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Monday, 3 June 2013

Mixed messages

It is becoming very difficult to read and understand news from China.  There are too many conflicting reports and inconsistent objectives and one wonders who is really in control.  Could this be a prelude to stagnation?  More on that in a moment.

Turning back the clock
In recent days the markets, the investors into and the people living in many emerging markets seem to be reaching a turning point - in currency flows, sentiment and strategy.  Recent protests which have broken out in Turkey, the Eurasian darling economy and one of the Goldman Sachs Next-11 post-BRIC  economies have been followed this week by plunging stockmarkets and questions about the future.  Prime Minister Recep Tayyip Erdogan, for a decade a popular, respected and dynamic leader, held responsible for bringing a long boom to Turkey has seemingly aggravated protests and been labelled in the international media as hubristic, tone deaf and too closely echoing an arab dictator than the enlightened leader considered previously.  Once lauded for assertive diplomacy towards Israel, Turkey had even taken steps to formulate a nuclear non-proliferation plan for Iran with Brazil, another up-and-coming power (a first since the plan was outside usual US led efforts).  The Lat-Am powerhouse is itself sliding into a deflationary spiral it seems with the falling Brazilian Real doing nothing to encourage local businesses into increased activity (contrary to predictions of finance minister Guido Mantega, who coined the term "currency war") and a recent minor bank-run has exposed the possibility of an imminent or likely popping of a domestic credit bubble.

Broadly speaking the cause for investor nervousness is the withdrawal of liquidity by the US Federal Reserve.  Having supported emerging markets for years with its money printing programs, which have sent trillions of dollars into all manner of countries searching for yield (as the US has sought to inflate away its own debts), the announcements by the Fed that, with signs of inflation and asset price bubbles in the US economy, it will now taper and start to slow its Quantitative Easing program, many investors have started to close emerging market positions and withdraw funds from these economies.

For China this matters too.  It is subject to similar trends - foreign banks like HSBC have been exiting the local market, selling their stakes in national champion banks like ICBC and exiting the market (having failed to achieve the predicted growth) and foreign investors are withdrawing funds or holding back on future investments.  As also noted however, the advent of ultra loose stimulus policies in Japan (which seek to replicate and extend the US easing policies to its own economy) poses a specific threat to China in that the rapid lowering of the Japanese yen may put a lot of pressure on Chinese exporters (causing them to have to drop their prices, at a time when labour costs are rising) and threaten to burst Chinese asset bubbles as real interest rates peak.

Apart from any particular difficulties China may face at the current moment all of the above suggests a broader shift might be underway and in fact far from a momentary pause, the current changes in fact form part of a move in economic activity as investment and fast growth dissipate from emerging markets elsewhere.  In short we would be turning back the clock to a world before the BRICs and the paradigm of decoupling emerging markets. 

Steering the train
Not that you would know any of this from reading certain news and reports.  Two books have been published which detail the global commercial empire which has been constructed for the Chinese state's foreign commercial interests, each shining light on a hitherto dark area.  

In China's Superbank, Henry Sanderson and Michael Forsythe delve into the rise of China Development Bank, the unique monolith nurtured by princeling Chen Yuan into the powerhouse which recently lent more to large infrastructure projects across the developing world than the World Bank and has been at the centre of the rapid growth of the Chinese economy (in particular inventing the controversial local government financing platforms which critics believe may become very risky for the Chinese economy soon).  In China's Silent Army, Juan Pablo Cardenal and Heriberto Araujo have explored the many outposts of China's commercial interests around the globe and drawn insight from the vast range of projects and characters they have come across.  As per an article in the New York Times on the latter, the message is that China is taking over (and in case you missed it a Chinese company Shenghui completed the biggest Chinese acquisition of an American company when it bought Smithfield Foods, America's biggest pork producer).

And similarly, news of state backed hacking by Chinese government or military units (and/or their affiliates) along with announcements that the Chinese Navy is patrolling the waters of the United States Exclusive Economic Zone for the first time all point to increased strength and more aggressive posturing of China towards its neighbours (in addition to South China Sea disputes that is).

However, all is not as it seems.  Several Chinese entities have seen their acquisition efforts falter, one example being financial behemoth CITIC which saw its $2 billion investment in an Australian iron ore mine balloon to $8 billion (with delays) compounded by further $2 billion losses on unfavourable hedging.  And as suggested in the sub-heading there may be some interesting historical parallels.

For while there are outward signs of strong successes, in China proper there are reports which suggest all is not well and possibly stagnating.  None of these will be unfamiliar to readers of this blog, but the scale of the reports is worth noting.  The Economist finally has a piece (though ostensibly told through a review of a book) suggesting the team finally acknowledge the scale of shadow banking in China and the risk dynamics.  Debt levels at Chinese companies have been described as "alarming".  The BBC and other outlets reported that China labour costs are now high enough that many factory owners are considering relocating.  And of course the administration is quietly getting on with the task of battling gargantuan corruption of state officials.

It was whilst reading about efforts at reform during the Brezhnev era of stagnation that the writer saw some detail about the failed anti-corruption campaign.  For a bureaucracy the size of the Soviet Union (or China), taming an out of control culture of inducted officials was just too difficult.  And yet meanwhile on the world stage the Soviet Union was at its zenith and projected its military and political power the furthest (though in doing so it set up the conflicts with each of the major powers that would later weaken its empire).  The economic malaise had been set in motion many years before, and hence (to finish) a joke which may offer the reader some parallels with the current situation facing China:

Vladimir Lenin, Joseph Stalin, Nikita Khrushchev and Leonid Brezhnev are all travelling together in a railway carriage. Unexpectedly the train stops. Lenin suggests: "Perhaps, we should call a subbotnik, so that workers and peasants fix the problem." Stalin puts his head out of the window and shouts, "If the train does not start moving, the driver will be shot!". But the train doesn't start moving. Khrushchev then shouts, "Let's take the rails behind the train and use them to construct the tracks in the front". But it still doesn't move. Brezhnev then says, "Comrades, Comrades, let's draw the curtains, turn on the gramophone and pretend we're moving!" 

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