China Is Slowly Twisting In The Wind

Includes: EWH, FXI, PEK
by: Carlos X. Alexandre

A day doesn't go by that someone, somewhere, doesn't refer to China as the economic power of the future, although those voices have dimmed recently. The seemingly unstoppable "state capitalism" is nothing but a mirage. The second stage of Chinese economic reforms in the late 80s and early 90s, which were further stimulated by the discontent displayed in Tiananmen Square in 1989, set the political decline in motion. These have been masked thus far by economic growth. In short, once one goes from pure servitude to an environment of opportunity, there's no going back - at least not without kicking and screaming.

Certainly the boom that took place after China embraced "state capitalism" is visible, but the economic well-being is hardly widespread, and China's claim to fame is mostly due to cheap labor and avid western buyers looking to save and make a buck. As reported by Reuters, "China's acceptance of a slower rate of growth" is only a public acknowledgement of well-known internal economic constrains that have been building over time. And without the usual consumption suspects, there's no outlet for the capacity in place -- and that's the main issue.

Oil, copper and equities all fell after Premier Wen Jiabao, in his annual state-of-the nation report to China's parliament, penciled in growth for 2012 of 7.5 percent. That would be the slowest pace of expansion since 1990 and well down on last year's 9.2 percent growth rate.

Last month, Bloomberg had already given a preview of what Wen Jiabao would communicate, and the two key words that kept surfacing were "inequality" and "instability". Although, the latter is not confined to the financial system, and is ultimately the core concern of the government.

China's Premier Wen Jiabao is seen signaling next month that curbing pollution, inequality and the risk of financial instability eclipse the benefits of faster economic growth, a survey of analysts indicated.

Despite the official word that slower growth is "acceptable," the focus is still on keeping the boat afloat. Caixin reported that "hopes are running high that a government push for affordable housing construction will stimulate investment growth."

But the potential for these projects to underpin investment growth is closely tied to spending by local governments, including some that are already heavily in debt, as the central government wants local coffers to match its housing funds. Some say uncertain private investor and bank support will be needed as well.

In addition, and according to China Daily, "China reduces holdings of U.S. govt bonds," coinciding with a decline in China's foreign reserves.

According to the latest monthly figures from the U.S. Treasury Department, China's holdings of U.S. Treasury bonds dropped for a fifth consecutive month in December to $1.15 trillion.

And I am certain that the reduction in U.S. Treasuries did not, and will not, find its way into European debt, because the domestic economic issues are quite substantial, and although I believe that lower future demand for U.S. Treasuries will drive rates higher, the impact thus far has been muted. The political power issue will stay on the front burner, and any reform must be weighed against the need for the state to remain in control. The issue of inequality is best highlighted by a Bloomberg article, "China's Billionaire People's Congress Makes Capitol Hill Look Like Pauper."

The net worth of the 70 richest delegates in China's National People's Congress, which opens its annual session on March 5, rose to 565.8 billion yuan ($89.8 billion) in 2011, a gain of $11.5 billion from 2010, according to figures from the Hurun Report, which tracks the country's wealthy. That compares to the $7.5 billion net worth of all 660 top officials in the three branches of the U.S. government.

But as Stratfor pointed out, inequality in China is nothing new, although the numbers above are a "bit" beyond the norm.

Historically, when China involves itself in global trade, as it did in the 19th and early 20th century, the coastal region prospers, while the interior of China -- which begins about 100 miles from the coast and runs about 1,000 miles to the west -- languishes. Roughly 80 percent of all Chinese citizens currently have household incomes lower than the average household income in Bolivia. Most of China's poor are located west of the richer coastal region; this disparity of wealth time and again has exposed tensions between the interests of the coast and those of the interior.

Certainly we have grown accustomed to despising wealthy politicians and the 1% citizen category of the west, and it is true that inequality is growing, is well visible in these parts of the world, and is unhealthy for our future. But to think that the "superior" ideological foundation of the People's Republic of China, which ends up providing for everyone except the people, is a good alternative, makes one cringe. Then again, how exactly is China the economic power of the future?

Last month and according to ABC News, "U.S. Secretary of State Hillary Rodham Clinton blasted Russia and China as "despicable" for opposing U.N. action aimed at stopping the bloodshed in Syria." But why did China, and Russia for that matter, veto the U.N. resolution? Because eventually China will find itself in the same position, also known as the defendant's table. From the Berlin Wall to the Great Wall of China, they all tumble in due time for obvious reasons.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.