This weeks’ entry is fairly miscellaneous, a consequence both of the amount and variety of news coming out of China and my own hectic schedule, which prevents me from dealing with all of these issues in a more unified way.  Between lots of investor meetings and finishing up a number of writing commitments, I am preparing next week to go to New York and Washington for ten days.

As an aside, the timing of my trip was determined by an East Coast tour, centered on New York, which my music label, Maybe Mars, is arranging for some of the best Beijing musicians, including the surreal folk singer Xiao He, one of the most astonishing and creative musicians I have ever worked with.  For those of my regular readers based in or near New York who may be interested in checking out the Beijing new-music scene, I strongly recommend that you keep an eye out for the shows, beginning November 5 and running through the end of the month.  These guys are really good and I expect a great reaction from the New York music community.

But back to more mundane stuff.  Last week’s excellent economic numbers once again reinforced everyone’s existing prejudices.  I discussed why in a September 11 entry in response to similar numbers last month.   Those who believe that the stimulus package has essentially resolved China’s plight and eliminated its vulnerability to export demand saw the 8.9% year-on-year GDP growth rate (at the lower end of a narrow range of expectations) as proof that Chinese growth has solidly recovered.  Andy Rothman at CLSA in a research report released the following day had this interpretation:

Other than GDP coming in just under 9%, no surprises, and we agree with the NBS spokesman, who this morning said ‘the overall situation of the national economy was good.’  We maintain our forecast of about 8% GDP growth for this year, and 8-9% for 2010 (closer to 9% if you expect a US/EU recovery to generate a bit of a net exports boost for China).

He then went on to say something that puzzled me:

The fact that China’s GDP grew by 7.7% in the first nine months of the year while exports were still extremely weak (the trade surplus was US$ 135.5bn, down by US$ 45.5bn YoY) illustrates that the mainland economy is not export-led.  Net exports delivered a -47% contribution to GDP growth in the first three quarters, while final consumption accounted for 52% of growth and investment 95%.

I think almost by definition if the decline in exports had such a terrible impact on the growth rate, China must be heavily export dependent, and it was only the impact of a massive stimulus that permitted such high growth rates – in fact the IMF actually claims that 60% of Chinese growth in the past decade was explained by exports and investment in the tradable goods sector.  China, it seems to me, is heavily export dependent, and it is only the massive, and temporary, impact of the stimulus that keeps growth up.

Infrastructure spending

Although Rothman is considered to be one of the most bullish analysts on China’s medium-term prospects, he hasn’t come close to expressing the cheerleading sentiments of Fareed Zakaria, who seems to have very little doubt or worry about China’s economic trajectory.  In an article in two weeks ago in Newsweek he wrote:

The great surprise of 2009 has been the resilience of the big emerging markets—India, China, Indonesia—whose economies have stayed vibrant. But one country has not just survived but thrived: China. The Chinese economy will grow at 8.5 percent this year, exports have rebounded to where they were in early 2008, foreign-exchange reserves have hit an all-time high of $2.3 trillion, and Beijing’s stimulus package has launched the next great phase of infrastructure building in the country.

Much of this has been driven by remarkably effective government policies. Charles Kaye, CEO of the global private-equity firm Warburg Pincus, lived in Hong Kong for years. After his last trip to China a few months ago he said to me, “All other governments have responded to this crisis defensively, protecting their weak spots. China has used it to move aggressively forward.” It is fair to say that the winner of the global economic crisis is Beijing.

I am not sure China hasn’t done the same thing – protecting its own weak spots – since both the Chinese stimulus and the US stimulus essentially went to exacerbating the sources of each country’s domestic balance, US excess consumption and Chinese excess investment, but at any rate there is a 500-year or longer tradition in the West that when we write about China we are really using a mythical China to write about our own societies.  I think Zakaria’s article may be an example.  He goes on to say:

And look at the nature of China’s stimulus. Most of U.S. government spending is directed at consumption—in the form of subsidies, wages, health benefits, etc. The bulk of China’s stimulus is going toward investment for future growth: infrastructure and new technologies. Having built 21st-century infrastructure for its first-tier cities in the last decade, Beijing will now build similar facilities for the second tier.

China will spend $200 billion on railways in the next two years, much of it for high-speed rail. The Beijing-Shanghai line will cut travel times between those two cities from 10 hours to four. The United States, by contrast, has designated less than $20 billion, to be spread out over more than a dozen projects, thus guaranteeing their failure. It’s not just rail, of course. China will add 44,000 miles of new roads and 100 new airports in the next decade. And then there is shipping, where China has become the global leader. Two out of the world’s three largest ports are Shanghai and Hong Kong.

Although Zakaria’s main point may be to insist that the US is failing sufficiently to upgrade its infrastructure (a point with which I and many other people would heartily agree), the idea that therefore, and in contrast, China’s infrastructure spending is a good idea may be very mistaken.  I think China probably already has the best infrastructure in the world for its level of development, and it is not clear that spending a fortune upgrading it makes economic sense, unless you assume that every country at any low level of development has a near-infinite capacity to upgrade infrastructure.  In that light, there is an interesting article in today’s South China Morning Post on this very subject.

China’s high-speed rail network will overtake Europe as the world’s biggest by 2012, posing a threat to the country’s troubled airline industry.

The cheaper tickets and often quicker journeys to be offered by high-speed trains are expected to substantially cut the market share of domestic carriers that already face bruising competition from airline rivals.  Although still in its infancy, the mainland’s high-speed rail system will account for most of the world’s fast tracks by 2020 as Beijing accelerates a mammoth transport infrastructure programme.

Faster, faster, faster

It is easy to get excited by this building program, but are those high-speed rails, which may be fast, exciting and fun to ride, economically justified?  Even if they were justified in the US or Europe, where the economic value of every hour saved is many times the value in China, they are probably not justified in China.  After all an American might gladly pay $100 a month to cut his daily commuting time by one hour, but for most households in Beijing or Shanghai this would be the equivalent of paying one-third to one-fifth of their income – probably not worth it.  And note that I am not even mentioning one of the sub-stories in this article – that China’s airline industry may be seriously hurt by the high-speed rails even as China is splurging on a massive airport investment program.

So does it matter if we waste a little money?  Of course it does.  Remember that if the total economic benefits are less than the cost of the investment, we can’t simply assume away the difference.  We need to figure out who will pay, and it shouldn’t come as a huge surprise if Chinese households ultimately pay for this waste, as they always have, through all the “normal” channels – sluggish wage growth, very low returns on their savings, indirect taxes on income and consumption, and so on.  If they do pay, not only will this make it very hard for them to sustain the consumption splurge that we are all demanding of them, but it represents a transfer of resources from those that must pay for the railway to those that most often use it – all Chinese must pay for benefits that accrue mostly to the wealthier segments of China’s wealthiest cities.

This is a large part why many analysts are not impressed by China’s investment-driven growth.  Not only is much of it explicitly aimed at increasing production, much of the rest of it is implicitly likely to reduce consumption.  Those of us with a pessimistic outlook of course read last week’s data release differently than do those who see the numbers as evidence that the stimulus is “working”.  For example in my last two posts I discuss the risks of inventory build-up, and the increasing sense I am getting that a lot of what I expected to show up as inventory build-up may be happening outside corporate balance sheets.  In that light reader Pangea Joel left a comment on my last post that alerted me to this very interesting and very apposite article on Bloomberg:

Private investors in China, the world’s largest metals user, have stockpiled “substantial” quantities of copper as the government ramps up stimulus spending to spur the economy, according to Sucden Financial Ltd.  Pig farmers and other speculators may have amassed more than 50,000 metric tons, Jeremy Goldwyn, who oversees business development in Asia for London-based Sucden, wrote in an e- mailed report after a visit to China. That’s about half the level of inventories tallied by the Shanghai Futures Exchange, which stood last week at a two-year high of 97,396 tons.

Sucden’s estimate underscores the difficulty analysts face in gauging metals demand in China amid increased speculation by retail investors, whose holdings remain outside the reporting framework undertaken by exchanges. Private investors in China also had as much as 20,000 tons of nickel, Goldwyn wrote.  “People who have nothing at all to do with the copper trade have been buying copper as a store of value, much like they would with gold,” said Jiang Mingjun, an analyst at Shanghai Oriental Futures Co.

…“Private stockpiles, built by many including the much- vaunted, pig-farming speculators, have clearly absorbed substantial quantities of metal,” Sucden’s Goldwyn said. “Much of this metal will remain out of the normal market place.”  Scotia Capital Inc. analyst Liu Na highlighted the role of Chinese pig farmers and other private speculators in the metals markets in an Aug. 17 note that cited reports from state-owned China Central Television. These speculators may become “quick sellers” if sentiment turned, Liu said in that note.

To be sure, Sucden’s Goldwyn wrote that the stockpiles of copper and nickel held by farmers and others in China may “not be ‘dumped’ back in the foreseeable future as some have recently suggested, wherever prices go.” Goldwyn didn’t give a reason.  The metals holdings by pig-farmer investors and other private speculators give “the impression that there is strong demand in China,” said Jiang at Shanghai Oriental. “But it is actually those who take a pessimistic view of the economy and are looking to preserve their wealth who are buying.”

Caution at the banks

This is something that we are all going to have to keep an eye on – an awful lot of investment has become inventory accumulation and speculative stock-piling, and this automatically increase volatility since in any downturn de-stocking exacerbates the slowdown.  Meanwhile it is not as if analysts inside China are as bubbly as those outside China.  Last week one of China’s most senior bankers gave pretty strong warnings about the impact of excessive credit expansion.  According to an article in last week’s Financial Times:

China needs an “urgent” tightening of monetary policy to prevent the huge stimulus measures introduced this year from inflating stock and property bubbles, one of the country’s leading bankers has warned.  Qin Xiao – chairman of China Merchants Bank, the country’s sixth-biggest – says in Thursday’s Financial Times that the government should not be afraid of a “moderate slowdown” in the economy.

“Monetary policy must not neglect asset-price movements,” he writes. “Therefore it is urgent that China shifts from a loose monetary policy stance to a neutral one.”  Mr Qin’s unusually frank warning comes ahead of the publication on Thursday of third-quarter gross domestic product figures that are expected to underline the rapid recovery in China’s economy, with analysts forecasting growth of nearly 9 per cent compared to last year.

This was followed by a statement by Liu Mingkang, chairman of the China Banking Regulatory Commission.  Here is Bloomberg’s take on a statement he delivered last week on the CBRC’s website:

China urged its banks to lend “reasonably” this quarter, after a surge in credit increased risks in the nation’s banking system.  The China Banking Regulatory Commission will closely monitor the impact of global capital flows and domestic policy adjustments on liquidity in the banking system, Chairman Liu Mingkang said in a statement on the regulator’s Web site today. The CBRC will ensure that “ample liquidity is always maintained,” he said.

…Commercial lenders’ bad-loan ratio dropped by 0.76 percentage point from end of last year to 1.66 percent as of Sept. 30, as non-performing loans declined by 55.8 billion yuan to 504.5 billion yuan, Liu said today. The decline masks growing risks in banks’ loan books, he said.  “Behind the ‘double-dip’ in non-performing loan data, credit risks under the rapid lending growth are accumulating,” Liu told a CBRC meeting in Beijing. The risks “need high attention and should be effectively dissolved.”

While I am on the subject, on Saturday I was discussing with Logan Wright, who co-teaches the PBoC Shadow Committee seminar I run at Peking University, the loan numbers for September.  Net new lending last month was RMB 517 billion, which when corrected for the RMB 352 billion reduction in discounted bills and a RMB 211 billion increase in short-term loans represented a very strong increase of medium- and long-term lending of RMB 657 billion.

Logan told me that of the new lending number, the Big Four banks and the largest national banks only accounted for around RMB 125 billion (RMB 110 billion and RMB 15 billion respectively).  They also accounted for most of the run-off in discounted bills.

