.3 during China’s biggest annual holiday seems dire when coupled with the PMI’s employment sub-index fall for a fourth month in a row to 46.9, its lowest point since February 2009, during the global financial crisis. The Chinese government would obviously like to address the looming employment crisis by opening up the credit spigot to spur consumer demand, but that seems almost impossible with Chinese banks already facing a loan crisis and having trouble getting short-term funding.

One of China’s ancient proverbs is the curse, “May you live in interesting times.” Facing a production, employment, and banking crisis sounds like very interesting times for China.