Aside from the fact that Leland is an Oxford-educated China historian, a brilliant economist, and a genuinely nice guy, what first caught my attention was his remarkable track record of contrarian calls since the inaugural issue of the China Beige Book in Q1 2012… from the initial slowdown; to unexpected bounces in economic activity; and even the June 2013 cash crunch where interbank interest rates spiked dramatically in a matter of weeks, signaling that a wave of defaults was on the way. (I should note that John has sat on China Beige Book International’s advisory board and has worked closely with Leland for most of the firm’s history.)
Before we proceed, here is a short but important description of the history and methodology behind the China Beige Book. Although survey data has its limits in any economy, this is as good as it gets for a semi-closed economy like China’s.
Beginning in early 2010, our team set out to craft a Chinese analogue of the US Federal Reserve’s Beige Book. Over the next twelve months, we conducted a study of the Beige Book and the methods used to prepare it, including contact with officials at each of the regional Federal Reserve Banks involved in its preparation. We then worked to develop a method that would be similar, but more comprehensive and systematic, in its approach to the world’s second largest economy – a Beige Book “with Chinese characteristics.”
Our approach triangulates three methods, repeated every quarter: a quantitative survey of over 2,000 leading firms from key sectors across the country; qualitative one-on-one in-depth discussions with C-Suite executives in the same industries across every region; and a separate, targeted banker survey of loan officers and branch managers, designed to home in on the complexities of both the official and shadow economies. With the data from this approach, we are able to compare regions and industries within a quarter, as well as track changes over time, both in near and real time.
The result of these efforts is the largest and most comprehensive survey series ever conducted on a closed or semi-closed economy…
I cannot share the report in its entirety or reveal too much of its contents, but Leland did give me permission to share part of the regional overviews and research highlights from the Q1 2014 report. If you are able and willing to pay the six-figure annual subscription fee, Leland’s work will blow your mind and dramatically change your perspective. For the rest of us, the following excerpt can at least point us in the right direction… and I am discovering that Leland’s media interviews and tweets (@ChinaBeigeBook) are quite telling, as well. (You can also follow John and me on Twitter at @JohnFMauldin and@WorthWray, respectively.)
China Beige Book, Regional Overview (Excerpts from the Q1 2014 report)
China Beige Book regions (listed below
Region 1: Shanghai, Jiangsu, Zhejiang
Growth slowed – retail & real estate gains weakening sharply – despite stability in manufacturing and pickups in services, transport, and agriculture. Borrowing was stable with rates down at banks and up at non-bank lenders. Hiring slowed, as did margin growth. On-quarter weakness was modest, but the on-year drop was worrisome.
Region 2: Guangdong, Fujian
Despite the national slowdown, Guangdong’s pickup continued, driven by manufacturing and transport. Growth was steady in retail, off in services and property. Wage growth remained high but costs inflation eased, boosting margins. Borrowing ticked up, with bank rates steady and shadow rates up. The export power-house found an encouraging second wind.
Region 3: Beijing, Tianjin, Shandong, Hebei
The capital region saw Q1’s worst results, due to trouble in services and manufacturing. Property and mining were stable, retail slightly better. Margin growth suffered. Borrowing was stable and moved to banks, on the country’s lowest interest rates. Beijing is leading the national economic slowdown.
Region 4: Heilongjiang, Jilin, Liaoning
The Northeast slowed as mining contracted and manufacturing, property, and farming growth eased. Services was stable and retail saw a pick-up. Hiring and wages strengthened, while pricing weakened, pressuring margins. Borrowing ticked up, rates easing. Rebalancing does not look easy in this old industrial region.
Region 5: Hubei, Henan, Chongqing, Sichuan, Anhui, Jiangxi
Growth slowed sharply, slipping in retail, services, property, farming, and mining, with only manufacturing stable. Hiring was steady but input costs grew faster, narrowing margin gains. Borrowing slid again, with lower interest rates in both formal and shadow finance – not an encouraging trend.
Region 6: Shaanxi, Shanxi, Inner Mongolia, Ningxia
Growth took a hit, gains slowing in this crucial mining sector. Manufacturing, real estate and, especially, retail weakened. Services and transport were the bright spots. Hiring and margin growth both eased. Borrowing was flat as rates went up. The North remains dependent on struggling mining.
