China's growth a global red herring

More and more, people are turning to China's flawed GDP figures to get a reading on global growth. The best indicator of world economic activity does start with a C – but it's not China.

When I was working in Treasury a few years ago, a colleague told the story of his official visit to China. He was speaking to his Chinese counterpart in the economic forecasting section and was marvelling at the accuracy of the economic forecasts of the Chinese government. He said to his Chinese friend, "your forecasts are remarkably accurate. For GDP and inflation you are never out by more than 0.1 or 0.2 percentage points. Quite often, you are spot on. How do you do it?”

Without an overt hint of discomfort or irony, the Chinese economist answered: "John – not only do we make the forecasts, but we also compile the data."

This background is important in judging the true momentum of the Chinese economy and with it, global growth.

It has been clear for some time now that the global economy is faltering. The Reserve Bank governor, Glenn Stevens, agrees. Yesterday when Stevens announced that interest rates in Australia were on hold, he said, "the world economy has softened. Current assessments are that global GDP will grow at no more than average pace in 2012.”

This is the same thing as saying that global GDP is more likely than not to grow at a below average pace and at best will only be average. The glass half full versus half empty approach, it seems.

How far below average and whether this period of softness extends into 2013 are the current big policy issues.

It is not easy to measure global economic growth in an accurate or timely way. Most countries publish their quarterly GDP data at least one and often two months after the end of each quarter. The world has frankly moved on well after these GDP numbers are published. The estimates of GDP are also notoriously unreliable and what might be an initially positive reading for an economy is often revised away when the statistical agency incorporates more reliable information.

The reliability of the Chinese economic data is increasingly important for estimates of global growth and for Australia what actually happens in China is critical. A decade or two ago, it didn’t really matter that much that the Chinese data were dodgy – China accounted for only 5 per cent of global GDP. But now China is close to 15 per cent of global GDP and in a couple of years will it will overtake the US as the biggest economy in the world. A misleading signal from China could have huge implications for the rest of the world.

The Chinese authorities produce GDP estimates just a few days after the end of each quarter, so they do have the virtue of being timely. But in producing such timely data, they cannot be accurate. The fact that the data are rarely revised only adds to the suspicion the numbers cannot possibly be a true reflection of the growth rate in China.

It was recently reported that Chinese GDP growth was 7.6 per cent in the year to the June quarter. The RBA’s Stevens said yesterday that "China's growth has moderated to a more sustainable pace” and he is presumably basing this assessment on the GDP result.

But are Stevens and the rest of us being lead up the garden path?

How do we best judge the position of the global economy?

The answer is reasonably straightforward – look at commodity prices.

There is reliable and accurate price information on commodity prices on a daily, even minute by minute, basis.

Of course, commodity prices are determined by a mix of supply and demand, but it is safe to say that generalised rises in commodity prices are associated with accelerating or strong global economic growth, while global downturns inevitably will be accompanied by weaker commodity prices.

Forget Chinese GDP or US non-farm payrolls when judging global growth – look at commodity prices for the global growth pulse. Admittedly volatility in daily commodity price moves can be misleading, but if over the course of a few weeks or even months a trend forms, it is likely that the move is being driven by global fundamentals.

This brings us to recent trends in commodity prices. The current weakness in commodity prices is consistent with global economic sluggishness. The Reserve Bank’s own index of commodity prices in US dollar terms has fallen 15.2 per cent since August 2011. The base metal sub-index is down 26.8 per cent since April 2011.

The Thomson Reuters/Jefferies CRB Commodity Index is down around 11.5 per cent from its August 2011 peak, even allowing for the powerful and what will be temporary effect on some agricultural commodity prices from the severe drought in the US. In Australian dollar terms, the falls have been larger.

All of this suggests the global economy is fragile and subdued. It would be nice to see a sustained upturn in commodity prices at some time in the next few months because if we do, it is likely to be a reflection of a global recovery – and this is regardless of what the Chinese GDP data shows.

Stephen Koukoulas is an economist and financial market strategist who between October 2010 and July 2011 was economic policy advisor to Prime Minister Julia Gillard.

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