Talk of China 'Overheating' Continues to Be Wrong

Includes: CAF, CHN, FXI, PGJ, SNP
by: Enzio von Pfeil

Notes from Dr. Enzio von Pfeil's recent appearance on Bloomberg Television U.K.

The Economic Time™ in China (sub. req.) is characterized by an excess demand for goods and an excess supply of money.

Real Economy

  • Overheating is a myth: industrial output remains strong, so the idea of “too much money chasing too few goods” does not apply.
  • Indeed, China’s policy mix remains extremely growth–friendly: fiscal expenditures are rising by a real 24% a year!
  • Hence, real demand remains strong (we call this “excess demand”), which is what Beijing wants: growth, growth, growth... 10 million NEW jobs must be created EACH year just to keep social unrest at bay...

Monetary Economy

  • Thus, (October) non-food inflation is FALLING by an annual 10%; only FOOD inflation is rising - by an annual 15%.
  • NO Central Bank can control crop prices or, indeed, the weather!
  • So why the recent measures?

1. EVENT: effective 25th December, reserve requirements raised the most in four years, by one percentage point, to 14.5% of deposits that must be set aside as reserves. EFFECT: This freezes RMB 400bn in excess money. LOGIC: the government wants to control reckless lending. So, by giving the banks less money to “play with”, they will have to be a little more careful to whom they lend…that is the official line, at least. My guess is that with lending rising by an annual 15% they are worried about bubble trouble…particularly in the property sector – and particularly after the Olympics end...

2. EVENT: Qualified Foreign Institutional Investors [QFII] now may invest USD 30 billion in overseas funds – up from USD 10 billion. EFFECT: this means that USD 20 billion more get to flow out of China. But, with forex reserves of USD 1.5 trillion, that USD 20 bn extra equates to an eye-popping 1.4% of total forex reserves. LOGIC: the Central Bank wants to drain reserves in order to contain growth in liquidity. So, these dollars, having flooded in via the trade account, now can leave officially via the capital accounts. This heralds further opening of China’s capital accounts

3. However, things are not so "different" this time. For instance, we do not believe in the magic of "decoupling". All of which means that while we remain China bulls, and even with the U.S. market's dead cat bounces leading Asia, markets are vulnerable. Particularly to when they accept that America's looming stagflation has to kill her profits...

4. Besides, don't overrate the importance of Fed Funds to the market...

Inflation Forecast

  • It could reach about 7%, but that is a food – driven phenomenon.

Paulson visit: expect more parochial platitudes festooning his arrogance of ignorance / pay attention to Susan Schwab, however.

  • It seems as if he really knows everything better than anyone else.
  • Besides which, his Bank is extremely powerful, controlling the U.S. Treasury, Citi (NYSE:C) and Merrill (MER) via ex-Goldman (NYSE:GS) executives.
  • So he will be his usual, gushy parochial self. I hope that Wu Yi bats him one: what does Hank Paulsen understand of China’s issues? He is just playing to his domestic audience – and presumably looking for gainful employment once Bush leaves the Black House...

On a more general note, I am afraid that China will be America’s whipping boy for the nefarious U.S. “policy” in the 'Muddle East'. In other words: the unpopular and tragic mess that Bush is creating in the 'Muddle East' is costing him votes – so he will garner votes by beating up on China. Hank Paulsen is just one of his henchmen. Put differently, Bush is running a “market neutral” policy, as a hedge fund expert explained to me today: what the right hand taketh, the left hand giveth...

Due to personal dealings with Susan Schwab years ago, I am more inclined to listen to what she has to say as the USTR. She has a far better grasp of the real issues – and will hopefully inject some feminine common – sense into Capitol Hill’s scurry for votes before the elections...

SINOPEC (NYSE:SNP) deal with Iran

  • I have no corporate insights.
  • But, we all know that “the great game” is re-emerging in that new players are scrambling for access to resources.
  • My guess is that Iran will use China as a joker in its pack when dealing with America...
  • Thus, with China becoming America’s 'Muddle East' whipping boy, and with China becoming Iran’s “joker” in her game of poker with America, we are in for interesting times on the geo-political stage. How will America handle this?