This week's entry is fairly miscellaneous, a consequence both of the amount and variety of news coming out of China and my own hectic schedule, which prevents me from dealing with all of these issues in a more unified way. Between lots of investor meetings and finishing up a number of writing commitments, I am preparing next week to go to New York and Washington for ten days.
As an aside, the timing of my trip was determined by an East Coast tour, centered on New York, which my music label, Maybe Mars, is arranging for some of the best Beijing musicians, including the surreal folk singer Xiao He, one of the most astonishing and creative musicians I have ever worked with. For those of my regular readers based in or near New York who may be interested in checking out the Beijing new-music scene, I strongly recommend that you keep an eye out for the shows, beginning November 5 and running through the end of the month. These guys are really good and I expect a great reaction from the New York music community.
But back to more mundane stuff. Last week’s excellent economic numbers once again reinforced everyone’s existing prejudices. I discussed why in a September 11 entry in response to similar numbers last month. Those who believe that the stimulus package has essentially resolved China’s plight and eliminated its vulnerability to export demand saw the 8.9% year-on-year GDP growth rate (at the lower end of a narrow range of expectations) as proof that Chinese growth has solidly recovered. Andy Rothman at CLSA in a research report released the following day had this interpretation:
Other than GDP coming in just under 9%, no surprises, and we agree with the NBS spokesman, who this morning said ‘the overall situation of the national economy was good.’ We maintain our forecast of about 8% GDP growth for this year, and 8-9% for 2010 (closer to 9% if you expect a US/EU recovery to generate a bit of a net exports boost for China).
He then went on to say something that puzzled me:
The fact that China’s GDP grew by 7.7% in the first nine months of the year while exports were still extremely weak (the trade surplus was US$ 135.5bn, down by US$ 45.5bn YoY) illustrates that the mainland economy is not export-led. Net exports delivered a -47% contribution to GDP growth in the first three quarters, while final consumption accounted for 52% of growth and investment 95%.
I think almost by definition if the decline in exports had such a terrible impact on the growth rate, China must be heavily export dependent, and it was only the impact of a massive stimulus that permitted such high growth rates – in fact the IMF actually claims that 60% of Chinese growth in the past decade was explained by exports and investment in the tradable goods sector. China, it seems to me, is heavily export dependent, and it is only the massive, and temporary, impact of the stimulus that keeps growth up.
Although Rothman is considered to be one of the most bullish analysts on China’s medium-term prospects, he hasn’t come close to expressing the cheerleading sentiments of Fareed Zakaria, who seems to have very little doubt or worry about China’s economic trajectory. In an article two weeks ago in Newsweek he wrote:
The great surprise of 2009 has been the resilience of the big emerging markets—India, China, Indonesia—whose economies have stayed vibrant. But one country has not just survived but thrived: China. The Chinese economy will grow at 8.5 percent this year, exports have rebounded to where they were in early 2008, foreign-exchange reserves have hit an all-time high of $2.3 trillion, and Beijing’s stimulus package has launched the next great phase of infrastructure building in the country.
Much of this has been driven by remarkably effective government policies. Charles Kaye, CEO of the global private-equity firm Warburg Pincus, lived in Hong Kong for years. After his last trip to China a few months ago he said to me, “All other governments have responded to this crisis defensively, protecting their weak spots. China has used it to move aggressively forward.” It is fair to say that the winner of the global economic crisis is Beijing.
I am not sure China hasn’t done the same thing – protecting its own weak spots – since both the Chinese stimulus and the US stimulus essentially went to exacerbating the sources of each country’s domestic balance, US excess consumption and Chinese excess investment, but at any rate there is a 500-year or longer tradition in the West that when we write about China we are really using a mythical China to write about our own societies. I think Zakaria’s article may be an example. He goes on to say:
And look at the nature of China’s stimulus. Most of U.S. government spending is directed at consumption—in the form of subsidies, wages, health benefits, etc. The bulk of China’s stimulus is going toward investment for future growth: infrastructure and new technologies. Having built 21st-century infrastructure for its first-tier cities in the last decade, Beijing will now build similar facilities for the second tier.
