Germany & France GDP, US Industrial Shocks, China's Financing Surprise

The weight of shocks and surprises last week fell squarely on shocks - in data terms it was the  most miserable week since early June.  However, here are three aspects of the data which are worth bearing in mind: 

1. Germany and France GDP: Fundamentally Divergent Patterns Masked by Identical 3Q GDP Growth
2. US Industrial Weakness - The End of the Beginning? 
3. China's Aggregate Financing Surprise - Look Beyond Bank Lending

1. Germany and France GDP   The preliminary estimates of 3Q GDP showed both France and Germany growing +0.2% qoq. This was as expected for Germany, but a pleasant surprise for France (even if it may be revised away later), which suggests a comforting stability within the core of the Eurozone. Unfortunately, the likelihood that France and Germany will continue to grow at a similar pace in coming years is an illusion. The problem is not so much to do with the financial problems of the Eurozone per se, but rather that the two countries grow in different ways. Whilst for the first decade of the Eurozone this was masked by historic coincidence, it is unlikely to be so in the next decade.

Between 2000 and 2007, German growth averaged 1.7% a year, whilst France average 2.1% in real terms, suggesting a compatibility that tilted slightly in France’s favour.  However, Germany was pursuing a growth model based on  relatively low growth in capital stock but high and rising rates of return on that capital, whilst France’s growth was secured by high growth in capital stock but a far lower, and falling, rate of return.

Estimating growth of capital stock by depreciating all investment over a ten year period, between 2005 to now growth of Germany’s capital stock averaged 1.1% pa, whilst France’s was leaping along at 4.5% pa. The chart above shows that as a result, whilst Germany’s return on capital was likely rising throughout most of this period, France’s was (and is) falling. 

That behaviour isn't surviving the financial crisis: in 2008 at the beginning of the crisis, France’s capital stock was growing at 6.9% yoy, whilst Germany’s lagged at 2.1%. In the year to 3Q, I estimate France’s growth of capital stock had slowed to 3%, whilst Germany’s had risen slightly, to 2.4%. These numbers are the very cornerstone of future growth: and they strongly suggest that the years when France’s economy keeps pace with Germany’s are over.

2. US Industry Shocks  The industrial shocks fell thick and fast this week: industrial production fell 0.4% mom in October, with manufacturing down 0.9%, which dragged down capacity utilization rates to their lowest since November 2011. The news was exacerbated by a shockingly weak Philly Fed survey, a weakness in part reflecting the impact of Hurricane Sandy on production and orders. However, although those grabbed the headlines (and depressed sentiment), the news was not solely bad.

To understand why, consider the chart above, which tracks growth in output against growth in manufacturing and trade sales. Throughout much of the last year, the trend in sales has been declining relative to output. By June, we had finally reached the point where output was growing faster than sales – surely a herald of a production slowdown needed to restore equilibrium. This deteriorating supply/demand imbalance has led to recurring bouts of industrial weakness, of which September’s 0.4% mom decline was the latest manifestation.

But now look at the chart again: sales are now picking up both absolutely (manufacturing and trade sales rose 1.4% mom in September) and relative to production. In addition, total inventories rose 0.7% mom, and exports jumped 4.2% mom. In short, manufacturers and buyers are seeking, and beginning to find, an equilibrium. This doesn’t mean that US industrial weakness will quickly pass: but October’s output fall is more likely the end of the beginning than the beginning of the end.    

3. China Aggregate Financing Surprise The one genuinely positive surprise last week came from China and passed virtually unnoticed. The surprise was the strength of the Rmb1.29tr in new aggregate financing extended in October, which was 63.1% higher than in October 2011. However, the data was largely ignored, in favour of the  ‘disappointing’ Rmb 505bn in new bank loans made during the same month. Now bank lending is a subset of China’s monthly ‘aggregate financing’ which also includes bankers acceptances, trust loans, bond issues and fx loans.

Historically bank lending has accounted for the lion’s share of China’s visible financing, but is being steadily eclipsed by other financing methods. This eclipse is partly driven by the perennial efforts of cash-rich banks (loan/deposit ratio of 69%) to escape the corset of PBOC’s lending disciplines. But currently, in addition, the large-scale issuance of bankers acceptances helps to reliquefy cramped industrial cashflows without necessarily re-igniting property markets. In coming years, meanwhile, the envisioned phased liberalization of financial markets and institutions is likely to keep driving down bank lending as a proportion of total financing.

All of which raises the question: what is happening to overall financing levels. We know that growth of banks’ loan books slowed to 15.9% yoy in October and has been slowing