China: Consequences of the Sleeping Lion Awakened 30 comments
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U.S. President Barack Obama has begun a nine-day tour of Asia at a time when the U.S. economy is struggling to emerge from a deep recession. But nothing looms bigger than China, the largest holder of U.S. debt (around $797.1 billion, up 10% this year), that has emerged from the global economic downturn in an ever stronger position. When Obama sets foot in China for the first time, he will confront a dramatically altered balance of power between the two nations.
Two Decades of Explosive Growth
This seismic shift is driven by China's astonishing economic growth over the past two decades and has accelerated during the global financial crisis. Its 9% to 10% annualized GDP growth rate in the past two and a half decades is unprecedented in world history.
In 1992, Chinese gross domestic product (GDP) was less than 7% of America's GDP. By 2000, the figure topped 12%. When Obama won the election in 2008, the Chinese economy had grown to equal more than 30% of U.S. output. New data show that China is on track to grow more than 8% in 2009, driven by high industrial output and retail sales.
Impressive Stimulus Package…and Working
During this global recession, China's astonishing growth did slow down, but unlike most developed economies, China never entered a recession.
The Chinese have launched the world's biggest investment program (about $585 Billion) after the start of the financial crisis last year. Beijing's stimulus program is estimated to amount to about 13% of Chinese gross domestic product, making it almost twice as large as the U.S. program and close to five times the size of its German equivalent.
The government's massive economic stimulus program has transformed the country into an enormous construction site. As a result, China’s industrial production rose 16.1% year-over-year in October, the most since March 2008 and a slide in exports eased to 13.8% the slowest pace this year. However, behind the impressive economic data, troubles might be lurking.
China Bubble Forming
China’s purchases of dollars to prevent appreciation gave it foreign-exchange reserves totaling $2.3 trillion in the third quarter, the world’s largest. Meanwhile, its sale of Yuan to keep it fixed to the dollar contributed to a 29% jump in its money supply, and the peg helped spur more than $150 billion in speculative funds from overseas in the past six months, according to China International Capital Corp.
In addition to playing the stock market, a lot of the money is being diverted into houses and land. There are also reports of excess capacity created by the aggressive stimulus effort. Record apartment prices and a high flying stock index this year are prompting warnings against "financial risks" and the development of bubbles in real estate markets.
Yuan-Dollar Peg Angers Many
Beijing has kept the Yuan pegged at about 6.83 per dollar since July 2008, seeking to help manufacturers battered by the collapse in demand abroad. The Yuan advanced 21% in three years from July 2005. (Fig. 2 & 3, click to enlarge)
China Quashes Yuan Policy Speculation
Most expect that in Obama’s meetings at the Asia Pacific Economic Cooperation (APEC) summit and then in Beijing, China’s fixed-rate policy will likely be part of the discussion. On that note, investors are seeing a rising Yuan. Twelve-month non-deliverable forwards for the Yuan in Shanghai are signaling trader bets on a 3.5% gain from the spot rate of around 6.83.
However, in what seems to be an official effort by Chinese authorities to dismiss the renewed speculation of Yuan appreciation in the near term spurred by a recent language change from The People’s Bank of China, on Saturday, the state-controlled Chinese news agency Xinhua reportedly said that the government would not allow the currency to gain against the dollar in the short term. Goldman Sachs (GS) also just reiterated its three, six and 12-month forecasts for the Yuan to stay at 6.83 against the dollar.
Yuan to Appreciate…Eventually
China’s drive to create jobs and maintain social stability through export-led growth means politicians aren’t ready to loosen controls on the currency. In addition, China’s trade surplus will probably be half last year’s level at $200 billion, which means a bit less pressure on the Yuan to appreciate. The U.S. doesn’t want a stronger Yuan either because that would cause a collapse in the dollar in the short term.
Over time, China will likely be under pressure to open and let the Yuan appreciate in the next 24 months, and possibly as early as the 2nd half of 2010, albeit at a very gradual and modest pace, while most likely still pegged to the dollar. Eventually, the Yuan will appreciate considerably due to China’s high growth rate and its population’s high savings rate (35-50% range) .