This means that most of the new lending, especially the net increase in risk, took place elsewhere.  Where?  Mostly, it seems, in the smaller city banks and cooperatives.  Since these are the banks most directly under the control of the city and local governments, it seems that these are at the forefront of the fiscal and credit expansion – in line with some of the other stories I have been relaying about the difficulty local governments have been having in financing their share of the fiscal expansion.

College blues

I am just guessing, of course, but I wonder if in the next few years as the growth benefits of the fiscal stimulus package wears out we might not see a rapid consolidation in the banking industry as the healthier (less sickly?) large banks are “encouraged” to absorb the smaller banks, struggling with the legacies of the loan boom.  I think there is already some sense of that process occurring among the leadership, although in general I don’t get the impression that anyone in a senior position has a clear sense of what China’s exit strategy is likely to be.  In fact the impression I get is that leaders are basically responding to day-to-day changes without any clear sense of what is likely to happen next.  That is not necessarily a bad thing, of course, but I suggest that foreign analysts who speak feverishly of a great master plan to protect China from the consequences of the crisis may be a little overexcited.

Thee final points.  First, there was an interesting article last week in Asia Times on rising graduate unemployment which, as regular readers know, was a problem even before the crisis hit and which is becoming more serious:

An explosive report released by the Chinese Academy of Social Sciences (CASS) in September said earnings of graduates were now at par and even lower than those of migrant laborers. The news came as a blow to many high-aspiring parents and youngsters in a country that has for centuries prided itself on cultivating elite Confucian intelligentsia.

Some 6.1 million graduates entered the job market this summer, 540,000 more than last year. In 2008 the employment rate for graduates was less than 70%. This year nearly two million of graduates, many of them postgraduate diploma holders, are expected to be left without job placements.

University education is one of the most widely-accepted, and only, forms of upward social mobility in China, so it is a worrying thing that the benefits of college education are seriously undermined.

Second, currency intervention is back in the news, but this time among Asian countries worried about intra-regional currency fluctuations.  Although the biggest story is the decline in trade deficits and the impact that must have on the aggregate of trade surpluses, an almost-equally important story must be the maneuvering among trade surplus countries to increase or protect their share of the trade deficits.  This maneuvering necessarily includes rival currency-management strategies.  Here is the Financial Times on the subject:

China, Japan and other east Asian countries must have “serious” talks on currency co-operation to prevent a recurrence of violent fluctuations that have raised trade tensions in the region, said the president of the Asian Development Bank on Sunday. Haruhiko Kuroda said currency movements threatened the growth of trade between Asian countries, widely regarded as a key way of reducing the region’s reliance on exports to the US and Europe.

…The yen has strengthened to near-record levels against the US dollar since the beginning of the global financial crisis. Many other Asian currencies initially depreciated against the dollar and yen but later strengthened against the weakening dollar and the renminbi.  Traders say Thailand, Malaysia and Singapore are among east Asian countries that have intervened in currency markets recently to try to slow the appreciation of their currencies.

And third, I spend a lot of time talking to large hedge funds and institutional investors – with at least three or four one-on-one meetings a week – on China and market conditions.  It worries me that recently I have heard investors say many times, generally very sophisticated investors, that we are clearly in a bubble and the best strategy is to ride it out as long as we can.  This has almost become one of the mantras of sophisticated investors – the less sophisticated, I guess, assuming that the crisis is safely behind us.

It worries me because of course we can’t all collectively ride the bubble and bail out before everyone else does.  I wonder if this means that an awful lot of the big funds can be expected to rush to the doors at the same time when things turn bleak.  If so, of course, that means we are likely to see both the upside and the downside market risks increase.  Several of my fund management friends have insisted the problem has to do with the nature of hedge fund compensation.  Most of the hedge funds were hurt pretty badly in the financial crisis, but a very large number of them were very pleasantly surprised by how quickly they’ve been able to make back a substantial share of their losses.

This means that recovering the high-water mark, which many thought would take years, has suddenly become a lot easier, and many expect that if the markets go on as they have been doing for another year or so they’ll be back in business (that is, able to charge performance fees once again).  This may create a natural, albeit dangerous, incentive to take big risks on the likelihood of a rapid recovery.

The release of September trade data earlier this week was pretty interesting, although because of two or three extra working days last month, plus the very big holiday at the beginning of October which might have pushed activity into September, some of the comparisons are misleading.  Exports were down 15.2% year-on-year, better than the expected 20-21%.  Imports were down 3.5%, much better than the expected 15%.  Month-on-month figures showed a rise in both imports and exports.

So much ink has been spilled in discussing these numbers that I won’t try to summarize, but it is worth noting that for many analysts the numbers were a very positive surprise.  Typical was this Reuters report reprinted in the New York Times:

China reported surprisingly strong trade figures on Wednesday, providing fresh evidence that the world’s third-largest economy is firmly on the path to recovery and that global demand is improving too.

…Brian Jackson, an economist at Royal Bank of Canada in Hong Kong, said the slower pace of decline was good news for China’s recovery because growth this year has depended too much on the government’s 4 trillion yuan ($585 billion) stimulus package.

But even in this article there were hints that the numbers, especially the import numbers, might not be as positive as expected.

Commodities were a driving force behind the sharp improvement in imports. China bought a record 64.55 million tons of iron ore in September, up 30 percent from August; imports of copper rose 23 percent.

Merrill Lynch’s October 14 research report puts it this way:  “Commodity import growth was stunning.”  Andrew Batson in an article in today’s Wall Street Journal explains why the high commodity share of imports might not be as positive an indicator of surging demand as the headline numbers suggest:

A pickup in China’s metal imports in September is stoking debate about how much of the nation’s commodity intake this year is driven by demand and how much is stockpiling that will soon end.

…The trade figures issued Wednesday showed China’s imports of copper rebounding from July and August slowdowns to post a 87% rise from a year earlier. Iron-ore imports also hit a monthly record, at 64.55 million tons in September, up 65% from a year earlier. The gains in imports defied many forecasts that purchases would slow after China took advantage of low prices early this year to build up stocks of many commodities. The data could be a signal that underlying demand for raw materials is stronger than first thought.

I read the data differently – not so much as evidence that demand is stronger then we thought but rather that real imports are weaker than we thought.  According to the October 14 research report by Mark Williams, of Capital Economics, “We do not expect the trend to last. China’s recovery is being driven by investment, but the recent pace of commodity import growth has been much faster than justified by the rise in current demand.  Inventories of many metals have more than doubled since the start of the year (copper inventories are up 500%).”

I think I agree with Mark.  I already discussed in last week’s entry the recent conversations I have had with chemical and steel analysts and investors who were puzzled by their inability to match China’s imports with any reasonable estimate of the end use of these products.  One place where we might see the discrepancy is in a rise in inventories, but although these have been rising, they haven’t been rising fast enough to account for the differences.

Are investors stockpiling?

It seems that there may be another explanation, and that is stockpiling by private investors.  From what I am being told, it seems that a number of wealthy Chinese investors have been speculating directly in commodities, and so some of this inventory buildup is occurring not at the company level but at the investor level.  The Wall Street Journal article mentions this possibility:

Copper stockpiles also have increased. Royal Bank of Scotland analysts estimate that as much as 900,000 metric tons of unreported copper stocks have built up in China this year. There has been some official purchasing by the State Reserves Bureau, but also a lot of private traders buying imported copper because it could be resold for a higher price domestically.

I have no information about how these positions might be financed, if this is true, but I would worry if they were debt financed, and I would worry even more if corporations were financing them indirectly by lending to principles.  Shang Ning, the very smart secretary of the PBoC Shadow Committee seminar I run at Peking University, has been trying to figure out ways of indirectly measuring this kind of stockpiling, but frankly we don’t as of yet have any very good ideas.

Clearly a lot of policymakers are worried about excess commodity stockpiles.  Earlier this week Bloomberg reported on plans to curb steel production.

China, the world’s largest steel producer, is working on plans to curb excess capacity as the nation faces “severe oversupply,” according to the nation’s third-largest mill.  The government may have detailed plans on how to close obsolete mills, advance mergers and reduce the number of iron ore importers by the end of the year, Deng Qilin, the general manager of Wuhan Iron & Steel Group, said in an interview.

…“The government will impose strict measures to effectively close outdated mills and boost consolidation,” Deng, also the chairman of the China Iron and Steel Association, said while attending the World Steel Association annual meeting in Beijing yesterday. “We bigger players will surely benefit from such a move.”

There is more than just steel.  An article in yesterday’s Xinhua reports the following:

The National Development and Reform Commission (NDRC) will mainly redress production overcapacity in six sectors, said Chen Bin, director of the Department of Industry of the NDRC, Thursday.  The six sectors include steel, cement, plate glass, coal-chemical industry, polycrystalline silicon and windpower equipment.

The NDRC also warns of obvious production overcapacity in sectors like electrolytic aluminum, ship manufacturing and soybean oil extraction, said Chen during an on-line interview on www.gov.cn., the website of China’s central government.  He said China would fight serious overcapacity in sectors like steel industry and offer guidance for new-born industries like windpower equipment to avoid low level repetitive construction.

China has achieved preliminary progresses in fighting the global economic downturn, but the foundation for economic recovery is not stable yet and overcapacity might lead to bankruptcy, unemployment and bad bank loans if it was not checked in time, he said.

Industrial policies create overcapacity

I agree with the last paragraph, but otherwise I am pretty skeptical about the fight against overcapacity.  According to my model of China’s overcapacity problem, the source of the imbalance is a set of industrial policies that systematically shift income from households to producers, and as long as these policies continue there is little chance of resolving the problem of excess production.  I have a longish piece coming out next month as a Carnegie Brief on the Carnegie Endowment website, in which I discuss this as part of a discussion about why I expect a rising US savings rate to lead almost inexorably to trade tensions.  Here is the relevant section from the first draft:

Although China is still a very poor country, there is no question that Chinese household income has grown substantially over the past few decades, but it has not grown nearly as quickly as GDP.  While China’s GDP grew at 11-12% over the 2002-2007 period, for example, MIT economist Yasheng Huang estimates that household income grew at a much lower 9%.  If we were able to adjust Huang’s measure to take into account changes in other forms of household wealth – which are described below – growth in household income would have been even lower.  This is why consumption has declined as a share of national income, and why China’s total production has exceeded its total consumption by a large and growing amount.  This is at the root of China’s high savings rate.

Why haven’t Chinese households maintained their share of national income?  Largely because the rise in household income was constrained, especially in the last decade, by industrial polices which were aimed at turbo-charging economic growth.  These policies systematically forced households implicitly and explicitly to subsidize otherwise-unprofitable investment in infrastructure and manufacturing.  Although these policies powered employment and manufacturing growth, they also led to wide and divergent growth rates between production and consumption.  These policies included:

• • An undervalued currency, which reduces real household wages by raising the cost of imports while subsidizing producers in the tradable goods sector.
  • Excessively low interest rates, which force households, who are mostly depositors, to subsidize the borrowing costs of borrowers, who are mostly manufacturers and include very few households, service industry companies or other net consumers.
  • A large spread between the deposit rate and the lending rate, which forces households to pay for the recapitalization of banks suffering from non-performing loans made to large manufacturers and state-owned enterprises.
  • Sluggish wage growth, perhaps caused in part by restrictions on the ability of workers to organize, which directly subsidizes employers at the cost of households.
  • Unraveling social safety nets and weak environmental restrictions, which effectively allow corporations to pass on the social cost to workers and households.
  • Other direct manufacturing subsidies, including controlled land and energy prices, which are also indirectly paid for by households

By transferring wealth from households to boost the profitability of producers, China’s ability to grow consumption in line with growth in the nation’s GDP was severely hampered.  Of course the gap between production and consumption is the savings rate, and as production surged relative to consumption, a necessary corollary was a rising Chinese savings rate.

The basic problem, then, is that there are very powerful policies that force a discrepancy in production and consumption growth, and the only way to eliminate overcapacity is by reversing these policies.  I am not sure that attempting to address overcapacity by administrative means can succeed, and certainly the track record of other efforts over the past year to address the imbalance doesn’t suggest otherwise.

