Tuesday, July 31st, 2007
China Tries to Tap the Brakes on Growth
By Martin Hutchinson
And William Patalon III
By moving to tighten credit yesterday, China is trying to maintain an economic balancing act that would make a high-wire artist envious.
On one hand, China wants to maintain a super-high growth rate, understanding that’s the only way it can overcome poverty, keep a lid on a miasma of financial sins including rampant bad debts, and generate the kind of investment capital needed to bring the country into the capitalist age. If it over-accelerates, China’s economy could steam out of control and jump the tracks, feeding into an economic collapse that will dwarf the 1997 Asian contagion.
But on the other hand, if it can manage to keep the China Economic Express train steaming along at a pace that’s a notch or two shy of “out of control,” investors will continue to reap the profit windfalls created by the largest wealth-creating market on the planet.
Clearly, investors across the globe are hoping that China can avoid the kind of fatal slip that sometimes befalls a high-wire performer.
In pursuit of this last goal, China yesterday ordered commercial banks to shrink the pool of money available for loans – the latest in a series of token efforts that have done nothing to slow an economy that grew at a scorching 11.9% in the year’s first half, its fastest pace in 12 years.
This was just the latest of Beijing’s token moves, each intended to make it appear as if China is seriously trying to throttle back growth.
While China’s short-term prospects are tough to gauge, with volatile markets likely to be the norm for months, the nation’s long-term prospects are outstanding, most research shows.
But the near-term maneuverings China is making are mostly very obvious attempts to pacify government leaders in the capitalist west who want China to temper its export-led growth. These opponents – led by the United States – have accused China of engaging in all sorts of unfair trade practices.
Trading Partners Are Also Trading Tensions
Trade tensions between the United States and China go back a long way, and at various times have centered on disagreements over intellectual property, subsidies, trade barriers, and even recent concerns about product liability. But none of these issues were ever as emotionally charged as the friction that’s developed over China’s currency valuation, and the ballooning trade deficit America faces with its key Asian trading partner.
Indeed, back in June, the still-spiraling tensions induced Congress to draft legislation that would punish China for its alleged trade infractions, as militant lawmakers repeatedly referred to China as a “currency manipulator.” The Bush Administration refused to cite China for this very serious global-markets infraction, a stance that brought an outcry from congressional leaders, though it also seemed to defuse the emotion of the moment. Even so, there’s still a very real possibility that one of these developments will be enough to vault the two nations into an all-out trade war, which neither country would benefit from.
Just weeks ago, when it announced a record-setting global trade surplus of $26.9 billion for June, China re-ignited allegations that it’s engaging in unfair trade practices. The positive trade balance for June represented an 85% increase over the same month a year ago. Total trade for the year’s first half was $980.9 billion, with a surplus of $112.5 billion. China is predicting a full-year trade total of $2 trillion, with a record surplus of $200 billion.
Last year, the United States recorded an $836 billion trade deficit, of which the Chinese bilateral deficit accounted for 28% – by far the largest portion. China’s trade surplus with the U.S. stood at $14.1 billion in June, helping it to reach $73.9 billion for the first six months of the year, according to the China’s Customs Bureau.
The United States contends that the deficit with China is actually much larger than that, even, meaning it’s an even-bigger problem that most analysts realize. Nothing China has done has had any visible impact on growth. China’s trade surplus continues to balloon: Its foreign-currency reserves are growing by $200 billion every six months and currently sit at $1.3 trillion.
For a bit of context, consider this: When China revised its 2006 Gross Domestic Product figures recently, its said the nation’s overall GDP reached $2.79 trillion for that year. In other words, China’s foreign reserves were nearly equal to half of what its entire country produces in a year.
Beijing continues to make moves that are token efforts, at best. Including an increase last week, Beijing has already boosted interest rates three times this year, bringing the benchmark rate on a one-year loan to 6.84%. Then yesterday, China’s central bank was back again, this time ordering lenders to raise the amount of money they keep on reserve to 12% of deposits, up from the previous level of 11.5%. Raising the reserve requirements is theoretically supposed to make it tougher for banks to make loans.
