Crunch time!

Very contrasting news and images coming out of China at the moment.  While Wen Jiabao was singing his final swansong at the Party Congress this week amidst the formal handover of power, property owners were fleeing to government offices to process property sales before the hastily announced 20% capital gains tax commences.  It is intended to slow down rising property prices.  It may have burst the bubble instead.

Express filing, Shanghai style

He did it his way
Wen's China was on display for all American's midweek when longtime China Watcher Gillem Tulloch, of ForensicAsia (with the assistance of others behind the scenes like Patrick Chovanec), took CBS' 60 minutes team for a walk through China's ghost cities.  The empty shopping centres, half started office blocks and empty landscape is one of Wen's legacies.

Another legacy is the opening up of reporting on social issues, along with professed policies by the leadership to do something about it.  Reports have circulated of polluted "cancer villages" and the below from a Daily Mail piece captures the mood at the moment:

The Chinese government has promised to tackle 'cancer villages' - areas where pollution is so bad it has lead to a huge rise in diseases like stomach cancer - after a huge social media backlash from both ordinary Chinese people and global campaigners.There has been an explosion of outrage about cancer villages on China's social media sites and blogs, which are used by increasingly powerful activists to raise awareness.

But problems run deep.  As in the case of Dalahai, a village in Inner Mongolia profiled by Caixin magazine which has suffered from a nearby radioactive tailings dam, the villagers must drill to increasing depths to tap water which is safe to drink.  It is a moot point anyway as many villagers have fallen ill, moved away or given up hoping for promised though inadequate compensation.

Going green
The Green agenda was supposed to be one of the highlights for Wen's legacy with the push for renewables and various environmental policies which have also failed.  Instead the policy failure so evident in the Beijing smog has been upstaged by tycoon and philanthropist Chen Guangbiao, who made headlines for a number of radical stunts, including  selling cans of fresh air, recommending Chinese people eat less, and attending this week's Congress by bike, in a green suit.  While refreshing it is uncertain how likely any of his recommendations will be to advance the agenda.

The wrong type of green (c) Reuters

The dead hand of the State
One of the big obstacles to reform is the vested interests of state enterprises.  Caixin had an excellent piece on the failures at the top of State shipping company Cosco which took up the completely wrong strategy and is now hemorrhaging cash.  The FT mentioned the role that the head of M&A champion Sinopec had, in weakening regulation to restrict the sulphur content of its refineries near Beijing which have caused much of the smog.  And on the green side, Caixin has just reported details of the termination of the head of Suntech, the failed solar company which officials were saying should have been consollidated with all the other failing solar companies by now.

Most worringly in a market where risks are dire and State Owned Enterprises have lavished shareholder funds - the property sector (which is now tanking), one key sensible measure - that the SOEs withdraw from the market, has been ignored.  This and everything else does not bode well.

The Year of Transparency?

新年快乐！Kung Hei Fat Choi!  Happy Chinese New Year to readers!

- Announcement - Following on from last month's Moutai Awards" (茅台奖), we still have some uncollected Moutai Baiju so award winners please feel free to get in touch!!  -

Pollution update - Airpocalypse now

While many may have seen pictures of smog in Beijing and elsewhere, in Shanghai one young lady has been at the centre of the public concern over air quality.

(c) Shanghai Environmental Protection Bureau

This unlikely figure is the new Shanghai air quality mascot.  Posted by one locally based blogger the young girl pictured is shown in different moods which ties into the air quality - green being most satisfactory.  Currently air quality in Beijing and Shanghai is tipping the serious end of the scale, and one entrepreneur has started selling cans of fresh air.

Discomforts aside the fog in Eastern China does provide a metaphor for a few key themes we could expect to see in 2013.

Fog of war
No light matter, China (and Japan depending on your point of view) are threatening war over the islands, including the Senkaku, Diaoyu islands.  Currently air and sea patrols are ongoing and last week a Chinese ship locked on its targetting systems onto a Japanese ship. 