The trade impact

In the steel sector here is one consequence of the continued surge in production, according to an article in this week’s Financial Times:

The unexpectedly swift recovery in China’s steel production has sparked fears that a glut of exports could puncture steel prices as the global industry struggles to emerge from the economic downturn, rival steelmakers have warned.  SK Roongta, chairman of the Steel Authority of India Ltd (Sail), said Chinese over-production was “a point of concern” for the world’s steel producers.

During the past year, producer margins have come under severe strain from falls in prices and high input costs. Global output fell more than 20 per cent in the first half of 2009.  The head of India’s largest state-owned steel group said that Chinese production accelerated 15 per cent in the past quarter, beating forecasts of just reaching double-digit growth.

“We believed that China would grow, but the growth in the past three to four months has certainly been a surprise. I’m not sure this level can be sustained,” he said.  “The magnitude of the growth is a surprise; not the growth per se.”

Meanwhile on Tuesday in the New York Times the always-perceptive David Barboza spells out very explicitly the implications in a much-discussed article titled “In Recession, China Solidifies its Lead in Global Trade”:

With the global recession making consumers and businesses more price-conscious, China is grabbing market share from its export competitors, solidifying a dominance in world trade that many economists say could last long after any economic recovery.

…China is winning a larger piece of a shrinking pie. Although world trade declined this year because of the recession, consumers are demanding lower-priced goods and Beijing, determined to keep its export machine humming, is finding a way to deliver.  The country’s factories are aggressively reducing prices — allowing China to gain ground in old markets and make inroads in new ones.

There are lots of reasons given for why China is able to increase its market share so dramatically, but there is little doubt in my mind that this process will cause rancor and increasing hostility, especially among trade competitors, and the focus will be on policies that continue to subsidize manufacturers.  Barboza goes on to say:

One reason is the ability of Chinese manufacturers to quickly slash prices by reducing wages and other costs in production zones that often rely on migrant workers.  Factory managers here say American buyers are demanding they do just that.

…Because China produces a diversified portfolio of low-priced and essential items, analysts say the country’s exports can hold up relatively well in a recession.  Few other countries can match what has come to be called the “China Price.”

“China has a huge advantage,” says Nicholas R. Lardy, an economist at the Peterson Institute for International Economics in Washington. “They can adjust to market changes very rapidly. They have flexibility in their labor markets. And as consumers trade down the quality ladder, China can benefit.”

The expiration of textile quotas in large parts of the world this year has also allowed China to increase its market penetration.  But equally important are government policies that support this country’s export sector — from Beijing keeping its currency weak against the dollar to its determination to subsidize exporters through tax credits and billions of dollars in low-interest loans from state-run banks.

Although the “wage flexibility” enjoyed by Chinese corporations may seem like a huge advantage, remember my earlier comments about how sluggish household income growth relative to GDP growth is the source of the overcapacity problem (consumption is likely to grow as fast as household income grows).  If I am right, it means that measures that can improve China’s export competitiveness are not good for the rebalancing effort if they exacerbate, rather than reverse, the process of transferring income from households to corporations.  Lower wages, of course, do just that, and so they cannot be a solution to China’s underlying overcapacity problem except to the extent that they allow China to expel trade competitors.  This is not a permanent solution by any means, especially in a world of rising trade tensions.

New loans still soaring

There are two pieces of related recent news.  The first, released on the same date as the trade data, was the PBoC announcement of new loans for the month of September.  According to an article Wednesday in Xinhua:

China’s new yuan-denominated loans in September rose to 516.7 billion yuan (75.68 billion U.S. dollars) from August’s 410.4 billion yuan, the People’s Bank of China, the central bank, said Wednesday.   New yuan-denominated loans in the first nine months stood at 8.67 trillion yuan, 5.19 trillion yuan more than the same period last year.

China’s foreign exchange reserve hit a new high of 2.2726 trillion U.S. dollars at the end of September, according to the central bank.  China’s monthly new loans had slowed from June’s high of 1.53 trillion yuan to 355.9 billion yuan in July as a result of bank contracting credit and the central bank’s open market operations. The figure rose to 410.4 billion yuan in August and then to September’s 516.7 billion yuan.

The broad measure of money supply, M2, which covers cash in circulation and all deposits, was up 29.31 percent from a year earlier to 58.54 trillion yuan at the end of September.   The narrow measure of money supply, M1 (cash in circulation plus current corporate deposits), was up 29.51 percent to 20.17 trillion yuan.

I think most people were surprised by the September net new loan number, expecting something in the RMB 450 billion range (last September total new lending was RMB 378 billion).  Although the current new lending of RMB 517 billion  is much lower than the astonishing RMB 963 billion monthly average this year, when you include the net paydown of bill financing in September of RMB 353 billion, the total new medium and long-term financing in September was actually RMB 870 billion.  This suggests that in fact September lending was equal to this year’s monthly average (especially if you think of the explosion in bill financing early this year as a form of “anticipated” lending).

Regular readers of my blog will know that I have no doubt that this kind of loan expansion can only make the overcapacity problem worse, since either it directly boosts current or future production, or, by leading to a rise in NPLs that will ultimately be paid for by Chinese households, it constrains future consumption growth. Interestingly enough, according to an analysis in Caijing, the share of new loans from the Big 4 was only 21%.  This is down substantially from 40% in August, 47% in July, and a whopping 70% in the first six months of 2009.

What gives?  For one thing, it means that most of the decline in lending from the insane levels of the first half of the year is explained by the decline in lending among the Big 4.   It is not so much that new lending is being pushed downward, since the smaller banks are increasing their lending at roughly the same rate as they have all year.

Chen Shanshan, an analyst at Bocom International Holdings, said large commercial banks scaled their lending after regulators tightened credit controls at the start of the third quarter.  Also, medium-sized banks saw their lending capabilities restrained by the tighter regulatory controls on capital requirements, he said.

“Banks are now actively selling loans,” and mostly selling them packaged as syndicated loans, an executive with a large commercial bank told Caijing.

I am not sure from this whether they are selling down to other banks or to investor groups.  Any color from any of my readers would be much appreciated.  As an aside on the reserve numbers, I haven’t done the numbers yet, and I have not had a chance to discuss this with Medley’s Logan Wright, but my initial back-of-the-envelope calculation suggests that hot money inflows may have moderated but are still positive.

The second piece of related news was the release yesterday by the US Treasury Department of its semi-annual report on exchange rate policies.  “Both the rigidity of the renminbi and the reacceleration of reserve accumulation are serious concerns which should be corrected to help ensure a stronger, more balanced global economy consistent with the G-20 framework,” the report said. “The Treasury remains of the view that the renminbi is undervalued.”

While the People’s Daily headline today was “U.S. says China not currency manipulator”, and most of the focus of the article was positive (although it did acknowledge that “it also alleged that the Chinese currency renminbi’s exchange rate showed a ‘lack of flexibility’ in recent period”), the Financial Times article was a little more nuanced:

The Obama administration said on Thursday that it had “serious concerns” about the value of the renminbi, but stopped short of accusing China of manipulating its currency in a closely watched report to Congress.

The Treasury toughened its language on China in its semi-annual report on exchange rate policies. While acknowledging that Beijing had been important in steadying the global economy, it said recent moves to accumulate more foreign exchange reserves “risk unwinding some of the progress made in reducing imbalances”.

But the Treasury did not say China was manipulating its currency, in spite of pressure from US labour groups and scores of legislators who argue that the undervalued renminbi makes China’s exports unfairly cheap . Pressure has built this year as manufacturers suffer huge job losses and the US unemployment rate creeps towards 10 per cent .

I am willing to bet that over the next year or two the language gets tougher, not easier.

Finally, I saw the following very interesting article on today’s Bloomberg:

China’s Ministry of Finance is, for the first time, allowing local governments to use the proceeds of land sales to fund stimulus projects, the China Daily reported, citing a ministry circular.  Local governments are required by the end of this month to have provided 1.18 trillion yuan ($173 billion) out of the 4 trillion yuan stimulus plan announced by Premier Wen Jiabao in November, the English-language paper said. Many local governments are finding it difficult to secure funds for projects because of the economic slowdown, the newspaper said.

Regular readers of my blog will have noted all sorts of unfortunate goings on here in recent days.  It has become impossible to get into the comments section, or indeed into any other section of my blog except the front page, and so to my great dismay the excellent discussions that have been so useful for me have been temporarily halted.  I am not sure why this is the case, and now that school has started again I hope to get one of my terribly smart Peking University students to find out and fix it.  

Actually in recent months a large number of China scholars who I know – and me too – seem to have been targeted by very specific viruses, with emails and attachments cleverly disguised to look like something we would want to read from someone we would trust.  I am not smart enough to know what those viruses do, but I have been warned that they probably allow someone access into my computers.  

Perhaps for the same reason my own blog has been hacked in some way, but it seems to me that if anyone really wanted to close me down they would have closed down the blog altogether and not just the comments section, so unless there is a commenter that regularly raises the ire of some censor out there, I suspect the problem has more to do with my blog site than with any malicious intent.  Of course if my blog suddenly begins posting pornographic pictures, spewing venom, or otherwise does some unexpected and obnoxious things, please know that it was probably not me who came up with the idea.

I have also had a lot of trouble getting my regular proxies that allow me to jump the great firewall and post onto my blog.  That is why my posting has slowed a bit, but it seems that yesterday and today the anti-proxy regiments have been at least temporarily defeated.

That’s good, because of course today the National Bureau of Statistics has released a whole lot of data.  A European TV station asked me to comment on the import of the data, and while I hate to make too much of a few data points, I was able to say rather glibly that the data pretty much confirmed the hopes of the optimists as well as the fears of the pessimists.  

I will explain why I think this below, but I should note that most analysts were pleased with the results, and the stock market surged on the news.  The SSE Composite was up 2.2% today.  Surprisingly it was down 0.7% yesterday, suggesting that there was probably no information leakage.  Things seem to be improving on that front.

To summarize the data released today, manufacturing output was up by 12.3% year on year, better than last month’s 10.8% and higher than consensus, although I think last August, during the Olympics, a lot of factories were closed so that this number may not be as impressive as it seems.  Steel output was up 29% and auto production was up 90%, which as my friend Mark Williams at Capital Economics points out is not likely to soothe worries about overcapacity creation.

Urban fixed-asset investment was up 33.0% for the first eight months of the year, which slightly exceeded already-high estimates of 32.5%.  This suggests that it is still investment that is in the driver’s seat, as far as growth is concerned. 

This might not be as obvious as all that.  A lot of people were excited that retail sales climbed 15.4%, slightly higher than consensus and the highest growth rate all year after seasonal factors are stripped out, but remember that retail sales are not a very good proxy for consumption growth.  Also remember that this surge in liquidity can easily cause consumption to rise in a temporary way without indicating anything structural about changing consumption and saving patterns in China.  In 1988-89 consumption in Japan also surged, probably as a consequence of the investment boom, but it was unable to survive, if I remember correctly, the contraction in that boom in the 1990s.

The most interesting piece of information is that net new lending for the month was RMB 410 billion, less than half the monthly average this year (RMB 1,105 billion).  This seems small given the huge numbers we’ve seen but, as I pointed out two weeks ago, last August new lending was around RMB 272 billion, and if you strip out the bills coming due the real increase in medium- and long-term lending is closer to RMB 550-600 billion.  More importantly, RMB 410 billion is a lot more than the rumors of RMB 300 billion that had panicked the market last week. 

The one piece of news that everyone read as negative was the trade data.  Exports were down 23.4% and imports down 17.0%, both substantially worse than expected, although leaving the trade surplus at a still-hefty $15.7 billion, which is roughly average for the year. 

