China: Catch a Ride on this Runaway Train

Includes: CAF, FXI, PGJ
by: Joe Rotger

Two reports from Bloomberg on China caught my eye this weekend:

  • China Raises Bank Reserve Ratio for 6th Time in Year
  • China's Trade Surplus Probably Doubled in March to $20 Billion
  • Which after reading a few lines,

  • China's economy may grow as much as 11 percent in the first quarter
  • M2, China's broadest measure of money supply, grew 17.8 percent in February, the fastest pace in six months,
  • while outstanding loans climbed 17.2 percent.
  • New lending was 981 billion yuan for the first two months combined, almost a third of the total for all of 2006.
  • The trade surplus surged ninefold in February from a year earlier to $23.8 billion, the second-highest on record.
  • "If the yuan appreciation doesn't get faster, China's trade surplus will likely widen to $30 billion monthly in the second half of this year from an average of $20 billion currently,'' said Shen Minggao, an economist with Citigroup Inc. in Shanghai.
  • While China tries to meekly put the brakes on its economy, raising its reserves one more time:

  • The deposit-reserve ratio, the amount banks must hold rather than lend, will rise by 0.5 percentage point to 10.5 percent starting April 16, the People's Bank of China said today. That matches the size of the previous five increases.
  • runaway_train_small
    Source: Affordable Housing Institute

    China is truly a runaway train.

    If you think the Yuan is undervalued - and who doesn't? - then it's a great opportunity to invest (or start a new company) in China, because it's cheap, which is being confirmed by their runaway stock market prices. In other words, China attracts FDI like flypaper. FDI entry will remain unstoppable till the day the Yuan is allowed to appreciate substantially —and not the slow and tightly manipulated appreciation which only started after July of 2005 (7% since then).

    As I see it, the dazzling growth in Chinese reserves is a bad omen for the rest of the world; especially, for the US, Europe and Japan. Apart from the market share which is being eroded away, the adjustments required in the west's labor pool will be precipitated much faster to a painfully brutal degree, with worsening salaries and unemployment, which will spill over to the rest of the world sooner than later.

    True, it would appear that there is a silver lining, the estimated 27% growth in March exports has been countered somewhat with a 20% increase in imports to China. But, it's not enough to counter the political consequences of the loss of jobs in the US. Protectionism slogans will bring many votes to the protection partisan candidates in the coming US elections —and inflation, too.

    As we've discussed in previous posts, protections in the US could disrupt the delicate world economic equilibrium between the two major opposing factions, the US Fed printing Treasuries versus the Asian labor arbitrage. Protections would enhance the probability of Chinese reprisals in the form of... no Treasury buying. And, this potential reduction in the supply of funds would trigger an abrupt rise in interest rates...within an inflationary derived protectionist environment —also known as stagflation...

    Of course, the US could very well toy with the idea of printing US dollars at this moment... which I don't think would be a very good idea —weakness comes to mind, jumping from the pan into the fire too.

    To round up. The case for long commodities is strengthened. China is a runaway consumer of raw materials and the US dollar could very well continue its decline against the Yuan (and others), further supporting the case for higher priced commodities.

    Makes one wonder... How in the name of God will this all end?

    The numbers are unreal: 17% all over... and 9 times... the previous year's February trade surplus?
    (To be honest, I doubt the ninefold figure, a clerical error somewhere).

    But, growing at $20+ billion USD per month could quickly amount to a yearly $260-300 billion USD trade surplus, something like a 60-70% increase —which is still quite an amazing figure.

    Congress is going to have a picnic with these numbers...
    Legislating trade protections will be a given...