Thursday, August 20, 2009
What's up with China?
A weak set of economic indicators for July laid the foundation for the latest market correction, challenging the Shanghai Composite's nearly doubling in value in the first seven months of the year.
Official figures released earlier this week also showed foreign direct investment into China also dropped more than 35% in July from the year-earlier period.
Meanwhile, data released earlier this month also showed a slowdown in the growth rates for industrial production and investments in urban fixed assets.
Then a sharp slump in bank lending in July -- following record loan disbursals in the first half of 2009 -- led to worries that a slowdown in credit could affect liquidity, a crucial factor behind the previously strong market performance.
And MarketWatch notes that UBS Research's China strategist John Tang reports that a further correction is likely over the next 30 days. But it quotes a Morgan Stanley analyst who is bullish on China, who says that it is a good time to buy in.
But let's dig a little deeper.
China's current-account surplus is off 32% for the first half of the year.
Financial Times Alphaville writer Izabella Kaminska convincingly argues that China's stimulus money is being recollected back from the people who receive it before it can do any good.
China has lent out a huge amount of money. Marketwatch's David Weider notes that "China loaned $852 billion globally through the first five months of the year".
Vitaliy Katsenelson argues that while China has been blowing a huge bubble in lending, the government may have enough of a surplus to pull it off - at least for a couple of years (especially given that the banks are controlled by the government).
But - at some point in the future - the bubble in bad loans will likely burst.
The country showed robust GDP growth while electricity consumption declined.
The laws of economics appear to be suspended for the Chinese, but they are not. They just have "better" accountants, ones that would make Enron's bean counters seem like dilettantes. A paper published by John Makin at American Enterprise Institute explains very well how Chinese got their GDP growth:
"Once China had announced its 8 percent growth target, it began to disburse funds directed at a sharp increase in public-works spending," Makin wrote.
"It is important to understand that the disbursal of funds is recorded as GDP growth," Makin continued. "So the government can easily control the pace of growth by the pace at which it releases funds that have already been allocated in the stimulus package to the creation of higher production or growth numbers."
Nice trick, huh?
"Funds disbursed for fixed-asset investment by state-owned enterprises or provincial governments are counted as having been spent when they are disbursed," Makin noted.
But perhaps the most insightful analysis comes from Andy Xie. Xie argues that China - like America - is erroneously applying Keynesian solutions during a period in which Keynesian solutions cannot work, i.e. after the collapse of a huge bubble (when only Schumpeterian economics works):
Keynesian thinking ignores structural imbalance and focuses only on aggregate demand. In normal situations, Keynesian thinking is fine. However, when a recession is caused by the bursting of a big bubble, Keynesian thinking no longer works.
Many policymakers actually don't think along the line of Keynes versus Schumpeter. They think in terms of creating another bubble to fight the recessionary impact of a bubble burst. This type of thinking is especially popular in China and on Wall Street. Central banks around the world, although they haven't done so deliberately, have created another liquidity bubble. It manifested itself first in surging commodity prices, next in stock markets, and lately in some property markets. Will this strategy succeed? I don't think so...
The current recovery is based on a temporary and unstable equilibrium in which the United States slows the rise of its national savings rate by increasing the fiscal deficit, and China lowers its savings surplus by boosting government spending and inflating an assets bubble.
This temporary equilibrium depends on government action. It does not have a market foundation that would support sustained and rapid growth. Nevertheless, improving economic data will excite financial markets.
China's stock market is cooling because the Chinese government is jawboning it down, based on fears of a big bubble downside. And the economy is beginning to slow. Markets outside China will likely do well for the next two months; diverging trends reflect that China's market recovered four months before others, and adjusts before others as well.
Financial markets will turn down again when investors realize that the global economy will have a second dip in 2010, and that the U.S. Federal Reserve will raise interest rates soon. The turning point may well come sometime in the fourth quarter. By then, it would become apparent that China has slowed. U.S. unemployment will not have improved and, hence, its consumption will remain stagnant. And production data that's pushing expectations now will cool after the inventory cycle runs its course...
This fool-the-market strategy may work temporarily. Its effectiveness must be reflected in oil prices; the Fed needs to target oil prices in its interest rate policy. If oil prices run from current levels, it means the market doesn't believe the Fed. That would force the Fed to raise interest rates quickly which, unfortunately, would trigger another deep recession.
Instead of a V-shaped recovery, we may instead get a W curve. A dip next year, although perhaps not statistically deep, could deliver a profound psychological shock. Financial markets are buoyant now because they believe in the government. The second dip would demonstrate the limits of government power. The second dip could send asset prices down -- and keep them down for a long time.