Region 7: Guizhou, Guangxi, Yunnan, Hainan, Hunan
Again out of sync with the rest of China, the Southwest sped up. Manufacturing, transport, and mining improved, but retail, services, and real estate saw growth slow. Hiring and input costs picked up, but so did pricing and margins. Borrowing ticked up, as shadow lenders’ rates moved back above banks’ rates.
Region 8: Xinjiang, Tibet, Gansu, Qinghai
The West again boasted China’s best overall growth, though manufacturing, retail, and services slowed. Only property picked up, with mining and transport stable. Hiring and input cost growth were steady, but pricing and margin growth eased. Borrowing remained China’s least frequent as rates jumped.
China Beige Book, Research Highlights (Excerpts from the Q1 2014 report)
Manufacturing is fine, yet the economy is not
The pace of Chinese economic expansion has painfully slowed. Revenue, sales, profit, and wage growth are all weaker than a year ago. The slowdown is particularly steep in the North [region 6] and Northeast [region 4] and also pronounced in Beijing [region 3] and Central China (region 5).
By sector, stable first-quarter growth in manufacturing confirms our long-standing thesis that it is no longer the economy’s bellwether…
A bounce-back later this year is possible
The worst performer according to CBB figures, both on-quarter and on-year, is real estate and construction. While property companies are getting crushed, the sector is also notoriously unstable for both structural and political reasons. It would be no surprise if real estate were to rally before the end of the year.
More immediate reason for optimism: Growth in new domestic orders was solid (save in the Northeast), and domestic orders and export orders were both stronger in powerhouse Guangdong. The results do not indicate a boom later in 2014, but they do suggest that linear forecasts of continued deterioration are overly simplistic.
Financial segmentation is profound
The ongoing debates about monetary policy assume that anticipated loosening or tightening applies across the spectrum of borrowers. CBB data say otherwise, and in multiple ways. First, while the number of firms reporting that they borrowed stabilized in Q1, it did so at a very low level. Shoving more liquidity at the credit market will have limited effects until participation expands. This includes RRR cuts – though of course these may occur for political reasons.
Second, shadow finance may be revving up for a comeback. CBB numbers show a recovery in the sales of wealth management products (WMPs), likely due to competition from online banking. This is cash leaving the traditional banking sector and, while non-bank lending did not pick up in the first quarter, the groundwork is being laid for it to do so.
Online banking may be encouraging riskier behavior
Online lenders are typically viewed as a force for liberalization, as well as a potentially healthier alternative to unregulated shadow finance. Yet our data show their proliferation would impart significant costs as well…
What appears to be happening is the higher returns available in online banking are forcing banks to move more transactions off-balance sheet, in order to avoid the interest rate cap. While this may accommodate policy goals in the short term, an uptick in off-balance sheet funding portends more shadow bank lending down the line.
Interest rate spread between banks & shadow banks highest in a year
Bank loan rates and bond yields eased slightly this quarter, but the cost of capital increased again for those borrowing from non-bank lenders. While the shifts were not dramatic, the spread between bank and non-bank loan rates nationwide is now the largest since Q1 2013. This highlights the still more challenging road for those firms, principally domestic private entities that are pushed outside formal lending channels.
Growth Is Slowing But Not Collapsing (So Far…)
After reading through the latest report, consulting with friends who are also familiar with the research, and bombarding Leland with a never-ending stream of questions for the last month, John and I still cannot claim to have enough information to make a directional call on the world’s most powerful (and least understood) macro force… but we know more about the inner workings of China’s economy than we did when we wrote to you a couple of months ago.
Great data often has that effect – it’s like shining a light into the shadows (including China’s shadow banks). We can see the nuanced regional contrast in economic activity, the modest (but still insufficient) rebalancing between sectors, and pressure points in the credit markets that suggest last summer’s interbank volatility may return in 2014.
We also see a far more mixed picture of economic activity than a lot of the widely followed headline data suggests. The overall pace of Chinese economic growth is clearly slowing but not collapsing. The credit transmission mechanism is obviously broken, as you can see in the chart below (with government and government-sponsored borrowers in zombie industries consuming the majority of the country’s credit… in turn forcing households to borrow through shadow banks at massive risk premiums); but so far, the credit bubble is not imploding.
On that note, China Beige Book International is the only independent research firm in the world that tracks the non-bank (shadow) lending rates not just nationally, or by region, but for every sector in every region over time. Leland and his team have essentially