China will spend $200 billion on railways in the next two years, much of it for high-speed rail. The Beijing-Shanghai line will cut travel times between those two cities from 10 hours to four. The United States, by contrast, has designated less than $20 billion, to be spread out over more than a dozen projects, thus guaranteeing their failure. It’s not just rail, of course. China will add 44,000 miles of new roads and 100 new airports in the next decade. And then there is shipping, where China has become the global leader. Two out of the world’s three largest ports are Shanghai and Hong Kong.
Although Zakaria’s main point may be to insist that the US is failing sufficiently to upgrade its infrastructure (a point with which I and many other people would heartily agree), the idea that therefore, and in contrast, China’s infrastructure spending is a good idea may be very mistaken. I think China probably already has the best infrastructure in the world for its level of development, and it is not clear that spending a fortune upgrading it makes economic sense, unless you assume that every country at any low level of development has a near-infinite capacity to upgrade infrastructure. In that light, there is an interesting article in Monday’s South China Morning Post on this very subject.
China’s high-speed rail network will overtake Europe as the world’s biggest by 2012, posing a threat to the country’s troubled airline industry.
The cheaper tickets and often quicker journeys to be offered by high-speed trains are expected to substantially cut the market share of domestic carriers that already face bruising competition from airline rivals. Although still in its infancy, the mainland’s high-speed rail system will account for most of the world’s fast tracks by 2020 as Beijing accelerates a mammoth transport infrastructure programme.
Faster, faster, faster
It is easy to get excited by this building program, but are those high-speed rails, which may be fast, exciting and fun to ride, economically justified? Even if they were justified in the US or Europe, where the economic value of every hour saved is many times the value in China, they are probably not justified in China. After all, an American might gladly pay $100 a month to cut his daily commuting time by one hour, but for most households in Beijing or Shanghai this would be the equivalent of paying one-third to one-fifth of their income – probably not worth it. And note that I am not even mentioning one of the sub-stories in this article – that China’s airline industry may be seriously hurt by the high-speed rails even as China is splurging on a massive airport investment program.
So does it matter if we waste a little money? Of course it does. Remember that if the total economic benefits are less than the cost of the investment, we can’t simply assume away the difference. We need to figure out who will pay, and it shouldn’t come as a huge surprise if Chinese households ultimately pay for this waste, as they always have, through all the “normal” channels – sluggish wage growth, very low returns on their savings, indirect taxes on income and consumption, and so on. If they do pay, not only will this make it very hard for them to sustain the consumption splurge that we are all demanding of them, but it represents a transfer of resources from those that must pay for the railway to those that most often use it – all Chinese must pay for benefits that accrue mostly to the wealthier segments of China’s wealthiest cities.
This is a large part why many analysts are not impressed by China’s investment-driven growth. Not only is much of it explicitly aimed at increasing production, much of the rest of it is implicitly likely to reduce consumption. Those of us with a pessimistic outlook of course read last week’s data release differently than do those who see the numbers as evidence that the stimulus is “working”. For example in my last two posts I discuss the risks of inventory build-up, and the increasing sense I am getting that a lot of what I expected to show up as inventory build-up may be happening outside corporate balance sheets. In that light reader Pangea Joel left a comment on my last post that alerted me to this very interesting and very apposite article on Bloomberg:
Private investors in China, the world’s largest metals user, have stockpiled “substantial” quantities of copper as the government ramps up stimulus spending to spur the economy, according to Sucden Financial Ltd. Pig farmers and other speculators may have amassed more than 50,000 metric tons, Jeremy Goldwyn, who oversees business development in Asia for London-based Sucden, wrote in an e- mailed report after a visit to China. That’s about half the level of inventories tallied by the Shanghai Futures Exchange, which stood last week at a two-year high of 97,396 tons.
Sucden’s estimate underscores the difficulty analysts face in gauging metals demand in China amid increased speculation by retail investors, whose holdings remain outside the reporting framework undertaken by exchanges. Private investors in China also had as much as 20,000 tons of nickel, Goldwyn wrote. “People who have nothing at all to do with the copper trade have been buying copper as a store of value, much like they would with gold,” said Jiang Mingjun, an analyst at Shanghai Oriental Futures Co.
