China’s GDP Growth Takes Off Like a Rocket

On two of the fronts in the war against inflation/deflation (the enemy varies from week to week) there appeared to be progress yesterday and overnight. The Sino-American alliance delivered a one-two punch to recovery sceptics with some impressive numbers and Aussie stocks benefited. Let’s have a look.

First the rising power in the East. China’s GDP growth took off like a rocket in the second quarter, from 6.1% in the first quarter to a sizzling 7.9% in the second. Resource-intensive industrial output was up 9% in the quarter, according to China’s National Bureau of Statistics. And Chinese retail sales expanded at an annual rate of 15% last month alone.

If it wasn’t official before, it ought to be now. There is a credit boom in China and it’s impressive. Banking lending is up and government spending is on the loose and asset prices have responded with a big rally. And not just Chinese asset prices!

Here in Australia the news of China’s rising GDP sent the S&P/ASX 200 within a whisper of closing over 4,000. As is, it’s been a seven percent gain for the week. All thanks to the stimulative effects of Chinese monetary policy. Who says the Keynesianism stuff doesn’t work?

Well, I still say that. And not just me! “The difficulties and challenges in the current economic development are still numerous,” says Li Xiaochao, spokesman for the National Bureau of Statistics. “The basis of the rebound of the people’s economy is not stable.” And why isn’t it stable?

China’s economy is still based on export growth. Exports were down 21.4% year-over-year in June after a 26.4% year-over-year decline in May. True, that decline is “less bad” and as such constitutes a slight improvement, in a perverse way. But according to Xinhua News Agency data, China’s June trade surplus of $8.15 billion was almost half of the $15.2 billion figure forecasters expected.

What’s unstable about the second quarter GDP figure is that it shows domestic demand growing, not exports. China did increase its import demand for raw materials. But that was driven by stimulus, not by demand for Chinese products from the U.S. (where consumers are saving and reducing consumption) or Europe.

So my worry-at least from the perspective of an Aussie resource stock analyst-is that China’s GDP figures merely indicate a speculative bubble has been kicked off in Chinese assets thanks to expanded bank lending and the stimulus. What’s more, no economy-and certainly not one as big as China’s-can shift from an export-driven model to a domestic consumption drive model over night.

A more balanced growth formula is in China’s future. But its present is pretty precarious, I would say. A stable rebound would come from increased demand for Chinese exports. And I find it hard to see that happening this year, given that the English-speaking world is still in the middle of a balance sheet recession in which debt is being reduced and assets written down.

The risk is that once the Chinese stimulus dries up, so too will demand for Aussie resources. In China, you’ll see a big correction in the stock market (up 71% this year) and in real estate. The liquidity boom will have to give way to an asset bust. In Australia, I think it means the recovery from the March lows is imperilled by the reality that second quarter Chinese resource demand may have been largely artificial.

But hey, it’s Friday. Perhaps I should not be so gloomy. And doubly perhaps not when uber bear Nouriel Roubini-the man who called the credit crash-said the worst of the financial crisis is over and that the recession in the U.S. would end later this year.

From the Western front in the war against capitalism, Roubini’s reports that the “freefall” in the economy is over and there is light at the end of the tunnel which is not a train coming in the other direction. The Dow Jones Industrials were up just over one percent while the S&P closed up just under one percent on the good news from Dr. Doom.

And along came the Fed with what was billed was an optimistic forecast, but which hardly stands up to the scrutiny. The Fed released its meeting notes from its June 23rd meeting yesterday. And in those notes it revised its projections for second half U.S. GDP and for the 2010 growth rate of the U.S. economy. In April, the Fed projected GDP would shrink by 1.3% to 2.0%. The revised forecast released yesterday now says U.S. GDP will only shrink by 1.0% to 1.5%.

But wait…it gets better!

The Fed’s revised projections show that the U.S. economy will grow faster than it first thought in2010, once the recovery kicks (come on you recovery!). In April the Fed thought the U.S. would grow by 2.0% to 3%. But in the revised forecast now says the growth rate should soar from 2.1% to 3.3%. Huzzah! The bad news is the Fed also says unemployment will continue rising, giving us a “job-loss” recovery. Hmmn.

So there you have it. The “optimistic” Fed forecast is merely that the economy will shrink slightly less fast this year and grow slightly more next year, if indeed it grows at all and that unemployment will grow. This seems like a distinct lack of bullish conviction doesn’t it?

It’s hardly the sort of thing upon which to build a new share market that makes new highs. However it does appear to be the thing-coupled with the China credit offensive-to get cashed-up investors off the sidelines and right back into the market, which may give stocks a temporary adrenaline rush.

While I think there are some stocks-mostly the cash-flowing income producers I wrote about yesterday-that are worth picking up, I also think the China bubble and the Fed babble are setting us up for another bout of irrational exuberance that will surprise investors when it pops.

Your regular Money Morning editor Kris Sayce is off to Vancouver, British Columbia tomorrow and will be reporting all next week from the 10th annual Agora Financial Investment Symposium. Meanwhile, you’ll find Gabriel Andre’s final instalment of how to boost your returns from blue chip stocks in a surprising fashion. Have a good weekend!

Dan Denning
for Money Morning Australia