According to a recent article on Reuters, on Saturday Lou Jiwei, the chairman of the CIC, China’s sovereign wealth fund, said at a conference on Saturday in response to a question about his expected performance: “It will not be too bad this year. Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.”
In my last entry I noted that after the recent “green shoots” period, during time which it seemed hard to find anyone who was skeptical of our seeming ability to turn the corner on the crisis without actually having addressed any of the underlying imbalances, it was good to see that more and more analysts, and especially policymakers, had begun to worry again. President Hoover went down in a blaze with his “light at the end of the tunnel”, and of course one of my favorite stories of that time is his response in June 1930 to a delegation requesting a public works program to help speed the recovery: “Gentleman, you have come sixty days too late. The depression is over.”
As I see it the more policymakers worry, the better. This crisis is far from over. Until we know how the continued adjustment in US household consumption and debt will evolve, and how this adjustment will play out in China’s own changing consumption rate – most importantly whether it will complement the fiscal and credit expansion embarked upon by Beijing or, as I believe, conflict enormously with it – the crisis won’t be over. We need policymakers to resist the green-shoots nonsense and to worry about what happens when fiscal, monetary and credit tools stop working.
Although I thoroughly disagree with the “So we can’t lose” part of Mr. Lou’s statement – I have been a trader for too long to hear those words with anything but the deepest dread, and I am sure he didn’t intend the way it read – it is nonetheless interesting to me that by now skepticism is so widespread that a major investor can even propose our inability to work through the imbalances as a reasonable investment strategy.
We need skepticism. For one thing it has caused Beijing increasing worry about the risks of continuing to extend the stimulus package, to the point where they are now making serious noises about cutting back. My biweekly column in today’s South China Morning Post argues that in spite of the damage this has done to the stock market, it is undoubtedly a good thing that they are thinking about cutting back.
But it won’t be easy, and I suspect that already the effect of rumors about slowing the fiscal expansion is strengthening the hands of those who want to stomp again on the gas pedal. For example the stock market was down 6.7% today, bringing its total decline since August 4 to 23.3%. Even my superstar PKU student Gao Ming, who has so far ridden this chaos pretty well, admitted to me today that it was not a good day for him.
Why did the market collapse? Forget about fundamentals. As I have argued many times before, China lacks the necessary tools that fundamental investors use (e.g. good macro data, good financial statements, a clear corporate governance framework, a stable regulatory environment, a market discount rate) and so no matter what people say, there are no fundamental investing here. There is only speculation, and the two things above all that drive the markets are those old speculator favorites, changes in underlying liquidity and government signaling.
The whole market is worried about both, and the most important is concern that the days of explosive bank credit growth are behind us. On Friday, for example, Bloomberg reported that:
Today the mainland newspapers were even more worrying. Several reported that new loans in August would be just RMB 300 billion, after last months’ new loan total of RMB 356 billion, and RMB 1,231 billion on average during the previous six months.
RMB 300 billion is nothing to sneeze at, especially since that probably nets out a lot of bills coming due – so that new medium-and long-term investment is likely to be substantially higher. It is also worth remembering that August is normally a bad month for new lending – last year net new loans were only RMB 272 billion.
Still, after the deluge of new lending for the first half of the year, it clearly represents a significant contraction in the rate of credit expansion, and if you believe, as I do, that China’s “impressive” growth rate this year is actually a very disappointing consequence of a huge fiscal and credit stimulus, any indication that the stimulus will slow down cannot be good for sentiment.
I wonder, and I know I am not the only one wondering, what Zhongnanhai is thinking as it sees the impact of these rumors of a contraction in the furious rate of credit expansion. For one thing it seems that there are only two positions on the switch – “surge” and “swoon” – and I suspect that very quickly we will see the switch turned back to “surge”. Although there seems to have been a little upward blip in US import numbers, I think this represents more of a temporary bounce from a steep earlier decline, and that the external environment continues to be very poor.
My guess is that if the local stock markets do not soon recover their bounce (and they won’t without government help) and, even worse, if we start to see the awful sentiment seep into the real estate sector, Beijing will once again push forcefully for credit and fiscal expansion. In my opinion there is simply no way that domestic consumption – unless it is primed with government giveaways – can make up the slack quickly enough.
