China Update - A Prayer for The People's Republic

Posted by jeff

Wed Dec 26th, 2007 09:38 AM

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A couple of items have caught my eye in recent weeks regarding China. While we shoppers are gorging ourselves on Chinese goodies this holiday season, I thought it appropriate to do an update to my original piece, "Skinny Dipping Anyone ", on the raging growth machine that is the People's Republic.

According to the Chinese Central Bank's research bureau, economic growth in China is forecast to slow slightly in 2008 to 10.9%. This after closing out 2007 at an 11% clip vs. 10.7% in 2006 and at the highest rate since 1995. Let's face it the place is 'en fuego'. Importantly, inflation will be up 4.5% in 2007, and hit a decade high monthly rate of 6.9% in November, more than double the central bank's target rate and the highest since 1996.

As you can see from the charts above China's central bank is using a couple of its policy levers to try to slow the economy down and has been doing so for well over a year. Interestingly, their latest policy move was to raise the lending rate by 18 basis points to 7.47%, while raising 1 year deposit rates by 27 basis points to 4.14% - shorter term 6 mos. and 3 mos. deposit rates were raised even more. (Please note that our Fed only controls fed funds and discount rates, not the rates bank pay depositors or at which they make loans to borrowers. The Chinese authorities have much greater control - but as you will see even the central banks with the broadest powers really have only very blunt instruments to work with in tuning economies.) The Chinese are pushing up lending rates less than deposit rates and it is speculated that this is because the authorities want to make deposit rates more attractive so people don't move money into the raging stock market as quickly as they have been. Of course the mainland China stock market is up something like 86% this year (see chart below) so I don't know how tempting 4.14% really is in comparison. On the flip side, the government is believed to feel that capital is so available in this booming market from both overseas investors and the stock market that targeting lending rates won't do bubkis to slow growth, so they are hiking reserve requirements as a way of rationing bank lending - you can see this in the right-hand chart above. How reserve rates help central banks control money supply growth is explained in my recent piece Making Money Out of Thin Air.

Now bullish stock markets are not usually accompanied by the kinds of "tight" monetary policies now officially being pursued since the December 8th Chinese Central Economic Work Conference. Surging food prices and wages have persuaded government officials that despite the risk of popping a stock market bubble, they must curb money supply and investment to keep inflation from getting embedded in the economy, all the while increasing government spending to boost consumption and ensure a soft landing. YIKES! that's one tall order. Every time we have an interest rate increase cycle in the U.S., something goes pop....even when there is a soft landing. If it's the Chinese stock market that does so in this case it could get a bit ugly.

For many years China's state owned enterprises SOEs were closely watched for signs of China's success in transitioning to a market economy. Many of these businesses were, highly subsidized, barely profitable and often-times corrupt. After the Asian contagion threw a scare into the Chinese, the government worked hard to reform these businesses and allow the bad ones to die or be merged out of existence, while bolstering the strong. People don't pay as much attention to them these days as their numbers have dwindled to 150 recently from 196 in 2002. However, 2007 was reportedly a good year for them with profits up 30% to 1 Trillion yuan (roughly $136 Billion yankee dollars). But their are a couple of wrinkles, 9 internationally known leading companies like China Mobile, China National Petroleum and China Boasteel generated 70% of these profits. Additionally 31.2% of profit growth came from "non-regular revenue"...that's code for stock market investments. These are the same shenanigans that busted the US in the 1920s and Japan in the 1980s.

Speaking of Japan in the 1980s. It was the Japanese who swooped in and bought Rockefeller Center just as the commercial real estate downturn in the U.S. was getting underway in 1989. Interestingly, while they were too early in their call on U.S. real estate, the deal was more of a marking of the top in their home market and economy than in ours. Let us pray for the People's Republic that China's deals to buy stakes in Blackstone Group at the peak of the recent buyout mania and Morgan Stanley (as a contrarian play) last week aren't similar markers. With China expected to be one of the only growth locomotives in a world economy where Europe and Japan are slowing and the U.S. could have a recession......we need these guys to stay healthy. So stuff those stockings a little higher this year, say a prayer for the People's Republic and Have a Merry Christmas and Happy & Profitable New Year.

While my piece is meant to make you aware of the possibility of trouble in China, I write it somewhat tongue in cheek as I don't see a high probability of a major downturn there before the Olympic Games.

Bearish Sentiment on China In the Blogosphere:

China Fears Devastation to Exports

The Coming China Crash

We Interrupt This Blog To Announce the End of the World - Maybe