In tandem, both countries have recently been cited as having joined the currency war, a term coined by Guido Mantega, finance minister of Brazil in 2010, in which major economies engage in competitive devaluations of their currencies.  Commencing with the US Federal Reserves' Quantitative Easing (or money printing program) in 2008, both Japan (following an explicit announcement) and China (observed) have seen their currencies weaken this year. A recent statement by the G7 decrying a currency war and calling for stability ahead of an upcoming G20 meeting seemed to have little effect as volatility increased.

Promise of clear skies?
In one less discussed but important conflict progress is being made apparently.  Since the end of last year US authorities including the SEC and PCAOB have been negotiating with their Chinese counterparts to reach an agreement for the auditing of Chinese companies listed on US stock exchanges by US auditors (or verified by US aditors).  Paul Gillis, China accounting expert has details on his blog (here).  As had been discussed previously failure to resolve this could mean a mass delisting of Chinese companies from US exchanges.

However the China short-sellers, groups of analysts and funds seeking to expose and profit from Chinese corporate malfeasance are reportedly taking aim at Chinese companies listed in Hong Kong, of which there are many more, and for which there could be some bruising battles ahead.  Recent scandals involving Caterpillar and short favourite Zoomlion do not inspire confidence.

Bottom-up disclosure
Amidst strong speculation of future policy by outsiders, within China its leaders seem to be working hard to convey the message of a renewed focus on tackling social issues.  Several reports of top officials making impromptu visits to ordinary folk in remote areas have been reported by foreign media, including a a visit by prime minister Li Keqiang to the northern city of Baotou, where during an interview with a farmer, the farmer's son fell half-naked out of a cupboard behind the prime minister.

While applauded by bloggers as showing openness from the regime, the Baotou incident does remind one to ask just how many other things are hidden away in the closet in China and are likely to spring out at an inopportune time.

In terms of predictions for 2013, absent any big surprises it seems possible that many of the same issues will be redebated, not necessarily discovering any serious lurking issues in the background.  It seems possible that:

(i) NPLs will remain under-reported (and bad loans will continue to be unrecognised and accounted for);

(ii) Banks, especially state banks will continue lending;

(iii) another trust product, or several may fail;

(iv) large corporates will continue to load up on debt;

(v) overseas acquisitions will continue (just reading about possibly insolvent Suntech expanding into Uzbekistan);

(vi) one or more high level officials will be purged; and

(vii) great pressure will be placed on China's neighbours.

Now to wait and see...

Snakes and suitcases...

A year in review
Last year was a very generous year of gift giving it seems with many Chinese seemingly awash with cash and, in some cases looking to transport it out of China. Seizures were reported at airports in North America and a road checkpoint in France, while even within China bank staff at one bank in Henan province spent their time in the new year counting through a large mountain of low value bills deposited by one customer.  With the Year of the Snake soon approaching and awards season kicking into full swing, it seemed like a good moment to reflect on some of the achievements of 2012 and make some predictions.

China's latest export?

Intoducing the Moutai Awards"! 茅台奖!
Inspired by the longstanding favourite of Baijiu connisseurs (although since being banned at military banquets it has fallen in popularity as a luxury item), we now present our nominations for celebratory bottles of the oft-contaminated tipple to mark outstanding achievements (and notoriety) during the year.

Wedding of the year - At a price tag of approximately $150 million, the dowry given by Wu Duanbiao, a Fujian businessman to his daughter at the start of her 8 day marriage celebrations in December seemed to include everything but the kitchen sink, which presumably could have been manufactured by Wu's ceramics firm Fujian Wanli Group.

Scoop of the year - Although the Bo Xilai affair had readers worldwide captivated for many months and despite a commendable late effort by Bloomberg in exposing the complex web of connected Princelings ruling over China's Bureaucracy and Xi Jinping's family wealth, David Barboza of the New York Times stood out for his perfectly timed expose of Wen Jiabao's family business interests, on the eve of Wen's retirement.  Not only creating a lot of attention, it caused an immediate response from the Chinese authorities and was probably the reason for a number of recent measures, including the proposed removal of directors' personal details from the companies registry in Hong Kong (a key source for investigating officials' dealings) and the collapse of HSBC's exit from dominant insurer Ping An.  Special mention also to John Garnaut for his research into reshuffles of the Chinese military leadership prior to the leadership handover.