Speaking of which I saw an interesting article in today’s People’s Daily. On the one hand it seems positive for an eventual generational-inspired rise in consumption, and on the other hand it seems negative about structural impediments:
Thanks for this. I have been wondering how much cash China may pump into equity markets, this helps give an idea.
Perhaps we will hit GS’s target of SPX 1150 after all!
Had an interesting chat with someone who has recently returned from Shanghai.
He was told by some senior Chinese bankers that once the stimulus money is credited to the banks by the government, an order to disperse this money is also and always attached. The Chinese banks are not allowed to accumulate these funds in “reserves” as the US banks have done as shown in the Fed Res H 4.1 report ( http://www.federalreserve.gov/releases/h41/.
The government then assumes that the stimulus money has been dispersed immediately and then established “money multipliers” variables are applied and an instantaneous GDP value then calculated.
This value then goes towards the official GDP reporting.
I do not know if this is fact – but was a reliable source.
Anyone affirm this?
If this is fact, can one assume that given the major shock the world economies have taken, the Chinese money multipliers have dropped like a stone, in reality, just as velocity as dropped for the US money supply data.
This could mean GDP, if the analogy to US drop in money velocity holds, could be over 50% less than reported.
[...] It’s not yet the end of China’s massive stimulus – Michael Pettis [...]
Great, but sombre comments and very good that they get a lot of attention. It is odd that Mr Lou (the head of China’s state bank holding company cum SWF whose profits depend primarily on the profitability of the likes of BoC) is making his comments at a time when part of his investment firepower may have to be set aside for increasing bank regulatory capitals (unless the banks manage to slow down credit growth, which would be miraculous). Or perhaps he is pointing at the opportunities for CIC when the banks fail to raise enough from the market and CIC has to do some heavy lifting (of course, just the announcement that CIC intends to do something may be market moving) which should come at a price.
Chinese markets do seem to be influenced more by rumors and reactions to news than the US markets. However, they aren’t exposed to as much leverage as the US markets.
Sure, the big meltdown last fall hit hardest in China, but that was because hedge funds with the sound strategy of shorting the US and buying China got forcibly deleveraged. That ended up being a very good thing for Chinese investors as a whole and bad for the institutions and pension funds parking their assets in “alternative investments.”
Margin trading is less common and periodically banned. Hedge funds aren’t the dominant players in China that they are in the US. Nor does China have the same heavy influence that the options exchanges have over US stock movements every month around expiry.
It would be a mistake to think that fundamentals play a large role in US stock price movements. Sadly, most investors I talk to don’t know how to ready a balance sheet.
It may be a good sign that people respond to the news. In the US we get mostly mis-information from CNBC and other financial media outlets. It just isn’t safe for major broadcasters to tell the whole truth about the dirty stuff going on.
[...] It’s not yet the end of China’s massive stimulus (Pettis) [...]
Hey, I got you a shout out on ZeroHedge – You’re welcome. ; D
George:
Your story from the Shanghai visitor sounds a bit strange,
“He was told by some senior Chinese bankers that once the stimulus money is credited to the banks by the government, an order to disperse this money is also and always attached. The Chinese banks are not allowed to accumulate these funds in “reserves” as the US banks have done ….”
Chinese Banks have historically had and still do have a cozy relationship with “the government” but to suggest that Banks are ordered by the government to loan to a certain project probably overstates the case.
That’s not the way it works. It (influence) works at the party level based on guanxi (relationships). The top management at the SOE banks are all high level party officials. Also the backdoor leverage on the banks often comes from provinces and cities who are big depositors, pressuring the banks to lend on pet projects. That still happens, big time.
Perhaps your story makes sense in the context of the funds being deposited into a Bank account and then disbursed pursuant to the depositors wishes. But i don’t think there is a firm, official order by “the government” to lend to any particular project.
Interesting article in Caijing today:
“China’s state-owned enterprises may unilaterally terminate commodities contracts as they try to cut massive losses from financial derivatives, an industry source told Caijing on August 28.
According to the source, China’s State-owned Assets Supervision and Administration Commission (SASAC) has sent notice to six foreign financial institutions informing them that several state-owned enterprise will reserve the right to default on commodities contracts signed with those institutions. (sic)
Chinese SOEs have suffered massive losses from hedging contracts since the onset of the global financial crisis. SASAC and the National Auditing Office has been investigating derivatives positions trading since the beginning of the year.