For the optimists, the economic numbers, with the exception of the trade data, were all positive and suggest that China is on track to recovery.  For them, the great risk to China was that the global contraction in demand would result in terrible damage to China’s export industry and, with it, would cause factory closings and soaring unemployment.  Rising unemployment would lead to a collapse in consumption, and of course would not make China’s transition easier

The main purpose of the stimulus package, in this view, was to forestall an economic contraction and with it the possibility that the economy would fall into an ugly process in which rising unemployment would cause a contraction in Chinese consumption which, when added to the contraction in foreign demand for Chinese exports, would push the economy into a tailspin.  In that sense the stimulus has proven to be a great success.  Chinese growth has slowed, but by a lot less than expected, and unemployment seems to be manageable.  The August data points pretty solidly to continued growth.

And yet, and yet….

For pessimists like me the global contraction underscored Chinese vulnerability to out-of-control US consumption, and the need to develop a more balanced approach in which Chinese consumers take a larger share of China’s production.  This vulnerability existed in large part because China was overly reliant on investment for its growth.  China has had probably the highest investment rate ever recorded for a large economy, and for years there has been widespread concern that much of this investment was misallocated. 

It is only because the cost of capital is artificially so low (thanks to Chinese households, who are forced to earn a miniscule return on their savings) that many companies are able to show profits at all.  A few months ago I wrote about an HKMA paper that suggested that the implicit interest-rate subsidy to SOEs – not relative to the “right” interest rate in China (whatever that may be but which is certainly many percentage points higher than the official lending rates) but relative to the borrowing cost of large Chinese private corporations – accounted for 100% of SOE profitability.  If China had reasonable interest rates, in other words, (and in fact there were negative real rates for much of the recent past), SOEs would on average be value destroyers.

This, by the way, is why China’s supposedly puzzling addiction to capital-intensive growth rather than labor-intensive growth – more befitting to an economy with lots of unskilled labor and very poor technology – is not so puzzling.  If you artificially lower the price of a particular input, it is not surprising that producers will use more of that input than might otherwise be considered optimal.  With capital practically free, capital is everyone’s favorite input in spite of incredibly low labor costs.

With the recent surge in government financed investment (and I include most bank lending in this category), it would be surprising to me if much of this year’s new investment were not of even lower quality than the older investment, with very low or even negative expected returns.  If this turns out to be true, it means that the only way these investments could be viable is by effectively continuing to “tax” Chinese households to subsidize state-owned enterprises and large manufacturers.  This tax of course will come mainly in the form of low wage growth and extremely low deposit rates on the savings of Chinese households.

This is why we all hope Chinese growth will become more reliant on rising consumption rather than on rising investment, much of which is certain to be unprofitable.  The current path requires a large trade surplus to absorb the difference between what China consumes and what it produces, but it is not clear that foreign consumers will absorb the balance.  China is trying to plug the gap by a surge in government-financed investment, but this is likely only to widen the gap in the future. 

So the August data suggests that while China is growing, it is actually more reliant, not less reliant, on investment.  What is worse the very poor import numbers suggest that in spite of high retail growth figures, consumption growth in China is still sluggish.

For the pessimists, then, the August numbers confirm that the stimulus package may be boosting production solely because of government-financed investment, and that a serious misallocation problem will result in more future pressure on Chinese households to foot the bill.  The export numbers show that China’s external accounts continue to deteriorate, and it will take more than simply an end to the global crisis to return to the good old days.

So who is right, the optimists or the pessimists? 

In fact both are right.  If the purpose of the stimulus package was solely to protect China from the immediate employment impact of the global contraction in demand, it has been an almost unqualified success.

But if at least part of the goal was to help China shift its unbalanced growth model to one less reliant on foreign, and especially American, consumers, it is not clear that any progress has been made.  In fact to the extent that a significant share of new investment has been wasted, it may actually make future imbalances worse.

China’s response to the global crisis needs to be seen as a two-part process.  The first part is to goose economic growth in response to the rapid deterioration in the external environment.  The second part is to rebalance the economy away from its excess reliance on investment and foreign demand.  The August data seem to confirm that China is very successfully managing the first part.  Whether it has made any progress on the second part is still very much open to question.

The Shanghai and Shenzhen stock markets are still hogging the spotlight.  Although down 18.0% from its recent peak exactly one month ago, the past three days have been good for Chinese stock market investors.  After rising 0.60% on Tuesday and 1.17% on Wednesday, the SSE composite was up a very smart 4.79% today. 

So what happened?  Better-than-expected earnings from Chinese corporations?  A surge in US household income and a decline in US unemployment boosting the prospects for China’s tradable goods sector?  A huge new loan number for the month of August?

Actually, none of the above.  In fact the US numbers look especially bleak for China.  In spite of some seemingly good news on the macroeconomic side, unemployment in the US is still rising, and even that masks the depth of the problem.  Many Americans who have lost jobs have since then found new jobs, but at lower pay, so that although they don’t show up adversely in the unemployment data, they nonetheless represent lower income to workers as certainly as rising unemployment does, and this will have an impact on future private consumption.

Societe Generale’s ever bearish Albert Edwards had an excellent piece on the subject on August 6, in which he argues that: 

US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June. 

If US household income is declining so sharply, we can’t really expect a sharp pick-up in imports, even ignoring the fact that households are also in the process of deleveraging, and so cutting back even more sharply on consumption that their incomes might indicate.  But in spite of still-bad news in both the external or internal environments, the markets are nonetheless in a much better mood than they were just a few days ago.  Why?  The People’s Daily explains: 

Chinese equities climbed Wednesday after the country’s securities regulator said it would take measures to promote the steady and healthy development of the market.

Or, if you prefer Bloomberg’s slightly more forthright explanation:

China’s stocks rose the most in two weeks on speculation regulators will adopt measures to boost the nation’s equities following declines in the past month.

The main cause of the surge seems to be a statement made Liu Xinhua, vice chairman of the China Securities Regulatory Commission, at a forum in Beijing yesterday which was proclaimed on the front pages today of China’s two biggest financial newspapers, the China Securities Journal and the Shanghai Securities News.  Mr. Liu promised that regulators will promote a “stable and healthy” market.  This has been interpreted to mean that the authorities will not let the market continue falling, and will introduce measures to force it up.

Bloomberg continues, with something that is widely acknowledged but wasn’t covered in the People’s Daily article:

The government may take measures to stabilize the market before the 60th anniversary of the founding of the People’s Republic of China on Oct. 1, the start of a weeklong holiday. “They want everything to be stable and in harmony,” said Francis Lun, general manager of Fulbright Securities Ltd., in an interview with Bloomberg Television today. “They will approve more stock market funds and allow them to buy into the market.”

There is a general sense that no one wants the markets to misbehave before the all-important October 1 celebration of the sixtieth anniversary of the birth of the People’s Republic.  Needless to say this begs the question about when exactly should you, as an investor, get out of the market?  The day before?  But if everyone knows that, then shouldn’t you get out two days before, or maybe three, since everyone has presumably figured that one out too?

In 2006, 2007 and 2008 I wrote often about the dangers of this sort of market signaling.  There may be perfectly good reasons to want to manipulate the markets with non-fundamental information, but every time this happens it further undermines the development of a healthy capital market that allocates capital based on economic prospects by undermining the value of fundamental information and reinforcing the value of speculation on government intentions.  Still, on such an important anniversary I suppose it was totally unrealistic to think that the authorities would let angry investors spoil the party.

The stock markets may have also taken some heart from a good, although sobering, speech from Premier Wen when he met with World Bank President Robert Zoellick earlier this week.  According to an article in Xinhua, Premier Wen said that

China’s government would continue to pursue proactive fiscal and moderately easy monetary policies.  ”We will not change the orientation of our policy,” Wen said.

Wen said China would fully implement and continue to enhance and perfect policy in response to the international financial crisis to achieve the goals of economic and social development.

This 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 the lack of an “exit strategy,” in the end the State Council and the policy leadership were still more worried about a sharp slowdown in growth than about the risks of excessive investment:

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.

A recent report by CLSA also says that the PBOC apparently believes that one of the causes of the lost decades of Japanese growth was premature tightening in the late 1990s which “killed the momentum of economic recovery when it was only in the budding state,” and so the PBoC has cautioned against doing the same in China.  It is better to be too loose than too tight. 

Although I think perhaps the right comparison is not with Japan in the later 1990s but rather with Japan in the late 1980s, this “lesson” was reinforced by another, according to the same report:

Beijing seems to agree with Ben Bernanke that “The correct interpretation of the 1920s, then, is not the popular one–that the stock market got overvalued, crashed, and caused a Great Depression.  The true story is that monetary policy tried overzealously to stop the rise in stock prices.  But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy – both domestically and, through the workings of the gold standard, abroad.  The slowing economy, together with rising interest rates, was in turn a major factor in precipitating the stock market crash.”

Although I think I agree with Bernanke, again, I am not sure this is the right lesson for China.  The problem is that loose monetary policy is exacerbating the imbalance that China needs to work though, since most of the expansion is being directed at investment in expanding current and future capacity, but this comes at the cost – which was not the case in the US – of constraining the future growth in domestic consumption.  Without rapid future consumption growth, as I have argued many times, I just don’t see how China can support rapid GDP growth once the huge fiscal push becomes unsustainable and runs out of steam.

Clearly this concern is still part of the internal debate.  Chi Fulin, president of the China (Hainan) Reform and Development Research Institute and a member of the Chinese People’s Political Consultative Conference had an interview which was reported in an article in today’s People’s Daily.  In his comments he makes many of the same points I have been worrying about, albeit perhaps in a more politically acceptable way:

Chinese leaders should rethink the country’s reform package amid changing global and domestic situations and take “quicker and radical” steps to move toward a market-oriented economy by 2020, said a senior political advisor.  The reform measures should speed up urbanization, break down industry monopolies by the State, deregulate energy, offer equal social welfare for both rural residents and urbanities, and improve the government’s efficiency.

“Our top leaders should take quicker and radical measures in these endeavors within the coming two or three years. By doing so, China can do a better job in post-crisis management as well,” Chi Fulin, president of the China (Hainan) Reform and Development Research Institute told China Daily in an exclusive interview.  “Looking at the goal of realizing a market economy by 2020, we cannot afford to lose the time window of the next two or three years in the reform.”

 Several times in the interview Chi mentions the “urgency” of the need for reform, which included removing many of the production subsidies, price deregulation of resource products, and reducing the State’s industry monopoly.  My interpretation of his comments is that he is, as politely as possible, warning that the government still hasn’t taken the necessary steps to restructure the economy.  He concludes “Whether consumption can become a leading engine of China’s economy depends on how successful the reform is.”

——-

On a very, very different subject, I hear that there were more demonstrations and unrest in Urumqi today.  My understanding is that the large group involved met in a square over claims that people in Urumqi have been attacking innocent people with syringes.  There have already been demands for retribution.  Here is what China Daily says:

URUMQI: Police have seized 15 people for stabbing members of the public with hypodermic syringe needles in northwest China’s Xinjiang Uygur Autonomous Region, a senior local official said Wednesday.  Of the 15, four were officially arrested and prosecuted, said Zhu Hailun, head of the political and legal affairs commission of the Communist Party of China (CPC) committee in Xinjiang.

This is way outside my area of expertise, but ever since the early days of AIDS there have been persistent reports around the world of AIDS victims randomly attacking people with syringes and injecting them with infected blood.  I have no idea of what has happened in Urumqi, but I wonder if this talk about syringe-wielders isn’t underpinned by these kinds of rumors.  I am not a weapons expert, but it seems to me that attacking someone with a syringe would otherwise be pretty inefficient.  Even an ordinary beer bottle has to be a better weapon than a syringe.

For what it’s worth, it seems that as widespread as these AIDS-infected-syringe claims have been in the past, and as certain as many people are that they have occurred, there has apparently never been any credible confirmation of such an attack — no eyewitnesses, no police records, no medical records.  This is apparently one of those urban myths that we seize upon for reasons that may have more to do with our own fears than with any reality.  I’d be curious to see whether or not these attacks in Urumqi are confirmed and, if so, to get a better sense of why anyone would use such a weird weapon.

