Generation game

Solar flare up
Since the last post there have been moves to further consolidation and government control of the solar industry as two of the largest players, LDK and Suntech are facing increased state involvement and even takeover.  Amidst global oversupply, plummeting prices and possible trade law sanctions, a couple of themes are present (i) use of bankruptcy is not prevalent yet (with rollovers of debt preferred) and (ii) increasing state involvement.  An excellent article by Tim Worstall in Forbes had a headline which summed up the situation - "China still hasn't got the hang of this capitalism thing", namely the importance of unprofitable enterprises going bankrupt.  It would seem fairly obvious that there are plenty of impediments to swift and orderly wind-down of institutions - loss of face, bureaucratic interference, vested local government interests and the like.

But it wasn't supposed to be like this - the article refers to an official who pronounced that the government intended the industry to consolidate - i.e. a large number of enterprises close or merge - intentions which were complicated by unwillingness of banks and local governments to toe the line.    And what a contrast from the fanfare in a previous Forbes article announcing the launch of the new US style bankruptcy regime China in 2007 - the predictions of a "high level of sophistication" and "determination to build a sound legal system" seem over-enthusiastic statements now.  Possibly due to the need to promote stability ahead of the leadership change next month, officials seem to be falling back to tried and tested methods of state interventionism, which will only continue to propagate distortions in the current financial system.

It's a family affair
At the time of writing there has been an overwhelming response to the New York Times' investigation into the wealth and connections of Chinese Premier Wen Jiabao's family.  It is not just that the Chinese administration has blocked access to the Times' website (as it did with Bloomberg and the Brookings Institution when they released similar findings regarding incoming Xi Jinping and Li Keqiang), responded with what the Financial Times referred to as a "hatchet job" piece in the People's Daily, or that unusually the administration has instructed lawyers to deny and  look at pursuing legal redress (which members of the legal community thought were poorly thought out) With the Guardian comparing it to the Pentagon Papers as the most "direct challenge to a sitting government", it is clear that the investigation has ruffled feathers at a sensitive time.

It is not clear yet if there will be a lasting impact from these revelations about China's leaders - the Economist which has a special report covering the upcoming Party Congress, concludes that all the disclosures strengthen the case for reform.  Like many similar autocracies the connected elite of China have had an entrenched position for a long time in China and it seems unlikely that this will change after the handover beyond certain personnel changes (which was the conclusion of Katherine Hille in the FT).  But could tensions between ruling factions and their connected others spillover after the transition?

Factional tension was suggested by Hille (noting rumours on Chinese social media that information in the New York Times had been provided by factional opponents of Wen) and more broadly the Wen revelations have opened a greater discussion on corruption in China, which as the FT Alphaville blog noted that perceptions of corruption were reaching levels where they could be destabilising.  Cue then a closed door lecture from a Chinese (or Hong Kong-based) academic arguing that China is in fact nearly bankrupt and a warning from permanent China bear Gordon Chang warning that there is now a "stampede" of money and even officials are now fleeing China and all does not seem well.

A light-hearted piece in the Daily Mail might suggest otherwise (with news of a marriage of the niece of president-in-waiting Xi Jinping to a young unknown British businessman, Daniel Foa) but there is a very deep family tension involved in this year's leadership trauma.  Forming part of a highly recommendable podcast of experts (comprising Chovanec, Garnaut and Anderlini) was a real insight into the the deep inter-generational enmity between Jinping and Xilai (and their factions in the Party), which had arisen between their fathers, Xi Zhongxun and Bo Yibo, during the cultural revolution.  Garnaut in particular has been in explosive form revealing casualties of the factional struggles for position in both the military and political leadership. Add to this interventions of factions led by Hu Jintao/Wen Jiabao and Jiang Zemin and things look set for an explosive mix.

An Englishman called Daniel Foa holds a book (c) ImageChina

As has been noted China's new leaders are likely to signal a clear directional change in policy very soon after the handover (as has been customary).  Whether they retain a princeling dominance and an absolute autocracy or opt for a more compromising approach (such as a management focussed Singaporean model) will remain to be seen.

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.