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Tuesday, 9 October 2012

Two steps forward?

Gathering headwinds...
After a break from blog-posting it is interesting to see a consensus forming as doubts further crystallise around the China and BRICS growth story.  At least on one report, the IMF has joined the increasing ranks of observers who are bearish on growth prospects, while in Beijing another chapter in the grizzly Bo Xilai saga progressed when, on the eve of a national holiday, it was announced that a consensus on the persistent political questions had been reached - Bo Xilai would be expelled from the party (to face a criminal trial) and the 18th National Party Congress would take place on 8 October (apparently a date which will bring good fortune).

Good luck will be needed, because China is facing a number of headwinds, including tensions with Japan over disputed islands and the slowing economy which has even been noticed in the wealthy tech hub of Dongguan.  Aggressive positioning such as talk of rapid sales of Japanese bonds by the Chinese (at a time when it is trying to diversify its holdings of US treasuries), a no-show by Chinese banks at an IMF Conference in Japan (when Chinese banks may need assistance from the IMF sometime in the future) and announcements of ever-increasing local stimulus (which UBS called "unicorn", JP Morgan called "castles in the air" and the Beyond Brics team have taken to comparing by regional cuisine), seem counter-productive while uncertainty surrounded China's leader-in-waiting, who disappeared for 12 days recently.

The human side to the evolving atmosphere has come to the fore recently - not only with the riots at Foxconn facilities (and if you are hoping to read this on an iphone 5 - deepest sympathies), but also with deflationary prospects further reducing likelihood of a rebalancing and growth in consumer demand.  Gavekal Dragonomics has noted that given the current destocking cycle and fading CPI numbers, a little bit of inflation may be a good thing.  At the sharper end, industries like solar are desperately trying to slash costs and restructure debts.
Chinese de-stocking in action
A gold postscript
There have been some interesting commentaries about global currencies and the monetary system in the past couple of weeks, including from the Economist and from George Magnus of UBS who still sees issues from global savings imbalances.  Following on from the last post there has been some further discussion of the possibility that China is in fact stockpiling gold (here also and even that China and Russia are stockpiling in concert in response to US quantitative easing).  Ironically for both China and Russia, any suggestion of monetary system strength has been challenged by heavy use of reverse repos by the countries' central banks (by which the central banks inject cash into the domestic banks in exchange for securities  - other link here).

It was noted in the commentary of the Russian moves that the repos coincided with announcements from the Central Bank of Russia that it would not intervene to support the Ruble (Russia's currency).  While it was noted that this was a gesture likely to be received well by markets as pro-reform (like Renminbi liberalisation in China), especially given the CBR's previous failures to do so, the alternative explanation, that the central banks simply do not have sufficient resources to defend their currencies from outflows.  Parallel to this it was announced that official estimates predicted a sooner than expected ending for Russia's long established current account surplus, due to falling exports and high government expenditure.

Beyond any policy preferences the central banks may have in pursuing reverse repos (and the short term stimulus they provide), there remain risks for the central banks, namely i) that they will become less effective and ii) the central bank will run out of resources to execute the repo operations.  There is evidence of both these effects in China (links here and here).

Some analysts expect ineffective repos could lead to an RRR cut (reducing the amount banks are required to hold in deposits) which could free up lending and accelerate inflation and stoke lending and the property bubble - something it turns out is additionally caused by social factors including the one child policy according to Foreign Policy magazine.  Growth in the Chinese property market is already picking up, but as shown by Also Sprach Analyst in a current series, the current valuation models may significantly miscalculate the market.

A call for more clarity on China is probably due.  Or at least after the unicorns are gone.

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