At this point, however, the China Express is chugging along at full-steam, and perhaps is even out of control. If that’s the case – and it’s not completely clear that it is – then the monetary and fiscal brakes it’s using are inadequate, and investors are merely along for the ride.
What’s also not clear is just what strategy investors should use. China is the linchpin of Asia, and will be the No.1 generator of new wealth for decades to come. In the short-run, there may well be some significant bumps along the way.
Investors can leap clear, or can remain aboard until the economy hits something, accepting that the crash could be unpleasant when it comes, but also not knowing how long it will be before that happens, if at all.
If you leap clear now, you’ll lock in the profits you’ve already earned.
But there may be an opportunity cost: You could end up leaving substantial future profits on the table. And the longer that crash can be deferred, the more time everyone has to make more money in China’s stock and real estate markets.
China’s Catch 22 Quandary
Chinese growth has been accelerating for over three years now. The Shanghai stock market took off at the end of 2005, and is up about 300% since then. Since the end of last year alone stocks are up 130%.
The People’s Bank of China has resorted to several interest-rate increases, but only by about a quarter of a percentage point each time. China’s Yuan has been allowed to appreciate, but only by about 8% against the dollar in the two years since it was first allowed to “float”. And that’s far less than what U.S. trade officials have wanted to see.
Nothing China has done has had any visible impact on growth. China’s trade surplus continues to balloon: Its foreign-currency reserves are growing by $200 million every six months.
China’s consumption has grown rapidly. And so have its investments – growing at an annual rate of nearly 26 % in the year’s first half. Because of the overly modest moves that the country has made, the Chinese economy has only grown hotter.
With that, we can see that China faces a real Catch 22.
On one hand, there’s a lot of global pressure for the country to throttle back on its potentially out-of-control growth. And a really strong argument could be made that a somewhat slower pace of expansion – one that won’t end up with a crash as potentially damaging as the one that ended the dot-com bubble here in the United States – would be much better for China’s long-term health than the hyper-boom that’s now underway (and that’s got the very real potential of ending badly).
Unfortunately, after suffering under real Communism for half a century – the Chinese people have no prior memories of an economic boom and soaring living standards like one that they’re reveling in, right now. The idea that this marketplace miracle should for some reason be extinguished is to them bizarre. Thus, over a million new brokerage accounts are being opened per month, and the Chinese passion for gambling is now manifesting itself in the ever-more-extravagant valuations on real estate, and the limited float of the Shanghai and Shenzhen stock exchanges.
And even if China’s new class of savers wanted to put their money in a safe haven outside their country, they couldn’t legally do so anyway.
And yet, China’s economic and political leaders (in many cases, one and the same) dare not take any actions draconian enough to stop the boom. Indeed, any development that actually threatens to end the boom is to them deeply unwelcome. For one thing, there are about $1 trillion of bad debts in the Chinese banking system that are being covered up by the accountants, and which are growing monthly as more money is lent to the bankrupt companies and hopeless projects that incurred the debts in the first place.
Thankfully, Western investors in 2006-07 have poured over $100 billion of new capital into the Chinese banking system, and that’s delayed any day of reckoning. Chinese authorities know that the bubble must some day burst, but from their point of view, the later the better.
And even if China wanted to put on the brakes and slow this boom to a more sustainable pace, it’s not clear how it could do so.
There is no proper domestic money market, so raising interest rates only affects the bookkeeping entries by which banks lend their “dud” customers enough money to pay their interest charges, keeping the loans “current”. Taxes could be raised, but tax evasion is rife and would become even more so, thus blunting any economic benefit.
The exchange rate could be strengthened, but that would attract even more speculative capital into the country, raise Chinese workers’ living standards and spending, and probably crash the banking system.
Profits Are Up 1,056.2% for This Wisconsin Company
Commodities are on a tear - and so is mining equipment. This "pick-and-shovel" company has already sold out two-thirds of its equipment for 2008. Australia, Canada and China are battling for orders. And the Street hasn't figured it out yet. All the details are in our Power Plays Report.