Broadcast of the year - Congratulations to the team at Sinica who delivered a highly insightful discussion on the eve of the party congress and leadership handover.  Featuring a heavyweight panel of John Garnaut, Patrick Chovanec, Jamil Anderlini and regular hosts Kaiser Kuo and Jeremy Goldkorn.  The explanation of the history of Bo Xilai and the leadership was very precise and revelations, including Bo's penchant for Sylvester Stallone, quite surprising!  A runner's up award for Max Keiser who over a number of broadcasts on Russia Today has been seeking to highlight China's buildup of gold reserves which could shock markets in 2013.

Most creative use of official resources - in a crowded field, Wusu City police chief Qi Fang stood out for his resourcefulness, in housing his twin mistresses and employing them in the city's police department.  Equal second place goes to Lei Zhenfu, who found time to star in a sextape, and Yang Dacai, a Work Safety official from Shaanxi province who managed to amass a collection of luxury watches on his official salary and keep smiling amidst the human and machine wreckage of several traffic accidents. Definitely hard work did not go unrewarded this year.

For services to architecture - Developers of the Meiquan 22nd Century building were a late contender, having commenced a Chongqing development due to be completed before the Zaha Hadid designed Wangjiang SOHO development (which it is a poor copy of) is finished.  Earlier in the year, plans announced for the completion of the world's tallest (and possibly ugliest building), Sky City in Changsha, in an unbelievable 3 months, were noteworthy, as was the world's largest, the New Century Global Centre in Chengdu.  But for sheer pointlessness the planners of the ghost town of Ordos in Inner Mongolia are the winner in particular because it was also able to be used this year as the world's largest skate park.

Most subsidised sector - Jury remains out on this one.  Railways seem to be the winner with about $104 billion announced for 2013 (following similar amounts in 2012).  Shipbuilding and solar were notable also.

Congratulations to our winners!  They or their representatives can get in touch for some fine baijiu tipple!

(c) Shenzen Standard

Coming up next - some predictions for 2013...!

Seeking cash...

Holes emerging in the edifice
Some of the headlines in the last couple of weeks:
- China's WMPs - wealth management products suffered their first recorded default.  Called "Weapons of Mass Ponzi" by some commentators, these lightly regulated or unregulated products are managed by various financial businesses but sold through banks and other networks to retail customers.  They are high risk and offer a higher return than typical bank products such as deposit accounts, which offer mostly negative rates of interest after inflation.  Customers of a mid-size bank Hua Xia protested when notes sold to them in one of the bank's branches defaulted.  The notes paid income from a domestic issuer unrelated to the bank and streamed income from a pawn shop and car dealership (details here).  As had previously been seen in the Zheijiang Guarantee scandal, part of the structure involved guarantees which were not met and bank staff were blamed.  More importantly questions were raised as to how many other schemes were likely to fail.

Despite assurances from regulators during the recent party congress, regulators do not know the extent of exposure and so this week the China Banking and Regulatory Commission ordered banks to check and ensure management of non-traditional products.
Take away: Expect vast amounts of these sub-prime style investment products to be flooding through the Chinese financial system.  It is doubtful that the regulators or the banks will be able to contain them for much longer or prevent contagion if too many collapse.

- Unimaginable sums of money have been flooding out of China - A report out this week covering illict flows from developing countries in 2000-2010 listed China as the top source of all flight money, with more funds leaving the country clandestinely ($2.74 trillion) than all of the other top 10 countries combined.  This is broadly in line with other studies on corruption in China (link here).  The atmosphere of corruption has remained pervasive since the recent party congress and Vice magazine had a great article covering the scope of illict behaviour of officials being reported daily across China ("Chinese officials at it again...").
Take away:  Victor Shih of Northwestern University has looked at the impacts sudden acceleration of capital flight could have on China's foreign exchange and fiscal position and this could be an unstabilising factor going forwards.

