China Is Looking Fragile 27 comments
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I often start my mornings with egg, cheese and turkey sandwich at Panera Bread. Friday morning was no different. While reading newspapers on my Kindle, sipping hazelnut coffee (I know I just lost respect of the true coffee drinkers), I started with Thursday’s FT, and an article on China piqued my interest. China plays a very important role in the global economy and thus I pay close attention to it. I started reading:
“The benchmark one-year lending rate was cut by 27 basis points to 5.31 per cent, while the one-year deposit rate was lowered by the same amount to 2.25 per cent.”
This is not surprising news, but shows originality - China doesn’t want to be like the US, thus it cuts interest rates in multiple of 27 basis points, not a boring 25 basis points.
“The government estimates more than 10m migrant workers have lost their jobs so far, while 6.5m university students will enter the workforce next year.”
China is unlikely to escape the fate of developed countries, it faces rising unemployment. This raises a question – will it lead to political unrest? High unemployment in China is very different than high unemployment in the US or Europe. Unlike in the developed world, there is not much of a social net in China. In the US if you lose a job, you may be forced to shop at Wal-Mart (WMT) instead of Target (TGT) and you have to downgrade to basic cable – only 50 channels, sorry. I am oversimplifying, but we've got have unemployment benefits and many other government programs that will not allow one to starve. That is not the case in China; its safety net is in infancy, therefore high unemployment may mean hunger for many, and political unrest. The Chinese government knows this well. Unless it comes up with social net very quickly, it will stimulate the hell out of its economy that goes far beyond the stimulus it announced - this means more government spending. (I hear that the previously announced stimulus was just a reshuffle of normal government spending.) The next news makes things even more difficult:
“Chinese exports collapsed in November, contracting 2.2 per cent year on year after seven years of double-digit growth, while industrial output growth slowed to 5.4 per cent from 8.2 per cent in October.”
Though economists still forecast 5% GDP growth next year in China, the above statistics put that forecast in doubt. But even if 5% GDP growth forecast is right, as I’ve discussed in the past due to the unique nature of the Chinese economy (it has tremendous operational and financial leverage) it can only function in two modes – forward and backward; there is little middle ground. At the low growth speeds, and 5% is low for China, the manufacturing part of the economy simply chokes up and starts losing money. Thus the following news makes a lot of sense and is simply scary:
“China’s foreign exchange reserves, the largest in the world, apparently fell in October for the first time in five years, according to an official from the State Administration of Foreign Exchange.” [emphasis added]
Published economic numbers are very likely not describing a true economic reality in China. Despite economic growth, for the first time in a long time, China feels a need to dip into its piggy bank – foreign reserves. But here is a scary part – that piggy bank is mostly in the US dollars. The US Government is printing a lot of money at the moment to deal with our own problems; the printing press may not be inflationary in the short run (although definitely inflationary in the long run) as velocity of money is declining – banks are barely lending and consumers are deleveraging and are reluctant to borrow. But if the Chinese economy continues to deteriorate – a likely scenario as the deterioration just started – the Chinese government will stop buying US Treasuries and even worse, it will start digging into its US reserves. Since there are no other natural buyers (in size) of the US debt, our interest rates may actually skyrocket, the US dollar drops against Chinese currency, while our inflation may still remain low. This is bad for China twice:
- High interest rates mean even lower economic growth from the US and thus even lower consumption of Chinese-made goods.
- China cannot afford a weak US dollar – its US dollar reserves are worth less, and more importantly, its product becomes more expensive for US consumers.
Here is another thought: All this is taking place while long-term government bonds are at the lowest rates ever (or close). Long-term US Government bonds are likely the most overpriced asset in the world, period!
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This article has 27 comments:
b) Safety net hasn't been established but guess why savings are so high...
c) Foreign exchange reserves fell; c1) measured in what? The dollar dropped like a bric c2) somehow they need to finance their stimulus plan
d) If needed the CCP still has enough power to temporarily employ the people that lost their jobs by taking them over to state enterprises.
e)The biggest question is not peasants, it's students.
This is not surprising news, but shows originality - China doesn’t want to be like the US, thus it cuts interest rates in multiple of 27 basis points, not a boring 25 basis points. ""
Vitaliy, if you are going to point something out like this especially.. please do some research ... the basis points drop 27 basis points is because so many banks in rural areas use abacuses still rather than computers to calculate. It is easier for them to calculate at the 27 level with an abacus rather than the Chinese Govt trying to be original or misguided in policies as so many pundits far from China seem to think.
