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Tuesday, July 10, 2012 4:51 AM

China Import Growth Plunges, Trade Surplus Hits 3-Year High; Will US Response Be Protectionism? Is China Headed For a Deflationary Shock?

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China's trade surplus hit a 3-year high this month as import growth plunged. That setup raises many questions.

First, let's consider the initial story. Bloomberg reports China’s Import Growth Misses Estimates for June

China’s imports rose less than anticipated in June, pushing the trade surplus to a three-year high and adding pressure on the government to support demand as the global economy slows.

Inbound shipments increased 6.3 percent from a year earlier, the customs bureau said in a statement today in Beijing, compared with the 11 percent median estimate in a Bloomberg News survey of 32 economists. Export growth slowed to 11.3 percent and the trade surplus rose to $31.7 billion.

Rising surpluses may further strain trade relations with the U.S., which surpassed the European Union in the first half as China’s biggest foreign market and is in the midst of a presidential election marked by criticism of the Asian nation.

The country’s trade surplus with the U.S. and lack of currency gains have been issues in the U.S. election campaign this year, as American job growth slowed last quarter. Mitt Romney, the Republican presidential candidate, has criticized President Barack Obama as too soft on China. At the same time, Obama has expanded trade complaints against the nation: Last week he accused it of imposing unfair taxes on American vehicles, mostly from General Motors Co. and Chrysler Group LLC.
Will US Response Be Protectionism?

Mitt Romney has pledged to designate China a “currency manipulator” and impose duties on its imports if the yuan isn’t allowed to float freely.

If Romney increases tariffs three things will happen, all of them bad.

  1. Prices will rise
  2. Growth will slow
  3. China will retaliate with tariffs of its own or by buying more goods from Europe instead of  goods from US produces 

In essence everyone will pay higher prices for goods and services in hopes of bring back a few hundred manufacturing jobs (while losing tens-of-thousands of jobs in the ensuing economic slowdown).

Agreement With Lagarde

It is not often I agree with IMF head Christine Lagarde, but this time I do. Please consider IMF's Lagarde urges caution over protectionism
IMF Managing Director Christine Lagarde on Tuesday said the global economic situation was worrisome and urged countries to be cautious of protectionism.

Lagarde described as "quite alarming" a report published by the World Trade Organization in June which said the world's trading nations were succumbing to protectionism in the wake of the global financial crisis.
Cusp of Deflationary Vortex?

Ambrose Evans-Pritchard writing for The Telegraph proposes China Headed For a Deflationary Shock
China is on the cusp of a deflationary vortex. This was signalled late last year by the sharpest contraction in the (real) M1 money supply since modern records began. The hard data is now confirming the warnings.

Consumer prices have been falling for the last three months, producer prices have been falling for four months. This is not a food cost story. It is systemic.

Is this the long-feared hard landing? Of course it is.

The problem was the explosive growth of credit in the preceding years. This is roughly twice the intensity of credit growth – around 50 percentage points of GDP – before the US and Japanese blow-offs.

There seems to a near universal assumption that China can pull the levers of the state banking system and set off a fresh credit boom whenever it wants.

Well, perhaps, but loan demand has withered. The big four banks lent just 190bn yuan in June, down from 253bn in May.

"Large banks are all offering money, but no one is taking it," said a Shanghai dealer quoted by Reuters. This is more or less what happened in Japan in the 1990s, what is happening in Europe now. It is what happened to half the world in the 1930s.

But at the end of the day, the country is bursting with industrial over-capacity.

Woe betide the world if China does indeed land with a thud. We will then have a synchronised planetary slump for the first time since you know when.
Less for More vs. More for Less

Pritchard correctly cites the problem as the "explosive growth of credit in the preceding years."

While not proposing a direct solution (thankfully - because I nearly always disagree), Pritchard fears something that needs to happen.

In a comment to Pritchard's post, Pater Tenebrarum responds "It would of course be excellent news for all of us if we were indeed flooded with cheap goods. Who wants to pay more for goods instead of less? Apparently paying less is considered a great calamity. Not by me though, and I feel pretty certain that there are a few billion consumers who would agree with me."

Count me in the group of a few billion people who would gladly pay less for more, rather than more for less.

Mike "Mish" Shedlock
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