A source from a state-owned company told Caijing that most of China’s SOEs engaging in foreign exchange and international trade have participated in derivatives trading, involving capital topping 1 trillion yuan.”
Pretty cool if you can just change the rules of the game when you are on the wrong side of a trade!
Thanks Dave.
George and Jeff, there is definitely substantial directing of loans by policymakers, especially large loans, and we constantly hear that the bank party committees are very involved in lending decisions for large loans. I don’t know about the relationship between loan disbursals and GDP accounting but, as you know, there is a very active discussion about the reliability and accounting of data.
Jeff, this wouldn’t be the first time. In late 2007 and early 2008 the market was filled with discussions about certain exotic derivatives (basically bets on the shape of the euro curve) that Chinese banks sold to local corporations and hedged with foreign banks. The bets went bad and there were all sorts of complaints about failure on the part of Chinese banks to meet margin requirements and failures on the part of local corporations to accept the losses. I think in general there is a sense that when a derivative goes bad, it shouldn’t be counted because the whole thing was inappropriate. I am not sure the same logic applies when a derivative pays off. One not-completely-unintended consequence, however, is that it may discourage banks from offering complex products to corporations. If you believe, as I do not, that financial losses are caused by derivatives, then it may not seem a bad thing.
Another point:
When you look at the options for savers in China it’s really hard to beat the stock market.
Interest paid on savings accounts is very low in China.
(correct me if my research is off)
You’d probably get less than 1% on a savings account.
On a one-year time deposit you could get around 2%
A P/E of 50 is equivalent to interest rate of 2%.
Real estate became even more popular after the market fell, but we all know how that’s going to end for the average condo investor.
That pretty much leaves stocks as your best bet, but the average people I talked to were more interested in mutual funds that diversify into a variety of investment classes. Until the masses are really diving back into the stock market we probably won’t be near the top.
I think two things to watch for are
i – Any change in the tax on share trading. This sets of dramatic swings on the market usually (or even rumours about changes) and is a key government tool for influencing the market.
ii – A sign that CIC or the national pension fund are propping up the market (further / again). Andy Xie has been mentioning the potential for this, as I think did Nomura in a recent note on China.
We have at least one more week before any statements from PBOC will demonstrate lending for August. With the new proposals about CAR changes etc the banks can’t feel too confident in continuing to lend at 1H levels
The rally is over. Goldman needs someone to take them out of their trade, as they did in oil at $140 and other trades. We are seeing a rebuild of inventory, but the capacity issue is going to stop the recovery in its tracks. Green shoots for 5 months now and US capacity utilization is 65%, though it might have increased recently. It isn’t only Americans that are going to contract their consumption, as other countries are only maintaining their employment due to government schemes. Bubble blowing is the most damaging of all economic manipulation. This is a debt problem, a big debt problem and it will take a modified bankruptcy and some careful maneuvering of money to end this depression. Giving 10% tax credits to people that are likely poor credit risks to buy houses will compound the problem farther down the road. Though I am not sure I agree with his tactics, I believe Steve Keen is leaning in the right direction. The real bubble has burst, the one which blew the Asian growth miricle in the first place, Bretton Woods, etal.
Houhui,
You envisage CIC supporting stock prices?
But that would mean they would be increasing their domestic portfolio. Either by broadening it or by adding to existing holdings. I guess that they will limit this type of investment to the financial sector and especially prevent downward pressure on FI stocks if/when these must add to their regulatory capital.
CIC has to be careful, as it seems to be assuming more and more activities rather far removed from passive investment. I am curious about that story re a 1500 man NY office. Doing what?
[...] Was geht in China ab? gedanken von prof. Pettis: http://mpettis.com/2009/08/it%e2%80%…sive-stimulus/ … But it won?t be easy, and I suspect that already the effect of rumors about slowing the [...]
re Chinese GDP accounting
http://www.minyanville.com/articles//8/6/2009/index/a/23918
If I were a Chinese central banker and I wanted to be able to convince people it was business as usual in terms of Chinese GDP I might be interested in calling money dispatched for lending a part of GDP before it was spent. ESP if this would make financial reporting easier as it well might be expected too.