 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:

Some of the blog readers have noticed some weird goings-on with recent entries.  From time to time an entry will pop up that seems totally inappropriate to current events.   

Sorry.  This is because the old host of my blog, when it was on a different site, is closing down, and I have been going through the time-consuming and boring task of trying to take as many entries as I can from the old site and posting them in the archives on this site.  The repetitive nature of this process leads me sometimes to forget to post the original date of the entry, in which case it shows up as the current entry until I see the mistake and change it. 

I am still planning to post the longish piece I wrote, on my view of what the SED discussions should have been about.  However since I am beginning tomorrow an eight-day trip organized by two different banks to meet with and speak to their clients (full disclosure: since one of the meetings is in Bangkok I am sneaking out to Phuket for a couple of days to get in some beach time), I thought I would save that post for during my trip and talk about a few other interesting things. 

First off, a lot of investors and government officals have recently been trudging to Beijing in spite of the heat and mugginess and seem to be eager to discuss the outlook for China.  Perhaps because the press, and more importantly a lot of Chinese academics and think tank types, are beginning to worry much more in public about the medium term outlook, the conversations seem to be a lot more worried than they have in the past.  On my upcoming trip I hope to get some more idea of what big investors are thinking, and if I am allowed to repeat their views, I will. 

Next, I see that recent US GDP numbers are getting a mixed reception.  Second quarter GDP contracted by an annualized 1.0%.  That isn’t a good thing, of course, but it is much better than the 6.4% contraction in the first quarter, and also better than the 1.5% contraction that the market was expecting.  According to an article in today’s Financial Times: 

While the contraction was much smaller than in the previous three quarters and slightly better than economists had expected, the data showed that the government stimulus and a slowdown in imports had cushioned the drop.  

Of course most analysts continue to be worried about, and debate, whether the US is better off slowing the stimulus, and so reducing debt while speeding up the needed adjustments at the cost of higher unemployment, or continuing pushing forward – a debate very similar to that taking place in China.  Given my focus on China my main concern – no big surprise – was US consumption, which declined by more than GDP, which I expect to be a regular feature of the next few years. 

Consumer spending, which represents about two-thirds of GDP and has traditionally been the engine of US growth, fell a much worse-than-expected 1.2 per cent as Americans continued to cut back in the face of rising unemployment and the falling value of their homes and investments. 

In Japan, a country that I am spending more and more time learning about because of some worrying parallels between their 1980s and China’s current condition, the numbers continue to be very poor.  Again the Financial Times today tells the story: 

Wages in Japan suffered their sharpest drop in nearly two decades in June, fuelling concerns that the economy would remain under pressure from depressed consumer spending.  Monthly wages, including overtime and bonuses dropped 7.1 per cent from a year earlier for the 13th decline in a row to Y430,620, according to the Labour Ministry.  It was the steepest drop in wages since the government began compiling data in 1990. 

Wages in China, on the other hand, seem to moving in a very different direction – no surprise, I think, given the extent of the stimulus package.  Here is what Xinhua said on Wednesday: 

Average wage per capita for Chinese urban employees grew 12.9 percent year on year to 14,638 yuan (about 2,149.78 U.S. dollars) in the first half of this year, said the National Bureau of Statistics Wednesday.  The growth rate was 5.1 percentage points lower than that in the same period last year, the bureau said.  

Even acknowledging all the distortions, and recognizing that this year’s growth rate in wages was much lower than last year’s (will this put pressure on consumption growth?), this still seems like a very healthy growth rate.  Funnily enough however the numbers were questioned in, of all places, today’s People’s Daily.  In their article they had this to say: 

Banter and sarcasm erupted in the wake of a National Bureau of Statistics (NBS) report Wednesday saying the average pre-tax wage per capita for urban employees grew 12.9 percent, year-on-year, to 14,638 yuan (2,142.43 U.S. dollars) in the first half of this year.

The seemingly inspiring and encouraging news did not draw much applause, but a hail of criticism from the public, with many being skeptical of the figures’ credibility. The term: “I’ve been given a raise,” referring to the furor over the NBS’s statistics, has become increasingly popular among China’s mass of Internet users.

On the popular online forum tianya.cn, a commentary read, “The statistics released by the NBS are miraculous, as the increase managed to surpass the GDP growth of 7.9 percent registered in the second quarter against a backdrop of the global financial crisis.”  However, the poster noted, most people’s pockets remain shallow.

…A poll on tom.com showed as many as 88 percent of 2,816 respondents believed it is reasonable to doubt the income rise announced by the NBS. 

I was impressed by the fact that the article just reported the skepticism and didn’t make much more than a very half-hearted attempt to explain why the public is wrong to be skeptical.  As an aside, in recent weeks it seems to me that there has been an increasingly heated, but not always on-the-record, debate about the conflicts and contradictions implied by official Chinese growth numbers and other indirect measures of growth – with Marc Faber last week giving an especially blunt assessment.  I have been hearing from a lot of Chinese and foreign colleagues about challenges to the data, and although I am not smart enough to contribute much to this debate, I expect it to become more public – already there have been several articles in the Chinese press referring obliquely to disagreements about the data and defending the quality of the NBS statistics.  Perhaps the People’s Daily is now leading the charge for prosecution? 

Speaking of prosecution in the Chinese press, Caijing continues to feature a series of excellent articles questioning the impact of the stimulus package.  I won’t summarize them all, but I found this article in this week’s issue, by Chen Changhua, interesting: 

Through bank lending and money supply, liquidity has been ample in the market. However, nominal GDP growth lagged far behind the growth in lending and money supply, which could raise suspicion that a large portion of the funding has entered asset markets. 

In the next one or two years, the global economy won’t be able to recover and, due to overcapacity, consumer price index (CPI) will not be able to rise sharply. Even if the central bank wants to tighten money supply then, various aspects of society won’t support it. It’s no longer a question of whether the central bank should rein in its loose monetary policy, but whether or not it will actually do it. 

China’s fiscal and monetary policies in the past few years have placed growth before anything else. It is unlikely that the Chinese government will raise interest rates when economic recovery has not yet been secured.  

Chen’s basic argument is that policymakers should be encouraging private enterprises to compete with SOE’s because when the “bubble implosion” occurs (he doesn’t seem to think that the “if” is worth pondering), China will be better served by the productivity-enhancing private sector: 

How quickly a country can recover from an economic slump is determined by the productivity of the country. Japan has not been able to recover from the 1990 slump mainly because there are not enough competitive new-generation enterprises to replace old enterprises.    

If it is difficult to avert a new round of asset bubbles, then opening domestic markets to private enterprises is a good option.  In the past few years, state-owned enterprises have become larger and stronger while playing the role of the offense while private enterprises have been on defense. Maybe it’s just a hope of mine that private enterprises will muster their forces soon as well. 

One of the big worries about the stimulus, of course, is that it is forcing a further concentration of credit and economic activity into the SOEs, who are among the least productive players in the Chinese economy – even when you don’t question whether or not their profits are real or simply a function of highly subsidized interest rates.   

Meanwhile the debate about the duration of the fiscal stimulus rages on.  On the one hand Andy Xie, former chief Asian economist for Morgan Stanley, and someone well plugged into Chinese policymaking circles, said in an interview with Bloomberg: 

“The government is worried that this bubble is becoming too big so they’re going to cut credit growth by probably half in the second half,” said Xie, now an independent economist, in a Bloomberg Television interview in Hong Kong today. “I think the property and stock markets will come under pressure probably around October time.”  

China’s banking regulator said yesterday it plans to tighten rules on work capital loans, seeking to prevent misuse of funds. New loans in July may be less than 500 billion yuan, the Shanghai Securities News reported on its front page, without saying where it got its information.  

It’s “undeniable” that a portion of this year’s new lending entered the nation’s stock and property markets, Cheng Siwei, former vice chairman of the standing committee of the National People’s Congress, China’s parliament, said in June.  

On the other hand Vice Premier Li Keqiang (a graduate of Peking University, I am proud to say) wrote recently in Qiushi, according to an article in today’s Bloomberg: 

China will maintain its “proactive” fiscal and “moderately loose” monetary policies to help the economy recover from a slump, according to Vice Premier Li Keqiang.  The foundations of the recovery aren’t yet solid enough, as evidenced by the continued slide in exports, lower corporate earnings, falling prices and industry overcapacity, Li wrote in the Aug. 1 issue of Qiushi, a twice-monthly Communist Party magazine.  

The outlook for the global economy is still uncertain and recovery is being hampered by rising trade and investment protectionism around the world, Li wrote. There’s been no “fundamental change” to the dollar’s dominant position in the international financial system, though the trend of diversifying away from the greenback will continue, he added.  

Finally, and on a separate point, like me Nouriel Roubini has been wondering about the impact of recent Chinese commodity stockpiling.  According to an article in Reuters today he gave a speech in which he discussed the impact of future commodity prices.  Among other things he said: 

“In the short term there has been a massive stockpiling of commodities by China,” he said. “My concern is that China might have accumulated an inventory of commodities that is probably excessive to the growth of their own economy.” 

I agree.  I am pretty sure that a lot of recent purchases represent many quarters and even years of future demand, and so they are distorting the trade numbers by implying the country is importing more than current demand implies.  By the way for those interested in my argument as to why China should not be stockpiling commodities quite so quickly, here is today’s version of my bi-weekly column for the South China Morning Post.

I am working on a fairly long entry that I will post this weekend about why a trade rebalancing and a consumption/savings rebalancing will take place in both China and the US whether or not we want it.  This week has been crazy, among other reasons because a festival in Taiwan has invited one of our indie bands and one of our experimental bands (Carsick Cars and White) to perform this weekend at the Music Terminals Festival in Tao Yuan City.  Getting visas for these kids has been brutally difficult and they actually had to cancel one of their club gigs, on Thursday, because of problems with getting things done on time.  Still, if any of my readers are going to be in Taiwan this weekend, I strongly recommend that you check out the festival, which besides the two Beijing representatives features a lot of great bands from around the world (or if you prefer club gigs, check them out Friday night at a pre-festival show at The Underworld, in Taipei).

So much for the good news.  The bad news is described in an alarming article in today’s Wall Street Journal which shows that trade tensions are continuing to rise.  

I have been hearing rumblings for a while about tougher stances being taken in Europe and the US in response to the perception that China is exacerbating the global contraction in demand by increasing subsidized resources available to manufacturers, most importantly by channeling a huge increase in lending at interest rates subsidized by Chinese household consumers and socializing the risk.  These new protectionist moves seems to be an expression of just this.  The article goes on to say:  

As I have been arguing for over a year, as unemployment around the world rises and as the necessary contraction in US net demand picks up pace, there was inevitably going to be a conflict with China as Chinese policymakers responded to the collapse in trade in the only way they could, by substantially stepping up investment.  The result is that China’s trade surplus has contracted very slowly – much more slowly than the contraction in the US trade deficit – and the result was a huge squeeze on the tradable goods sectors around the world. 

The fact that policymakers in Europe, China, Japan and the US seem to have no clue as to how difficult the transition for each of the other countries is likely to be, and so are doing not nearly enough to coordinate their response (in fact lecturing and finger waggling seem to the favorite forms of policy coordination), makes trade conflict almost a dead certainty.  I don’t think there are necessarily any bad guys here – each country is desperately doing what it can to get itself out of this mess – but there is a lot of failed opportunity and I am pretty sure that the trade environment will continue to decline. 

The problem is illustrated in two interesting recent pieces.  My friend Dan Rosen, of the Rhodium Group, has a very illuminating July 17 report that shows the composition of Chinese growth in the past decade.  He shows that for the past five years net exports accounted for about 10% to 15% of Chinese GDP growth, before collapsing to minus 41% in 2009 YTD. 

Until recently investment’s share of GDP growth peaked at around 65% in 2003 – a very high share by any standard – and going back the full thirty years of China’s reform period achieved an historical high astonishing of 81% in 1985.  From 2005 to 2008 the investment share of GDP growth averaged around 40% – still high – and then in the first half of this year accounted for a mind-boggling 88% of this years GDP growth. 

