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Thursday, 15 March 2012

Degrees of control...

While you were away...
Following on from the last post there were a couple of items of interest.  First, there were some comments last week from Luis Miguel Castilla, the Peruvian finance minister that in the event of any Chinese slowdown, Peru would be OK.  As reported in this FT Alphaville blog post, Castilla argued that domestic stimulus would offset China related slowdown and
...even if there is a slowdown in demand from China, commodity prices will still be higher than they were five to six years ago...
Given demand from China has been the main driver of commodity prices this seems optimistic.  The Alphaville team make the same point and they include a striking graph from a Capital Economics note which seems worth repasting here:

And any slowdown in China's demand for commodities might not just involve a simple slowdown in the rate of orders but could be distorted and possibly extended by chronic overcapacity problems in a number of key commodity consuming industries.  As explained in an article in the Sydney Morning Herald:
The Chinese steel industry has built-up vast over-capacity over the past decades and the excessive production amounts to more than 122 per cent of demand, according to Wuhan Iron and Steel. 
How much overcapacity? Well the article details that Wuhan Iron and Steel has diverisified into the business of rearing pigs while back in January analysts found various anecdotal evidence, including this empty car park at a blast furnace:
A destination for Australian raw material exports
Still commodity data in China is imprecise as was noted for copper inventory estimates last year (not to mention various copper collateral financing schemes).

Back-to-market banks
Meanwhile expectations remain that many banks will return to the market for further capital raising (as Bank of Communications' $8.9 billion private placement was announced), something Walter and Howie note has happened very often since the first IPOs of Chinese banks in the mid 2000's.  Reports of statements by Central Bank Governor Zhou Xiaochuan at the National People's Congress seemed conflicting as some reports referred to capital shortages and funding shortfalls, while others suggested the Required Reserve Ratio, the main instrument for setting bank capital levels in China, could be relaxed.  An article in the Epoch Times covered arguments why some anticipate a hard landing of China's banks, while to add to the confusion JP Morgan, said in some respects, the Chinese economy already was in a hard landing.

Degree of control
With such imbalances, it is not surprising that questions have arisen as to the stability of the political sphere and of Chinese society as a whole.  Most people take it as a given that the Chinese authorities have sufficient control of the economy and the population although there are questionable assumptions with this.

Statements by Prime Minister Wen Jiabao at the current National People's Congress have suggested it is facing challenges with its economic and political oversight of China Inc.  At the start of the Congress, the lowest overall growth target in a long time was announced, followed on Wednesday by the pronouncement of the need for further political reform to avoid a "second Cultural Revolution".

This latter comment was directed at discrediting Bo Xilai who was dismissed from his post of the mayor of Chongqing and blocked from joining the all powerful Politburo Standing Committee.  Bo's period in office had seen a revival in socialist era cultural activities and an offensive (of questionable means) against organised crime which attracted some popularity of city residents but disdain from officials.  A scandal involving Bo's security chief had brought a conflict between Bo and other factions into the open and overshadowed the National People's Congress.  Further details here.

It is not just political infighting which observers are concerned about, but further weakness in the system itself.  Gordon Chang, an established observer who blogs on both political and economic matters predicted in 2001 that by 2011 the Chinese political and economic system would collapse, on the basis of inherent flaws in China's governance and economic management (he recently revised it to this year).  One point Chang makes in his blogs is how China's leaders are concerned to prevent inflation but it constrains their ability to fix imbalances in the economy, while structural issues (like the negative real savings rate for depositors) remain.

Inflation driven by high commodity prices and labour shortages can arguably be attributed as a driver of urban strikes such as those of factory workers and taxi drivers in the last year.  However Chinese authorities also face continuing political unrest from the North west region of China (Xinjiang) and Tibet where riots have re-erupted in recent weeks.  Protests in 2011 in response to the Arab Spring were muted however internal weaknesses of China have attracted comment from outsiders such as John McCain, who spoke at a recent security conference in Europe.

Given all the recent speculation as to what sort of "landing" the Chinese economy will have it seems important to consider how much control over its economic system as much as what will be the outcome of its decisions on this system.




2 comments:

  1. Would you expect the commodity based economies like Canada severely impacted by China slowdown?

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  2. Thanks for your comment Manochin2!

    I certainly think there is a chance of a severe impact for three reasons:

    i) A China slowdown will mean an immediate fall in commodity exports which have been the driver of growth in the economies of countries like Australia and Canada;
    ii) The impact from the fall could be exacerbated by falls in commodity prices which have been high due to Chinese demand, thereby reducing income from non-China exports (such as Canada exports to the US); and
    iii) the other "real" parts of such economies have overheated due to excess liquidity from the resource sector and now are entering a slowdown.

    Concern over the impact of a China slowdown was heightened last week following the comments by BHP's Ian Ashby at a conference as to the flattening demand for steel in China. I've posted some links on my Twitter page (https://twitter.com/#!/TheAnalytic) and will look at the issue in my next blog!

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