Why I would want to do this I don’t know…
perhaps I should read the article I linked to…lol
Here is what appears to be the source article which is from Soc General.
http://www.sgresearch.socgen.com/publication/DAC91889EC66D615C125760A00284BE5.pdf
OK I’m sorry to be pasting links so lazily but George Robinson wanted some verification of how China’s reported GDP may be distorted and this really is the source I think. Feel free, Michael, to edit my previous comment posts with non-source links.
http://www.aei.org/docLib/08-EO-Aug-2009g.pdf
Rien Huizer,
Yes, and they have already done it this year (In January and February).
Prof Pettis,
I was wondering if you had heard at all about this “permission not to honour commodity derivatives contracts” thing. SCMP’s Tom Holland wrote the monitor about it today and I have seen it somewhere else over the last few days. I remember you saying that any commodity speculation was a “double down” bet…i suppose it is not so dangerous if you just refuse to pay up when you lose!!!
Not sure if anyone else gets this feeling we’re going to see this cycle of bubbles and efforts at reducing these bubbles going in continuous motion in the near future. Frankly, there isn’t any real case for fundamentals being good enough for the kind of market surges that have taken place – the fact that analysts are going on TV to proclaim the end of the crisis and laud fundamentals is making breakfast a messy affair- what with the milk spilling and all. ;p
the liquidity overdrive known to most of us as stimulus/rescue packages have all but turned players into speculators which can only mean a series of bubbles. Ironic isn’t it that the crisis started off with the end of asset bubbles and (at least part of)the intermediate solution leads to bubbles.
If the credit freeze was a heart attack and the stimulus packages emergency medicine, perhaps it is time to consider what the real problem is and look for long term solutions – obviously when you survive the short term, the long term no longer remains a fairytale ;p So rather than play the blame game , looking hard at the real causes of the crisis and aiming policies /measures at those specific areas should be the aim ; after all am pretty sure no one wants to be one of those “less than bright” people (Chinese, American or otherwise) Mr Pettis dreads!
Simon: I looked up the article (above) by the aei.org/doclib/08.
The article is correct in spelling out the details of how China’s largely output based GDP numbers are made, but risks giving the impression that they are part of a “plot to fool the public.
The Chinese data are admittedly pretty bad, but similar techniques are used in many OECD countries. Hence, the UK and Canada produce 3 measures of GDP (output, income and expenditure); the UK produces a compromise GDP measure of the three, while Canada prefers an “output based” measure for statistical reasons (if my memory is correct).
In principle, all three measures should give the same results, but there are big problems in all countries with respect to gauging inventory changes and incomes of those outside the dependent labour force.
The fact that the Chinese measure government spending at the point and time of disbursement probly reflects administrative limitations.
The issue is how reliable are China’s GDP measures? I personally think that the output (level) measures are biased downwards because of poor and outdated sampling; while the expenditures and income data are probably even worse. The growth rates are anybody’s guess.
A few years ago it was widely believed that the GDP numbers were grossly overstated – but subsequent revisions raised the level by over 15%. Hence, the question is how can one assess what is going on in an economy with over 150+ million migrant workers and a rampant “underground economy”? How about beer or electricity consumption? regards James
From the AEI article:
“It is important to
understand that the disbursal of funds is
recorded as GDP growth.”
I had missed this essay.
That suggests confirmation of my casual source.
Thats dot.com and Enron accounting and evaluation and in Western economies has always resulted in a crash. It also almost assures a sub “1″ money multiplier of the stimulus amount.
Here is an off topic, yet on topic article that might be of interest to you Michael………
Early-warning signals for critical transitions
Complex dynamical systems, ranging from ecosystems to financial markets and the climate, can have tipping points at which a sudden shift to a contrasting dynamical regime may occur. Although predicting such critical points before they are reached is extremely difficult, work in different scientific fields is now suggesting the existence of generic early-warning signals that may indicate for a wide class of systems if a critical threshold is approaching.
http://www.nature.com/nature/journal/v461/n7260/abs/nature08227.html
Very interesting post. Looks like the Chinese gov had the stones to do what we should be doing here in the US. Contracting stimulus. Eventually deflation will win out anyway, why not start now. Why push programs intended to add debt to balance sheets? Why can’t we allow deleveraging?
[...] It’s not yet the end of China’s massive stimulus (Pettis) [...]