This year’s growth, in other words, is almost wholly a function of the massive increase in investment, and this increase in investment started out largely in the form of reopening production facilities and producing more “stuff”, without any significant rise in consumption.  As we know, when production increases faster than consumption, either the trade surplus or inventories must rise. 

On that note Xinhua published the following article on Monday: 

The per capita consumption spending volume of Chinese urban residents stood at 5,979 yuan (875 U.S. dollars) in the first half of this year, up 8.9 percent year on year, the National Bureau of Statistics (NBS) announced Monday.  Deducting price factors, the growth reached 10.3 percent.   The per capita disposable income of Chinese city dwellers rose 9.8 percent year on year to 8,856 yuan in the first six months. Deducting price factors, the increase reached 11.2 percent, said the NBS. 

Consumption has been rising at around 9% a year for the past several years.  Notice that if GDP growth slows to under 9%, the savings rate in China will automatically decline. 

The second interesting piece is put out by the Economic Policy Institute, a group I believe not noted for its commitment to free trade.  It shows China’s share of the US trade deficit excluding oil.  According to their numbers: 

Perhaps as a consequence of a fiscal stimulus aimed at boosting investment and production, China’s share of the US trade deficit has grown significantly.  Since the US trade deficit is shrinking quickly, this means that other exporters are getting killed.  As I have argued for a while, this is not sustainable and will almost certainly cause trade tensions to erupt. 

Does this mean China is behaving in a predatory way?  I don’t thinks so.  I have warned for a long time that it would be very difficult for China to make the necessary transition to a consumption-led economy quickly enough to accommodate the global adjustment taking place.  Unless it is willing to see its economy collapse, there is simply no way China can reduce its negative net demand quickly enough to match the contraction in US demand and so avoid squeezing the hell out of the global tradable goods sectors.  That is why policy coordination is so important, especially between China and the USD, and of course that is why I continue to be a pessimist.  I do not think this policy coordination is taking place.  I will write about this more later this week. 

To continue the discussion of last week, we are getting more conflicting signals about policy confidence.  On the one hand Bank of China seems to love this party.  According to an article in today’s Bloomberg: 

Bank of China Ltd., which doled out the most loans among Chinese banks in the first half, plans to keep expanding credit unless the government clamps down on the nation’s record lending boom.  The nation’s third-largest bank will maintain its original target of generating about 10 percent of China’s new loans in 2009, Beijing-based spokesman Wang Zhaowen said by telephone yesterday. Bank of China may “fine tune” its strategy in line with any government policy changes, he said.  

…Bank of China will continue to lend to 10 key industries with government policy support, including steel, shipbuilding and automobile, Wang said. About 30 percent of its loans went to those industries in the first half.  

On the other hand two of the other members of the Big Four seem a lot more cautious.  Today’s South China Morning Post has this article: 

Mainland’s two biggest state-owned commercial banks have put a lid on their lending targets for the year, according to domestic media reports, in a move that will significantly slow overall credit growth in the second half. Industrial and Commercial Bank of China (ICBC) is aiming to issue full-year new loans of 1 trillion yuan (HK$1.3 trillion), while China Construction Bank (CCB) has set a goal of 900 billion yuan, Caijing magazine reported. 

The two banks, mainland’s largest by market value, granted new loans of 825.5 billion yuan and 709 billion yuan, respectively, in the first half.  If they stick to their reported targets, this would imply that ICBC would have already issued 83 per cent of its full-year lending total, while CCB would have already issued 79 per cent. 

It is surprising to me that these members of the Big Four are responding so differently, at least in public.  I wonder if the management of the different banks belong to different factions and so interpret the fiscal stimulus package differently.  Perhaps my friend Victor Shih, who understand these things better than I do and who sometimes reads my blog, might comment? 

Finally the Financial Times on Monday continued the thread discussed in my Saturday post with an article called “China warns banks over asset bubbles.” 

Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming.  The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier. 

…Beijing’s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation.  regulators are now concerned that too much money is being lent by the state-controlled banks and the country’s tentative economic rebound could come at the cost of a stable financial system. 

In statements published last week, Wu Xiaoling, who recently retired as deputy governor of the central bank, warned new lending this year would probably reach as high as Rmb12,000bn, a staggering increase of 40 per cent of the entire stock of outstanding loans in just one year.  

…Ms Wu hinted Beijing may soon raise the amount of money banks must hold on deposit with the central bank, marking a change of policy from last year when it aggressively slashed the reserve requirement ratio and interest rates.  The central bank has also ordered 10 banks, including Bank of China, to buy Rmb100bn worth of central bank notes with a maturity of one year and a return of just 1.5 per cent, according to Chinese media reports.  This move is interpreted as a warning to banks that have been the most active lenders that they should now start to rein in their excessive behaviour. 

Although I am often surprised by how eagerly foreign commentators have embraced the Chinese fiscal stimulus story and see it as a great, shining success, I am happy to say, mercifully, that in China there is a lot more skepticism.  There seems to be a serious debate among Chinese policymakers over the stimulus package.   

The debate lists, on one side, people centered on the PBoC, the CBRC and the National Bureau of Statistics, who are worried that the stimulus may be exacerbating Chinese imbalances.  On the other side are people in the State Council, the Ministry of Commerce and in the provincial and municipal leadership who are more worried that any half-heartedness will lead to a significant rise in unemployment.   

In the past week or so the former, with whom I am of course in complete sympathy, seem to have become increasingly worried and have been making a lot of noise.  The formidable Hu Shilu, editor of Caijing, (and by the way Evan Osmos wrote a very interesting article about her in the current New Yorker) recently made a strong case against continuation of the current fiscal program when she wrote in an editorial this week that “a policy that encourages loose lending and investment is driving China’s economic engine down an old, unsustainable path.” 

Various signals suggested China’s economy had returned to a stable track by the end of the second quarter, giving us an opportunity to reassess macroeconomic policy.  Data released by the National Bureau of Statistics showed that China’s GDP rose 7.1 percent in the first half of the year, and 7.9 percent in the second quarter alone. Apparently, China’s economy has bottomed out. 

Arduous efforts contributed to this upward trend. External developments have had a much more serious impact on China’s economy recently than during the Asian Financial Crisis a decade ago. However, first half growth was only a bit below the level recorded in 1998. And although heavily dependant on exports, China may yet achieve its 2009 growth target of 8 percent, even while other major export countries report contractions. 

These achievements could intoxicate Chinese policymakers. But we see no miracles here. In fact, economic growth recovery in China is being driven by investment. Some 6.2 percent of the country’s first half GDP growth rate can be credited to investment, while consumption accounted for 3.8 percent. The net export business contributed a minus 2.9 percent to the growth rate figure. 

Hu makes the point that the “surprisingly high” Chinese growth is neither surprising nor cause for celebration.  It is the automatic outcome of a huge stimulus, and the real question, as I have argued many times, is not whether high current growth indicates that China has turned the corner on the crisis (it most certainly has not, in my opinion), but whether the cost of achieving this growth is excessive and will lead to more difficult conditions in the future. 

It’s long been acknowledged that China’s traditional methods of achieving economic growth cannot be sustained. However, we are now racing down this traditional path of economic development.  

Dramatic increases in the currency supply and lending have been backing this investment, the single most important engine of economic growth. M2 increased 28.5 percent and yuan-based lending rose 34.4 percent in the first half, setting new records for each. But nominal GDP growth was only 3.8 percent during the first six months of 2009. And these astronomical increases in currency and lending are a double-edged sword that can support GDP growth as well as endanger the economy. 

…It’s high time we re-emphasize the actual policy of moderation. A moderately loose monetary policy is necessary for an unpredictable, downward-sloping economy. However, monetary policy that’s too loose will have more drawbacks than merits once an economy levels out. It’s only a matter of time before loose monetary policy leads to inflation and asset bubbles. 

She concludes, very diplomatically I think: 

In the current economic environment, the more quickly China’s economy grows, the greater the effort needed to adjust future methods of economic development. Now is the right time to consider the timing of exit from stimulus. The third quarter can be a crucial juncture. 

She is not alone in criticizing the stimulus.  Another formidable lady, Wu Xiaoling, former People’s Bank of China vice governor, was interviewed by National Business Daily on Wednesday, and warned that the combination of excess capacity and excessively loose monetary policy was leading to asset bubbles.  According to an article in yesterday’s South China Morning Post, 

“Under conditions of overcapacity, excess money supply will not lead to rises in price indexes, but it could generate asset bubbles,” she said at a forum in comments reported by the Chinese-language National Business Daily.  ”The money has really gone out and if it is a time when there is no investment in the real economy and no one will put the money in banks to earn interest, then the funds will flow into the property market and stock market,” she said.  

China’s central bank may have to raise banks’ reserve requirements to mop up excess liquidity, she said, adding that this was simply a tool for managing the money supply and should not be misunderstood as monetary tightening. 

…Ms Wu said that China faced a dilemma in easing the rate of loan growth. Inflationary pressures would arise if lending continued at the same pace, but without sustained lending, many big projects may wind up unfinished because they are contingent on longer-term financing.” 

Although an increasingly large number of Chinese academics and think tank researchers have been raising warning cries, I think she is the first official or ex-official to go so public with her worries.  That doesn’t mean other public officials don’t act as if they are worried.  The CBRC for example announced this week the good news that the NPL ratio declined from 2.42% at the end of 2008 to 1.77% at the end of June.   

Part of this reflected an actual decline in NPLs, and most of it of course reflects the surge in new loans, but the CBRC is not acting complacent.  They have reinforced credit control policies on second-home purchases and their spokesman insisted earlier this week that there would be “strict enforcement” of the CBRC’s mortgage lending policy.  

According to another article in Caijing, “the authorities have consistently been encouraging banks to raise their loan-loss coverage, reflecting fears that the massive surge in new credit extended in the first half may lead to a rise in bad loans.”  The South China Morning Post had this to say on that subject: 

Beijing has required banks to raise their bad-loan reserve ratio to 150 per cent at the end of the year, forcing the lenders to set aside an additional 70billion yuan ($79HK.4 billion) as provision amid deteriorating asset quality, a fresh sign of China’s mounting worries about a backlash from its stimulus package.  

Liu Mingkang, the chairman of the China Banking Regulatory Commission, told a government working conference over the weekend that all mainland-based banks including local units of foreign giants such as Citigroup  and HSBC Holdings must boost their reserve ratio to 150 per cent, as risks were increasing amid a torrent of imprudent loans in this year’s first half.  

“Rapid growth in banking loans has led to accumulated risks,” Mr Liu was quoted in a CBRC statement as saying. “Reckless operations of banks were seen as some banks rushed to extend loans without due diligence.” 

The article goes on to quote She Minhua, a banking analyst at China Jianyin Investment Securities as saying “The requirement is basically a message that asset quality deterioration is deepening.  A serious problem will probably surface in 2010.” 

And Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said earlier this week that China, the world’s largest steel producing nation, should curtail “reckless investments” in the industry by withholding project approvals.  According to an article in Bloomberg: 

China’s demand for steel is about 500 million metric tons, less than the annual output capacity of 660 million tons, Zhu Hongren, spokesman for the Ministry of Industry & Information Technology, said at a conference in Beijing today. Zhu is reiterating figures given by the China Iron & Steel Association in February for last year.  

Crude steel output in China rose to a record 266.6 million tons in the first half as the nation’s $586 billion stimulus package spurred demand from builders and carmakers. Annualized, this would beat the 460 million tons output forecast by the steel association for this year.  

“The industry must produce according to market needs, and avoid adding to the excess capacity,” Zhu said. “They should avoid reckless investments. The government must also take action to curtail additional investments by companies that are already in excess.”  