On Nov 11, in Singapore, World Bank chief Zoellick calls the dollar's role as a reserve currency "relatively secure," but says over the next 10-15 years the Yuan (Renminbi) will provide an alternative once it is internationalized.
Strong Growth Prospect
China is a communist country with capitalist power. Despite China bears’ prediction of a Chinese size collapse, for a country with such a tremendous resource base and centralized system, busted bubbles in sectors most likely will not derail the country’s global leadership path started over two decades ago.
In a speech a few days ago at a conference organized by the Monetary Authority of Singapore, International Monetary Fund (IMF) Managing Director Dominique Strauss-Kahn called on Asia to play a leading role in guiding the global economy to a new, more sustainable path for global growth.
The IMF expects Asia’s GDP growth, driven mostly by Chindia, to be 5.75% next year—almost double the 3% rate forecast for the global economy. Specifically, the IMF projects China annual growth to be 8.5% and 9% for 2009 and 2010 respectively. In contrast, advanced economies annual growth in 2010 is projected to be about 1.25%, following a contraction of 3.5% in 2009. (Fig. 4, click to enlarge)
Chinese Exposure Desirable
China’s surging asset prices, a dollar collapse and a double-dip global recession are the biggest risks investors face in 2010. But many analysts are bullish on China for the long-term as 500 million educated and unemployed Chinese spur greater domestic spending and production.
Yet, Americans are estimated to have only 2% to 20% foreign stock exposure. That means Chinese stocks represent probably a low single-digit percentage, at most, in the average portfolio. With very few high investment return prospects, China is one market that should be given some serious consideration as part of a long portfolio.
There are many ways to play the Chinese market. The following are just a brief overview of some that I will discuss in this article.
B Shares
For investors interested in adding some Chinese exposure, B shares are a good bet for those who hold dollars and want to benefit from China’s fast economic recovery. The shares traded at an average discount of 49% to their A-share listings, according to BNP Paribas.
China's dollar-denominated B shares at the Shanghai Stock Exchange jumped 9.42% to 251.19 points last Friday, posting an 18-month high. The surge mainly resulted from market expectations of Yuan appreciation.
Though it is difficult to pick a good individual B shares stock right now as most are probably fully valued, it is best to avoid stocks of property developers as a way to minimize the risk of a potential real estate bubble. According to Morgan Stanley (MS), the sector’s share price has gained about 155% on average in the past year.
ETFs
An ETF is a convenient way to invest in China. But it could be a bumpy ride as a three-year measure of volatility for China ETFs is more than double that of the S&P 500.
The two most popular China ETFs are iShares FTSE/Xinhua China 25 Index (FXI) and SPDR S&P China (GXC). Both of these are very heavily weighted towards financials. On the other hand, PowerShares Golden Dragon Halter USX China (PGJ) has only about 6% exposure to financials, and has been around since 2004.
For currency plays, the WisdomTree Dreyfus Chinese Yuan (CYB) and Market Vectors Renminbi/USD ETN (CNY) are two ETFs specializing in the Yuan. But a recent WSJ article cautioned investors about the pitfalls of the Yuan ETF because it is in a contango market similar to that of the United States Natural Gas Fund (UNG).
Consumer and Commodity Blue Chips
Since B shares and China ETFs may have more risks and volatility than some might like, blue chip companies with an increasing presence in China could be a less risky way to ride the Red Dragon.
Chinese President Hu Jintao recently said that the government is focused on expanding domestic spending, “especially consumer demand” to strengthen the economy. This could present opportunities for consumer-related stocks. U.S. blue-chip companies such as Wal-Mart (WMT) and McDonald's (MCD) are likely to benefit from this trend.
Similarly, with China’s insatiable appetite for all natural resources, non-U.S.-based producers such as BHP Billiton (BHP), Rio Tinto (RTP), and Vale S.A. (VALE) could also provide good portfolio diversification.
Nevertheless, I would advise against commodity futures ETFs due to the intensifying regulatory scrutiny and the potential “rolling effect” commonly experienced in a contango market as discussed in my previous article.
