Any first-year accounting student knows that the easiest way to make a company's revenue and earnings look good is to change when a company recognizes a sale or an expense.
Recognize a sale as soon as the salesperson puts down the phone, and revenue goes up. Recognize a sale only when the money is in hand or, even more conservatively, spread it out over the life of a contract, and revenue goes down.
China knows this, too. And, according to John Makin of the American Enterprise Institute, the country's official economic figures -- we're talking the Chinese government's numbers here and not those reported by individual companies -- systematically overstate the speed of the country's economic recovery.
In an August article entitled "China: Bogus boom?" Makin explains that China's system is designed to report production and not, as in U.S. statistics, expenditure growth, which is the sum of consumption, investment, government spending and net exports.
That's why China's November stimulus package has already got the Chinese economy humming at a growth rate close to 8%, according to the official numbers, even as Washington's package is still finding its way into the economy.
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Here's how China's numbers machine works, according to Makin:
Beijing decides on a $586 billion stimulus package in November. That money gets recorded as growth in gross domestic product as soon as it's disbursed. None of this waiting around for the money to stimulate economic activity before anything gets recorded as GDP. Nope, the money is counted as spent by state-owned companies and local governments in national economic statistics as soon as the check leaves the building. None of this messy lag, for example, while local governments identify projects, send out requests for bids, sort through bids, award the contracts and then wait for contractors to get to work.
Selling (or at least counting) fast
But the system doesn't stop there. As soon as something is produced it goes into the national numbers in such categories as retail sales. Make it, ship it, and it's a sale. As Makin writes, "Shipments to retailers are counted as retail sales on the apparent assumption that ultimately all goods shipped will be sold at some point in the future."China's retail sales numbers have climbed about 15% in the first half of 2009 from the first half of 2008. How much of that actually went home with customers and how much is still sitting on shelves or in storerooms is anyone's guess.
I wouldn't argue that U.S.-style national accounting is perfect or even superior to the Chinese system. (See General Electric's (GE, news, msgs) recent settlement with the Securities and Exchange Commission over charges that the company fudged its accounting to make quarterly earnings numbers.) A hurricane that destroys New Orleans, requiring massive rebuilding, counts as a boost to GDP in the U.S. system, for example, because it increases economic activity. (Of course, it decreases national wealth, but GDP measures activity, not wealth.)
But investors get into trouble when they assume that China keeps score like the U.S. does.
On Jubak Picks
Qiu Xiaolong's Inspector Chen detective series, set in a modernizing Shanghai, paints a fascinating picture of how politics and economics intertwine in today's China. It's fiction, but the mysteries capture the realities of power and the limits of the free market in China better than any official figures. See Jim Jubak's review in Stuff Jim Recommends on his JubakPicks.com blog.
For example, investors have bid up the price of commodities and commodity stocks in the belief that China is buying more iron, coal, copper -- you name it -- to fuel its manufacturing sector. A few economists have wondered whether the commodities bought on global markets are actually being consumed in China. They worry that much of it is going into stockpiles. If these commodities are going into products, they ask, shouldn't we be seeing a bigger increase in Chinese exports? Instead, Chinese exports are still declining, dropping 20% in the first half of 2009.
Continued: Why the answer matters
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