Storm Clouds Form For China Recession

February 19, 2008 by Douglas A. McIntyre

When tens of thousands of visitors make their way to China for the summer Olympics they may be greeted by a country heading into a deep recession.

The Chinese government announced today that inflation got further out of hand, hitting 7.1% in January. So far, the country’s banking policy has not helped. According to one analyst quoted by MarketWatch "Even though China has raised interest rates and their reserve-requirements ratio … it really hasn’t done very much to rein in the monetary aggregates." That probably means that banks will have to further tighten credit and try to keep the out-flow of money into the economy at a dull roar.

But, there are several pieces of data which point to a sharp slowdown in Chinese growth, and perhaps even a contraction as the year goes on. A recession in the West is now all but a foregone conclusion. Certainly big huge US companies like Wal-Mart (WMT) will cut inventory coming from China as their US sales flatten. Demand for everything from auto parts to garden hoses is going to fall, perhaps precipitously.

On the other hand, if credit in China is tightened by the central government much of the capital which has fueled the run in the stock market and real estate will be wrung out of the economic system. It is often said that stock market activity is a leading indicator of recessions and recoveries. The Shanghai Composite is down 15% over the the last three months after being up almost 100% over the nine months prior to that.

China has also been willing to underwrite the cost of energy, buying oil on a market where crude is over $90 a barrel and selling by-products like gas and diesel at a fraction of where a real supply-and-demand market would mark their prices. That means that the real rate of inflation in China may be closer to 10% without the government’s hand in the economy.

An inflation rate of close to 10%, tightening credit from banks, and falling exports add up to one thing–a China recession.

Douglas A. McIntyre