My general feeling is that this situation is more likely in the West; my sense is that most Chinese have a bit of respect for their Government - in contrast to, say, here in the US.
Also, the following sentence is puzzling:
but we've got have unemployment benefits and many other government programs that will not allow one to starve.
Unemployment benefits here in the US are quite limited, in amount and in duration; also, welfare benefits are time limited, thanks to Clinton era reforms. More importantly, social networks here are very weak - by comparison with almost anywhere, but especially compared with China.
Bottom line, I think that the US is more fragile and vulnerable to the prolonged downturn that we are in the early stages of.
I would not be investing in China - but this is just due to balancing risk and reward. Certainly I can envision investments in China returning huge returns, but in most scenarios I play out I see a huge trade war globally with significant turmoil in China.
Author is right in at least one point, that over half of China's foreign exchange reserve is parked in US Treasury and Agency bonds is very scary indeed. It has been looking scary for quite some time, but so far it has surprisingly turn out OK for China because of the desperate 'flight to quality' that pushed up US dollars and pushed down US treasury bond rates. As other currencies and commodities has plunged against the US Dollar, China may accelerate the long expected diversification away from US Dollars, if the cental planners can overcome their fear of betting on the wrong onvestments again. (All known financial sector investments in western markets by Chinese entities has been disastrous so far.)
they are all multiple of 9. This is how the abacus is constructed to register from 0 to 9 in each column.
On Dec 27 08:01 AM Shaun Rein wrote:
> " “The benchmark one-year lending rate was cut by 27 basis points
> to 5.31 per cent, while the one-year deposit rate was lowered by
> the same amount to 2.25 per cent.”
>
> This is not surprising news, but shows originality - China doesn’t
> want to be like the US, thus it cuts interest rates in multiple of
> 27 basis points, not a boring 25 basis points. ""
>
> Vitaliy, if you are going to point something out like this especially..
> please do some research ... the basis points drop 27 basis points
> is because so many banks in rural areas use abacuses still rather
> than computers to calculate. It is easier for them to calculate at
> the 27 level with an abacus rather than the Chinese Govt trying to
> be original or misguided in policies as so many pundits far from
> China seem to think.
Dont put China down.
1) From a cultural perspective, Chinese culture is much more hierachical than the western culture. Chinese people are one of the most resllient nations. In hardship, they tend to work towards better tomorrow. Only in extreme situation, they rebel. GDP growth <7% and milions people can't find a job is not one of those extreme situations. In early 90's when the government reformed the state run enterprises and put millions people out of job, there were some unrest but the country managed through w/o major problem.
2) People understand the problem stemmed from the western world, and the government has done everything possible to protect the economy. The government is not at fault for the hardship.
3) Unlike what the western media portrays, most Chinese people are appreciative to what the government has done in general over the past 30 years. Having suffered from revolutions before 1978, majority of people agrees with the party/government that maintaining a stable society, avoiding aggressive unrest and reform (such as the one went in Soviet Union in 1990's) are of paramount importance. Despite the coming hardship, resorting to large scale social unrest and reform is not going to resonate well with the people.
Your suggestion that China's selling of US Treasury securities will drive US interest rates up must assume the US Federal Reserve will not be in the market as buyers. While there is little evidence they are buyers yet they have indicated they are evaluating the possibility. If the Fed buys the bonds China wishes to sell then the debt is monetized and rates do not rise. There will be downward pressure on the value of the dollar but that is an economic stimulus which is needed now.
The day is rapidly approaching when China will be a global economic engine along with the US.
At the end of the day, the real culprit is the debt culture which allows people to have today what they rightfully will not potentially earn until tomorrow. The world needs to abolish central banks and fractional reserve lending else the problem will never be solved. Fractional reserve lending is the biggest scam ever created in the history of man.
In terms of per capita income (per capita GDP), it is very poor. 46.5% of the world average and only slightly better than Sub-Saharan African nation of Namibia and less than Botswana. China need all the encouragement we can give to tie over the current world financial crisis.
That's odd. Given that the total number of TEUs entering west coast ports dropped by 14% in November (YoY) I would have thought it might be a little higher than a 2.2% contraction. Japan acknowledges a somewhat larger drop - perhaps that accounts for it? Or perhaps the Chinese are fiddling the stats - again?