Author's Disclosure: No Positions
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This article has 30 comments:
test213
admin at invetrics.com
disclosure: I don't work for Etrade and am not in the stock business
but do own lots of Chinese stocks.
I missed reading anything about that. Instead I read an article touting the mightiness of China and the Chinese economy.
Note to the communist handlers: In english the phrase is "sleeping giant."
Herny Ford sold his model T by the Car that kept on running and running and his cars ran more reliable than that of the horses and to assembly one car after another made his cars more affordable for every man that have a decent job and that's America
No doubt China's brilliant policy of pegging the yuan to the US$ has helped it conquer one and all in industrial output. Once again, another group has outfoxed and out-thought American policy makers and the brilliant politicians for more than 30 years.
The US economy has had no 'real' growth for almost 30 years as others have profited from our own stupidity, greed and slothiness.
How do you buy B-shares from the US?
Having said that, I wouldn't short China over the next 24 months.....
On Nov 16 09:14 AM China Interest wrote:
> The similarities between China now and Japan in the late 1980s have
> substantial overlap. Be cautious folks! I live in China and not all
> things are what they seem.
Go to India and you will know what I mean instantly.
On Nov 16 09:23 AM Tony Petroski wrote:
> The title said "Consequences of the Sleeping Lion Awakened."
>
> I missed reading anything about that. Instead I read an article touting
> the mightiness of China and the Chinese economy.
>
> Note to the communist handlers: In english the phrase is "sleeping
> giant."
I also live in China and the massive bubble that has been allowed to develop is painfully obvious. To make matters worse, the locals haven't been though any recent bubbles and believe price appreciation in luxury apartments is guaranteed at 10%/year.
20-40 years from now, I'm certain that China will be very powerful and very important.
However, when bubbles inflate, investors frequently forget the values of a) INTEREST INCOME b) INFLATION and c) OPPORTUNITY COST.
The current "gov't expansion plan" that is keeping the economy running is just throwing lighter-fluid on the fire to keep it from flaming out.
On Nov 16 09:14 AM China Interest wrote:
> The similarities between China now and Japan in the late 1980s have
> substantial overlap. Be cautious folks! I live in China and not all
> things are what they seem.
I don't think the central gov't will allow the bubble to pop before the end of the World's Fair 2010, even if it did massive damage to the economy. So I'll give you 12-months, but I doubt it will make it for a full 24-months.
On Nov 16 11:55 AM Tom B wrote:
> You are exactly right. Japan had a lot more going for it, and in
> the 1980's than China does now, and yet, it proved to be a bubble.
>
>
> Having said that, I wouldn't short China over the next 24 months.....
>
Well said. However, if (and this is open to debate) the Chinese government still retains sufficient control of the levers of economic and social control domestically, a dramatic shift of the domestic economy (and of labour and other resources) from serving export needs to greater service of domestic infrastructure and consumption needs might be possible, buffered by large foreign currency reserves, and even welcomed by all concerned. This despite short term domestic economic dislocations.
This is not to say that such a shift is planned or desired, only that it may be a possible option for China if its exports falter significantly.
On Nov 16 04:48 PM William Legrand wrote:
> So, per the article, China is buying vast amounts of U.S. dollars
> and massively devaluing the Yuan through new issuance. That's not
> a healthy economic engine, more like one on the brink of mass recession/contraction
> if exports fall.
China is heavily invested in infrastructure and manufacturing capacity build-out under the assumption of sustained year-over-year GDP growth of at least 8-10%. Without massive and growing exports to support its already-built capacity, much of China's economy will collapse. Through heavy-handed manipulation of currency by the Chinese government, China's urban population has yet to achieve an average income level or enough savings to support a large-scale transition of its manufacturing capacity to domestic consumption anytime soon. China's huge-majority rural population is far too destitute to drive domestic manufacturing consumption anytime for decades to come (and China wants to keep it that way for now due to limited natural resource availability, such as dwindling fresh water reserves and ever-present risk of famine).
China and the U.S. are tied at the hip. Neither can economically survive without the other right now because the inter-dependencies run too deep. As the U.S. dollar changes value (only downwards as of late), so must the Chinese yuan in lockstep, otherwise both countries suffer near-immediate negative repercussions.