Even Justin Lin, the World Bank’s chief economist, and someone who has been more of a cheerleader for China’s economic model than a critic, made a statement that suggests to me an indirect criticism of the fiscal stimulus package, although he (and others) may disagree with my interpretation.  According to a July 15 article in the Telegraph:  

But for all the warnings I don’t want to exaggerate my account of rising skepticism among Chinese economists and regulators.  In spite of possible back-door attempts by the PBoC and the CBRC to manage the excesses associated with the fiscal stimulus, it is pretty clear I think that policy is still being managed largely by policymakers who are far more worried about rising unemployment in the short term than about asset bubbles and an exacerbation of the unbalanced development model. 

The front page of today’s People’s Daily, for example, makes this clear.  They cite Finance Minister Xie Xuren’s insistence that “China will stick to proactive fiscal policy in the second half.”  According to the article, which is also carried in Xinhua: 

China will continue its proactive policy and reform its economic structure in the second half of this year to boost economic growth, Finance Minister Xie Xuren said Thursday.  Xie told local financial bureaus at a conference in Beijing on Thursday that the proactive policies, which included increased investment from government, tax cuts and subsidies to low income families, had taken effect in stimulating a recovery of the national economy. 

Xinhua today also prominently cites Peking University professor Li Yining as saying that “China should stick to its proactive fiscal policy and moderately easy monetary policy to fuel the economic growth as the foundation for recovery is not solid yet.”  I was not at the conference, so I wonder if professor Li’s comments were spun a little, because according to the Xinhua article he also said that “the current economic advance was pushed by investment, which was not the final demand – stable economic recovery should be sustained by increased consumption,” and warned that Chinese banks should “improve credit quality and structure.” 

So for all the rising skepticism among policymakers and scholars I think there is little doubt that we are going to see still more fiscal stimulus along the lines we have already seen.  If there is indeed global excess capacity, as Justin Lin says there is, I cannot see how an investment-driven program to increase capacity, and one which is almost certain to involve a huge additional misallocation of capital (after all, 8% growth given the sheer size of the fiscal and banking stimulus is actually a disappointingly low level of growth), can be much more than a short-term stop gap.  On the contrary, I think it will make the medium term adjustment even more difficult. 

On that note I want to recommend Victor Shih’s excellent OpEd piece in the Wall Street Journal – Asia yesterday.  He argues that: 

Should this pace of credit expansion continue for the remainder of the year, China may well face a difficult trade-off down the road. The economy is unlikely to face a financial crisis because most of the debt is owed to domestic investors and depositors and China can still prevent large-scale capital flight. However, if inflation spikes next year, the central government will have to choose between shutting off credit, which will reveal a massive nonperforming loan problem currently obscured by a torrent of new loans, or an unprecedented level of inflation. High inflation is destabilizing, as it has caused major runs on the banks before. If additional credit expansion in the face of rising inflation is not an option, the greater the extent to which lending is uncontrolled at the moment, the bigger a nonperforming loan problem the central government will face in the future. 

An often overlooked ingredient to China’s success story is that generations of top-level central technocrats like Chen Yun, Yao Yilin and Zhu Rongji time and again used their political influence to constrain local investment bubbles, thus forestalling high inflation and major financial crises. Past retrenchment campaigns were unpopular and controversial, but senior technocrats nonetheless maneuvered to stop uncontrolled local investment. As credit continues to rocket toward the stratosphere, China is in increasing need of such leadership again. 

Before closing this long post I want to add three additional comments.  The first involves a conversation I had with one of my Tsinghua students who graduated in 2003 and now works as a currency trader.  Last year he bought a few apartments in Chengdu, the capital of Sichuan, his home province, for speculative purposes, and in spite of surging land prices he seemed to think it was a terrible trade.   

I asked him why, and he said that although real estate prices had gone up dramatically since he bought the apartments, and he needed the money back, he nonetheless found himself unable to sell the apartments.  That’s a little weird, I thought.  Rising prices should mean eager buyers, but he can’t get anyone to take the apartments off him?   

Has any other of my blog readers experienced anything similar?  Of course the historian in me remembers that during the final two years of the Japanese bubble, when land prices soared to levels never before seen in history, there were complaints by sellers that transaction volume was so thin that they couldn’t actually sell their land. 

My second comment concerns university unemployment.  I have been writing for three years that unemployment among college graduates in China was soaring, and that authorities were understandably nervous.  So nervous, it seems, that they have been putting pressure on university to do more to get jobs for their graduates by limiting their next-year enrollment to the number of graduates this year with jobs. 

There are, of course, two ways to improve statistics.  One way is to improve the underlying reality.  The second way is just to fake the numbers.  According to a Tuesday article in the People’s Daily:  

I had no idea that I already had a job,” the student, who had been hunting for work, wrote anonymously on a website.  In order to ensure a high employment rate and deliver a satisfactory work report during the global financial crisis, some Chinese universities have been faking work contracts or employment agreement for graduates, Southern Metropolis Daily reported yesterday.  

This kind of thing will mean that the college employment numbers, a very useful figure for understanding the effect of economic growth in China, are now much less useful.  Already the People’s Daily article cites differences between the Ministry of Education numbers and a private firm’s numbers. 

The Ministry of Education said that nearly two thirds of them [2009 college graduates] had already secured jobs before graduation in early July.  But this figure differs widely with an employment report from an independent consulting firm on higher education.  A report from MyCOS HR Digital Information Co said 58 percent of prospective graduates had not signed job contracts by the end of June and that 2 percent had contracts cancelled. 

By the way the article has an interesting graph on the number of college graduates over the past eight years, for those who are interested.  The total number of university graduates has surged from 1.45 million in 2002 to 5.59 million in 2008 and 6.10 million this year.  The intervening years saw 2.12, 2.80, 3.38, 4.13, and 4.95 million graduates. 

My third comment is about the great article in today’s Wall Street Journal on the explosive development of the Beijing music scene, a subject that all my friends know is one dear to my heart.  Anyone who is interested in knowing more about this scene should read it. 

Tags: Steundent employment, Victor Shih

Today is the second day of the dreaded gaokao, the national college entrance exam that more than half of all Chinese kids in their age cohort will sit to determine whether or not they will go to university (just over 60% of the test takers will start college next September) and, much more importantly, which one they will attend. Throughout Beijing anxious parents are standing glumly in the heavy (but cleansing) June rain waiting for their kids to emerge from the exams so that they can pepper them with worried questions. It is a scary time for a lot of people.

In the previous six years the number of students taking the exam has jumped every year, from 5.3 million in 2002 to 10.5 million in 2008. This year, for the first time, the number of students sitting the exam has actually declined to 10.2 million.

The official position is that the decline reflects a drop in the number of 18-year-olds in China, but there has been widespread discussion in the press that the decline was too large to be explained just by the smaller number of high-school graduates, and that in part it reflects fears of rising unemployment among college graduates. College is becoming a less attractive option to some Chinese.

6.1 million college students will graduate this month and, according to the Ministry of Human Resources and Social Security, about 1 million have been unable to find jobs so far. Over the past three years the number of college graduates finding jobs has stagnated even as the number of graduates has surged, even during the boom years of 2006 and 2007. Part of this was caused by the surge in college enrollment, but at least part of the employment difficulties facing college graduates has been blamed on the very poor quality of university education, especially in the new or newly expanded schools, and its failure to prepare students for the kinds of jobs that the market wants.

Over recent months the government has made finding position for graduates, including in the army and as rural high school teachers, a top priority. The front page of today’s People’s Daily has an article citing a speech by Premier Wen Jiabao in Xi’an (in Shaanxi province) encouraging graduates to widen their job search:

Chinese Premier Wen Jiabao has urged the country’s college students to find grassroots jobs in less developed regions as the economic downturn increases pressures in employment market. Visiting Xi’an, capital of central Shaanxi Province, from Friday to Sunday, Wen said employment was one of the government’s priorities for the sake of the country’s economy and for the future of individuals.

“College students, laid-off workers and migrant workers waiting for jobs are my biggest concern,” Wen told job hunters at an employment center. He encouraged graduates from universities and colleges to find work in grassroots regions, and called on employers to create more jobs.

Since the second half of last year, the government has implemented a series of policies to create jobs. The State Council, or Cabinet, also decided to give living allowances to graduates who went to the central and western regions for internships.

Besides exhorting college grads to take the kinds of jobs they usually shun, the government is also still working on boosting growth. The Ministry of Finance recently raised the rebate of export taxes by around 15%, according to another article in today’s People’s Daily. This is part of the move to increase China’s export competitiveness, but I am not sure these kinds of measures are likely to have much positive global impact beyond crowding out export competitors and worsening the global trade environment.

As badly as Chinese exports have been hurt, and exports were down 22.6% year on year in April, Chinese exporters have still done much better than other exporting countries in Asia and elsewhere, suggesting that they have managed to avoid much of the brunt in the contraction in global imports, led by the contraction in the US. This, as I argued in last week’s entry, has as much to do with credit and interest rate policies as it does with any inherent competitive advantage.

Not surprisingly, given these moves, expectations of a rise in the value of the RMB are declining. For the fifth day in a row, according to an article in today’s Bloomberg, the 12 month RMB forward declined, trading currently at 6.714, implying a 1.8% appreciation over the year (because these forward markets cannot easily be arbitraged, they do not price according to interest differentials, as forwards normally do, and so may contain more expectational content that a lot of other forward markets).

Meanwhile an interesting article in always-hard-hitting Caijing worries about the flood of bank credit, and whether borrowers are earning nearly enough to cover interest costs:

Chinese bank lending increased to more than 5 trillion yuan between January and April, nearly three times the credit level reported during the same period last year. Even if new loans average only 500 billion yuan during each of the remaining eight months of 2009, the year’s total would be more than 9 trillion yuan – more than all loans issued over the previous two years combined.

The industrial sector’s recent performance provides solid grounds for concern over this rapid credit growth. A National Statistics Bureau survey of 22 regions found industrial profits totaled only 323 billion yuan during the first quarter, down 32 percent from a year earlier. That means annual profits for all industries will amount to only about 1.6 trillion yuan this year.

Outstanding loans currently stand at 35 trillion yuan. Assuming companies have kept a moderate debt ratio averaging less than 50 percent, their capital investments now exceed 35 trillion yuan. And profits of 1.6 trillion yuan versus 35 trillion in capital investment means an annual return rate of only 4.57 percent, below the weighted loan interest rate of 4.76 percent we saw in March. In this sense, companies seem to be in a rather weak position to finance debt with earnings.

Although the writer of the piece, economist Lu Lei, thinks that continued expansion in the banking system creates enormous risks, he doubts that the PBoC will put the brakes on bank lending for a number of reasons, the most important being that commercial bank lending is at the heart (and lungs and nearly every other organ I can think of) of the fiscal stimulus program, and without it, there is no stimulus.

Looking at tax revenues, local governments nationwide were unable to collect as much in the first quarter as in the same period 2008. In fact, tax receipts fell 1.4 percent, in sharp contrast to the 34.7 percent increase posted a year earlier. Cursed with double pressure from a directive to invest and shrinking revenue, local governments have had every incentive to use banks as financing proxies.

Now we’re faced with the possibility of undesirable negative GDP growth. Banks, concerned about defaults, may grant only 300 billion yuan in new loans every month for the rest of the year. So we’re stuck with a painful choice between two losing scenarios: a more moderate monetary policy that would cripple fiscal policy, leading to an outright “hard-landing;” or continuing a loose monetary policy backed by fiscal spending, which risks future loan losses and a weaker market. To get around the problem, the central bank may be forced to fill holes at banks by pumping in money, in effect imposing an inflation tax on all consumers

Lu lei’s “painful choice” is exactly right, and what an inevitable worrier like me has been worrying about since last summer. In January I wrote about this “all but the kitchen sink” policy, of throwing everything they can into stimulating the economy, and said that although this would certainly result in higher than expected growth this year, it would come at a real cost. I wrote:

This strategy may be politically necessary but ultimately represents a gamble on the duration of the global slowdown. If the duration is short and the slowdown light, it will have been a winning gamble, and once the world takes off again China can get serious about resolving the internal imbalances.