I like the comment about similaritlies between the U.S. of the 1930s and China of today (CLH). I think that China may have more advantages in the current situation than the U.S. had during the Great Depression. I have the impression that China, in spite of migration to the cities, still has a substantial agrarian population, more so than the U.S. had 80 years ago. This population can better weather economic downturns than can the urban poor and since the migration to the cities has been so recent, it can be reversed, at least temporarily (Yamu).
The extremely low percapita income (huangthomas) also gives a bigger cushion to using internal spending on infrastructure by using some of their large reserves (jepittman), which amount to $1.9 trillion (Simon Leoung). This reserve goes a long way when used in a country where 100 million live on less than $370 per year (huangthomas). With a velocity of 4, that level of compensation uses a little over $900 billion per year for 100 million employed.
I found this comment stream very enlightening, more so than the article. which discussed some things I was more familiar with than factors raise by commentors. (It was a good article Vitaliy - don't be offended.)
Finally, cuckoo's personal experience comment was interesting, but perhaps his correspondents are in an economic class that would be among the last to be affected if China does go into recession.
Honestly, I wish China well but there is apparently much internal unrest that is being successfully kept out of the press; I expect it will only get worse when illegal internal immigrants return to poor inland villages. Communist regimes produce dubious figures. Throw in the Japan-style demographics and preference (and cheap medical tech) for male children. China will need to make some massive cash outlays for pensions and healthcare.
A recent article (in the NYT, I think) on how young Chinese haven't been saving because, like once upon a time on Wall Street, ever more money was just around the corner to pay today's bills.
Though I would view this comparison with a grain of salt (the usual saying of comparing apples to apples, oranges to oranges), the point I am emphasizing is that lower wages, lower salaries, and lower standard of living over there would make any stimulus package go farther. Without any scientific justification, I would venture to multiply the effects of their US$576B stimulus package by a factor of 3 to 5 times. If this hold credible, that package would simply look like 2 to $3T.
The present high standard of living in the U.S. would make pain and adjustment much more difficult compared with ones in China who are used to a lower expectation.
One thing is quite certain. In the past several decades, our Best and Brightest seemed to head for Wall Street, drying up the supply of technical and scientific graduate students, and our academic halls were empty. If China went broke, or has fewer monies, there will be fewer Chinese foreign students to fill our "Smokeless Industries" (i.e., the Colleges).
I predict after 20-25% closing of our hospitals around the country, the next bubble to come would be for around 30% of our colleges to close shop - a much delayed right-sizing of a oversupplied and over0b
Many new ways of constructing homes for energy efficiency, for example, are minimally more expensive in the West and maybe even less so in China. There may be fewer barriers to distributed-energy systems in China. Pioneering with micro-grids there would be a service to the world, which needs to gear up with this technology.
If fewer solar cells are being purchased by the west, installing them domestically could begin to happen at a faster clip. The Henry-Ford way of wanting workers to own what they make is still a good business model. China has many reasons to pioneer distributed-renewable-... systems. Competition in this sector comes from Dubai, but China has more brains to throw at the issue than Dubai, though I am aware Dubai is recruiting with its dollars.
When I went to China in 2001, I was on a tour of medical facilities. The doctors assigned to talk with us were remarkably open. When asked to comment on their approach to dementia care, for example, they were direct and practical, with a series of physical things to check given perplexing behaviors. They were also open about suicide by pesticide, a problem for women left in the countryside when men have moved to the city for work.
To some degree, they were jaded. So many westerners were traveling to China and had shared their own perspectives. In mental health, for example, China was doing all sorts of interesting things, including ballroom dance therapy, karaoke therapy--you name it. European groups had shared, and Japanese groups had been through. Tour guides could choose to be trained in American English, English-English, Australian-English, and so on.
Western nations who had not shared with each other in all likelihood, had shared with China. I felt I really got my money's worth because it was like a world tour rolled into one, and accessibility in the West would likely have been less.
In some ways, when pent-up demand to go to China burst through, The Chinese could stay home and fish valuable information out of the stream as it passed by dropping off-shore currencies. They have enough manpower and cash to go offshore for information, as has been pointed out.
If the world needs to learn to do less with more while capitalizing on colorful history, I would say China has got a leg up. Try, for example, to keep Kissinger out of China. When I was there, my group was bumped from the section of the wall we had been scheduled to see, because Kissinger was going to be there privately with an entourage. Is Kissinger unique in his fascination with Chinese history and culture? I don't think so.
What are some U.S. pundits saying were the biggest TV moments of 2008? Replaying the Olympics at year-end wind-ups is incredible PR for brand China. I will not be betting against China. I'm in a renewable-energy stock, STP.