China May Be in for Some Short-term Hurt

China May Be in for Some Short-term HurtNever mind the eurozone and Europe, China is quickly becoming more of a sore spot, and this is a major concern given that the Chinese economy is the second largest in the world. Greece is the 29th largest and Spain is the 12th largest, so an implosion in China would likely have a devastating impact on the world economies, particularly those of the country’s key trading partners.

The evidence has been mounting for slowing. China’s economy expanded at 7.6% in the second quarter, down from 8.1% in the same quarter in 2011, according to the National Bureau of Statistics. The positive was that the reading was higher than numerous estimates calling for 7.3% growth. But then I wonder if the gross domestic product (GDP) reading is valid. Pundits have been suggesting that if the GDP figure came in at eight percent or higher, there would be questions regarding the trustworthiness of the calculations.

My thoughts are that the numbers can be fabricated to some extent, as the government controls everything in the country, which is the inherent risk with two systems (capitalism and communism) and one country, as in the case of China.

A good indicator of the slower growth is the decline in energy consumption in China, so it’s realistic to surmise manufacturing and the economy must be hurting.

The consumption of electricity grew a mere 3.7% in April, according to the National Energy Administration (NEA), representing a 3.3% decline from March.

Lower consumption of power suggests lower growth and demand. If consumption continues to decline, watch the GDP, which correlates to this reading.

Chinese Premier Wen Jiabao said the economic stalling could continue for an extended period. The government is open for aggressive stimulus and rate cuts. The People’s Bank of China has cut interest rates twice over the past two months. Yet with the country’s benchmark one-year lending rate at six percent and deposit rate at three percent, there is ample room for additional rate cuts and monetary stimulus, along with fiscal spending, especially since inflation has been on the decline to the current 2.2%, the lowest level since January 2010 and well below the government’s upper target rate of four percent.

While the country is stalling, I still feel a hard landing could be avoided, but things could change rapidly. To avoid an economic crash that could send the global economies into another tailspin and potential recession, the Chinese government will pump billions into the economy to try to avert a hard landing.

In the Chinese business community, we are seeing signs of fragility with profit warnings from numerous Chinese companies—and you think this only happens in America. (See “Don’t Expect Much from Second-quarter Earnings.”) Earnings at Chinese state-owned companies declined 11.6% in the first half, according to the Ministry of Finance.

The flow of foreign direct investment (FDI) into China contracted by three percent in the first half of 2012. The FDI reading declined in each month from January to June.

The situation could worsen as the foreign and domestic demand for Chinese goods fall.

China could become more of a problem, and its condition will continue to be tied to what happens in the eurozone and other key trading partners, including the U.S. China currently relies heavily on foreign business and less on domestic consumption, something it wants to change as the country moves forward.

And the impact is being felt by U.S. companies with significant business activity in China.