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Monday, 9 July 2012

Lights flashing red

A hit to growth plans
Over the weekend, China was unlucky to score a mention in a list of risk factors which New York University Professor Nouriel Roubini identified could cause a "perfect storm" for a global economic collapse in 2013 (the other factors were the final climax of the Eurozone crisis, a US slowdown, slower emerging markets and US/Israeli conflict with Iran).  Data out on Monday confirmed these fears - an annual decline in the Producer Price Index (by 2.1%) and less than expected annual increase in the Consumer Price Index (2.2%, falling 0.6% compared to May) caused a flood of discussion examining for perhaps the first time that China may enter a period of deflation.

Scanning across a variety of reports the salient points seemed to be:
(i) whether or not there is actually deflation, because of China's previously stellar rates of growth, the disinflationary effects could feel just as bad (especially because of the extent of debt throughout the Chinese economy);

(ii) through measures by the central bank (the People's Bank of China) and comments from Premier Wen Jiabao, the Chinese authorities have signaled their intention to counter the declines and boost activity (either with additional reforms or new spending);

(iii) while some investors were cheered by the discussed measures, it remains to be seen weather genuine stimulus can be delivered - authorities are neither able nor willing to repeat the four trillion yuan ($586 billion) 2008/9 stimulus package (as central banks worldwide are running out of "policy bullets") - hence the ambiguous comments from Wen of "aggressive" fine tuning;

(iv) in any event for some analysts, such as those observing contraction in the money supply, severe downturn may now be inevitable - as Ambrose Evans-Pritchard has put it in the Telegraph - "China is on the cusp of a deflationary vortex"


Plans for the economy have taken a detour (c) Camera Press/TPG
China's AIG moment
For many, the excess of debt held by Chinese local governments, off-balance sheet through opaque and lightly regulated local government financing vehicles (or "financing platforms") compared strongly to the implosion of America's subprime loans, as many came close to, or did default last year.  In recent days, China based professor Patrick Chovanec has drawn another comparison between stress in networks of cross-guaranteed companies and the collapsed reinsurer AIG.  As Chovanec notes, Chinese financial newspaper Caixin has brought to light a second guarantee and cross-loan structure, around the Hangzhou-based property developer Tianyu Construction Co. Ltd, and both scandals suggest the scale of losses on these structures could be hard to predict and vast:
the inter-company guarantees at the heart of the Hangzhou Tianyu meltdown add a whole new dimension to the exposure of Chinese banks, beyond the professional guarantee companies themselves.... 
And as if to add credence to the concern, an official denial as to the scale of the problem was published at the end of last month


In a similar mindset, more publications have noted an accumulating number of anecdotal signs of stress in the Chinese economy, including attempts by governments to embrace austerity measures (including selling off fleets of luxury cars and imposing limits on official banquet expenses).


And finally, the team at FT Alphaville have continued to follow the developing story of China's large corporates having large dollar-short positions (consisting of US dollar loans which were taken out when expectations were that the dollar would continue to weaken).  There is an interesting analogy made with the Eastern European economies who struggled with large loan portfolios priced in Euros when their currencies fell during the 2008 crisis.


A China Bailout?
Discussion of China's reserves can often lead to the conclusion that though gargantuan they may not be able to be deployed in quantity or sufficiently rapidly to prevent a currency crisis or other event.  So a question for readers - if China does find itself squeezed by being short US dollars or some other crisis and it's reserves don't kill the problem - how would (or could) China be bailed out?





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