- China is seeking to attract massive amounts of new foreign capital from sovereign wealth funds and central banks - A recent relaxation by the State Administration of Foreign Exchange of an investment quota of $1 billion under the QFII program means that now, through small changes to their portfolio, reserve managers could cause large shifts of capital into China (details here).  There was speculation about motives and questioning as to how such a policy interacted with efforts to liberalise its currency,
Take away:  At a time when banks are seeing increasing shortages of cash towards the end of the year this move does suggest signifcant sums to flow into China in future.

- Chinese corporates facing tough times - An interesting piece describing actions on the ground at LDK, once the world's largest solar panel maker, but now subsisting on funds from its main state-bank creditors under the weight of an impossibly sized $3 billion debt is here.
Take away: Industries like shipbuilding and solar are at the forefront of the Chinese slowdown.  Expect to see a greater spread across industries, including the property sector and eventually (when problems find their way back to the creditors), to the financial system.  

Lost century?

Back to work
Following a relatively smooth 18th party congress, China Inc has got back to work, albeit with a slightly different vision for more balanced growth.  There was not so much to take away from the various press showpieces, especially since (as is usual), many of the real decisions had been made in the final days leading up to the summit.  A post mortem piece in the Chicago Tribune highlighted the role of retired senior figures still play in the party - there must have been plenty of non-Chinese wondering what Jiang Zemin was doing centre stage at the conference.  The Wen family saga  rolled on, with a second instalment from the New York Times examining the very profitable stake held in insurance blue chip Ping An insurance by Wen's family and the lobbying to Wen on behalf of Ping An in 1999.  Wen's response included being asked to be forgotten.

In the swansong atmosphere it seemed likely that press would look around for an identifiable theme and many outlets settled on comparisons with Japan at its zenith.  One comparison, in a fairly high level of detail for the BBC was quite simply titled "Will China fall flat on its face"!  One of the most concerning points of comparison, which has been noted elsewhere, was the different developmental stage between China and Japan - thanks to its one child policy and it starting form a much lower income base, China has rapidly accelerated the aging of its population to now approaching Japanese levels (though getting a dividend along the way with a relative boost of young workers which is now decelerating) and consequently may grow old before it grows rich. 

More worrying in the immediate term was the surprisingly candid, though balanced piece by Charles Dumas of Lombard Street Research who nicely brought together all of the strands of the Chinese economy which are of concern - debt, stimulus, defaults.  What is particularly worrying is the ease with which, in 2 places, Charles can lead to a conclusion of the occurrence of banking crises - as a matter of course, as inevitable as a policy setting! - without policy change (debt reduction) and with trend growth shifting down to 5 per cent, "a plague of banking crises" could be a result, as could occur if financial liberalisation proceeds.  This is not the story spun by the large financial institutions promoting use of the Chinese currency (the Yuan/Renminbi) in trade settlement and with greater convertibility.

But these two things combined paint a worrying picture.  If China has all of the preconditions of a Japanese style financial collapse - sufficient to bring about the slow burning decline of a "lost decade" or "lost generation" (a term in vogue even in the West as it pushes through austerity, or in the case of the European Union, can-kicking), then could the less favourable demographics, level of social cohesion or uncertain environment make the impact for China worse than Japan?  As it happens there are deep social divisions in China with assertive foreign policy in areas like the South China Sea stirring tensions amongst the population and with reports of inequality and division within Chinese society attracting increasing concern and attention.  The task of the Chinese Communist Party to reinvent itself for slower growth and newer ideologies also complicates things.  Added sleaze and corruption scandals make for grim prospects.

Underlying the resurgence of nationalism is a sense of continuity with the period from the mid-19th century until the mid-20th century, when the sovereignty of the Chinese empire and state was subjugated to foreign powers and influence, starting with the First Opium War until the expulsion of foreigners after the Second World War (the Century of Humiliation).  As commentators have noted, the current administration perpetuates the focus on restoration of international profile and prestige while skipping over the Party's failures. Inability for self-criticism may come to harm the Party and the nation in years to come, and should the effects of China's boom be felt across one or more generations, Chinese may have to face up to another century of lost potential in many years to come.

Cracks appear in the China bull market (c) Caixin

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.

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.