…“Private stockpiles, built by many including the much- vaunted, pig-farming speculators, have clearly absorbed substantial quantities of metal,” Sucden’s Goldwyn said. “Much of this metal will remain out of the normal market place.” Scotia Capital Inc. analyst Liu Na highlighted the role of Chinese pig farmers and other private speculators in the metals markets in an Aug. 17 note that cited reports from state-owned China Central Television. These speculators may become “quick sellers” if sentiment turned, Liu said in that note.
To be sure, Sucden’s Goldwyn wrote that the stockpiles of copper and nickel held by farmers and others in China may “not be ‘dumped’ back in the foreseeable future as some have recently suggested, wherever prices go.” Goldwyn didn’t give a reason. The metals holdings by pig-farmer investors and other private speculators give “the impression that there is strong demand in China,” said Jiang at Shanghai Oriental. “But it is actually those who take a pessimistic view of the economy and are looking to preserve their wealth who are buying.”
Caution at the banks
This is something that we are all going to have to keep an eye on – an awful lot of investment has become inventory accumulation and speculative stock-piling, and this automatically increase volatility since in any downturn de-stocking exacerbates the slowdown. Meanwhile it is not as if analysts inside China are as bubbly as those outside China. Last week one of China’s most senior bankers gave pretty strong warnings about the impact of excessive credit expansion. According to an article in last week’s Financial Times:
China needs an “urgent” tightening of monetary policy to prevent the huge stimulus measures introduced this year from inflating stock and property bubbles, one of the country’s leading bankers has warned. Qin Xiao – chairman of China Merchants Bank, the country’s sixth-biggest – says in Thursday’s Financial Times that the government should not be afraid of a “moderate slowdown” in the economy.
“Monetary policy must not neglect asset-price movements,” he writes. “Therefore it is urgent that China shifts from a loose monetary policy stance to a neutral one.” Mr Qin’s unusually frank warning comes ahead of the publication on Thursday of third-quarter gross domestic product figures that are expected to underline the rapid recovery in China’s economy, with analysts forecasting growth of nearly 9 per cent compared to last year.
This was followed by a statement by Liu Mingkang, chairman of the China Banking Regulatory Commission. Here is Bloomberg’s take on a statement he delivered last week on the CBRC’s website:
China urged its banks to lend “reasonably” this quarter, after a surge in credit increased risks in the nation’s banking system. The China Banking Regulatory Commission will closely monitor the impact of global capital flows and domestic policy adjustments on liquidity in the banking system, Chairman Liu Mingkang said in a statement on the regulator’s Web site today. The CBRC will ensure that “ample liquidity is always maintained,” he said.
…Commercial lenders’ bad-loan ratio dropped by 0.76 percentage point from end of last year to 1.66 percent as of Sept. 30, as non-performing loans declined by 55.8 billion yuan to 504.5 billion yuan, Liu said today. The decline masks growing risks in banks’ loan books, he said. “Behind the ‘double-dip’ in non-performing loan data, credit risks under the rapid lending growth are accumulating,” Liu told a CBRC meeting in Beijing. The risks “need high attention and should be effectively dissolved.”
While I am on the subject, on Saturday I was discussing with Logan Wright, who co-teaches the PBoC Shadow Committee seminar I run at Peking University, the loan numbers for September. Net new lending last month was RMB 517 billion, which when corrected for the RMB 352 billion reduction in discounted bills and a RMB 211 billion increase in short-term loans represented a very strong increase of medium- and long-term lending of RMB 657 billion.
Logan told me that of the new lending number, the Big Four banks and the largest national banks only accounted for around RMB 125 billion (RMB 110 billion and RMB 15 billion respectively). They also accounted for most of the run-off in discounted bills.
This means that most of the new lending, especially the net increase in risk, took place elsewhere. Where? Mostly, it seems, in the smaller city banks and cooperatives. Since these are the banks most directly under the control of the city and local governments, it seems that these are at the forefront of the fiscal and credit expansion – in line with some of the other stories I have been relaying about the difficulty local governments have been having in financing their share of the fiscal expansion.
I am just guessing, of course, but I wonder if in the next few years as the growth benefits of the fiscal stimulus package wears out we might not see a rapid consolidation in the banking industry as the healthier (less sickly?) large banks are “encouraged” to absorb the smaller banks, struggling with the legacies of the loan boom. I think there is already some sense of that process occurring among the leadership, although in general I don’t get the impression that anyone in a senior position has a clear sense of what China’s exit strategy is likely to be. In fact the impression I get is that leaders are basically responding to day-to-day changes without any clear sense of what is likely to happen next. That is not necessarily a bad thing, of course, but I suggest that foreign analysts who speak feverishly of a great master plan to protect China from the consequences of the crisis may be a little overexcited.