Chan-lee,
Could not agree more. All we know about macroeconomic data is that whatever is published is rarely useful for policy, and the data used for policy are usually only avaibale with a lag (and difficulty). Then there are sampling and methodological problems, and the more informal or non-cash an economy is the worse tha data.
However the Chinese measure of CDP based on income continues to fascinate me, because of its low and declining employment share. Because of the prevalence of profits in state/state related firms (and the accounting for rural income -an inherently iffy affair in most developing countries and with China’s army of migrant workers whose pay may well be directly or indirectly “non employment”??) The division may be entirely wrong, but still, it is a statistic that is freely available and one would expect a party with a class conflict background to me at least technically careful with such a Dickensian measure. When I was young, the IMF was considered a capitalist tool. This year it took the IMF’s country assessment to criticize this strange development. Sometimes I wonder what the spin doctors in China are trying to achieve. It sould not be too hard to show a slightly less greedy division between the party and the people.
When people interview mr Lou, his minders should help him not making statements that may have difficulty in coming across as intended (the bubbles are making him immortal in a way he may not like) but addressing things like the “fund” method being applied elsewhere in the state finance structure, especially his own CDB backyard and explain the difference between instrumental and autonomous pools of capital and/or control. Of course it is glorious to make money for the whole people, but there has to be some structure and method. This used to be a country run by engineers, not traders.
RodgerRafter, and just think what would happen if inflation were to rise and the PBoC was constrained in its ability to raise interest rates.
Houhui and Rene, I am not sure the CIC has much firepower to support domestic stock prices. I need to check my old notes, but I think there RMB funding has been fully invested and much of their cash consists of dollars, which they cannot easily sell to the PBoC for domestic use. I would guess that the authorities have other, more flexible ways to support the market.
Simon, Makin’s report is a very interesting one but in my conversations with several much smarter people than me it seems that there may or may not be less here than meets the eye. That is not to say that there aren’t big problems with the data, and certainly there are many cases of disbursements being counted as growth before those disbursements have been economically justified, but from what I understand the jury is still out on his main claims about the inflation of GDP numbers by loan disbursements. I will try to dig up more.
[...] was taken by everyone as a pretty clear conformation of what I discussed in last week’s entry – that although there were increasing worries about the cost of the fiscal stimulus package and [...]
Michael,
Right, CIC is a principally a USD animal. It would be cumbersome. Perhaps more psychogically. But Huijin will probably support bank prices (and subscribe to capital raisings if necessary and especially to relieve pressure on the market in the bank stocks.
I’m always trying to figure out how monetary issues work, and I can’t really truthfully say I’ve got it nailed yet, but I have got to the point where the thought of calculating GDP numbers immediately upon making loan disbursements sounds quite hilarious to me.
In the less than rigorous study of economics that I’ve done in my spare time, I have often come across discussions of velocity of money, and also the money multiplier which is a consequence of fractional banking, but I’ve never seen them combined into something like the “General Theory of Money”.
Until recently. I came across an article by Van R. Hoisington and Lacy H. Hunt, Ph.D. about Fed monetary policy and balance sheet expansion as it relates to the current situation in the US, which in nutshell is liquidity trap, and can we fix deflation and does that mean we will we get inflation(or bubbles, or currency crisis, or interest rate spike, since I believe we have more choices nowadays). But the excerpt here is the first time I’ve seen someone come up with an equation that integrates both variables and allows you to solve for GDP if you can figure out what to plug into the variables. I’ve heard velocity of money is pretty easy to get and I’ve seen Fed charts of that one. But money multiplier I believe is a little tougher. Then they both seem subject to possible time lag error.
So here it goes. Maybe this is old news to everyone else.
==================================
Aggregate demand (AD) is planned expenditures for GDP. As defined by the equation of exchange, GDP equals M2 multiplied by the velocity of money (V). M2 equals the monetary base (MB) multiplied by the money multiplier (m). Professors Brunner and Meltzer proved that m is determined by the currency, time, and Treasury deposit ratios, as well as the excess reserve ratio. The money multiplier moves inversely with the currency, Treasury deposit ratios, and excess reserve ratios and positively with the time deposit ratio. For example, if those ratios rise on balance, then m will decline. By algebraic substitution AD(GDP) = MB*V*m. In our present case, the massive increase in the Fed’s balance sheet has created a sharp surge in excess reserves, and thus m has fallen.
===========================================
So is there any chance they can actually know the necessary variables?