Can you perhaps amplify a bit for us? Thanks.
On Nov 16 09:14 AM China Interest wrote:
> The similarities between China now and Japan in the late 1980s have
> substantial overlap. Be cautious folks! I live in China and not all
> things are what they seem.
On Nov 16 08:20 AM beijingpaddy wrote:
> Besides ETFs and B shares, US retail investors can buy into many
> Chinese stocks via the Hong Kong Exchange using Etrade's Global Trading
> Platform. I have been using it for a long time and like its smooth
> process. Most times I find it cheaper (as fewer people are chasing
> the stocks) to buy in HK than buying ADRs on the US exchanges. Also
> often stocks trade cheaper on the HK exchange than the same company
> does in Shanghai.
>
> disclosure: I don't work for Etrade and am not in the stock business
>
> but do own lots of Chinese stocks.
On Nov 16 10:48 AM Alan Young wrote:
> How do you buy B-shares from the US?
Given the rapid modernization and rise in living standards of at least the coastal provinces and a rising middle class in those provinces, might the leadership envision circumstances evolving soon where a transition, rapidly if necessary, to an economic model based much more on domestic development and much less on export to North America etc. is practical and wouldn’t large accumulations of reserves of foreign currencies and of strategic commodities advance the day when this transition scenario becomes practical?
bob adamson
On Nov 16 06:10 PM William Legrand wrote:
> To bob adamson:
>
> China is heavily invested in infrastructure and manufacturing capacity
> build-out under the assumption of sustained year-over-year GDP growth
> of at least 8-10%. Without massive and growing exports to support
> its already-built capacity, much of China's economy will collapse.
> Through heavy-handed manipulation of currency by the Chinese government,
> China's urban population has yet to achieve an average income level
> or enough savings to support a large-scale transition of its manufacturing
> capacity to domestic consumption anytime soon. China's huge-majority
> rural population is far too destitute to drive domestic manufacturing
> consumption anytime for decades to come (and China wants to keep
> it that way for now due to limited natural resource availability,
> such as dwindling fresh water reserves and ever-present risk of famine).
>
>
> China and the U.S. are tied at the hip. Neither can economically
> survive without the other right now because the inter-dependencies
> run too deep. As the U.S. dollar changes value (only downwards as
> of late), so must the Chinese yuan in lockstep, otherwise both countries
> suffer near-immediate negative repercussions.
I see China, more specifically the Chinese government, caught in an inescapable Catch-22. The Communist Party of China (CPC) is accustomed to and expects to maintain a firm and authoritative power grip. Yet more and more Chinese are being raised in an urban culture with constant exposure to Western values (consumerism) and under an economic dogma that is best described as heavy-handed capitalism (almost-friendly fascism). Specifically because of the relatively-new and rapidly-growing urban culture and accompanying expectations and affectations, the CPC finds itself with no choice but to slowly unwind its power grip in order to grow the economy and raise the urban standard of living. Otherwise, the CPC risks a repeat of Tienamin Square, perhaps on a scale a magnitude of order larger. Rather than risk an all-or-nothing totalitarian strategy, the CPC seems resigned to gradually loosening up, come what may. The CPC apparently failed to anticipate the U.S. economy turning so sour so quickly. Now the CPC finds itself reacting the only way possible in the short run to maintain the status quo, namely following the U.S. lead of money issuance and debasement. The CPC is anything but pleased about it, hence all of the chest thumping in recent news headlines. But it has no choice if the Chinese economy is to remain intact.
I suspect most urbanized regions of China are more than capable of transitioning from export-based to domestically-driven economies given another 10 to 15 years of steady 6-8% growth, provided that income levels keep pace with inevitable inflation. As for now, Chinese wealth reserves are disproportionately the domain of the Chinese government and a minuscule super-elite class. Barring a return to hard-line Communism, wealth confiscation, and massive suppression of its urban centers (à la North Korea), I cannot foresee China standing on its own (or attempting to) before 2020.