Of course if the global slowdown is long and deep, the gamble will have failed. That means, dear readers, that if Chinese GDP growth in 2009 is higher than I projected – say 8% – I will not whip out the party hats and favors. Instead I will immediately begin whining about the state of the banking system.

To make matters worse there is a story that appeared a few weeks ago in an article in Australian newspaper The Age, warning about something that has been much discussed over the past year, that the fiscal stimulus package, or more precisely, the way it is being financed, could lead to rising contingent debt at the provincial and municipal level.

Beijing will have to jam on the economic brakes to save cities from bankrupting themselves, says a top Chinese adviser. He Fan, an assistant director at the Chinese Academy of Social Sciences who frequently advises top leaders, says as much as two-thirds of Beijing’s 4 trillion yuan ($A773 billion) stimulus program will be spent by local governments, financed mainly by state-owned banks.

“Some local governments will virtually go bankrupt,” Professor He told BusinessDay. “Previously, local governments got all their money from selling land. This is not sustainable. Some areas have already sold quotas from the next 30 years.” A number of large cities are thought to be at risk, including Kunming and Hangzhou, with their funding problems exacerbated by a slump in real estate sales.

Professor He goes on to worry that easy money has poured into asset markets as well as questionable projects that were previously rejected by the NDRC.

“Banks have strong incentives to lend to NDRC-approved projects because if they end up as a fiasco, there is no political risk,” he said. “They can say ‘it is not my fault, the NDRC told us to lend’.”

When banks are encouraged to lend huge amounts, and with an implicit guarantee against any losses, it is pretty hard to imagine their not embarking on a wild lending spree. On a related but very different subject, I have been corresponding with Steve Keen, a professor at the University of Western Sydney and someone whose blog I often read and whose unconventional insights I find very valuable and persuasive (the fact that he is an expert in and admirer of the works of Hyman Minsky doesn’t hurt either).

I wrote to him to ask his thoughts on the implications on monetary policy and debt structures of China’s rising savings rate. It seems to me that as savings rise as a share of GDP, this must have dampened the impact of the very loose monetary conditions in China over the past several year. If this is the case, and if savings rates do indeed decline in the next few years, there could be important consequences for monetary policy. I plan to think about this a little more and, if I come up with anything interesting to say, I will write about it. Maybe some of the readers of this blog might have some interesting ideas. Steve Keen’s initial response included the following:

Now that the American private sector has stopped borrowing, but both American and Chinese governments are pumping base money into the system, and American consumers and businesses are desperately trying to delever, the dynamics alter considerably. But I expect the overall result will be a relative fall in the Chinese “savings rate” and a rise in the American one.

Obviously I think looking at this from the point of view of savings rather than debt is why we haven’t worked this out to date. A lower consumption rate is definitely part of it, but the debt flows themselves-which generate the monetary flows that then accumulate in accounts depending on consumption rates–are the driving part of the story, not the consumption rates themselves.

Tags: Steve Keen

Last week I spent in Brazil, where I was honored to meet someone I admire very much, former Brazilian President FH Cardoso, along with a large group of Brazilian investors, politicians, and academics, including several old friends. At some point I will write about some of the things I learned there, but I am still a little too tired and jet-lagged to collect my thoughts. As soon as I returned to Beijing I had to go spend two days in Wuhan, a city I had never visited before but a really interesting place with an absolutely wild cultural scene, not all of whose characteristics are totally legal, and so because of all this travelling it has been eight days since I last posted anything here. My apologies.

Since I am still a little addled and way behind on work I don’t have much to write today except a series of miscellaneous notes. The first is extremely anecdotal, admittedly, but also worrisome and more than a little humorous. In an entry two weeks ago, as evidence of some of the dangers of the current loan boom, I mentioned an article that my friend Dan Rosen had sent me. It discussed a statement made by Lin Zuoming, the General Manager of AVIC, the largest single borrower in the current lending spree, who said that now that he had raised $35 billion, his biggest single worry was “how to allocate the borrowings to increase returns.” Dan found it a little worrying (as did I) that anyone could engage in such massive borrowing without a clear sense of what he planned to do with the money.

Today Dan sent another article that partially helps clear up the mystery. AVIC has recently decided to place RMB240 million with a private equity fund to invest “in technological renovation and production capacity expansion of the special spherical plain bearings project,” which I think are ball bearings.

I don’t doubt that ball bearings are a profitable business, but it seems to me a bit of a stretch for an aircraft manufacturer (although I suppose airplanes use ball bearings) to make a large investment in a ball-bearing producer. In the 1970s Americans learned the hard way how dangerous it was to allow CEOs free rein to exercise their natural preference for expanding their companies into a wide range of unrelated businesses – all of which was made easy and almost inevitable by access to seemingly “free” capital. We spent a very difficult 1980s watching the famous conglomerates created in the 1960s and 1970s brutally torn apart so as to eliminate their huge inefficiencies.

Give CEOs anywhere unlimited access to very cheap funding, and pressure them to take as much of it as they can, and it would be surprising if they didn’t manage to convince themselves of the viability of quite a few projects that, under different funding circumstances, they would have avoided.  By the way, in this context I should mention a very interesting April 2009 paper, produced for the HKMA by Giovanni Ferri and Li-Gang Liu, which argues that the rapidly rising profitability of SOEs may be a mirage.

We are interested in in investigating whether the profits of SOEs would still be as large as they claim if they were to pay a market interest rate.  Using a representative sample of corporate China, we find the costs of financing for SOEs are significantly lower than for other companies after controlling for some fundamental factors for profitability and individual firm characteristics.  In addition our estimates show that if SOEs were to pay market interest rate, their existing profits would be entirely wiped out.

In my reading it seemed to me that the authors only compared SOE funding costs to that of other Chinese corporates, and did not take into account the possibility (very likely) that overall interest rates are much lower than they would normally be because of regulatory controls.  Had they done so, they might have found that SOEs are actually value destroyers, made profitable only by the fact that the income of savers has been “appropriated” and converted into subsidies via very low interest rates.  Besides what this means for value creation in the economy, this is important because it also affects consumption levels (remember that in China low deposit rates are associated with higher savings) and trade policy.  In another entry I will discuss low financing costs as being as much a trade-related policy as tariffs and currency levels.

At any rate as the AVIC anecdote suggests I suspect that at least part of the current fiscal stimulus in China will end up creating more corporate monsters who will work hard to keep productivity growth in the future low. This is all the more likely since it seems to me that quite a few Chinese policymakers (and much of the general public) are a little too comfortable with the idea of national champions and other forms of corporate gigantism, even though the evidence for their social and economic value is pretty limited.

This of course is not in and of itself an argument against a large stimulus program, since it would be easy to counter that even wasteful spending is acceptable in a crisis (I don’t necessarily agree, but many wise people have said so), but of course I am very worried that China is making it more difficult to deal with its own transition. At any rate I am not sure that wasteful spending to drive this year’s growth rate up from 6% to 8% is such a great idea if it causes future growth rates to drag significantly. This will not be a quick crisis which we can put behind us next year.

I discuss all of this in an article in yesterday’s Financial Times, titled “Asia needs to ditch its growth model,” with which many of whose arguments regular readers will be very familiar. My basic argument, of course, is that policies that constrained domestic consumption growth while boosting production implicitly required someone (the US) to run large trade deficits, and with US savings on the rise, those days are over, at least over the next decade. As if to reinforce those claims, last week there was a very interesting article in the New York Times about US savings, which starts out with “The economic downturn is forcing a return to a culture of thrift that many economists say could last well beyond the inevitable recovery.”

The piece argues that it is unlikely that this time, unlike after previous short-term crises, Americans will return to high levels of consumption once the economy stabilizes. Higher savings rates may persist for long after the economy finally turns around.

To continue on trade-related issues, I thought I would refer to an article in last week’s Financial Times with the ominous title “US lawmakers to revive China tariff bill.” According to the article:

A group of Republican and Democratic lawmakers will on Wednesday revive a bill that threatens to raise tariffs on Chinese goods to punish the country for what they call “currency manipulation”. Highlighting the protectionist sentiment within Congress, the bill would let companies apply for tariffs on imports from countries deemed to be deliberately undervaluing their currencies to be more competitive. China is its main target.

“By illegally subsidising its exports through the undervaluation of its currency by 30 per cent or more, China distorts the gains from trade, creates barriers to free and fair trade, harms US industries and has destroyed millions of US jobs,” those sponsoring the bill said in a statement.

Their move comes as countries across the world consider protectionist trade rules in the face of recession. Measures such as anti-dumping investigations rose 18.8 per cent in the first quarter of this year against the same period in 2008, according to research by Chad Bown at the Brookings Institution, with China’s exporters the target in two thirds of those cases.

As I have said many times before, I am very pessimistic about our ability to prevent a sharp rise in trade friction and an equally sharp contraction in international trade. The OECD website is currently running an article called “World trade set to fall 13 percent, OECD urges governments to avoid protectionism” in which they claim that world trade will drop 13% from 2008 to 2009.  Not surprisingly China is worried, and today’s People’s Daily discusses one of the now-familiar response:

Chinese Premier Wen Jiabao announced Wednesday that China will shortly send another buying mission to the European Union (EU) to increase imports from Europe. The Chinese trade promotion mission sent to the EU immediately after Wen’s European tour in January had produced positive results, Wen told reporters at the end of the 11th summit between China and the European Union (EU).

“China is ready to work with the EU to further promote mutual investments, enhance cooperation in small- and medium-sized enterprises, trade facilitation, science and technology, transportation and post, in an attempt to fight all forms of trade and investment protectionism,” said Wen. He expressed the hope that the EU will loosen control over export restrictions on high-tech products and nurture new growth potential in economic and trade cooperation in order to further promote China-EU trade.

In spite of the good-will generated by these buying missions (and I am not sure how much good will this really creates — my European corporate friends are extremely cynical about these missions), I don’t think there are a lot of warm and fuzzy feelings about trade anywhere in the world just now.  The various claims by interested parties don’t seem to be making the prospects very bright.

To show how confused the debate has become, and how unlikely we are to see a good resolution, I recently participated in a panel with a Chinese economist from a leading local investment bank who gave an impassioned argument against financial protectionism in the US. Among her claims were that China is totally open to foreign investment whereas the US and the West are almost wholly closed to Chinese investment which, she seemed to think, was extremely unfair. This is a claim I have heard so often in China that I am worried that it has become entrenched in local thinking.

The economist argued as evidence of this unfairness that that any foreigner could start a joint venture in China, or engage in any form of FDI, whereas the opposite was almost impossible. But this is mistaken on many counts. First of all, the restrictions on Chinese investments abroad have not been on FDI or other related start-ups and joint ventures. They have occurred when Chinese companies tried to buy large, existing companies that were considered, rightly or wrongly (and more often wrongly, I think), strategic assets.

But, and contrary to what the economist claimed, foreign purchases of equivalent Chinese assets are far more restricted. Almost every large company in China that a foreigner has tried to purchase has been prevented on the grounds of strategic interest, even some amazingly bizarre recent cases, and generally speaking most foreign companies don’t even try to buy large companies in China because everyone expects that transaction automatically to be turned down by the regulators. China, for example, would have never even considered anything similar to the purchase of IBM by Lenovo, and so no foreign company wonders about the possibility.

On the other hand, it is true that foreigners can fairly easily start new companies, enter into joint ventures in China (well, fairly easily – a lot of industries are off limits), and otherwise engage in FDI, but there are likewise almost no restrictions for Chinese investors in the US or elsewhere in the West to do the same. Any Chinese company that wants to start a company in the US from scratch can do so, with very few restrictions that would not apply to US or other foreign investors.

The point is that many Chinese sincerely believe that the restrictions facing their expansion abroad are much more onerous and stringent than the restrictions facing foreigners in China. Foreigners, of course, sincerely believe the opposite. Both sides feel aggrieved. Regardless of who may be right, the fact is that these very sincere beliefs make accommodation difficult.

Tags: Cardoso, HKMA