Thee final points. First, there was an interesting article last week in Asia Times on rising graduate unemployment which, as regular readers know, was a problem even before the crisis hit and which is becoming more serious:
An explosive report released by the Chinese Academy of Social Sciences (NASDAQ:CASS) in September said earnings of graduates were now at par and even lower than those of migrant laborers. The news came as a blow to many high-aspiring parents and youngsters in a country that has for centuries prided itself on cultivating elite Confucian intelligentsia.
“What is the point of putting so much effort and time into getting a university degree if at the end all you get is the salary of a migrant worker?” said Wang Lefu, who studied business management. “One needn’t have bothered with exams and all the bureaucracy.”
…For China the global economic crisis has exacerbated a serious unemployment crisis that has been many years in the making and that few believe will disappear with the first signs of global recovery. China’s official unemployment rate stands at about 4%. Yet a large group of laborers – the communist state’s 150 million migrant laborers or floating population, as they are sometimes termed here – is not taken into account when unemployment figures are calculated.
When the global financial crisis hit last year – diminishing trade flows and reducing manufacturing orders for China’s factories to a dribble – some 20 million migrants were estimated to have lost their jobs and returned home. The pressure of resolving unemployment tension in the countryside this year has been made even more difficult for Beijing by its difficulties in finding jobs for the country’s surging numbers of university graduates.
Some 6.1 million graduates entered the job market this summer, 540,000 more than last year. In 2008 the employment rate for graduates was less than 70%. This year nearly two million of graduates, many of them postgraduate diploma holders, are expected to be left without job placements.
University education is one of the most widely-accepted, and only, forms of upward social mobility in China, so it is a worrying thing that the benefits of college education are seriously undermined.
Second, currency intervention is back in the news, but this time among Asian countries worried about intra-regional currency fluctuations. Although the biggest story is the decline in trade deficits and the impact that must have on the aggregate of trade surpluses, an almost-equally important story must be the maneuvering among trade surplus countries to increase or protect their share of the trade deficits. This maneuvering necessarily includes rival currency-management strategies. Here is the Financial Times on the subject:
China, Japan and other east Asian countries must have “serious” talks on currency co-operation to prevent a recurrence of violent fluctuations that have raised trade tensions in the region, said the president of the Asian Development Bank on Sunday. Haruhiko Kuroda said currency movements threatened the growth of trade between Asian countries, widely regarded as a key way of reducing the region’s reliance on exports to the US and Europe.
…The yen has strengthened to near-record levels against the US dollar since the beginning of the global financial crisis. Many other Asian currencies initially depreciated against the dollar and yen but later strengthened against the weakening dollar and the renminbi. Traders say Thailand, Malaysia and Singapore are among east Asian countries that have intervened in currency markets recently to try to slow the appreciation of their currencies.
And third, I spend a lot of time talking to large hedge funds and institutional investors – with at least three or four one-on-one meetings a week – on China and market conditions. It worries me that recently I have heard investors say many times, generally very sophisticated investors, that we are clearly in a bubble and the best strategy is to ride it out as long as we can. This has almost become one of the mantras of sophisticated investors – the less sophisticated, I guess, assuming that the crisis is safely behind us.
It worries me because of course we can’t all collectively ride the bubble and bail out before everyone else does. I wonder if this means that an awful lot of the big funds can be expected to rush to the doors at the same time when things turn bleak. If so, of course, that means we are likely to see both the upside and the downside market risks increase. Several of my fund management friends have insisted the problem has to do with the nature of hedge fund compensation. Most of the hedge funds were hurt pretty badly in the financial crisis, but a very large number of them were very pleasantly surprised by how quickly they’ve been able to make back a substantial share of their losses.
This means that recovering the high-water mark, which many thought would take years, has suddenly become a lot easier, and many expect that if the markets go on as they have been doing for another year or so they’ll be back in business (that is, able to charge performance fees once again). This may create a natural, albeit dangerous, incentive to take big risks on the likelihood of a rapid recovery.