On Nov 16 08:45 PM bob adamson wrote:
> Thank you Mr. Legrand for what is obviously a knowledgeable and well
> considered assessment of China’s current situation. It does though
> raise the question: Would China’s leadership place China in the position
> you describe if, as it appears, this would place her fate at the
> mercy of circumstances outside their and China’s control (i.e. if
> the US screws up, China suffers as much or worse in consequence)?
>
>
> Given the rapid modernization and rise in living standards of at
> least the coastal provinces and a rising middle class in those provinces,
> might the leadership envision circumstances evolving soon where a
> transition, rapidly if necessary, to an economic model based much
> more on domestic development and much less on export to North America
> etc. is practical and wouldn’t large accumulations of reserves of
> foreign currencies and of strategic commodities advance the day when
> this transition scenario becomes practical?
>
> bob adamson
>
> On Nov 16 06:10 PM William Legrand wrote:
China will not let other countries to run its economy. China will manage its economy as it see fit. If trade is not fair, then, there will be no trade. No body is forced to buy, and nobody should be forced to sell. Like any game, some are better players than others. The better players will win more often. Losers always blame the rules.
Recently, I was reading (think it was Bloomberg, but it might have been the FT) that Chinese officials have been meeting with Russian officials for the purpose of trying mitigate/avoid the Russian experience when transitioning from from a totalitarian communist society to a "capitalistic" (or "quasi-capitalistic") one. It appears the Chinese leadership is aware of what needs to be done, in terms of steering their economy from its past and present course to more of a "consumer", or "internally directed" one, while still maintaining the reins of power.
The article suggested the Chinese might also do well to study India, Japan, and Mexico as examples of "democratic, free market" economies that are/were run by a single party for extended periods of time.
The Bloomberg or FT article to which you refer, Old Trader, could even more cogently have referred to the evolutions of both the Kuomintang in mainland China and later in Taiwan and the People's Action Party in Singapore. Both the Kuomintang and the People's Action Party went through an evolution over time from a strong belief in a state socialist model of economic development to a neo-capitalist model and both have been slow to shed their authoritarian, almost Leninist, model of political monopoly control of the state (although the son of Chiang Kai-shek was able to legitimize a break with this authoritarian tradition to an extent that the son of Lee Kuan Yew in Singapore has not found possible while Lee Kuan Yew continues to live).
Noting the forgoing is not to suggest that such a ‘guided capitalist’ model is ideally suited to a Chinese state but only that a good case can be made that the leadership of the Communist Party of China have a special fascination with the success that the Kuomintang and even more the People's Action Party have had in achieving economic success while retaining political power.
bob adamson
On Nov 16 11:36 PM Old Trader wrote:
> To both Bob Adamson and William Legrand,
>
> Recently, I was reading (think it was Bloomberg, but it might have
> been the FT) that Chinese officials have been meeting with Russian
> officials for the purpose of trying mitigate/avoid the Russian experience
> when transitioning from from a totalitarian communist society to
> a "capitalistic" (or "quasi-capitalistic") one. It appears the Chinese
> leadership is aware of what needs to be done, in terms of steering
> their economy from its past and present course to more of a "consumer",
> or "internally directed" one, while still maintaining the reins of
> power.
>
> The article suggested the Chinese might also do well to study India,
> Japan, and Mexico as examples of "democratic, free market" economies
> that are/were run by a single party for extended periods of time.
China and the US have arelationship which will continue their economic dominance
China is moving closer to capilaism and we are moving closing to socialism
Bottom line is asians will NEVER buy all the worthless high margin items china can produce so inexpensively
Its not about money its about culture
The quote describing China was originally by Napoleon (of France). There are two translated versions: Sleeping Giant and Sleeping Lion. We Chinese typically refer to the "Sleeping Lion" metaphor as lion is often referenced on our literature and architecture as well.
On Nov 16 09:23 AM Tony Petroski wrote:
> The title said "Consequences of the Sleeping Lion Awakened."
>
> I missed reading anything about that. Instead I read an article touting
> the mightiness of China and the Chinese economy.
>
> Note to the communist handlers: In english the phrase is "sleeping
> giant."
"China Grapples With Pressure Over Currency Controls "
online.wsj.com/article...