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Monday, 15 July 2013

Growth is dead!! Long live growth!

It is a criticism with some basis that the pursuit of economic growth in China at all costs has become something of a mantra or cult and that even as the new fresh-faced regime seeks to move away from this to rebalancing and broader aims and social goals, western business media seem obsessive in their coverage of all pronouncements and speculation seeking to divine whether the magic number (annual GDP growth) will be 8%, 7.5%, 7.7% or something lower.  What did Finance Minister Lou Jiwei mean when he said 6.5% growth was tolerable on the sidelines of a China-US summit in Washington? That 6.5% was expected? That there was more comfort? to scare foreign speculators? To test the market impact perhaps?

Alas, since the SHIBOR shock when the PBOC cut funding in the interbank market for a time, the Chinese administration is having to posture a lot and send signals to try and guide the markets - not something it is necessarily good at!

Let's go back a step.  There are plenty of reports indicating (from the Chinese authorities themselves and from outsider's analysis) that the existing model is dead.  No more shopping centres/bridges/trains/roads to nowhere and hello consumerism.  Sounds simple enough - after all it is the lack of consuming that causes the high savings which distort the global economy and cause deficits in developed countries (which have been the centre for slowdown which is threatening China's exports and the exporting model), goes the reasoning.  Simple right?  And follows a nice circular logic?

Well not really!  Some points to consider:

Upside down fundamentals


China bull...hanging in a tree (c) CEN

The low consumption is a result of the structure of the banking system and economic policy.  The export preferencing low fx rate (in the RMB trading band) causes excess liquidity which is stored in US treasuries.  The PBOC buys the US dollars from exporters injecting RMB into the economy which must be sterilised to prevent inflation by forcing banks to buy PBOC bills and hold high reserves.  With scarce funds the banks prefer to lend to SOEs and live off the spread over fixed rate depoist source of funds which pay a low interest that is negative after inflation (due to the above).  The Chinese people get negative interest rates at the bank and can only buy gold (which they are doing in record numbers) or real estate (did we mention the world's biggest building was built in Chengdu at the size of 20 Sydney Opera Houses?!- this in addition to more shopping space in that city than much of Europe).

Regulation light wealth-management products have appeared to fill the gap offering high interest avenues for risky investments causing a further bubble, but the overlying point is that there is relatively little consumption.  Currently, ordinary people in China subsidise the state and its enterprises.  Their funds are transferred into investment.  Along with Michael Pettis who has been saying this needs to change (and will change) for a long time, many key figures have made this point, including Patrick Chovanec who said recently on twitter that the solution is to reverse the process, by liquidating the US treasuries.  Bringing the US dollars back into China to counteract receding investment and unsterilising - repurchasing the bills to put back yuan into the Chinese economy.

It is the view of this blog that this will not happen without a crisis, because i) the treasuries are impossible to liquidate easily without risking the valuation of the remainder (although that is what the US wants and is trying to force through its QE based US dollar devaluation), ii) it would fracture the edifice of China invincibility that is keeping the economy running, iii) as Victor Shih has noted, by the time it did so wealthy individuals would have already withdrawn enough of their funds from China to wipe out capital in the Chinese banking system rendering it insolvent.

That is a dire end-game scenario, but to return to the main point - consumption - no consumption is going to occur in a significant way unless all of the above happens.  Consumption can't happen without structural reform (Chovanec would probably argue that Yuanisation of US treasuries so to speak could kick start sucha process, but this is splitting hairs somewhat).

If not for anything above you should at least get a sense that consumption will take a bit more to take root than a couple more empty shopping centres!

Reactionary forces gathering
It has been noted that the SOEs, citadels of investment are fighting hard to stave off reforms and keep their privileges.  This will slow or block reforms and recent articles suggest the reform movement is slowing - investment still made up a significant and growing part of gdp in growth the second quarter.

Another more poignant example is the recent announcement of a massive ramping up of spending in the solar power sector - a sector flooded with capacity (45MW production capacity in China compared to global demand of 35MW) where high profile and industry wide bankruptcies are only starting occur. An official was quoted last year saying there would have to be consolidation and solar firms would have to close.  Instead there is this recent announcement that screams return to the bad old days:
China aims to more than quadruple solar power generating capacity to 35 gigawatts by 2015 in an apparent attempt to ease a massive glut in the domestic solar panel industry.
Within top sections of the Party there are reportedly divisions between different commissions and the Politbureau and this will only be likely to intensify.

China on consumerism: You're doing it wrong!
Many will have seen the report of a cartel seeking to sell chicken feet 46 years past its sell by date and many will have seen the reports of GSK and other multinational food and pharmaceutical companies investigated over corruption and also allegations of profiteering.  Taking a step back from the specific facts and the overall sense seems to be that China is unhappy with and unable to bring about conditions for sensible prices for certain consumer goods (feeding into high inflation and risks of unrest) and instead of addressing the underlying cause is going about in a ham-fisted manner attacking the multinationals to try and force a way around the problem.  A short term solution at best.

More fundamentally as illustrated by an excellent observational piece in the FT about passengers on China's first cruise ship, Chinese consumers are just venturing into whole new markets and are very different from preconceptions.  As with all China's modern history, things will not turn out as expected.

1 comment:

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