China’s Bogus Export Boom

By John Richardson

CHINA’S strong export growth in July and August is widely viewed as fantastic compensation for weaker growth at home. It also viewed as a sign that the global economy has perhaps, turned a corner,

But now it looks as if a substantial proportion of this export boom was, in fact, bogus.

Here is why:

• It looks as if fake invoicing has once again artificially inflated China’s export numbers (this last happened in late 2013).
• In the latest survey from China Confidential, a Financial Times service, 54% of respondents said that the false issuance of invoices is common. This is a sharp increase from the last survey in May.
• This is backed up by mysterious movements in the trade account. A category called “other exports” increased by 38% in August to $20.2bn, following a 92% rise to $3.9bn in July, according to China’s General Administration of Customs.
• No official explanation has been given for these fluctuations.

How this works is as follows:

1. An exporter sends a businessman, who is often based in Hong Kong, a fake invoice for goods (this businessman might well work for an offshore subsidiary company owned by the exporter in China).
2. The businessman pays the invoice by depositing dollars in the local manufacturer’s offshore bank account.
3. The manufacturer then uses the export paperwork to get permission from his bank to convert the dollars into Yuan. The factory owner may also get a fee from the investor, and can collect a VAT rebate on top.
4. Money raised by the fake invoice is then invested in the shadow banking system at annualised interest rates of 12%.
5. The idea, of course, is to make so much money from speculation in shadow banking that this pays a healthy return to both the local manufacturer and the offshore businessman.
6. Plus, as happened late last year and into early 2014, the Yuan has been appreciating of late. And so there is also an opportunity to make a foreign currency gain.

This looks like another scam ready for a government investigation as China continues to play its whack-a-mole game.

An earlier scam, which is now being closed down, involved importing actual cargoes of polyethylene (PE), mono-ethylene, copper and aluminium.

History is therefore repeating itself, but, as usual, not in exactly the same way.

Earlier this year, anyone who looked hard enough would have seen that:

• Genuine demand growth for this flood of imported commodities simply wasn’t there. PE apparent demand growth (imports, minus exports plus domestic production)  was, for instance, at 11% in January-July 2014 against real demand growth estimates for the full year of only 6%.
• This meant that these imports had to be about speculation in shadow banking. On this occasion, the financing for this gambling came from letters of credit, issued by foreign banks, that were used to pay for the imports.

And anyone who looked hard enough at China’s “export recovery” would have noticed this:

• Literally mountains of anecdotal evidence, from our colleagues at ICIS pricing, supported the idea that this year’s peak manufacturing season would be a disappointment. (The peak season, which runs from July until around September, is when China’s manufacturers ramp-up production of finished goods in order to export to the West in time for Christmas)
• Paul Satchell, a UK-based chemicals analyst, in his Volume Proxy report, has consistently warned of a poor peak manufacturing season.
• How could the season be anything but disappointing, given the economic weakness in Europe?

Now there is even firmer evidence of very weak global trade growth.

“The World Trade Organisation (WTO) has released its latest forecasts for global trade and it is not a pretty picture,” wrote the FT’s Beyonbrics blog, in  a 24 September post.

“The WTO’s economists have lowered their forecasts sharply. They now expect global trade volumes to grow just 3.1%this year, down from the 4.7% they predicted in the spring.”

The trouble is that even this revised-down growth number looks a stretch because global trade expanded by only  1.8% in the first six months of this year.

A further downward revision in the WTO estimate seems inevitable as a result of the economic problems in Europe. Europe accounts for one-third of global merchandise exports.

And here is another reason to expect a further WTO downgrade: One of the few bright spots in global trade has been the strength of China’s exports. But we now know that many of these exports are likely to have been bogus.

What does this teach us? Amongst other things, it is this:

1. As the New Normal develops, it is absolutely essential to challenge headline data, to dig much deeper.
2. This involves asking harder questions of yourselves, your colleagues and your contacts.
3. This will be an uncomfortable and difficult process.
4. But it quite simply has to be done as we have no other choice.